Social Investing: What Is It?

Social investment has received a lot of attention in recent years, especially after the financial crisis. However, most people have questions: What is social investment? Let’s answer that question.

To understand what social investing is, we must first look at how traditional investors view the world. In traditional investing, investors evaluate investment decisions based on two main factors: risk and financial return.

Risk, return, and social impact

Every investor has a certain comfort level with the range of risks and returns, and they invest within that range. An investor may be willing to give up some return if an investment is safer. On the other hand, the same investor may be willing to take a little more risk with an investment if it results in a higher return.

In social investing, a third factor comes into play: social impact. Social impact means that the business supported by the investment provides some benefit to society beyond the income it generates for investors. Conversely, a company can also have a negative impact on society, and a social investor will also take this into account when making investments.

Just as traditional investors are willing to make a trade-off between risk and return, social investors are willing to make a trade-off between risk, return, and social impact. If a company is doing something that improves the environment, for example, a social investor may be willing to forgo some financial return or assume greater risk on that investment, depending on their personal comfort level.

In short, social investment can be defined as the consideration of a company’s social impact when making investment decisions. According to this standard, a number of investment approaches fall under the umbrella of social investing: mission investing, responsible investing, dual bottom line investing, triple bottom line investing, ethical investing, sustainable investing, and green investing.

Social Screening

Within the social investment universe, there are two broad categories: social screening and impact investing. In social screening, an investor establishes a list of social standards that they want their investments to meet.

The investor eliminates any company that does not meet these standards and then invests in “socially responsible” companies that meet them in a way that meets the investor’s risk and return objectives.

A number of socially responsible mutual funds have emerged that use this approach. They adopt a social screening methodology, define a broad basket of investments that adhere to these standards, and then have their management company invest in that basket to meet the financial goals of the mutual fund.

Impact investing

The second broad category of social investment is known as impact investing or, sometimes, community investing. In impact investing, rather than investing in companies that do no harm, one invests in companies that do good for society.

Impact investing companies provide services for charitable or social purposes, but also have a business model that can generate revenue and support a financial investment. They straddle the line between charity and business.

Impact investing companies can be structured as nonprofit or for-profit companies, but they rarely take the form of large public companies listed on the capital markets. As a result, impact investing is more difficult and usually takes the form of private investment in the form of a bill or loan.

Impact investment sectors

So what exactly are these impact investing companies? To get a better idea, let’s look at some of the sectors that can be considered impact investing.

Affordable housing is a sector that most people are familiar with. Most people support an organization like Habitat for Humanity with donations, but a foundation, for example, can support them with a low-interest loan to fund the organization’s projects.

Microfinance is another area of impact investing. A microfinance institution provides small loans to entrepreneurs in developing countries to give them the opportunity to start or grow their own businesses and escape poverty. A microfinance institution operates similarly to a bank, allowing it to generate income and support investors.

There are many other similar sectors that generate income and have a social mission at their core: fair trade, community development organizations, social enterprises, etc. In each sector, companies can often find investors who are willing to give up some financial return or take on a little more risk because of the social impact of these organizations.