For investors who want to explore impacting investing, a key early step is determining the types of investments to focus on. This includes understanding not only the various asset classes available to them, but also which ones are best suited to meeting their impact goals.
What Are Asset Classes?
An asset class is a group of investment vehicles with a comparable financial structure. Typically, they are also subject to the same laws and regulations. While there is not complete agreement about how many assets classes there are, many investment professionals divide them into five categories:
- Equities or stocks are ownership shares in publicly traded companies.
- Fixed income or bonds are debt securities paying interest.
- Cash or cash equivalents are highly liquid investments, such as money market funds.
- Real estate and other physical assets, also known as “real assets,” are tangible assets that may provide inflation protection.
- Futures and other financial derivatives are instruments based on an underlying asset.
Asset classes provide specific risk and return profiles and perform differently in various market situations. That is why having a portfolio of diversified assets can reduce overall risk.
Impact Investing Asset Classes
Several asset classes are of particular interest to impact investors. Those most commonly associated with impact investing include:
Private Debt and Fixed Income
These investments are popular among impact investors because of their potential to offer stable, competitive, and uncorrelated returns, as well as a wide variety of sectors to invest in. They focus on enterprises or projects addressing social and environmental issues and can assume either conventional or unconventional structures, from green bonds to community development loan funds aimed at boosting economic development.
This alternative investment class is also widely used by impact investors. It typically involves funds run by outside managers who make debt and equity investments in impact enterprises that are in early or growth stages of development. By investing in private equity, retail and institutional impact investors may have the opportunity to work directly with companies, helping to align those companies’ strategies with investors’ impact and financial objectives.
Investing in public markets now comprises a sizable portion (17%) of overall impact investments. The most efficient approach for impact investors may be investing in impact funds, since there are relatively few impact-oriented public companies. These funds use different screening methods, such as positive environmental, social, and governance (ESG) analysis or excluding businesses that are seen as causing societal or environmental harm. Other funds concentrate on particular issues, such as gender equity. Last fall, there were $2.4 billion in assets under management in gender-lens strategies in the public markets, up from $100 million four years before.
Owning shares in public companies also allows investors to participate in the proxy voting process, giving them another lever to pull in making a positive impact.
Of course, other asset classes can also be oriented toward impact or sustainability. For example, investors can invest in properties aimed at revitalizing under-served communities or providing affordable housing. They can also hold cash in community banks making investments in environmental groups.