A microfinance lender in Tamil Nadu, a rice farm in Tanzania, a housing project in Chiapas and a rural development bank in Pakistan: all these projects are recipients of impact investment capital, committed to “doing good while doing well,” in one of the fastest growing investment trends of the past two decades.

Impact investing has developed out of traditional philanthropy in an effort to find solutions that allow investors to make profitable investments that can also address social and environmental challenges. Impact investors seek to combine the seemingly conflicting aims of investing for maximum risk-adjusted returns and contributing to social good. The level of return expectation varies according to the type of investor. Individuals or foundations tend to prioritize social impact over financial return and are willing to forgo the latter if the social goal is clearly advanced.

By contrast, institutional investors, especially those like pension funds which owe a fiduciary duty to their beneficiaries, usually look for a return that is at least competitive with traditional asset classes. As a result, investment risk appetite will also differ. Most impact investing takes place via private transactions with small businesses, often operating in emerging markets where poor governance and inadequate information flow may add greatly to the risk of the projects.

Investors in these companies will look for a commensurate financial return, as well as measurable social impact on the ground. While some prefer the terms venture philanthropy or social investment, impact investing represents a distinct style of responsible capitalism which has become particularly popular among foundations, endowments and high net worth individual investors.

Industry pioneers, such as the $3 billion Rockefeller Foundation in New York, see impact investing as a way to find solutions to poverty reduction and other social problems; but more importantly to access the private sector capital markets that ultimately hold the wealth required to scale up these solutions globally. While charitable donations by high net worth individuals were down 35 per cent in 2010, according to Bank of America Merrill Lynch and Indiana University, the impact investing sector is expecting steady growth.

In 2010, JP Morgan forecast potential impact investment capital of $400 billion to $1 trillion globally over the next ten years. Much recent activity in impact investing has been effectively direct investing, with the typical venture capital approach sometimes supplemented by grants and capacity building. The Omidyar Network, for example, launched in 2004 by eBay founder Pierre Omidyar, “has invested $450 million in equity and grants to promote microfinance, entrepreneurship, technology and government transparency, mostly in developing countries.”

Investment managers such as the Acumen Fund and the Capricorn Investment Group, which manages the Skoll Foundation’s multi-billion dollar portfolio, are active in emerging markets across Asia, Africa and Latin America.

Impact investing does present significant challenges to investors. It can be difficult to obtain basic investment information in emerging markets, and equally hard to monitor and track the performance of small companies and projects. This is compounded by the complexity of trying to quantify the non-financial “impact” of investments: it is not that simple to compare the social benefits of investing in, for example, vaccinations in Ghana versus cleaner burning cooking stoves in India.To help donors and investors tackle this issue, the Global Impact Investing Network (GIIN), a non-profit company supported by the Rockefeller Foundation, has worked with B Lab to develop industry infrastructure aimed at improving information flow and creating a more efficient marketplace.

GIIN’s Impact Reporting and Investment Standards provides a standardized language and framework for measuring the social and environmental performance of impact investments, including a list of nearly 400 metrics, such as customer poverty level and access to education. B Lab has created a similar tool for institutional investors, with support from ratings agency Moody’s and several financial companies.

Improved transparency, the creation of analytical tools for investors and the beginnings of a clear market structure are encouraging mainstream institutional investors, such as pension funds, to look at impact investing as a credible asset class. For example, TIAA-CREF, a huge US pension fund, has committed approximately $650 million to impact investing, mostly to low income housing; and American insurance company Prudential is another significant player, with about $400 million in impact investments.

As more funds are allocated to this sector, the impact investing industry is evolving rapidly to meet the demands of a wide variety of investors. Traditional debt and equity are being supplemented by more innovative structures, such as the Social Impact Bond issued in the UK, where return is linked to measures of social performance such as reduction in prisoner reoffending rates.

Alexandra Tracy is chairman of ASrIA, the Association for Responsible Investment in Asia

This article was originally featured in a special report on Sustainable Investments, produced by Raconteur Media and distributed in The Times (UK)