Just over 10 years ago, JPMorgan, the Rockefeller Foundation, and the Global Impact Investing Network (GIIN), published a report claiming that impact investment was an emerging asset class that would reach between $400 billion and $1 trillion in assets under management by 2020. That seemed like a pretty ambitious forecast at the time, but as it turns out, that forecast actually wasn’t ambitious enough.
Stanford Social Innovation Review reported that “in 2020, the market reached roughly $715 billion in assets under management, according to GIIN. The International Finance Corporation (IFC) put the estimate even higher: $2.1 trillion.” With such remarkable growth over the last 10 years, and interest in impact investing exploding as a result of the pandemic, one thing is clear: impact investing is here to stay, and it’s evolving almost as quickly as it’s growing.
In this article, we’re going to help demystify the concept of impact investing by breaking down exactly what it is, different forms it can take, guiding principles, and examples of funds, initiatives, and influencers to follow to stay on top of the latest impact investing trends.
A Practical Definition of Impact Investing
Traditional investments are made with the single goal of maximizing financial return on investment.
Impact investing is a critical source of capital to the growth of social enterprises, and it also imposes systems of measurement and reporting on social enterprises and other impact organizations. Impact investing can take many forms, and any of the asset types in the graphic below can be impact investments. Still, regardless of the rate of return, the critical element that all impact investments have in common is measuring and reporting on impact.
How is Impact Investing Different from ESG Investing?
Though Environmental, Social, & Governance (ESG) investing and impact investing are often confused or used interchangeably, there are some important differences.
ESG investing represents capital deployed to any enterprise that reports on ESG factors (for example, a company like Apple is often included in ESG funds, despite being a for-profit corporation.) It requires companies to start disclosing more information about their positive and negative ESG factors.
You can think of ESG investing as a way of investing into traditional companies and entities, but in a way that forces those companies to report on ESG factors. It doesn’t necessarily mean that they are achieving a specific target or contributing to a certain Sustainable Development Goal, but they are required to report on these factors. The idea here is that because these companies are obligated to report on these ESG factors, they will be under more pressure/held accountable for making them better.
Impact investing, on the other hand, is investment specifically for the purpose of accelerating the growth of social enterprises.
In the below graphic from Goldman Sachs, you can see the differences between ESG Investing and Impact Investing:
Impact investments serve the specific purpose of deploying capital to social enterprises that are actively working to achieve the SDGS. So, a large for-profit corporation like Apple, for example, would not qualify for impact investments because it doesn’t exist explicitly for social impact, but it does qualify for ESG investments because of its reporting on ESG targets.
The Spectrum of Impact Investments
Impact investments can take a variety of forms, but regardless of the investors approach to impact and expected financial return, they are all at some point hoping to get their investment back. In other words, this is not philanthropy: it’s a true investment. It’s important to note that some investors will be happy simply getting their investments back, while others want their investments back with a certain rate of return. Similarly, some investors will be happy knowing that their capital went to a social enterprise, while others will ask for specific metrics of impact related to their investments.
The graphic below from Bridgespan Group categorizes different types of impact investment along two dimensions: approach to impact and expected financial return.
Along the “approach to impact” dimension, investors can be passive (hoping to make an impact, but not sure), intentional (intentionally choosing to invest with impactful organizations), or evidence-based (rigorously measuring to make sure that the intended impact is created.) Along the “expected financial return” dimension, some investors are more financially motivated and looking for market rate returns, some are willing to concede on financial returns for the sake of impact, and some are only looking to recover part or none of their initial capital investment.
As you can see, traditional philanthropy falls in the category of passive, with a complete loss of capital (i.e. distributing grants without the expectation of repayment.) ESG investments are also passive, but with some capital return expected. As you move towards intentional impact, you can see that the types bifurcate into below market rate returns with a focus on impact, or market rate returns only with impact oriented social enterprises. Moving to the evidence-based side of the spectrum, you’ll find social impact or development bonds with close to market rate returns from organizations with rigorous impact measurement.
How Do You Know that Impact Investing is Actually Making an Impact?
As impact investing has grown as an asset class, a variety of organizations have been launched to ensure that we avoid “greenwashing” and ensure that this capital is actually used to make a real impact. Over the last few decades, different measurement standards and principles have been developed, but only in 2019 was a global standard developed – and it’s one that will undoubtedly continue to evolve over the coming years.
9 Key Principles of Impact Investing
To truly mainstream impact investing, we need a set of criteria to align around as an international standard. To better define impact investments, the IFC (International Finance Corporation, a subdivision of the World Bank) created these 9 Impact Principles:
According to the IFC website, “The Impact Principles are intended to be a framework for investors for the design and implementation of their impact management systems, ensuring that impact considerations are integrated throughout the investment lifecycle…They do not prescribe specific tools and approaches, or specific impact measurement frameworks. The expectation is that industry participants will continue to learn from each other as they implement the Impact Principles.”
Let’s look at a quick overview of each principle:
Principle 1: Define strategic impact objective(s), consistent with the investment strategy
This principle is related to intent. The idea is that the manager of the investment portfolio/fund should define specific strategic social/environmental impact objectives that are consistent, credible, and scale proportionately to the amount of money invested.
Principle 2: Manage strategic impact on a portfolio basis
This principle relates to measurement. The idea is that the manager needs to have a process in place to monitor impact performance of these investments, and suggests aligning staff incentive systems with the achievement of impact, as well as with financial performance.
Principle 3: Establish the manager’s contribution to the achievement of impact
This principle relates to documentation. The idea is that the manager should establish and document exactly how they are contributing to realizing the intended impact of each investment.
Principle 4: Assess the expected impact of each investment, based on a systematic approach
This principle also relates to measurement. The idea is that for each investment, the manager should quantify the concrete, positive impact potential of the investment using a suitable measurement framework. It also suggests that the manager should continuously assess the likelihood of reaching those targets, and identifying potential risk factors.
Principle 5: Assess, address, monitor, and manage potential negative impacts of each investment
This principle is about mitigating unintended negative consequences. The idea is that for each investment, the manager should systematically analyze and document Environmental, Social and Governance (ESG) risks to be avoided or mitigated. It also suggests that managers take proactive action with their investees to address gaps.
Principle 6: Monitor the progress of each investment in achieving impact against expectations and respond appropriately
This principle ties back to the measurement framework from principle 4. The idea is that the Manager should monitor progress of realized impact in comparison to the expected impact for each investment. If the investment is no longer achieving intended outcomes, the manager should take corrective action.
Principle 7: Conduct exits considering the effect on sustained impact
This principle relates to long-term impact. When the investment period ends, the Manager should consider what impact the timing, structure, and process of its exit will have on the sustainability of the impact.
Principle 8: Review, document, and improve decisions and processes based on the achievement of impact and the lessons learned
This principle is about data driven improvements. The idea is that the Manager should review and document the impact performance of each investment, compare the expected and actual impact, and other positive and negative impacts, and use these findings to improve operational and strategic investment decisions.
Principle 9: Publicly disclose alignment with the Principles and provide regular independent verification and alignment
This principle is about accountability and transparency. The idea is that the Manager should publicly disclose, on an annual basis, the alignment of its impact management systems with the Principles and, at regular intervals, arrange for independent verification of this alignment.
Ensuring that Impact Investments are Actually Impactful
Unfortunately, there is a lot of “greenwashing” in impact investing. Take Blackrock, for example, which touts the need for impact investing, yet still keeps billions of dollars worth of assets in extractive and oil and gas companies. One former leader at Blackrock, who quit, was featured in Bloomberg for the article Corporate Climate Efforts Lack Impact, Say Former Sustainability Executives.
The Impact Management Project features 5 dimensions of impact to help us understand the real impact of investments that follow the 9 principles above:
Other efforts, like IRIS+ (developed by the Global Impact Investing Network,) provide a framework and generally accepted system for measuring, managing, and optimizing impact. Impact investors should use a framework like this and follow the principles above – which include reporting on impact publicly – to be truly deemed impact investors.
The Impact Investing Ecosystem: Examples of Initiatives
The impact investment ecosystem is made up of a variety of stakeholders, which as you can see in the graphic below from FutureLearn can be roughly divided into the supply side, the demand side, the intermediaries, and the enabling environment:
When we go back to the purpose of impact investing – providing social enterprises the capital they need to scale, as well as requirements for measuring and reporting on impact – it makes sense that accelerators play a major role in getting the organizations on the demand side ready for impact investment. Accelerating the Accelerators, a great initiative from Conveners.org, shows that there’s this broad spectrum of companies that exist to support social enterprises in moving from the initial idea stage to prototyping to scaling.
In the map below you can see that organizations like Impact Hub, Fledge, Agora Partnerships, SeedSpot, and others provide support to early-stage social enterprises in the idea stage, while organizations like the Global Social Benefit Incubator (GSBI) and Village Capital provide support to social enterprises in the piloting and prototyping stage, along with others who intervene later in the process to support scaling. Of course as you move from the left to the right of this map, you move out of more traditional accelerators into more traditional investors, groups like Acumen, and Radical Capital. The bottom line is that at each stage of the social enterprise growth process, and across various needs like planning, pitching, mentorship, partnerships, and capital acquisition, a variety of social enterprise support organizations exist to support the path to growth.
Another good resource to understand the impact investing landscape is the map below from Colorful Ventures, which shows organizations that provide networks where you can find social enterprise services based on various stages of growth. It includes everything from research to convening – there’s fellowships and awards that help promote the best social enterprises, there’s incubators and accelerators, there’s impact investors, there’s investment marketplaces, institutional investors, and even a growing number of stock exchanges specifically for impact investing vehicles.
As you can see, there are a lot of organizations in this space, but there’s also a lot of turnover. Many of these organizations end up eventually merging, acquiring or being acquired, or forming partnerships to maximize impact.
Impact Investing Influencers to Follow
Despite the rapid pace of change in this space, there are a few organizations that have anchored the impact investing movement since the beginning that are really worth following:
- Acumen– Acumen was founded by Jacqueline Novogratz in 2001 to use the power of entrepreneurship to build a world where everyone had the opportunity to live with dignity. Acumen invests “Patient Capital” to bridge the gap between the efficiency and scale of market-based approaches and the social impact of pure philanthropy. Acumen is an industry leader not only because it sets a very high standard for impact investing, but also because it played a major role in popularizing the impact investing movement.
- Global Impact Investing Network (GIIN)– The GIIN is the global champion of impact investing, dedicated to increasing its scale and effectiveness around the world. Its work has been a crucial part of helping to set standards for what impact investing is and should be.
- ImpactAlpha – ImpactAlpha is a leading source for impact investing news. It works to enable a more just, equitable and sustainable world by exposing, informing, narrating and critiquing the impact investment space, while fostering a growing community of agents of impact.
- United Nations Principles for Responsible Investment – The six Principles for Responsible Investment are a voluntary and aspirational set of investment principles that offer a menu of possible actions for incorporating ESG issues into investment practice, providing more feedback on reaching a universal standard.
- Global Impact Investment Rating System (GIIRS)– GIIRS Ratings are the gold standard for funds that manage their portfolio’s impact with the same rigor as their financial performance. Social enterprises can take the GIIRS assessment in order to qualify for impact investments.