September 18, 2022

Five-Minute Brief: Driving Change with Impact Investing

Impact investing enables investors to create positive outcomes for people and the planet

As the world continues to grapple with social and environmental challenges—including climate change and social inequality— there is increasing demand for investors to contribute solutions. Unlocking private sector finance and ingenuity can help expedite progress towards a more inclusive society and healthier environment.  

Recognizing both the need and the opportunity, investors are adopting a spectrum of responsible investing approaches that consider non-financial factors while generating financial returns.

  • ESG integration helps investors identify, assess and manage the effects that material non-financial risks and opportunities have on investments to protect value
  • Negative screening investing intends to directly avoid negative impacts
  • Thematic investing considers solutions to specific social and environmental challenges (e.g. climate change)

Impact investing enables investors to demonstrate that they are creating and contributing to positive change. At over $700B in assets under management (AUM) globally, it is increasingly seen as an opportunity for investors to respond to growing demand from stakeholders, including customers, employees, suppliers and regulators to solve global challenges.

What is Impact Investing?

Impact investing is a form of responsible investing designed to contribute positively to measurable social and environmental change while generating a return. Investors leverage investment capital to support a range of market-based solutions to global challenges such as sustainable agriculture, renewable energy, access to education, improved mental health and more. Below we outline three defining attributes of impact investing to help gauge whether the strategy is right for you.

#1: Positive intent

Impact investing is characterized by an investor’s explicit intent to solve challenges and improve positive social or environmental outcomes (i.e. the change to levels of well-being or the condition of the planet) alongside financial returns. To assess impact potential, investors break it into its component parts – who, what, how much, contribution and risk[1] – and use the ‘ABCs of impact’[2] to define their intentions and compare investments:

  • A: Act to avoid harm. Managing or avoiding negative impacts an investment has is a minimum threshold. ESG criteria provide helpful guidance in this area.  
  • B: Benefit stakeholders. In addition to avoiding harm, striving to maintain or increase a positive outcome for stakeholders.
  • C: Contribute to solutions. Targeting underserved populations at large scale with investments that have a substantial and lasting effect in improving outcomes.
#2: Additional contribution

Additional contribution refers to how an investor improves social and/or environmental outcomes beyond what would have happened anyway in a business-as-usual case.

Investors typically contribute in four different ways[3]:

  1. Signal that impact matters: this is most commonly done by reporting to shareholders and other stakeholders on how non-financial considerations informed the investment process.
  2. Engage actively: investors may proactively support investees to help manage and improve their impact. This is done by joining boards, direct mentoring or other strategies like shareholder activism.
  3. Grow new or undersupplied capital markets: leading impact investors create new opportunities to drive impact by investing in areas where others perceive risk to be disproportionate to returns. Real estate and infrastructure impact investors often take this approach to invest in frontier markets or reach underserved populations.
  4. Provide flexible capital: investors may concede returns they may have received through another investment.  

Impact investors often do these things in combination. For example, an investor providing patient capital—that is capital that forgoes short-term profits for long-term returns—while also actively engaging with companies that improve outcomes for underserved populations would be leveraging all four of these contribution approaches.

#3: Strong measurement

Impact investing requires investors to assess how successfully they are changing outcomes, as well as manage and report on that impact. This involves measuring outcomes (e.g. higher rates of child literacy) as opposed to outputs (e.g. number of literacy programs funded) and improving impact performance accordingly.

These measurement approaches are often specific to and driven by investment strategies and asset classes. Private market investors, for example, often have the greatest potential to measure impact given their ability to outline reporting terms and actively engage with investees. By contrast, minority investors in public equities have limited ability to influence data collection and reporting practices, making it difficult to monitor how investment decisions are or are not driving intended outcomes. In these circumstances, investors may rely on voluntary impact reporting, a practice that’s gaining traction among forward-thinking listed companies.

Knowing what to measure and what standards and frameworks to use has been a persistent challenge for impact investors. However, substantial progress has been made. Tools like the Impact Management Platform provide a comprehensive overview of principles and complimentary standards that may be applied at various stages of the investment process. Investors can now distinguish between frameworks that:  

To integrate impact measurement into the investment cycle from screening to exit, impact investors can also leverage frameworks like the Operating Principles for Impact Management. Many investors are getting their outcomes and processes independently validated to signal the credibility and integrity of their impact investing practices.  

Is impact investing right for you?

Investors can begin by assessing if their existing portfolios can be doing more to generate positive outcomes for people and the planet.  In our next impact post, we’ll be sharing some practical pathways investors can follow to apply impact investment principles to enhance outcomes.