The financial services industry has been in deep debate over exactly what impact investing is and how to quantify it. The term 'impact investing' is still routinely being used interchangeably with ESG terminology, and this confusion can potentially pose risks for businesses or funds.
The Global Impact Investing Network (GIIN) defines impact investments as “investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return.” Investors looking for financial returns that also promote social and environmental values might not see their objectives met through ESG screening and due diligence. Accusations of green-washing – from the LPs and from regulators – are the almost inevitable consequence of this.
And this risk of conflating impact investing and ESG is becoming more acute as impact investment becomes more popular. In 2020, the IFC estimated that $2.3 trillion was invested for impact purposes – a figure that has only increased since. Volumes of capital directed to impact investing and the diversity of stakeholders involved have grown. Covid-19, the extreme weather conditions and changing regulations have all helped raise awareness and push the dial in the direction of impact investments.
Understanding exactly where their money is going and ensuring that it is doing good is increasingly important to investors. Now, more than ever, impact measurement and management (IMM) is needed to provide investors with meaningful metrics that highlight the full impact of their investment, above and beyond basic monetary concerns.
Impact measurement is one of the more challenging objectives in impact investing. At present, there is no single established global standard—but, guidelines have emerged that can help direct impact investors toward meaningful reporting metrics. Some of the most relevant sustainability frameworks include the IRIS+ System from the GIIN, the UN’s Sustainable Development Goals, and the External Rate of Return developed by Time Partners in collaboration with the London School of Economics. But measurement is just one part of the toolkit and while there are no universally accepted standards of measurement at present, the following best practices are key to developing a meaningful framework for impact investment.
Based on our experience working with impact funds, we’ve outlined ten core ways impact funds and fund managers can ensure they are getting the ‘impact’ element of their fund right, and avoiding greenwashing.
1. Substantial thesis
With ever-increasing numbers of impact funds available, each fund has to differentiate itself with a compelling investment and impact thesis that is clearly articulated, coherent and rooted in evidence. Fund managers need to distil their investment thesis into a concise, persuasive pitch that stands out in a competitive market.
2. Robust fund design
One common reason funds can have a tricky time securing capital commitments is due to underestimating the importance of robust fund design. Fund managers need to consider critical elements including: a balanced team that can execute for both financial and impact returns; a substantial deal flow pipeline that shows an ability to find good deals and deploy capital; and thoughtful consideration of details such as terms, drivers of return, and opportunities to add value.
3. Team composition
Founders and leaders of successful impact funds frequently have varied backgrounds, with expertise in both the social and private sectors. Establishing a team with ‘cross-silo’ experience enables successful funds to communicate effectively with the full range of stakeholders, and take a systematic approach to the challenges of developing and executing an impact investing strategy.
4. Measurement and management
Commitment to IMM is a major hallmark of successful impact investing. With it, fund managers can discern, demonstrate and articulate impact – which can can mobilise more capital into the fund. Many successful impact fund managers release yearly impact reports that demonstrate their mission-related performance, which provides additional confidence to investors.
5. Capital deployment
One of the key things a fund manager can do correctly is deploy capital effectively. Attractive funds demonstrate a clear and continuous pipeline of investments, so fund managers need to present LPs with a universe of opportunities that closely aligns with the investment thesis, impact strategy and risk-return objectives.
6. Leveraging on technology
For managers of private equity impact investment funds, a considered strategy for increasing both growth and efficiency of each portfolio company is essential. To maintain high-touch, hands-on relationships, fund managers need to dedicate adequate time and resources. Strong industry and sector knowledge – plus enabling technology especially on the reporting side – is critical to creating that efficiency and transparency.
7. Fund focus
A focused fund – e.g. an ocean fund, a climate fund or a food fund – is easier for investors to categorise and therefore more likely to attract their money. But fund managers need to carefully explain why that specific theme is important to them, in order to avoid any accusations of either greenwashing or ‘chasing the market’.
8. Rigorous screening
Impact investing funds should employ a rigorous impact-screening mechanism from the pre-investment stage. It’s important that LPs are excited about supporting the same impact that the fund is investing in.
9. Learning curves
Like other investment vehicles, impact funds can suffer from ‘first deal syndrome.’ But impact funds also invest more heavily in improving certain areas, which can lengthen the time to profitability. Because impact adds a layer to investments, new impact funds in particular should expect more of a J-curve when they look at their returns.
10. Focus on your core
As a fund manager, your focus needs to be on your core business and to be able to do that, you need to build a strong team of external partners including law firm, fund administrator, ESG consultant and placement agent that will accompany you throughout your growth journey.
Impact investing remains a complex space to navigate. As the confusion over language suggests, the sector has some way to go. But its value proposition is undeniably exciting, as is the potential of a future in which social and environmental considerations are woven into the fabric of investment decisions by default. The rewards from getting it right could be almost limitless.
This insight was originally published by Sustainable Investment.
Looking for more like this? Read our comprehensive guide to setting up an impact fund
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