Impact investing: how to avoid the worst-case scenario

At the end of 2023, the UN Environment Programme (UNEP) confirmed what we all feared: the world is heading for a temperature rise far above the 1.5℃ limit that could help us avoid the worst impacts of climate change. Their report called for all nations to deliver economy-wide transformations to aggressively target net zero carbon goals and limit greenhouse gas emissions.

As global challenges like climate change, biodiversity loss, rising inequalities and general unrest intensify, aligning financial returns with positive social and environmental impact has never been more important. This article will explore the nuances of impact investment strategies, highlighting the critical role of innovation and collaboration in achieving a sustainable future.

Impact investing vs. sustainable finance

Impact investing and sustainable finance are often used interchangeably, but, while related concepts the two practices are quite different, with nuances critical to understand given the urgency for change.

To achieve their impact goals, impact managers often develop a theory of change. Defined by the United Nations Development Group, this method outlines how specific interventions are expected to lead to developmental changes, grounded in causal analysis and evidence. A well-constructed theory of change provides a structured approach to investing, helping managers articulate their strategies, track progress and identify potential obstacles.

Impact investment returns

Impact managers aim to achieve positive social and environmental outcomes without sacrificing financial returns. Given that financial gains drive many activities, it’s essential to align impact goals with compensation.

While many focus solely on financial performance, the concept of the triple bottom line—“people, planet and profit”—emphasises the interconnectedness of social, environmental and economic value, a notion introduced by John Elkington in 1994.

Linking remuneration to impact KPIs enhances accountability and transparency, encouraging managers to prioritise long-term outcomes over short-term gains. This approach requires clear metrics and performance targets, prompting managers to track progress and establish internal review processes. By tying compensation to these outcomes, managers are incentivised to achieve measurable impact, with regular reviews ensuring the system remains effective and adaptable.

What comes next?

Each year, an estimated $4 trillion is required (United Nations Trade & Development, s.d.) to combat climate change and achieve the UN’s Sustainable Development Goals (SDGs). This figure reflects the urgent need for a substantial shift in global financing flows focused on delivering positive outcomes. Clearly though, finance alone won’t win the game.

To avoid the Intergovernmental Panel on Climate Change (IPCC)’s worst-case scenario and steer the global economy to a sustainable future, we must also look past regulations and financial flows.

Several innovative concepts have entered mainstream conversation within the financial space, including eco-capitalism, post-growth capitalism and circular economies as pathways to a sustainable future. These paradigms transcend regulatory frameworks, emphasising systemic change and holistic approaches to sustainability.

Our focus must transcend mere financial returns, emphasising the importance of impact-oriented action in addressing global challenges. Embracing innovative economic paradigms, leveraging on regulatory frameworks, as well as a educating a new generation of conscious consumers and investors, will help us steer financial flows toward a more equitable, resilient and sustainable future.

This is an abridged version of an article originally published by Paperjam.