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What is Impact Investing?
Today, Impact investing is considered to include the pursuit of financial returns at market rates from investments that deliver real world change (or “Impact”), or the pursuit of sound financial investments with positive externalities. This type of Impact Investing, known as “Non-concessionary Impact” Investing, is on the opportunities side of the Sustainable (or “Responsible”, or “ESG”) Investing equation. This contrasts with the more traditional view that Impact investing is “Concessionary” and involves investing for social benefit at the expense of financial outcomes, a view perhaps explained by the origins of Impact in the Social Responsible Investing (“SRI”) movement of previous decades.
Whether or not an Impact investment programme is Non-concessionary or Concessionary depends on the intentions of the investor at the point of taking the decision to invest. If their minimum acceptable rate of return is driven only by financial risk, i.e., it is same as for a non-Impact investment of similar financial characteristics, then it is Non-concessionary. If, on the other hand, they would apply a lower return hurdle in order to secure their Impact objectives, then it becomes Concessionary. This ex-ante designation is independent of the financial outcome realised and cannot be reinterpreted ex-post:
- A Non-concessionary Impact investment that yields poor financial returns does not become a Concessionary Impact investment; it remains a poor investment, perhaps a potential “lessons-learned” case study; and
- Conversely, a Concessionary Impact investment that yields higher than expected, market rates of financial returns does not become Non-concessionary.
The Global Impact Investing Network (“GIIN”), a global champion of impact investing, defines Impact as “investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return”1.
Article 9 of the EU’s Sustainable Finance Disclosure Regulations refers to “a financial product [that] has sustainable investments as its objective”2, and anecdotally, this seems to be widely accepted as capturing Impact Funds.
Realising outcomes, or, extracting the essence
The path to realisation of the financial outcomes of an investment is well-established and almost obvious. Consider an Impact investment that achieves a sound financial return as well as its Impact Objectives. The sale or redemption of the investments will be accompanied by the investors’ receipt of realisation proceeds; they’ll “see” the money in their bank account. However, this does not, by itself, enable them to participate in or receive or consume the Impact benefit of their investment.
The investors’ participation in the Impact outcomes may be necessary for reasons of accountability: they may have represented to a Board or other stakeholders that the investment had a dual purpose, and mere receipt of expected redemption proceeds does not allow them to confirm attainment of the second, Impact-related objective. The participation may simply comprise the quite legitimate outcome of a feeling of satisfaction that their investment has delivered the real world change they desired. It may also be much more serious than that: the Impact Objective may be a major strategic objective for the Investor, e.g., the pursuit of Net Zero.
For an investor to realise the Impact objective from investing in an Impact Fund, the GP of the Fund would need to first identify the potential for Impact and determine appropriate Key Performance Indicators (“KPIs”) to capture this prior to each investment. These KPIs would be measured at the point of investment, then monitored and tracked throughout the life of the investment up to its realisation3, and reported, with due reliability, to the Investor.
Consider the case of two hypothetical funds, Fund P and Fund Q. They made identical investments on identical financial terms and realised the same financial outcomes. Their investments had significant Impact in their sphere of activity. Fund P determined, measured and monitored KPIs which it reported as Impact outcomes to investors, and Fund Q did not4. An Investor seeking Impact outcomes would have a rational preference for Fund P, over Fund Q. This would be because Fund P has a track record of facilitating Investors’ participation in the Impact outcomes and Fund Q does not. In a world where investors may be seeking Impact, subsequent raises may either favour Fund P, or put competitive pressure on Fund Q to report Impact.
The Future of Impact Reporting
The rise in awareness of Climate Change and Net Zero pledges by many asset owners is one indication of a growing demand for Impact participation by investors. Asset owners will be seeking investments that help them achieve such real-world objectives (or Impact), and it does not seem unreasonable to expect that demand for Impact strategies (whether or not labelled or marketed as such) will increase.
As GPs become more accustomed to reporting impact, competition could lead to further advances in Impact Reporting practice, including widespread adoption of sustainability reporting standards, and perhaps even attribution of Impact outcomes to individual investors based on the (relative) quantum and timing of their investments. This would extend investor statements into the realm of impact5, and probably drive the development of assurance services around impact reporting.
Emlyn Ade Palmer - March 2022
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1 https://thegiin.org/impact-investing/need-to-know/#what-is-impact-investing
2 https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32019R2088
3 Best practice involves post-realisation tracking of KPIs to assess sustainability of the Impact.
4 Note that the critical deliverable is Impact reporting to the investor; measurement and monitoring of Impact KPIs are necessary but not sufficient for Impact delivery.
5 If ESG risk is feedback from negative externalities, Fund Newsletters may well report unintended Impact in future.
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