Performance-based compensation has long been a core feature of investment funds, and it’s not hard to see why. When a fund manager’s profit is tied to the returns they generate for their investors, they are probably going to work pretty hard to maximize those investor returns.
So when it comes to impact investing funds, which have the goal of providing social and/or environmental returns as well as financial, does it make sense to incentivize managers based on financial performance alone?
The IFC’s Operating Principles for Impact Management, designed to promote transparency and accountability in impact investing, suggest that fund managers align staff incentive systems with the achievement of impact. In private equity funds, that might take the form of ‘impact carry’, whereby a percentage of returns generated by the fund are paid to the fund manager contingent upon achievement of specified impact objectives.
Although it’s not yet a mainstream practice, there are already a few funds using impact carry.
For example, Spanish impact investing firm GAWA Capital has 50% of its carry determined by impact performance, based on a comprehensive impact score calculated for each investment at the due diligence stage, and then recalculated at midline and exit to evaluate progress. And at UBS’s impact fund of funds, carry is awarded in direct proportion to an ‘Impact Coefficient’ which represents the percentage of social benchmarks that are met by the fund.
Now, it wouldn’t be proper to discuss impact-linked compensation without touching on impact measurement. Fund managers and their investors need to be able to determine the right metrics and assessment frameworks on which to base impact carry, in order to avoid the trap of perverse incentives. For example, trying to maximize the number of ‘jobs created’ might lead a fund manager to make investments that generate low-quality jobs, as higher-quality jobs are harder to create.
But there is hope. Launched last May, the GIIN’s IRIS+ system for impact measurement and management is already being used by more than 4,600 organizations. And 60 Decibels has been busy enabling impact investors to efficiently capture beneficiaries’ perspectives on the outcomes they experience, minimizing the risk of misaligned metrics.
While impact carry has intriguing potential for driving outcomes, there are sure to be growing pains, and the lack of universal measurement is a big hurdle that needs to be overcome. But as the industry moves toward standard, consistent, and clear metrics that could underpin effective impact carry structures, we may see greater uptake of this emerging practice. Watch this space.
Josh Zail, Investment Intern
Fund manager compensation structures have come under fire recently for “exacerbating wealth inequality”. Could impact carry be part of the solution?
Impact-linked finance models like Social Impact Incentives and Beneficial Outcomes Linked Debt reward high-impact enterprises financially for achieving impact outcomes. The additional revenues enable them to improve profitability and attract further investment to help them scale. As the enterprise grows, so does the impact!
On Impact by Sir Ronald Cohen, one of the founders of the impact investing movement. A succinct and digestible guide to the Impact Revolution and our role in it.
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