Impact investing: principles, challenges and perspectives
A quick overview
The last decade has been significantly marked by the rise of environmental and social concerns from investors, even if some extra financial considerations/strategies are actually a few centuries old. These concerns came up with a will from investors to have a specific impact on the world. This will is most notable in a recent financial concept: Impact Investing.
The term “Impact Investing” was invented in 2007 by the Rockefeller Foundation. It corresponds to investments realised with the intent to generate both a financial return and an environmental and/or social impact. Most of the time, these are linked to the United Nations Sustainable Development Goals (UN SDGs).
Usually, we distinguish two types of investors:
- Performance first: investors not willing to make any financial sacrifice in order to reach extra financial outcomes.
- Impact first: investors willing to make some financial sacrifices (regarding risks and/or returns) to reach additional outcomes.
One can see on the above figure that Impact Investing is an under-represented, slow-growing sustainable investment strategy, when comparing to others. Indeed, as of today, most popular strategies are the least demanding ones, while Impact Investing focuses on identifying and certifying a given impact, and is thus much more complex to implement.
Yet, past years have also been notable for the multiplicity of engagements from states and financial companies. And as the regulation is evolving, one can expect more and more investments to include some of the Impact Investing elements, especially regarding the impact assessment.
The technical specificities of Impact Investing
The idea of impact relies on the counterfactual notion: what would have happened if a given investment/activity wouldn’t have taken place. The Global Impact Investing Network (GIIN) gives the following definition of Impact Investing:
There are three mandatory specificities:
- Intentionality: unvoluntary outcomes should not be considered, impact results have to be evaluated with respect to predefined objectives.
- Additionality: some kind of additional benefit above what would have happened without the investment must be proven.
- Measurability: investor has to measure and share the investment social and/or environmental performance, guaranteeing transparency and responsibility.
Hence, best practices in this field are:
- Pre-establishing and communicating on the environmental/social initial objectives to all stakeholders.
- Fixing performance measures/targets linked to the objectives (as standardised as possible).
- Follow and manage the performance evolution with respect to the targets.
- Regularly report the achieved performance.
During the assessment, measuring the output (direct short-term results) is quite easy, measuring the outcome (middle-term results, eventually after the end of the project/activity) is harder and the impact (long-term results, independently from other project/activities with similar objectives) is extremely challenging.
The additionality is the difference between the outcome and the impact, and the toughest specificity to comply with.
A practical example
We distinguish the Investor Impact and the Company impact. In the end, the impact of the funders depends on the impact of the companies they finance, which can come from:
- The product impact, coming from the goods and services it provides.
- The operational impact, coming from the practices of a company, from its management and operations.
Let’s take the example of a company crafting and providing mosquito nets in order to prevent deaths from malaria.
- First question is had the mosquito nets been made and shared (output)?
- Second question is had they been effective in reducing death from malaria (outcome and impact, usually answered using social science techniques like randomized controlled trials, etc.)?
For an investment to have an impact, it also has to verify the additionality, i.e. increasing the quantity/quality of the companies’ impact related production beyond what would have happened. Thus, it needs to provide more capital than what the company would normally get. It also cannot crowd out other sources of capital such as philanthropy or other investors.
Impact can also come from non-monetary advantages such as:
- Growth/improvement support;
- Company promotion;
- Bringing new investors;
- Providing technical and/or financial advice.
In our example, if the investor is just financing the company the same way any other investor would be ready to do so, its impact is null. Counter-intuitively, if he rather invests in a company with a negative impact (e.g. an Oil & Gas) and convinces it to improve itself, its impact could be greater.
Impact Investing today and what is to come
As of today, Impact Investing can take many forms. The Impact Management Project (IMP) lists:
- Financing (capital provision to undersupplied markets)
- Active engagement (non financial support, shareholders engagement)
- Signaling (in and outside of the market)
- Etc.
There are also financial products specific to Impact Investing. Most common ones are Social Impact Bonds (SIBs) and Development Impact Bonds (DIBs). These will not be detailed here, but can be explored using the Impact Bond Dataset (see below).
A lot of additional impact assessment frameworks exits but have not been evoked here, like Social Return On Investment, the CISL model by Cambridge, the Sustainex model by Schroders, etc (find more in the ESG Data Cartography by ILB Data Lab). Yet, impact assessment methodologies are far from standardised, and as of today it is extremely challenging for an investor to robustly justify its impact.
Impact Investing is already playing a significant role contributing to the UN SDGs realization. One can hope that the considerations and methodologies developed in its context will spread out to other sustainable investment, helping identify best practices and the ones related to greenwashing.
If you are a financial practitioner eager to work on this topic, and looking for advanced formations and/or practical methodology developments or else, you can contact the ESG Lab, our structure dedicated to operational R&D on green and sustainable finance subjects at the Institut Louis Bachelier.
Acknowledgements
We would like to give credit and a special thanks to Maria Villalonga Goñalons, since the content of this article is entirely based on her work at the Institut Louis Bachelier, and Thibaud BARREAU for writing the article.
