Impact Investing for Systems Change
Although systems change is traditionally viewed as the realm of policymakers and philanthropists, impact investors introduce investment capital as an additional tool to change systems.
We now live in a world of increasingly open systems and impact investing promises to create innovative and effective new investment products at the boundaries of existing systems. Many people believe that the complex challenges and wicked problems facing the world today can only be solved through integrated approaches to policy, philanthropy, and investment. A wicked problem is a social or cultural problem that is difficult or impossible to solve for as many as four reasons: incomplete or contradictory knowledge, the number of people and opinions involved, the large economic burden, and the interconnected nature of these problems with other problems.
Systems change is about addressing the root causes of social and environmental problems, which are often complex and embedded in networks of cause and effect. It is an intentional process designed to fundamentally alter the components and structures that cause the system to behave in a certain. Investment has become a fundamental component and influencer of systems. Our world has become more integrated, but frameworks and practices remain largely separate — with the private sector actors, policy makers, and philanthropists staying in their own lanes.
Intentionally or not, investors change systems. As impact investors become more accountable for their assets, they have the opportunity to engage with other stakeholders who have not historically been involved in the investment process. An investor is just one of many stakeholders in the impact investing ecosystem. Investors rely on their investments to eventually create impact on the ground level. Impact investing can trigger legitimate debates about the appropriate roles and boundaries among the private, public, and nonprofit sectors. For example, the charter school movement in the United States, in which private organizations receive public funding to construct and operate schools, has attracted both accolades and criticism. The model has been touted as a critical innovation to address underperforming schools, but it is also criticized for questionable effectiveness and negative effects on public school systems.
Investors are not elected democratically, so questions also arise about the legitimacy of them using financial power to establish priorities for social and environmental spending. Some investors may try to use impact investing for bridging gaps in public services or incentivizing nonprofits to create more financially sustainable business models. However, a lack of public funding does not automatically mean impact investing will be a better solution. Some stakeholders view impact investing as an inadequate and inefficient tool for driving environmental and social rights and, therefore, will favor clearer regulation and enforcement. Successful impact investing will not solve these debates, but investors need to understand how their deployment of capital can be viewed and judged by other stakeholders.
How to Get Started
The following roadmap guides an asset owner towards making your first impact investment or building a nuanced impact portfolio. For more details (180 pages worth), please refer to the Impact Investing Handbook: An Implementation Guide for Practitioners.
To bring the roadmap to life, we will track with one asset owner’s journey as she and her family office develop and implement their impact investing strategy. For context, this asset owner sold her fashion business for $450M, starts $40M foundation. Bothered by fashion industry’s heavy water usage, she begins with water-related grantmaking where she eventually is frustrated by lack of scale. She sets out on a journey to learn more after being introduced to impact investing by an article then attending a related conference. One key challenge is consensus building with her husband who holds a more traditional view of keeping investments & social-good separate.
What: Create your personalized definition of impact investing and begin mapping the resources you hope to activate — including nonfinancial assets.
Asset Owner: Agrees with the GIIN definition and wants to activate her $500M portfolio, her $40M foundation, her $5M donor advised fund, her fashion expertise, her experience a female business leader, and an important relationship with a trusted family attorney.
Who: Identify your position in the impact investing ecosystem of players, with particular attention to the capital chain, or flow of capital from asset owner to intermediaries to enterprises to customers and beneficiaries.
Asset Owner: Identifies key stakeholders as a close family attorney, her husband, regulators, affiliate groups, peers, and the whole capital chain. Her husband has the most influence on the portfolio so she will keep him in mind as she moves forward.
Why: Develop a theory of change which identifies both investment and impact goals, leading to a logic model of how resources in the WHAT chapter will be activated to achieve the portfolio’s goals.
Asset Owner: Align as much of her portfolio with a “do no harm” mentality by first understanding what she currently owns, prioritizing impact themes of water, climate, and the arts. Where possible, she would also like to overlay a gender lens. She is seeking a diversified portfolio with an allocation to less liquid, impact-aligned opportunities towards a risk-adjusted rate of return of a 5% payout plus inflation.
How: In order to arrive at your investment policy statement (IPS) and impact investment statement (IIS), adding specific tools and structures to the theory of change. Then identify specific products that may give expression to each segment of your portfolio.
Asset Owner: Identifies priority tools and structures including ESG screens on positive climate and water considerations, cash transferred to a community bank, venture capital to promising water and arts startups, and a gender lens across the entire portfolio.
So What: Follow the three-part process to build your approach to IMM: Why are you measuring? What are you measuring? and How are you measuring? First, decide on which parts of the portfolio you plan to evaluate, and segment the evaluation approach accordingly.
Asset Owner: Motivation to measure is a balance of proving past impact, improving impact for the future decisions, and personal learning. She will commit to the IFC’s Operating Principles, track the percent of assets screened using negative and positive ESG criteria, categorize investments according to the IMP’s ABC Framework, align to SDG 5 and 6, and track progress on worker health and safety, pay equity, and board diversity.
