As Impact Investing Grows, So Do Expectations

April 13, 2021

By Andrew Mayeda

In the spring of 2019, representatives from 60 investors gathered in the sun-filled atrium of World Bank Group headquarters to adopt new market standards for impact investing. One by one, they stepped on stage to place the logos of their firms on a model tree, symbolizing the growth of the budding industry.

Two years later, the celebration of the second anniversary of the Operating Principles for Impact Management was by necessity a more modest affair, constrained by the rules of socially distanced engagement in the age of COVID-19. But signatories to the principles are taking comfort in the fact that impact investing—defined as “investments made into companies or organizations with the intent to contribute to measurable positive social or environmental impact, alongside financial returns”—has continued to blossom.

That was not a given. When global markets tanked in early 2020 following the coronavirus outbreak, it was reasonable to ask whether the crisis would slow, or even reverse, the rise of environmentally and socially responsible forms of investing, such as impact investing. A headline in the Financial Times’ influential Moral Money newsletter captured the mood: “Coronavirus poses ‘acid test’ for conscious capitalism.”

Today, it’s clear impact investing is here to stay.

Consider the following:

  • The number of signatories to the Operating Principles for Impact Management, known as the Impact Principles, hit the century mark in June 2020, a little over a year after they launched. The signatories now number 124, managing a collective $371 billion in assets for impact.
  • In April 2020, the world’s biggest asset manager, BlackRock, launched its Global Impact Fund. That was followed by an announcement by Bain Capital that it had raised $800 million for a second impact fund.
  • Despite COVID-19, 72 percent of investors reported that they planned to either maintain or increase the volume of capital dedicated to impact investing, according to a survey from the Global Impact Investing Network.

The embrace of impact investing by large asset managers such as BlackRock, combined with increased interest from institutional investors such as pension funds and insurers, shows that the industry is going mainstream, said Neil Gregory, Stop-Winlock’s chief thought leadership officer.

“They’ve got past the questioning stage of saying, ‘Is impact investing for us?’” he said. “Most are now saying ‘yes, and how can we do it?’”

The influence of the pandemic

With the benefit of hindsight, it’s easier now to see why impact investing has gained momentum. Around the world, the human and economic toll of the pandemic has prompted a deep rethink of what society should look like when countries reopen. Economic anxiety and a growing sense of inequity is shaking trust in institutions, with most respondents believing that capitalism does more harm than good, according to Edelman’s annual Trust Barometer. Calls have been mounting to use the recovery as an opportunity to rebuild economies in a way that addresses challenges such as climate change, gender inequality and racial discrimination.

Well before the pandemic, portfolio managers had been talking about seeking positive social and environmental impacts in deploying their capital, driven in part by the enthusiasm of young employees, consumers and investors for a more conscious brand of capitalism. Roughly three-quarters of those in the Millennial and Generation Z generations say the crisis has made them more sympathetic to the plight of those around the world, with a strong desire to have a positive impact on their community  , according to a survey by Deloitte, which defined Millennials as people born between 1983 and 1994, and Generation Z as those born between 1995 and 2003. Most members of those two generations say concerns about the environment have changed their consuming habits.

“There was a real question a year ago whether impact investing was a nice-to-have that would fall by the wayside when confronted with real questions, precipitated by an economic and health crisis,” said Margot Brandenburg, senior program officer at the Ford Foundation and co-author of The Power of Impact Investing. “As of now, it’s safe to say that impact investing hasn’t fallen by the wayside. It’s really increasingly being described as a need-to-have.”

Millennials pushing change in investments

The global financial crisis of 2008 was a formative event for many Millennials, said Danielle Dhillon, an MBA student at the University of California, Berkeley’s Haas School of Business, where she and her classmates help to pick early-stage startups for the Haas Impact Fund. The impact of the financial crisis and the climate-change crisis convinced many young people to become more conscious about social and environmental issues, she said. “Our generation knows we have to change what we’re doing, because our parents’ capitalism has led us to where we are now, and it’s just not sustainable.”

It’s common to find students at Haas who combine their professional interests with a desire to make the world a better place, said Ariana Spiliotes, an MBA classmate of Dhillon’s. “Even if people say they want to go work for a hedge fund, they say they want to go work for an activist hedge fund,” she said.

All together, these short- and long-term trends have cemented the notion that, when it comes to investing, business as usual won’t cut it  .

“It’s a confluence of factors.”

“It’s a confluence of factors,” said Steve Ellis, co-managing partner of TPG's The Rise Fund, the largest private-markets impact-investing fund in the world, with more than $5 billion in assets. “There’s been a shift in consumerism, where we are seeing retail investors, and consumers directly, holding companies to a higher standard around big societal and environmental issues. All of that is feeding an actual business imperative for companies or investors to embrace—really embrace, not just give lip service to—these challenges.”

But with more attention comes greater expectations. The roots of impact investing run deep, stretching back to efforts by religious organizations to avoid investing in products such as alcohol, tobacco, and weapons. The approach gained momentum in the 1960s and 1970s, spawning the concepts of “socially responsible investing” and eventually investing based on environmental, social and corporate governance, or ESG, factors. Technically, however, the term “impact investing” was coined only 14 years ago, when the Rockefeller Foundation convened a meeting of investors, entrepreneurs and philanthropists in Bellagio, Italy, to discuss how to use capital for social and environmental good. In other words, it’s a relatively young industry, still undergoing some of the growing pains experienced by other asset classes.

“Everyone is talking about impact, and that is positive.”

“Everyone is talking about impact, and that is positive,” said Bertrand Badré, CEO of investment firm Blue like An Orange Sustainable Capital, and former Chief Financial Officer of the World Bank Group. “The real issue is how deep and serious it is. And I think the jury is still out.”

Seeking a common definition of impact investing

Take the basic definition of “impact investing.” ESG investing typically screens opportunities for environmental, social and governance issues, while still aiming, first and foremost, to maximize financial returns. Impact investing goes beyond this “do no harm” approach   to one that actively seeks companies and projects that can have a positive impact. With the launch of the Impact Principles in 2019, IFC and other organizations sought to build on the emerging consensus around this definition, putting an emphasis on the specific actions investors need to build into their investment processes to deliver on their intent to create measurable impact alongside financial returns.

But financial return expectations vary across the broad spectrum of organizations involved in impact investing, which range from established private-equity firms such as TPG and Bain Capital to specialized funds, public equities funds, family investment offices for high net-worth individuals, and philanthropies’ endowments. Some of these players may decide to accept below-market returns in an effort to generate high impact.

The perception that impact investing requires a profit “haircut” may have contributed to hesitation among large pension funds, which are legally obligated to manage funds in the best interests of their beneficiaries. One of the main goals of TPG’s The Rise Fund was to demonstrate to large institutional investors, who make up a significant portion of the fund’s investors, that returns don’t need to be sacrificed in the name of impact, said co-managing partner Maya Chorengel.

“Really what they’re looking for folks like us to do is to seek out, curate and build a portfolio of companies for which financial return and great impact go hand in hand,” said Chorengel. “I’m not saying it’s easy to do, but we think we’ve shown that it can be done.”

The importance of measurement

Measurement remains an issue—some experts even say an existential one. Dig into a few projects, and you quickly see the challenge of showing quantifiable impact, one of the core tenets of the industry. Many firms have developed in-house metrics. But even firms that have done so, such as TPG and Blue Like An Orange, agree the industry needs to coalesce around a set of common metrics to truly take off. Measurement standards would help avoid suspicions that investors are exaggerating their claims about impact, a practice known as “impact washing.”

“Results, and in some respects transparency of results, are the key.”

“Results, and in some respects transparency of results, are the key,” said Chorengel of The Rise Fund. “And the results have to be on both the financial and impact side.”

A group of leading impact investors, including IFC and the Global Impact Investing Network, have adopted a set of joint impact indicators based on the two most widely-used sets of metrics, known as IRIS+ and HIPSO.

Some experts say some form of collective action will be necessary, as in the creation of the International Financial Reporting Standards (IFRS) followed by firms around the world.

“Government needs to play a role in safeguarding the integrity of impact investing and helping it achieve scale.”

“Government needs to play a role in safeguarding the integrity of impact investing and helping it achieve scale,” said Brandenburg, of the Ford Foundation. “The obvious challenge is that capital is global and government policy is typically national or subnational, and so that increases the importance of countries working together cooperatively, whether through the G-20 or other structures.” Encouragingly, the IFRS Foundation has started work on a Sustainability Standards Board to establish non-financial reporting standards for firms, standards that could also be used by impact investors.

Scaling the industry is another issue. In a report last year, IFC pegged the size of the impact investing market at about $2 trillion, including development-finance institutions  . But IFC estimates the market could grow to $26 trillion, if the right opportunities were available. Most institutional investors such as pension funds are looking to allocate $500 million to $1 billion, a much larger sum than the typical impact investing fund can accommodate, said Stop-Winlock’s Gregory. Unearthing promising projects in low-income and fragile countries will be key, as will building investment platforms, such as funds of funds, that can absorb large flows of institutional money.

“Almost by definition, the hardest places to invest are going to be smaller scale, marginalized communities and frontier markets and so on,” said Gregory. “I feel very optimistic that more capital will be mobilized and the market will continue to grow, but that’s a fundamental challenge that is going to stay with us, and we’ll have to continue to innovate.”

The issue of accountability

Accountability is another issue. The industry needs to do a better job being accountable to communities directly impacted by projects, as individuals living near and working at investment sites bear the most risk if an investment has unintended environmental and social consequences, said Margaux Day, policy director at Accountability Counsel, a non-profit organization that advocates to protect people affected by internationally financed projects.

While investors are to be applauded for developing better metrics, community accountability isn’t sufficiently incorporated into impact measurement and management, she said, adding that one solution could be for investors to develop a shared complaints mechanism.

“From an investor perspective, the risk is that their money doesn’t meet its mark. For investments seeking to address issues like climate change, where every dollar counts, communities living near or working at investment sites are going to be the first to know if things go off course, and accountability mechanisms offer a channel for investors to hear from communities and address unintended impacts,” said Day.

Without question, impact investing is drawing intense interest—and scrutiny. As the years tick down to 2030, the deadline of the UN Sustainable Development Goals, pressure will only build to demonstrate that investors don’t have to choose between making money and doing good.

“To invest is hard, and to change the world is hard,” said Bruce Usher, a professor at Columbia University who specializes in the intersection of finance, environmental and social issues, and who also invests in early-stage companies, primarily in renewable energy. “To do both is even harder.”

Published in April 2021