We are in the midst of a massive wave of human ingenuity. As issues like climate change and criminal justice become increasingly acute, innovation and capital flock to address them. Private markets are stepping up, challenging antiquated notions that impact and alpha are mutually exclusive. This is a beautiful thing, but like any other (relatively) new idea, it comes with challenges. This time, the stakes couldn't be higher.
With 2022 behind us and the impact investing market now sized at $1T, I'd like to share some of the major trends and challenges I see at the heart of impact investing and social innovation as they move mainstream.
1. There is major confusion about what ESG is and is not, and it's positioning the field for dismissal.
Phillip Morris and Exxon Mobile ranked in the top 20th ESG percentile. ESG is misperceived to signal a company's benevolence. This is a problem.
ESG does not equal impact.
ESG was designed to mitigate risk for the company. It was designed to safeguard the company and its investors, not the planet. As reports scour ESG's questionable social and environmental returns, remember, ESG is not designed for this. It's designed to insulate companies from the inevitable effects of social and environmental volatility. Impact is designed to fuel change for people and planet. The two terms get conflated, but their intents and practical applications are very different. ESG focuses on operational risk exposure from social and environmental volatility. Impact focuses on improved outcomes, access and resource efficiency usually from products and services. Conflating them means that ESG writ large will be blamed - potentially dismissed - for failing to achieve a sustainability it was never designed for. We really need clarity here, and tools that account for the major differences. Check out HBR's recent article about this.
2. Companies lack impact data and the tools to make reasonable, meaningful claims without it.
I talk to investors with an impact lens almost every day, and when I ask them about their measurement practices, they often speak to their concerns about overburdening companies with requests for impact data. But this concern reflects a deeper reality. Impact measurement is perceived as an added burden because the reality is that purpose-driven companies almost always lack impact data. They may know for example how many people they've served clean water, but they cannot speak to additionality - the percentage of the customers drinking water uniquely because of their solution. I don't care whether they're seed or pre-IPO, companies often don't know what data to collect or how, or often how to make sense of it if they have it. It's no wonder then that impact quantification is viewed as burdensome. Investors themselves often don't know where to begin.
3. Even with impact data, metrics must be contextualized and comparable to be meaningful
We're accustomed to financial analytics. We know what healthy margins, growth rates or IRR's look like for different types of companies. We know what returns to expect with different strategies. But we usually don't know what impact metrics mean. If a company claims it can reduce 10 tonnes of carbon, is that a lot or a little? What kind of effect does this have on the broader problem? Over what period of time? Without experience and an advanced degree, absolute numbers without context don't tell us a whole lot. I want to know whether our most pressing challenges really subside as a solution scales and to what degree. Isn't this why we're building and investing in them? And I want to know how it compares to others to know whether this is my best option.
Contextualization, comparability and benchmarking are missing when it comes to impact. Which means that the solutions with the greatest potential for lasting, scalable change may lose out on funding to the prospects with the greatest financial promise. The goal is to have the tools, the intelligence to be able to build and invest in solutions that can maximize for both financial and impact returns, or evaluate tradeoffs according to mission and mandate. That should be our North Star.
4. Investors must have the tools to evaluate the legitimacy of company-level claims with the same clarity and analytical sophistication of traditional financials.
Investors want to back companies that deliver healthy returns while also addressing the world's most pressing challenges. But the two worlds speak different languages. It's not fair to expect asset managers to speak sustainability and understand the credibility of claims across the spectrum of impact verticals, especially when those claims are just narratives. Storytelling and intentionality must be supported with the same clarity and standardized analysis that we expect with financials. When investors go to place their bets, how can they understand whether a $5M investment would 1x current impact? 10x it? 1000x? Could that investment drive greater multiples with another company? The two worlds need to speak to one another if they're going to play together.