Trends and Challenges for Impact Investing & Social Innovation in 2023

With 2022 behind us and the impact investing market now sized at $1T, we’d like to share some of the major trends and challenges we see at the heart of impact investing and social innovation as they move mainstream.

We are in the midst of a massive wave of human ingenuity, enveloped in the burgeoning field of impact investment.

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 concurrence of socially responsible organizations and private markets is a beautiful thing, but like any other (relatively) new idea, it comes with challenges.

Understanding the Difference: ESG vs Impact Investing

In looking to quantify the positive impact a company has, many people will point to environmental, social, and corporate governance (ESG) as a sound metric. However, with this metric, companies like Phillip Morris and Exxon Mobile rank within the 80th ESG percentile.

ESG was devised to mitigate risk for the company, with the main focus on safeguarding the company and its investors rather than prioritizing the well-being of the planet. Its quintessential purpose lies in shielding companies from the inescapable consequences of social and environmental volatility.

Why aim for impact instead of ESG for sustainable change?

Impact is designed to fuel change for people and the planet. The two terms get conflated, but their intentions and practical applications are very different.

ESG brings attention to operational risks arising from social and environmental volatility, while Impact emphasizes enhancing outcomes, access, and resource efficiency through products and services. Misunderstanding these concepts unjustly places the burden on the broad scope of ESG, potentially leading to its dismissal in achieving sustainability goals it was never intended to address.

There is a need for clarity and impact assessment tools that account for the major differences. Check out HBR’s recent article about this for more information.

Why do Companies Struggle with Impact Analysis Tools?

We speak to investors with an impact lens almost every day, and when asked about their measurement practices, they often speak to their concerns about overburdening companies with requests for impact data.

This concern highlights the perception that measuring impact is seen as an additional burden. However, it’s important to recognize that socially responsible organizations often lack comprehensive impact data. While they may have knowledge of the number of people served with clean water, they may struggle to articulate their additionality—the percentage of customers benefiting exclusively from their solution.

Regardless of whether they’re seed or pre-IPO, companies frequently struggle with determining what data to collect, how frequently to collect it, and how to analyze it effectively using sustainability analysis methods. It is not surprising, then, that quantifying impact is often perceived as a burdensome task, especially by investors who themselves may be grappling with the evidence gap in impact investing and may be unsure of where to start.

If you’re lost on where to begin, here is a useful resource from The Global Impact Investing Network.

Contextualizing and Comparing Metrics Essential for Meaningful Impact

Financial metrics like growth rates or IRRs have become second nature to us. However, despite our familiarity with these concepts, comprehending the full extent and implications of actionable data can still pose challenges.

When a company declares it can reduce 10 tonnes of carbon, one might wonder, is this a significant or negligible amount? What impact does such a reduction have on the larger issue at hand? And for what duration does this effect persist?

In the absence of experience and an advanced degree, isolated numerical values devoid of context provide limited information. Impact assessment tools are, therefore, critical in understanding the broader ramifications.

We need to comprehend the true mitigation of our most pressing challenges as a solution expands and to what extent. Moreover, it is imperative to gauge how it fares against alternatives in order to ascertain if this represents our optimal choice.

When it comes to impact data, we often lack proper contextualization, comparability, and benchmarking which contributes to the ongoing evidence gap in impact investing. As a result, solutions that hold the greatest potential for long-term change may find themselves overshadowed by opportunities that promise greater financial returns. It is crucial to address this discrepancy to ensure a more balanced allocation of funding for lasting impact.

The objective is to possess the necessary tools and personnel to construct and invest in solutions that optimize both financial and impact returns. Additionally, this includes the ability to assess tradeoffs in alignment with the mission and mandate.

What Tools Do Investors Need to Evaluate Company-Level Impact Claims?

Investors want to back companies that deliver healthy returns while also addressing the world’s most pressing challenges, but this is easier said than done.

When investors go to place their bets, how can they understand whether a $5M investment would double or triple the current impact? Could that investment create a greater impact with another company?

It’s difficult for asset managers to understand sustainability and 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 impact assessment tools that we expect with financials.

For investors to feel comfortable in this space, there must be a consistent method to comprehend the impact claims of a company and bridge the prevailing evidence gap in impact investing.

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