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Impact investing is on the rise, but despite growing interest, the space is still plagued by some roadblocks that limit the flow of capital into the ecosystem. Impact investing can take on anything from venture investments in climate tech, to microfinance loans in emerging markets, to affordable housing in the US. Some impact funds prioritize social or environmental results, and are thus willing to accept concessionary returns, while others focus on investment results, prioritizing market rate returns.  
 
Ultimately, the grouping of these diverse investments into one category has created some confusion in the financial community. Is impact investing profitable? What is an impact strategy? How does one measure impact? Here we explore the impact investing landscape, addressing some common questions about the space.

What is impact investing? Exploring impact investing principles

Impact investing, falling under the umbrella of sustainable investing, is a strategy of investing in enterprises , organizations and funds with the dual goal of generating a positive, measurable social or environmental impact alongside a financial return. This dual goal of a positive financial and social return is often referred to as the double bottom line. Most commonly, impact investments are made in the private markets through closed-end structures such as PE and VC funds, but private debt is an increasing avenue for impact investors.

What constitutes “impact”?

“Impact” refers to external positive environmental or social influence achieved by a company and is concerned with outward-facing effects on pressing matters in society. Impacts can be made in emerging or developed markets across a multitude of categories, such as education, climate and diversity and inclusion—to name a few.  
 
Impact takes on different meanings to different investors and can vary significantly across business sectors, investment strategies and geographical regions. These differences are informed primarily by the context of the stakeholders, enterprises and the populations served by an investment. For example, an investment in a small business in an emerging market might be deemed impactful because of the resulting job and income creation in a disadvantaged location. The same investment in the US, however, may simply be categorized as a small business loan.
 

Who makes impact investments?

Impact investment strategies exist across a wide variety of alternative asset classes. There are impact funds available for PE, VC, debt, infrastructure, hedge funds, real estate and even funds of funds. Some investors are dedicated to making only impact investments, while others may house both impact and non-impact funds in their menu of offerings. A few of the biggest players in the impact investing landscape include:
 

• Foundations 
• High-net-worth individuals (HNWIs) 
• Family offices 
• Pension funds and insurance companies 
• Government institutions 

How is impact investing different from ESG?

ESG—or environmental, social and governance—is a framework used to evaluate a company’s risk exposure, management capacity and value creation opportunities in these three areas. ESG risks or opportunities could fall under areas such as environmental sustainability, legal and regulatory compliance and ethical business practices.  
 
As previously mentioned, impact investing is an outward facing investment strategy, in which investors seek to have a direct positive environmental or social result while also making a financial return. While many equate impact with ESG, ESG is more concerned with how the world and the company’s actions are going to materially impact the company rather than how the company is impacting the world. ESG is part of the investment process whereas impact is a strategy, concerned with the types of investments a manager is targeting.

What is an impact strategy? Exploring different types of impact investing

Within the landscape, there are many types of impact investing. Various investors carry their own return goals, risk tolerances, and missions for what they hope to impact. Certain investors take a thematic or specialist lens, zooming in on a specific area, such as pollution, agriculture, or health. Others take a more generalist approach, investing in companies aiming to use their investment dollars to affect a wide range positive outcomes. Some investors care about certain geographies while others prefer investing by stage—from the new solutions found with VC start-ups to the opportunity to improve existing businesses through PE investments.  
 
Many LPs try to align their impact investing to their organizational missions—a university endowment might invest in education, a community foundation might seek out affordable housing options, and a sovereign wealth fund may look for economic development opportunities. It can sometimes be difficult to pair an LP’s goals for their impact investments to available strategies in the market. For those with very particular impact goals in mind, especially if there is a narrow geographic focus, compromises must typically be made.  Maybe a GP can be convinced to make a best effort attempt to find attractive investments in a particular impact category in a particular geography, but the fund may also have to look elsewhere if market-rate returns are still expected. 
 
 While there are a variety of paths investors can take in the impact investing landscape, there is no right or wrong approach, and this broad spectrum of different types of impact investing can result in very different looking impact portfolios.
  

Is impact investing profitable?

Perceptions and reality are hard to unwind when it comes to the performance of impact investments. Some impact investments are made with the understanding that the social or environmental impact justifies a lower, or concessionary, investment return.  Among these might be low-income housing funds, which provide a fixed income stream to investors at a lower than market rate.  There are many impact fund managers, however, who reject this idea and insist that market-rate returns are what they intend to provide. Some in this latter camp shy away from naming themselves impact funds because they fear that the label will scare off potential LPs. They will sometimes call themselves “finance first” funds to ensure potential LPs understand their stance.
 
A 2020 survey conducted by the Global Impact Investing Network (GIIN), showed that two-thirds of impact investing organizations within the impact investing landscape seek out market-rate returns with the remainder willing to accept concessionary returns. Typically, the desired rate of return will depend on the type of investor. For example, according to the survey, 48% of private debt-focused investors pursued market-rate returns while 81% of PE-focused investors targeted market-rate returns.   
 
While some rail against the idea of investing for below-market returns, in the case of affordable housing funds, investors are often asked to accept concessionary returns in order to maintain the affordability of the property. Should the landlords push for market-rate rent increases or make improvements that allow them to charge much higher rents, the stock of affordable housing would diminish with these investments. However, impact funds can also be extremely lucrative—many climate-related investments in the tech space fall under the impact umbrella and often, provide strong, competitive returns.

Impact investing frameworks

There are a variety of frameworks and standards within the impact investing landscape investors can reference when determining how to build and report on a strategy. However, the most frequently adopted are the IRIS+ framework and the UN’s Sustainable Development Goals (SDGs).   

IRIS+ Framework

In response to the broad array of terminology and themes plaguing the impact investing landscape, the GIIN created the IRIS+ Framework, a thematic taxonomy designed by industry practitioners to define impact categories and themes along with core metric sets for reporting and evaluating each theme.  This framework provides a shared language for assessing, reporting and evaluating impact performance. IRIS+ is advantageous to the impact investing landscape in that it was designed with investors in mind—the GIIN worked with global stakeholders from the asset owner, asset manager and service provider communities to create an impact investing framework built on how investors, and the enterprises in which they invest in, develop strategic goals, portfolios and business models.  
 
In the framework’s current form, there are 17 impact categories ranging from areas such as agriculture and education to water and air. Each of these 17 categories is then broken down into investable themes along with strategic goals and delivery models. For example, investable themes under agriculture include food security, small holder agriculture and sustainable agriculture. Themes under climate include climate change mitigation and climate resilience and adaptation.  
 
The IRIS+ framework has played a significant role in the impact investing landscape. Not only does it provide guidance on impact investing principles, but it has also played an influential role in providing the resources necessary for the standardization needed to scale the space.  
 
By offering a system designed by and for investors for defining, measuring, managing and reporting impact, IRIS+ allows investors to compare impact investing data and allows for the transparency and credibility needed to increase interest among investors.  

IRIS+ categories and themes

Sustainable development goals

The UN’s Sustainable Development Goals (SDGs) were developed in 2015 and consist of 17 global objectives to be achieved by 2030, ranging from gender equality to clean water and sanitation to sustainable cities and communities. The SDGS offer guiding quantitative metrics to achieve each of the objectives and are accepted by every country in the world, making them one of the frameworks leveraged most often by impact investors.  
 
However, the SDGs were not designed solely with investors’ needs in mind—rather, they are meant to guide the efforts and resource allocation of governments, businesses and charitable organizations. With the achievement of social goals at their core, the SDGs do not always provide a clear path to an investment opportunity, with public policy initiatives or other solutions without a profit motive sometimes providing better fits for certain objectives. But despite not being specifically designed for investors, the SDGs have seen widespread adoption among many private market participants, leading more investor-centric standards to map their taxonomies to them.   

Measuring and reporting on impact metrics

Many of the most passionate players in impact investing hold the philosophy that only quantifiable impact is impact or that impact investing principles should require measurement as a necessary component of an impact strategy. However, it can be incredibly challenging to track the effect or impact that a product or service has and there has yet to be any universal convergence on a standardized reporting framework in the space. Although, this is changing with the increased convergence towards the IRIS+ framework.  
 
The lack of standardized reporting in the impact investing landscape does pose challenges to investors. Every portfolio company has its own relevant impact metrics, and each GP rolls up those metrics in portfolio level reporting to their LPs. This often cause LPs to receive vastly different reports from each GP with whom they have invested, leading to a lot of data, but not a lot of information, since many of the metrics are difficult to aggregate. This lack of unity about how to quantify impact has raised concerns about impact washing, a topic discussed in detail in our analyst note ESG, Impact and Greenwashing in PE and VC.  

What’s the future of impact investing? 

As impact investing landscape matures, the performance of pioneering impact funds has been crucial for establishing credibility, best practices and paving the way for future managers. The entrance of mainstream investment firms lends additional credibility and attention to the approach, helping attract a larger base of for-profit capital. Although this is a welcome development, PitchBook analysts advise that impact investors take care to ensure these firms are offering products that are truly managing for the double bottom line. 
 
At a base level, impact investing is an innovation on philanthropic capital that investors seeking social or environmental change can utilize to scale the reach of their allocation while still enjoying financial returns. More products are coming to market to meet this need, improving the universe of investable opportunities.