Impact investing is a way for financiers to actively solve the world’s problems. From decarbonising industries to expanding access to healthcare and education, it promises to align capital allocation with ethical ambitions.
The market is rapidly gaining momentum. Impact investing surpassed $1.5tn (£1.1tn) in commitments globally in 2024, according to the Global Impact Investing Network (GIIN). But investors often fail to ensure their activities deliver the social or environmental outcomes they aim to achieve.
Impact risk isn’t actively managed
Few impact investors attempt to confirm the results of their strategies, according to a study published in the Journal of Business Ethics entitled Who Loses in Win–Win Investing? A Mixed Methods Study of Impact Risk. The researchers asked 124 impact investors to define impact outcome and explain the metrics for measuring success. They found that determinations of impact are often based on compelling narratives or assumptions – what feels right – rather than rigorous evaluation.
The study revealed that many investors pay little attention to ‘impact risk’ – the chance that their intended outcomes won’t be achieved or that their activities could even cause harm. If such risks are not actively managed, well-intentioned projects can go awry. For instance, clean-energy developments may uproot vulnerable communities or healthcare efforts might fail to satisfy local needs.
“It’s not enough to mean well. Investors must challenge the results they say they’re delivering.” So says Lauren Kaufmann, an assistant professor at the University of Virginia’s Darden School of Business who co-led the research.
The win-win mindset
This oversight stems from what Kaufmann calls the ‘win-win mindset’: the belief that financial success and social impact inherently go hand-in-hand. More than half of the investors surveyed agreed that the two are inextricably linked.
Such thinking stems from investors’ failure to provide impact-specific data. “Financial professionals are accustomed to defining success or failure using financial metrics,” Kaufmann explains. “Consequently, they tend to use financial measures of performance, such as revenue growth or sales figures, as a proxy for impact performance.”
But impact and financial performance can decouple. A company might be financially healthy, but if the goal is to empower more women in leadership, for instance, strong financial performance alone will not indicate progress towards that objective. “This reliance on financial metrics means investors are more likely to miss whether their investments are truly achieving positive social goals, even if the portfolio company is financially healthy,” Kaufmann says.
Investors must challenge the results they say they’re delivering
The researchers found that investors tend to consider impact risk very early on in the deal cycle, typically during pre-investment screening or due diligence. But once an investment passes this initial screening, investors consider it to be ‘de-risked’. “The consideration of impact risk often tapers off dramatically, or entirely, following capital deployment,” Kaufmann says. “Those who believe that their investments are inherently impactful due to thorough pre-investment due diligence may then assume that post-investment financial success automatically implies social impact.”
This is potentially problematic for communities or ecosystems that depend on these investments to deliver results.
While the win-win mindset may be useful in screening and identifying opportunities, it limits investors’ understanding of the full effects of their activities. “Most investors we spoke to exhibit a lower likelihood of ongoing performance measurement or evaluation,” Kaufmann says. They are less likely to set quantitative targets, form hypotheses and understand why investments might fall short of impact goals.
What’s next for investors?
“There’s a growing concern that impact investing is more comfortable with storytelling than with evidence,” Kaufmann explains. “If we want to live up to the promise of this field, we need to get much more serious about understanding what works, what doesn’t and why.”
Investors, Kaufmann argues, should approach impact as a hypothesis – one that must be tested, tracked and refined with the same rigour applied to financial returns. “This means monitoring outcomes over time, listening to affected communities and being open about both successes and shortcomings.”
Digital tools are emerging to help investors gather both qualitative and quantitative feedback directly from those impacted by investment activity, asking them how their lives have changed thanks to the intervention. Yet questions remain about how investors can effectively evaluate impact risks without burdening themselves or their portfolio companies with potentially onerous reporting requirements.
There many industry-backed frameworks to support investors in assessing and measuring impact value and risk, such as Impact Frontiers and GIIN’s IRIS+, both of which align with the UN Sustainable Development Goals. However, these are often underused or only partially implemented.
One reason for this is the perceived complexity and generality of the frameworks. Investors frequently struggle to adapt the guidelines to specific contexts, Kaufmann says. “Many impact investments are seen as too bespoke or niche, making it difficult to pull down high-level guidance into the granular, sector-specific detail required on the ground.”
Impact investing faces several challenges
Too many investors and analysts still believe that ethical investments will fail to generate financial returns comparable to those of traditional investments. Impact investors therefore face significant pressure to demonstrate the viability of their strategies, even though measuring social or environmental impact is notoriously complex and outcomes may take years to materialise.
Because of this, Kaufmann argues, many investors are reluctant to concede any failures to hit impact targets, fearing that such admissions could cause sceptics to denigrate their strategies and discourage activity in the space. Impact underperformance therefore is likely under-reported. According to recent GIIN surveys, only 1% to 3% of investments have failed to achieve their impact goals. But Kaufmann says these figures are unrealistically low considering the challenges involved in measuring impact risk.
There’s a growing concern that impact investing is more comfortable with storytelling than with evidence
“Establishing channels for investors to have frank open conversations and share failures could help the industry collectively improve,” she adds.
Another challenge is the emphasis on creating standard rigid benchmarks to compare impact across or within impact funds. “While these efforts are well-intentioned, because asset owners want to efficiently allocate capital, the industry may not yet be at a stage where such uniformity can provide all the necessary information,” Kaufmann explains.
Political scrutiny is further complicating impact investing. Many US states have introduced legislation banning ESG investments, which makes candid post-investment monitoring even more challenging. “Without these external pressures, the motivation for deep, critical analysis using these frameworks is further diminished,” Kaufmann says.
As the market for impact investing grows, so does the responsibility on both investors and portfolio companies to ensure that well-meaning investments create tangible, positive results. Managing for impact should be just as rigorous as managing for profit. When investors assume their business model inherently delivers positive outcomes, they risk overlooking tough questions and may fail to act when problems arise.
Impact investing is a way for financiers to actively solve the world’s problems. From decarbonising industries to expanding access to healthcare and education, it promises to align capital allocation with ethical ambitions.
The market is rapidly gaining momentum. Impact investing surpassed $1.5tn (£1.1tn) in commitments globally in 2024, according to the Global Impact Investing Network (GIIN). But investors often fail to ensure their activities deliver the social or environmental outcomes they aim to achieve.
