Oscar Byrne, Paul Hewat, Teun Lowie, Xenia Loos & Marlene Stam, from Collective Action
What is Impact Investing?
Impact investing, a term coined in 2007 by the Rockefeller Foundation, refers to investments where the generation of positive social and/or environmental impact is targeted alongside financial return. Unlike traditional finance, impact investors add impact as a third dimension alongside risk and return, aiming to invest in profit-driven companies providing solutions to social and environmental challenges without sacrificing return.
How is this different from responsible or sustainable investing?
Sustainable investing integrates ESG factors into investment strategies, balancing financial returns with sustainability criteria. It uses ESG ratings (from providers such as MSCI and Sustainalytics) to assess company risks and opportunities, building sustainability criteria that align with their investment strategy1. However, ESG ratings focus on internal compliance, not the actual impact of a company’s products or services on society and the environment.
Impact investing takes it further, targeting companies whose core products or services actively solve social or environmental problems. For example, an impact investor might invest in a company developing innovative water purification technology for communities lacking access to clean drinking water. This company’s primary goal and revenue stream come from solving a critical problem – in this case, water scarcity and contamination. Sustainable investing, on the other hand, focuses on companies that operate in a more environmentally and socially responsible manner within their industry, even if their core product isn’t directly solving a global challenge. In this context, a sustainable investor might choose to invest in a car manufacturer that has significantly reduced its water consumption in the production process, achieving the lowest water usage per vehicle in the industry. While both approaches consider environmental factors, impact investing directly funds a solution to the water crisis.
What are the core characteristics of Impact Investing?
The practice of impact investing is defined by three core characteristics (Figure 1):
Figure 1: The core characteristics of impact investing.
Intentionality:
Impact investments must have a clear intention to generate measurable social or environmental benefits. This is commonly supported by a “theory of change” that communicates a clear pathway from needs to activities, outcomes, and ultimately, to achieved impact. This aspect of intentionality is what differentiates impact investing from other investment strategies that take into account impact considerations but fail to incorporate it into their core mission in each investment.
Measurability:
Impact investments require rigorous measurement and reporting of outcomes to ensure accountability. This includes necessary management toward the outlined intention through feedback loops and communicating progress to other stakeholders within the investment chain towards the desired impact. Measurability should be built into the investment strategy based on reputable evidence and data to support investment decisions.
Additionality:
Impact investments should produce outcomes that go beyond what would have occurred without the investment and should not be attributable to other factors.
The Spectrum of Capital
This paradigm shift away from “traditional finance” is depicted in the Spectrum of Capital (Figure 2). It illustrates the range of investments focused purely on financial returns, from the integration of ESG risks and opportunities, to targeting measurable impactful solutions with varying financial return targets, culminating in philanthropy.
Figure 2: The Spectrum of Capital
Impact Investments, unlike sustainable investments, are typically limited to private markets (e.g., Private Equity, Debt, and Real Assets). They fall under two categories:
1. Thematic investments: A rapidly growing segment attracting family offices and institutional investors with a fiduciary duty to generate both financial returns and a positive impact. These target planetary themes (climate, food and agriculture, water, circularity, biodiversity) or social themes (healthcare, education, financial inclusion). Investors often choose themes aligned with their background, values and strategic priorities (e.g., a health insurer prioritising healthcare investments).
2. Impact-first investors allow a trade-off in financial return for enhanced impact in their targeted area, accepting below-market rate returns. Common players in this space include government and development finance institutions that can prioritise specific social and/or environmental goals while providing proof of financial viability to private sector investors.
A prime example of thematic impact investing is Dendra Systems, an environmental tech company leveraging AI and drone technology for biodiversity conservation. Dendra’s solutions focus on data-driven forest restoration, offering services from drone-based tree planting to software for monitoring ecological health. Their business model demonstrates a clear theory of change with measurable impact, making it attractive to investors seeking both environmental benefits and financial return. By scaling their services, Dendra Systems achieves significant positive impact on biodiversity while providing a compelling investment opportunity in the growing field of environmental technology.
ENDS
Sources:
https://www.msci.com/sustainable-investing/esg-ratings
https://www.impacteurope.net/stream/additionality
https://thegiin.org/publication/research/2023-giinsight-series/
Collective Action Research
