Impact investing grows up: from intentionality to additionality (Part 1/5)

This is part one in a series of five articles. You’ll find part two here, part three here, part four here and part five here.

Falko and Harald discuss the current state of impact investing: where we are, why we’re here, and where we need to go. They draw on recommendations that commentators made as far back as 2012, and introduce new frameworks that help investors who are looking for “additional impact” to identify the most effective tools. This is part one in a series of five articles.

Part 1: Introduction & Summary 

The term “impact investing” was coined in a Rockefeller Foundation meeting in 2007. While we don’t know the exact date, we can assume this means impact investing is celebrating its 18th birthday this year, which would make it a late adolescent: almost, but not quite, ready to enter adulthood.

Of course, the practice that is described by the term – the practice of addressing social and environmental problems with investments that also generate financial returns – existed before 2007, but a community of practice and research really came into existence only after the term was coined: investors who call themselves “impact investors” and try to allocate (parts of) their portfolios to impact, advocacy groups such as the GIIN and Toniic being established and supporting the community, academics publishing research about impact investing.

We’ve been following this young adult’s progress for the last ten years and (full disclosure) have also actively mentored and promoted her. At the same time, we’ve seen that impact investing, like any teenager that is finding her way, has not reached its fully-developed adult state, and can take paths and decisions that seem irrational, perhaps inadvisable.

In this series of five articles, we paint a picture of this youngster: how did she get to where she is today? What are her ambitions? But also we want to advise her. We feel we have sufficient investment, academic, sustainability and advisory experience to offer some recommendations that will allow impact investing to reach its full potential and for it to make a significant contribution to a better world. 

But we we are also inviting into this article some wise aunts and uncles who have been counseling her – counsel that hasn’t always been taken on board.

OK, enough with the adolescent analogy. In short, the argument that we set out here is as follows:

1. The original idea of impact investing is causing change that wouldn’t otherwise occur: CC2.
2. But many investors have also been attracted by the “good person” identity and the “warm glow” that impact investing confers.
3. Identity and warm glow are achieved by emphasizing “intentionality”, by affixing easily obtainable labels to investments, and by measuring impact with methodologies that do not capture additionality.
4. Investors have also been promised that “impact & return go hand-in-hand” and so many invest in easily accessible markets and projects that are already profitable but don’t provide additionality.
5. Therefore a lot of impact investment has been the re-labeling as “impactful” of market-rate investments that would have been made anyway.
6. And so many impact investors have drifted far away from the original idea – cause change that wouldn’t otherwise occur – as they ignore their investments’ causality and additionality and assume that where there is change it can be attributed to them.
7. Therefore, investments that offer real additionality are overlooked, because they do not (yet) offer market rate returns or because they are in markets that aren’t easily accessible.
8. In short, impact investors seeking CC2 who can make concessional investments should redirect their focus here: less accessible markets where their investments can literally make a difference.
9. Investors who cannot make concessional investments but whose deep pockets we’d still like to leverage can be brought in by using subsidy elements ensuring they meet their risk/return requirements.
10. Bringing activities towards, or into, the overlap of the “impact” and “return” circles in the SDG Venn diagram, thereby making that nexus larger, is hard work, but private wealth, institutional investors and philanthropic foundations can play a role.

In sum, we are advocating a shift in focus: from the strong emphasis on intentionality and identity – which requires asking: “can this impact investment be attributed to me?” – to an emphasis on additionality and systems – which requires asking “how do we ensure adequate funding of needed solutions to global problems?” And: “how do we effect the system change that is often needed for this?”

And so, in the four following articles, we discuss the following aspects of impact investing: 

Additionality & Measurement 

Impact investing is all about investing to:

• Cause (“C”)…

• Change (“C”)…

• That Wouldn’t Otherwise Occur (“TWOO”, or “2”)

We don’t want to coin a new phrase but in article 2 in this series we refer to this thinking as “CC2”: there should be some kind of change; the change should be caused by the investment; and the change wouldn’t have occurred without the investment. Note that these last two elements are another way of saying that we are looking for additionality.

We think that most involved in impact investing today would agree with this CC2 model. However, in establishing where there is impact the focus today is predominantly on the second element: is there change? There is little regard for the two other elements: did our investments cause that change? And is it change that would have happened anyway? While this is understandable – there are no metrics or indicators for either of these two elements – we’ll argue impact investors should be more attuned to them by developing thoughtful theories of change and thinking about measurement more in terms of ex-ante rather than ex-post reasoning. 

“Impact & return go hand-in-hand” & SDG Venn diagram

Much of the community has been drawn into this space by the promise of, not only impact, but also market-rate, or even above market-rate, financial returns: investments are often promoted with the line “impact and return go hand in hand”. This win-win narrative is good PR but doesn’t do justice to reality.

Referencing the SDG Venn diagram, in article 3 of this series we argue that, while it’s certainly possible for impact investments to offer market-rate returns, (1) finding those investments or realizing that return requires more than a little hands-on involvement of investors; (2) the total market for these investments is small, and the number of opportunities in secondary markets involving listed companies is close to zero; (3) by suggesting that finding market-rate impact investments is easy, because they are plentiful, impact investors are discouraged from seeking opportunities to get involved in investments that do not (yet) offer market-rate returns – usually the projects that are most in need of financing. And that will deliver the largest impact.

Intentionality & Identity

The importance of intentionality has been dramatically overstated. This has likely happened because for many impact investors, perhaps unwittingly, an objective of making impact investments has been to achieve “warm glow”, and attain the identity of someone who does good for the world. Emphasizing intentionality allows them to do this. However, because the emphasis is on satisfying the intentionality component, there has been less appreciation of the other – we’d say more important – component: additionality – causing change that wouldn’t otherwise occur. So, as we conclude in article 4 of this series, while many an impact investment may have been made with full intent to deliver impact, likely few of them would pass the CC2 test: did they (1) cause (2) change (3) that wouldn’t otherwise occur?

Systems & Subsidies

Next, in article 5 we talk about the market for impact investments that do not (yet) offer market-rate returns, i.e. require some form of subsidy, and we’ll argue that impact investors who genuinely want CC2 – cause change that wouldn’t otherwise occur – should direct their focus here. Using the SDG Venn Diagram again, we identify a number of tools they can consider. Incidentally, this doesn’t necessarily mean giving up returns. For those investors who are seeking only market-rate returns there are various tools that can be used to turn non-investable assets into investable assets.

Our arguments lean heavily on those of a number of commentators who – in a set of articles published by the Stanford Social Innovation Review (SSIR) – have started making similar observations as far back as 2012, but that we feel have been overlooked. We want to bring them back to the current debate and will therefore reference them frequently:

• Sectors, Not Just Firms; Do No Harm: Subsidies and Impact Investing and Government Matters (2012), By Matt Bannick & Paula Goldman (“Bannick & Goldman”)

• The Trouble With Impact Investing: P1 / P2 / P3 (2012); Kevin Starr (Part 2 with Laura Hattendorf (“Starr”)

• When can impact investing create real impact / Unpacking the Impact in Impact Investing (2013); a long and shorter version of the same article, Paul Brest & Kelly Born (“Brest & Born”)

• How Investors Can (and Can't) Create Social Value (2016); Paul Brest, Ronald Gilson and Mark  Wolfson (“Brest, Gilson and Wolfson”)

• How to Overcome ‘Warm Glow’ and Other Barriers to Effective Impact Investment Decisions (2020); Matthew Lee & Jasjit Singh (“Lee & Singh”)

• Impact Investing Can’t Deliver by Chasing Market Returns (2023); Jim Bildner (“Bildner”)

We picked these from a much larger universe of articles on impact investing because they best encapsulate how to think about its moving parts, but also to show that smart advice on impact investment has been available from the early days, and that we can be more effective by heeding it.

This article is also based on insights from four papers that Falko co-authored together with other academics in recent years:

• Between impact and returns: Private investors and the sustainable development goals (2022); with Timo Busch, Sebastian Utz, Anne Kellers

• Do Investors Care About Impact? (2021); with Florian Heeb, Julian Kölbel, Stefan Zeisberger

• Unlocking the black box of private impact investors (2021); with Sarah Louise Carroux, Timo Busch 

• Wealthy Private Investors and Socially Responsible Investing: The Influence of Reference Groups (2021); with David Risi, Anne Kellers

Finally, in writing this series, we have greatly benefited from conversations with Paul Brest, James Gifford, Robert Boogaard and Jonathan Harris.

In one of the SSIR articles referenced above, Kevin Starr said “When you do a three- part series called The Trouble with Impact Investing, people might reasonably conclude that you just don’t like impact investing. Not so—I think that if we do it right, impact investing might do a lot of good.” 

We feel exactly the same way, and in the articles that follow want to provide practical guidance on what it means to “do it right”.

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