Everything and therefore nothing: why we must reject the ‘impact’ investors adding nothing new

Almost every mainstream investor has, by now, come across the term ‘impact investing’; a significant number has at least one fund with an impact label. However, without a generally agreed set of characteristics that help assess what real impact investing is, there is a growing risk of impact washing – in other words, recycling traditional activities under the impact investing banner.

Existing sector surveys do not help to clarify boundaries. All existing market analyses are based on surveys, whose respondents self-identify as impact investors by virtue of their intention to create positive social impact. However, intentions are completely subjective, and thus not a good way to determine who is and who is not actually doing impact investing.

Measuring social impact is often considered a way to lend objectivity to the subjective measure of intentionality. However, despite the proliferation  of impact measurement methodologies – which are largely the realm of researchers and academics rather than investors themselves – as yet there is  no single way to measure and compare investments according to their social impact. Those who work in impact investing know very well that  impact is measured on an individual transaction basis. Impact investors tend to choose a methodology based on their preferences and according to  what is appropriate for their own investment and communication strategy.

 Social impact measurement is extremely important and it is right to study the subject. But, at least for the time being, it cannot be the key factor to define the boundaries of the impact investing sector.

 As a result, it is clear that we lack clear boundaries and, in particular, an appropriate segmentation that enables us to distinguish the various players.

 I strongly believe that the boundaries should be drawn following the original motivations behind impact investing: to promote new business models suited to dealing with social needs and creating social innovation.

 This would mean defining the actual market of impact investing as the entirety of operators that promote new enterprises and other early-stage responses to solving pressing social issues.

A defining feature: additionality

Using this definition, the boundaries are drawn according to additionality. Investors that focus on bringing new solutions to pressing social issues are in – the others are out. In this way we avoid traditional activities being recycled under a new name. Defining the boundaries of impact investing based on additionality helps recognise that investors that provide resources in the initial phase of a venture’s development have specific competences and operational knowhow.

Unlike the additionalists, later-stage impact investors are harder to isolate, categorise and monitor, because they invest in businesses that also attract traditional investors.

In this case, the history of microfinance can teach us something. Mainstreaming microfinance was only possible thanks to those who, having worked patiently and competently for 20 years, managed to achieve scalable models that then attracted the interest of a wider number of investors, each with different motives.

In the current debate, however, additionality is linked to a small segment of the market with ‘concessionary’ financial returns. In reality, additionalists seek to develop solutions to pressing social issues – unlike many intentionalists, who limit themselves to creating an element of social impact within existing commercial activities.

Additionality is at the basis of all innovation that a company achieves and therefore cannot be considered as niche in impact investing, but rather as the engine

The concept of additionality is not new, as it is at the heart of venture capital, where it is referred to as disruption. VCs’ raison d’être is to find new, therefore additional, solutions compared to existing ones. Additionality is at the basis of all innovation that a company achieves and therefore cannot be considered as niche in impact investing but rather as the engine, if the sector really wants to promote social innovation. Not recognising the centrality of additionality will reduce impact investing merely to a new financial product, limited to measuring the social impact of companies financed.

Impact investing is therefore VC applied to a more complex context, as generating social innovation is far more difficult than generating technological or commercial innovation.

From ‘impact first’ investors to ‘solution first’ investors

The historical distinction between ‘impact first’ and ‘finance first’ investors in impact investing is thus no longer adequate. It is in fact more correct to speak of ‘solution first’ investors, i.e. those investors that according to the canons of venture capital want to promote social innovation. Solution-first investors accept that social innovation is extremely complex and can take a very long time – and then produces, in the first phase of the company’s development, financial returns that are lower than that of the market. This new way of defining the market gives dignity and space to those who want to deal with more complex social issues and are in fact solution-driven. We must recognise the importance of this small nucleus of investors who, with limited resources compared to the immense private wealth circulating, create real social innovation that benefits all society, though generating no immediate financial returns.

We must recognise the importance of investors who, with limited resources compared to the immense private wealth circulating, create real social innovation that benefits all society, though generating no immediate financial returns

Financing companies that solve social issues can be a very risky investment, but – as they grow – they can become financially viable and bring returns to their investors. So, as in VC, investors change with their investees. In impact investing it is thus not a matter of foregoing a priori a financial return, but for the impact investor to accept the risks and above all the lengthy timescales that certain solutions need to reach a commercial risk/return correlation.

The evaluation of solution-first investors should therefore not just look at the results of their measure of social impact – which can at times be very superficial – but also more broadly at the solutions they’ve managed to develop compared to existing ones.

A new ambition for impact investing

The last 30 years have been dominated by the paradigm of shareholder value. There is increasing consensus that this paradigm is now creating inequality and other problems. Impact investing was introduced as an alternative approach. However, by gradually turning into a financial product, rather than a means to create better conditions for society, impact investing is losing sight of its original objectives.

Impact investing should also play an advocacy role – and this can happen only if it operates outside the current confines of the financial market, and helps to change it. The enormous amount of financial liquid wealth is causing the value of companies to become more and more tied to their capacity to attract resources. Often it is not the entrepreneur who creates value, but the investors who contribute to creating that value through their investments. They therefore have an enormous responsibility in the choices they make.

Impact investors must help move capital towards solutions that create more social value, by explaining to their mainstream counterparts that if these solutions are successful then they will scale and become mainstream, creating not only social, but also financial value for the investors.

Our societies are in trouble and everyone must recognise that investment choices have an impact on society as a whole. Institutional investors must ask themselves whether it is in the interest of their fiduciaries to protect their pensions to the full by accepting the negative effect that these choices will entail. It is therefore a question of convincing them to make a choice not of goodwill, but rather of self-interest.

Is this the right way to define impact investing? Is there a better alternative? Are there risks of drawing boundaries in the first place? Join the debate by tweeting, using the hashtag #ImpactPapers. 

Want to learn more? Hear from thought leaders from around the world at EVPA's 15th Annual Conference, Celebrating Impact, taking place in The Hague, 5-7 November.