Navigating Impact Investing

EXECUTIVE SUMMARY

The rapid growth of impact investing presents an unprecedented opportunity to harness the power of capital markets in service of addressing social and environmental challenges. However, along with this growth has come greater diversity and complexity, and with it, an acute need for clarity and common understanding. Addressing this need will be a critical next step in the market’s evolution and maturation.

Challenges and objectives

Even as the field of impact investing has made progress on multiple fronts, market observers and participants still face challenges in comprehending and navigating the market, in part due to the lack of shared knowledge and frameworks. This can create frictions for investors and investment managers:

• Misunderstanding - Practitioners agree the lack of common ways to talk about impact investing remains a key challenge for the field, contributing to confusion and uncertainty.
• Inefficiency - Investors and investment managers lament the bespoke, drawn-out effort required to identify appropriate counterparties that are aligned on financial and impact objectives.
• Misalignment - Practitioners also worry that investors will turn their backs if financial or impact expectations are misaligned or unmet, in the absence of more universally understood frames that can better establish appropriate objectives.

The Navigating Impact Investing project was created in Fall 2015 to explore these challenges, how they are currently managed by practitioners, and what may be needed to help optimize the process of matching an investor's unique risk, return, and impact preferences with the right impact investment opportunities.

Findings

Research and practitioner insights indicate the crux of the problem is the difficulty articulating, analyzing, and differentiating the impact in impact investing. Whereas the tools exist to understand investments on the basis of financial characteristics, the same cannot be said of impact characteristics. Proven methods for evaluating impact are becoming more widely adopted, but the project surfaced a need for additional clarity on impact at a more basic level, earlier in the investment process.

In traditional and impact investing, asset classes provide tremendous benefits as a frame for grouping investments with similar financial characteristics. Unfortunately, there is no equivalent shorthand for the impact in impact investing – i.e., no limited, agreed set of objective categories of investments that share similar impact characteristics and can therefore be more readily compared and contrasted. The research team has posited that an analogous set of “impact classes” could be an important additional grouping of the market, alongside other established tools and frameworks. The project has taken an inclusive approach, looking at the impact dimension of investments across asset classes, across sectors, and consequently, across a portfolio.

There is broad support for this hypothesis. In a post-event survey following a convening of 40 members of a dedicated project advisory group in February 2016, 81 percent of the 27 respondents agreed “the field of impact investing needs a broadly accepted and applied framework for categorizing the many ways in which funds/intermediaries create impact through investment.”

As indicated in the same post-event survey, if successfully developed, impact classes could:

• Make it easier for asset owners and their advisers to filter down the range of impact investing opportunities to find the cluster or clusters that are most appropriate for an asset owner's preferences (76 percent agreed)
• Encourage investment managers to provide information on approaches to impact that is more consistent and/or standardized, providing efficiency benefits for asset owners and their advisers (77 percent agreed)
• Help networks, academics, and others to research and analyze the market by providing a necessary system of classification (76 percent agreed)

Designing impact classes

Translating the impact class concept into a practical framework that can be broadly adopted requires careful consideration and diverse input from the market. Practitioners emphasized a number of design characteristics. Impact classes should be:

• Simple
o Straightforward and compelling: Impact classes that can be easily understood will likely have wider adoption and be more useful as a result.
o Limited in number: The fewer the number of impact classes, the more likely they are to yield efficiency benefits.

• Objective
o Meaningful, but objective: Impact classes need to offer product providers the opportunity to distinguish their work, but retain the possibility of third party verification.
o Neutral on the degree or quality of impact: Impact classes need to be descriptive without making value judgments.

• Universal
o Inclusive, cutting across asset classes, sectors, and public and private markets: One of the most promising opportunities for impact classes is to be able to compare the impact dimension of investments across asset classes, across sectors, and consequently, across a portfolio.
o Categorical and exhaustive: Impact classes should capture and distinguish the depth and breadth of activity in impact investing, but also not stifle further innovation.

A number of intriguing variables have surfaced during the course of the research, with the potential to distinguish approaches to impact investing in a way that is consistent with the design requirements above. The three that emerged as most promising include:

• Role of impact investing capital: The role of capital in influencing the formation, growth, or behavior of an investee and its impacts can be readily categorized.
• Type of impact evidence: The nature and depth of impact evidence provided by investment managers and required by investors can be objectively distinguished by a limited set of classifications.
• Market and beneficiary characteristics: The characteristics most commonly referenced in our interviews for distinguishing impact investments include the stage of development of the target market, the level of vulnerability of beneficiaries, and the extent to which the capital provided is essential.

The challenge is to consider how these or other variables can be brought together into a single framework that, if and when implemented, brings about broad, practical benefits to the market. Impact classes should not remain a theoretical concept or just another framework – the goal is that over time and with further consideration they become an actionable tool grounded in practical applications.

Next steps

Impact classes remain a concept under development. Further research and market engagement will help to inform the key next steps: further clarifying purposes and audiences, defining the right variables that underlie impact classes, and determining the means of achieving broad adoption, if basis for exploring the potential relationship between impact and financial performance. It is clear the prospective, broadly agreed benefits of impact classes merit the close attention of practitioners. This research shows that many diverse stakeholders in impact investing concur: There is a need to segment impact investing more definitively, around the approach that investors take to delivering impact, and in a way that can cut across asset classes.


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