How to Spot an Impact Investment

As the impact investing industry nears its 15th birthday (depending on who’s counting), it’s hard to refute that we’ve made enormous strides in professionalizing this investment approach. The size of the industry — represented by assets under management (AUM) — has skyrocketed. In 2013, impact investing represented a $25Bn opportunity. In 2021, that number is $715bn and climbing.

Where we’ve encountered challenges, we’ve endeavored to course correct. In our early days, for example, Impact Measurement and Management (IMM) was mostly ignored. But in the last 3 years, the emergence of many more robust — and increasingly standardized — frameworks have helped move the industry towards a consolidated and comprehensive way of measuring the good that we aim to do. Early pioneers in IMM have combined forces with new platforms and technologies to make data capture and reporting easier. The ubiquity of the Sustainable Development Goals (SDGs) have been (mostly) a gift — providing even the most unfocused investor with an accessible shared language to talk about the systems they want to shift. In the U.S. in particular, a global reckoning around justice, equity, diversity and inclusion (JEDI) has accelerated a conversation around power — expanding the focus beyond who receives capital to include a discussion around who makes these critical investment decisions.

But despite our collaborative efforts to build rigor and deep meaning in the work that we do, confusion persists. At Spectrum Impact, we support clients by building long-term, cost-effective, and scalable impact investing strategies — strategies that will help protect impact programs and products for years to come. Our clients are energized by the promise of impact investing, but they look to us for guidance on how to turn that energy into action.

We’ve reflected on our work over the last three years to connect the dots on what, exactly, makes an investment an impact investment.

While the below list is in no way exhaustive, we’ve found that that these 5 characteristics are almost always present in the impact investments we work with. Jump in!

Let’s start with the basics. Does an impact investment have to actually be an investment? For us, the answer is yes. This may be obvious, but there is a lot of debate across our ecosystem about whether this is actually true. An investment is essentially a purchase — of an asset or an item — that you hope will appreciate over in time. Either by generating income or even increasing in underlying value. The hope of financial upside is critical. It signals an intention that is important to quantify when we evaluate whether we’ve been successful. It tells us — among other things — that the promise of a financial return was considered in making this investment. It signals investor expectations and helps to define some of the objectives of deploying this capital.

This does not mean that investors who deploy “catalytic capital” or consider themselves “impact-first” investors are not impact investors. Far from it. These investors also act with the intention to generate returns, but they have a higher degree of acceptance that they may not hit those targets - particularly if the absence of returns is necessary to create outsized positive impact.

Targeting a double bottom line is hard work. It requires a range of decisions — and even sacrifices — that traditional investments nor grantmaking have to contend with. That hard work should show up in how we price, reward, and evaluate these investments: so being honest about our objectives is key.

For many of our clients, identifying intention in the investment process continues to be challenging. We hear a call for more objectivity and definition in what impact investing is across the ecosystem — and we understand why. A lack of definition is what makes access to this field so difficult. But we also believe that impact needs to remain subjective. Your definition of impact is yours — it should differ in the eye of each beholder. What is impactful to you is not the same for others. So while there’s demand for us all to agree on what is impact and what’s not, we need to think critically about what a one size fits all definition could mean. Are we prepared to collectively agree on which investments are meaningful and which are not?

That’s where intention comes in. Intentionality is a key criteria to help determine whether someone is an impact investor or something is an impact investment. It questions the motivation for making that investment or building that business. In other words, are your impact goals built into your decision-making process? What evidence do we have of that? Do you speak openly about your dual objectives? Do you partner with — or raise money from — people who have similar goals? Do you evaluate success based on your impact mandate?

Intention can feel elusive but if we ask the right questions of ourselves and our investees — and manifest these questions into our formal due diligence processes — we’ll get closer to authentically operationalizing the change we hope to see.

One of the best ways to validate intention is to measure. For a lot of investors, measuring impact seems like an incredibly daunting task. Determining the measures that actually point to improvements can feel impossible. And interconnected factors — like history, culture and geography — make isolating the effect of any one investment on a single individual even more challenging. There are many forces at play.

But in the last 3–5 years, the impact investing industry has made great strides in championing more robust impact measurement and management (IMM) frameworks. Recently, we’ve seen a dedicated and meaningful effort — across the investor community — to standardize which frameworks we use and how. The Impact Capital Managers effort, for example, brings together over 66 impact funds that are committed to sharing best practices and consolidating their IMM processes to better support entrepreneurs.

While there is much evolution and sophistication still to be had in IMM, investors and entrepreneurs who commit to measurement are signaling their intention in a meaningful way — through action.

Measuring impact is only half of the battle. Sharing your progress (and — especially — lack thereof) is the other. While measurement bears the lion’s share of criticism in this work, we find that transparency is really the bigger challenge. Almost as a rule, investors are a tight-lipped group. At the fund level, that confidentiality is part of a tradition of “keeping the secret sauce secret.” Some of that is warranted. GP performance can make or break future fundraising, and sharing too much information can skirt dangerously close to divulging proprietary information — or even harming the portfolio companies themselves. For example, if your portfolio-wide performance is poor, what are we saying about some of the individual companies in your portfolio? What assumptions are we making about whether they can be successful? For LPs, our “gotcha” culture is primed and waiting to spot failure in an investment context — either a bet that didn’t pay off, a risk that became embarrassing, or even an expression of values that people don’t agree with.

But the secrecy also makes our efforts to discuss the value, efficacy, and opportunity of impact investing extra challenging. GPs and LPs who share their performance — particularly around impact — are setting the bar for the type of transparency that is necessary to ensure that capital is going to the places that can effectively put it to work. And investors who share that performance in the face of loss or failure are extra catalytic. They warn us of other work that is needed — to build markets or incubate enterprises — before investment capital can do its work.

The same is true for entrepreneurs that are developing new solutions to complex problems. The promise of the future of impact investing is to encourage the traditional investment markets to naturally seek out impactful solutions — ones that generate impact and financial returns for investors. To do that effectively, we must know — as a community — what’s working and what’s not.

The conversation around additionality is something of a third rail in impact investing. Part of its electric charge has to do with the binary thinking purported by staunch advocates — that if an investor is not demonstrating additionality to a particular investment, then it is not impact. We don’t agree. But we do think that elements of additionality should be present for something to maximize that impact.

In our work, we believe that the capital markets do work. Not always correctly, and certainly not for everyone. But as a system, they provide a mechanism to match supply and demand by establishing a metric for value: price. This system also creates a sustainable way (in terms of cost and speed) for investors to make those investments. But for all of its efficiency, it has some serious problems.

If the capital markets were inherently suited to solve our most complex social challenges by defining, pricing, and scaling investment solutions, then they already would have. If this was a truly rational and values-agnostic ecosystem, capital would have sought out any opportunity for upside — and underserved customers, untapped communities, and newly emerging economies would surely benefit. But we know it is not this simple. And this is due in part to the fact that the capital markets are an insular ecosystem. Like attracts like. We price and reward based on the things we know to be successful. Innovation — in the true sense of the word — is a liability, not a strength.

Additionality helps to separate what the market would naturally provide in its machinations, from the risk-adjusted, patient, outside-of-the box capital that impact investors deploy. There are various types of additionality — everything from adding outsized financial value, to mitigating risk (perceptions or actual risk), creating a demonstration effect for a new solution, and even championing new and unlikely collaborations. Though a supposed lack of additionally doesn’t exclude an investment from being impactful, it is a helpful heuristic to determine the motivation of an investor or the potential of an investment.

— — —

These characteristics barely scratch the surface of all the ways to identify impact. And due diligence — the process of evaluating investments (and in some cases intention) — is more art than science. But if we can continue to coalesce around the elements that we think signal authenticity, then we have the opportunity to responsibly welcome more and more people into this work.

And we need all hands on deck to realize global sustainable and equitable change.

#impinv founder at Spectrum Impact. Ex @CaseFoundation + @BNYMellon + @RockefellerFdn. Bookworm, travel glutton, and lifelong Pens fan. www.spectrum-impact.com