There is an obvious appeal to impact investing. While non-profits and grant funders are focused exclusively on fostering positive social, environmental, and cultural change, they do so at the expense of -100% financial returns. On the other hand, traditional finance tends to overlook these critical considerations while prioritizing short-term gains, generating potentially harmful, long-term effects in their wake.
Which is why, as environmental and social existential threats continue to mount, impact investing has soared in popularity. It provides a way to harness the power of finance for both profit and purpose, bringing together asset allocators (i.e. asset owners such as pension funds, family offices, and endowments, as well as the entities that advise them such as wealth managers and outsourced investment firms, also referred to as “Limited Partners” or “LPs”) who seek to use those assets to solve pressing global challenges, and asset managers (i.e. fund managers that execute the day-to-day operations of investing directly into enterprises through debt or equity instruments, also referred to as “General Partners” or “GPs”) who know how to deploy said capital in order to achieve measurable positive outcomes.
But how do asset allocators know where to place their bets? Many asset allocators have reflected on the fact that they lack the necessary experience and/or data to confidently evaluate impact opportunities. And while there are some regulations that serve to protect investors from bad actors, LPs lack a reliable method to discern which GPs are best-positioned to deliver on their impact claims. Conversely, highly intentional GPs struggle to demonstrate the authenticity and distinctiveness of their commitment and capacity to drive significant impact.
Which begs the question, what can GPs do to signal to investors that they have the correct practices and capabilities in place to achieve their desired outcomes? How can they demonstrate their accountability to LPs in a way that fosters trust and, ultimately, secures investment?
Through our research and conversations with both LPs and GPs, we’ve outlined four definitive pillars of impact accountability: strategy, governance, management, and reporting. Notably, these pillars broadly map to core tenants of many leading industry standards such as TCFD and SDG Impact, among others. Each section below also includes key questions that both cohorts can ask themselves as they work to strengthen the rigor of their approach and improve the likelihood of creating lasting positive change.
Strategy
A fund’s impact strategy offers the bedrock of impact accountability. While a well-defined strategy is set by defining how investments will generate positive social or environmental change, its strength is determined by its clarity, ambition, and the evidence that support it.
A strong strategy should include a well-evidenced impact thesis that connects a problem statement, investment strategy, and incorporates expected measurable goals/outcomes. Fund managers need to ensure they understand potential risks associated with their strategy and establish targeted goals/commitments to demonstrate its ambition.
Key Strategy Questions:
- Is the fund’s impact thesis clearly described and credibly linked to the positive social and/or environmental changes it’s seeking to effect?
- How relevant and ambitious are the fund’s impact objectives and targets?
- Are potential negative impacts and risks identified as part of the strategy
Governance
While an impact strategy is foundational for accountability in impact investing, allocators should also assess the extent to which a fund’s commitment to the strategy is evidenced in its internal organizational resourcing and oversight. In other words, does the team have the right expertise, incentives, and leadership engagement to ensure impact considerations and trade-offs are appropriately understood and weighed against other factors?
Strong governance mechanisms can be demonstrated in a number of ways. Linking impact performance to staff incentives, providing sufficient resourcing for impact/ESG initiatives, and ensuring impact is truly embedded within investment processes and decision-making are all ways to perform well in this pillar.
Key Governance Questions:
- Does the team have relevant expertise and experience related to the strategy?
- Is there sufficient resourcing focused on impact to execute the strategy?
- Is impact integrated within investment processes, decision-making, and incentive mechanisms?
Management
Impact management is ‘the how’ of the strategy’s execution. It is assessed by evaluating the processes and tools that are used throughout an investment’s lifecycle to drive impact results. This involves understanding how a GP evaluates prospective investments for impact/portfolio eligibility as well as how its impact results are monitored over time. Experienced LPs will want to make a determination as to the quality and consistency of a fund’s processes and policies for managing impact.
LPs expect robust tools for consistent impact analysis across all portfolio investments. They also require internal systems that align GPs with evolving best practices, facilitate regular impact data collection, and actively monitor risks. Additionally, LPs favor a culture of continuous improvement, advocating for the ongoing integration of lessons learned and feedback loops.
Key Management Questions:
- Is there a robust due diligence and screening process to ensure investments are evaluated for alignment with the impact strategy?
- Does the manager actively monitor and engage with its investees to understand progress, mitigate risks and maximize impact?
- How committed is the manager to reviewing impact performance and refining its strategy accordingly?
Reporting
Many LPs describe spending considerable time during the diligence process establishing expectations for regular impact reporting from GPs. When we talk about reporting, we’re talking about a fund’s ability to present – on a regular basis – the impact results of the portfolio in a a complete and reliable representation . And while impact reporting is a commonly discussed topic, there are specific elements that LPs are particularly interested in.
First, the clarity and quality of impact data presented in the report, including underlying data management systems and practices. If there are gaps, or a lack of candor around both good and bad news, LPs may question the integrity of the report.
Second, LPs are interested in a complete set of impact disclosures at both the portfolio and individual investment levels. They want to understand how the investments being made are contributing to the fund’s overall strategy and expected results – and are interested in seeing performance data presented in ways that allow them to gauge progress relative to prior periods, a baseline, and/or an external threshold.
Key Reporting Questions:
- Is the Fund’s impact reporting comprehensive and contextualized sufficiently to interpret performance?
- Are the underlying data and processes used by the fund to collect and manage impact data sufficiently robust that you can have confidence in the reported impact information?
- Is the Fund committed to providing regular and standardized reporting?
BlueMark believes that in order for impact investing to scale with integrity, there must be both greater rigor and consistency in the ways the market evaluates managers’ commitment and capacity to achieve impact.