What do we define as impact investing?

WHAT DO WE DEFINE AS IMPACT INVESTING?

The NAB – Netherlands Advisory Board on impact investing – has been collaborating since 2022 with the European Impact Investing Consortium to align definitions of impact investments and harmonize survey methodologies. The members of the consortium are Impact Europe, GSG Impact (our parent organisation) and other European NABs (France, Belgium, Spain, Italy, Germany and the UK), as well as a couple of academic institutions.

Consensus resulting from discussions of the European Impact Investing Consortium

The three defining features of impact investing:

a clear ex ante intention to contribute to solving social and/or environmental problems in addition to earning an appropriate financial return
impact measurement and management, using the impact data collected to understand what works and what to improve, ultimately taking better informed decisions
financing companies or projects whose primary mission is to provide solutions to address social or environmental challenges and/or benefit otherwise neglected/underserved target groups

THE NECESSARY CONDITIONS

At the core of what distinguishes impact investing from other investment approaches that may incorporate impact considerations are two fundamental characteristics: intentionality and measurability. Impact investors' commitment to intentionality must be systematic, encompassing all investments within the fund, and integral to the decision-making process at the time of each investment (ex-ante). To ensure ongoing positive contributions to social and environmental goals, investors should measure their impact. However, it is necessary to go beyond measuring, focussing on managing impact, thus using the impact data collected to understand what is working well and what to improve, making sure to take better informed decisions. Having processes in place to not only measure but also actively manage impact ensures ongoing improvement and adaptation to challenges and opportunities to amplify impact outcomes.

SEPARATING PRIVATE AND PUBLIC IMPACT INVESTING

Another important achievement of the Consortium is having made clear that, in all strategies, there is a distinction between public and private markets, since processes, investees and levers to drive impact are very different. Private impact investing typically entails a longer investment horizon, deeper engagement with investees, and a broader array of financial instruments, providing access to investment opportunities that are often not available to, or easily accessed by, broader stakeholders, such as institutional investors. Conversely, investing in public markets often limits the levers at disposal of capital providers to influence impact-driven decisions. While sharing the overarching goal of creating positive social and environmental impact, it often follows shorter term investment horizons and is subject to different expectations regarding liquidity and risk-return profiles. Despite the lack of widely acknowledged criteria to distinguish sustainable from impact investing in public markets, the Consortium acknowledges the opportunity to recognise this segment of the market and in the next survey will test a series of questions that were developed starting from the guide on listed equities published by the Global Impact Investing Network (GIIN) and the questions on listed assets included in their survey.

THE INVESTOR STRATEGIES MAP

Agreeing that each investor strategy yields distinct results and outcomes was not challenging to achieve consensus on; hence, our main discussions were directed towards how these strategies could be segmented. In doing so, we looked at two main dimensions: the investor level, to assess how the capital is allocated, and the investee level, to assess where the capital is allocated.

> Investor level – How is capital allocated?

The decision on how to allocate the capital is steered by the investors’ intentionality, i.e. their conscious and deliberate search for a social and/or environmental impact, with the aim of pursuing a positive result for a defined community and the planet. Adding the extra lens of additionality to the intentionality element can bring more clarity when it comes to the specific contribution the investors bring to their investments. Investors have two primary choices:

Investor additionality is an intervention that will lead, or has led, to effects which would not have occurred without it. Given the well-acknowledged difficulties to prove additionality, we decided to assess it through evidence of an investor contribution. We distinguish between two types of investor additionality:
- non-financial additionality: reflecting active engagement from the investor that improves the investee's impact performance, and
- financial additionality: accepting disproportionate risk/return ratios or providing patient, flexible and/or concessionary capital to undersupplied or underfunded projects. A notable example of achieving this is by deploying catalytic capital, which targets gaps left by mainstream finance or the public sector, in pursuit of impact for people and the planet, which otherwise could not be achieved.
No investor additionality occurs when investors do not actively pursue additional impact with their own contribution.

In its methodology, on classifying sustainability-related investments for the purpose of future market studies, the European Sustainable Investment Forum (Eurosif), introduces four distinct categories including “impact-generating” and “impact-aligned” investments. While there are similarities between Eurosif’s and this paper’s approaches, in particular recognising the role investors can play in making positive impact through investments and active engagement, some substantial differences still persist. The discussions between Eurosif and the European Impact Investing Consortium aimed at convergence and finding common ground are ongoing and will benefit the whole financial system.

Note from the Dutch NAB: In the Netherlands, we have found that many institutional investors already categorise non-additional impact investments as impact-aligned, whereas impact investments made with financial or non-financial additionality at investor level is often referred to as impact-generating. Therefore, we have used this categorisation in our survey (and in our soon-to-be-published diagnostic study about the state of the Dutch institutional sector).

2.>Investee/asset level – Where is capital allocated?

To make informed decisions about where to direct capital for the greatest positive effect, it is key to identify the strategies of the investees supported. In understanding where the capital flows, our consortium builds upon the most adopted framework by impact investing practitioners: the ABC of Impact developed by the Impact Management Project (IMP), which ensures a clear understanding of the actions and intentions of investee organisations. This classification distinguishes various types of assets/companies:

A – Act to avoid harm: organisations that identify where they (or their asset) is causing harm to people and the planet, and focus on improving those outcomes to get nearer the sustainable range established by social and environmental thresholds.

B – Benefiting stakeholders: on top of acting to avoid harm for all stakeholders (A), these organisations also generate an improved well-being for one or more groups of people and/or the condition of the natural environment, so that it is within the sustainable range established by social and environmental thresholds.

C – Contributing to Solutions: organisations that actively contribute to addressing social and/or environmental challenges with specific and relevant solutions, improving the well-being of a group of people or the condition of the natural environment so that the outcome is improving towards the sustainable rang. Due to the additional impact these companies seek to generate, we use the term “investee additionality” to describe them, which should be distinguished from “investor additionality”. Note: see the annex for illustrative examples of the different enterprises’ intentions.

While categories A and B can create positive impacts or significantly reduce negative ones, only category C indicates that investees organisations actively focus on developing solutions to urgent social and environmental challenges.

To complement and support the distinction between the different categories, we propose using the five dimensions of impact developed by IMP, as recently suggested by Impact Frontiers. Combining the investor and investee levels, and segmenting investor strategies accordingly, we identified five investor strategies, which are listed below.

SUMMARY

1. Responsible Investing: investments towards organisations that are Acting to avoid harm, already showing improvements compared to the past.

2. Sustainability-Improving (or Transition) Investing: investments that are actively supporting harmful organisations to help them develop a serious and consistent strategy to achieve outcomes within the sustainable range. Investors adopting this strategy support investees financially and/or non-financially.

3. Sustainable Investing: investments promoting sustainable outcomes. Investors pursuing this strategy incorporate ESG factors into decision-making and allocate capital to organisations classified as Benefiting stakeholders, whose performance is within the sustainable range.

4. Impact Investing (or in the Netherlands, also identified as impact-aligned): Investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return. Impact investing primarily focuses on organisations classified as Contributing to solutions providing capital at market conditions and without investing significant non-financial resources to improve the impact of their investees.

5. Additional Impact Investing (or in the Netherlands, also identified as impact-generating): investments directed to impact enterprises that often target underserved capital markets and are classified as Contributing to solutions. Investors adopting this strategy create a positive impact that would not have occurred without their financial and/or non-financial contribution.