A Wharton study reveals gaps between impact investing funds’ external marketing of their social mission and their internal focus on financial performance.
Do impact investors walk their talk on delivering social impact? Or are they more focused on financial returns?
A new brief by experts at Wharton’s ESG Initiative brings nuanced perspectives on how funds operationalize their commitment to financial performance and social impact creation. The brief, titled “Operationalizing Impact: An Analysis of Impact Investing Fund Practices,” is based on data from a survey of 222 impact funds worldwide, conducted between 2020 and 2022. The findings revealed inconsistencies between what the funds publicly proclaim on their social impact goals, and how much attention that gets in their internal operations.
According to the brief, its relevance derives from a paucity of insights into how impact funds balance their twin goals of social impact and financial returns in their internal practices and reward structures.
“There’s been a persistent question in the impact investing field concerning how investors should balance their commitment to impact and their commitment to financial returns,” said Michael Brown, head of research at the ESG Initiative and a co-author of the brief. Brown’s co-authors are Wharton management professors Katherine Klein and Tyler Wry. Klein and Wry are also faculty co-directors of the Wharton Impact Investing Research Lab, which is part of the ESG Initiative.
The research findings are based on survey data from the Impact Finance Research Consortium, a collaboration between the Wharton School, Harvard Business School, and the University of Chicago Booth School of Business.
Key Findings
The survey asked respondents to describe the extent to which their funds emphasized financial goals and expertise versus impact goals and expertise in their marketing and communication to prospective investors; in their hiring, training, and performance evaluation of staff members; and in their compensation system. The survey asked them to indicate their extent of agreement or disagreement with various statements on a scale of 1 to 5, where 4 equates to “agree” and 5 equates to “strongly agree.”
On average, survey respondents said that their funds’ marketing and communication emphasized a “dedication to achieving strong social and/or environmental impact” (average rating of 4.5) more than a “dedication to achieving strong financial returns” (average rating of 4).
But internally, the priorities were reversed. For example, survey respondents reported that “to earn the trust and respect of senior managers,” it was more important for associates to have “strong expertise and experience related to finance” than “strong expertise and experience related to social and/or environmental impact.” The brief’s starkest results related to compensation — specifically carried interest (fund managers’ share of investment profits). The survey results showed that impact funds were much more likely to base carried interest on the fund’s financial performance than on its social and/or environmental impact.
Drawing from the findings, the brief raised two pertinent questions: Are the funds guilty of ‘impact washing,’ where they fail to integrate their proclamations of social commitment into their internal practices and incentive structures? Or, do they find it inherently challenging to measure their social impact? A combination of those two factors may explain the patterns the study revealed, the brief stated. It called for continued research on the misalignment between stated goals and operational realities in impact investing.
For sure, many impact funds are consistent in emphasizing social impact in both their communications and their reward structure for employees. “This study identifies high-level patterns and trends in the impact investing field, although there are outliers in the survey sample that deviate from the general patterns we’ve identified,” Brown said. For instance, some of the funds surveyed placed equal emphasis on training and rewarding their personnel to achieve both social/environmental impact and financial performance, he added.
“Most impact investors report that they perform very well financially and also invest in ways that align with their impact thesis,” Wry said. In fact, many funds, and many of their investors (limited partners, or LPs) “don’t perceive a tradeoff between creating social impact and market-rate financial returns,” he added. But there are exceptions he pointed to: for example, “catalytic” impact investors, who consciously sacrifice financial returns to create greater impact, but these funds only represent about 15% of all impact investors, he noted.
“Many LPs have a sincere desire to create impact through their investments, as do many fund managers, but this is very hard to see if a fund doesn’t have an effective impact measurement strategy,” Wry said. “In comparison, financial performance is easy to measure, so there’s a real risk that this dominates, and funds fail to deliver meaningful impact … or worse, create unintentionally negative outcomes.” Measurement challenges are part of the explanation for the study’s finding that many impact investors don’t link employee compensation to impact performance, he added.
But without more satisfactory measurement of social outcomes, funds are vulnerable to criticism for “impact washing,” Wry continued. “But my sense is that this isn’t very common. The bigger issue is that a failure to measure social and environmental impact gives license for cynical investors and entrepreneurs to claim the ‘impact’ banner when their only real interest is to create financial returns and aggrandize themselves.”
“Precise measurement of impact performance is definitely challenging,” Klein noted. “At the same time, I believe it is both possible and important for impact investing funds to cultivate and reward impact expertise among their staff members through hiring, training, performance evaluation, promotions, networking, and more. To meet impact investors’ ambitious social and environmental goals, funds need deep expertise to discern which investment opportunities are most promising and which sound good but are unlikely to deliver the impact they promise.”
Takeaways for Impact Funds
The brief advised impact funds to design internal systems that “genuinely balance financial and impact considerations,” sharpen their impact measurement tools, and reset compensation practices to better reflect their impact goals. “Our findings suggest that many investors could do more to operationalize their dedication to impact in how they run their funds,” said Brown, who created a research-based primer to help leaders implement effective impact measurement systems.
Wry advised “serious impact investors” to invest in developing “a reasonable impact measurement strategy.” Such a plan should clearly lay out the logic for how each portfolio company creates social or environmental impact, and identifies a few KPIs that can be used to track them, he said. “This will allow the fund to have more confidence that it’s creating impact, help to see instances of mission drift in portfolio companies, and report impact data that can help them communicate with and raise future funding from impact-focused LPs.”
Wry offered a couple of examples of firms that have advanced in impact measurement. One is 60 Decibels, which gathers social impact data on impact across multiple sectors. Another is private equity firm TPG’s research arm Y Analytics, which calculates the “impact multiple of capital” for each company before making an investment decision.
Impact funds that want to develop impact metrics and link them to compensation could begin by asking their LPs to specify “clear and meaningful metrics,” Wry continued. Next, they could have their approach audited by an outside agency and link that to the compensation of partners, he added. “They shouldn’t let perfect be the enemy of good. Start small, learn what works, and keep iterating and improving.”
The top three sectors in which the surveyed funds invested were food and agriculture (45%), energy, and health care (36% each), followed by environmental protection/conservation and education. In terms of focus by the United Nations’ Sustainable Development Goals, nearly 60% of the funds focused on “decent work and economic growth,” followed by “good health and well-being” (48%), and “climate action” (42%).
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