Impact Investing Biases Revealed: Wishful Thinking Proven Significant
A new study published in the Journal of Business Ethics by Lauren Kaufmann of the University of Virginia and Helet Botha of the University of Michigan-Dearborn has highlighted the need for the impact investing industry to adopt more accountable measures. The study, titled "Who Loses in Win-Win Investing? A Mixed Methods Study of Impact Risk", was based on 124 interviews with impact investors from around the world and an online experiment with 435 participants.
The researchers found that many impact investors make decisions based on narratives or assumptions, rather than on sustained, rigorous evaluation. This reliance on stories over evidence could lead to unintended negative outcomes, as impact risk is often overlooked.
One investor, who works in developing markets and has a background in water management, suggested that the impact sector could learn from the history of economic development and the importance of fact-checking. The investor pointed out that with $84trn being transferred from the baby boomer generation to younger investors by 2045, time is of the essence.
The study warns of the danger in siloed thinking and not considering risk later on in the deal cycle of a company. The report urges investors to treat impact with the same level of scrutiny as financial performance, including tracking outcomes over time, engaging with affected communities, and more transparency about successes and failures.
To address this problem, the study suggests implementing more systematic, evidence-based impact assessment frameworks. Key approaches include:
- Adopting continuous, data-driven impact measurement tools, rather than static, retrospective analyses such as traditional Social Return on Investment (SROI), which tend to be inconsistent and subjective.
- Conducting thorough due diligence and risk mapping that includes regulatory, political, and stakeholder analysis to uncover vulnerabilities before investment and throughout the holding period.
- Encouraging investors to focus on transparent, measurable social and environmental outcomes supported by empirical data and independent verification.
- Embedding impact evaluation into the investment process, including regular monitoring, evaluation, and reporting, so that impact claims are substantiated continuously rather than taken on faith.
The potential risks of relying on narratives over rigorous evaluation include misallocation of capital, reputational damage, financial risks, and perpetuating wishful thinking. By shifting from narrative-driven investment decisions to rigorous, transparent, and continuous impact evaluation, the industry can mitigate these risks and ensure that investments deliver the promised social and environmental benefits.
Interestingly, the study suggests that industry data potentially underreports impact underperformance, with only between 1% and 2% of investors reporting falling short of their impact goals. The researchers also note that the GINN and Impact Frontiers measurement frameworks are often underutilized or applied only superficially.
In conclusion, the study underscores the importance of adopting more rigorous, evidence-based impact assessment frameworks in the growing $1.5 trillion impact investing sector. By doing so, the industry can live up to its promise of creating positive social and environmental change while delivering financial returns.
- To achieve positive social and environmental change while delivering financial returns, the impact investing sector should adopt more rigorous, evidence-based impact assessment frameworks, such as the ones that incorporate continuous data-driven impact measurement tools, thorough due diligence, and the focus on transparent, measurable outcomes.
- As a vast amount of $84 trn is expected to be transferred from baby boomers to younger investors by 2045, the need for accountability in the impact investing industry is more pressing than ever, with emphasis on treating impact with the same level of scrutiny as financial performance.
- In line with the growing $1.5 trillion impact investing sector, the industry should strive for transparency, engaging with affected communities, tracking outcomes over time, and implementing evidence-based measures to avoid negative social and environmental impacts, financial risks, and misallocation of capital, thereby ensuring investments are aligned with their intended social and environmental benefits.
