Impact Investing 101
A primer on early stage impact investing in emerging markets
TL;DR Navigate the $1.164 trillion impact landscape, understand the core characteristics and misconceptions that pervade the industry, and join us in reshaping our commitment to drive impact in emerging markets.
There’s a lot of buzz around “impact investing”. The sector has experienced remarkable growth in recent years, capturing the attention of investors, entrepreneurs and philanthropists. Recognizing the urgency of global challenges like poverty, inequality, and climate change, there is a growing global movement advocating for the need to allocate more capital to improving lives and the health of our planet. The complexity of today’s challenges demands innovative approaches and more effective solutions beyond traditional actors like governments and philanthropists. As such, impact investing is more than just a buzzword; it holds the potential to play a historic role in reshaping the role of capital and mobilizing additional resources to build a more just, inclusive, and sustainable future.
Despite its rapid growth and surge in popularity, impact investing evokes both promise and criticism. Sceptics raise concerns about “green and impact washing”, the lack of standardized and comparable measurement, the challenges around proving contribution to impact, and the trade-offs between financial and impact returns. These criticisms contribute to confusion and misunderstandings about what impact investing really means. At Sturgeon Capital, we believe that investing in early-stage, high growth technology companies can be a catalyst for meaningful transformation in emerging markets. In this blog post, we aim to unpack the core definitions of impact investing and address some of the common misconceptions.
The Evolution of Impact Investing
The impact investing industry has garnered a wider audience recently, but the broader concept of socially responsible investing is not new. Originating primarily within development finance institutions (DFIs), this approach gained momentum in the private sector with the rise of microfinance institutions in the 1970s and their aim to use private capital and microloans to foster financial inclusion in emerging markets. Over time, impact investing has evolved across asset classes including debt and equity, introducing a private market perspective to contribute to global development across sectors and regions. It was not until the mid-2000s that the Rockefeller Foundation coined the term “impact investing” and incubated the Global Impact Investing Network (GIIN), the leading network of practitioners.
Although the impact investing market is still maturing, efforts to accelerate the development, scale and effectiveness of the industry are gaining significant momentum. In the GIIN’s latest market sizing report (2022), the size of the worldwide impact investing market is estimated to be USD 1.164 trillion in assets under management with over 3,300 organizations. The market has grown substantially over the past decades, reflecting the growing awareness of global challenges and the consensus that investors can and should be contributing to the solutions. Businesses are awakening to their potential for positive impact, and consumers are shifting their purchasing preferences towards purpose-driven companies.
So… what is impact investing?
The GIIN, the global champion of impact investing, defines it as “investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return”.
Let’s remember, all investments have an “impact” - both short and long-term, positive and negative. Impact investing is a strategy to leverage investment capital for positive outcomes, with the explicit aim of accomplishing specific goals that are beneficial for society. It’s not really an asset class, but rather an approach that can range from a venture investment in a fintech company that’s facilitating access to finance for underserved populations (check out Datacultr) to a microfinance loan supporting small businesses in Uzbekistan (check out Oasis MFI) to affordable housing projects in developed markets. The key element that groups these diverse examples and differentiates them from other types of investments is the intention to finance solutions to problems; without the intent to be impactful, it’s just investing[RB1] . This commitment includes articulating a clear impact thesis, transparent impact goals, and strategies for achieving the impact.
Translating this intent into action, and then committing to measure, manage, and report on the social and environmental performance of portfolio companies is integral. Impact measurement and management (IMM), hailed as the “hallmark of impact investing”, is arguably the biggest challenge for participants. There are a variety of fragmented methods and resources available, which are organized into principles, frameworks, and standards to guide impact strategies. Recently, the industry has united around a handful of frameworks, and according to the 2023 GIINSight Series on IMM, the most used were the UN Sustainable Development Goals (SDGs) (76%) and the Impact Management Norms (52%). To describe, implement, and measure impact investment activities, credible impact investors rely on shared terminology, generally accepted tools and standardized metrics, most commonly the IRIS+ metrics (78%). Impact data must not only be measured, but leveraged for investment decision-making, identifying risks, and mitigating negative consequences. Lastly, actual impact performance must be disclosed in a comparable and actionable manner to stakeholders. IMM is complex and there’s an overwhelming number of definitions, terms, and abbreviations. It deserves its own “101” blog post – stay tuned.
Source: GIINsight 2023: Impact Measurement & Management Practice. The Global Impact Investing Network
Core Characteristics of Impact Investing
Despite progress and growing consensus in the impact investing sector, more capital is needed to address the pressing challenges of our time. To help the market scale with integrity, give impact investors clarity on expected practice and the terms to participate, and ensure investments have the highest likelihood of effectively contributing to positive impacts, the GIIN developed the Core Characteristics of Impact Investing. These are a baseline of expectations around what it means to practice impact investing and they help investors “define the credibility of their practices, consider the quality of the practices of potential investment partners, and identify practical actions they can take to scale their practice with integrity” (GIIN).
Summarized by the GIIN, investors making impact investments adhere to four practices:
Intentionally contribute to positive social and environmental impact alongside a financial return
Use evidence and impact data in investment design
Manage impact performance
Contribute to the growth of impact investing.
Debunking Common Misconceptions
Let’s address two of the most common misconceptions repeated in the impact investing space. The first elaborates on the second part of the GIIN’s definition; impact is alongside a financial return.
#1: Impact investing does not mean compromising on financial returns
At its core, impact investing challenges the traditional notion that financial returns and social and/or environmental impact are incompatible – impact investors seek a financial return on capital, albeit across a spectrum that ranges from below-market-rate to risk-adjusted market rate. An increasing number of asset owners and investors are recognizing the advantages of incorporating impact considerations, moving away from the trade-off mindset regarding investment performance and purpose-driven goals. In fact, according to the 2023 GIINSight Series, 74% of impact investors target risk-adjusted market-rate returns. At the same time, many companies are offering products and services where positive value creation is intrinsic to the business model. When such businesses grow and achieve commercial success, so does their positive impact. Studies such as the 2021 Net Impact Report by the Upright Project, conclude that impact is definitely not at odds with profit.
At Sturgeon, we view financial and impact returns as complementary and mutually reinforcing, rather than contradictory and competing priorities. This aligns with a strategy coined Impact Alpha, recognizing that the integration of impact objectives into the investment process can add value across our portfolio, and ultimately enhance overall investment performance. Impact considerations can provide unique insights not yet valued by the broader market and promote additional rigour in operations, stakeholder engagement, and risk management. This approach empowers companies to better understand the needs of their customers, design more effective businesses, build authentic brands, and attract differentiated sources of talent and capital. By targeting investments in sustainable business models with a core focus on products or services that address problems in their markets, we aim to drive both financial and impact returns at scale.
Source: 2023 GIINsight: Impact Investing Allocations, Activity & Performance. The Global Impact Investing Network
#2: Impact Investing is not the same as ESG investing
Impact investing and ESG (Environmental, Social, and Governance) investing are often used interchangeably, but these are distinct approaches. ESG encompasses the criteria used to assess corporate behaviour and screen potential investments. In essence, it highlights the potential financial losses a company may face by neglecting ESG risks and the financial gains achievable by capitalizing on ESG opportunities. ESG investing is more about how these factors affect the company and less about their effect on the world. It's crucial to note that, while ESG investing seeks to avoid harm and may potentially benefit stakeholders, the primary objective remains financial returns and it may not always result in net-positive outcomes. Impact investors go beyond avoiding harm and make conscious decisions to use capital to contribute to solutions.
About Sturgeon Capital’s Approach to Impact Investing
Sturgeon is a for-profit and for-impact investor, investing in early-stage, high growth technology companies that blend financial returns with real and measurable social and economic impact. We believe that leveraging technology and the digital transition in emerging markets to provide access to high-quality products and services, particularly for un(der)served populations, is highly impactful and will compound social and financial returns.
Sturgeon goes beyond providing capital to exceptional entrepreneurs; we collaborate with portfolio companies to identify, measure, and optimize their impact. We advocate for startups to understand the problems their users face and consciously embed impact into their business model from day one. Our support spans various markets, business models, and company stages, drawing on our experience and networks. We believe that active engagement will enhance the probability of success for portfolio companies in terms of both impact and financial performance, ultimately fostering sustainable businesses that drive economic development in their regions and generate returns for our investors.
As we progress in the realm of impact investing, Sturgeon Capital is excited to share that we're refining our impact investing strategy and measurement and management framework. This update reflects our dedication to staying at the forefront of industry advancements and actively contributing to a more inclusive and sustainable future. Stay tuned for practical updates and lessons learned as we navigate this journey, reinforcing our commitment to growing the sector and increasing the amount of capital being directed to contribute positively to many of today’s global challenges, especially in the unique and underserved regions that Sturgeon operates in.
Impact investing is dynamic and exciting, especially in the early-stage VC space. Its growth, driven by the urgent need to address global challenges, has sparked a critical dialogue on not only reshaping the role of capital but also ensuring the “impact” market grows with integrity, intentionality and rigorous measurement. In future posts, we’ll dive into more of the complexities and criticisms, and share our experience with the challenges of impact measurement and management.
Meanwhile, we would love to hear from you – do you believe impact investing and financial returns can go hand-in-hand in building a sustainable future? Share your thoughts and questions as we continue our impact investing journey.
What to learn more about impact investing? Still confused by all the terms?