Can we help save the world by investing sustainably? With the financial sector undergoing a remarkable transformation in the face of environmental and social challenges, Dr Brigitte Bernard-Rau of University of Hamburg looks at impact investing, the new powerful investment strategy. A fundamental shift in how we think about the role of capital and finance in society, the strategy challenges the traditional idea that investors have to choose between making money and making a difference.

By Brigitte Bernard-Rau

In a world facing unprecedented environmental and social challenges ranging from climate change and biodiversity loss to food security, inequality, well-being and healthcare, the financial sector is undergoing a remarkable transformation. Impact investing has emerged as a powerful approach that challenges the traditional idea that investors have to choose between making money and making a difference. But what exactly is impact investing, and how does it differ from other forms of sustainable finance?

Understanding impact investing

At its core, impact investing represents a fundamental shift in how we think about the role of capital and finance in society. As defined by the Global Impact Investing Network (GIIN), impact investing is an investment strategy encompassing 'investments made with the intention to generate positive, measurable social and environmental impact alongside financial return'. However, this apparently simple definition belies how complex the transformative potential of impact investing is.

To fully grasp the distinctive role of impact investing in modern finance – with its materialistic approach – it is necessary to see where it sits on the broader spectrum of investment approaches. At one end of the spectrum we have traditional investing, where financial return and profit maximisation reign supreme and social or environmental considerations play no role in decision-making. As we move along this continuum we encounter increasingly sophisticated approaches to incorporating social and environmental performance factors, giving way to a variety of sustainable finance investment. Of this, impact investing is the ultimate investment strategy, championing positive and transformative change by combining financial return with social and environmental goals.

Investment approaches in a nutshell:

• traditional investing focuses solely on financial return, ignoring social and environmental factors. It has long been the cornerstone of capital markets;
• ESG integration incorporates ESG (environmental, social and governance) factors as risk indicators in investment decisions but does not see them as primary investment drivers;
• sustainable finance integrates ESG considerations into investment decision-making and sees sustainability as a value creator. It supports investment that addresses sustainability challenges and brings about positive social and environmental change. It also includes investing in the transition, financing both what is already environment-friendly today (green finance) and the shift to environment-friendly performance levels over time (transition finance);
• impact investing refers to a significant shift in financial markets, a ‘substantial reorientation towards impact’, and addresses the question Does investment in sustainability contribute to a better world?. Therefore, impact investing emerges as the most intentional approach, actively seeking to achieve both financial return and measurable positive social or environmental impact with equal commitment.

The two faces of impact investing: aligned vs generating

Within impact investing, a crucial distinction exists between impact-aligned and impact-generating investment. This differentiation helps investors understand not just where their money goes, but also how it contributes to positive change.

• Impact-aligned investment supports companies that have already shown that they use positive environmental or social practices and have proved their commitment to positive impact through their operations and outcomes.
• Impact-generating investment actively creates new solutions to social or environmental challenges, often focusing on transformation and systemic change.

This theoretical distinction is brought to life through real-world applications across different sectors.

Clean energy

In the clean energy transition, impact-aligned investing might involve purchasing shares in established renewable energy companies or electric vehicle manufacturers. These companies already contribute to environmental sustainability through their core business models. Impact-generating investment in this same sector might instead focus on funding early-stage battery technology startups or innovative community solar projects in underserved areas, creating entirely new solutions to energy challenges.

Sustainable agriculture

The sustainable agriculture sector offers another illustrative example. Impact-aligned investors might support established organic food producers or sustainable farming operations, while impact-generating investors would focus on developing new regenerative agriculture techniques or revolutionary urban farming solutions that could transform how we produce food.

Social impact

In the sphere of social impact, aligned investment often supports companies with strong diversity policies and fair labour practices. In contrast, generating investment might fund new, affordable housing developments or pioneer educational technology solutions for underserved communities, actively creating new pathways to social equity.

The investment process: from intention to impact

Success in impact investing requires a rigorous process which, with the intention of bringing about positive social and environmental change, begins with setting clear impact objectives. Investors have to define specific environmental or social outcomes that they seek to achieve, establish measurable targets, and often align these goals with established frameworks such as the United Nations Global Indicator for 17 Sustainable Development Goals and their 169 targets of the 2030 Agenda.

This intentionality distinguishes impact investing from other forms of sustainable finance. It requires impact-oriented investors to start a due dilligence process that thoroughly assesses both financial performance and the ability to generate and measure meaningful social or environmental outcomes.

Financial appraisal of an investment is a well-established practice, supported by standardised metrics and robust methodologies. However, non-financial appraisal, such as evaluating social and environmental impact, remains comparatively less developed and lacks universal frameworks. Investors therefore have to go beyond traditional financial analysis to assess how deep a company's commitment to impact is. This includes evaluating the management's commitment to achieving impact goals, their capacity to measure impact effectively and their ability to transparently disclose and report outcomes. The assessment process often involves examining specific impact metrics tailored to the goals of the investment, ensuring alignment with recognised frameworks such as IRIS+ or the Impact Management Project (IMP, 2024).

Additionally, to enhance the due diligence process, differentiating between ‘company impact’ and ‘investor impact’ is essential. Company impact is the direct social or environmental effects generated by a company's operations and products. In contrast, investor impact is the influence that investors have on a company's behavior and outcomes through their investment choices and engagement strategies. Understanding this difference is crucial in order to assess the overall impact of investment accurately and to develop effective impact measurement practices.

Challenges, complexities and considerations

Despite its promise, impact investing faces significant hurdles:

1. impact measurement: in the absence of standard measurement metrics, it is difficult to quantify or compare social and environmental outcomes. Transparency and rigorous tracking and reporting of impact metrics are crucial to provide consistency and accountability, ensuring that impact claims are backed by evidence;
2. attribution challenges: it is difficult to isolate the effects of specific investment amid broader systemic changes and attribute them to one's investment. Determining how much of the observed change can be directly attributed to a specific investment remains one of the most persistent challenges in impact investing. For example, improvements in SDG 3 – Good Health and Well-Being – might be the result of a combination of investment in healthcare facilities, education, and infrastructure, rather than a single targeted investment. Developing methodologies such as counterfactual analysis and control group comparison is necessary but can be resource-intensive and not always feasible, particularly for smaller projects or in developing markets;
3. impact washing: exaggerated or false claims by companies or funds about their social or environmental impact undermine trust in the sector. To maintain trust and integrity within the entire impact investing field, transparent reporting and verified impact claims are of the utmost importance (ITF). Clear standards for impact measurement and robust verification methods, along with third-party audits and independent certification, are vital for maintaining credibility.

Unlocking the transformative potential of impact investing

Impact investing stands at the forefront of a profound transformation in global finance, representing far more than just another investment strategy. It embodies fundamental reimagining of the role of finance in society. It challenges the traditional belief that financial return and positive social and environmental impact have to exist in separate spheres.

The evolution of impact investing has demonstrated that investors can simultaneously pursue profitable return while contributing to meaningful social and environmental change. By integrating purpose with profit, impact investing provides a compelling approach for a financial system that serves both people and planet.

Brigitte Bernard-Rau is a postdoctoral researcher and fellow in the School of Business, Economics and Social Sciences at the University of Hamburg. Her research focuses on ESG ratings and rating agencies, sustainable finance, socially responsible investing, impact investing and corporate social responsibility. She has recently published Sustainability Stories: The Power of Narratives to Understand Global Challenges (Springer Nature, 2024). The book features over 30 inspirational stories by different authors from across the world, who talk about various ways of engaging in the common good and making a difference in communities, professional practices and people's lives.