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Areas of Improvement and Risks

Addressing very complex social issues through market based approaches is a daunting challenge in itself. Given its early stage, and the difficulty of the challenge at hand, impact investing has several areas of improvement and risks that need to be acknowledged. Being aware of these issues will allow practitioners to set proper expectations from their stakeholders and to take measures to mitigate the specific risks related to impact investing.


Impact measurement

This is one of the biggest areas of improvement in the impact investing sector. Measuring social impact is not as straightforward a task as measuring financial performance because impact is measured on the basis of qualitative or subjective things (eg. How do you know if you improved the quality of life for people? How do you measure if you increased opportunities for people to pursue their aspirations?). This challenge is generally approached by measuring outputs and relating them to impact (eg. You can measure the increase in income of a group of people as an objective measure, which you indirectly link to an improvement in quality of life). Industry standards are being developed in order to guide impact investors in the task of measuring and reporting on impact.


Mission Drift

One great risk in impact investing is for investors to drift away from the social mission by gradually placing greater emphasis on the financial objectives of the investment. This may happen for several reasons, for example, pressure to meet return or investment targets, or there isn’t a clear statement on what the mission is, or serving less disadvantaged clients may provide more resources to potentially later serve the most needy, etc. One way for impact investors to avoid mission drift is to be very explicit and transparent about what the social and financial mission of the investments will be. This can help filter out potential investments that may be more financially appealing but outside of the scope. Another tool for avoiding mission drift is to periodically monitor the performance of investees using indicators that are relevant to the mission and taking action when results start to drift. Lastly, compensation in impact investing has to be consistent with the investment social and financial objectives.


Investor / Investee relationship

Another great risk in the field of impact investing is the physical distance between the investors and the investees. This is a challenge because administrative and travel budgets are usually limited and it is hard to establish a solid relationship, founded on trust and mutual commitment, over the phone or email. Investors try to mitigate this risk by the depth of their due-diligence; if they can establish trust from the onset they are more likely to build a relationship for the long-term. Establishing very clear guidelines and expectations from the beginning is key; this can be done through detailed investment terms and reporting requirements.


Due-diligence

The due-diligence is still an area that needs to be improved in the industry. Investors often set out to search for opportunities based on a vague concept of the impact they wish to have, this poses a risk to the credibility of the industry because insufficiently researched organizations can turn out to be terrible investments. For this reason, due-diligence has to be conducted following detailed criteria and observing all aspects of the potential investee, from social impact indicators to governance and human resources management. Due-diligence can be expensive, but it is absolutely necessary because it reduces the probability of selecting inadequate investees and the costs associated to a bad investment.