The Practice of Impact Investing

The World Economic Forum’s report, From Ideas to Practice, Pilots to Strategy, is a collection of articles that offer concrete approaches and actionable insights for professionals interested in engaging more with impact investments.

The International Finance Corporation (IFC) invests in private enterprise in developing countries. We do so to promote economic development as well as to make a profit. When we make investments, our aim is that all of them should do well on both dimensions. Of course, they don’t always do so, so we invest a lot of time to understand the link between our investments and their development results. By measuring our development results and financial performance, we have seen a convincing correlation between those investments that do well on a financial yardstick and those that show strong development results. This has positive implications for the ongoing debate on social impact investing.

An independent study by the World Bank Group’s Independent Evaluation Group1 looked at 176 IFC debt and equity investments totalling $3.1 billion that reached early maturity in the three-year period of 2006-2008.The study looked at each project’s development and investment outcomes, scoring each outcome “high” or “low.” Projects scoring high on both outcomes or low on both outcomes represented 83 percent of all projects. This rose to 89 percent when the analysis focused on equity investments only (64 investments totalling about $800 million).

In our experience, superior financial performance seems to go hand in hand with strong development results. This is not completely surprising, since an investment in a company that grows fast, employs more people, pays more taxes, invests more in research and development, responds well to environmental and social issues and increases exports, is likely to yield good returns and support local economic growth.

This correlation also emerges when we look at an investee company’s financial returns and its environmental, social, and corporate governance (ESG) performance. The preliminary results from two internal analyses we conducted on our equity portfolio suggest that companies with good environmental and social performance achieve financial returns dramatically better than those with low environmental and social performance. This result holds for non-listed as well as listed companies; leaders in ESG also displayed lower return volatility. These correlations reflect the instinctive belief that well-managed companies will score well on many dimensions; but, what does it say about causation?

Traditional investment theory holds that financial returns (or, more precisely, risk-adjusted returns) will be negatively affected if an investor introduces a non-financial objective. The argument is simple: adding a new constraint necessarily limits the attainment of the original objective. A double bottom line is not a free lunch. If this is true, it has challenging implications for the mainstreaming of impact investing. Can financial returns and social impact be mutually reinforcing, or are they bound to restrict each other?

This is where it gets interesting. We have integrated our ESG analysis into our investment decision process. Essentially, when evaluating a potential investment, we are assessing a company’s current ESG performance (including its capacity to improve). While it is just one of many criteria examined, we have come to the conclusion that strong ESG capability today is a predictor of future financial performance; in other words, to predict a company’s financial performance, pay attention to its current ESG capability. So, including an additional objective of promoting environmental and social sustainability actually supports attaining the financial objective. The additional objective has helped not hindered the achievement of the first.

While superior ESG capability may be a leading indicator of strong financial results, this does not mean that the former actually causes the latter. Nevertheless, we have good anecdotal evidence from our portfolio that inadequate ESG capability can certainly cause poor financial performance by negatively affecting business operations. For example, a mining company that loses its licence due to environmental infringements or social issues is not doing much good for the local economy or for its investors. Viewed from the portfolio level, the risk-return ratio is improved if these types of poor performers are excluded, thus enhancing overall returns as well as reducing risk.

Of course, IFC’s experience is focused entirely on investments in developing countries; it is possible that the relationships we perceive between financial returns, ESG capability, and social impact are peculiar to developing countries with their less-developed capital markets. These relationships may also be driven by our particular style of minority growth equity investing. Still, the alignment is remarkably consistent across region, sector, and vintage year when viewed from the perspective of both our direct investing and fund investing businesses.

One caveat is worth mentioning: it takes time and effort to incorporate non-financial factors into investment decision-making. It may lead to better decisions, but it does require resources. IFC’s Development Impact Department comprises about 25 staff, with 25 more specialists in investment departments who measure development impact. In addition, 16 corporate governance and 60 E&S specialists work on more than 600 investments made each year (and many that we decide not to make), as well as on a portfolio of nearly 2,000 existing investee companies. We use our IFC Performance Standards on Environmental and Social Sustainability to govern our investment activities, covering both the due diligence conducted prior to investment and the subsequent performance of our portfolio companies on a range of environmental and social issues.

These standards are designed to help clients avoid, mitigate, and manage risk as a way of doing business in a sustainable way. Launched in 2006 and updated in 2012, IFC’s Performance Standards define thresholds of behaviour that we expect our portfolio companies to reach across a number of areas, including assessment and management of environmental and social risks and impacts; labour and working conditions; resource efficiency and pollution prevention; community health, safety, and security; land acquisition and involuntary resettlement; biodiversity conservation and sustainable management of living natural resources; indigenous peoples; and cultural heritage. We view this not only as a compliance activity but also as one where we advise and assist our clients to improve performance on dimensions relevant to their businesses. Our internal team includes specialists in all these areas, some with technical backgrounds and others with legal or investment expertise.

Similarly, IFC has established its Corporate Governance Methodology, a system for helping investee companies and other clients to address corporate governance risks and opportunities.

While we firmly believe that attention to ESG criteria adds to our track record on financial performance, this is not a free good that can be replicated by every investor. As a development finance institution, IFC’s strategic drivers include both financial sustainability and development impact. The double bottom line approach requires more resources, but in our experience this is self-reinforcing rather than counter-productive.


Common standards are vital. As impact investing evolves, many debates on how to define and measure social impact, and various types of social objectives, will arise. However, if we can develop a common language, as exists on the financial side of the equation, it will become much easier to compare different investors, investees, investment styles, and strategies and thus understand where the alignment is strongest (and where not). This will differ by industry and region and will evolve over time.

In 2002, we convened a group of 12 commercial banks, leaders in project finance, to discuss environmental and social issues in their field. In the following year, these banks used IFC’s environmental and social standards, then referred to as IFC’s safeguard policies, as the basis for a voluntary risk-management framework known as the Equator Principles. This framework has been adopted by 78 financial institutions from 35 countries, covering an estimated 70 percent of international project finance debt in developing countries.2

Similarly, in 2005, the United Nations helped initiate the creation of the Principles for Responsible Investment (PRI), a set of six core principles for institutional investors looking to incorporate ESG criteria into their long-term investment decision-making. Currently, about 1,200 investors representing $35 trillion in assets under management have signed on to the principles.3

These examples illustrate how like-minded early adopters can create a template for a set of minimum standards. For impact investing, these standards could cover how social impact is defined and measured prior to investing, and how it is subsequently evaluated as investments mature. The objective would not be to cajole investors into becoming impact investors, but to allow those looking to invest with impact to speak a common language and develop a shared set of investment approaches and evaluation tools.


Where will social impact investing go from here? Traditional investment theory might suggest that greater capital deployed in a specific area tends to reduce returns, including social returns; however, this is the same traditional thinking that suggested financial returns could not be aligned with social impact. Far from reducing social and financial returns, the growth in impact investing will actually help to develop common standards, language, and measurement yardsticks; these in turn will reduce transaction costs associated with a double bottom line, thereby benefitting investors, investees, social entrepreneurs, and their clients.

1 Independent Evaluation of IFC’s Development Results 2009, February 2009. Independent Evaluation Group (IFC), World Bank Group.
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