Introducing Impact Returns
A next-generation approach to combining finance and impact
A better future depends on our ability to allocate our finite resources in a way that yields the best possible combination of financial, social and environmental outcomes.
While techniques for measuring social and environmental outcomes continue to improve, investors have lacked a framework for quantifying their impact in a way that can be coherently compared to financial returns. This has led to silos that optimize for one narrow outcome or another, rather than the combined value.
Impact Returns are a solution to this problem. They empower investors to make decisions that optimize their total impact-adjusted returns—financial plus impact—leading to the best possible long-term, combined value.
Building on the work of pioneers in the financial, impact and academic worlds, we've identified 'Three Keys' to getting valid impact returns that can be combined with financial returns.
Click each key to see nuanced explanations of the underlined concepts.
Key 1 – Magnitude: Assess the magnitude of all material outcomes on each dimension of impact.
Like financial value, impact has a magnitude.
Just as venture capitalists must differentiate between potential billion-dollar ventures and 'lifestyle' businesses, it's essential to distinguish between impacts that differ vastly in scale, whether by 2x, 10x or more.
Magnitude should be assessed on all dimensions of impact (e.g. the IMP dimensions).
To be practical it is important to only focus on outcomes which are reasonably material, but to make sure this includes all significant positive and negative potential outcomes.
The ability to 'measure' outcomes is improving, thanks to all the people working on modern impact measurement practices, including tools, data and standards. But, it's also possible to project the magnitude of expected outcomes, even in cases where measurement is hard or 'impossible'.
Key 2 – Contribution: Adjust for the 'contribution' of each actor in the impact pathway, relative to what would have otherwise happened, in a positive-sum, non-binary way.
Contribution is about assessing the difference between outcomes given an actor's action and what would otherwise happen. For investors, this difference is 'investor impact'. For companies or other organizations, it is 'enterprise impact'.
To assess investor impact it is necessary to look at the contribution of each actor in the impact pathway from the investor to the end outcomes. If an investor didn't make an investment or didn't engage with a company, it's likely that other investors would have stepped in to replace most of their investment or engagement. The expected difference is the investor contribution to the underlying enterprise.
Next, consider that if the enterprise didn't receive this extra investment or engagement, competitors may have stepped up their efforts, leading to similar outcomes. Thus, the investor's contribution only matters if it causes the company to change its enterprise contribution by generating outcomes that wouldn't otherwise be expected to occur.
It is important to assess contribution in a positive-sum way. This means using a contribution methodology that answers the question 'What way of assessing contribution is going to lead to the best outcomes in the long-term?'. This is a helpful question to ponder intuitively. Crucially, this question has precise answer within formal economic models and this answer is the basis for the contribution methodology that we have developed.
This approach offers a welcome break from circular discussions about how to do zero-sum 'attribution', which tend to have little direction other than a vague notion of 'fairness' and avoiding 'double counting'. It also differs from the binary, all-or-nothing definition of 'additionality' that seems all too common (i.e. 'this investment is additional only if the entire project wouldn't have otherwise happened').
With our granular, non-binary approach to contribution, we have found that many investments have a 'contribution multiplier' somewhere between 1%-30% (see our case study report for examples). Acknowledge this is positive-sum because it helps avoid 'El Farol bar'-like problems where either investors crowd into the same investment because they all think they are making a huge contribution, or no one thinks they are making a contribution so nothing gets funded. The reality is that, most of the time, investing alongside others can be impactful, but not enough to justify the greenwashing, crowded investments and false hopes that have been promoted in the past.
Furthermore, there are good reasons to expect financial performance to be correlated with contribution. In this light, it's surprising that many investors and analysts are scared of these concepts. Whether due to historical political baggage or fear of new ideas, this is a missed opportunity. By honestly assessing and communicating their contributions, investors can enhance their reputations.
Key 3 – Strategic Pricing: Translate impact into a risk-adjusted financial value using a 'strategic price of impact' (SPI) that represents the investor's willingness to pay to improve outcomes. The SPI should be less than the social costs and be informed by opportunity costs.
The 'strategic price of impact' (SPI) is not a normal price at which you can buy or sell. It's a strategic tool to help you make decisions in a way that is consistent across all your investments.
How do you determine the right 'price'? Similar to Key 2, first you have to ask the right question. In this case the question is: 'What SPI, when applied consistently across all opportunities, will yield the best combination of financial and impact results?'. The answer will partly depend on your subjective beliefs and values, but it also has objective constraints.
Setting the right SPI is key to not leaving impact or financial returns 'on the table'.
If you set the SPI too high, your impact return estimates will drown out the signal in the financial returns. If you followed through on this, you would end up with a portfolio that only makes sense if you're looking to give all your money away as fast as possible. This might be fine for your impact, but it leaves plenty of financial returns (and future impacts) on the table.
If you set the SPI too low, your impact returns will be insignificant. If you followed through on this, you would end up with a portfolio that looks identical to that of an investor who ignores impact. This may not hurt your financial returns, but it leaves plenty of impact on the table.
Even if you believe financial results and impact are positively correlated, you should still have a positive willingness to pay for impact. First, this 'cost' doesn't have to be about charity - it can be a risk-adjusted cost associated with making bigger bets on profitable, impactful enterprises than you would if these enterprises weren't impactful. Second, a strict zero willingness to pay would imply that there is no amount of outcomes, no matter how big, that would compel you to accept lower risk-adjusted financial returns to make it happen.
The upper bound for the SPI should be informed by your opportunity costs - the best alternative opportunities you have to generate impact and returns. It's highly unlikely that these best alternatives will imply an upper bound that is at or above the social costs used for cost-benefit analysis, social returns and SROI.
Indeed, the social cost is the maximum that society should be willing to pay for a given impact. For better or worse, there are usually many opportunities to generate impact at costs that are significantly lower than the social value created. Only in an ideal world where all net positive impact opportunities are fully funded would the marginal price of impact equal the social cost.
The SPI can be seen as a generalization of the 'internal price of carbon' that many organizations have adopted. A key difference, in addition to being applicable to impacts beyond carbon, is that consideration of 'contribution'. Contribution isn't relevant for businesses that are just thinking about their financial risks and opportunities (due to climate policy), but it is a crucial nuance to get impact right.
Another simple way to think about the SPI is: 'How much would I need to donate to a charity to replicate the impact of my investment?'. This is as close to a 'market price' as we can get when it comes to impact. Similar to how your accountant wouldn't allow you to value investments based on the maximum price you'd be willing to pay, you shouldn't use social costs to value your impact. It would be odd to pay a charity the social cost for creating an impact when you could find another charity generating the same impact at a lower cost. The amount required by the latter charity should set the upper bound for your SPI.
The charity framing is just a particularly simple way to think about the SPI. In general, great 'impact investment' opportunities can also set bounds on your SPI.
Our team has developed a proprietary methodology for assessing impact returns that successfully puts these Three Keys into practice.
We've iteratively refined this methodology by applying it to real investments. In addition, as part of our rigorous validation process, our technical paper is undergoing academic peer review.
Now, we're releasing our new case study report to share this methodology and demonstrate it with three high-profile examples.
Impact Returns are a Middle Way
Impact Returns are a 'middle way'. They avoid the extremes of common views that don't treat impact with the nuance that it requires.
When you combine impact returns with financial returns, you can optimize for Impact-adjusted Returns (financial + impact). This has profound implications.
It means you can validly say things like:
“This investment has a 15% financial return plus a 5% impact return, for an impact-adjusted return of 20%. Given my goals, this is better than an alternative investment with a 19% return (e.g. 19% financial return + 0% impact return) for the same risk.”
This is 'valid' because of the Three Keys. Not comfortable putting that much weight on impact returns? Then use a lower 'strategic price of impact'. Don't believe your investor actions are impactful enough to directly compare to financial returns? Then be more conservative in how you assess your contribution, but still work out your impact returns.
The goal with 'impact-adjusted returns' is to empower investors to make the most internally-consistent decisions possible.
While 'internally consistent' may not sound sexy, it means that you can:
Integrate impact into existing investment processes and financial analyses
Make better decisions by comparing investments on their impact-adjusted returns, ex-ante and ex-post
Improve portfolio construction based on total impact-adjusted returns
Impact returns (and impact-adjusted returns) can be applied to any area of impact and any asset class.
We've already applied them to:
Impact areas including climate, biotech, global health & development, AI, and mental health.
A wide range of investment types from public equities to early-stage direct investments, as well as grants.
There are countless opportunities to build on our impact return methodology by applying it to new contexts.
Check out our case study report to see which well-known impact investments we used as examples to produce the table below.
Investing for Impact
Impact returns offer a precise way to define 'Investing for Impact':
“Investing for Impact is the practice of integrating impact returns into the investment process, with a 'strategic price of impact' that is significant enough to meaningfully alter the allocation of capital and other resources compared to if impact wasn't considered.”
This means 'investing for impact' requires actively identifying investment opportunities with material levels of impact returns and taking action when they are found. This could mean:
Making neglected investments that wouldn't otherwise be on your radar.
Divesting when this could have a material positive impact.
Making larger, more concentrated investments in your most impactful opportunities.
Seeking to make a non-financial contribution.
Connect with us
We are seeking experienced leaders and financial innovators to partner with us to make a lasting difference to how investors approach impact by building ventures that leverage the insights associated with impact returns.
Join us. Connect with us to learn more about the potential opportunities.
Get help. As a non-profit initiative, we are happy to help projects that align with the principles behind impact returns.
About the Total Portfolio Project
We started the nonprofit Total Portfolio Project to help accelerate advances in how capital is allocated for impact and as part of this project we developed the concept of impact returns.
Nancy de Ruiter
If you're a financial economist, see our technical paper for the rigorous derivation of a new portfolio theory that includes impact returns