The article was sponsored by the Vistria Group
There may be a lot of noise in the US about whether impact investing is sustainable, but investor demand for impact investments that also deliver market returns has steadily grown over the past decade and is expected to accelerate. Some projections indicate that investments in companies whose products contribute to social or environmental impact and can demonstrate responsible and ethical environmental, social and governance (ESG) practices will reach $33.9 trillion by 2026, representing 21.5 percent of the total global assets under management, according to PwC.
Several key drivers are accelerating this growth. First, there is growing recognition that impact measurement and management are important value creation tools. There also is a shift in wealth ownership, a growing demand for more sophisticated financial risk management approaches, and an escalating urgency for both public and private sector actors to create solutions that address systemic global social and environmental issues.
The merits may be compelling, but impediments remain. The industry has come a long way in measuring impact and defining ESG factors, but a glaring gap exists: the overly narrow definition for what qualifies as an impact business has led to a “scarcity” mindset in investing for impact.
More than a marketing tool
In this rapidly shifting landscape, optimizing impact is no longer a nice-to-have; it’s a crucial business imperative and investment differentiator.
However, impact due diligence is notoriously complex, with limited examples of best practices. The prevailing approach can oversimplify the process by focusing solely on screening investments in or out. While defining go/no-go impact parameters is necessary, relying solely on negative and positive screens is inadequate. They can narrow the scope of qualifying investments and perpetuate a scarcity mindset that prevents broader deployment of capital for impact at scale.
The persistent scarcity mindset often portrays impact investing as something attainable only under exceptional circumstances. The corresponding approach to screening investments can either be lenient, leading to misleading impact claims in the market (greenwashing), or overly stringent, requiring companies to qualify as “impact companies” before receiving investment. In all cases, it disregards the potential of investments in companies that may not meet all impact criteria but have the right features to create substantial impact value, nonetheless.
Additionally, this mindset perpetuates the misunderstanding that impact is only a marketing tool or that only a select few investments qualify, with the implication that returns must be sacrificed.
Despite the clear market signals that more capital is poised to move toward impact strategies, the scarcity frame has contributed to confusion and constraints in fundraising and allocation.
Consequently, numerous promising companies with significant impact and profitability potential are overlooked, considered un-investable by some impact-focused investors. Unfortunately, that means those assets are often not purchased or managed to optimize impact. The $4.3 trillion financing gap required to achieve the Sustainable Development Goals (SDGs) highlights the necessity of broadening opportunities for addressing social and environmental challenges at greater scale.
This raises the question of how to expand the scope while upholding the integrity of investments that combine social and environmental goals with profitability.
Realizing impact potential
The Vistria Group believes impact is a core driver of value creation, and every company has the potential to contribute a positive impact for its stakeholders. The firm also believes investors have a role in helping the companies in which they invest realize their impact potential to the fullest.
Vistria chose its flagship sectors – healthcare, knowledge and learning solutions, and financial services – because they are foundational to individual well-being and there is significant untapped opportunity to unlock impact potential. The firm asserts that abundant investment opportunities exist to generate positive impact and create lasting value. In partnership with management teams, Vistria aims to help companies become the best versions of themselves, progressing along a continuum of impact alongside financial growth, resulting in a win-win-win for all stakeholders. This shift in mindset from scarcity to abundance provides an opportunity to actively increase outcomes and drive returns.
To assess impact potential, the firm has undertaken a multi-year effort to develop the Vistria Optimal Impact (VOI) methodology with contributions from NORC at the University of Chicago. The VOI offers a standardized way to diligence the impact potential of an investment in a rigorous, repeatable, data-driven and comparable manner. The aim is to inform allocation decisions and support the strongest impact drivers for any given investable opportunity, enabling a company to express and achieve its optimal impact.
The VOI approach maps to best practices and standards, and builds on Vistria’s industry-aligned framework that considers ESG conduct and the impact of each company’s products and services. Using the VOI model, Vistria identifies potential impact opportunities in every flagship fund investment, from fostering diversity, equity and inclusion (DE&I) to scaling products and services that benefit a diverse abundance of people.
This approach evaluates impact growth potential, taking into account critical business drivers across various dimensions. The output is a multidimensional score that offers a relative gauge of an investment’s potential return on impact. The VOI score shows the main opportunities for growth in impact value in line with the investment growth case, throughout the investment’s lifetime.
For Vistria, this rigorous approach to impact diligence allows for differentiated insight. Success means recognizing and minimizing a broader set of risks that others miss, and seizing and maximizing a broader set of opportunities that others overlook. The abundance mindset, coupled with a deeper impact diligence approach helps the firm find good companies and aims to help them become great.
According to a survey by Fidelity Charitable, 61 percent of millennial investors actively opt for investments that yield a positive impact alongside a financial return, in stark contrast to only 20 percent of baby boomers. This is noteworthy because millennials are poised to amass wealth five times greater than their current holdings by 2030. Simultaneously, American women are expected to wield significant influence, with control over a substantial portion of the $30 trillion in financial assets held by baby boomers today. According to a recent UBS study, female investors are more inclined to invest based on sustainability considerations than their male counterparts.
ESG data is now a vital tool for robust risk management. Consideration of ESG factors helps businesses with compliance planning and disclosure improvement, and is advancing the creation of comprehensive risk mitigation strategies to proactively address potential threats and seize regulatory tailwinds. This shift is primarily driven by the heightened awareness of the adverse consequences of climate change and social inequality on revenues, and has affected treasury, investment and supplier policies. Eighty-eight percent of public companies and two-thirds of privately owned ones are implementing ESG initiatives, coupled with increased transparency, according to NAVEX’s global survey in 2021.
A little over a decade ago, the 2030 SDGs were established. For policy makers, the goals offer a roadmap to drive policies and incentivize change. For the private sector, they offer a roadmap for attractive investment opportunities. Despite progress, the UN recently called for increased urgency to close the $4.3 trillion financing gap needed to reach the Goals.
Impact-generating capital is projected to grow faster than other asset and wealth management categories, and a growing body of research shows investments can optimize for positive impact and mitigate ESG risk to produce “statistically significant excess returns,” according to an MIT paper published in 2023. At the same time, investors continue to struggle with impact diligence, defaulting to a narrow view of impact, leaving value on the table. To bridge this gap, managers must consider a different way of viewing impact opportunities, through a lens of abundance and optimization.
The principle of abundance is rooted in the belief that there are ample opportunities available for everyone; that society is resourceful, creative and possesses unlimited potential. It focuses on strengths and the idea that there will always be room for improvement, collaboration and shared success.
Therefore, almost every company has the potential to drive positive impact for its stakeholders: its employees, customers and the communities in which it operates. Investors like Vistria have a role to play in helping companies realize their impact potential to the fullest while also paving the way for a different kind of investing, one that marries profit and purpose, at scale.
Diligencing impact potential
How does the VOI work in practice?
Let’s assume a fund manager is interested in investment opportunities that address post-pandemic learning loss in the US. The manager is considering investment in a company that offers a range of educational resources designed to achieve specific learning outcomes in public school districts. Currently, the company has limited geographical and delivery format focus.
In addition to financial due diligence, the manager uses the VOI approach to evaluate the company’s potential to deepen the quality of its model, expand access to new geographical areas and serve a broader spectrum of students. The firm also uses the approach to assess the company’s ESG maturity, including its awareness of regulatory risks and opportunities. It evaluates the company’s workforce and human capital potential, considering DE&I efforts. The assessment also covers the company’s ability to execute an impact strategy alongside its growth strategy.
During impact diligence, the manager uncovers several key findings. They identify alignment in terms of impactful products, services and potential for geographic expansion. Additionally, they discover opportunities to implement workforce development programs for educators, helping address critical district needs for qualified educators.
Using the VOI approach, the manager makes an investment with an impact thesis that aligns with the financial growth case and emphasizes the optimization potential of the workforce. This approach provides the basis of a value creation strategy.
Kelly McCarthy is head of impact and Jon Samuels is partner and co-head of Vistria PRG at The Vistria Group