Impact investing, or how companies manage environmental and social outcomes as part of investment decisions, is now affecting a growing share of assets, both in public and private markets.

It has also come under pressure from regulators and investors seeking to prevent ‘greenwashing,’ or the practice of attaching the Environmental, Social and Governance (ESG) label to investments that don’t deserve it, said Professor Cathy Clark of Duke University’s Fuqua School of Business in a talk on Fuqua’s LinkedIn page.

“Estimates put ESG and impact investing at between a fifth to a third of the total assets under professional management globally today,” said Clark, who also serves as the faculty director for Fuqua’s Center for the Advancement of Social Entrepreneurship (CASE).

“However, as more investors seek to deploy their assets in ways that align with impact goals, how do they know that the asset managers are actually walking the talk?” she asked.

The main question, Clark said, is whether increased disclosure requirements are enough, or if investors need to ramp up their impact management practices. This could mean engaging more frequently with their asset managers, to make sure they are “good stewards of their investment capital,” Clark said.

The impact investment market

Estimates indicate that in the last decade, the size of ESG and impact investing has reached around $9 trillion in public markets and more than $1 trillion in private markets—the latter ones include private equity, private debt, community development, international development, philanthropy and corporate impact investing, which is “where much of the investing market dedicated to measurable impact has historically taken place,” Clark said.

New players have entered the sustainability market, she said, now encompassing a wide range of investors—high-net-worth individuals, family businesses, pension funds, endowments, sovereign wealth funds, and public agencies devoted to development finance, for example.

The challenge is that the asset owners usually rely on intermediaries for the management of their investments—usually fund managers—and they may find it challenging to track the impact of their assets.

“The asset owners are at least two times removed, and sometimes more, in the capital chain, from where impact occurs on the ground,” Clark said. “What evidence can they access to prove that the managers they choose are not greenwashing but are actually doing well on impact as well as returns?”

Disclosure requirements

Regulators such as the Securities and Exchange Commission (SEC) have also “gotten pickier” in drawing the line of what constitutes an ESG investment, Clark said.

The SEC’s “Names Rule” of September 2023, for example, applies to investment funds and aims to prevent the use of names that may mislead investors. The rule states that funds that use a certain name suggesting “a focus in investments with particular characteristics” must invest at least 80% of their assets in those investments.

Clark says the hope of the rule is to avoid funds misleading investors by “pasting the sustainability label on the investment container without changing their everyday practice.”

However, she says this is just a “starting point,” and noted an increase in shareholder advocacy, with investors holding companies to account surrounding impact goals.

A framework for true impact

Leveraging interviews with investors and fund managers around the world, Clark and CASE, in collaboration with the impact verification and analytics firm BlueMark, created a framework that provides guidance to impact investors on how to perform more detailed due diligence around impact, and how they can engage throughout the lifecycle of the investment to be sure their assets are aligned with those intentions.

Clark said that “pre-investment,” the asset owners should evaluate if the fund managers have integrated the impact culture in their businesses’ operations, have a team aligned with this culture, and have “developed the governance structures that support the impact goals.”

“An investor told us their company has a very strong preference for impact funds with an incentive structure linked to the achievement of specific impact targets,” she said. “So that's a very concrete example of walking the talk, where this team is not going to be incentivized only by financial returns, but part of their compensation is going to be related to the achievement of specific impact goals.”

Post-investment, she said, most impact investors said that regulatory reports and disclosures are not enough for them to understand what the fund managers are doing.

“They said they need to conduct regular check-ins on impact, more frequently than just annually,” Clark said. “They need to see reporting on progress relative to a set target or goal that they wrote down at the beginning of the relationship.”

The investors also reported that taking action on the assets that are doing well financially but not as well in terms of impact is the logical consequence of this monitoring practice.

“These practices are rigorous but also quite doable, judging by the diversity of funds and entities that are engaging with this work,” Clark said. “And as more regulatory requirements converge, I predict that the practices of impact management will become more mainstream as well.”