State of Sustainability Podcast

Solo Episode: Impact Investing — Dead or Alive?

SAIF: Welcome back to another episode of the State of Sustainability. The last couple of episodes have been heavy on resilience and volatility, so this time we're going a little off-piste: we're going to talk about impact investing.

A few caveats before I jump in. For most of this episode, I'm using "impact investing" as a broad basket that includes ESG investing, sustainable investing, and everything you might group under mission-oriented investment. I'm going to focus primarily on the mainstream asset class — mutual funds, private equity, sustainable bonds — the kinds of things available to the market at large. I'll touch on climate tech VC, but that's not the core focus.

The journey I want to take you on starts with the current state of play, moves into what we've learned from the facts as they stand, and then asks: where is this space headed? Is there a future for impact investing or not?

The Current State of Play

Impact investing assets under management are still near all-time highs — around $1.5 to $1.6 trillion. But inflows have collapsed. In the US, the last ten or so quarters have shown net outflows: money has left the space, not entered it. In Europe the picture is more mixed — some quarters of outflow, some of inflow — but net outflows in Europe would historically have been an anomaly. The trend is clear: while the stock of capital is only modestly down, the momentum has gone into reverse almost everywhere.

One pocket that's still growing is the Middle East, but I think that reflects a categorisation problem more than a genuine surge in mission-oriented investing. A large proportion of sukuks and other Islamic finance instruments get classified as impact investments, even though they're used for a wide range of purposes. It's essentially a structural artefact of how we define the category.

On returns: most ESG fund portfolios are, frankly, a little confused. Depending on which fund you look at, you'll find Tesla, Nvidia, Microsoft, and all sorts of other holdings — because ESG originated as a risk framework. The logic is: if a company isn't ESG-risky, it's ESG-friendly, and therefore eligible. That means most ESG funds exclude or underweight oil and gas, but otherwise broadly track the market. Their performance ends up being cyclical depending on which sectors they happen to hold. When oil and gas does well, ESG funds underperform. When energy transitions are driving the market, they look good. This makes them an unreliable investment vehicle, and the underlying logic doesn't really constitute an investment thesis.

One structural improvement would be to shift from long ESG funds to short ESG funds. If the ESG framework is genuinely a risk lens — identifying companies that are mispricing non-financial risks — then the alpha lives in the gap between the current price and the correct price. That's a short thesis, not a long one. You're betting certain companies will do worse, not that others will do better.

A Brief History of Impact Investing

Impact investing has evolved along two parallel tracks.

The private markets track is older and more interesting. The early funds — Acumen Fund, Bridges Ventures, Root Capital, Sir Ronald Cohen's work — went into the space with a genuine mission-aligned thesis: find entrepreneurs solving social problems, invest in them, and measure returns in both monetary and social terms. The double bottom line. Capital for these funds often came from philanthropists who believed capitalism could be a more effective vehicle for social good than philanthropy itself.

Many of these funds are still doing great work, but even the best of them tell a cautionary tale. Jacqueline Novogratz has mentioned that in all of Acumen's years, they've produced only one or two unicorns. That's not a criticism — Acumen explicitly measures returns differently — but it does illustrate that even the most mission-focused, long-running funds don't generate the same monetary returns as mainstream funds of comparable pedigree and duration.

The cautionary poster child from the peak of this era is Abraaj Capital. Abraaj grew out of Dubai as an emerging markets asset manager targeting healthcare, infrastructure, sanitation, and similar social themes, with capital from the Gates Foundation and other major philanthropic pools. What worked well about the model was a genuine insight: in emerging markets, social causes and economic interests often align naturally. Healthcare is underinvested, but there are also millions of paying patients who want to access it. At the right price point, the business case is real. The same logic applies to affordable housing. Abraaj later collapsed in scandal — the founder was found to have been co-mingling funds across different purposes — but the underlying investment thesis for mission-aligned emerging markets investing had genuine merit.

The ESG framework track is where private markets' boutique approach was attempted at public-market scale — and where it hasn't worked particularly well. The term ESG first appeared in a UN committee in the mid-1990s as a way for finance professionals to bucket together non-financial risk factors. It was formalised as a risk framework in the UN Global Compact's 2004 paper, Who Cares Wins, and from there it was picked up by the World Economic Forum, the SDG framework, and eventually by public markets in earnest around 2016 and 2017.

What happened next was a category error. ESG was an exclusion framework — a set of reasons not to invest in certain things. It was then repositioned as an inclusion framework: a reason to invest in ESG-compliant companies. That's a structurally flawed inversion of the original logic, and unsurprisingly it hasn't produced the outsize returns that were promised.

The high-water mark was Larry Fink's letter to shareholders declaring climate investing the new normal of investing. Since then, he has quietly walked back any explicit reference to climate in BlackRock's investment activity. A lot of noise for very little substance.

What We've Learned

Three lessons stand out.

First: ESG was a poor investment strategy. Not because the underlying issues don't matter, but because ESG as a risk framework logically implies a short thesis, not a long one. If certain firms are mispricing non-financial risks, the opportunity is to bet against those firms, not to bid up companies that happen to avoid those risks. The long ESG fund is structurally misaligned with the thesis it claims to represent.

There are caveats. You might argue that a company like Tesla, ten years ago, was positioned to capture the long-term tailwind of electrification, and therefore worth a long position. But if Tesla succeeds, it will succeed because it's a well-managed business with strong IP and good margins — not simply because it's in the right thematic space. Good businesses attract mainstream capital regardless, which means an impact investor participating in a well-run Tesla-type company is simply buying into an asset that the market is already bidding up. No particular advantage.

Second: the intellectual honesty problem. The premise of impact investing is that you can balance a double bottom line with both variables equally weighted. You can serve God and mammon simultaneously, in equal measure. But this is empirically unsound. Mission alignment is a constraint. It means there are things you will not do purely for financial reasons — which means your monetary returns will structurally be lower than those of an unconstrained investor. That is the original sin at the heart of impact investing. Not acknowledging this trade-off upfront is a form of dishonesty that has eroded trust in the whole category.

Third: the measurement problem. It has never been clear what should be included in ESG, how to measure success across different elements, or how to compare outcomes across different themes. The outcomes of an affordable housing project are not comparable to the outcomes of a renewable energy project. Measuring both under the same ESG umbrella produces a metric that means very little. Within a specific theme — housing or renewables — comparing assets makes sense. Comparing across themes is, to borrow a word from my CFO, asinine.

Where Impact Investing Can Actually Work

Despite all of the above, I do think there are three areas where impact investing has a viable future — provided there is genuine intellectual honesty from both those managing and those supplying the capital.

First: brand equity and strategic value. This is most applicable to corporate venture capital and large family office private equity, where the impact label itself is a balance sheet asset for the parent organisation. A corporate VC that invests in mission-aligned areas adjacent to its core competences can generate real brand credentials, attract talent, build trust, and strengthen its licence to operate — all while the fund pursues a financially viable investment thesis. Microsoft's Climate Innovation Fund and Amazon's Climate Pledge Fund are examples of this logic in practice. Whether you call it greenwashing or strategic brand-building depends on the integrity of the underlying investments, but the mechanism is real.

A personal fantasy of mine: Coke Studio — Coca-Cola's music platform in Pakistan, Brazil, Turkey, and India — has genuinely developed local music scenes and created something of cultural value. You could imagine it being structured as an impact investment vehicle that both serves a social purpose and builds brand equity for Coke. Danone's experiments with low-cost nutritional products in Bangladesh operate on similar logic. These kinds of investments, when structured with integrity and thematic focus, can generate brand value that justifies accepting a below-market financial return.

Second: venture philanthropy. This one still has a real place. Many philanthropists I know have concluded that capitalism is a more effective vehicle for doing good than traditional philanthropy. The economics are straightforward. A dollar donated to a nonprofit will often lose 20 to 40 cents to operational overhead before it reaches the actual project. That's not a criticism of nonprofits — covering operational costs is a genuine and underappreciated funding challenge — it's just a structural feature of the model. A dollar invested in a for-profit venture generating even a modest return, by contrast, can compound. It can be recycled and redeployed. The dollar does more work over time.

Baroness Bryony Worthington, one of the authors of the UK's first climate legislation, mentioned to me that she and her husband had gifted each other debt instruments — small loans to social entrepreneurs in emerging markets. I did the same for a friend as a gift. Much of that money has since been repaid and is ready to be redeployed. The original dollar has already done multiple cycles of good. Venture philanthropy, both through equity and through lending, allows philanthropists to double or triple dip on their capital.

Third: catalytic first-loss capital. This is more niche, but important for development finance institutions and multilaterals — the IFC, the World Bank, the Green Climate Fund. The mechanism is blended finance: structuring a project's capital stack to attract different investors at different risk-return profiles.

A simplified example: a project requires $1 million and can generate a 5% return — $50,000. That's not enough to attract a mainstream private equity investor given the risk profile. But if you slice the capital stack into tranches, you can make the project work. A philanthropic tranche of, say, $300,000 accepts zero return. A DFI tranche of $400,000 accepts a below-market return of 2%. The remaining $300,000 can then be offered to a PE fund at roughly 17% — an attractive return on the riskiest tranche. The catalytic, first-loss capital from the DFI or philanthropic source makes the whole structure viable. This is where multilaterals are uniquely positioned to add value: they have a mission mandate, accept below-market returns by design, and their participation unlocks private capital that would otherwise stay on the sidelines.

Is Impact Investing Dead or Alive?

It needs a serious rebrand and a serious reset of expectations. The $1.5 trillion currently sitting in impact capital looks like the product of category confusion and inflated promises. A more honest, more focused version of the space would be smaller — and that's fine. More money will likely flow out before things stabilise.

What a healthier version of impact investing looks like: venture philanthropy, for those who want their capital to do more good and are honest about accepting a financial trade-off. Corporate VC or strategic impact investment, for organisations where the impact label creates genuine non-financial value. And catalytic blended finance, for multilaterals and DFIs deploying mission-oriented capital to crowd in private investment.

In all three cases, the measurement problem needs to be solved by being thematically specific. ESG as an omnibus basket for multiple incomparable themes simultaneously doesn't serve anyone well. And in all three cases, the expectation needs to be set clearly upfront: a focused, mission-constrained fund will probably not match market returns, and that should not be treated as failure. It should be treated as the expected outcome of a trade-off that was knowingly made.

Done honestly, impact investing can be a genuinely exciting place for capital to go and for asset management professionals to focus their energy. Done dishonestly, it will keep haemorrhaging credibility — and money.

That's it for this edition of the State of Sustainability. If you enjoyed the show, hit follow so you never miss an episode. And if you'd like to do us a favour, please consider sharing this episode with a friend.

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