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At Briink, we are closely tracking the exciting progress and transformations in the world of impact investing, from both regulatory developments and market practices.
Impact investments promise not just financial returns, but also the potential to drive significant social and environmental changes. Crucially, impact investing is evolving from a marginal asset class to an all-encompassing investment approach. This is leading to a new breed of asset managers who view impact as an integral part of the investment process.
So far, however, asset managers have been able to get away with broad, and somewhat vague claims about their impact initiatives. Statements such as “promoting social welfare”, “facilitating the decarbonisation of the economy”, or “championing diversity and inclusion”, are sometimes put forth without a clear explanation of how their investments directly contribute to these goals. As a result, regulators and market participants have stepped in to develop frameworks and policies to create standard metrics and approaches for defining truly impactful investments. Regulations such as the EU’s Sustainable Finance Disclosure Regulation (SFDR) ensure that impact focused asset managers uphold sustainability standards. Ultimately, these laws will protect the integrity of impact investing and prevent ‘greenwashing’ by demanding greater transparency around ESG topics.
As a further response to the need for attainable and measurable impact goals, the Global Impact Investing Network (GIIN) has pioneered the adoption of the “Theory of Change” — a conceptual roadmap that outlines how an organisation’s resources can be harnessed to achieve the desired positive impacts through the allocation of capital. Originally used by community development charities, the Theory of Change framework was designed to describe the cause-and-effect relationship between specific actions and interventions undertaken and the desired impact.
The Theory of Change model can help investors better articulate their investment goals, and how to achieve them to create social or environmental change. Critically, these frameworks can become the basis for a more transparent and structured communication with stakeholders around investment intention and impact.
As such, the Theory of Change model should be the backbone of any impact investor that aims to meaningfully measure and manage their investments.
There are many different approaches on developing a Theory of Change for impact, however, most of them include these five essential steps:
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Many impact investors have already adopted the Theory of Change framework in their impact theses.
For example, Lightrock, a global private equity firm investing in sustainable businesses, focuses on various sectors and has developed a separate theory of change for each sector. This enables the firm to identify investment opportunities in different industries to drive sustainable growth in all aspects of the economy. Using the Theory of Change model allows them to “take a comprehensive and innovative approach to value creation (return and impact)”. By applying this more nuanced approach, Lightrock backs up their investment thesis with a robust framework that creates a clear narrative of the impact approach, enabling better communication with stakeholders.
Tenacious Ventures is another example of an impact investor using this model to build their investment thesis. For example, they use Theory of Change to formalise their goals and it has underscored their commitment to demonstrating how every action they take plays a part in driving meaningful change. Finally, they use this model to quantify and measure their outputs, i.e., their investment impact. As highlighted before, this clear and measurable approach can foster meaningful engagement with investors who are looking to generate sustainable investment returns.
These practical examples show that the Theory of Change can not only help with setting a robust impact investment thesis, but also provides the tools to measure and communicate key objectives and the impact delivered. That being said, the accurate application of this framework requires non-negligible efforts in terms of ESG data collection, development of a convincing impact model, and short-term and long-term evaluation and monitoring of the achieved impact.
While there are many moving parts and aspects to be considered when developing a Theory of Change, the collection of granular data that can be consistently evaluated against the desired goals is key to a successful application of this framework. Here’s where we believe technologies such as AI and Large Language Models (LLMs) can play a transformative role in the impact investing space.
AI and specifically LLMs can process vast amounts of qualitative and unstructured data quickly and accurately, matching the data to the key impact objective.
This can save valuable time and resources to your in-house team, and allow you to focus on building and delivering on your bespoke impact model, rather than on reporting and data gathering. As opposed to financial data, in fact, ESG data is predominantly found in unstructured and non standard formats, which cannot be easily analysed via traditional data analysis techniques. In the context of impact investing, these technologies can be used to analyse reports, news articles, and other sources of information to assess the alignment of certain investments with the impact thesis of the asset manager. This could offer a more comprehensive and evidence-driven view of the social and environmental changes that are being powered by these investments.
Moreover, AI and LLMs can help streamline the development, refinement, and realisation of the Theory of Change model itself. While they shouldn’t be seen as a substitute to human judgment, these tools can provide robust support to impact investors throughout their investment journey, from aiding analysts in the due diligence process of investment, to the crucial phase of quantifying and communicating the social or environmental impact of investments. If you want to see for yourself how an LLM-powered AI tool can help your business take its ESG and impact analysis to the next level, you can let us know by getting in touch with our team here.
As impact investing continues to evolve, the importance of effective impact measurement becomes more critical. The correct and systematic application of frameworks such as the Theory of Change can help investors build an audit-proof roadmap to change, and ensure that commitments translate into concrete action items. By harnessing the power of AI and LLMs, we can enhance our understanding of the impacts of our investments, ensuring that we’re driving meaningful change and contributing to a sustainable future.
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