Impact investing is an opportunity for public and private money to support emerging markets that lack the capital needed for growth and poverty reduction, but the foundations are wobbling. Collective delusion about the true impact of investments has the potential to undermine a vital instrument for global development and bring about the potential collapse of impact investing. The current paradigm of linear, simplistic cause-and-effect models for impact risks distorting markets and directing capital toward investments that may not be effective.

We’ve seen this before. The crisis of confidence in voluntary carbon markets was caused in large part by buyers realizing they were not getting the non-financial return on their investment that had been promised, with the result being an 87 percent reduction in the price of credits across a two-year period.

If we keep pretending that investments generate impact when, and in ways that, they don’t, then we are a few high-profile critiques away from a similar crisis of confidence. To improve, it is important to understand the current practice, its limitations, and then to examine how a systemic approach more reflective of real-world dynamics can improve capital allocation, management, and measurement so that impact investing can realize its potential.

How We Pretend Investments Create Impact

Impact means many things to many people, but the Sustainable Development Goals (SDGs) are as good a place as any to start. Despite the documented flaws in impact investing, including in the pages of SSIR (Viglialoro et al, Bildner, Foroughi, Starr), and attempts to change things to prevent the collapse of impact investing, standard practice remains that 1) asset managers identify a pipeline investment within their target IRR range and other fund parameters such as sector, 2) the “impact team” attaches the work of that company to an SDG and develops an impact thesis, which is used to support the investment decision, 3) the activities of that company or firm are then measured to assess impact. In the middle, approaches range from activist investors to passive investors, but typically the activism relates to financial performance or compliance, particularly in relation to ESG and reporting.

Read the full article about the potential collapse of impact investing by Ben Taylor, Zannatul Ferdous, and Jason van Staden at Stanford Social Innovation Review.