Although impact funds are good at talking up the social and environmental aspects of their investing strategy in their marketing materials, their internal processes are much more likely to play up the financial aspects of their products, a new briefing from Wharton’s ESG Initiative shows.

The brief, titled “Operationalizing Impact: An Analysis of Impact Investing Fund Practices,” is based on data from a survey of 222 impact funds worldwide, conducted between 2020 and 2022. The findings revealed inconsistencies between what the funds publicly proclaim on their social impact goals and how much attention that gets in their internal operations.

“There’s been a persistent question in the impact investing field concerning how investors should balance their commitment to impact and their commitment to financial returns,” said Michael Brown, head of research at the ESG Initiative and a co-author of the brief, in a post on the Knowledge at Wharton website, a business journal from the Wharton School at the University of Pennsylvania.

“Our findings suggest that many investors could do more to operationalize their dedication to impact in how they run their funds,” said Brown, who has created a research-based primer to help leaders implement effective impact measurement systems.

Brown’s co-authors are Wharton management professors Katherine Klein and Tyler Wry. Klein and Wry are also faculty co-directors of the Wharton Impact Investing Research Lab, which is part of the ESG Initiative.

The internal impact

The survey found that in their external marketing and communications, impact funds emphasized social or environmental impact slightly more than financial returns. But in their internal management practices, they prioritized financial expertise when hiring and developing staff, evaluating performance, and designing compensation systems.

This disconnect suggests that “while most funds adopt the rhetoric of impact investing, many struggle to ‘walk the talk,’” the brief noted.

“Most impact investors report that they perform very well financially and also invest in ways that align with their impact thesis,” Wry said. In fact, many funds, and many of their investors (limited partners, or LPs) “don’t perceive a tradeoff between creating social impact and market-rate financial returns,” he added.

There are exceptions he pointed to: for example, “catalytic” impact investors who consciously sacrifice financial returns to create greater impact. But these funds only represent about 15% of all impact investors, he noted.

On average, survey respondents said that their funds’ marketing and communication emphasized a “dedication to achieving strong social and/or environmental impact” (average rating of 4.5 out of 5) more than a “dedication to achieving strong financial returns” (average rating of 4).

But internally, the priorities were reversed. For example, survey respondents reported that “to earn the trust and respect of senior managers,” it was more important for associates to have “strong expertise and experience related to finance” than “strong expertise and experience related to social and/or environmental impact.”

The brief’s starkest results related to compensation — specifically carried interest (fund managers’ share of investment profits). The survey results showed that impact funds were much more likely to base carried interest on the fund’s financial performance than on its social and/or environmental impact.

‘Impact washing’?

That raised two questions, the researchers said: Are the funds guilty of ‘impact washing,’ where they fail to integrate their proclamations of social commitment into their internal practices and incentive structures? Or, do they find it inherently challenging to measure their social impact?

A combination of those two factors may explain the patterns the study revealed, the brief stated. It called for continued research on the misalignment between stated goals and operational realities in impact investing.

Wry advised “serious impact investors” to invest in developing “a reasonable impact measurement strategy.” Such a plan should clearly lay out the logic for how each portfolio company creates social or environmental impact, and identifies a few key performance indicators that can be used to track them, he said.

“This will allow the fund to have more confidence that it’s creating impact, help to see instances of mission drift in portfolio companies, and report impact data that can help them communicate with and raise future funding from impact-focused LPs.”

Read more: Companies that deliver positive impact are also more likely to deliver better financials