Investing in impact: looking beyond ESG

Previously in this series, we explored the driving factors of both impact investing and the traditional venture capital model – a recurring and valid topic, as both models share some commonalities. A slightly more nuanced question arises when comparing the similarities and differences between Environmental, Social and Governance (ESG) criteria and impact investing.??

While both focus on the environment and correcting historical social disparities, they also have important distinctions. In this article we discuss the definition, measurement mechanisms and outcomes of each, putting into context the role and effectiveness of both models in striving to make positive change in the world.?

Definition and focus??

Both ESG and impact investing emphasise sustainability, better corporate practices and long-term orientation to the contribution to global goals such as the United Nations' Sustainable Development Goals (SDGs). However, a Financial Times article, defines ESG as “...about exclusion, about trying to avoid companies that have bad scores”.? Explaining that ESG is a set of criteria which “...are used to direct capital into existing companies trying to improve their social and environmental footprint.” On the other hand, there is impact investing, which is described as “...capital [which] is directed into enterprises or funds that were created with the goal of having a positive impact.”?

Impact investing can be considered the proactive approach of the two models, as it involves actively seeking and injecting capital into companies that are designed, and have the greatest potential, to solve a specific issue. For example, the case of EIT Urban Mobility focuses on urban challenges and solutions. One standout is Waybler, a Swedish startup that has designed a new solution for installing EV (electric vehicle) charging points where the electric cable is pulled through stones instead of underground. This means the rollout of such infrastructure can be done quicker and more cost-effectively than before – a prime example of an innovation that solves a specific issue.?

Measurement mechanisms and their validity?

Impact investing centres itself on measurable outcomes. However, accurate measurement involves navigating a range of metrics and variables. To make things easier, EIT Urban Mobility works with The Upright Project to quantify the impact of current and potential investments on an ongoing basis. EIT Urban Mobility's 2024 Impact Report illustrates the power of measurement in optimising investments that can create the most positive impact. This approach has resulted in an investment portfolio with a net impact ratio (NIR) which exceeds the industry average – 46% NIR versus 37%. These positive percentages, in varying degrees, mean that the portfolios are contributing more positively than negatively to the world. The maximum value of the next impact ratio is 100% symbolising a company with no negative impacts, while there is no minimum value.

Valtteri Vulkko, COO of The Upright Project explains the role that specific measurements have in impact investing: “Seeing EIT Urban Mobility achieve a 46% average net impact ratio is a testament to the power of targeted impact measurement. The Upright Project's model enables investors to understand the broader impact of their portfolios, offering a unique opportunity to prioritise companies that drive meaningful change for both people and the planet. This success not only highlights EIT Urban Mobility’s commitment to impactful investing but also sets a compelling benchmark for the industry, demonstrating the potential for capital to drive significant positive outcomes.”?

In contrast, ESG relies on scores or ratings that assess a company’s performance relative to industry peers and is therefore not standarised. On receipt of an ESG score, one should also be aware that this is a score based on the company's ability to mitigate risk rather than create positive change.?

As Fredrik H?nell, Director of Impact Ventures at EIT Urban Mobility, explained at Slush 2024, “[A cigarette company] can have a really high ESG by ticking all the boxes. However, it has a really low impact due to the negative effects on health.”?

How impact and outcomes differ?

Impact investing balances measurable impact with financial return, often addressing specific challenges. With emphasis on impact, success can be assessed through tangible metrics, such as CO2 emissions or the equivalent of jobs created. In the case of EIT Urban Mobility, the impact created by the company’s startup portfolio is clear:??

• Social: the equivalent of 1,070 (direct or indirect) jobs created?

• Environmental: the equivalent of 10,027 tonnes of emissions reduced?

• Knowledge: the equivalent of 55,266 hours of engineering services equal to over 25 years of highly skilled, full-time work?

• Health: In promoting active forms of mobility the health impact of the portfolio corresponds to 242 life years?

In contrast, ESG incorporates environmental, social, and governance factors into traditional investment strategies to enhance financial performance. By identifying companies with strong ESG practices, the goal is to reduce risks (e.g. regulatory fines, reputational damage) and capitalise on opportunities such as clean energy growth. ESG’s focus is on long-term, risk-adjusted financial returns rather than directly driving social or environmental outcomes. Therefore, ESG ratings serve as filters to identify companies poised for stable growth through sustainable practices.?

In summary: creating impact vs avoiding harm?

Impact investing targets specific challenges by funding companies that have the ability to solve them. ESG, on the other hand, serves as a filter to identify companies poised for stable growth through sustainable practices. While both approaches seem to have similar goals in mind, their actions, methods of measurement, and outcomes wildly differ.??

This is not to say that companies lacking a core focus on impact should not examine, adjust, and change their business practices to make them more sustainable. Rather, it highlights that a good ESG score does not necessarily reflect a company’s true impact, whereas a definitive net impact ratio provides a clearer measure.??

If you would like to know more about IT Urban Mobility’s support to impactful startups and investment processes, you can read more here.