Aligning incentives in impact investing

Impact investing has matured over the past decade, but the incentive structures shaping behavior across investors, intermediaries, and enterprises have largely stayed the same. We organized this webinar in collaboration with Roots of Impact to look at how this can be changed.

Bjoern Struewer, Founder & Co-CEO of Roots of Impact, and Natasha Dinham, Co-CEO, drew on their experience implementing Impact-Linked Finance across sectors including inclusive finance, water, e-mobility, and skills development. The discussion focused on aligning incentives on both the supply and demand sides of capital, at the fund and enterprise level, with particular attention to where these structures work best in Asia.

Resources referenced in the session:

• How incentives can successfully steer capital toward impact - ImpactAlpha
• Impact-Linked Finance: Learnings Report (June 2024) - Roots of Impact
• Impact-Linked Finance: Lessons Learned - Roots of Impact
• Impact-Linked Finance Self-Study Course
• Impactlinked.co

Questions from the session

1. Impact by Design & Systems Change

Where are some of the biggest incentive misalignments?

Misalignment in impact finance can be observed at multiple levels of the capital chain, including wealth advisors, investors, fund managers, and investee enterprises. Recognizing these misalignments is critical to achieving intended impact outcomes.

Addressing misalignment requires a clear understanding of its underlying causes. As discussed in the webinar, one important approach is to redesign incentives so that they are aligned with desired impact objectives. However, other mechanisms may also be needed to tackle structural and behavioral drivers of misalignment.

How can funding be mobilized to an ecosystem rather than an individual project?

Building and strengthening an ecosystem requires close collaboration among its various stakeholders. Funding is an important enabler, but it is only a subsequent step in a broader process of ecosystem development.

Alignment of incentives is equally critical in systemic interventions. Well-designed incentives targeted at key leverage points within a system can encourage collaboration, coordination, and sustained engagement among ecosystem actors.

Aside from impact-aligned compensation, how can fund structures be designed better for impact?

There are many ways in which fund structures can be designed from the outset to better support impact objectives. For example, permanent capital vehicles and evergreen fund structures can, in certain contexts, provide stronger alignment with long-term impact goals than traditional closed-end funds. More broadly, thoughtful fund design can help ensure that incentives, governance, and capital deployment are aligned with the desired outcomes. You can learn more about our impact-by-design approach here.

How do incentives and blended finance work together?

Incentives can be effectively embedded within blended finance structures. For example, a third-party funder may provide outcome payments contingent on the achievement of predefined impact targets, or offset interest rate rebates that reward investees for delivering measurable outcomes. In this way, blended finance can align financial incentives with impact objectives and encourage behavior that contributes to the desired social or environmental results.

2. Impact-Linked Compensation

What type of impact-linked compensation can you recommend for funds without carry? Is this more prevalent in some asset classes?

Impact-linked carry is most commonly used in equity funds. For debt funds, an alternative approach is the use of impact-linked bonuses, whereby either the fund management fee is adjusted based on the achievement of predefined impact results or the management team receives a separate performance bonus linked to impact achievements.

However, impact-linked bonuses can also be applied to equity funds. More broadly, there is no requirement for equity funds to rely on a traditional carry structure. Carry is simply the conventional approach, whereas alternative incentive mechanisms can be designed to align manager compensation more directly with the achievement of impact objectives.

3. Impact-Linked Finance

Which sectors has Impact-Linked Finance been most prevalent in?

In general, impact-linked finance can be applied across a wide range of sectors. The most important criterion for its application is the ability of the enterprise to demonstrate a clear and direct attribution to the impact being rewarded.

This condition can be met in many different sectors and thematic areas, including agriculture, energy, climate, water and sanitation, health, gender, and many others. Wherever impact outcomes can be credibly linked to an enterprise's activities and measured with sufficient confidence, impact-linked financing mechanisms can be designed to incentivize and reward their achievement.

Are there any funds in Asia providing impact-linked financing to enterprises?

Roots of Impact will soon be launching a new fund focused on green ventures. Starting in Asia, the fund will provide capital with embedded impact incentives, alongside technical assistance, to early- and growth-stage ventures operating at the intersection of climate action and community impact.

The fund will focus on three key areas:

• Climate-resilient livelihoods

• Distributed low-carbon technologies and infrastructure

• Circular economy solutions

By combining catalytic capital, impact-linked incentives, and tailored technical assistance, the fund aims to accelerate the growth and impact of ventures that contribute to both environmental sustainability and inclusive development.

Can incentives also be used to prevent mission drift?

Yes, incentives are a powerful mechanism for preventing mission drift. When designed effectively, they help ensure that stakeholders remain focused on the intended impact objectives over time.

Moreover, incentive structures can be tailored to support long-term goals, encouraging decision-making that prioritizes sustained impact creation rather than short-term results. In this way, well-aligned incentives can play a critical role in preserving mission integrity and reinforcing commitment to long-term outcomes.

How do you ensure integrity of end-customer data?

We typically engage independent verifiers to assess and validate the achievement of impact outcomes. This helps ensure objectivity, credibility, and transparency in the measurement process, while providing confidence to funders and other stakeholders that impact results have been achieved as intended.

How do you avoid unintended consequences of incentives (e.g., when the metrics aren't perfect)?

While metrics do not need to be perfect, they must be carefully designed to avoid unintended consequences from the outset. This requires a thoughtful and professional approach to ensure they drive the intended outcomes.