Impact Voices | May 17, 2023

Why don’t more impact fund managers tie compensation to impact? Let’s find out.

Aunnie Patton Power and Riannah Burns

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Guest Author

Aunnie Patton Power

Guest Author

Riannah Burns

Impact investing has now reached more than $1 trillion in assets under management. With this growth, concerns over “impact washing” have also grown. In fact, a majority of impact investors cite impact washing as their biggest concern facing the industry in the next few years.

Well-designed and implemented impact-linked compensation structures could be an effective motivation tool to hold fund managers accountable to their stated impact goals. Similar to how fund managers tie their remuneration in various ways to their financial performance, they could embed various impact-related rewards and penalties in their compensation structures.  

So why are so few impact fund managers tying compensation to their impact outcomes? 

Little research has been done to understand impact-linked compensation’s potential role and value to the field of impact investing. We have a benchmark for how (un)popular it is: BlueMark’s latest Making the Mark report found that less than a third of verified investors (those whose impact measurement and management practices have been reviewed by BlueMark) link impact performance directly to financial incentives. We have heard from practitioners about adoption challenges. But we know very little about the practices and learnings of general partners and limited partners who use impact-linked compensation. 

Despite a lack of data, we have seen sustained interest in impact linked compensation as a potentially important tool for impact fund managers to demonstrate credibility, achieve greater clarity on impact objectives, and focus investment teams on improving probabilities of realized impact. 

That’s why The ImPact has launched the largest research study to date on impact-linked compensation with support from the Tipping Point Fund on Impact Investing.

By collecting data, documentation and insights from industry participants, we hope to create evidenced-based tools for GPs to establish appropriate impact-linked compensation structures (including carry, annual reviews and bonuses) while empowering LPs to better assess compensation during due diligence. 

The research case 

GPs in impact investment funds must balance more complex risk, return and impact trade-offs when making investment decisions than non-impact funds. Many, however, adopt the financial-only compensation mechanisms of traditional funds, whose core objective is to maximize risk-adjusted financial returns for their investors. 

We are long past the binary discussion of impact versus “market rate” financial returns. But there are some cases where impact and financial returns create contradictory outcomes. The risk to impact fund managers is mission-drift, or failure to achieve social outcomes when in pursuit of financial goals. 

For LPs and GPs that want to protect social outcomes, incentives can act as a hedge against mission drift, particularly when incentives or compensation structures are tied to social or environmental goals. But both parties must think carefully around the design of incentive structures. 

GPs that have adopted impact linked compensation structures choose to raise the financial stakes of non-financial performance. For them, impact-linked compensation is an important signaling mechanism, as well as a way to embed more robust portfolio management practices.

For those that don’t, the decision not to integrate impact-linked compensation appears to be a choice rather than an oversight. One study co-authored by Professor Anne Tucker of Georgia State University (an advisor to our project) reviewed 53 impact investment fund contracts, finding little variation in traditional waterfall compensation (i.e. the order of distributions to LPs and GPs) but significant variation in hurdle, carry and catch-up target rates compared to non-impact funds.

On the LP side, Investor preferences have been studied comprehensively in the environmental, social and governance, or ESG, investing field. Nearly three-quarters of S&P 500 companies now tie executive compensation to some form of ESG performance. (Notably, this is most common in extractive industries such as utilities and energy, with 100% and 90% adherence respectively). Just over half of investors believe ESG-linked pay is appropriate if ESG targets are specific, transparent and measurable. 

Interestingly, the most common method of ESG-linked pay, employed by 48% of firms, is a qualitative assessment of ESG in individual performance assessments.

Implementation challenges

Fund managers that do not integrate impact-linked compensation in their investment approaches often cite a lack of interest from investors, as well as difficulty standardizing impact management and measurement, which forms the basis for assessing performance.

On the first point, initial observations have shown mixed demand from LPs: some want to ensure strong mission lock, while others believe the practice adds unnecessary complexity and cost.

On the second point, transparency and comparing performance across funds remain key challenges for managers and the market, despite widespread adoption of standardized impact measurement and management practices, such as the Global Reporting Initiative and GIIN’s IRIS+. BlueMark reports that while 85% of investors have a thesis linking a fund’s actions to outcomes, only 15% have well-established supporting evidence. Nearly 90% of investors cite lack of transparency on impact performance as a key challenge.

Moreover, funds’ implementation of standardized impact reporting frameworks varies, making it challenging to develop boilerplate legal templates for impact-linked compensation.

Existing models

All that said, roughly a third of impact fund managers do use impact-linked compensation in some way, according to BlueMark. 

Aureos Capital was one of the first impact investing firms to adopt impact-linked compensation. Its 2009 Africa Health Fund had an established 15% base rate of carry for achieving financial hurdles. That rate would increase if the fund also achieved its impact targets.

Brazilian impact fund manager Vox Capital went a step further: its fund had to achieve both financial and social targets to receive its full carry. Otherwise, the team would only take half of its share of profits.

One of the leading LP proponents of impact-linked compensation is the European Investment Fund’s Social Impact Accelerator–a fund of funds–which requires fund managers who apply for funding to embed impact into their incentive structure. They ask funds to define one to five impact indicators per portfolio company and set quantifiable targets for each indicator. Progress is measured annually, if not more, and reported as an impact multiple, which compares the pre-investment target to realized impact. 

The framework is an alignment of interest tool and not a reporting tool, driven by EIF’s position that impact is positively correlated with financial returns. 

Research framework

Our research intends to identify the critical design and decision factors that enable impact-linked compensation to succeed, and create evidenced-based tools that support wider adoption by GPs and inform LPs investment decision-making. 

In the design of our research, we have drawn from Reward Value’s three-part framework, which requires choosing an appropriate “yardstick” to measure performance, a mechanism to link performance to pay, and governance that ensures the incentives are working as intended.

In choosing an appropriate yardstick, we are looking at how managers select metrics that reliably reflect achievable impact without adding significant reporting cost burden as well as how they are integrating stakeholder voices into their data. 

For the mechanism, we are looking at the choices around tying impact to the bonus, carry, and/or annual review. This choice is effectively a decision between longer- versus shorter-term incentives, which includes weighing the signaling and motivational effects. 

And finally, we see the role of governance in ILC as one of the most important, and least understood areas. One of the questions we are asking is how to maintain ambitious targets that motivate team members, while ensuring flexibility to adapt as the fund evolves. We see the governance practices that support impact linked compensation as key success factors and plan to spend a significant amount of time engaging with industry participants around this issue.

We ask all GPs, LPs and intermediaries with or without impact-linked compensation to participate in our survey, share your insights, and contribute to the development of best practices. By completing the survey you’ll get an exclusive invitation to join the first impact-linked compensation research convening on May 24th to discuss the current state of the practice, learn from case studies, and engage in small groups around specific challenges. 

Don’t miss out on this opportunity to help shape the future of impact investing. 

Learn more and participate in the survey at

Aunnie Patton Power is an ImPact Fellow at The ImPact and convenor of the Oxford Impact Finance Innovations Program.

Riannah Burns is a Social Finance Analyst at White Box Enterprises and a Research Assistant on the Impact Linked Compensation Project.