• Sophoi

Sophoi Sensemaking 1 - On the value and use of Theory of Change for Impact Investors

Updated: Feb 9, 2021

In impact investing, an impact thesis is a critical tool for articulating why investments will lead to the positive environmental and social impacts demanded by shareholders. Funds that are transparent about their impact performance are then rewarded by growing shareholder confidence and may even outperform competitors. Sophoi Impact has found success applying our expertise, and the tools developed in our climate change monitoring, evaluation and learning (MEL) practice, in a different setting - impact measurement and management (IMM).


Impact funds have a mandate that goes beyond financial return. So, a more nuanced approach is necessary to capture the full range of socio-ecological and economic impacts and outcomes of impact investments. As the financial sector becomes more environmentally and socially conscious, the impact investment sector looks to build robust evidence for measuring firm- and portfolio-level performance. Tools and approaches are also needed to then define these results up to the impact level for course correction and learning purposes. MEL practitioners have long used the theory of change (ToC) framework to link project inputs and activities to corresponding outputs, outcomes, and overall impacts.


A ToC is a diagrammatic illustration of a simplified pathway to impact. Developing a ToC is usually a collaborative learning process, establishing and testing critical assumptions on how interventions (in this case, a fund’s investments and operations) will lead to impact. The ToC also helps to define what information the fund will need to collect along the way to ensure investors are on the right impact pathway. Impact investors can benefit from this exercise in logically mapping progress and outcomes, especially since measuring impact is key to their overall performance.


In close collaboration with Archipelago Eco Investors (AEI), Sophoi Impact has developed a ToC which translates AEIs Plastics Fund One (PF1) investment strategy into a clear, coherent, and measurable set of impact pathways. The ToC we have co-created with AEI illustrates and elaborates pathways from firm-level to impact-level results. The ToC also specifies the roles of PF1 key stakeholders (fund investors, fund manager, and firms) in achieving the defined results and outcomes at various levels.


Our simplified AEI PF1 ToC (below) allows investors to understand the ‘essence’ of the investment fund and how it will deliver a positive impact. We have expanded on this simplified ToC in a more detailed ToC which is valuable for collaborative planning and presents a robust foundation to build out wider IMM tools like indicator frameworks and reporting mechanisms.


Archipelago Eco Investors Plastics Fund 1 – Simple Theory of Change

We’ve learned a few valuable lessons in co-creating the ToC with our AEI partners.


1. Effective IMM depends on creating an impact-oriented culture among fund partners, stakeholders and potential investors. Often this means tailoring impact measurement and management (IMM) tools to suit the firm and fund managers knowledge needs and demands. The PF1 is a plastics recycling fund investing in firms reducing, reusing, and recycling plastic. For each investment made under the PF1, the path to impact may be different. So, we have relied on the IRIS+ catalogue to guide our thinking on metrics that will best capture the aggregate outcomes of the PF1. Each firm will also have different priorities and resources when capturing results along their pathway to impact. While we have remained flexible in the way we capture progress at the firm level, we have selected three core, measurable key performance indicators: i) reduction of CO2 emissions, ii) reduction in virgin plastic use and iii) the internal rate of return. Three simple impact metrics, guided by robust principles like the SDGs, are sufficient tools to manage and measure investment impact.


2. There is a delicate balance between complexity and simplicity. The fund manager has a role in ensuring that the IMM captures and communicates the granular relationship between firm performance and portfolio outcomes and, similarly, ensuring aggregate portfolio results are contributing to the overall impact of a fund. Expanding impact measurement beyond the internal rate of return (IRR) can get complicated and create an unnecessary reporting burden for firms and fund managers. In our experience developing the PF1 ToC, we continuously gravitate towards simplicity. We have produced a simplified ToC for illustrative purposes, alongside a more functional, detailed ToC to inform the IMM.


3. A ToC can form the foundation on which to develop the IMM system. We developed a KPI framework based on the impact pathways illustrated in AEIs ToC, focusing on key qualitative and quantitative indicators that track pathways to impact. The development of this KPI framework will be the focus of our next Sophoi Sensemaking blog. We are ensuring that the KPI framework is coherent with the latest IMM standards, principles and frameworks which include the SDGs, the EU Sustainable Finance Taxonomy, and IRIS+ framework.


This Sophoi Sensemaking blog is the first in a series of pieces where we reflect on and share the practical insights generated through our work. The initial Sophoi Sensemaking series will focus on our support to impact investors developing their impact management and management (IMM) frameworks. We intend the Sophoi Sensemaking series to be practical and useful – please do respond with comments, questions, and shared experiences.