Impact investing has garnered much attention for its potential to channel capital into material social and environmental objectives.1
This segment of responsible investing has been defined as “investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return.”2 But it is important for investors to dig deeper into what exactly constitutes such impact. And importantly, how do you measure it? Given its nascent nature, impact investing is still a murky, vague and contentious concept — a challenge to its own development and to the growth in asset flows.
A new whitepaper3 from Qontigo and Clarity AI, whose technology platform helps investors understand, measure and optimize social and environmental impact, seeks to shed light on the current state of impact investing. It does so by reviewing prominent impact management and measurement frameworks, and by comparing ‘impact-branded’ investment practices to assess the level of alignment between theory and practice. The latter exercise gains precedence at a time of rapid growth but slow standardization in the impact market.
Growth meets challenges
The paper acknowledges that impact investing suffers from conceptual, mislabeling and applicability issues. It also analyzes systematically the strategies of the small but rapidly growing share of investors considering impact in their investments, and finds that few are doing it thoroughly: less than a fifth of self-identified responsible investors meet standard criteria of impact investment. On a more positive note, identifying and understanding frameworks to assess the impact of companies and portfolios is a helpful starting point for true impact strategies, the paper argues. The authors conclude with recommendations on how the investment industry can address the impact-measurement challenge.
A common baseline towards a definition of impact investing
The whitepaper reviews three prominent impact investment frameworks4 and analyzes how each one considers impact definition, measurement and deliverance. A common baseline exists for all three frameworks, the authors find, when defining impact resulting from investment decisions. This baseline consists of:
- Intentionality: an unambiguous desire to contribute to measurable social or environmental outcomes through the investment process
- Additionality: an increase in social or environmental benefits that would not have occurred without the investment
- Inclusivity: the benefits from impact investments flow towards underserved populations
What do current impact investment practices tell us?
In an interesting addition to existing research on impact investing, the Qontigo and Clarity AI whitepaper examines the extent to which real-world investor approaches currently embed these three criteria in their impact-branded products.
By looking at the 2020 reporting of investment practices from 960 signatories to the Principles for Responsible Investing (PRI), the authors accessed qualitative descriptions of processes relating to sustainability-themed listed-equity funds. They then selected those responses that mention the term ‘impact’ as a proxy to analyze prevalent impact-investment approaches. This search yielded 74 such responses (or less than 8% of total respondents) that reported on signatories’ active listed equity ESG incorporation practices — a small sample, yet a representative one in terms of assets under management.5
This sample of investor responses was then manually screened for evidence of intentionality, additionality and inclusivity. The authors awarded a score on a scale of 0–2 in each one of the three criteria, with 0 being no evidence and 2 being significant evidence.
Sixty-two of the 74 investors who mentioned ‘impact’ (or 84%) scored between 0 and 2 in total, demonstrating no or low recognition for the intentionality, additionality, and inclusivity of their impact-investment process. The results are reflective of an industry that likes the impact brand but in practice is, at best, confused about the process of impact creation and, at worst, appears to overlook the topic completely.
“We believe these poor trends are indicative of the general impact investment narrative,” the report says.
At the other end of the spectrum, 12 investors (16% of respondents who mentioned ‘impact’) scored between 3 and 6, with seven investors (9%) getting full marks. “This demonstrates that a listed equity impact investment approach that is conscious of its intentionality, additionality and inclusivity is perfectly possible, as measured by our methodology,” the authors wrote.
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Seeking accurate impact measurement
The whitepaper also discusses a few practical ways to track impact measurement, including the United Nations’ Sustainable Development Goals (SDGs), a common such framework. Here, the authors warn that in order to develop a comprehensive and holistic view of companies’ impact through the SDGs, it is important that investors take into account a company’s entire value chain. They should go deeper than assessing whether companies are in some way connected with achieving high-level goals to also measure each company’s performance on contributing to underlying targets — a task that is hindered by lack of thorough data and research coverage. Knowing that a company is committed to reducing inequalities or to responsible consumption is very different from knowing how much they actually contribute in real terms to those goals. Putting that in terms that enables comparisons across companies is key, the paper says.
A second challenge is to compare impact across different dimensions. In other words, how can an investor aggregate, for example, a company’s negative impact from carbon emissions and its positive impact from employment creation or waste reduction?
A final challenge relates to ‘impact labeling’, where data providers may downplay key impact metrics that are hard to measure. “Maximizing exposure to companies that perform well on SDG metrics,” the authors write, “can miss the dimension of intentionality and additionality and exclude the dimension of active engagement – arguably the most powerful impact lever available to public market investors.”
Despite these challenges, there are innovative tools that can help investors reconcile the gaps. The authors single out the framework from the World Benchmarking Alliance (WBA) and Clarity AI’s SDG Impact Methodology. The latter, for example, estimates companies’ full-fledged impact according to each one of the 52 official UN underlying targets, and puts it in impact units by using an assessment of the value of specific social benefits. This enables comparison and optimization across SDGs.
Sound methodologies, data and labels
Understanding impact definitions, measuring real-world outcomes, enabling investors to use this data in stock selection, and fighting ‘impact washing’ are key to defining and nurturing impact investing, the authors say.
“Sustainable investment will only deliver on its promise if it can rely on sound methodologies, data and labels,” they write. “Impact investment is an attempt to re-establish a sound value proposition. It is a promise that seeking collective societal benefits will eventually translate into better conditions for long-term sustainable returns.”
1 Different organizations have provided an estimate of the size of the impact strategies market. According to the Global Sustainable Investment Alliance, impact investing accounted for USD352 billion at the end of 2019, the smallest of seven sustainability strategies tracked by the organization. The Global Impact Investing Network (GIIN) in June 2020 valued the impact market at USD715 billion.
2 Definition by the Global Impact Investment Network.
3 Bocquet, R., Mehrotra, S., Georgieva, A., Pina, P. Coelho, R., Lastra, C., ‘On the Way to Impact Investment: Mind the Gap Between Theory and Practice,’ August/September 2021.
4 The three frameworks considered are The Impact Management Project (IMP), the GIIN’s Impact Framework and Julian Kölbel’s and Florian Heeb’s ‘The Investor’s Guide to Impact.’
5 The 960 PRI signatories actively managed at the time a total of USD21.1 trillion in listed equities. The 74 signatories that reported on their active listed equity ESG incorporation practices managed a combined USD20.5 trillion across all asset classes.