Intention is not enough: Impact investors seek standardised measures of ‘impact’
The impact investing market is thriving. Asset managers from across the spectrum of the industry are buying into the trend, raising funds to invest in projects that aim to make positive social or environmental change, as well as a strong financial return.
According to an annual survey by Global Impact Investing Network (GIIN), the impact investment universe was estimated to be worth USD715 billion in 2019, more than 40 per cent up from just a year ago.
But that growth has been hard-won. In the beginning, there was an abundance of short-term tourist capital, slapping a green label on a fund, with unproven capabilities for impact.
“Fast-forward to today, and there is a much more mature pool of capital,” says Vikram Raju, head of Impact Investing, AIP Private Markets at Morgan Stanley Investment Management.
Raju spent 25 years investing in the emerging markets space where he says impact was “a positive by-product” but not a primary focus. Going to work for the International Finance Corporation, part of the World Bank group, in 2011 was the turning point.
“Climate investing was not typically a career-enhancing move at that time,” says Raju, who joined in the aftermath of the ‘cleantech bubble’. Between 2006 and 2011, venture capital firms poured USD25 billion into early stage companies promising a green energy revolution, and on average lost more than half of their money.
“Some people from the internet investment world came in hoping to 'change how people consume energy', but vastly overestimated how quickly this would take root. For example, there was funding for lots of early stage, clean energy companies but many came up against the classic early stage investing problem: too much capital going into ideas that had not been fully-analysed or were not commercially scalable.”
The other legacy that harmed impact investing at that time was one of “philanthropically-oriented investors” whose investments generated glossy pictures, but not returns. Raju says this created a “big challenge for impact investing as many investors didn’t see the potential for returns”.
It led many to brand impact investing as a no-returns game. Still to this day, the biggest problem that puts investors off impact investing is a fear that these investments will not provide competitive financial returns.
Raju calls this a misconception, given that the “number one” thing that disqualifies potential investments from the private equity fund he manages is that they do not meet his expected return threshold.
“We are focused on providing clients with market-leading impact opportunities and solutions which generate commercial return as well as having a tangible impact.” In other words, if he does not generate serious returns, then serious capital will not come in.
But returns do not seem to be a problem for most impact investors. The GIIN’s annual survey of impact investors in 2019 found that 88 per cent said they were meeting or exceeding their financial expectations.
Raju says once the returns threshold is passed, he looks for companies where it is inherent to their business model that if the business grows, so does their environmental impact.
He gives the example of a citrus producer in Spain, wanting to develop a comprehensive fruit offering, grown using hydroponics. This will reduce water use by 25 per cent and at the same time helps the company to be more cost efficient.
“If they grow the way we think they can, they will save water in each of their farms. This is a tangible example to offer investors; a commercially important project which produces a high-quality product while saving gallons of water.”
All of the impact is then measured against specific company-based metrics. Morgan Stanley procures a legal commitment for the company to report the numbers related to their impact, be it gallons of water saved, or reducing landfill, often multiple times a year.
Nevertheless, current measures of impact are fairly rudimentary. As yet, there is no “industry-wide set of metrics” for impact, but Raju believes the industry is moving towards finding the “gold standard of having a universal measure or currency for impact across all investments”.
The impact return, not the financial one, is the one that concerns most of the investors. 66 per cent of impact investors in GIIN’s annual survey said ‘impact washing’ is an incredibly important issue to tackle if the market is to scale.
The GIIN says new solutions may be on the horizon and that soon impact will become a feature of company performance, just like the liquidity or risk and return profile of an investment.
“It’s not enough just to have a goal, it’s also important to be able to demonstrate measurable performance against that goal,” says Kelly McCarthy, the director of Impact Measurement and Management at GIIN.
“Now more than ever, there is a real cry as the world needs companies to act and reflect on a broader number range of topics than those that have been required by regulators, and those typically captured in profit and loss statements.”
The GIIN is developing a series of impact benchmarks to compare the impact of one investment against another. Their methodology is based on Iris+, which was established in 2008 by the GIIN to provide metrics for investors to measure the impact of their investments. Currently, half of all impact investors use IRIS metrics, and over 15,000 stakeholders around the world.
‘Impact’, as McCarthy sees it, must be broken down using context. “You have to take the size of a problem relative to where that problem exists. For example, if the problem is education in the southside of Chicago, you have to determine: ‘What is the size of education problem?’ We can put a number on that, and then, in context, ask, ‘How well are companies addressing that problem?’”
Once you can measure impact effectively, capital can be put to best use. Being able to judge an investment against the benchmark for addressing climate issues would bring more credibility to the market. “Imagine if we could talk about whether you’re in the top quartile for addressing climate issues, or the bottom quartile for addressing jobs and unemployment statistics?”
McCarthy is keen to remind investors that financial and accounting transparency is a relatively recent phenomenon. “Only about a century ago, you couldn’t actually tell if company A had better or worse financial performance than company B. It was only once financial accounting rules, and ways to make sense out of the data, were developed that markets around the world began to operate in a much more transparent way and investor confidence in capital decisions grew.”
As impact investing comes to the fore, bigger pools of capital are circling, and one of the keys to unlocking that investment potential is in having reliable, standardised ways to prove that impact is about outcomes rather than intentions.