While ESG, particularly the integration of environmental factors into the investor process, is becoming a mainstream market trend, there is also a growing focus on impact.
Not only as its own particular investment lens, but as a critical part of understanding what can turn ESG from an investment lens into a practice. After all, if there is no assessment of the impact that decisions have, how can we know if corporate and investment strategies are making any difference?
Amit Bouri, chief executive of the Global Investor Impact Network (GIIN), says what’s going mainstream is taking a specific lens to ESG, one of financial materiality, or what impact will ESG factors have on the bottom line.
He believes that while this is a good thing, it’s limited in its approach, as it’s really only looking at factors that are financially material to the company and investor.
This makes sense, as it fits current market structure, but it remains questionable whether such an approach will be sufficient to ‘move the needle’ in addressing global challenges ranging from climate change to inequality and beyond.
‘Impact investment’ is a 21st century term, often ascribed to the Rockefeller Foundation, and first used in 2007 to explore ‘doing well by doing better’. It grew out of philanthropy, beyond the realm of social impact bonds and into a wider exploration of how to generate financial return alongside multiple co-benefits to society and the environment.
What really helped to transform the market was the introduction of the 17 Sustainable Development Goals (SDGs) in 2015, which provided a defined set of goals against which companies could assess what they were doing.
Impact investment has a range of approaches, from the provision of guarantees, first loss capital, capacity building, many of which also grew out of the philanthropy markets, but the private markets are getting involved.
US-based asset manager Nuveen, for example, has a range of investments addressing impact, with a focus on low-income consumers. While they may have very little, services that can address the failure to serve such consumers with access to housing, energy, education and financial services.
While impact investing represents a small proportion of its investments, it takes a longer-term view than many investments in private equity, and aligns its impact investments with the SDGs.
Growth of the impact investing market
The size of the impact market certainly continues to grow. The last market survey published by impact investment network the Global Investor Impact Network (GIIN) in 2020 estimated the size of the market at $715 billion.
The International Finance Corporation (IFC), the private sector arm of the World Bank, said that impact investment was around $2.3 trillion in assets under management in 2020, with around $636 billion having an impact management system in place (so similar to the GIIN’s definition of impact investment).
While the IFC’s numbers suggest that around 2% of global assets under management are directed towards ‘impact’, what it highlights is the use of impact assessment and management as transformational.
ESG impact means looking to the future
Bouri says there is an “increasing recognition that investors need to be investing in the economy of the future – it has to be more inclusive, more socially sustainable.” While investment in technology has driven much ESG in the last few years, Bouri believes that it’s time to invest in the support systems through which the economy functions.
Bouri says: “If we look at the world producing sustainable returns over the next 30 years, we know that we need to transform food and agricultural systems, housing and shelter, healthcare.”
Many current markets are not sustainable, from labour markets, education, even healthcare and, says Bouri, there is a “tremendous opportunity to put capital to work in those models of the future, creating measurable impact.”
Approaches to ESG and impact
One of the ways in which ESG and impact have been differentiated has been in looking at investor motivation and the extent to which actions are internal or external.
Evan Vahouny, chief impact officer at proof of impact, a SAAS-based ESG and impact data platform, explains that different approaches can be grouped into three categories: avoiding harm or mitigating risk; benefiting stakeholders (in positive ways to sustain financial performance over time); and contributing to solutions e.g. having a positive impact on systemic problems.
Difference between ESG and impact investing
The GIIN differentiates between the approaches of impact and ESG in its IRIS+ metrics, which are the most widely accepted system for impact investors to measure, manage and optimise their impact.
While both impact and traditional ESG frameworks account for benefit to stakeholders, ESG seems to focus more on internal issues ranging from diversity, worker safety, anti-corruption, regulatory compliance, etc, while impact is more about contributing to solutions, ranging from climate change to access to education and healthcare, even poverty alleviation.
Both the GIIN’s IRIS+ and the Global Reporting Initiative’s (GRI) frameworks explore the motivation behind corporate and investor action, the idea of benefiting stakeholders not just shareholders.
The more internally driven ESG frameworks from the Sustainability Accounting Standards Board (SASB), the Taskforce for Climate Related Financial Disclosure (TCFD), the Principles for Responsible Investment (PRI), even the ESG ratings from companies like investment research firm Morgan Stanley Capital International (MSCI) come across as operationally focused in terms of what needs to happen in order to minimise harm.
There are a range of impact frameworks. The Impact Management Platform (IMP), was developed originally by fund management group Bridges’ Impact Foundation, which created the Impact Classification System (ICS) now being used by the GIIN.
The SDG Impact Standards were developed by the United Nations Development programme, while the IFC Operating Principles, for example, look more externally at product and services and the impact they have overall.
It is this secondary approach, raising the issue of double materiality, that is currently the key difference between the US-based approach of the IFRS’s newly launched International Sustainability Standards Board (ISSB) and the European Financial Reporting Advisory Group (EFRAG)’s recently released metrics intended to underpin the EU’s new sustainability reporting standards.
Choosing the right impact investment framework
Every company and institution should undertake a materiality assessment to decide which challenges and metrics are material to their business, either in internal or external impact terms, on which it intends to address and report on.
Understanding long-term goals and the difference in these approaches will only become more important over time if accusations of greenwash are to be avoided. Critical to the avoidance of greenwash is, of course, measurement and comparability.
These are still the holy grail of both impact and ESG, but while comparability and transparency is improving, there is still a long way to go. If the financial markets are going to be effectively realigned to tackle global challenges, return on investment must be understood as a combination of return on capital and impact.
Impact measurement and management
The core challenge, according to Bouri, is developing ways in which impact can be usefully measured and reported, from both the corporate and portfolio (or financial investor) perspective.
The first step is around alignment, working out how a company or a portfolio lines up on today’s targets, whether they be the SDGs, the Paris Agreement or net zero.
The second step lies in understanding performance, a significant challenge given the range of approaches and methodologies. That means identifying metrics and strategies, and then building out benchmarks and solid data.
Understanding how investors recognise their impact is a necessary lens and Bouri sees the development of a system for measuring, managing and optimising impact as a public good.
Such developments, however, have to start somewhere. The IRIS+ metrics are currently in use by 25,000 globally and users can start with an SDG or impact theme leading to strategies investors can use, core metrics, etc.
What matters is thinking about environmental and social issues, not as distinct and separate but rather looking at the intersection of racial and gender equality and climate change across different sectors.
Such intersections are important and can be seen clearly in many sectors, increasingly so in areas such as with energy and agriculture.
While the GIIN is an investor network and its work dedicated to investor interests, this is a hugely important step and one that will reverberate across the ESG market as investors begin to be able to compare performance. The measurement of impact is going to become an integral factor to effective ESG.
IRIS+ impact metrics
Today, the GIIN’s current focus lies in developing benchmarking, enabling investors to understand how they are performing against the market. While financial performance benchmarks, which are key to investor success, are commonplace in investing, there has not been a standardised way of comparing and benchmarking progress based on impact.
The GIIN has worked with a team of 13 leading accredited asset managers that include BlueOrchard Finance, LeapFrog Investments, Triodos Investment Management and Triple Jump. These investors, which supply finance through both debt and equity, in a diverse range of financial service providers in both emerging and developed markets, have helped to develop a beta version of the first IRIS+ impact performance benchmark, for financial inclusion.
They intend to launch impact performance benchmarks in additional sectors on a rolling basis; forthcoming sectors include agriculture and energy. Also releasing alongside the beta version of the first IRIS+ benchmark are two new short GIIN reports focused on gender equality and non-financial support in financial inclusion.
Bouri says: “Growing adoption enables communication across portfolios – prior to this benchmark, investors operated in a vacuum of impact data. [They may have had impact data] for their own portfolio but no context for what good looks like across the market – for example, is a 100 new jobs good or bad relative to the market?”
He believes that the GIIN’s prototype is the beginning of a bigger shift in the way in which the markets operate and says: ‘If we want a world that is inclusive, sustainable and regenerative, we have to change the way in which investment is done.”