Fund Solutions

Impact Market “Dynamic but Disorganised”

New reports seek to clarify impact investment definitions, including self-assessment framework for providers.

The global market for impact investments is a “dynamic yet somewhat disorganised market of diverse participants, standards and concepts”, according to a report from the International Finance Corporation (IFC). What constitutes an impact investment and how impact can be measured are divisive questions for institutional investors. The IFC report, along with another from impact investment consultant Tideline, are the among recent attempts to quantify the market and clarify the options available to asset owners.

According to IFC estimates, the global market for impact investments totalled US$2.3 trillion in 2020 (equivalent to about 2% of global AUM), of which just over a quarter – US$636 billion – “clearly have an impact management system in place”.

The IFC defines impact investors as having three core characteristics. They must intend to achieve social and/or environmental goals through their investment; have a credible narrative about how their investment will achieve the intended goals; and have a measurement system that links intent and the contribution of their investment to improvements in outcomes delivered by the enterprise in which the investment was made.

A measurement system enables the investor to “assess the level of expected impact, ex ante, in order to continuously monitor progress and take corrective actions when appropriate, and then finally to evaluate the achievement of impact, ex post”, said the report.

Even for established and dedicated impact investors, warned the IFC, compliance with these attributes might not be readily observable. This is particularly true for investors that also manage other types of investments alongside impact investments. “Combined with a rising number of investors labelling themselves as impact investors, it is becoming more difficult for asset owners to determine which investment strategies and assets should be considered impact investments,” said the IFC.

Adoption of common principles

Despite these complications, adoption of common principles is providing some clarity to asset owners. The availability of information on measured impact assets (those that can be credibly observed to be managed with intent for positive impact, have an identifiable contribution, and have a measurement of impact) has increased. As of May 31, 2021, 97 signatories to the Operating Principles for Impact Management had published their disclosure statements, which constituted half of measured impact assets under management (AUM). “This is a testament to the increasing level of transparency and discipline in the market,” said the IFC.

Although still relatively small, the market is attracting considerable interest, with potential to increase in scale and thereby contribute to the achievement of the Sustainable Development Goals (SDGs) and those embedded in the Paris Climate Agreement, said the IFC.

The IFC report concluded that the portion of the impact investment market in which intent to contribute to measurable impact is clearly observable, and in which there exists a direct narrative of contribution to impact, is relatively small and mostly restricted to investments in private markets.

Under a broader de­finition that includes the wider universe of development banks, private impact funds without identifi­ed measurement systems, as well as public impact intent funds, the report estimates an additional US$1.646 trillion is invested with an intent for impact.

Framework for impact labelling

Tideline’s report attempts to address investors’ “confusion” by introducing a Framework for Impact Labelling that enables users to differentiate investment approaches according to the degree to which they integrate “three core pillars” of impact investing: intentionality, contribution and measurement.

“In the absence of universal standards for product and fund labelling, we believe accurate self- classification backed up by robust evidence and independent verification is a critical part of any sustainable investment journey and essential to growing the sustainable investing space with integrity,” said the report.

The Framework illustrates the different approaches to sustainable investment, bringing together contribution, intention and measurement (the latter being a function of a strategy’s degree of intention and contribution). The more a strategy combines contribution and intention, the more likely it is to have quantitative, specific, outcomes-focused measurement, said Tideline. ESG integration strategies focus on metrics that capture inputs (such as carbon emissions from company operations), whereas impact investing strategies focus on capturing outcomes (such as carbon emissions reduced).

Tideline said there were a range of approaches to sustainable investment, with the most impact-focused including impact investments as well as some thematic investments and ESG-focused investments with strong active ownership. “In Tideline’s work we have found that when many asset owners say they are looking for investment opportunities with impact, they are not looking only for ‘impact investments’ narrowly defined, but at the much larger universe of ‘impact-focused’ products.”

Impact-focused strategies tend to have high degrees of both intention and contribution, while thematic investments often have a high degree of intention, but can vary widely in contribution. ESG integration strategies can vary widely in both intention and contribution.

Choosing a label sends a signal to the market about what kind of investment strategy an asset manager has, said Tideline. “To be successful, asset managers need to understand the different labels, what they mean, how they’re used, and how the market will likely react.”

 

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