Jamie Broderick, Director at the Impact Investing Institute, says investors are increasingly focused on companies’ social and environmental value.
It’s hard to define. It’s harder to measure. And it can be near-impossible to find a credible supplier. But impact investing is an idea whose time has come.
“The mood of the times is that capital has to become more accountable for impact. The climate emergency created that link between the problems we have as a society and the use of capital to address those problems,” says Jamie Broderick, Director and Board Member at the Impact Investing Institute.
In fact, you may be doing it without even realising. Impact investing is sometimes associated with financing well-intentioned but unproven start-ups, or environmentally-focused projects that might struggle to attract mainstream finance. But that would ignore many of its biggest opportunities.
“You can create impact if you use your capital with the intention to change the way listed companies do business to create positive environmental and social outcomes. A lot of people don’t think of that as impact investing, but if you use your capital to change a company’s gender balance or improve its supply chain to avoid slave labour, then your action falls within that definition of using your capital both to get a return and to cause measurable social and environmental benefit,” explains Broderick, previously UK head of UBS Asset Management and chief executive of JP Morgan Asset Management in Europe.
Moving the needle
Although the climate crisis was the catalyst, its impact was not immediate.
The setting of the UN’s Sustainable Development Goals (SDGs) and the signing of the Paris Climate Agreement in 2015 provided clear, common objectives around which frameworks for measurable positive impact could be constructed.
But it would take a shift in public perception in 2018 to really move the needle. While the IPCC’s Special Report made the scientific case for intensifying climate action, Greta Thunberg’s address to COP24 in Katowice had a wider impact, suggests Broderick, cemented by David Attenborough’s Our Planet series, in which the veteran broadcaster highlighted the damage wrought by human economic activity on natural ecosystems.
Retail and institutional flows into ESG funds have regularly set new records ever since, with the unequal effect of the pandemic bringing social and governance factors to prominence alongside environmental issues in 2020. The tenth edition of the Global Impact Investing Network’s (GIIN) annual survey, released last June, estimates the impact investing market at US$715 billion.
But the explosion of supply and demand has muddied the waters, leaving many struggling to differentiate impact from greenwash. At the same time, frameworks for measuring impact are still evolving (GIIN launched its Joint Impact Indicators last month), notwithstanding increasingly comprehensive efforts to measure and reduce greenhouse gas emissions and decarbonise portfolios.
Risks and opportunities
At the institutional level, Broderick suggests the majority of UK pension schemes still frame their ESG investment policies primarily in terms of addressing risks arising from the activities of investee companies.
“It’s only at a later phase that people move beyond the risk and start looking at opportunities. There are pension funds with ESG statements reflecting a balance between risks and opportunities. They’re minority today, but a growing minority,” says Broderick.
Even so, investors which only look at risks can have impact. If focused on supporting the transition to net zero, they may engage to accelerate transition paths, rather than simply divesting from firms with high emissions. But they may be missing out on the impact opportunity if they only seek to protect their portfolios and do not consider investment in firms developing solutions to climate risks.
“A big question for investors is: where do I get delta from the pressure that I’m exerting on companies? There’s a difference between the delta you can create from turning an A-rated company into an A+ compared with investing in a company which is a B- but with a lot of scope for improvement. Investors at the more sophisticated end are looking for the positive change in a company,” says Broderick.
To help pension funds to grasp the opportunity, the Institute issued in Q4 2020 its four Impact Investing Principles for Pensions, in collaboration with Pensions for Purpose, alongside a report clarifying the fiduciary duty of trustees, sometimes seen by trustees as a barrier to impact investing.
“It’s perfectly possible to identify impact investments that are in no way concessionary in terms of risk and return profile,” says Broderick. “There is a residual sense among some schemes that investing for impact means making a financial concession and that’s one of the myths we’re trying to bust.”
Identifying impact integrity
Whether investing in today’s leaders and laggards or tomorrow’s superstars, asset owners need support from asset managers to invest efficiently and effectively. They also need frameworks of measurement to ensure they are achieving the desired results. In both cases, the current landscape reflects a work in progress rather than an end-point.
The Institute advises asset owners to “appoint investment consultants and managers with impact integrity”. This means layering an addition set of considerations on top of traditional due diligence on people, process and performance.
For Broderick, the first challenge is to identify whether the culture of a manager is supportive of investing for impact. “The asset owner should ask for evidence impact is core to the enterprise, is embedded in the culture and drives decision-making, e.g. a decision that went one way rather than another because of an impact consideration.”
As part of this impact culture, the manager also needs to demonstrate a coherent theory of change. Originating outside traditional investment circles, the term may be unfamiliar to some, but Broderick says it can have practical as well as conceptual value.
“You can view it in terms of: ‘Can you describe how this way of working will be effective, such that its activities will generate change and impact?’ The manager’s theory of change is really their explanation of how they expect to generate impact,” he says.
Second, managers must show impact through data and reporting. In short, this means gathering and reporting reliable, accurate data from investee companies which demonstrates that its activity is generating desired, planned positive outcomes.
Third, Broderick also flags the importance of ‘additionality’, meaning the manager should be able to demonstrate that its investment process is focused on firms which actively seek to create additional sources of environmental or social value. Increasingly, managers are also expected to further differentiate investor impact from company impact.
Long, tedious and slow – but necessary
Broderick agrees that this combination of attributes is relatively scarce among managers right now. “The people that do it best are probably the dedicated ones who started in the impact business with a sense of mission 10-15 years ago and now have it embedded in their culture,” he says.
“The number of companies asset managers with a credible impact heritage and culture is small, and there aren’t many following through with data and reporting and a focus on additionality. But the entire industry is moving in this direction, certainly on the data and reporting side, even if they’re not necessarily change their cultures.”
It is perhaps understandable that impact reporting remains an area of complexity and fragmentation. If large-scale institutional interest in impact investment was limited before the formulation of the 17 SDGs and their underlying 169 targets, it can be little surprise that a universal set of investment standards and metrics is still emerging. As Broderick notes, each SDG has a different set of metrics, because each one is addressing a different kind of problem.
The Impact Investing Institute recently developed a set of sector-wide sustainability reporting standards for social housing in the UK – as part of a coalition of 18 banks, investors, housing associations and others – which includes metrics for the wellbeing of tenants, GHG emissions and length of tenure, for example.
Broderick accepts that the effort required to develop standards across multiple sectors and geographies can be long, tedious and slow – but necessary. Further, he points out that it can leverage existing initiatives, citing the UK’s National TOMs (themes, outcomes and measures) Framework, used largely in the public sector to provide minimum reporting standards for measuring social value.
Focused primarily on five themes – jobs, growth, social, environment and innovation – the TOMs use a system of outcomes and measures to provide organisations with a consistent approach for monitoring and improving social value in their management and procurement processes. Another initiative with its roots in the UK public sector is the Unit Cost Database, which attempts to assign a monetary value to a series of social outcomes, relating to education, employment, health, housing, to help local authorities allocate resources and budgets.
“The National TOMs are a UK phenomenon, but they’re an example of the kind of exercise that can be conducted over a multi-year period to find a set of appropriate outcomes and measures to track progress across a wide range of defined categories,” says Broderick.
The end of externalities
Initiatives and frameworks to help asset owners and managers to better understand the social and environmental impact of company activities and investment decisions are also evolving fast.
At a high level, they can encompass the EU’s disclosure and taxonomy regulations, the directors’ duties defined in Section 172 of the UK Companies Act, the IFRS Foundation’s planned Sustainability Standards Board, the Dasgupta Review’s emphasis on natural capital, the Task Force on Nature-based Financial Disclosures and the US Business Roundtable’s 2019 redefinition of the purpose of the company, to encompass responsibilities to stakeholders.
These developments all share a common recognition that ‘externalities’ can no longer be considered as such, due to their very real and tangible impact on company balance sheets. This is also the starting point for the Impact-Weighted Accounts Initiative (IWAI) at Harvard Business School, a project chaired by Sir Ronald Cohen and led by George Serafeim, Charles M. Williams Professor of Business Administration at the school.
Last July, the project published an assessment of the effect of environmental impacts – measured ins US$ terms – on the balance sheets of 1,800 companies, calculating that 15% of apparently profitable firms would run at a loss; a further third (32%) would suffer a reduction in EBITDA of 25% or more if environmental damage was fully accounted for.
The project intends to publish costs for product and employment impact this year in order to provide a more complete picture of company impact. “More than the methodology, the value of these initiatives comes from embedding the idea in everybody’s consciousness that companies don’t just create financial value. They also create positive and negative social and environmental value,” says Broderick.
Although these efforts are at various stages of maturity, they suggest a tipping point has been reached, in terms of the factors that investors must consider to make responsible investment decisions and the need for impact measurement frameworks. For Broderick, however, the current situation is necessary but insufficient.
Calculations and assessments of impact only have force in the presence of mechanisms to turn negative impacts and costs into powerful disincentives. We can successfully measure carbon emissions, for example, but this ability is only meaningful if there is a clear and unavoidable cost, such as a carbon tax.
“The logical conclusion or direction of the Impact Weighted Accounting Initiative is for these negative costs to be visited back upon the companies in the form of either regulation or investor preference. If you’re creating a lot of damage, we’re going to calculate the cost and either regulators will put pressure on you or investors will avoid you,” says Broderick.
The impact movement has come a long way in a short time, but companies are yet to feel its full force.