Measuring Impact: the evaluation of impact investing

This article is written by Iraoho-Intern Kiri Lenagh-Glue.

A $1 trillion industry is nothing to dismiss out of hand. Growing from an estimated $114 billion in 2018 to $502 billion valuation in 2019, the global impact investing sector is projected to reach the trillion-dollar value in 2020.1 Within New Zealand itself, impact investing grew from $358 million in 2018 to $4.7 billion in 2019, around 1.6% of New Zealand’s assets under management.2 This comes as little surprise, as there has been a surge in the global adoption of environmental, social and governance (ESG) criteria across sectors with regards to strategies, products, and funds. However, as the popularity of these funds grow, concerns have been raised about the efficacy and overall tangible impact of impact investing, as opposed to other methods to drive social and environmental change.

Fundamentally, impact investing rests on a set of assumptions that need to be satisfied in order for it to be deemed effective, as outlined in an extensive report by Hillebrant and Halstead on merits and challenges around impact investing.3

Firstly, an investor must identify a company with enterprise impact. While you would be hard pressed to find a company with an apparent ESG impact focus which shies away from marketing their importance, genuine enterprise impact translates to a company that will improve the world through its success. Not only must an investor consider the company’s offerings, but the counterfactual as well. Suppose an investor identifies a company that produces wind turbines to generate energy in a manner that reduces carbon emissions. However, if by investing in this company it displaces a more effective wind turbine company with a subpar product, a net benefit has not been achieved by that investor, or the success of that particular company.

Secondly, an investor must have “additionality”, where an individual’s investment in a company will make notable difference in that company’s performance, through the availability of additional capital, or expansion of networking capabilities, knowledge base, and other forms of non-monetary support. The scope for an investor’s “additionality” is far greater in VC and angel investing, but such investors must accept that there will likely be “a trade-off between financial returns and social impact.”4 The greatest impact an impact investor can have with regards to “additionality” is at a stage when an investment is not at its most profitable, and they cannot expect market-rate returns. Returning to the fictional wind turbine company, it is easiest to understand “additionality” as the success brought to the company because of that investor. For instance, because of an impact investor’s capital the company was able to keep the lights on and continue product development, or the company was able to take advantage of an investor’s personal networks and industry connections.

While it is valuable to have a framework in place as to what criteria an impact investor should consider when approaching an impact investment, there is still a question about how to measure ESG impact. One such methodology developed by The Rise Fund and The Bridgespan Group is the impact multiple of money (IMM).5 IMM aims to evaluate the projected financial value of the ESG return on an investment, through a set of six steps:6

  • Assessing the Relevance and Scale
  • Identifying Target ESG Outcomes
  • Estimating the Economic Value of Those Outcomes to Society
  • Adjusting for Risks
  • Estimating Terminal Value
  • Calculating Social Return on Every Dollar Spent

The resulting calculation determines a dollar valuation of ESG return for every dollar invested, which can be understood as the “directional estimate of the potential magnitude of a company’s [ESG] change.”7 Therefore, businesses and individuals can directly compare IMM values between various investment opportunities, while establishing a minimum threshold for an acceptable ESG return. For instance, The Rise Fund, will reject any company where their minimum social return is less than $2.50 for every $1 invested, or has an IMM of 2.5X. It is important, however, to acknowledge that while IMM can give a significant directional estimate for a particular company, the reliability of various criteria will fluctuate depending on the stage of a particular venture.

Although there have been uncertainties between economists surrounding the overall performance of ESG-oriented assets,8 a 2019 report by the Center for Economic and International Studies (CEIS) found that, between firms which had low ESG indicators and those with high ESG indicators, those with lower indicators routinely expected higher returns.9 Considering the secondary criteria for impact investors outlined by Hillebrant and Halstead, this is not entirely surprising; an impact investor’s greatest value lies in investing in companies which cannot expect market-rate return. The report by CEIS noted that many impact investors and Socially Responsible Investment (SRI) funds are driven by investor preference, rather than the promise of high return on investment. Indeed, in a 2020 report, KPMG indicated that in the past 12 months, interest in ESG-oriented strategies, products, and funds has grown across the hedge fund industry. Overwhelmingly, this interest has been driven by the demand of institutional investors, with 85% of hedge fund managers reporting that institutional investors and their consultants are looking to use their capital in generating positive ESG outcomes.10

Impact investing, however, is not the only method for an investor to be engaged with ESG aligned investing, and certainly is not the most effective method of investing. Some ESG aligned funds such as SRIs, use various internal metrics and policies to guide their investment mandate, while still offering a for-profit investment portfolio to investors. At Matū, we have a strong ethical investment policy which guides our investment decisions and our investors’ expectations.11 Simply avoiding “sin” industries, such as weapons, tobacco, and illicit drugs, alongside more modern iterations of negative impact companies, such as ones who will generate environmental harm or use data exploitatively, is not good enough. A foundational principle to Matū’s investment policy is kaitiakitanga, guardianship and protection. We seek to help limit the harm companies might be creating in the world, as well as ensuring positive benefit from their actions. Matū has a long-term focus and intergenerational ambitions, which can make it difficult to quantify the immediate impact of our investments, however it allows us to be confident in the ultimate net positive impact we generate for New Zealand and the world.

Beyond investing in SRI or impact funds, there are other methods of financially engaging to generate ESG-oriented outcomes. As highlighted by Hillebrant and Halstead, comparing the return on investment by a socially neutral investor whose primary driver is the expected financial return, versus an impact investor who is solely investing with the primary aim of generating social benefit, will likely result in the socially neutral investor being more successful. An individual donating to high-impact charities, or investing as a socially neutral investor for profit and then donating return proceeds at a later date,12 will likely be more effective in generating positive impact, rather than attempting to optimise the trade-off between ESG impact and financial performance.13

There is no denying that the primary drive towards ESG-oriented investment has been championed by industry investors in a bottom-up movement to consciously shift away from “sin” industries, and demanding that their capital is utilised in efforts to better the world.14 Impact investing, while not the most successful at generating ESG return as opposed to other charitable or activist actions, is certainly a part of this increasing global trend, and is absolutely far better than not doing anything at all.

1. KPMG. Responsible Investment. https://assets.kpmg/content/dam/kpmg/ie/pdf/2019/10/ie-numbers-that-are-changing-the-world.pdf
2. RIAA. Responsible Investment Benchmark Report 2020 New Zealand. https://investmentnews.co.nz/wp-content/uploads/RINZ20.pdf
3. Hillebrandt, H. & Halstead, J. Donating effectively is usually better than Impact Investing. https://lets-fund.org/impact-investing/
4. Hillebrandt, H. & Halstead, J. Donating effectively is usually better than Impact Investing. https://lets-fund.org/impact-investing/
5. Harvard Business Review. Calculating the Value of Impact Investing. https://hbr.org/2019/01/calculating-the-value-of-impact-investing
6. The Rise Fund. Measurement. https://therisefund.com/measurement
7. The Bridgespan Group. Calculating the Value of Impact Investing. https://www.bridgespan.org/insights/library/impact-investing/calculating-the-value-of-impact-investing
8. USSIF. Financial Performance With Sustainable Investing. https://www.ussif.org/performance
9. Ciciretti, R., Dalò, A., & Dam, L. The Contributions of Betas versus Characteristics to the ESG Premium. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3010234
10. KPMG. Sustainable investing: fast-forwarding its evolution. https://assets.kpmg/content/dam/kpmg/xx/pdf/2020/02/sustainable-investing.pdf
11. Matū Fund. Ethical Investment Policy. https://matu.co.nz/wp-content/uploads/2019/09/Matū-Ethical-Investment-Policy.pdf
12. EA Concepts. Timing of philanthropy. https://concepts.effectivealtruism.org/concepts/timing-of-philanthropy/
13. Hillebrandt, H. & Halstead, J. Donating effectively is usually better than Impact Investing. https://lets-fund.org/impact-investing/
14. KPMG. Sustainable investing: fast-forwarding its evolution. https://assets.kpmg/content/dam/kpmg/xx/pdf/2020/02/sustainable-investing.pdf