ILG Redefines and Quantifies Impact

    Stockholm (NordSIP) – An increasing number of asset managers are talking about ”impact” investing, including those that mostly manage very liquid equity strategies. Historically, the word “impact” often referred to the zone where for-profit investments meet charitable projects, and they often came in the shape of small private equity or debt-financed opportunities. Several impact funds even had difficulties reaching any scale, given the small size of their investments. Hence sceptics wonder how liquid investments may achieve any impact at all.

    Here we look into one specific report written by the Investment Leaders Group (ILG), a global network of pension funds, insurers and asset managers working together with the Cambridge Institute for Sustainability Leadership (CISL), and supported by academics in the University of Cambridge. “In search of impact – Measuring the full value of capital” attempts to redefine what impact means and proposes a comprehensive framework to measure and present investment impact. “We believe that investors have a crucial role to play in reshaping economic and business strategy, but to take on this role it is necessary to escape from the current pattern of short-termism and rethink the methods, tools and techniques of mainstream investing,” it states. While we have dissected the first report on the subject, a new and updated version is about to be unveiled.

    Redefining impact

    For the authors of the report, impact may be defined as “the non-financial consequence of investing” and equates the concept to an “ESG dividend”. Following the logic that every financial investment may have consequences of the environment and on society, any investment products generate impact, whichever product category or asset class it belongs to. However, the report makes an important distinction between investment impact and ESG integration. While the latter is the process of taking ESG into account in the investment decision, the former focuses on the social and environmental outcome of the investment.

    “In a world of volatile environmental risks, resource scarcities and social inequalities impeding economic progress, it is not enough to know simply that an asset is improving its social and environmental performance. It has become necessary to know whether it is doing enough to be considered part of the solution to the ambitions for the next fifteen years agreed by world leaders in 2015 under the auspices of the United Nations,” the authors state.

    It’s different, this time

    The report proposes a framework to measure impact, but first, it underlines some crucial distinctions relative to other existing methodologies. Financial materiality is often at the core of ESG measurements, but this framework focuses explicitly on the social and environmental impact that are not financial, at least not in the short term. For example, the report suggests, a mining company that violates indigenous rights in a country with no proper enforcement might not experience short-term financial risk, but the impact on its community could be significant.

    There are two other important distinctions between the ILG framework and other initiatives: it is not norms-based but focused on outcomes, and it is applicable across asset classes. Furthermore, the authors aimed for a system that is simple to understand for those who may benefit from the measurements (i.e. the end investors).

    Measuring impact

    The work of the ILG relies on the Sustainable Development Goals (SDGs). “These goals were agreed by world leaders in New York in 2015 following five years of discussions amongst almost 200 governments. They are the closest thing to a strategy for planet Earth over the next 15 years that humanity has ever generated,” the authors explain to justify their choice.

    To place the SDGs in the most relevant context for investments, the ILG proposes to group them into six impact themes (three social and three environmental): Basic Needs, Wellbeing, Decent Work, Resource Security, Healthy Ecosystems and Climate Stability (See Figure 1). The ‘G’ dimension of ‘ESG’ is not explicitly part of the themes, as the authors consider that Governance is not an outcome on its own, but rather a part of the process leading to social and environmental impact.

    The framework then provides specific metrics (See Figure 2) for each of the impact themes, and proposes to measure them quantitatively first, and then adjust them qualitatively, by looking at the likely impact over time. Each metric can benefit from “Refinements”, which present an opportunity to make use for additional information when available.

    The report provides details on how to measure two of the six impact themes (Climate Stability and Decent Work), and guidance on the remaining four.

    Aggregating measures at the portfolio level

    The report proposes to aggregate the measurements obtained for each investment and, to do so, it divides the total impact by the enterprise value so that it can serve across asset classes. The resulting ‘impact intensity’ figure is then multiplied by the amount invested, and aggregated into a total score. The weights of every single measure can be adjusted in order not to double count impact at a portfolio level. One example the report digs into is Climate Stability, which relies on quantifying greenhouse gas emissions (GHG). To be as relevant as possible, GHG measures should include Scope 1, 2 and 3 but there is a risk of triple counting in a portfolio invested across an industry value chain. Measurements should be adjusted, for example, in the case of a portfolio containing a transportation company, a vehicle manufacturer and a fossil fuel producer.

    Disclosing results to beneficiaries

    One of the authors’ key recommendation relates to the presentation of impact measurements. They should be simple, and they should be part of different reporting documents, such as standard fact sheets, so that end investors can consider the impact at the same time as financial considerations (see figure 3), but also portfolio management tools and annual reports.

    While measurements and reporting methods are likely to require more work and a determined top-down push to see the light in a widespread fashion, the framework presented by ILG is nevertheless a handy and well-thought out step in the right direction.

    In a few weeks, NordSIP will discuss these questions with experts from global asset manager AXA who has been offering impact investment vehicles for several years, Geneva-based asset manager Union Bancaire Privée (UBP), who has taken an active role in the ILG and boutique impact manager responsAbility. One of the experts who will present at the event is Victoria Leggett of UBP; she has been personally involved with the ILG. “Our work with the Investment Leaders Group provides a unique opportunity to collaborate with our peers and create both practical and considered research that is made available to the broader industry. The ILG is a small group – we are 12 organisations and as such every voice counts,” she says. At the lunch seminar, we will also discover and have the opportunity to discuss the new version of the ILG report.

    Please drop us a line if you are interested in joining our Copenhagen lunch seminar “Impact in Focus” on September 29.

    Featured image © Shutterstock

    Source: ILG Report “In Search of Impact

    Aline Reichenberg Gustafsson, CFA
    Aline Reichenberg Gustafsson, CFA
    Aline Reichenberg Gustafsson, CFA is Editor-in-Chief for NordSIP and Managing Director for Big Green Tree Media. She has 18 years of experience in the asset management industry in Stockholm, London and Geneva, including as a long/short equity hedge fund portfolio manager, and buy-side analyst, but also as CFO and COO in several asset management firms. Aline holds an MBA from Harvard Business School and a License in Economic Sciences from the University of Geneva.

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