A push by fund index providers to tighten the criteria for what qualifies as an environmental, social and governance fund has led to fresh discussion around measurement and reporting. MSCI, for example, is moving to strip thousands of funds of their ESG ratings.
While it is important that ESG ratings are not misleading investors, the debate can distract from a more important question: how can asset managers go further than an ESG risk approach to actually create positive impact along with financial returns?
Measurement is central to impact investing, yet confusion reigns over best practice. It is helpful to remind ourselves why impact reporting is so important: it’s not so we can pat ourselves on the back as investors, but to take crucial steps towards achieving tangible impact.
Attribution
Language is important. We often hear claims that an investment has created a specific impact or saved a certain volume of greenhouse gas emissions. This requires scrutiny of the level of additionality, or the extent to which positive outcomes are driven by engagement or deployment of capital. For example, does buying a publicly-traded share in a company from another investor on the market cause impact? What would have happened anyway? In this case, reporting should be clear on the nature of attribution and that the investor’s capital has not directly caused the impact
Outputs to impact
It’s easy to get lost in jargon of outputs, outcomes and impact, but the distinction is important. Outputs are usually easiest to measure, but these do not give a clear sense of impact on people and planet.
Snowball has partnered with impact measurement firm Net Purpose to help understand the outcomes and impact of listed companies within our portfolio. We believe Net Purpose is a market leader when it comes to converting outputs to outcomes and impact, doing so with integrity using the latest research and providing transparency into the assumptions and methodologies used.
Take PT Bank Rakyat Indonesia, an Indonesian bank serving micro, small & medium enterprises (MSMEs). MSMEs play a key role in strengthening many economies. They account for almost half of formal employment but are constrained by a lack of access to finance.
Bank Rakyat’s main reported output is the number of loans disbursed and the number of customers. Outcomes are the annual number of MSME customers that obtained new access to financial services, the resultant revenue potential and the number of jobs supported by these loans. Impact includes changes to the quality of life of end customers, as well as societal benefits through new goods and services, increased employment, and multiplier effects on the economy.
But a blind eye cannot be turned to negative impacts. For example, Bank Rakyat has also co-financed a $400 million loan to Adaro Energy, an Indonesian coal miner. The net impact therefore needs to be considered, with meaningful engagement essential to drive better practices.
Without an understanding of outcomes and impact, capital can go into investments which have impressive-seeming output metrics but are not making a dent in long-term poverty, or worse, are leading to outcomes like debt spirals or aggressive collection practices.
Credible baseline
Impact is not a single number in isolation, but rather represents change over time against a credible baseline. Most reporting does not detail the assumptions used to calculate the key performance indicators (KPIs) cited.
Circularity Capital, which invests in circular economy companies, is an exemplar. Its portfolio company Grover, for example, rents out consumer electronics reducing the number of virgin-manufactured products. Circularity has worked with consultant Advancing Sustainability to generate a “virgin units avoided” figure based on the number of users of each product and the asset use-period compared to the typical patterns for products purchased new. Industry recognized ratios are then used to calculate the emissions avoided.
The underlying assumptions are crucial, and it is prudent to take a conservative approach. Grover’s reported avoided emissions are significantly lower than those of a competitor with a similar business model. This is not because the companies have a materially different impact, but because the assumptions driving the reported metrics are different: the competitor assumes all old mobile phones would otherwise end up in landfill, whereas Grover takes a more nuanced approach recognising that some mobile phones are sold second-hand, passed on to other family members, etc.
Aggregation
We have always been cautious about aggregating KPIs across our diverse portfolio. It is particularly hard to do so for social metrics.
Snowball’s social housing investments housed 68 people in 2021 (the pro rata number attributable to Snowball). ‘Individuals housed’ is an easily understood term, but aggregating can lose the nuance of impact created. For example, the impact on an individual living long-term in conventional affordable housing is different from someone homeless and in crisis placed in short-term accommodation with access to specialized support services. As investors, we should be asking: what do we learn and lose by aggregating impact KPIs?
Nonetheless, there are times when standardizing companies’ impact and comparing relative performance can help determine how best to allocate capital.
Double-counting
It seems straightforward to attribute the clean energy generated by a wind farm to its operator. But what impact should be allocated to Vestas which manufactures the wind turbines? Or to GEV Wind Power, which maintains and repairs them? These “impact enablers” contribute to the decarbonisation impact of the wind farms, but there is a risk of double-counting impact.
There is emerging consensus that the total impact should be attributed to different partners along the value chain. However, guidance is sometimes contradictory, provides little direction on how this should be managed in practice, and partners often do not agree on a consistent attribution approach. Consequently, the risk of double-counting persists – and so we encourage investors to challenge impact reporting and push for transparency.
There also remains a lack of clarity about attributing impact across the capital structure. Equity managers typically calculate impact based on their percentage ownership of a company. But what about capital provided as debt? The sector has yet to coalesce around best practice and frequently debt and equity investors each take the approach that maximizes their own reported impact.
Toward more accountable impact
Investors should not let themselves be distracted by ESG rating debates, and instead focus on making investments which produce measurable positive impact.
Presently, there is a risk that asset managers with the slickest marketing and most positive-sounding claims attract capital, contributing to risks of greenwashing. But there are steps investors can take to avoid this.
At Snowball, we believe progress is underpinned by transparency and accountability. We encourage managers to conduct verifications of their impact practices, ideally by impact specialists such as The Good Economy and BlueMark.
Asset managers should disclose their methodologies and assumptions, and should be open about the challenges faced and shortcomings in data. This provides accountability not only to investors but also end stakeholders and ultimately improves outcomes. We should not let the perfect be the enemy of the good, but we should also embrace the challenge ahead to get better over time.
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Jake Levy is investment manager and impact lead at Snowball, a London-based impact investment manager.
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