Putting impact to the test

Investment is flowing into projects that promise environmental and social benefits alongside financial returns, but how can managers demonstrate genuine impact?

Impact investing has proved irrepressible in recent years. The Global Impact Investing Network (GIIN) estimates that the worldwide market across assets topped $1 trillion for the first time in 2022, doubling in size over the past three years while almost tripling the number of organisations actively managing assets over that time, from 1,340 to 3,349.

Even the pandemic and war in Ukraine have failed to curb appetite from investors. Economic uncertainty, precarious energy security and global hunger have all been exacerbated in recent years and shone a spotlight on the importance of the UN’s Sustainable Development Goals. The funding gap alone has widened upwards of $4 trillion across infrastructure and other assets.

Increasingly, capital is being funnelled into funds that promise a combination of financial returns with positive social and environmental change. 

But the rapid emergence of the sector has also caused many to be sceptical and question the reliability of claims. Talk is cheap and without proper frameworks for measuring and tracking, impact investing risks becoming a mere sideshow to real lasting change.

“Measuring impact is critical to what we are all trying to achieve,” says Jon Collinge, sustainability director at alternative asset manager Morrison & Co. “Infrastructure investing is about providing services that enhance the environment and society, aiming to make the world a better place. Improving how we measure impact gives us greater licence to discuss the positive contributions we are making to society.” 

Laying the groundwork

Defining the strategic objectives and goals of an impact investment is the first port of call for managers, serving as an important reference point for tracking and measuring performance. Often, this means selecting targets most relevant to portfolios and funds, and agreeing the mechanisms in place to measure progress.

“KPIs need to focus on social and environmental objectives, carefully tailored to each investment and business,” stresses Adrien-Paul Lambillon, ESG and sustainability specialist at Partners Group. “When setting impact metrics, thinking about measurability or aligning to specific SDGs, it is crucial to consider how they affect the core business.”

Investors often also confuse the goals of ESG with impact investing. While diversity might be an important topic, tracking the number of female board members should be considered an operational ESG issue rather than impact, explains Lambillon. “That is an example of how businesses are run rather than what a business does or how it can contribute towards environmental and social objectives.” 

Collinge agrees. “ESG is quite passive, factoring in environmental, social and governance concerns into investment activities, whereas impact is much more active as you are purposefully investing in assets with an intention to deliver a significant contribution to society or the environment.”

Impact funds often start by mapping KPIs and metrics to the UN’s SDGs. In a 2020 survey for GIIN, 52 percent of respondents said that they develop goals in line with global development agendas like the SDGs or the Paris Climate Accord. The same percentage explained they examine the social and environmental problems that they want to address and set targets to measure progress against these challenges. Forty-five percent of respondents added that they set targets depending on investor objectives. 

Capital flows to the SDGs are also constantly shifting. Research from Dutch impact investment consultant Phenix Capital shows that the number-one SDG for capital raised across all impact funds last year was access to clean energy (SDG 7). Just over half of capital raised was by managers focused on access to information and communication technologies (SDG 9). Access to health care (SDG 3) was in the third spot. 

Vital statistics 

This trend is perhaps not too surprising considering the pandemic and increased focus on energy security since March 2022. In contrast, the top three SDGs for impact funds in 2021 were climate mitigation (SDG 13), SDG 7 and SDG 9. Last year, SDG 13 dropped into seventh place as climate concerns fell in precedence, again likely due to the war in Ukraine and changing priorities. $259 billion was raised against climate goals in 2021, against just $99 billion last year.  

Once metrics and targets have been set, sourcing and collecting impact data is the next important step for accurately measuring progress. “Managers need to ensure data collection is reasonable, regular, and built on efficient systems and processes to ensure that even the smallest of portfolio companies and their teams are resourced appropriately,” says Kristina Kloberdanz, chief sustainability officer at Macquarie Asset Management. 

Marcel Metzner, senior impact associate at growth equity firm Planet First Partners, adds that “impact data should be collected as much as possible from direct sources and accompanied by the methodology utilised for its calculations and evidence of the source of that underlying data”. Often, managers also look to improve the quality of the data by verifying their data measurement and methodologies via a third-party, either under a full peer-review process or audit. 

Partly due to the nascent nature of impact investing, one of the main challenges is the availability, quality and granularity of the data, either because it does not exist yet or because of a heavy financial burden and the time needed to collate and capture data.

Lisa Shaw, managing director of infrastructure debt at Vantage Infrastructure, points to the debt space, where “based on our experience, there is still hesitation from the borrowers to provide data – and even when it is provided, it is very rare for it to be certified or validated in any way”. She says: “We have seen huge year-on-year fluctuations driven by companies still refining how they calculate their data points.”

The GIIN found just 8 percent of the 278 impact investors it surveyed thought that collecting quality data presented no challenge, versus 35 percent claiming a significant challenge and 57 percent a moderate challenge. The survey also showed that only 26 percent of respondents believed aggregating, analysing and interpreting data presented no real challenge. 

Given that impact investing is still an evolving strategy, flagging the maturity of the data can be useful for managers and investors, showcasing the limitations of the existing data and being transparent about how the process could still be improved. “Commitments to transparent reporting by managers must incorporate challenges and lessons learned,” adds

Two sides of one coin   

Beyond simply measuring positive impact, weighing potential negative outcomes and adverse impact are also gaining more attention. A 2022 survey from advisory Cambridge Associates found that one third of respondents engaged in negative screenings across their portfolios to some extent, with fossil fuels, weapons and tobacco the main considerations. Screening fossil fuels also grew by 10 percentage points over the past two years as investors raised more climate concerns about the long-term risk of stranded assets.

Adverse impact indicators vary across subsectors, but factors often considered by managers include disruption of ecosystems and deforestation that directly impact biodiversity and climate concerns. 

Similarly, exposure to carbon-intensive fossil fuels might be a relevant factor. Failing to conduct due diligence on the unintended negative outcomes of investments, and focusing only on positive results, risks producing a skewed view of social and environmental impact. 

“We need to have a balanced scorecard when talking about the positive impact that our investments are having,” says Collinge. “We need to be honest with ourselves and disclose where there are carbon emissions or other negative metrics. Without the complete picture, we have not earned the right to tell the full impact story.” 

Meeting in the middle

Blending quantitative data points with qualitative targets is also a challenge, particularly with the subjective nature of social impact goals. Asset managers want to be able to translate targets into measurable KPIs backed by performance data, or at least be able to provide evidence that there was tangible change.

“If we want to unlock enhanced performance across our assets, we have to be able to produce quantitative analysis,” explains Collinge. “For all the engagement we have with portfolio companies, it is often not until they actually see their performance on a scale of one to 100 or against their peer group that we actually start to see change.” 

This is where the emergence of greater standardisation and industry benchmarks should make it easier for infrastructure firms to compare and contrast investments. The GIIN’s IRIS+ framework is one benchmark that has gained traction across the infrastructure space in recent years, allowing managers to compare data. It is used by more than 7,000 organisations.

Each core metric aims to ask five key questions: What is the goal? Who is affected? How much change has happened? What is the contribution? And what is the impact risk? 

“Being able to standardise and point to an established framework is important as it gives greater credibility to what we are trying to achieve,” says Shaw. “It also helps trying to access data from borrowers or portfolio companies as we can point to a metric in the framework and explain why it is needed.” 

The IRIS+ framework organises impact investments into social and environmental themes, with a collection of standardised goals and metrics selected within each category. For example, one goal might be providing all individuals with consistent access to sufficient, safe and reliable energy. Metrics in the IRIS+ framework include measuring consumption of renewable energy and amount of money spent on connectivity over a given time period.  

“Measurable, repeatable and comparable metrics are key if we are to make collective progress,” adds Kloberdanz. “While we seek to use industry metrics sets for tracking and reporting on performance, a challenge we have found is that they can often be limited for new sectors, especially when investing for targeted social outcomes. There is still a need for developing custom metrics occasionally.” 

For Dan Watson, head of sustainability at Amber Infrastructure, “benchmarking can be a useful tool, but it is important that it does not detract from taking real-world action”. He also warns that it can “create a reporting burden when time could perhaps be better spent on improving the sustainable performance of investments”. 

As impact investing evolves, a balance needs to be taken to ensure progress is accurately benchmarked, but disclosures are not so punitive that managers struggle to find the time and resources to actually make a tangible environmental and social difference. 

“It is essential that we collaborate, learn from each other and share our experiences for the betterment of everyone in the industry,” says Collinge. “Infrastructure has enormous potential to deliver positive environmental and social impact.” 

The rules of engagement 

Mandatory sustainability regulations are poised to shape the asset class dramatically

“Regulations are positive in that they increase standardisation, but we have seen a lot of confusion and cautiousness, particularly with the Sustainable Finance Disclosure Regulation,” says Adrien-Paul Lambillon, ESG and sustainability specialist at Partners Group. “All this focus on reporting and administrative burden favours the largest companies because impact funds do not always have ESG data availability, or the coverage like in the public market space.”

Ahead of the mandatory raft of SFDR changes in the EU that came into force in early January, many impact funds opted to downgrade their sustainability status. Data from services firm Morningstar at the end of Q3 2022 showed more than a tenth of all Article 9 funds were planning to downgrade to Article 8 status because of the pending regulations. “The SFDR has had a dramatic impact,” adds Jon Collinge, sustainability director at Morrison & Co. 

But the regulations might also reveal a difference between managers’ ability to gather data, argues Dan Watson, head of sustainability at Amber Infrastructure. “Whilst regulations provide guidance on what to measure, it is down to the manager to determine how they collect the relevant data. It is important that managers can access good quality data and not have to rely on estimation, which can introduce reporting risks.”

Lisa Shaw, managing director of infrastructure debt at Vantage Infrastructure, adds that it can also be very difficult for debt providers to access all the data and therefore accurately classify a fund as Article 9. “Regulations are great from an impact-washing perspective, and can move the industry in the right direction, but I think it would be helpful if there was recognition that it is particularly challenging to meet the data requirements across the private space.”