Impact Investing: the Good, the Bad, and the Unmeasurable

Summary

The article analyzes the tools that impact investors have to gain confidence their investment decisions satisfy both financial and socio-environmental returns. Enterprises demand these same tools to track progress, compare results with peers, and be transparent with stakeholders. A key takeaway is the pressing need to move away from qualitative reports and express social impacts in quantitative values instead. A review of existing frameworks reveals a general unsuitability of traditional reporting standards while identifying opportunities from newer frameworks. A tangible case study walks the reader through the application of one such framework to a company’s operations and shows a clear decisional outcome for impact investors. Ultimately, the article aims to spark a conversation around widely discussed themes that companies thus far approach with little practicality.

What is impact investing, and why is it relevant?

The Global Impact Investing Network (GIIN) defines impact investments as “investments made into companies, organizations, and funds with the intention to generate social and environmental impact alongside a financial return. Impact investments can be made in both emerging and developed markets, and target a range of returns from below market to market rate, depending on investors’ strategic goals.”[1]

Root-cause drivers of value creation include social (trust and governance), environmental (energy and water), and human (customers and employees) factors. Several studies have proven that enterprises that focus these drivers can realize enhanced returns and profit potentials with lower risks. This is in addition to the underlying objective of building a better world.

Evidence crops up across different organizations and operators. For instance, San Francisco-based HIP Investor[2] has rated and ranked more than 30,000 investments and funds globally, including company equities, bonds, and mutual funds. The results revealed potential sources of untapped returns for companies adopting the above factors in their operations. For another point of reference, the GIIN carried out a survey on 151 impact investors. Respondents reported that their portfolio performances overwhelmingly met or exceeded expectations for financial return, in investments spanning emerging markets, developed markets, and the market as a whole.[3]

A more pragmatic approach entails appreciating an enterprise’s objective. For example, an organization may aim to improve access to housing, create employment for minorities, implement energy efficiency, or provide access to credit for the underbanked. Such goals directly address a defined and untapped market, thus positioning the company in a low-competition and high-demand environment. Call me naive, but this is not charity: it is pure business strategy.

Moving from a qualitative to a quantitative approach

Investors who seek to achieve social impact with their investment decisions have well-established frameworks to gauge financial risk and return. However, they often lack a standard method for including social impact into the equation[4]. In the absence of such frameworks, early-stage companies are the first to suffer because their limited history rarely offers enough evidence of the social impact investors are looking for.

The need for better tools reaches every company’s stakeholder, and it comes from a requirement for tangibility, materiality, and measurability of the initiatives entertained. If five years ago an oil company was proud to operate in a sustainable manner for having reported on Global Reporting Initiative (GRI) compliance and for having prepared an annual corporate responsibility report, things are different now.

An emerging trend is that corporations that entertain any corporate social responsibility (CSR) initiatives seek to communicate them in tangible ways. They can measure and compare them both with previous reporting periods and with peer companies. The initiatives are relevant in comparison to the size of the business, the materiality of the initiative, and they ultimately involve all stakeholder groups.

Which companies measure social impact?

Non-profits, for-profits and hybrid organizations such as B Corps, from early-stage ventures to public conglomerates can and will measure social impact. Every enterprise seeks to do so because it will increasingly affect stakeholder decisions in support of such companies.

Employees already prefer socially engaged employers. Around 86 percent of new professionals and imminent college graduates “say it’s important that the company they work for behaves in a socially responsible way.”[5] A 2012 report surveyed over 1,726 currently enrolled university students revealing that, all things being equal, 35 percent of them would take a 15 percent pay cut to work for a company committed to CSR. Moreover, 45 percent of the respondents would take that pay cut for a job that makes a social or environmental impact, and 58 percent would take that pay cut to work for an organization with values like their own.[6] Another study found that “85 percent of employees said they were likely to stay longer with an employer that showed a high level of social responsibility.”[7]

A growing number of institutional and non-institutional investors include social impact in investment criteria. Government and educational institutions also sustain positive impact on their surrounding communities with grants and facilitations.[8] [9] [10] Finally, brand commitments inform and engage today’s customers before, after, and around the product. According to Amy Fenton at Nielsen, “Consumers around the world are saying loud and clear that a brand’s social purpose is among the factors that influence purchase decisions.”[11] Nielsen also reveals that almost two-thirds of consumers are willing to pay extra for products and services that come from companies committed to positive social and environmental impact.[12]

Internal applications for management

The majority of this article centers around impact investing. However, it is important to note that the quantification of social and environmental impact is first and foremost an internal tool for accountability with stakeholders. The practical numerical format resulting from certain frameworks analyzed below is instrumental in comparisons with previous assessments, either for an entire business, for a department, or by an area of focus.

It is ultimately also a tool to track progress toward medium- to long-term goals set at the management level. One example is Levi’s 2020 goal[13] “to use 100 percent sustainable cotton through sources such as Better Cotton and recycled cotton, significantly reducing our total water footprint.” Another case is Unilever’s goal “to halve the environmental footprint of the making and use of our products”[14] by 2030, to name just two. From the same executive-level standpoint, a relevant benchmark is how other companies are doing in the same impact areas, where the company is falling short, and what it can learn from others.

Nevertheless, there are few resources for effective comparisons over time. The next section discusses some alternatives.

Known frameworks for measuring social and environmental impact

1. Number of beneficiaries: A rudimentary yet effective idea involves counting the direct and indirect beneficiaries that a company initiative touches. What this system lacks is the capacity to measure the scope of such impacts.
2. GRI: The Global Reporting Initiative “helps businesses, governments and other organizations understand and communicate the impact of business on critical sustainability issues such as climate change, human rights, corruption and many others.”[15] The GRI is the most widely adopted standard for CSR reporting. It maintains a comprehensive list of standards organized under three series: economic topics (200 to 206), environmental topics (300 to 308), and social topics (400 to 419). The framework offers the opportunity to delve deeply into each issue and show how the company has done in that regard. However, it does not force management to report in a quantitative fashion, nor is its lengthy format suitable for screenings and comparisons.
3. UN SDGs: The United Nations’ Sustainable Development Goals (SDGs) depict a comprehensive map of the macro-areas of work, whose progress directly better our world. The clear division into defined fields of impact, from “Affordable and Clean Energy” to “Zero Hunger”, and the specific targets set for each make this tool valuable for governments. Furthermore, the involvement of the 193 member states in the creation of the framework hints to the possibility for wide adoption at country level. Nevertheless, it is still unclear how businesses can effectively measure their progress on the 17 goals and relative 169 targets. The result is a presumable low adoption of the framework at company level, and thus the impractical use of it for impact investors.
4. IRIS metrics: The Global Impact Investing Network established a community for impact investors and targets to work toward under defined standards. As part of the GIIN, the Impact Reporting and Investment Standards (IRIS) catalogue provides 559 metrics under 12 focus sectors. These aim to measure the social, environmental, and financial performance of an investment. While similar in rationale to the GRI, IRIS metrics strive for measurability. Yet the inability to summarize and express total impact effectively is a deficiency that remains in this framework.
5. B Impact Assessment: B Lab is “a non-profit organization dedicated to using the power of business as a force for good.” The most actionable of its tools is the B Impact Assessment, currently in beta version. This tool attributes a score to the company for a number of impact areas, organized under governance, workers, community, and environment. The company can immediately compare each score with the average score of other companies that have completed the B Impact Assessment. This, therefore provides a cross-industry and cross-market benchmark. Additionally, the total score from the assessment carries the immediacy and simplicity of a single parameter expressing impact from diverse areas of focus.
6. SROI: Social Value UK devised a guide with the UK Cabinet Office in consultation with practitioners, members, and academics. Their Guide to SROI (social return on investment) provides “a clear framework for anyone interested in measuring, managing and accounting for social value or social impact.”[16] While the approach varies depending on the program evaluated, there are four main elements needed to measure SROI. These include inputs (investment of resources in the activity), outputs (direct and tangible products from the activity), outcomes (changes to people resulting from the activity), and impact (the outcome minus an estimate of what would have happened anyway). A general formula to calculate SROI is as follows: SROI = (social impact value - initial investment amount) / initial investment amount *100%. Clearly, the calculation of social impact value (that is, assigning a dollar value to social impact) poses challenges and methodology problems. Yet to this day, SROI is one of the better frameworks that blends social assessment with known financial ratios.
7. SIP: Philadelphia-based GoodCompany Ventures developed the SIP (social impact projection). This forward-looking model integrates social impact into the assessment of early-stage social enterprises’ return potentials. The case study below outlines the steps for this assessment. It is important to outline how the output obtained is a single dollar-format number. Its purpose is for comparison with the company’s five-year cumulative revenue and with the investment sought. This framework adopts a similar rationale to the SROI. However, its forward-looking nature offers a natural comparability with the investment. In other words, the company can analyze both its investment and its impact over a period of five subsequent years. This makes it arguably the only adoptable tool for early-stage companies, or any company whose historical performance is not reflecting its full potential. Its biggest weakness is that it depends largely on the company’s financial projections. Thus, companies should use it with caution.

Applications of the SIP framework: the Treedom case study

Treedom is an outstanding and recently funded B Corp I have been involved with for several years. On Treedom's website, individuals and corporations are able to plant fruit trees in areas affected by deforestation, with direct benefits on carbon dioxide (CO2) reduction. In addition, they provide labor and economic opportunities to the local sustenance farmers that plant and own the trees. The company recently completed both the SROI assessment for its reforestation project in Kenya, and the SIP assessment to determine the overall social impact of its operations over the next five years.

Under the SIP, Treedom identified two social externalities from the IRIS catalogue: CO2 tons absorbed (catalogue number OD4108) and incremental income for beneficiaries (catalogue number OD6247). The next step determined the relationship between company revenue and units in the two externalities. The assessment revealed that for every $1,000 in revenue, reforestation-related services absorb 47 tons of CO2. This same revenue generates $722 in incremental income to sustenance farmers. Over five years, Treedom’s financial projections estimate the company will absorb 10.6 million tons of CO2 and generate $233.6 million of incremental income for beneficiaries. The final step requires converting the impacts in market-based monetary values. This occurs via a simple 1:1 ratio in the case of incremental income, and by a $40 per metric ton of CO2 offset (the average market value at the time).

The social impact projection, therefore, results in $426 million from CO2 offset and $234 million from income to beneficiaries for a total output of $660 million. We can easily compare these results with the funding required to execute them and with the operating results themselves. In the case of Treedom, the SIP is worth three times the expected turnover in the next five years and 110 times the current financial requirements from investors.

Key takeaways and questions for the future

• The most exciting indication is the evolution of the expression of social impacts. They have transformed from purely qualitative values into quantitative values.
• Impact investors need to consider and integrate the non-financial return of an investment. This is essential during their due diligence processes, while the investment is in the portfolio (so they can track any progress), and at exit as part of the overall return assessment.
• Comparisons between impacts and funding requested (as well as with revenue projections) provide the most immediate and linear ratios for an assessment of whether the target company meets the fund’s mandate and selection criteria.
• Comparing social impacts between companies belonging to different industries and geographies provides an effective screening and prioritization tool for impact investors. While no widely adopted existing framework allows such comparisons, operators can force the preparation of such an assessment as part of the funding application process.
• The large number of frameworks available with no consensus from researchers or investors overwhelms businesses that aim to implement a valid, long-term approach to impact reporting.
• Are impact investors actually using any of these frameworks? And if not, what gives them enough confidence their investment decisions satisfy both financial returns and socio-environmental returns in the best interests of their limited partners?
• Are these methods perfect? Absolutely not, but they force us to have a discussion around materiality and relevance.