Measuring the impact of sustainable investment

Written by Mike Appleby on 21st Jul 2020

Over recent years, there has been a considerable proliferation of strategies that adopt a sustainable approach to investing. Increasing numbers of investors seek to align investments with their broader view on society and the environment and feel a sense of personal responsibility for their protection.

The ‘new normal’

Moreover, the ‘new normal’ that is widely anticipated once the COVID-19 pandemic has receded is likely to favour sustainable businesses. Unnecessary travel looks set to be replaced with video conferencing technology for instance, while a renewed emphasis on sustainable healthcare plays well to this theme. Indeed, it is perhaps no surprise that many sustainable strategies with little exposure to sectors that have been hard hit since the start of the crisis, such as oil and mining, have enjoyed strong relative performance.

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But with greater prominence comes greater scrutiny, and investors are rightly keen to know precisely what impact for good their investments are having. The environmental and social performance of investments or ‘impact’ describes a broader benefit that goes beyond pure financial returns.

Sustainable investing in the mainstream

Now that sustainable investing has entered the mainstream, people naturally want to understand the contribution their money makes to the development of a more sustainable economy. The practice of greenwashing has placed further emphasis on the need for greater transparency from asset managers and the importance of transparency in demonstrating their sustainable credentials. The fact that, at present, there is no standard reference framework for measurement creates challenges and quantifying the impact of investments is therefore a rapidly moving discipline.

The strict ‘classical’ definition of impact investing describes an approach which is designed to generate positive, measurable and typically pre-determined social and environmental impacts alongside a financial return. However, the terminology used to describe environmental and social performance is not actually that important; call it impact or not as it continues to change.

Communicating impact

What is important is how asset managers communicate it and how it guides their investment process. There are a number of different frameworks for disclosing and communicating the impact of the investments, with many more initiatives emerging. In our view, while they offer a useful starting point, they are too blunt a tool and none as yet offers the panacea the industry
requires.

They tend to map entire industries to the United Nations’ Sustainable Development Goals (SDGs), and fail to capture the divergence between companies within industries. It is exactly this divergence that enables investors to make investment decisions and find those companies which are on the right side of investment themes and are quality, profitable businesses. We appreciate these impact reporting frameworks are still being developed and refined and look forward to seeing them improve and become increasingly useful in the future.

Transparency

So how can asset managers communicate transparently with their investors on the impact of their investments? First, it is important to be clear on a fund’s objectives in relation to an ESG goal and demonstrate how these objectives directly contribute to the SDGs at the specific performance indicator level of the goal for those who want to use this vocabulary.

Engagement with companies in which funds are invested is also essential in order to measure and communicate the primary impacts of the products or services the business provides as well as how it is managing the main impacts from operations. This engagement should set clear objectives, for example a company setting out specific targets on issues such as carbon reduction.

Should these targets not be met, fund managers should withhold their votes or ultimately divest from these companies. Moreover, engagement should form an integral part of the investment process rather than a separate consideration. The level of this engagement and the information it elicits from investee companies should then be presented clearly to investors.

Carbon analysis

Other points that fund managers should seek to communicate to investors might include an independent analysis of carbon and how funds compare to the markets in which they are invested, in terms of carbon emitted, investments in solution providers and information on exposure to fossil fuels. We are currently assessing a more sophisticated portfolio carbon tool that looks at climate goals and different average global temperature rise scenarios, which we hope will augment the simple carbon foot-printing.

Measuring impact is a challenging and evolving area but any participant in the asset management industry which seeks to promote their sustainable investment credentials should be committed to developing an appropriate framework. In doing so, they will be better placed to satisfy the increasing demand from clients who want to quantify the impact their investments are having on the real world.

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Key Risks
Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital.

Disclaimer
The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product.