Measuring social impact
Work needs to be done to standardise the measurement of the social impact of investments. Michele Giddens warns against oversimplifying the question
GlaxoSmithKline’s announcement in June that it will offer its rotavirus vaccine at cost price in the poorest countries could potentially save hundreds of thousands of lives and represents another example of the dynamic growth of interest in the social and environmental aspects of business over the past decade. This has been mirrored in recent years by a greater focus within the investment community on environmental, social and governance (ESG) factors - and the emergence of an ‘Impact’ investment sector, which helps address social and/or environmental problems while also creating financial returns.
But while measuring financial returns is simple, it is not easy to measure the social impact of investments, and this is critical to capitalising on the enormous potential of the sector. Experts on both sides of the Atlantic are in search of the holy grail of a standardised approach, with influences being drawn from practice, public policy and academia. But is a standardisation of methods feasible - or even desirable?
In recent years, the application of responsible and sustainable investment practices has been evolving and diversifying into new areas, moving on from pure quoted SRI funds aimed at so-called ‘ethical investors’ into other asset classes including bonds and private equity, aimed at more mainstream investors. This is evidenced by the number of signatories to the UN-backed Principles for Responsible Investment (PRI), which jumped more than 30% from 2009 to 2010 and now includes over 700 asset owners and investment managers that control over $22trn (€15.3trn).
In the case of responsible or sustainable investment, investors are motivated less by purely ethical concerns and more by the belief that failure to consider ESG issues can increase the risk in a portfolio and potentially decrease its value. This certainly tallies with our experience at Bridges Ventures.
By investing with the deliberate intention of producing positive social and environmental impacts, we have learned that businesses that can create innovative solutions to pressing societal needs tend to have fast growth potential. We have invested in companies which seek to improve our stewardship of the natural world by converting waste to energy, such as Aerothermal. Our investment in Babington Business College is aimed at equipping the next generation with skills to compete globally. Equally, we have found pockets of growth in an otherwise sluggish UK economy in environmentally friendly care homes that address the health challenges of an ageing population. JP Morgan and the Rockefeller Foundation issued a report in 2010, ‘Impact Investments: An Emerging Asset Class’, which estimated that over the next decade, growth within just five sectors of impact investing will generate profits of between $183bn and $667bn, and attract collective investments of between $400bn and $1trn.
All of which will increase the pressure to develop standard metrics and benchmarks to measure social impact and, in turn, reveal the positive correlation between financial and social performance. Unlike a company’s financial performance, in practice measuring and demonstrating social impact is subjective and difficult to quantify, not least because of the diverse nature of the social or environmental problems the enterprises are addressing. The result is limited comparability across investments. But while there is no single metric for assessing the impact of an investment, most investors have created their own systems for tracking and measuring impact. A range of third-party measurement systems and benchmarks are now gaining support from investors and the wider impact and sustainable community.
For large corporations, the most widely followed attempt to standardise measurement of sustainability investment is the Global Reporting Initiative (GRI) which sets out a framework of the principles and performance indicators that organisations can use to measure and report their economic, environmental, and social performance. Interestingly, the London 2012 Olympic Games recently launched its first GRI-checked report, the first from any organising committee. Some large members of the institutional investment community such as Dutch pension fund PGGM and Aegon also report following the GRI framework, but it remains more widely used by corporations and banks.
For the institutional investment community, the Principles of Responsible Investment (PRI) produces guidance on ESG investment across asset classes, with private equity being the most recently added. However, the fact that the Principles are not compulsory, or supported by a governance framework which mandates reporting, makes it difficult to assess the real impact they might be having in reshaping the way we think about investment markets. In addition, neither PRI nor GRI seeks to benchmark performance between funds or companies.
Some ambitious approaches are being pioneered in the nascent field of impact investment. These developments may indeed inform the wider debate over time. The Impact Reporting and Investment Standards (IRIS), backed by the Rockefeller Foundation and the Global Impact Investing Network (GIIN) provides a framework made up of a number of indicators designed to apply across sectors and geographies. The framework allows users to identify the set of IRIS indicators which best align with their impact objectives.
For example, IRIS provides standard metrics for job creation, which on the face of it sounds relatively simple. However, if we want to compare results between companies or funds and it needs to be clear whether we are assessing full-time versus part-time, or whether protecting a job that might otherwise have been lost should count. Importantly, the IRIS initiative is now working on taking this further. It is developing an initial set of performance benchmarks that draws upon the data contributions of funds within the IRIS framework. These benchmarks will allow organisations and investors to better measure their performance relative to their peers and relative to the broader set of contributing organisations.
The Global Impact Investing Rating System (GIIRS) aims to create a globally applicable ratings system or assessment framework to ensure impacts by one company can be directly compared to another, using an approach much like Morningstar investment rankings or S&P credit risk ratings. Supported by the likes of the Rockefeller Foundation, Deloitte, USAID and Prudential Financial, the system, when launched later this year, will rate impact in the areas of governance, workers, community, environment, suppliers and consumers, allowing investors to compare the social impacts of companies and the funds that invest in them.
Social Return on Investment (SROI), promoted by the New Economics Foundation in London, among others, aims to create comparable measures, but by using financial proxies to reveal the value of outcomes that do not have direct market values. It has the benefit of giving a single answer about how much social value (in euro) is created for every €1 of investment and could therefore provide easy comparison between investments. However, there is scope for variation in terms of what data is put into the calculation and, in our experience this undermines the result, with investors wanting to dig into and debate the underlying metrics in any event.
Is there a ‘holy grail’?
Standardisation of metrics is important, but the driver should be the way in which focusing on social and environmental impact actually affects the underlying assets - and improves their financial performance. Our own, Bridges Ventures’ IMPACT scorecard gives detailed reporting to our investors and is capable of conforming to standardisation through IRIS and, potentially, GIIRS. The key driver is to engage with the companies we invest in to improve their social and environmental performance in ways that also improve commercial performance. Similarly, KKR’s green portfolio programme is focused on building value for investors by sending a specialist team, KKR Capstone, to work with investee companies on environmental initiatives. They reported $160m of financial benefit to their 16 Green Portfolio companies in 2008-09.
It is encouraging to see the increasing reach of principles and guidelines like the PRI and GRI. Further, the innovative work of IRIS and GIIRS within impact investment has the potential to move the industry towards better standardisation and comparability. However, it is hard to imagine social impact being meaningfully distilled to a single result, as evidenced by the limitations of monetising it and creating an SROI. Social and environmental impact cannot be reduced to a currency and still be meaningfully interpreted any more than the complex question of financial risk-return can. The holy grail is not a single metric for what is ‘good’, ‘bad’ or even ‘better’. Instead it is a financial system in which social and environmental issues are integrated into investment decision-making throughout the process of making, holding and exiting investments - in such a way as to enhance long-term value and sustainable financial returns.
Michele Giddens is an executive director at Bridges Ventures