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How Do You Measure Impact Investing?

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Measuring an investment’s social effect is important. It can help organizations make better decisions, communicate their value, and balance financial returns with social returns. But there’s a problem. The business world has several universally accepted tools for estimating a potential investment’s financial yields, such as the internal rate of return. However, no analogue exists for evaluating hoped-for social and environmental rewards in dollar terms.

Impact investing has been developing and evolving over the last decade as consumers and investors alike demand solutions to the world’s biggest environmental and global health issues.

Impact investments are investments that have direct positive social and/ or environmental impact with measurable financial returns.

Impact investments are meant to make money, while promoting and maintaining social and/ or environmental responsibility. Impact investing is the next level of investing beyond environmental, social, and governance (ESG).

What is the differentiator between ESG and impact investing?

Impact investments aren’t just made by avoiding negatively-impacting investments. Instead, they’re made by focusing on companies that make significant positive impact through any of these vehicles.

The Impact Investing Challenge

The biggest challenge in impact investing is the lack of consistency in how “impact” is measured. Diane-Laure Arijalies, assistant professor at Ivey Business School writes in her article “Why Impact Investing Matters: A Primer”:

“Measuring impact is art and science…Investors and managers alike increasingly want to assess businesses’ impact on society. But measuring a firm’s wider societal impacts is not easy. Accounting standards for measuring impact do not exist, and the measures in use are still evolving…”

As Arjalies explains, there are many different types of impact investments; the basis for measurement is inherently inconsistent. For example, a Forest Bond may be measured based on its biodiversity protection, whereas a real estate development may look at the number of parks in a neighborhood, energy use, and access to employment.

An independent research project at the Harvard Business School showed that investors use impact measurements for different objectives in different parts of the investment cycle, and methods for measuring impact vary based on the objective.

The researchers divided these objectives into four main phases:

  • Estimating Impact
    In the first phase investors work on estimating impact, “conducting due diligence to assess the potential social return before committing to an investment”.
  • Planning Impact
    This phase is followed by planning impact,“choosing themetrics and data collection methods that the investor will use to monitor a program’s effects”.
  • Monitoring Impact
    Once the program is underway, investors and investees focus on monitoring impact “measuring and analyzing impact throughout the life of the investment to track the intervention’s effects”.
  • Evaluating Impact
    And finally, sometimes investors turn to evaluating impact, “measuring an investment’s social consequences after the program concludes to assess portfolio performance and next steps for the investor, including re-investment”.
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Investors have different measurement objectives in different phases of the investment cycle

The researchers went on to classify the different measurement methods based on how they relate to each other and grouped the methods into four main categories.

  • Expected return methods weigh the anticipated benefits of an investment against its costs; social return on investment (SROI), in particular provides a framework to calculate an investment’s present social value impact compared to the value of inputs
  • Theory of change methods outline the intended process for achieving social impact, often using a logic model, a tool that maps the linkages between input, activities, output, outcomes and ultimately impact.
  • Mission alignment methods measure the execution of strategy against the project’s mission and end goals over time, using rubrics such as scorecards to monitor and manage key performance metrics on operational performance, organizational effectiveness, finances, and social value.
  • Experimental and quasi-experimental methods are after-the-fact evaluations that use randomized control trials or other counterfactual approaches to determine the impact of an intervention compared to the situation if the intervention had not taken place.

Each measurement carries advantages and disadvantages, which the researchers describe in detail in their paper, but the main point is that they do not all accomplish the same objectives.

Based on their findings the researchers propose an integrated model for investors looking to improve their impact measurement practices and recommend different sets of impact measurement methods based on the maturity of the investor and investee.

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Other key industry players have also recognized the analytical shortcomings and are working on finding new ways to better understand impact measurements and management. Among them are Root Capital, the MacArthur Foundation, Bridges Impact +, the World Economic Forum, and the Rockefeller Foundation. This work has produced a number of interesting metrics, including social return on investments (SROI).

The demand for impact investing is higher than ever today, and continues to grow and businesses and investors must develop better ways to assess social and environmental impact. At Transformation, we are taking the opportunity of this demand to create sustainable and high-impact projects in the areas of energy, water and agriculture, and technology. We are dedicated to helping clients make strategic investment decisions in a unique, innovative way.

June 24, 2020

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