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The Sustainability Story
Dean Hand: Measuring Success in Impact Investing
00:31:38
Host Nicole Gehrig welcomes Dean Hand, Chief Research Officer at the Global Impact Investing Network (GIIN). They delve into the critical topic of impact investing, clarifying its definition amidst common misconceptions in the investment marketplace....
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Hello everyone and welcome to the Sustainability Story PODC. This podcast focuses on key sustainability topics around the globe. I'm Nicole Gehrig, one of three co hosts and I'm excited to have Dean Han with me today from the Global Impact Investing Network, or gin. Dean is the Chief Research Officer at the gin and in that role, Dean serves as an observer on the Advisory Board at the CFA UK Certificate in Impact Investing. She is responsible for developing and guiding the gins research agenda as well as training strategy for impact analyst skills development. Both are cornerstones of the GINS work to enable impact investor practice and performance and seek to ensure that capital is most effectively used to fund the world's most pressing challenges. The GIN is a global champion of impact investing. It's dedicated to increasing its scale and effectiveness around the world. So welcome Dean and thank you for joining us today.
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C
Nicole, thank you. It's a pleasure to be here. I'm looking forward to our conversation.
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B
Me as well. So I wanted to start with defining impact investing since it's a term that we sometimes see misused in the investment marketplace. Last year, the CFA Institute, the PRI Principles of Responsible Investment and the gsia, the Global Sustainable Investment alliance, collaborated to publish standardized definitions and guidance for the uses of key responsible investment approaches, including screening, ESG integration, thematic investing, stewardship and impact investing. And our definition and guidance for impact investing is consistent with the gins definition, which is really investing with the intention to generate positive, measurable social and or environmental impact alongside a financial return for intentionality. We refer to the investor's intention to contribute to that generation of measurable environmental or social benefit. And it requires a theory of change or really a credible explanation of how an investor contributes to the positive impact that's separate from an investee's impact. And lastly, it requires a measurement of the environmental social improvements that the investor has achieved. I read that the GIN estimates that the size of the impact investing market as of 2022 is over a trillion US dollars. So Dean, you've been an advocate and subject matter expert in impact investing space for a long time now. How has the concept of impact investing evolved over the years?
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C
So that's a Great question. And thank you too for also referencing the definitional document that you put out via our friends at the unpri. We were also thrilled to be able to contribute to some of that development as well. But you know, the gin was first conceived 15 years ago, actually this month. And so pretty much every year we've been working with industry stakeholders to kind of understand where how they are executing on their impact investing strategy. And we've been collecting data for pretty much all that period. And there are two kind of really big changes that we've seen evolve over that period of time. One is the volume of capital that is increasing towards that is increasingly being or growing towards impact investing strategies. And then the sophistication of actually measuring impact results and managing towards those results. So if I just go back to the kind of the size of the market or the volume of capital, eight years ago we started measuring that supply and it really has shown steady growth in three ways. The number of investors that are now well over 3,000 organizations that we've been able to actually identify as being executing on impact investing strategies, the absolute volume of capital to that over trillion mark, as well as the compound annual growth rate that we track over a period of time is significant and strong. And we're in the process at the moment of conducting our 2024 market sizing effort, which is a figure that we are just working on at the moment and will only release in October. So the market is. All indications are that the market is actually growing and a market sizing exercise is really just to try and give a data point that helps people understand what progress is actually being made. There are a wide variety of strategies where investors are executing on their impact investing strategy. But specifically the important thing is that as you described in terms of a definition, what we're really trying to hone in on here is how investors are using that intentionality, measuring and managing towards that intentionality and really understanding what those results are driving towards those solutions that actually address some of our most intractable challenges. The second area where we've seen a significant evolution over those 15 years is in the practices of measurement and management, which is obviously a fundamental tenant of impact investing. Fifteen years ago, more than 80% of investors were using their own proprietary framework to measure impact results. In effect, impact results were pretty much as investors chose to define it then, whereas now most investors, more than 80% of them, use an external standard framework to set their strategy and their targets. So what we do see is that investors see an enormous amount of harmonization across impact measurement frameworks and a greater level of clarity around which frameworks to use when. So that is a very strong shift in the market as to what investors are actually using to determine whether they are actually achieving their results or not.
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B
It is really exciting to see the growth in impact investing strategies and how they're becoming more accessible to all different types of investors, not just institutional investors. A greater level of clarity in impact measurement frameworks will help enhance the credibility and effectiveness of impact investing strategies and contribute to stronger, more measurable, sustainable outcomes. So in one of your publications, you describe how institutional asset owners should take a holistic approach to impacting investing. Can you explain how this can be achieved?
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C
Sure. So you know what? We look at institutional asset owners. So just to be clear, those are the world's pension funds, the world's insurance companies, sovereign wealth funds, for example. They often collectively hold the biggest pools of capital around the world. Yet they often are concerned about not only if I take an example of a pension fund, how much their beneficiaries may retire with in terms of the capital, but also the context in which they retire too. For an institutional asset owner to adopt an impact lens approach, which really means taking a holistic approach to their construction of their portfolio, so introducing both a financial lens as well as an impact lens to make sure that they're achieving both those objectives alongside each other, it really allows for an institutional asset owner, in fact, any asset owner for that matter, to more than just make money, but rather to actually consider what the beneficiary, what the effects are on their beneficiaries. And it encourages institutional asset owners to systematically consider how their investments can improve the quality of life for their beneficiaries. And a critical step in this direction, say for a large foundation, this large pension fund, is to lay out their logical model, a theory of change, as it were, and in order to be able to actually figure out exactly how they're going to achieve that. Now, logical models are actually not new to most investors. I often make the comparison that when you're investing from a financial perspective, you actually do have a logical model. You may not describe it in that way, but most portfolio managers or trustees of an asset owner will sit down at some point in time and say, I need to achieve these financial outcomes. And in order to get there, I'm going to take this portion of my capital, I'm going to structure it in this way using these asset classes. I'm going to talk to these types of investments, these institutions, these instruments, in order to achieve that consumer price index plus 3%. The logical model from an impact point of view is really integrating those two things is to be able to actually put the two together and make sure that you can actually say in order to be able to actually achieve those financial outcomes, I need to actually conduct this set of activities. But I'm also interested in an overlay that may look at how I as a pension fund that may be concerned for example with say quality of education or something along those lines, how I'm going to actually put that together with my financial strategy as well.
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B
So when I think of overarching impact thesis or you know, theory of change for large institutional asset owners, I think of investing to accelerate the net zero transition, which I think a lot of asset owners are doing right now with their, their full holistic portfolios. So they're taking an ambitious approach that integrates climate lens across all investments and that should lead to better real world outcomes. Not every investment would need to contribute to that outcome. So it's looking at still prioritizing those outcomes and that the asset owner might prioritize investments that have credible transition plans. They might engage with issuers to develop transition plans, set targets, you know, to have action plans to decarbonize their investments or portfolios. And they might also invest in decarbonization technologies and climate solutions. So really that asset owner would be contributing to net zero through engagement as well as can be funding new climate solutions.
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C
Exactly. And I mean, you know, if we, if we just, I mean you've given some great examples and you know, I can add to them in some ways. But if they could, for example, if we just put an asset class overlay on top of that, if they were interested in making sure they needed to have private debt within their portfolio, they could also invest in sort of some off grid finance, solar finance capability. If they wanted to make sure that they had publicly traded debt in their portfolio, green bonds would probably add to that. If they wanted to have equity, whether that be private or listed, they could look at some kind of distributed energy distribution and storage. And if they were looking at making sure that they had real assets within their portfolio, energy efficient retrofits would probably be something that could be aligned. So there is a building on your example of the types of things that they would invest. If I add in that asset class overlay, that's an example of how an institutional asset owner may affect that. Now most investors are often on a journey. This takes a lot of moving slowly from point to point to point to be able to actually develop a portfolio that matures over a period of time in both its practice and its execution. So a lot of institutional asset owners may start with a carve out to be able to actually say, let me test out some of these strategies using a particular asset class in order to be able to actually test out how viable this is for me. And that's a conservative but perfectly acceptable way of actually executing on an impact investing strategy. What we're driving towards in the application of an impact lens is to actually move from a carve out towards a more holistic approach over a period of time. But we do recognize that any investor out there is going to want to make sure that they are comfortable with the strategy before stepping into a deeper execution of it.
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B
Right. That makes perfect sense to me. So impact investing, if we're looking at it as a holistic approach, it can be pursued across range of asset classes. So how does impact investing differ by asset classes specifically, which we'd like private and public markets, equities and debts markets as well.
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C
So sure. So. And I think what you mean, if I've understood you correctly, is that you know, a tenet of impact investing is your ability to be able to measure and manage your investments towards that intended target that you've laid out. And you know, certainly much of impact investing practice has often developed in private markets. And some of the underlying assumption behind measurement and management practices has often assumed that you have line of sight or a direct relationship with the underlying investee company, or even via your asset manager. Now in public markets, that maybe may execute slightly differently in terms of the way in which you actually execute on your measurement and management. And that doesn't mean to say that you can't do it, of course you can, but you might just do it in a slightly different way. So what we've seen in listed equities, for example, which by the way, in terms of impact investing strategies, public debt and listed equities are some of your strongest grow, fastest growing asset classes when it comes to impact investors executing on their impact investing strategies. But enlisted in a public asset class, you may have to use other methods to be able to actually understand how your investment is actually tracking to achieve the results that you may have. So if you've got bonds, for example, you would want to know upfront what that bond actually, what that green bond hopes to actually achieve. And you may well have a discussion with the issuer from time to time as to whether it's in fact actually achieving that goal. If you have got listed equities, you may exercise your voting In a particular way, you may choose the kind of engagement mechanisms that a shareholder may use to be able to actually keep track of your investment. It just plays out in a different way compared to private markets, but the principle remains the same.
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B
Right? Yeah. You've touched on a lot of things that I think of when thinking of private investing versus public investing in impact investing. So, right. In the private markets, you might be contributing completely to new capital. Right. To allow for the expansion of operations, Whereas the investor contribution listed equities through secondary market trading is much harder to measure. The attribution is more complex.
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C
Yeah. Is that, you know, going back to my point that I said earlier, is that, you know, the genesis of impact investing largely evolved in the private market space. And while the public asset classes are the fastest growing asset classes for investors to execute on their impact investing strategies, by far the volumes of capital in public and private market are still below that of private markets. And these practices are going to evolve over a period of time and they're not as well baked as they are in private markets.
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B
So maybe can you elaborate on how you can effectively measure a theory of change or credible explanation of the investor's contributory role that is distinct from the investee's impact? And does that impact investing require portfolio to have a specific quantitative target, future state and environmental or social conditions so that you can measure the progress on achieving those impact objectives?
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C
Yeah, so I'm going to break down your question into two parts because I think that it's worthwhile just talking a little bit about a theory of change. And then, you know, what are the kind of quantitative and qualitative kind of metrics that one might have? So I mean, a theory of change is obviously a logic model for and is good practice for any investor. And I think measuring a kind of like, you know, is my approach, good practice is just a good thing for anybody to do in order to remain competitive. It's more important probably to measure the success of the strategy rather than just the practices to get there. But as I explained earlier, is that logic models or theories of change have been used in financial management of investment results for millennia. So, for example, for my given financial priorities, if I have this volume of capital in my portfolio, I diversify across a range of asset classes using a certain set of instruments, a certain set of institutions, and in a given set of macroeconomic conditions, I expect that my portfolio may produce X percentage, say, over a particular index or something along those lines. That is effectively a theory of change. And so if you follow a similar pattern and use a similar logic model that integrates them for my given priority. Let's say we go back to the example that you talked about earlier in terms of energy and climate change. If I use my contribution, which could be my capital, the terms of my investment, my engagement and my timing, and invest in off grid solar finance systems, if I'm using private debt, for example, and so on, I expect that my portfolio to achieve X percentage over the consumer price index, but also Y number of people that may have access to sustainable energy sources. That's an example of using a theory of change in that, integrating it in that way. So good practices are really, really important. We know that. However, as I said, what's more important is understanding how effective those practices are in achieving the impact results. And it's this effectiveness and efficiency for every dollar of investment, what are the results that I'm actually achieving? And so just in terms of kind of like the quantitative targets is that ideally it is better to actually have a quantitative target. It's the nirvana, if I can put it that way, that all impact investors are aiming for. But what we also recognize is that, you know, to quote the American philosopher Emerson, that you know that sometimes it's a journey and not always the destination that we can kind of focus on. So investors are on a journey to try and actually do this well. But we also have to remember that context really matters for impact results. So just having a metric and a quantitative metric at that is not necessarily ideal if you don't in fact actually consider that context. So let me give you an example of what it is that I'm actually trying to explain. So for example, if you have a metric that you want to give unbanked people access to finance is one thing, okay? So you could measure for example, the number of people that have access to affordable financing in a given geography or in a given kind of mechanism. But if we don't in fact actually put the overlay on top of it about responsible lending practices, it's quite possible that your intended impact of giving people access to finance may in fact actually lead to an over indebted situation with the very community that you're actually trying to assist going forward. And so what you would want to do is have a quantitative target, but also look at whether the investment that you're investing in actually applies responsible practices in order to be able to actually execute or understand the results of your impact as being a positive change in the lived experience of the end beneficiary.
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B
I agree that quantitative targets are ideal. Additionally, investor Contributions should aim to solve specific problems or address underserved needs, ensuring that investments are made responsibly. As you have illustrated, many funds label themselves as impact funds by merely aligning investments with the Sustainable Development Goals. And while the Sustainable Development Goals can serve as a starting point for an impact investing strategy, they also require a theory of change, an action plan to achieve a desired future state in environmental and social conditions, and the method to measure progress toward that outcome.
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C
Sure. And maybe I can just add to what you're saying there because I think it's really important to understand is what we see from most investors is that they often use and the most popular one ones understandably are the Sustainable Development Goals. So they use these high level frameworks like the Sustainable Development Goals to guide an overall impact strategy. However, when they want to get down to those quantitative targets, they tend to go a step lower and use a very specific sets of definitions and metrics to be able to actually describe normally in metric sets, to describe what combination of metrics are needed to get to that goal that helps them achieve that overall priority. And even though 84% of investors have indicated in our latest research at least some progress towards harmonization across impact frameworks is that it is very useful and hopefully in the example that I've illustrated, is to take a common sense approach to be able to use a framework to describe your priorities. SDGs are a fantastic example of those. And then specific frameworks to actually like an IRIS system to be able to actually define the specific metrics that you're aiming to target.
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B
Thank you for your clarification. So unlike financial returns, impact metrics can vary widely, making it difficult to compare outcomes across different investments. And there's also the challenge of integrating impact data with financial performance data. What do you see as the biggest challenges related to data in impact investing in terms of measuring and reporting impact?
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C
Sure. And thank you for that question. That's a really good one. I'm going to deal with the first one in terms of some of the biggest challenges before I kind of move on to some of the reporting and the accountability around it is that, you know, investors, and this has been fairly consistent over the last couple of years, is that good proportion, 91% of investors consider the inability to compare their impact performance to, say, peers as a significant challenge in the market. And what's interesting about comparison is that comparison is really, really important for an investor to actually know what good enough impact results actually look like, whether you're comparing it to peers or whether you're comparing it to say, the scale of the problem that you're actually trying to solve. So if we think of a sustainable development goal, for example, and we know that we've got a finite period to be able to actually achieve those goals, how fast am I moving on my impact goals in order to be able to get there? And comparison is that critical thing to be able to actually do. And you're quite right, it's not easy to do it in the context of social or environmental factors that you're trying to convey that financial performance is just binary zeros and ones. You can very quickly know whether your performance is good enough or not. But what we need to understand is that in impact performance, that can be a little challenging to be able to get to that particular point. However, what we have discovered is that it is possible to normalize and weight and standardize impact results so that we can understand the results at a point in time, over time, and then at the required pace. And so three years ago, the GIN actually built, with input from well over 300 investors, a methodology to do exactly that, to compare and analyze the results in a standard way. Context very much matters. So comparing a particular asset class in a particular geography, or even looking more broadly than that, and sometimes the context matters, from one investor to another, it may differ slightly, and that's okay. But on the back of that math, as it were, to be able to compare and normalize results as I've described, the GIN built impact performance benchmarks to be able to actually understand how you can see those comparisons in action. So using standardized metrics in financial inclusion, agriculture and energy, and we've got two more that are coming online this year in healthcare and in forestry. Those benchmarks were built to show what is possible. So we have over 140 investors that are contributing data. They've got over 5,000 annualized investments in the benchmark. We've been tracking their benchmark data and many use it to come to the second part of your question, to add to their integrated reporting, because now they can see exactly where their investments sit relative to a peer group and relative to a particular context, an asset class geography, a type of investment in those particular sectors. So some investors, if we think about the use case that they're using it for, are using it as part of their pitching, they're using it as part of their reporting, sometimes in their quarter to quarter impact management feedback, or really understanding how they can drive those results towards the intended outcome that they're looking for.
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B
So you've provided us with a wealth of information on how you can implement impact investing across your portfolio for different asset classes. And you've touched on some of the challenges for data impact and this the impact performance framework that the GIN has put forth. I wanted to know more about regulatory frameworks and how some might say there's a lack of interoperability between some of the frameworks and how that might lead to challenges in comparing impact metrics if they're not available across a portfolio of investments, given disclosure requirements, for instance. So what roles does public policy and regulation play in maybe promoting impact investing is.
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C
Yeah, I think the advent of the public policy that we've seen, particularly in Europe and in other geographies around the world, that policy and regulation do play a significant role in shaping capital markets and therefore also shaping impact investing. And it's very welcome to see that kind of regulatory development that is happening because it helps the market mature, particularly around disclosures and particularly around common labeling that may occur. Yes, there are some things that need to actually play out in respect of the things like the interoperability of frameworks, for example. And you know, I think that it's fair to say that many investors are confident, even though it might be challenging, that they will actually figure out how to actually align them over a period of time. And there will obviously be normal kind of review processes that happen, as we know. But what they do encourage is investors to be more transparent with their practices and products. And that is always a good thing. And so it's very easy sometimes to get stuck in the challenges of policy and regulation. But if we just keep a kind of bigger picture principle of what we're driving towards here, what the industry across capital markets is driving towards, is that having that kind of level of transparency, a reasonable level of consistency, actually does drive the market forward. Impact investors obviously very concerned about transparency and being clear about what it is that they're actually doing. And so we see increasing practices where investors are getting third parties to actually verify their impact practices by literally auditing their practices. And those kinds of things together with the regulation, will lead to greater transparency in the market over the long term.
- [29:18]
B
You highlighted how regulatory markets promote transparency and asset managers practices and products through disclosures and the pursuit of specific fund labels. This has also led to a rise in third party verification of impact investing strategies, enhancing the credibility and transparency. And I agree that transparency and disclosures are crucial for helping investors understand a product's investment objectives and to help them make more informed decisions. The CFA Institute has been working on fund classification over the past year and we recently published a report titled how to Build a Better ESU Fund Classification System. This report aims to assist regulators and market participants in developing robust ESU fund classification systems. It provides detailed guidelines for categorizing different types of ESU funds into mutually exclusive groups, including those targeting specific environmental and social outcomes. And we believe that ESG fund classification aids regulations and regulators in creating relevant disclosure requirements for different types of funds.
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C
Congratulations on the release of the report. I certainly enjoyed reading it. And one of the things that I noted in it, which I think is really helpful and sometimes important for bodies such as the CFA to actually do, is to put out something like that that actually helps advance the discussion and advance the debate on what this kind of clarity is actually all about and how we can actually make things clearer for investors. And so these types of frameworks sometimes can be very useful in actually driving towards a North Star that investors may need to work towards in terms of what they do with their particular practice and their execution.
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B
Well, thank you Dean, for the time and the discussion today. I really enjoyed discussing impact investing with you.
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C
Thank you. And Nicole, it's been really good to talk to you too. And perhaps I can just leave your listeners with this particular thought is that impact investing as a strategy is, I think, a really important opportunity for investors to be able to do way more than just make more money. I think we know that the world is dealing with really challenging issues, in particular inequality. We know the world from a climate point of view. We cannot deny that we're becoming hotter than we ever have been before. And the way in which we invest is critical strategy in order to be able to address some of those challenges in our world.
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B
Thank you so much, Dean. I agree 100% with.