The rise of sustainable investing has combined a focus on impact to the measurment of success of an investment portfolio.
Sustainable investment portfolios can generate healthy returns and beat mainstream benchmarks. Yet for an ESG investor, an investment portfolio’s impact goes hand in hand with other outcomes beyond profit and loss.
Traditionally, investors have compared their returns to an appropriate equity index or leaned on gauges such as risk-adjusted return, typically defined by standard deviation. Today, there are many more ways to appraise a portfolio’s results.
Assessing Changes in Measuring Impact
Impact measurement has improved as the availability of data from companies on ESG matters widens and becomes more granular. However, there is still no single accepted formula, and measurement largely depends on the bespoke configuration agreed upon between investors and their advisors.
Furthermore, there can be considerable variation in the extent and quality of the ESG data supplied by portfolio companies, as well as the way that data is interpreted by investment professionals. Although many impact investors’ goals align with the UN Sustainable Development Goals, it is crucial to clearly define and document specific impact objectives with advisors and investment managers at the outset. These objectives will play a role in determining how to measure impact further down the line.
Approaching New Impact Indicators
Although there is still no set industry standard to measure impact, tools such as the IRIS (Impact Reporting and Investment Standards) Catalog of Metrics offer metrics to measure an investment’s impact. An initiative promoted by the Global Impact Investing Network, IRIS metrics are numerical measures or qualitative values that account for social, environmental, and financial performance.
An investor looking to combat global warming might measure the impact of an investment against an IRIS climate metric such as Greenhouse Gas Emissions Mitigated, which includes reductions in greenhouse gas emissions from direct and indirect sources.
Alternatively, the IRIS Board of Directors: Female indicator Is one metric in IRIS+ that assesses diversity and inclusion.
More specific impact metrics can also apply to sectors. One IRIS metric in the area of real estate is Building Area of Efficiency Improvements, which indicates the areas of buildings projected to receive energy efficiency improvements as a result of investments made by the organization.
Once metric scores have been collated, the task is then to aggregate and appropriately distribute them across the portfolio to build up an overall impact score for the fund.
In response to the diversity of investment firms’ approaches, some standards stress versatility.
Adopting a Bespoke Approach
Investment firms can create their own outcome metrics tailored to specific sectors and client impact goals. However, different measurements compiled in unique ways and interpreted by various investment firms can result in varying scores for the same portfolio and signal a lack of consistency in measuring impact for investors.
In response to the diversity of investment firms’ approaches, some standards stress versatility. For example, the evolving Common Framework is a flexible standard meant to help firms aggregate their bespoke indicators according to recognized frameworks such as the United Nation’s Sustainable Development Goals.
The flexible framework is 30% complete and will take many years to finalize. In the meantime, investors can continue to check for GIIRS ratings on their sustainable investment funds. This framework was developed by nonprofit B Lab and held out as the gold standard for assessing funds based on portfolio impact on workers, customers, communities, and the environment.
As the consistency of information provided by portfolio firms continues to improve, the ever-increasing spotlight on sustainability may ultimately help to improve the quality of impact measurement.