The first months of our journey have been a steep learning curve on many aspects of impact investing. Through networking with experienced impact investors, we have researched how different organisations approach this field. One of the most critical calls to make is, of course, what you consider an impact investment at all. Besides expecting an appropriate financial return (otherwise it would be philanthropy), here is our current thinking on this topic.
The United Nations have done a remarkable job by defining a framework of 17 Sustainable Development Goals (SDGs) we need to achieve by 2030. This means all of us: governments, NGOs, individuals, but also businesses. The SDGs do not stop at lofty aspirations, but concretely define targets and metrics for each goal. For example, SDG7 - Affordable and clean energy is subtitled "Ensure access to affordable, reliable, sustainable and modern energy for all".
Each goal also has targets defined, e.g. "Target 7.1 - Universal access to modern energy" or "Target 7.2 - Increase global percentage of renewable energy". Each target in turn has valid indicators of where we stand on it. For target 7.2, this would be indicator "7.2.1 - Renewable energy share in the total final energy consumption".
Since its launch in 2016, the UN reports annually how we are tracking against our goals via targets and indicators. (spoiler alert: we are not moving fast enough in most areas.)
But how would a business know it is helps or possibly even hurts an SDG? This is where further mapping to business-level metrics needs to occur. While large players sometimes use their own taxonomies, there are standardized sets of metrics to leverage.
For example, the IRIS metrics, maintained by the Global Impact Investor Network GIIN, are widely used by impact investors and impact entrepreneurs to find common ground for reporting. The investor can make the funding contingent on certain impact hurdles being met, which allows the entrepreneur to drive activities towards financial return (metrics well understood) and impact. Impact investment funds typically offer aggregate impact metrics across all invested portfolio companies by using such a standardized framework.
Why should businesses care?
It all sounds very tedious but imagine your business builds a piece of equipment which is vastly more efficient in preventing greenhouse gas emissions than currently available solutions. You can commission a research paper that documents the CO2e savings for a single unit. In order to report on your overall impact, you can use IRIS indicator "PI5376 - Greenhouse gas reductions due to products sold", which is clearly defined as units sold times emissions of product replaced minus emissions of product.
With this you can showcase in your business plan what the impact will be and demonstrate that the positive impact is core to its growth. The more you sell, the more impact you bring. This is very attractive to consumers and investors as it has exponential benefit.
Now let’s talk about how we define impact investing. We believe there are three primary criteria that matter.
A very simple definition of an impact investment might look something like this: "Investment in any asset class that can demonstrate by metrics how its success contributes to an SDG target indicator." If all financial investments were screened by this definition, investment money would flow quite differently than it does today. An investment transition would happen and a massive DivestInvest movement would occur, exactly as we need it.
But is this definition of impact investing enough? In other words, is investing in a solar park truly impact investing now that it has become so mainstream? To answer that, I think we need to consider the all important dimension of additionality.
Additionality means that an investment must enable impact that would not happen otherwise. Solar parks in Germany improve the grid mix with clean energy, hence can be reported on by metrics. But they are also just plain good business now that some of the initial political and technology hurdles have been passed. It could be argued that true impact is only achieved if it wouldn't happen otherwise. However, a balanced impact portfolio will have a variety of different types of investment and we would still consider solar investment worthwhile and impactful as part of a blended approach, even it offers limited additionality.
Besides meaningful reporting and additionality, there is one more essential ingredient in impact investing: why an investment is made. The intention to have a positive social or environmental impact is a fundamental mindset for an impact investor.
If you invest in Tesla to make a quick buck on a volatile stock, that's very different from investing with the belief to change mobility forever. Intention will unite the investor and investee in their mission, helping them navigate rough patches with patient capital. It also means both parties are sitting at the same side of the table, that of achieving something positive together for planet and people.
Our definition of impact investing
With that, we could amend our working definition as follows: "Impact investment is intentional investment in any asset class that can demonstrate by metrics how its success contributes to an SDG target indicator that would otherwise not happen." Quite a mouthful, but we'll go with it for now and see how we fare in assessing investment opportunities.
We'll report back...
p.s. A big thanks to all the experienced impact investors that have shared their views with us to get us up to speed. Much appreciated...
Looking for ways to align my portfolio with my values and beliefs.