Navigating the thicket of ESG metrics
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Sustainable investing may be gratifying for wealthy individuals and families, but it is far from simple. A lack of standards in the measurement and reporting of ESG (environmental, social and governance) products and funds can leave investors confused. And when it comes to impact investments, capturing the right data takes time, effort and, often, a hands-on approach.
The problem for ESG investors is not a lack of data but an oversupply of tools and frameworks. “There is a plethora of standards and different levels of disclosure in the market,” says Amy Clarke, chief impact officer at London-based Tribe Impact Capital, a wealth manager. “It can be really challenging to understand what measures are meaningful.”
Julia Paino, co-chair of impact investing at Nexus, an international network of young investors and philanthropists, describes a frustration she shares with her peers: “When you peel back the layers, a lot of the third-party agencies measuring for ESG are compiling metrics that reward fundamentally unsustainable companies,” she observes, from her base in Boston.
To add to investors’ confusion, different providers often come up with different scores for the same company. For example, California-based investment manager Research Affiliates last year found that, with the exception of environmental scores, two rating providers assessed every dimension of Wells Fargo’s ESG performance differently, one giving the bank a far better result than the other.
“Buyer beware,” says Liesel Pritzker Simmons, who with her husband Ian Simmons runs US-based Blue Haven Initiative, an impact investing-focused family office. “With some ratings, you get an A-plus just for putting out a climate report, and with others you actually have to produce a good climate report.”
Darshita Gillies, founder and chief executive of Maanch, a digital impact measurement platform based on the UN Sustainable Development Goals, identifies a more fundamental problem. “Before you even get into how to navigate the ESG landscape from a private wealth or family office perspective, there is no standard definition of what an ESG product is,” she says.
Another challenge for investors is that dozens of standard setters have emerged in recent years, each with a different acronym and measurement methodology — something known as ESG’s “alphabet soup”.
As concerns mount about greenwashing in sustainable finance, the EU has introduced rules to establish what can be considered a sustainable investment fund, setting tough disclosure requirements for asset managers that want to market a fund as a sustainable product.
More developments in standards are on the horizon. One of the most significant could be the launch next month by the International Financial Reporting Standards Foundation (which oversees international accounting standards) of the International Sustainability Standards Board, which will set standardised ESG reporting metrics.
However, for wealthy individuals and families whose investment choices are driven primarily by the desire to make a social or environmental impact, standardised measurement tools and tick-box approaches may not always yield the information they are seeking.
“There is a desire to have an easy-to-use framework,” says Diane Seymour-Williams, a partner at London-based Acorn Capital Advisers. “But what is really important is what is behind the ticking of the box and the resources that have been deployed by asset and wealth managers to understand what is going on in a company.”
Finding the right approach depends on whether investors are putting their money into public equities and funds or are making direct investments into privately held assets through venture capital and private equity deals. “Family offices and individual investors manage a lot of their direct investing portfolio in-house and have staff looking at impact metrics for those direct deals,” says Naina Batra, chief executive of AVPN, an Asian network of philanthropists and social investors. “But they farm out the public market investments to private banks and asset managers.”
In some cases, family offices with sufficient resources track the impact of their public market investments in-house, says Batra. She cites Singapore’s Tsao Family Office, which focuses on responsible investments through public and private equities and fixed income investments, and which, she says, has developed its own measurement capabilities for all these assets.
For those who outsource impact management and measurement, selecting the right manager is critical, says Pritzker Simmons. “In our public-equity portfolio, we have been split between active and passive managers,” she says. “Our active managers have been chosen because of their point of view on sustainability.”
These professionals, she says, can push for improvements in the sustainability performance of companies in the portfolio. “They work with management teams to move them from moderate to good or from good to great,” she says. “We trust those managers.”
This is the approach taken by US-based Veris Wealth Partners, which specialises in impact and sustainable investing. “We select best-in-class managers in all asset classes, so a lot of our due diligence is of how the manager does diligence around E, S and G metrics,” says Stephanie Cohn Rupp, Veris chief executive.
As stock markets offer families and individuals fewer opportunities to personally influence the performance of their investments, many prefer to focus on impact investing through private holdings. Unlike listed equities, private equity or venture capital investments make it possible for investors to gain direct insights into the difference their money is making. However, this requires some effort. “You have to work really hard to find the information to make the right judgment calls on whether the business is going to deliver the type of change we are collectively looking for,” says Clarke at Tribe Impact Capital.
Social impact projects are diverse and difficult to compare, which means impact-focused private equity or venture capital investments do not lend themselves to being assessed through ESG rating systems or the frameworks of organisations such as the Sustainability Accounting Standards Board or the Task Force on Climate-related Financial Disclosures.
“On the private side, it is really about how the manager assesses impact,” says Cohn Rupp. Rather than presenting raw data to its clients, the firm provides impact reports to show how their money is making a difference. “You never show pure ESG scores to clients because they are meaningless and they don’t really tell a story,” she says.
There has to be a degree of pragmatism in impact investment, says Acorn’s Seymour-Williams, “because a framework doesn’t necessarily address the precise circumstances of an investment”. But precise metrics are something Boston-based investor Paino sees as becoming more important to impact investors. “Five or 10 years ago, it was acceptable to talk about ESG impact broadly, but now it’s getting more granular,” she says. Paino is a partner in Desert Bloom Food Ventures, a fund that invests in and supports the growth of sustainable food companies.
She cites Hungry Harvest, one of Desert Bloom’s portfolio companies, which reduces food waste by recovering and selling fresh produce — more than 12,000 tonnes to date — that would otherwise be discarded. Hungry Harvest tracks exactly how much produce has been recovered, she says, and “those kinds of underlying metrics are of the utmost importance to understanding a company’s positive impact”.
To make sure they are using the right metrics, investors or their advisers must engage directly with companies they are investing in. “Usually, we work with the management teams, whether it is a fund or a company, to determine what those metrics should be,” says Pritzker Simmons.
The complexity of social problems and variation in local market conditions mean the resulting data are not always easy to compare, nor can the same measurement methodologies be applied to every impact investment. This is something Blue Haven has learnt through trial and error. “When we tried to roll everything up into one pretty dashboard, it didn’t work and it didn’t tell us anything useful,” says Pritzker Simmons. “Trying to compare a pay-as-you-go solar company in Kenya with an online platform for early childhood development in California doesn’t make any sense. They’re really different and doing different things in the world.”
Alphabet soup: a guide to ESG reporting bodies
The Global Reporting Initiative (GRI) launched its sustainability-focused reporting guidance in 1997 (its Global Sustainability Standards Board sets standards for sustainability reporting). Organisations such as the Global Impact Investing Network (GIIN) and B Lab later developed impact assessment methodologies.
Some organisations provide reporting guidance on an industry basis. For example, in 2018, the Sustainability Accounting Standards Board (SASB) launched a set of standards covering financially material issues for companies in 77 industries.
Others take a single issue as the focus for reporting guidance — such as the Task Force on Climate-related Financial Disclosures (TCFD), which has become the leading framework for corporate climate change disclosure.
Efforts to streamline and standardise ESG reporting have led to collaboration that could make life easier for companies, investors and their advisers. In April, B Lab and the GIIN, for example, aligned their impact assessment tools, enabling investors to use B Lab’s tool, the B Impact Assessment, and the GIIN’s Impact Reporting and Investment Standards (IRIS+) together.
In June, the SASB and the International Integrated Reporting Council (IIRC) merged, to become the Value Reporting Foundation.
Even so, efforts are being made to add rigour and standardisation to the measurement of impact investments. For example, TPG Capital’s The Rise Fund, co-founded by Bono, the Irish rock star, and Jeff Skoll, the first president of eBay, developed the Impact Multiple of Money process, which was spun off as Y Analytics. The process includes screening out companies with low potential for impact; examining a company’s social or environmental goals and whether they are measurable and achievable; and research that puts a dollar value on the intended social or environmental impact.
Meanwhile, the Impact Management Project (IMP), a global consensus-building forum, has identified five dimensions that investors can use to measure the social and environmental performance of assets in their portfolios. The first three — “What”, “Who” and “How Much” — help investors build a profile of the companies in which they are investing by asking questions about the gap or shortfall an enterprise is seeking to fill, who is benefiting from its products and services, how many people are being served and the level of change they are experiencing as a result.
The fourth and fifth dimensions — “Contribution” and “Risk” — enable investors to assess whether their investments are generating positive changes that would not have occurred otherwise and to highlight the risks to that impact, as well as the potential consequences to society and the environment of those risks.
To gain insights into how investments portfolios are contributing more broadly to people and the planet, the IMP suggests using the UN Sustainable Development Goals as a framework.
It is not alone in seeing the SDGs as a tool to assess the impact of sustainable investments. “The beauty with the SDG framework is that you have the targets that are set and you have the key performance indicators behind those targets,” says Clarke. “Those are very translatable for an investment manager.”
She argues, however, that while the metrics will improve, investors who care about making a difference with their money must keep on asking tough questions. “Impact investing is a bit like investigative journalism — you are peeling back the layers all the time to get to the essence of the story and find out what has happened,” she says. “So we tell clients, ‘Don’t be afraid to ask those questions.’”
This article is part of FT Wealth, a section providing in-depth coverage of philanthropy, entrepreneurs, family offices, as well as alternative and impact investment