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How Do You Evaluate Impact Investments?

Sept. 5, 2013
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Before making investments, Accion considers both an investment’s potential social impact through financial inclusion and its ability to generate financial returns.

Like all impact investors, Accion, which seeks to build commercially viable institutions that provide underserved communities with financial tools, must judge their investments on their financial returns as well as their social or environmental impact. For impact investors, financial returns are easy to determine, but impact is much harder to evaluate. In the past five years, impact investors have taken steps to standardize impact measurement terminology as well as impact investment evaluation and reporting. With standardization, they hope impact investments will be easier to compare and thus attract investors.Impact investors have created institutions and systems that evaluate impact just as Morningstar offers independent investment research for traditional investment and the International Financial Reporting Standards (IFRS) provide a common language for financial reporting. The first of these were in the context of microfinance with the Microfinance Information Exchange taxonomy and data collection and microfinance rating agencies such as MicroRate. In 2009, The Rockefeller Foundation sponsored the creation of the  Global Impact Investing Network (GIIN), to grow the impact investment industry, especially through the creation of standardized impact investment metrics (Impact Reporting and Investment Standards (IRIS)), an online global directory of impact investment vehicles (Impact Base), promoting industry leadership through a group of active large scale impact investors and elevating the profile of the industry through outreach to the wider community..

Currently, third-party impact investment evaluators such as the Global Impact Investing Rating System (GIIRS), an initiative of the non-profit B Lab, rate companies’ social and environmental impact as well as its financial performance based on a range of questions in categories such as governance, workers, community and environment, and key performance indicators relevant to the company’s industry, geography, and stage  (where possible aligned with IRIS) which evaluate the company’s performance based on the following criteria: financial performance, operational impact and product impact. . For example, a company that is building low-income housing might be evaluated, among other things, by the increase in number of affordable housing provided by the company.

Even though the GIIN is standardizing impact investment evaluation terminology through IRIS, the industry still faces significant obstacles. Third-party evaluators vary greatly in their methodology and impact investors still rely on a confusing number of evaluation metrics, especially when comparing investments across asset classes and impact areas. NerdWallet asked some impact investment experts about the challenges facing impact investors and how they might overcome those challenges:

Duke University Adjunct Associate Professor of Social Entrepreneurship Cathy Clark is convinced that the impact investing industry needs a strong infrastructure to attract capital:

“Investment networks like Investors’ Circle requires all companies to become GIIRS-rated which saves the individual investors a lot of time in trying to determine and evaluate their impact intentions and practices.  Other retail platforms like Calvert Foundation’s Community Investment Notes have found it helps to have great assessment tools and they have signed on to use some of the emerging systems in their work

“Those hoping to create standardized impact investment metrics face a bunch of challenges. First is just how hard it is to create systems that can really accommodate all of the different impact intentions there are in the world. Another is getting buy-in from many funds. Another is the motivation by many funds to do the least amount of work possible in measuring impact, since paying for this work is not really part of the normal management fee structure for a fund manager.  One of the groups working hardest to overcome these challenges in my opinion is GIIRS, which has a multi-sector approach to impact ratings, has worked with a community of funds and entrepreneurs for nearly a decade to create the ratings, and has made the system streamlined and easy to use.

“I fully believe that standard, transparent impact assessment systems are necessary to move impact investing from pioneers to mainstream investors. You couldn’t have a flourishing financial market without GAAP and Morningstar ratings. Impact investing needs the same infrastructure tools to succeed.”

Accion’s Frontier Investments Group Investment Officer Sara Taylor is worried about the burden that reporting impact data places on companies. When tracking impact, Accion works with companies to identify the key drivers of the business and, where possible, aligns the reported data with IRIS metrics and uses this to report performance to stakeholders.

“When thinking about what information to ask for, we consider the potential impact on companies that are already facing a number of challenges given their stage and the markets in which they operate. Our social mission of expanding financial inclusion is integral to our investment activities and is considered during both initial screening and deeper diligence. Once an investment is made, we think the greatest social impact can be achieved by helping these companies to scale and become profitable. We want to align the performance metrics we request with data that can be useful to the companies from an operational perspective. We analyze this information and use it to help improve companies’ performance and to encourage them to develop a data driven approach.“

”Most of our metrics are aligned with IRIS but, where equivalents do not exist, we create customized indicators.  As part of our role in supporting key industry initiatives, we are collaborating with IRIS and ANDE (the Aspen Network of Development Entrepreneurs) to expand the IRIS indicators to cover additional industries and business models such as financial technology.”

Acumen Fund’s Tom Adams believes that standardized evaluation metrics will give impact investors a common language to measure their impact. Although IRIS is growing, there are still too many options for impact investment evaluation. Adams feels that standardization will help potential investors choose appropriate products.

“It is difficult to gauge the depth of impact for impact investments. We have good tools to measure financial returns, but it is hard to measure the strength of impact for the investments’ beneficiaries. We need to innovate new ways of judging impact investments because once we are able to accurately compare two investments’ impact, it will be much easier for investors to choose the appropriate investment. They will be able to balance the right amount of financial performance and impact achieved.”

The Good Analyst, much like GIIRS, provides independent impact ratings, analysis and reporting. The Good Analyst Social Impact Manager Gabi Blumberg believes that standardization deepens an investor’s understanding of their products.

“Impact measures provide investors with real data to assess performance, which influences the management of existing investments and informs future investment decisions – leading to more impactful portfolios overall. It also improves relationships with investees by helping investors to engage meaningfully with the mission and impact of these organizations. It helps to ensure that objectives on both sides are aligned and this, in turn, can lead to support, advice and capacity building on both sides.

“Measuring impact investments leads to better communication. Having a clear sense of the impact being generated allows investors to report on their own impact and be held accountable by other stakeholders (incl. investors, commissioners, business partners, etc.).  Communication that flows both ways can also allow investors to gather feedback and improve.”

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