3 Jul 2020

What does the net impact approach offer to investors?

By Annu Nieminen, Founder & CEO of The Upright Project

Institutional investors and companies globally are putting increasing amounts of resources into understanding and communicating their “impact”. However, very few are yet good at measuring it.

As an investor or business leader in 2020, it is easy to get lost in the sea of concepts around sustainability, ESG and impact - and their differences. Very shortly put, measures of sustainability and ESG typically aim to describe how things are done. To better address their business needs, however, an increasing amount of investors is also starting to measure their impact - what is done. This means focusing on the core business of the companies, not just their ways of working.

The game is changing for investors and companies, too: new technologies enable outside-in analyses of companies and funds based largely on publicly available data. We at The Upright Project represent just one example. In short, we build a new type of machine learning enabled quantification model to measure the net impact of companies on the environment, health of people, society and knowledge creation.

During the past three years, while working with asset managers and owners who use our data, we have learned a few lessons about where the global investment scene stands today in terms of measuring impact.

Today, one of the most common pitfalls investors can fall into is failing to measure both the costs and gains of companies they invest in. Focusing only on minimizing negative impacts easily leads to faulty conclusions, such as: “Because they produce less GHG emissions, every SaaS company uses resources better than any energy company”. This is simply not true. Focusing only on maximizing the upsides, as is sometimes done in so-called impact investing, on the other hand, leaves out the fact that there are costs involved in creating any solution. We simply need to look at both at the same time: the net sum of the costs and gains a company creates. That is the only way to inform smart resource allocation for investors.

That’s why at Upright we build a model that measures both negative and positive impacts. This brings new perspectives to many sub-industries that are not necessarily seen as “impact investments” in the traditional impact discourse: what is the significance of the energy sector to running our schools, hospitals and other societal infrastructure? What about the construction industry, what is the value it creates and the role it has in enabling many functions in our society?

Another common mistake is giving up on truly measuring net impact because it requires looking deep into the assumptions made in the investment process. “But we can’t compare health and the environment. Let alone jobs and taxes!” This is a common first response to estimating the net value creation of companies. The counter argument is simple: But we do compare them. Every day. As investors, managers and consumers, we make choices between different value categories. We are just not conscious of the choices we make, as the trade-offs often make us uncomfortable and the analytical thinking required is difficult.

For example, a pension fund that has decided to invest X Euros in aircraft manufacturing and Y Euros in new medical technology has made a number of choices.

At Upright, our aim is to make these choices visible and conscious - choices we all make every day in our various roles. What is being prioritized in our investment strategy? What are we choosing to de-prioritize and why?

As professional investors, we need to deal with trade-offs and face that we cannot optimize everything at the same time.

A third common mistake is assuming one global value set which allows companies to be divided into good, semi-good and bad ones in one dimension.“What are the top10 companies in Sweden impact-wise?” might be a tempting question, but is simply not an intellectually sound one. The answer would vary depending on what the investor is aiming to maximize: perhaps job creation, or health outcomes, or fighting climate change, or creating new knowledge? Outsourcing this thought process and relying on one ready-made rating is tempting, but will hardly bring the business benefits sought with the efforts put into measuring impact. How we approach this at Upright is by stress-testing each fund and portfolio against multiple sets of values held by relevant stakeholders, and encouraging investors to formulate their own optimization criteria that support their investment strategy.

All in all, what is the takeaway for investors trying to navigate the impact space? Clients are increasingly asking “what does my money get done if invested in your fund”. Answers about compliance no longer suffice, but understanding is needed of the core business that is being invested in.

Preparing yourself with solid answers to these questions may prove handy in staying ahead in global competition. We are happy that NIB is among the organizations that are exploring the net impact approach and building understanding of what their investments really get done.