Monday, 21 December 2015

How do you measure the social impact of an equity portfolio?

Impact investing, or investing for social impact, is one of the most interesting developments in the investment marketplace over the last few years.  This generally refers to illiquid securities that aren't traded on a recognised exchange and isn't the subject of this post, but one aspect of impact investing is very pertinent for listed investment portfolios - the measurement of social impact.  As impact investments are chiefly concerned with social impact, a lot of work has been done on demonstrating and measuring social impact.  In particular, the Global Impact and Investing Network launched the Impact Reporting and Investment Standards, a set of metrics to measure an organisation's social, environmental and financial impacts.

" We've not been very good at analysing social impact as an industry and could do a lot better"

Notwithstanding the difficulties of this for a highly diversified listed portfolio, I think we've not been very good at analysing social impact as an industry and could do a lot better.  Best practice currently consists of describing what a few selected companies do and the social merit of that.  Valuable as this is, it hardly paints an accurate picture and is woefully incomplete.  Detailing the social and environmental impact of one company is one thing, doing it for 100 or more companies is quite another.  Creating a mountain of data would not only be extremely time consuming but ultimately, might not be very useful.

Too much data would only confuse investors
My initial solution is to classify each holding according to its ethical function.  This enables investors to understand what role each investment plays in terms of social impact, and the make up of collective funds in terms of ethical characteristics.  Its a somewhat crude mechanism but I think it gives a fair picture overall.  There's an element of subjectivity in classifying what constitutes best practice or what is a social solution, but nevertheless, it does bring some objectivity and transparency.  In practice, I've gone through every single holding of over 100 socially responsible investment funds and categorised them according to the following methodology:

Little Ethical Merit
Core activity confers no clear social or environmental benefits.  This is self explanatory - stocks which might meet negative avoidance criteria, but which seem to offer little in contributing to a better world.

Solutions Based
Core products and services are of direct social or environmental benefit.  These include clean energy, resource efficiency, clean air and water, healthcare, education, public transport, safety, sustainable food and agriculture, social housing and inclusive finance. 

Best of Sector
Social and/or environmental practices are amongst the best in its sector.  Necessarily, there is some subjectivity as to what constitutes best practice in a sector, but both secondary and primary research is used to assess relative performance.

Game Changer
Game Changers are companies whose shares are easily trade-able and that are key players in moving to a more sustainable world.  They may have elements which are ethically controversial but they constitute major companies with a large capitalisation that have a clear sustainability vision and can demonstrate that they are implementing this.

Having categorised each holding, the ethical distribution can be made clear, following the same sort of analysis and discipline that typifies financial analysis.

 Ethical classification of holdings enables a simple for of social impact reporting

This makes comparison of the content of ethical funds that much more objective and based on evidence rather than ad hoc examples and ethical criteria.  It also gives a much better overall flavour of the fund.  I'll look to develop this over time, but I've found it to be a very useful tool for both analysing funds and for reporting to investors.