The Challenge of Comparability in Impact Investing
In the rapidly expanding field of impact investing, measuring social and environmental impact has become a significant challenge.
While investors strive to establish impact indicators tailored to the specific realities of each project, some investors and regulators require an aggregated and comparable overview of the impact performance of funds. In this article, we will explore these challenges and existing solutions, while analyzing the implications and limitations that arise.
Bottom-Up and Custom Approaches to Impact Measurement in Impact Funds
At Citizen Capital, our impact strategy is based on the co-construction of specific indicators with each company. Since we invest in a variety of sectors, it’s impossible for us to use a standardized, predefined approach with a list of indicators for all companies. Instead, we work closely with companies to articulate their mission, translate it into strategic areas, and define relevant indicators. This process leads to an impact business plan where we set objectives over three to five years, just as we do for financial performance.
We conducted a survey among around 40 European impact funds involved in the #Unitedforimpact movement and found that 70% of them also adopt a custom approach, while 30% use a standardized approach for ease of aggregation at the fund level. However, even within that framework, they still supplement it with specific measures.
Challenges in Aggregating Impact Performance
Despite the importance of customization, we need a composite and aggregated measure to evaluate the overall impact performance of our portfolio. Currently, we aggregate portfolio impact performance by calculating the average achievement rate of impact business plan objectives, aligned with the recommendations of the EIF. This gives us a composite impact performance indicator tied to the team’s carried interest. However, the main limitation lies in the lack of real meaning behind this indicator, especially when it comes to effectively communicating with investors.
Major Challenge: Making Impact Measurable and Valuable
The real challenge today is enabling stakeholders to value impact, not just aggregate it. Our investors need to use this data to guide their decisions, particularly when making trade-offs in allocation decisions.
We find that private investors can more easily factor impact into their allocation decisions and value it because they can rely on more qualitative elements. However, it’s more difficult for institutions that need aggregated and comparable measures to integrate them into their decision-making process.
Effectively comparing the impact performance of different funds is crucial to helping institutions make better investment decisions.
Comparability Without Over-Standardization
The idea of standardizing impact measurement is tempting for some stakeholders and regulators to bring more clarity to the market. However, it’s essential to preserve the specific, tailored approaches that reflect the realities of the companies. The goal is not to oppose standardization and customization but to explore alternatives that make impacts comparable without losing sight of the uniqueness of each project.
Standardization would be particularly risky for social impact since indicators must remain adapted to the context and the product. We are currently exploring alternatives that allow us to maintain this specificity while converting these impacts into a common, comparable, and aggregable unit.
Toward Monetization?
One possible solution is to use a common ‘currency’ for comparing impact performance. For example, the Impact Valuation Hub coalition was launched to harmonize impact monetization methodologies, such as Social Return on Investment (SROI).
However, these approaches pose both methodological and philosophical limitations :
- Methodological limitation : The institutionalization of monetization in impact assessment presents a significant risk, particularly for innovative and socially driven projects that aren’t yet represented in existing studies. By focusing too narrowly on measurable financial outcomes, we may inadvertently overlook or undervalue the true transformative potential of projects, especially those rooted in social innovation. Quantifying impact can already constrain our understanding of a project’s broader effects, but attaching monetary values amplifies this limitation, steering us away from our fundamental role as VC.
- Philosophical limitation : Applying monetary and market-based frameworks to human lives or ecosystem preservation raises deeper ethical concerns. For instance, the Cambridge study on whale conservation, illustrates how purely financial cost-benefit analyses can lead to counterproductive conclusions, such as deeming extermination more “cost-effective.” These frameworks risk narrowing our focus, ignoring non-economic values essential to both social innovation and environmental protection.
That being said, monetization approaches offer a useful framework to capture the net impact of a project, facilitating the aggregation and comparison of results across various initiatives, while still allowing for specific approaches to be maintained. The limitations we’ve discussed shouldn’t be seen as reasons to abandon monetization entirely, but rather as points to be mindful of when using it as a tool. It should serve as a means of translating impact into a common “currency” for performance comparison, with the understanding that it only reflects part of the broader impact that projects can have.
Non-Monetary Alternatives: Well-Being and Net Impact
In the same spirit of translating impact performance into a common ‘currency,’ some approaches seek to achieve this without relying on monetary terms. For instance, Boussole Impact uses well-being, measured by the WELLBY indicator, instead of money to value impact. Organizations like 2050 apply specific indicators and use methodologies such as Upright to assess and communicate the net impact of investments. These methods offer a more holistic perspective by considering rebound effects and opportunity costs.
Ecological Accounting: A Paradigm Shift
The latest and most integrated approach identified, which could lead to a true paradigm shift in how we define value, is ecological accounting.
Several methodologies fall under ecological accounting. For instance, CARE, developed by academics, aims to incorporate both positive and negative impacts into a company’s balance sheet and income statement. This method involves comprehensive monetization of impacts, primarily valued through restoration costs. Another approach is the LIFTS Accounting Model, which directly integrates the Doughnut model (ecological ceiling and social foundation) into accounting without monetizing all elements. Other methodologies exist as well, such as Universal Accounting, which focuses solely on the income statement.
These approaches offer a more holistic view of a company’s value and can play a pivotal role in redefining impact measurement. They guide capital toward projects that yield significant ecological and social benefits while enhancing transparency.
Ecological accounting serves as a fundamental cornerstone for a paradigm shift in our society, enabling the reevaluation and redefinition of economic activity value by incorporating social and environmental costs and benefits. By transcending traditional financial metrics, this approach provides a comprehensive perspective that considers long-term impacts on the environment, biodiversity, and human well-being. By integrating these dimensions into decision-making processes, ecological accounting paves the way for systemic transformations in business models, making companies with high environmental costs less attractive while elevating those with positive impacts.
Conclusion
We must fundamentally rethink how we measure value to address society’s challenges. The good news is that these ideas, once considered radical, are gaining traction. However, we must proceed carefully, as our approach will significantly influence how we allocate capital and resources.
