When What’s Counted Doesn’t Count

In a recent article, Global Impact Investing Network CEO Amit Bouri wrote about a “coming of age for impact investing,” based on findings from a comprehensive financial-performance analysis of private equity and venture-capital impact-investing funds. It showed that risk-adjusted market rates of return are very feasible in impact investing, subject to carefully selecting the investments within a portfolio.

But while it’s clear that the impact-investing field is making progress on financial assessment, improvements in measuring impact are proving harder to come by. That’s not due to a lack of good measurement frameworks—IRIS and Big Society Capital, for instance, have produced valuable toolkits that spell out the indicators various sectors use to assess outcomes for clients of organizations that receive social-investment funding.

But the time and effort investors and their intermediaries devote to exploring what social difference their investments have made is often relatively small. A 2015 study from UCLA reported by John Gargani, for example, reports that about a third of impact measurement projects in social investment have a budget of less than $10,000 for their work. Instead, investors and intermediaries are easily tempted to assess investments based on data that are easy to measure, rather than harder-won data that may be more insightful.

As a result, assessment by impact investing firms can be superficial. For instance, as one Purpose Capital report has highlighted, typical metrics for culture- and sport-sector impact are the number of performances, the reductions in crime rates, the reported quality of life, and improvements in rates of disease. These themes only partially get at the essence of what can change for a client; they don’t adequately convey, to continue this example, a stretching of ambitions, an increase in empathy, a satisfaction gained from constructively expressing inner thoughts and feelings, or a recognition of what dedication can achieve.

Such practices wouldn’t matter so much if impact measurement’s influence on investment choices were small, but measurement weighs heavily into many investors decisions. Research reported by Principles for Responsible Investment in 2015 examined private-equity investors’ reactions to companies’ “good” and “bad” environmental, social, and governance (ESG) behavior, and found that valuations based on those reactions shifted by as much as 20 percent. And a 2015 study found that a trusted certification of ESG performance could double an investor’s willingness to invest in socially responsible mutual funds.

A recent paper I wrote for the Journal of Finance and Risk Perspectives seeks to explain and assess the biases in investment decisions due to measurement choices; it examines the actions of an “average” social investor choosing between risky and less-risky assets. Each social investor has preferences that affect their choices—notably the willingness to take a slightly reduced financial return in exchange for some social or environmental benefit. When we plug in the numbers, we can see that an investor’s lack of confidence in the achievement of social and environmental benefit means they are less willing to risk lower financial returns. The extent to which this occurs is an amount close to one percentage point per annum—a substantial effect, considering many social investors like to stay within one or two percentage points of market rates, if not match them or get even higher returns.

When social benefit is expressed in only relatively intangible outcomes (such as after-school programs that aim to build self-confidence among disconnected teens), rather than hard outcomes (such as job creation), it only compounds social investors’ aversion to risk. That creates incentives to focus on quantity rather than quality—for example, the numbers of teens that attend the program, rather than the number of teens inspired to make something of their lives.  

This is a serious problem for those investors and their intermediaries who value a holistic approach to measuring social value—the triple-bottom-line or social-return-on-investment perspective. Institutions seeking to promote impact investing have an important responsibility to:

1. Find better ways to highlight the social impact of investments to prospective investors by showing a broader range of impacts, clarifying the contribution of investments to those improvements, and establishing professional standards that their impact measurements should meet.
2. Make a much bigger effort—in partnership with others, including academics—to establish trusted and accepted measures of the more intangible aspects of social value, such as improvements in clients’ resilience, determination, opportunities, and social relationships.   

In short, without an increase in resources for the development of impact measurement, investors will continue to under-rate the achievements of programs that take a more holistic view of social and environmental improvement. Despite much effort, there’s still a long way to go if impact investing is to measure and promote what truly counts.

Read more stories by Neil Reeder.