Does impact need to be measurable to count as impact?

Impact is the buzzword of the hour. The use of the term competes with “sustainability” — an expression that is everywhere, yet few know what it actually, concretely means. However, as opposed to “sustainability,” impact is a clear-cut concept. It means change caused by an action. Impact is change beyond what would have happened anyhow

I recently wrote a post on the meaning of impact citing the definition coined by Julian Kölbel and me in the Investor’s Guide to Impact:

Impact is the change in a specific social or environmental parameter that is caused by an activity.

Applying this definition to investing highlights two aspects:

  1. The definition is based on a change that follows an investment. For example: After an investment in a solar energy company, the company expands its production capacity, thus producing more solar panels.
  2. The definition underscores that the change needs to be caused by the investment. For example: Without the investment, the production capacity of the company would have remained the same.

The nuances highlighted above might sound trivial and are often neglected. One of the reasons for overlooking questions regarding causality is the fact that cause-and-effect relationships are inherently hard to prove. Yet, if we talk about impact in the context of investing, it is essential to note that the impact of an investment lies in the change that goes beyond what would have happened anyhow. Sometimes, this aspect of causality is referred to as additionality, a term commonly used for carbon credits or counterfactual impact.

Does impact need to be intentional and measurable?

The post on our impact definition generated a lively debate, especially regarding the question: Does impact need to be measurable to count as impact?

I would argue, that any effect caused by an investors’ actions counts as impact, irrespective of whether it is measurable or not. To add to this, it is essential to look at impact investments holistically beyond their immediate and obvious change.

As an investor, your investments influence the world in various ways. Some of these impacts may be positive. For example, if your capital enables an e-mobility startup to ramp up its production and replace fossil fuel cars, one could say that you have had a positive impact. On the other hand, if the production and disposal of batteries used by the startup negatively affect the environment your impact is unfavorable. Not all of these impacts — good or bad — may be intentional and only a fraction of them can be measured.

I have summarized the types of impact in the following graph:

Investors influence the word in many ways. While some impacts are positive others are negative. Not all of these impacts may be intentional. And only a fraction can be properly measured.

I thus argue that the relevance of measurability depends on why you are interested in the impact of an investment. If you want to sell impact, impact should definitely be intentional and measured or be based on plausible and transparent assumptions. Yet, if you aim to optimize your impact as an investor, a narrow focus on measurable impact has its pitfalls too.

If you claim impact, you need to show impact

If you want to sell impact by making it an integral part of how you market a financial product, impact needs to be intentional and backed up solidly. This is not only the case for investments. From a regulatory perspective, marketing claims need to be backed up by evidence.

In 2016, Kellogg’s was forced to stop advertising their Special K as nutritious and full of goodness due to the lack of evidence to back the statement. Unfounded health claims are a classic, yet specific regulation is existing for environmental claims too. For example, EU-level guidance on environmental claims states that claims need to be robust, independent, verifiable and generally recognized evidence which takes into account the latest scientific findings and methods.

In other words, if an investment product makes impact claims, such as reducing greenhouse gas emissions, this statement needs to be backed up by verifiable evidence. A recent study by the 2degrees Investing Initiative showed that more than 50% of a sample of European sustainable investing funds make environmental impact claims. And almost all fail to back them up.

Investor impact vs. company impact

A key reason for the lack of solid backing for impact claims is the fact that investments do not affect the world directly. Their impact is indirect and largely mediated by financial markets. It is inherently difficult to provide evidence for causal effects in such a complex system. Here, it helps to differentiate between company impact (the change in the world caused by a company’s activities) and investor impact (the change in company impact caused by investment activities).

Investor impact is the change in company impact, caused by investment activities (source: Heeb, F. und Kölbel, J. F., 2020, The Investor’s Guide to Impact.)

If an investor invests in a “green” firm with a positive company impact, but the investment does not cause a firm to grow faster or become greener, there is no change and hence no investor impact.

A lot of progress has been made in measuring company impact. Tools like corporate greenhouse gas accounting and life-cycle assessments enable us to assess the impact of a company’s operations, products, and services. Various established data providers offer their tools to fill these knowledge gaps, meaning that even if company impact measurement is not perfect, there is progress. Despite this progress, the key bottleneck in supporting impact claims lies in investor impact. It remains difficult to assess how much influence a specific investment has on company impact.

The problem of measuring investor impact

There is still a long way to go to properly measure investor impact. Currently, we can identify different mechanisms of investor impact and circumstances under which impact is likely or unlikely. For example, if done right, we know that shareholder engagement can improve the ESG performance of large companies. Or that capital allocated to young green companies in immature financial markets can boost their growth.

However, we are far from being able to quantify the effect an individual investment has on a given company. Given the complexity of the question, I’m doubtful that we will get there anytime soon.

Complexity should not be an excuse to neglect investor impact, yet some asset managers have skipped investor impact altogether. This has been illustrated by the case of DekaBank sued over impact claims for its fund “Impact Aktien.” The case revolves around the statement that a 10'000 euro investment in the fund saves 575 kg CO2. However, this claim is based on measures of the impact of underlying companies. In other words, the statement relies solely on company impact and does not take investor impact into account.

Honest impact claims

So, what next? Should one wait to make impact claims until questions regarding investor impact are solved? Pointing the finger at products that cannot fully prove their impact does not answer underlying questions either.

One solution lies in making honest impact claims and being transparent about essential assumptions. In practice, instead of saying: by investing 10'000 euros, you save 575 kg CO2, a fund could say: we make use of our rights and voice as shareholders and urge our investee companies to adopt stringent climate targets. We assume that our efforts have a decisive effect on the company’s decisions to adopt such targets and thus lead to meaningful greenhouse gas emissions reductions. By investing in our fund, you strengthen our voice and our resources to do so. Such claims could be backed-up by the fund’s track record of engagements that have resulted in more stringent climate targets. Sure, this is less catchy, but more honest.

At the same time, we should have an open dialogue on plausible and not plausible assumptions, supported by solid research on the mechanisms of investor impact. Also, given the amount of ongoing research on the topic, it should be possible to develop frameworks that allow to qualitatively compare investor impact on different investments. Even if we cannot put a number on investor impact, we know that some investments are more likely to cause change than others.

A narrow focus on measurable impact may distract from the big picture

While it is essential to back impact claims, if the goal is to optimize the impact of investments, a narrow focus on measurable impacts may have its dangers.

Firstly, a narrow focus on easily measurable indicators may stand in the way of maximizing impact. It may prioritize an investor’s resources to challenges with easily quantifiable indicators and underappreciate indirect effects that are difficult to assess.

For example, the measurement of a companies’ climate impact is relatively well established and even the effect of other greenhouse gasses can easily be converted to CO2 equivalents. Quantification is relatively easy as greenhouse gas emissions can either be measured directly or calculated from data on fossil fuel consumption.

On the other hand, it is much harder to measure companies’ impact on biodiversity. Biodiversity is a complex, interlinked concept and is highly context-specific. Planting a tree next to your house cannot compensate for the biodiversity loss of cutting down the Amazon rain forest. Finally, assessing local biodiversity is rather labor-intense. Accordingly, while climate-focused investment products are booming, investments that aim to protect biodiversity struggle to get traction. Yet, this does not mean that climate change is more important. Or does it?

As argued by the effective altruism movement, if the aim is to create maximal impact with a given amount of money, the focus of action should be defined by the gravity of an issue and how neglected it is by others. Not on how measurable progress is.

Also, a focus on measurable impact favors direct effects over indirect impact pathways. The impact of companies that provide tangible solutions is easier to assess than the impact of companies that offer services that facilitate systemic change. For example, while it is relatively straightforward to calculate the climate impact of a company producing solar panels, it’s almost impossible to quantify the impact of an IT-company providing tools for inclusive governance.

The same applies to the level of investor impact. If a prominent investor, such as the University of Cambridge, decides to divest from fossil fuels, the effect on the fuel companies’ ability to finance new extraction projects is limited. Yet, it may provide tailwind for politicians to demand stricter climate regulation. It is almost impossible to measure and track this impact. Yet, the fossil fuel industry will not change without legislative changes too.

In other words, a narrow focus on measurable impact may favor approaches that work on improving the world one step at a time, at the cost of approaches that enable systemic changes.

If you want to maximize your impact as an investor, it’s crucial to adopt a holistic view on impact, be it positive or negative, measurable or not measurable, intended or unintended.

Where measurement is not feasible, a first step may be to set out a clear theory of change on how your investment activities affect the world. Stating assumptions explicitly is key in enablinga regular review of the chosen approach based on new learnings and updated scientific insights. Also, it is important to keep an eye on unintentional, unexpected impacts — especially negative ones.

Coming back to the question of what counts as impact, I argue that all causal change is impact. The required level of focus given to quantifiability and intentionality depends on how information regarding impact is used. It is important to back impact claims solidly. But when it comes to optimizing your impact as an investor, measurement challenges should not cloud the big picture. What helps is to work with qualitative assessments, transparency on assumptions, and a healthy portion of common sense.

Do you agree with this argumentation? What are your experiences when it comes to impact measurement and intentionality? I’d love to know what you think. Please leave a comment to this post or send me a message at florian.heeb@bf.uzh-ch.

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