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It’s time to professionalize the impact in impact investing. Here’s how.

Posted By Kusi Hornberger, Dalberg Global Development Advisors, Monday, December 16, 2019

The end of the 1960s saw a series of controversial and inconsistent applications of financial accounting principles, with a flurry of mergers and acquisitions in the United States and the rise of companies’ “opinion shopping” pitting accounting firms against each other. The result:  a crisis in how financial accounting was used and interpreted. This crisis was the impetus behind the 1972 Wheat Study on Establishment of Accounting Principles and led to the establishment of the Financial Accounting Standards Board (FASB) on July 1, 1973. 

Today we are seeing a similar crisis concerning a different type of accounting. This crisis relates to the lack of consistently applied professional standards for impact measurement and management within impact investing practice. Impact investing is booming, according to the most recent Global Impact Investing Network (GIIN) annual report; the five-year trend from 2013 to 2018 showed a 32% increase in yearly capital invested that brought total impact investing assets under management to $US 502 billion. Also expanding are the diversity of investor types and of impact measurement and management approaches. For this reason, along with the need to be able to measure progress against the SDGs as well as increasing interest and entry of large traditional private equity firms into the space, improved, consistently applied professional standards for impact are needed.    

In response, the International Finance Corporation (IFC) developed its operating principles for impact management. The all too common refrain from the industry and among our clients, however, is that these principles and tools are “too high level” and “don’t provide enough guidance” on how to measure and report impact. This skepticism and uncertainty have led to inconsistent methodologies for impact management application in practice, a lack of widely respected measurability, and the inability to compare different impact investment vehicles from an impact perspective. While these points may bear some truth, we think these criticisms are mostly just excuses. The tools and resources needed to make the practice of impact management more professional already exist. Here is our six-step approach to putting impact investing principles into practice.

1.     Define strategic intent using impact theses

The most important and strategic decision any impact fund manager must make is how to define the impact thesis of its fund. Much like investment theses, an impact thesis integrates the complex threads of the impact theory of change into a single thoughtful narrative supported by evidence. The Impact Management Project (IMP) has invested a tremendous amount of time building a global consensus on how to define, measure and manage impact in practice along the value chain. The IMP has deconstructed impact into five dimensions: what, who, how much, contribution, and risk. We believe every impact investor should clearly define those five dimensions for its fund investments, and we recommend that the industry continue to adopt this framework as the standard for thesis definition.   

2.     Identify associated key performance metrics and targets

Once an impact thesis has been defined, it is imperative to identify and set quantitative targets for two or three associated key performance metrics (social impact should not be boiled down to a single metric).These metrics should be logically connected to the business activities of the potential portfolio companies, easily collected, and based on the strongest obtainable underlying evidence. The good news is that you don’t have to search far for these metrics. For many years, impact investors have used different impact measurement standards. Now, because of the fantastic job done by GIIN and its team, the IRIS+ System has sufficient momentum to be adopted as the industrywide standard for impact accounting. IRIS+ provides an industry-validated catalog of quantitative metrics (primarily output metrics) that can be used to account for the social and environmental performance of an individual investment as it pertains to an investor’s impact thesis. To complement these quantitative performance metrics users should also still carefully think through the impact objectives and targets which are harder to quantify such as strategic intent and use IRIS+ metrics together with those objectives to be more rigorous in thinking about trade-offs, transparency and impact performance.

3.     Develop an impact rating tool to classify expected impact and diligence investments

The critical next step is converting your impact thesis and key performance metrics into an impact monetization or rating tool to use in classifying and comparing expected investment opportunity impacts. These tools translate impact into a single common unit that allows users to identify impact related trade-offs across investments, increases transparency, and forces frank conversation about the assumptions used to estimate the impact of any single investment. We have had the opportunity to evaluate several impact monetization tools, including the IFC’s Anticipated Impact Measurement and Monitoring (AIMM), TPG Rise Fund’s Impact Multiple of Money (IMM), and the Global Innovation Fund’s Practical Impact. Investors can develop impact ratings for investment selection in line with their goals by following impact due diligence guidelines. Some notable investors, such as Actis and Partners Group, have already used this system, and more firms should follow their example. After careful review and evaluation of the pros and cons of each, we find that the best tool presently available are the IMP impact classes and believe that it should be adopted as the industry standard moving forward. The IMP impact classes are also compatible with other impact rating and monetization approaches making them the most flexible and usable to a wide variety of investor needs. 

4.     Drive impact performance improvement plans in portfolio companies post-investment

Once invested, it is important to support portfolio companies in achieving their intended impact. One way to do this is through an impact assessment framework, such as the B Impact Assessment (BIA), tool to ensure and maximize the companies’ intended impact while also driving superior financial returns. These assessment tools help to inform supply chain, labor standards, and management or governance areas of strength and potential risks. Where risks are associated, corrective actions can be taken to mitigate them while ensuring impact outcomes are achieved.  

5.     Design reporting framework to regularly track outcomes against targets

Once all the tools are in place, it is equally important to define the format and frequency of your reporting on the outcomes achieved against your investment targets. We suggest that the outcome metrics and targets be integrated with the already established financial and operational metrics and that reporting for all occur at the cadence set for the financial and operational indicators. Integrated metrics can help organizations better align their core business activities and resource decisions to build more efficient and impactful investment decisions. The industry standard should be to update and integrate impact, financial, and operational metrics quarterly, with annual impact reports produced alongside or within financial performance statements. Integrated tools using Salesforce already exist and show how this could work in practice. This is the current practice for ESG investing, and it should be replicated by all impact fund managers. 

6.     Use an impact compliance audit to verify principles are applied consistently

The last critical step in basing practice on common industry standards is developing a framework that helps ensure the integrity of investors’ impact investment activities under the IFC’s impact investing operating principles. The framework must be applied by one of a pool of certified independent auditors, which will verify that the investor is holding true to the principles in practice. This process would resemble how financial audit firms today certify that financial statements comply with the common standard. We like the approach developed by Tideline, which assesses the compliance, quality, and depth of each component of the principles or the UNDP impact assurance tool which enables better market comparison and provides a scorecard. Moving forward, these approaches should be used voluntarily or adapted by all serious impact investors adhering to a common standard.

In closing, we would like to highlight these six steps as being essential to professionalizing impact measurement and management in practice. All fund managers are tempted to think they know best and can create superior systems tailored to their own needs and imaginations. While we support the urge to innovate, research shows that impact investing would benefit if more investors independent of asset class, legal structure, or geography adopted the standardized steps and tools discussed here. We have worked with a wide range of clients to achieve their desired results by doing just that. Reach out if you are interested in learning more.  

Kusi Hornberger is an Associate Partner in Dalberg Advisors Washington, DC office and co-leads its Finance & Investment Practice; and, CJ Fonzi is Partner in Dalberg Advisors Kigali, Rwanda Office and leads the Monitoring, Evaluation and Learning Practice.   

Tags:  impact evaluation  impact investing  Performance Measurement  social impact 

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Comments on this post...

Asgar Bhikoo, Allan Gray Orbis Foundation says...
Posted Wednesday, December 18, 2019
Great article. Thanks for the links. They are incredibly useful. I think if there was one thing I would add, is the relevance check or re-evaluating the problem statements of theories of change that organisations use. I think a market lens, needs to be applied to see how the problems that impact strategies are addressing are changing, and this need speak to adaptive and flexible impact management strategies as well. I guess another thing one might need to add is consensus/agreement reached by the stakeholders that are affected by the impact management strategy being deployed.
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