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How To Adopt A Mainstream Impact Investment Approach

This is the third in a series of articles written for industry professionals to introduce the concepts and methodologies for an approach to investment characterised as Mainstream Impact Investment (MII). This article was written to help explain how to adopt a MII approach, and builds on the previous article, which was written to introduce the reasons for adopting the approach.

1.0 – Introduction
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From the previous article; the benefits of adopting an MII approach relate to the value attributed to investing in businesses that are having a positive impact in the mainstream markets.

Well governed businesses create value for society in many different ways including; the value attributed by customers to their products and services, the benefits to local communities of employment and the taxes levied help pay for public services. However, almost all economic activity has a negative impact on the environment and so the need to reduce the environmental impact of creating value is paramount. This is the elephant in the room as far as mainstream business activity is concerned, and the MII approach targets businesses striving to reduce the environmental impact of creating value for society.

There are many benefits to an MII investment approach especially the exposure to businesses capitalising on the opportunities that responding to global challenges presents. These tend to be in high growth markets in which demand outstrips supply and are prevalent across all sectors of the economy. An MII approach also just makes good business sense, because by augmenting rigorous financial analysis with sustainability research means a broader range of important risk factors are inevitably taken into account leading to a more robust case for investment decisions.

The MII approach also supports the transition to a resilient economy and offers a mandate to investors who understand the significance of this transition and wish to align their portfolios with these values. MII is not relevant to all asset classes, but it is key to driving investment towards businesses overcoming global challenges and the comprehensive approach to analysis offers an attractive risk adjusted return for investors.


2.0 – The Investment Process
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The MII investment process has 6 stages:

  1. Screening – confirm compliance against the fund’s target profile and policy list.
  2. Due Diligence – assess the ESG management strategy and the underlying risks and opportunities to allow the fund’s investment committee to make an informed decision.
  3. Investment Decision – Enable the fund’s IC to make an informed investment decision that takes ESG factors into account.
  4. Investment Agreement (applies to PE Funds) – Secure and formalise commitments from the target to meet MII requirements including its ESG management strategy.
  5. Monitoring – Guide and assist the target to ensure its ongoing compliance with applicable standards, implementation of the ESG management strategy and improvement of ESG performance.
  6. Exit – Link evidence of improved ESG performance to the target’s value.

The objectives, activities and outputs of the Screening and Due Diligence stages are the topics discussed in this article.


3.0 – Screening
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The objective of the Screening stage is to confirm compliance with the fund’s target profile and policy list by qualifying answers to the following question:-

Does the target reduce the environmental impact of creating value for society?

The analyst’s knowledge of the target’s sector is important and access to research data and key insight into the negative impacts of the value created for society by peers in the sector is paramount. The objective of screening is to qualify answers to the key question within the context of the value created by the target’s products and services. This is achieved by undertaking a top level review of the business model, use of technology and operations to understand how the target’s approach to delivering value helps to reduce the environmental impact of the value created, relative to that of its peers.

Assessing the extent to which the target is willing and able to present relevant information needed for the due diligence process is also an important part of this stage. The output of the Screening stage is needed to help reach a decision whether or not to advance the target to the Due Diligence stage.


4.0 – Due Diligence
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The objective of MII due diligence is to determine how well the target manages material ESG issues by qualifying answers to the following question:-

Is the investment target a well governed, profitable business striving to reduce the environmental impact of creating value for society and as such does it have a business model that decouples economic growth from environmental destruction?

To answer this question the MII analyst evaluates 4 key areas of interest;

  1. Economic Viability; as with any conventional investment approach, the objective is to evaluate the extent to which the target is likely to meet the expected ROI and/or aligns with the underlying fund’s investment criteria.
  2. Governance; the objective is to evaluate the extent to which the target is fundamentally structured to manage social and environmental impacts and as such is aware of the negative impacts of its economic activity and importantly, what it does about the underlying challenges.
  3. Impact on Society; the objective is to evaluate the extent to which the business creates meaningful value for society.
  4. Environmental Impact; the objective is to evaluate the extent to which the business minimizes the environmental impact of creating value for society.

A qualified MII analyst must be able to distinguish between businesses that see sustainability and ‘doing business‘ as competing agendas and identify those that are fundamentally structured to succeed because they’re striving to reduce the impact of creating value, and not in-spite of the fact they are.

Importantly, the MII approach guards against investing in projects that declare positive impacts without also accounting for their negative impacts. It is because of this that MII is distinct from any other investment approach and concludes that whatever economic activity is needed to create value for society, it only qualifies as an MII target if it reduces the environmental impact of creating that value.

4.1 – Economic Viability
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The objective of the Economic Viability review is to evaluate the extent to which the target is likely to meet the expected ROI and/or aligns with the underlying fund’s investment criteria.

Is the target likely to meet the expected return from the investment?

This evaluation step is not discussed in this article.

4.2 – Governance Review
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The objective of the Governance review is to qualify evidence that the business has a strategy to identify the negative consequences of its economic activity and has a strategy to address the underlying challenges. The review is key to understanding the culture of the organisation and the mindset of its leaders and reveals crucial insight into how well the target is structured to respond to factors that might otherwise disrupt its business plans. This evaluation exercise is best qualified through the following 4 lenses:-

  1. Identify – evaluate the extent to which the target is aware of the negative consequences of its economic activity.
  2. Prioritise – evaluate how the target attributes risk and prioritises its response to identified impacts.
  3. Innovate – evaluate how the target approaches key challenges and thus mitigates or adapts to underlying risks.
  4. Report – evaluate how the target engages stakeholders to report impacts, risks and overcomes challenges arising from its economic activity.

The governance review steps are discussed below.

4.2.1 – IDENTIFY
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The objective of this stage is to understand the extent to which the target is aware of the negative consequences of its economic activities.

Does the business have an effective strategy to identify the negative impacts of its economic activity?

In seeking answers to this question, it is equally important to understand how stakeholders are engaged and encouraged to help answer this question. This is where the analyst’s knowledge of the target’s sector is important and access to research data and key insight in to the macroeconomic drivers of change is paramount.

Activities include reviewing relevant online information and contacting key staff to clarify the extent to which the company is aware of the negative consequences of its economic activity. It is equally important to understand how negative impacts are identified, because the authenticity of this information will be determined by the extent to which stakeholders were engaged in the process. Whilst it is necessary to assess the extent to which the target has readily identified key impacts, it is also important to be mindful that many challenges are systemic across the industry. This review therefore, is as much about determining whether the target is aware of its negative impacts, as it is about identifying the impacts themselves.

The output of the Governance | Identify review would ideally include a list of the negative impacts of the target’s economic activity and an indication of which stakeholders contributed to items on the list and how they were engaged in the process.

4.2.2 – PRIORITISE
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The objective of this step is to understand how the target attributes risk and prioritises its response to identified impacts.

Does the business have an effective strategy to prioritise the most significant negative impacts, risks and challenges?

When qualifying answers to this question, it is important to understand how the business evaluates risk and engages sector specialists and subject matter experts to determine the scale and significance of the key negative impacts. This is where analyst’s knowledge of the target’s sector is important and collaborating with sector specialists and subject matter experts is paramount. Whilst it is necessary to assess the scale of impacts, it is also important to be mindful that many of the resulting challenges are systemic across the industry. It is therefore important to assesses the extent to which the target is able to differentiate between challenges endemic to the company and those systemic across the industry.

The output of Governance | Prioritise review would ideally include an ordered list of the key environmental and social challenges attributed to the target’s economic activity, some of which may be marked as systemic to the industry. This list should include measures indicating the scale of the underlying impact, the short, medium and long risk of inaction and the value of a solution.

4.2.3 – INNOVATE
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The objective of this step is to understand how the target approaches key challenges and thus mitigates or adapts to underlying risks.

Does the business have an effective strategy to overcome key challenges?

When qualifying answers to this question, it is important to understand how the business responds to complex challenges and engages with innovators and solution providers from both inside and outside the organisation. This is where the analyst’s knowledge of business model innovation and innovation system’s architecture is paramount. The analyst should be mindful that some challenges are systemic across the industry, whereas others are endemic to the company and the approach to innovation will differ accordingly. Consequently, when evaluating how the target meets challenges it is important to consider how stakeholders from both inside the organisation and across the industry are engaged in the process.

The output of the Governance | Innovate review should be a summary of the effectiveness of the innovation strategy, including measure taken to manage systemic challenges as well as those endemic to the business itself.

4.2.4 – REPORT
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The objective of this step is to understand how the target engages stakeholders to report impacts, risks and overcomes challenges arising from its economic activity.

Does the business have an effective strategy to engage stakeholders, report impacts, risks, challenges and solutions?

When qualifying answers to this questions, it is important to understand the extent to which the business values transparency and is willing to disclose relevant and readily discernible information and how this is used to establish and reinforce the trust of its stakeholders.

Output from the Governance | Report review should include a summary of the effectiveness of the strategy for engaging stakeholders.

4.3 – Impact On Society
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The objective of this review stage is to evaluate the extent to which the investment target creates meaningful value for society. This is largely a qualitative study informed by information gathered from the Economic and Governance reviews, but augmented by a peer review of the sector. This is where analyst’s knowledge of the target’s sector is important and collaborating with sector specialists and subject matter experts is paramount.

What value does the business create for society?

When qualifying answers to this question, it is important to recognise that value to society takes many forms including; that attributed by customers to its products and services; the value to local communities and the supply chain attributed to the employment of staff; and the taxes levied support public services.

It is important to really understand what is meant by the value of a businesses products and services when determining the value of the targets economic outputs. As such it is necessary to discern between the offering and the service provided. For example, fuel companies may sell petrol, diesel etc, but it is the value of the realisable energy embodied in the fuel that is key to vehicle manufacturers and their drivers. Its not the kettle that is valued, it is its ability to boil water and its not the bread toaster, but its ability to make toast etc…

The reason it is important to understand the difference between the offering and the service provided is because in the final review stage, where the environmental impact of creating value is discussed, an MII analyst will conduct a peer review to determine the extent to which the approach adopted by the target minimizes the impact of the value it creates. Whilst products and services may vary (for example, not all energy suppliers are the same), it is the environmental impact of the value created (for example, energy) that needs to be assessed in the environmental impact peer review.

In the final analysis, target selection is on the basis that whatever economic activity is needed to create value for society, it only qualifies as an MII target if it reduces the environmental impact of creating that value. Therefore our examples could qualify if they’re evidently striving to reduce the environmental impact of creating energy, boiling water or making toast.

4.4 – Environmental Impact
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The objective of this review stage is to evaluate the environmental impact of the value created by the target for society. This is a quantitative and qualitative study informed by information gathered from the Economics, Governance and Impact on Society reviews, but augmented by a peer review of the sector. This is where the analyst’s knowledge of sustainability is important and collaborating with sector specialists, subject matter experts and having access to research data is paramount.

Does the business lower the environmental impact of creating value for society?

When qualifying answers to the Environmental Impact question, it is important to recognise that target selection is based on the principle that whatever economic activity is needed to create value for society, it only qualifies as an MII target if it reduces the environmental impact of creating that value.

It is also important to understand how measures to lower the environmental impact are achieved and in particular how the business model itself decouples economic growth from environmental destruction.

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