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How To Adopt A Mainstream Impact Investment Approach

1.0 – Introduction

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

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

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

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

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

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

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

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

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

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

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

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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Why Adopt A Mainstream Impact Investment Approach

1.0 – Introduction

Appending the word Mainstream to the phrase ‘Impact Investment’ certainly helps us draw a distinction between the many different interpretations of investment strategies that take Environmental, Social and Governance (ESG) factors into account. Broadly speaking, the term Impact Investment is associated with projects spanning the entire economic spectrum, from philanthropy at one end to for-profit ventures at the other.  The common thread is that they all aim to deliver measurable positive impacts.  However, most of the narrative tends to be focused on projects at the boundaries of the world’s economies, typical in marginalised and deprived areas of the world where there is much need to deliver positive ecological and societal impacts.

However, critics of the mainstream markets have long maintained that it is the negative consequences of conventional economics and their impact on local communities, society at large and on the wider environment, where the need for reform is most acute.  Businesses create value for society with the products and services they deliver and support local communities through employment and the taxes levied help support public services, but the underlying economic activity inevitably has unintended consequences. It is the profit end of the economic spectrum where the need to foster positive impacts is paramount.

2.0 – Economic Growth vs Environmental Destruction

It is important to recognise that almost all economic activity has a negative impact, especially on the wider ecosystem and it is the accumulated effect of these impacts that is altering the environment in ways that are threatening the conditions that hitherto have allowed human life to flourish.  The elephant in the room is the negative impact of all our economic activity and so it is essential we foster businesses that strive to reduce the impact of creating value.

Therefore, by contrast and in sharp distinction to Impact Investment, Mainstream Impact Investment (MII) focuses on the mainstream markets, but adopts a much more holistic approach that recognises the essential interdependence between the economy, society and the environment. 

In practice an MII approach creates wealth at competitive rates by investing in well governed businesses operating in mainstream markets, that strive to reduce the environmental impact of creating value for society; I’m referring to businesses that are evidently managing their social and environmental impacts; i.e those that are aware of the negative consequences of their activities and are doing something about them and in so doing, break the link between economic growth and environmental destruction.

3.0 – The Nested Dependency Model

To really understand the value of MII and how it differs from any other approach to investment, it is necessary to appreciate the relationship and interdependence of the economy, society and the environment. This is best illustrated by the ‘Nested Dependency Model’; a resilient economy depends on a stable society, but our communities, nations, indeed all of humanity is utterly dependent on the environmental conditions that allow human life to flourish. These conditions were the product of 3.5Bn years of evolution and yet the economic activity of our industrial revolution has altered the chemistry of the atmosphere, the oceans and the essential biodiversity of the ecosystem to the extent that these conditions now pose an existential threat to the stability of our societies and the resilience of our economies.

Understanding interdependence within the context of MII helps us to interpret the likely impact of business decisions. It also sets the direction of travel for business leaders and as analysts, helps us distinguish those that align with MII values. In simple terms it clarifies priorities and supports the principle that whatever economic activity is required to create value for society, this must be achieved by reducing the impact on the environment. The transition to a resilient economy must inevitably be led by well governed businesses striving to reduce the environmental impact of creating value for society.

4.0 – Challenges & Opportunities

It’s also worthwhile considering the effect of widespread concern for the resilience of the world’s economies and it is not surprising that critics of the mainstream markets have long recognised that the global context for business is steadily changing. Business decisions are being made against an unprecedented backdrop of uncertainty compounded by many macroeconomic factors such as the Covid pandemic, rising national debt as well as the challenges of global warming, water scarcity, income disparity, social unrest and extreme poverty.

The scale and pace of new factors threatening the resilience of our economies are indicators of the systemic failure of businesses and the resultant economies to create value at the scale and pace required to overcome these challenges.  It is also a salutary warning to all of us, that investment decisions must be carefully considered if we are to foster businesses that aim to mitigate or adapt to these challenges. 

On the upside, slowly but surely government policies and social attitudes are changing and many business leaders, entrepreneurs and innovators are rising to meet these complex challenges. A key driver for MII is to capitalise on the opportunities that responding to global challenges presents. Consider this; the global population is expected to reach 10Bn by 2050 and with 70% or approximately 7Bn expected to be living in cities, that means that between now and then cities are going to be built to house the equivalent of the entire present day 7.3Bn population of the world.  The opportunity for development is staggering, but so too is the challenge of doing this sustainably.

5.0 – MII Principles

MII is based on the conviction that the transition to a resilient economy will inevitably be led by well governed businesses striving to reduce the environmental impact of creating value for society and as others have observed, this will become the most significant process in modern economic history, matching the industrial revolution in scale and the technological revolution in pace. Whereas financial markets have a responsibility to support this process, investors too are also increasingly aware of the significance of this transition and given the scale of the challenges, and the scale of the investment needed to overcome them, it is essential that their returns match or exceed market rates. 

So let’s be under no illusion, the objectives of MII from an analysts perspective are no different to any other well managed fund. The aim is to create wealth for investors at competitive rates albeit by integrating rigorous financial analysis with sustainability research.  Analysing how businesses mitigate or adapt to disruptive macro-economic factors and the negative consequences of their own activities, helps analysts build a more robust case for their investment decisions. A key difference is that MII analysts have the insight needed to discriminate against those that see sustainability and business as competing agendas or as a compliance exercise. Importantly, they have the skills needed to identify businesses that succeed because they’re fundamentally structured to break the link between growth and environmental destruction and not in-spite of this. 

6.0 – Summary

Mainstream Impact Investment has a distinct strategy that creates wealth by investing in responsible businesses. Within the context of the value businesses create for society, MII is selecting the best in class as far as environmental impact is concerned. These are businesses fundamentally structured to identify risks, changes in policy and social attitudes and to mitigate the negative consequences of their economic activities. Importantly, these are businesses capitalising on the opportunities that responding to global challenges presents.

The MII approach is just good business sense, it takes into account a broader range of factors that reinforce investment decisions. Whatever your view, it is difficult to contest the assertion that inevitably the transition to a resilient economy must be led by well governed businesses striving to reduce the environmental impact of creating value for society.  So I guess you’re either part of the problem, or you’re part of the solution, but MII is a mandate for analysts and investors alike to align their financial portfolios with these values.


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Introduction To Mainstream Impact Investment

I’m not sure when the term Mainstream was first appended to the phrase Impact Investment, but it certainly helps us draw a distinction between the many different interpretations of the phrase.

Broadly speaking, the term Impact Investment is associated with projects spanning the entire economic spectrum from philanthropy at one end to for-profit ventures at the other end.  However the common thread is that they all aim to deliver measurable impacts.  

Whereas most of the narrative concerning Impact Investment tends to be focused on projects at the boundaries of the economy, typical in marginalised and deprived areas of the world, by contrast, critics of the mainstream markets have long maintained that it is the negative consequences of conventional economics and its impact on local communities or society at large and on the wider environment, where the need for reform is most acute.  

In sharp distinction, Mainstream Impact Investment (MII) focuses on the mainstream markets but adopts a much more holistic approach that recognises the essential interdependence between the economy, society and the environment. 

Clearly the global context for business is steadily changing. Business decisions are being made against an unprecedented backdrop of uncertainty.  Concern for the long term resilience of our economies is compounded by many macro-economic factors such as the Covid pandemic, the debt crisis in Europe, UK and the US as well as by the challenges of global warming, water scarcity, income disparity, social unrest and extreme poverty.

These are all indicators of systemic failure of businesses and the resultant economies, to create value at the scale required to overcome these challenges.  It should be a salutary warning to all of us, that investment decisions must be carefully considered if we’re to foster businesses that aim to mitigate or adapt to these challenges.  Furthermore, given the scale of the challenges, and the scale of the investment needed to overcome them, returns must be seen to match or exceed market rates. 

Consequently, any investment strategy must be based on the conviction that the transition to a more resilient economy must inevitably be led by well governed businesses that strategically manage their social and environmental impacts. 

The key to success for investors will be identifying companies that are led by business leaders who also understand the significance of this and are building their businesses to mitigate, adapt and even capitalise on the opportunity that responding to these challenges presents. 

This is what is meant by Mainstream Impact Investment.  It’s an approach that creates wealth at competitive rates by investing in well governed businesses operating in mainstream markets, that reduce the environmental impact of creating value for society. I’m referring to businesses that strategically manage their social, environmental and governance (ESG) factors, i.e those that are aware of the negative consequences of their activities and are doing something about them and in so doing, break the link between economic growth and environmental destruction – uncomfortable bed fellows that have gone hand in hand since the start of the industrial revolution.

So let’s be under no illusion; the objectives of Mainstream Impact Investment are no different than those of any other well managed fund. The aim is to create wealth for investors at competitive rates. However, in practice, this is achieved by integrating rigorous financial analysis with sustainability research. 

This approach just makes good business sense.  Analysing how businesses mitigate or adapt to disruptive macro-economic factors  and the negative consequences of their own activities, helps analysts build a more robust case for their investment decisions. A key difference is that analysts will discriminate against those that see sustainability and business as competing agendas or as a compliance exercise. 

Adopting an MII approach means identifying businesses that are fundamentally structured so that economic success is not undermined by the negative consequences of their own activities.  In one sense, analysts are looking for business leaders who know how to break the link between economic growth and environmental destruction.  

In practice, this involves understanding how businesses manage risks or factors that could disrupt financial performance.  It is essential to understand how businesses are structured to identify the negative consequences of their activities, but also how they go about mitigating or adapting to them.   

Crucially, an MII approach reveals much more about the culture of the organisation and the mindset and motivation of its leaders, which as investors, is the key insight analysts need to understand how well a business is structured to respond to factors that could otherwise disrupt their stated plans for growth.

The burning question of course is where is the evidence that economic growth and sustainability thinking are not competing forces.  After all wasn’t it Milton Friedman who described such thoughts as “unadulterated socialism which have no place in business“. 

The emergence of reporting standards such as the GRI (Global Reporting Initiative) and the numerous agencies measuring ESG performance has led to countless reports concluding that there is a good correlation between the performance of listed companies with good ESG metrics when compared to their peers.  Even Barclays produced a report, the first in their impact series, that drew similar conclusions for the bond markets.  

The fact is there are success stories right across the economic spectrum.  It may surprise you to know that there are many companies generating revenues in excess of $1Bn just from lines of business that subscribe to these values.  As other observers of the subject have pointed out, the top 10 alone are generating revenues in excess of $100Bn.

Take for example IKEA, which is committed to increasing sales and lowering impact by sourcing raw materials, like cotton and wood, from suppliers with responsible production methods, and it is powering its factories using renewable energy.  Unilever is committed to doubling sales and halving its environmental footprint by 2030. 

We should also be mindful that the global population is expected to reach 10Bn by 2050 and with 70%, or approximately 7Bn, expected to be living in cities, that means that between now and then cities are going to be built to house the equivalent of the entire present day population of the world, which currently stands at 7.3Bn.  The opportunity for development is staggering, but so too is the challenge of doing this sustainably.

To summarize, there are many well informed business leaders building long term value creation models and there are many investors who also understand the significance of what we’re talking about here.  

Mainstream Impact Investment has a distinct strategy aimed at focusing investment on fostering responsible businesses.  Whatever your view, it is difficult to contest the assertion that inevitably the transition to a resilient economy must be led by well governed businesses that succeed by striving to reduce the environmental impact of creating value for society.  So I guess you’re either part of the problem, or you’re part of the solution, but a Mainstream Impact Investment approach certainly gives a mandate to investors who wish to align their financial portfolios with these values.