Some years ago, when I was studying for my PhD at Cambridge, "impact" became a controversial subject in U.K. academic circles. Researchers found themselves under unprecedented pressure to justify the real-world influence of their work, and many struggled to do so.
Similarly, the difficulty of evidencing impact threatens to undermine the cause of ESG. There is little doubt today that responsible investing can lead to attractive financial performance, but the challenges of demonstrating its broader consequences remain significant.
We know that ESG investors expect their choices to make a positive, lasting difference. This being the case, might their determination to serve the greater good diminish over time if we cannot verify that this basic goal is being met?
This is an awkward yet hugely important question, not least given that the whole construct of investing is increasingly geared towards benefiting as many stakeholders as possible. Ultimately, it is vital to show that this construct operates as intended — and thus to validate it.
We need clarity around a number of issues if we are to avoid an ESG landscape in which a surfeit of rhetoric disguises a dearth of tangible results.
I believe that we need clarity around a number of issues if we are to avoid an ESG landscape in which a surfeit of rhetoric disguises a dearth of tangible results. These issues can be distilled into three overarching prerequisites.
The first is that we have to establish what we really mean by "impact." The second is that we have to prevent the term from being abused. And the third is that we have to accept that some ESG activities are inherently more impactful than others.
Let us examine these matters in turn and see what they tell us about where we stand on the impact learning curve. In tandem, let us attempt to encapsulate them as unambiguously as possible.
Efforts versus outcomes
The obvious starting point in rendering the concept of ESG impact less nebulous is to dispel any uncertainty around what "impact" actually represents in this context. The learning curve’s trajectory is doomed from the outset if we cannot address this most fundamental consideration.
We might look to the European Union’s Sustainable Finance Disclosure Regulation (SFDR) for clues. Depending on the degree to which they embrace sustainability, the SFDR classifies investment strategies under Article 6, Article 8 or Article 9.
Article 6 strategies do not integrate sustainability into their investment processes. Article 8 strategies should promote environmental or social characteristics — or both — by investing in businesses that exhibit good governance. Article 9 strategies should have "sustainable investment as an objective" and in some cases may be benchmarked against an index.
This alone suggests that Article 9 strategies are unique in terms of impact, since the implication is that their contributions to sustainability can — and sometimes must — be measured. Even here there is equivocality and latitude for interpretation, but we can immediately see that it is one thing to say that an investment aims to have impact and quite another to prove impact.
This distinction must be respected because abuse of the term is already rampant. Nowhere is this more apparent that in the careless language surrounding "impact funds," many of which promise impact but have no genuine capacity to corroborate it.
Provided investors fully understand their choices, nothing is wrong with investing in strategies that cannot truly measure impact. But implying that these strategies are something that they are not is both disingenuous and counterproductive.
Such abstruseness leaves responsible investing open to greenwashing on a monumental scale. We might dare to assume the effectiveness of ESG, but we would not be able to confirm it in an even remotely scientific way. The reality might be summarized as follows: Impact should be about outcomes achieved, not efforts undertaken.
Levels of ESG impact
ESG investors seek to allocate funds in ways that reflect their hopes for a better society and a brighter future. To a lesser or greater extent, every ESG product or solution should be able to satisfy this requirement. Yet the successful alignment of values does not automatically result in impact.
Imagine a matrix stretching from "Potentially high impact" to "Potentially low impact" and from "Impact proven" to "Impact not proven." Which ESG investments are we likely to find in the quadrant where "Potentially high impact" and "Impact proven" intersect?
Investors who really want to know that they are making a difference might usefully channel their wealth into philanthropy. Activist ESG funds would also tick both boxes, as they tend to entail conspicuous transparency around positive change.
We might reasonably expect substantive impact from investing in real estate, which is home to numerous ESG metrics and nowadays frequently involves collaboration with tenants, communities and other stakeholders. Investments that employ the power of active ownership — say, through dialogue with company management or via proxy voting — may also be particularly likely to improve policies and practices.
Several nuances are at play here, however. Perhaps foremost among them is that it is innately hard to show that investments in publicly listed businesses lead to better access to capital and subsequent real-world impact — unless, that is, such an investment is exclusively in new capital used to finance impact-centric R&D.
None of this is to imply that investments in the likes of listed equities will not deliver impact. It is merely to observe that their impact could be relatively tough to measure and will probably occur over the long term.
It is crucial to acknowledge, then, that there are levels of impact. It is also crucial to acknowledge that, while the alignment of values is an essential means for ESG investors, impact can be an elusive end. We might apply the following rule of thumb: the less direct engagement an ESG investment involves, the less manifest its impact is likely to be.
Building for the future
The fact that in many cases impact might not be immediately evident begs further awkward questions. How long might investors await proof of ESG’s transformative capacity? Should we settle for far-off milestones, especially in light of our belief that investing necessitates a long-term outlook? Should we insist on ongoing substantiation?
With regard to the environment, for example, might we withhold judgement until 2030 or 2050, per the goals enshrined in the Paris Agreement and in governments’ targets for net-zero emissions? Or should we be kept abreast of ups and downs on a regular basis, as with financial returns?
It could well be that perfect, irrefutable metrics will forever elude us. If so, then the best we can hope for might be ESG frameworks that are deemed to function effectively, and which secure widespread support.
One school of thought holds that a select group of third-party auditors — comparable to accounting’s Big Four — will emerge to apply agreed rules governing the quality of ESG outcomes. Another advocates that enhanced disclosure will gradually engender more commonality. Yet another posits that instructive consistency will forever stay a pipe dream.
Regardless whether any of these scenarios is eventually realized, we must recognize the futility of trying to gauge impact by measuring irrelevances. James Mackintosh has highlighted this tendency in his excellent Wall Street Journal series on the ESG investing "craze" — noting, for instance, that the selling of non-ESG stocks counts for nothing if the assets are simply bought by someone else.
Recalling U.K. universities’ tumultuous journey along the impact learning curve, maybe we should also bear in mind a salutary warning from physicist Alan Sokal. A fierce opponent of scholarly pretense, Sokal once wrote: "It is worth distinguishing between the claims made for research programs, which tend to be grandiose, and the actual accomplishments, which are generally rather modest."
In other words, there are invariably those who "talk the talk" yet fail to "walk the walk." In the arena of ESG, as in the realm of academia, we cannot settle for such a damaging disconnect.