In the early days of impact investing, some investors would make the case for setting impact targets. You can’t manage what you don’t measure, they argued.
The not-always explicit response: Yes, and you can’t be held accountable for what you never promised.
The latest Making the Mark report from the impact verification firm BlueMark found that only 42% of clients set impact performance targets as a condition of their investments. A larger number, 58%, work with portfolio companies to set targets after investments are made.
“Over the past four years that we’ve been doing this work we’ve seen a lot of positive trends,” says BlueMark’s Tristan Hackett, lead author of the report. “There’s a lot more consensus on what “good” looks like for impact management” (disclosure: BlueMark is a sponsor of ImpactAlpha).
BlueMark’s fourth Making the Mark report rounds up findings from assessments of 111 fund managers representing $234 billion in impact assets under management. BlueMark verifies impact management systems against frameworks like the Operating Principles for Impact Management, and also verifies impact reports and the claims that investors are making around the reported impact outcomes from their strategies.
“We look at three things primarily: the ambitiousness of the target, the materiality of the target, and the measurability of the target,” Hackett says in the Q&A.
Helping level up investors’ accountability and ambition are standards like the Operating Principles for Impact Management, and benchmarks like the Science Based Targets Initiative for corporate climate impact. The 2X Criteria for gender inclusivity, and the GIIN’s energy impact benchmarks are among a growing number of performance comparisons that investors can use to assess their relative impact.
Fund managers are taking a range of approaches. Some managers are setting and tracking specific key impact performance indicators, either both at the individual investment level or across a fund. Others are using external scoring tools, like B Lab’s B Impact Assessment. And still others set aspirational commitment targets, sometimes because data on the impacts they hope to achieve aren’t yet available.
“We’re a specialized impact verification firm, so we are looking to bring accountability to the impact investing market,” Hackett says. A lightly edited transcript of our conversation:
ImpactAlpha: You’d think that impact funds and impact companies would set targets in the course of their own planning. Less than half do. Can you be an impact company without setting targets?
Hackett: It’s definitely not a ubiquitous practice yet in the market. It’s really challenging, and that’s part of the reason why we haven’t seen it across the board in impact investing. Especially for funds that are in a blind pool or may not have access to good data, it can be tough to have visibility and clear targets up front. There are good reasons why you need to be flexible.
There are also bad reasons. Investors just may not have the pressure from their LPs or the intentionality to be setting those targets up front and doing that work. There are natural challenges with the work. But it’s also an underutilized accountability mechanism right now.
ImpactAlpha: Can you give us an example or two of what it means to set a target? What are we counting?
Hackett: I would bucket the targets into three primary types. The first would be impact metrics, or key performance indicators by a certain date. This is what most people think of when they think of impact targets. That would be ‘X number of underserved beneficiaries reached,’ or the number of affordable housing units built. It could be a GHG emissions reduction target. We typically see those for company-level impact targets, but they can also be rolled out at the portfolio level for a fund.
For funds looking to set an impact target at their portfolio level, we see scoring tools being quite useful. Managers may have their own impact scoring tool based on a set of dimensions or calculations. They can come up with a portfolio average based on that impact score. They can say, ‘We want our portfolio to be above 75% of our impact score.’ Then there are external scores as well, like the B Impact Assessment that B Lab puts out. That can be a useful tool for saying, ‘Across our portfolio, we want all of our companies that have a certain B Impact Assessment score,’ for example.
The last one is commitment targets. These are not necessarily related to the outcomes of a fund, but to a commitment that a fund makes. This would be like, ‘We want to deploy X capital towards SDG 7 by a certain date,’ or, ‘We want all of our portfolio companies to have a net zero target.’ It’s a bit more qualitative in the absence of good data.
ImpactAlpha: Where does the impetus for setting targets come from? Do companies set targets because the fund managers want them to? Do fund managers set them because LPs want them to?
Hackett: Number one is LPs. Limited partners want to have an idea of what to expect from impact performance, and they want to see that general partners are putting their money where their mouths are in terms of their intentions. Ideally, that accountability is coming from the LPs.
It can also be a useful tool for GPs to understand their own impact and do their own impact analysis on their strategy. In the absence of targets, how do you know whether your impact monitoring data is good or bad? If you have no clear expectations, it can be tough to make those decisions, so it’s an important tool for GPs to be able to optimize their own strategies.
ImpactAlpha: BlueMark has completed something like 200 verifications, covering something like $283 billion in assets under management. What have you found?
Hackett: We were a little bit surprised that the minority of clients are establishing targets with each investee at the time of investment execution. That is 42% of our clients. A greater proportion of investors are setting targets after investment execution: 58% come up with a target over the course of their portfolio management. So in the first six months or a year of portfolio company onboarding, the investor may work with the investee to set a target, but it will not be part of the investment terms. That makes it less of an enforceable accountability mechanism.
There can be good reasons for doing that. They may just not have the data yet. The company may not be tracking that [metric] historically. There may just be an information gap. Sometimes some capacity building is needed with investees to be able to set targets. Other times it may be that creating an accountability mechanism within investment terms may be a leap too far for some impact investors that aren’t ready or don’t have the confidence yet in their target-setting mechanisms.
ImpactAlpha: About one-third of your clients establish internal incentive systems. One of the uses of targets is to see whether the managers themselves are meeting their impact goals.
Hackett: In the report we found that in systems we verified, only about a third of our clients have [incentives] in place. I think part of the reason for that is the ability to set really clear, authentic impact targets.
The first incentive systems that we think about are for fund manager staff themselves. That could be through a bonus that’s unlocked after the achievement of an impact target. It could also be an impact carry mechanism that’s linked to an impact performance target achievement. We see a bit more uptake in bonuses linked to individual impact targets – about 15% of our clients.
Other incentive systems are for investees themselves, which I think often gets overlooked in impact investing. You can embed targets into investment terms and [incentive] mechanisms linked to the financing. Sustainability-linked loans are a good example, or private debt where you link the financing rate to the achievement of targets. There are broader mechanisms like pay-for-success or outcomes contracts.
ImpactAlpha: Is the field moving in a direction that gives you confidence about scaling with integrity? Or are people backsliding into less rigorous accountability for themselves?
Hackett: Over the past four years that we’ve been doing this work, we’ve seen a lot of positive trends. There’s a lot more consensus on what “good” looks like for impact management. The Operating Principles really helped with that as a foundational framework. Some of the work that Impact Frontiers and other bodies has done since has [helped] coalesce the market around a clear set of criteria for good practice. We’ve seen that uptake show up in our data in terms of the number of good practices that our clients are implementing.
As with any growth industry, we’re seeing more variability. There are more and more diverse investors and actors coming into the impact investing space. In this past report, we’ve probably had more variance than we’ve ever seen in terms of the quality of practices implemented. But by and large, [we’re] pretty confident in the growing maturity of the market.
And there’s some good tailwinds, including scrutiny from LPs. Regulations, while they’ve been confusing and created a lot of disclosure burden, have created a lot of attention around impact management and reporting practices. The Sustainable Finance Disclosure Regulation in Europe has been a watershed [moment] that let investors know that sustainable finance regulation would become a thing across the board eventually and they need to get ready for that.
ImpactAlpha: What are the key things a fund manager can do to level themselves up on setting targets?
Hackett: We look at three things primarily: the ambitiousness of the target, the materiality of the target, and the measurability of the target. It’s really important when investors and fund managers are starting the process of setting an impact target to consider those three aspects.
Ambition is about ensuring that a target is more than business as usual. [Investors] want to think about how they can prove an outsized [impact] contribution from their investment. There are helpful benchmarking initiatives and third-party standards, like the Science Based Targets Initiative [for corporate climate impact] and the 2X Challenge [for gender inclusion].
Materiality is about ensuring that the target is material to the business model, to the impacts [a business’s] products or services are pursuing, and to the fund’s thesis for impact. Practices like engaging with key stakeholders and materiality assessments are important for having confidence in the alignment to your thesis.
Measurability is the tricky one. That’s often working with a company to ensure that it has credible data, that there are good assumptions going into any calculations made, that you can get that data year over year to have confidence in what you’re reporting.
ImpactAlpha: Ultimately this could roll into ratings or rankings or other analysis and due-diligence on funds?
Hackett: We’re piloting a new service that looks to benchmark funds’ impact practices and reporting. As part of that process, we look at a fund’s process for setting targets and how material and ambitious those targets are. We also capture their performance against those targets to get a sense of whether they’re on track or doing what they said they would do.
The industry is still a bit far from having clear output data for benchmarking impact. As much as that is the holy grail, there are a lot of risks and challenges with jumping there too soon. We look at fund manager processes, what they’re tracking, their commitments and how credibly they’re performing.
ImpactAlpha: To be clear, you’re assessing funds against their processes and also against their own claims, as opposed to against each other or some uniform benchmark of their actual impact?
Hackett: We feel that is the most appropriate way to compare at this stage. We certainly hope the field and the data matures so we can benchmark outcomes as well.
ImpactAlpha: How many years or decades will it be before impact data and impact targets are on par with financial data and financial targets?
Hackett: Maybe it’ll be next year, if we get enough sustainability information going through AI!
The thing I often say here is, financial targets are still really, really hard as well. Anyone that’s done financial modeling and projections knows how many assumptions go into that, and how much you can create the outputs you want to see.
I do hope that in a couple years the number of investors setting targets and the amount of data that we have gives us a clearer baseline for understanding performance.