Bridge over ocean
28 September 2018 CFA Magazine

How Should Investors Measure the Societal Impact of Investing?

  1. Jeroen Bos, CFA

Analysts face difficulties in trying to measure the impact of ESG investing, but methodologies are improving and will continue to get better.

  • With ESG investing and integration now in the mainstream investment arena, the focus is gradually shifting to the actual impact that companies are making on society and the environment. Positive impact can lead to more sustainable longer-term business models, supporting valuations and risk–return characteristics of investment portfolios.
  • The measurement of this impact remains a challenge for analysts, but improved reporting and transparency, the rise of more data sources, and the standardization of measurement methodologies will lead to progress in the next few years.
  • For investors, engagement and executing on our duties as owners of the companies in which we invest can create a win-win for clients’ investment portfolios as well as for the broader society.


Responsible investing and the integration of environmental, social, and governance (ESG) factors in the investment process have become more important in recent years and have gradually moved into the mainstream investment arena. More and more academic research shows that ESG integration can have a positive impact on financial returns and improve the risk–reward characteristics of investment portfolios.

A new debate is now emerging about the impact that investments are actually making on society and on the environment and how to measure this impact. Methodologies for impact measurement are still in development. Investors, regulators, and non-governmental organizations (NGOs) are increasingly asking portfolio managers the following kinds of questions:

  • To what extent does a specific investment portfolio help improve society?
  • How many tons of CO2 emissions does the portfolio generate?
  • How much does the portfolio help prevent global warming?
  • What is the portfolio’s water efficiency?
  • How does the portfolio contribute to the United Nations Sustainable Development Goals (SDGs)?

Several ratings agencies have started to score investment funds on ESG and/or impact aspects, which makes the discussion even more commercially important for asset managers.  

Carbon Footprint

The societal impact of investments can be measured in many different ways. One of the most popular ways so far has been the measurement of a portfolio’s carbon footprint. In other words, how much CO2 are the companies in an investment portfolio emitting? Interest in these types of measurements has grown considerably in recent years, partly driven by the 2015 UN Climate Conference (COP21), held in Paris, and the resulting debates on climate change and global warming.

A number of initiatives are aimed at reducing CO2 emissions globally, including the Montreal Carbon Pledge (MCP) and the Portfolio Decarbonisation Coalition (PDC). Furthermore, since COP21, several regulators have become more attentive to the financial industry’s carbon emission exposure, and several of the world’s largest pension funds have launched targets to decrease the CO2 emissions of their investment portfolios over the coming years.  

But measuring the carbon footprint of investments is not a straightforward matter in practice. With no standard methodology yet in the market, an investment portfolio’s CO2 emissions can be measured in several different ways. One can measure the total CO2 emissions of the companies in the portfolio and weigh them according to their weights in the portfolio to arrive at an overall portfolio output. This method can also be applied to the benchmark, allowing for a relative comparison between the portfolio and the benchmark.

The methodology clearly involves some complexity. One should first make a correction for the size of the company. For example, the total CO2 emissions of a company with one supermarket are obviously less than those of a company with 100 supermarkets. A universal normalization methodology, using market cap, enterprise value, sales, assets, or a variety of other metrics, would improve comparability.

Also, it is important to choose which emissions one is measuring. Are they simply the direct emissions of the company one is investing in, the so-called Scope 1 emissions? Are they also the indirect emissions from the company’s consumption of purchased electricity, heat, or steam (Scope 2)? Or are they the emissions generated by the full value chain of the products a company is selling, including the emissions of up- and downstream operations (Scope 3)?    

Water and Waste

The methodology for measuring the carbon footprint can also be used to measure a portfolio’s water footprint. This is a topic that will surely gain prominence in the coming years as the intensity of discussions about global water scarcity increases. Companies’ water intensity and even factors such as their waste output could become more material in the future and have a larger impact on profitability.

Social Impact

Impact can also be measured from a social perspective. For example, the number of people who have obtained micro-financing could be a useful indicator of financial services companies’ impact. Other social impact metrics may include the number of people whose access to medicine has increased or whose quality of life has improved because of certain products. One might also consider company performance in terms of job creation and diversity.

Unlike environmental data, which has become significantly more accessible in recent years, social data is still in its infancy, not only in terms of availability but also in comparability. New sources of alternative and big data, as well as gradually improving disclosure by corporates, should improve this situation in the years to come.

Financial Impact

An obvious point of interest for portfolio managers is the financial consequences of the measured impact. By measuring the CO2 emissions or water consumption, for example, portfolio managers can gain insight into how efficiently companies are dealing with these costs. Lower CO2 emissions or water consumption could be expected to lead to lower cost structures, better margins, and higher profitability, and these improvements should have a positive impact on a company’s valuation.

Treating the environment well by reducing emissions or using less water can also improve a company’s profile in the eyes of consumers. This benefit could support the sustainability of its business model and hence its longer-term valuation. The same can be said about diversity because studies also show that healthy diversity in a company’s management team and workforce can lead to better financial results

Lower Risks

One could also argue that a company with lower CO2 emissions has less risk of being impacted by future increases in carbon pricing and/or carbon taxes. The same argument can be used for water usage; using less water reduces the risk of being negatively impacted by future water scarcity. By paying close attention to a portfolio’s exposure to these aspects of company operations, portfolio managers can help reduce portfolio risk.

In addition, the transition to cleaner energy sources and efforts to prevent global warming could lead to a situation in which a substantial part of global energy reserves, such as thermal coal, will ultimately not be used. This change would substantially reduce the value of these “stranded assets” and could negatively impact companies and sectors worldwide. If one also considers pension funds’ introduction of CO2 reduction targets, one could argue that parts of the market may be hurt by these trends. Hence, minimizing the exposure to these trends in one’s investment portfolios could clearly reduce risk and improve risk–return characteristics. To make a full assessment of this potential, one should determine whether these risks are already discounted in the current share price. 

Sustainable Development Goals

Introduced in September 2015 by the United Nations (UN), the SDGs have sharpened the focus on the non-financial impact of investments. The UN’s 17 goals are aimed at ending poverty, protecting the planet, and ensuring prosperity for all, with the objective of achieving a more sustainable planet by 2030 and making the world a better place.

Some of the 17 goals are easier to invest in than others; still, portfolio managers can take these goals into account when making investment decisions and steer their capital allocations toward them. I believe that companies whose products or operational models can help achieve the SDGs can also implement more sustainable business models. Accordingly, positive impact and attractive financial returns can go hand in hand, creating a win-win situation for the investor and society. Reporting on how investment portfolios are exposed to these 17 SDGs is also evolving rapidly, and I expect its momentum in capital markets to accelerate further.

Fund Scores: Handle with Care!

Measuring the impact of investments is loaded with challenges. The availability and integrity of data and the lack of methodology standards are just a few. This makes comparisons of investment portfolios difficult, not to mention the problem of drawing straightforward conclusions from such comparisons.

Missing elements from fund rankings (in terms of impact and ESG) include such factors as engagement and intentionality, which have not yet won a place in most ESG and impact rankings and comparisons.


In my view, asset owners have a duty to use their ownership position to engage with companies and to stimulate them to improve their impact on society by, for example, improving their carbon footprint, water usage, or social impact. This engagement should make the company more attractive and its business model more sustainable. The entire process can benefit investors (through improved financial performance and valuation) as well as society.

Academic evidence shows that investor engagement can materially improve financial performance, making it a powerful tool for driving positive change and making an impact. In addition, direct engagement with the management teams of these companies should provide better access to relevant data and a better sense of a company’s ability to create a positive impact on the world. For now at least, most methodologies for measuring investment portfolios’ ESG scores or impact do not lend themselves to the objective inclusion of investor actions, such as engagement and execution of ownership duties.


Intentionality addresses the question of whether companies actually intend to do good through their  products and solutions and through the way they operate in society. The right intentionality helps the sustainability of a company’s longer-term business model.

A company’s intentions as well as its ambitions concerning CO2 emissions are important factors in the analysis of securities. Studies have shown that positive ESG and impact momentum also has a strong positive relationship with improving financial performance. A focus on companies that have positive intentions and ambitions can therefore support better portfolio returns.

Intentionality and ambition are at this time still absent from rating agencies’ ESG and impact rankings. As is the case with engagement, there remains room for further development on this front as well.

Impact of Capital Allocation

Some argue that buying a stock on the secondary market does not create impact per se because no money flows toward the company and that only primary stock or debt offerings have a true impact. However, this view overlooks an important point: the potential impact of these capital allocation decisions.

With more investors willing to invest in businesses that make a positive impact on the environment and society and with more investors staying clear of companies that have a negative impact, the costs of capital will decline for the companies making a positive impact. They will find it easier to finance new initiatives in the future and hence to facilitate positive growth. Therefore, capital allocation toward companies that make a positive impact can clearly make a difference. One could even ask whether an impact-free investment actually exists at all.

Consequences for Portfolio Managers and Analysts

To make a comprehensive assessment of a company’s business model, one must take into account the impact the company is making on society. This additional insight should lead to better and more complete investment decisions.

Furthermore, portfolio managers and analysts can engage companies to increase the positive impact they are making. Through engagement, they can help improve a company’s longer-term business model, which in turn should have a positive impact on valuation and the longer-term share price development.

Targets, Exclusions, or Engagement

Measuring impact is the first step of a long journey. One of the debates in the market in the coming years will concern the increased transparency with regard to impact. Will asset owners set specific targets to reduce the CO2 emissions of their investments over time, as some large pension funds have already done? Will there be increased pressure to exclude, for example, the biggest polluters from an investment universe? Or will the focus be not on exclusions but rather on using the power of ownership to engage with these companies to push for positive change?

I believe it will be a mix of all three, where engagement can drive the most positive change and create the most impact. In the end, investors will need to decide for themselves which route they want to follow.   

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