Understanding ESG Part 5: Measuring ESG impact

Understanding ESG Part 5: Measuring ESG impact

Asset managers and their clients are increasingly incorporating environmental, social and governance considerations – collectively known as ESG – into their investment decisions. This reflects the spectacular rise of responsible investing – an investment ethos that delivers benefits beyond the bottom line and recognises that modern-day investment should be a matter of long-term ownership and sound stewardship.

In this article we explore the complicated relationship between ESG and impact. With more than a third of global assets under management now classified as “sustainable”, this is an issue that is attracting ever more scrutiny. We examine the difficulties around achieving, measuring and demonstrating impact, how they might be framed for investors and why addressing them is likely to be vital to both the long-term success and the enduring appeal of ESG.

ESG and the burden of proof

As discussed in part 4 of this series, there is now little dispute that an ESG focus can enhance investment performance. However, the challenges of evidencing responsible investing’s broader consequences – its actual impact in environmental, social and governance terms – remain substantial.

Investment success has traditionally been gauged in two dimensions – the twin Rs of risk and return – with assessment revolving around quantifiable gains and losses and relatively straightforward comparisons. The fundamental problem today, as ground-breaking Invesco research has argued, is that ESG has made investing “more than a numbers game”.

This is because attempts to measure ESG impact introduce an additional dimension. This takes the form of a third R – what we might call “responsibleness”. Although ESG is underpinned by an abundance of data, genuinely proving that investments have made a positive and lasting difference is not easy – and may even be impossible in some cases.

Ambiguity is already engendering confusion. There are many funds that integrate ESG data in their stock-selection processes, but this alone does not make them ESG funds per se – and it certainly does not make them dedicated “impact funds”, which represent another kind of solution altogether.

The principal reason why this issue is so important is that the investment community’s determination to serve the greater good is likely to diminish if its capacity to do so cannot be verified. The entire construct of investing is increasingly geared towards benefiting as many stakeholders as possible, and it is essential to show that this paradigm works as intended and can be validated.

The meaningful framing of impact therefore requires clarity around several issues. We first need to establish precisely what “impact” means; by extension, we need to avoid misuse of the term; and we need to recognise that some ESG activities are innately more conducive to impact than others.

A three-dimensional approach to investment performance

Historically, calculating and comparing the performance of investments has been a question of risk and return. This two-dimensional approach, which essentially relies on the quantifying of gains and losses, is no longer adequate in the age of ESG.

As shown below, the quest for sustainability demands the addition of a third dimension. “Responsibleness”, as we might describe it, can be much harder to quantify – notwithstanding the availability of a wealth of ESG data.

A three-dimensional approach to investment performance

Source: Invesco: “3D investing: adding a third dimension to traditional investing”, as at 12 November 2021.

The struggle to define “impact”

The European Union’s Sustainable Finance Disclosure Regulation (SFDR) is among the most significant ESG initiatives in the world. It seeks to heighten transparency in the market for sustainable investment products, particularly by preventing greenwashing.

Depending on the degree to which they integrate ESG considerations, SFDR classifies investment strategies under Article 6, Article 8 or Article 9. The resultant distinctions go some way towards addressing the uncertainties that surround achieving, measuring and demonstrating impact.

Crucially, strategies categorised under Article 9 are unique in having “sustainable investment as an objective”. In some instances they may be evaluated against a benchmark – for example, the EU Climate Transition Benchmark or the EU Paris-Aligned Benchmark for funds targeting reductions in carbon emissions.

There remains scope for interpretation under SFDR, which is why Invesco has acknowledged the regulation as “one piece of a large puzzle”. Nonetheless, the dissimilarities between Article 6, Article 8 and Article 9 highlight that it is one thing to claim that an investment aims to deliver impact and quite another to conclusively evidence impact.

At least in the short term, the likelihood is that these lines will continue to be blurred. Some fear that regulation could itself lead to more greenwashing or “window dressing”, with businesses and investment product providers striving merely to give the appearance of doing good.

Amid such difficulties, a very basic rule of thumb is that impact should be about outcomes accomplished rather than efforts undertaken. Investors who want proof that they are contributing to positive and lasting change may wish to keep this axiom in mind when choosing their investments.

Impact through a regulatory lens

The European Union’s Sustainable Finance Disclosure Regulation divides investment products into three categories. These are based on the degree to which ESG considerations are incorporated. A deliberately simple representation is shown below.

Genuinely meeting the demands of Article 9 categorisation is challenging. According to research by Morningstar, in July 2021 – four months after SFDR came into force – less than 3% of investment funds in the EU satisfied the requirements.

Impact through a regulatory lens

Source: Morningstar: SFDR: Four Months After Its Introduction – Article 8 and 9 Funds in Review, as of 2021.

Disparities and the need for standardisation

A primary goal of an initiative such as SFDR, as its full name makes obvious, is to encourage greater disclosure around sustainability. Yet disclosure is truly instructive only if it is accurate – or, to use a more emotive word, honest – and if it can be appraised through a reliable, consistent lens.

Unfortunately, reliability and consistency are less likely in the absence of standardisation – and standardisation in the sphere of ESG is elusive. There has been some consolidation since Invesco first drew attention to “a bewildering and ever-expanding proliferation of competing demands”, but how ESG is reported and measured is still far from ideal.

The status quo within the ESG ratings industry offers an illustration. Most investment managers leverage the outputs of four major organisations, but each of these off-the-shelf services has its own methodology – meaning that scores tend to lack correlation and so do not always lend themselves to helpful comparison.

According to a study by McKinsey & Company, insufficient standardisation is regarded as the main failing of sustainability reporting. Some 89% of investors surveyed said that lowering the number of purported “standards” would be beneficial, while three quarters said that there should be only one.

Will providers ever settle on a single standard? One school of thought holds that a select band of third-party auditors will eventually apply universal rules governing the quality of non-financial ESG outcomes, while another advocates that commonality will emerge over time – thereby allowing the most effective metrics to dominate – as disclosure is gradually augmented.

Conscious of these ongoing challenges, Invesco has created a proprietary analytics and scoring tool, ESGintel, which offers a holistic picture of how a business’s value chain is affected by various ESG factors. We are also exploring the use of mass-aggregated news data and other sources, as well as carrying out further cutting-edge research into how ESG impact can best be measured.

A snapshot of inconsistency

Data is the lifeblood of ESG and underpins almost all forms of analysis in this space. Yet even the largest providers do not invariably use the same sources, less still interpret information in the same way.

The table below shows the contrasting approaches of four of the most influential organisations in the ESG ratings industry. It offers a snapshot of the inconsistency that complicates the metrics applied to responsible investing – including those intended to assess non-financial outcomes.

A snapshot of inconsistency

Source: Invesco: “More than numbers: meaningful measuring and reporting in an ESG landscape”, as at 31 August 2021. Data correct as of April 2021.

Some final thoughts on framing ESG impact

At this stage in the history of responsible investing, as we have seen, ESG impact is still a nebulous concept. Going forward, clearer definitions, better metrics and superior disclosure are all imperative.

Accepting that there is considerable room for improvement, we proposed earlier that investors should first remember that ESG impact must be a question of outcomes. In other words, it has to be practical rather than aspirational. It should be centred on effects rather than on endeavours.

In addition, it might also be usefully noted that some investments are inherently more geared towards generating impact than others. This could further determine whether a specific product or strategy is fully aligned with an individual investor’s values and objectives.

Generally speaking, investments that entail direct engagement with businesses could be especially likely to drive positive and lasting change. This is because they tend to better reflect the underlying precepts of long-term ownership and sound stewardship.

There might also be merit in distinguishing between entity-level and fund-level ESG. The fact that a company has a good ESG rating does not automatically translate into attractive ESG performance in portfolio terms. Greenwashing often comes into play in this respect.

On the whole, then, investing responsibly with the express intention of having an impact is far from elementary. This is not to suggest that achieving, measuring or demonstrating ESG impact is impossible – but it is to say that each demands understanding, expertise and experience. 

Three preconditions for impact-aware responsible investing

There is a growing sense that investors’ enthusiasm for ESG could give way to scepticism and even cynicism if the uncertainties surrounding achieving, measuring and demonstrating impact remain unresolved. This is why investment professionals and policymakers alike are working to crystallise the idea.

Below is a rudimentary framework outlining what Invesco believes are the key prerequisites for dealing with these issues. This is offered in the full knowledge that solving the problems around ESG impact is much easier said than done.

Source: Invesco: “More than numbers: meaningful measuring and reporting in an ESG landscape”, as at 31 August 2021.


In this article we have explored the relationship between ESG and impact. We stated at the outset that the relationship is a complicated one, and it is important to appreciate that unravelling its complexities will take time – yet this is in no way to imply that the topic is beyond investors’ collective grasp.

We have observed that the notion of ESG impact is at present inadequately defined and that greenwashing is therefore a lingering problem. More encouragingly, we have seen that concerted efforts to bring greater clarity to this sphere are well under way and that investors can apply several useful rules of thumb to guide their choices in the meantime. Overall, there is good reason to believe that the challenges of evidencing responsible investing’s broader consequences will increasingly be met.

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