Impact investing today finds itself at a crossroads, navigating a natural tension between two paths–the imperative for growth and the obligation to maintain rigorous accountability.
But what if there was a middle path, one that balances scaling with safeguarding market integrity?
The good news is impact investing continues to grow as more investors embrace “impact” as a guiding concept for designing investment strategies with the potential to generate both financial performance and positive social and environmental outcomes.
Impact investing has grown globally at a 14% annual rate over the past five years, according to the Global Impact Investing Network (GIIN). In the UK, the impact investing market reached £76.8 billion by the end of 2023, growing at 10.1% annually, far outpacing the broader UK asset management sector, which saw growth between -2% and 0%.
The troubling news is confusion persists about what constitutes a legitimate impact investing approach and whether investment managers are prioritizing impact as a true value driver or simply following a fad.
New regulations in Europe, like the UK’s Sustainable Disclosure Requirements and the EU’s Sustainable Finance Disclosure Regulation, aim to set baseline market standards that prevent fraud and ensure funds disclose material risks and are marketed properly. However, as with most regulations, they are not necessarily designed to push the industry toward adopting best practices.
For that, market leaders have developed a range of voluntary, publicly available standards, frameworks and resources on “how” to be a best-in-class impact investor. Some examples include: the GIIN’s IRIS+ System, Impact Performance Reporting Norms (Reporting Norms), the Operating Principles for Impact Management (Impact Principles), and SDG Impact.
With this, a new challenge has emerged. Navigating this byzantine landscape of voluntary standards has proved complex and, at times, burdensome. Asset allocators are unsure as to which frameworks are most relevant to their strategies and which fund managers are adopting them most effectively. Asset managers, on the other hand, lack an efficient way to convey the strength and credibility of their impact. Many managers express their commitment to these standards and frameworks; however, perceptions of impact washing have undermined the reliability of such statements.
For these reasons and more, there is a growing demand for a reliable and efficient method to assess and compare impact investment products. We believe that a third-party mark of credibility offers allocators a clear indication of which managers are adhering to the impact mandate with integrity, while also serving managers a simple way to communicate the strength and accountability of their impact investment strategies.
It turns out there is ample precedence for the role of independent evaluation and ratings in markets for financial products, not to mention consumer products, that have successfully scaled.
Balancing growth and accountability
Impact investing is far from the only industry that has had to contend with how to balance the dual objectives of growth and accountability. Without mechanisms for accountability and quality control, market innovation and growth can risk derailment by market participants who seek to free-ride off the opportunities and disciplines of reputable players. Voluntary accountability mechanisms not only help to ensure growth is sustainable but ultimately can help to raise the bar for what it means to be an impact investor.
Credit ratings, for example, have a long history dating back to the early 1900s. This financial accountability mechanism was created to help investors assess the creditworthiness of issuers, such as corporations and governments, providing a standardized evaluation of the likelihood that an issuer would fulfill its debt obligations. These ratings quickly became an essential tool for risk assessment in credit markets.
Today, the credit markets are bigger than the equity markets, and credit ratings are widely used to set coupon rates for corporate and sovereign bonds to ensure that investors understand the risk-return profile of each borrower.
Investing as a journey, not a destination
Seasoned impact investors know that an impact investment cannot be defined by simply producing a set of impact metrics. At its core, impact investing is a practice, where the “how” is just as important as the “what” in differentiating market leaders from under-performers. The destination matters, but the journey matters even more.
To help market participants better assess the ‘how’ of impact, BlueMark has developed a rating system, called the Fund ID, designed to verify the full set of impact credentials of a fund.
The assessment encompasses the core aspects of a fund’s impact and ESG strategy, governance and management processes, and reported results.
The output of the BlueMark evaluation is a Fund ID rating and assessment report, which provides a shorthand for both fund managers and/or investors into funds (i.e., allocators) to better understand the strengths and gaps in a fund’s approach and performance.
The rating ultimately rewards fund managers who are committed to following best practices for impact investing. Funds who receive ratings Platinum through Bronze implement varying degrees of best practices across the four key pillars and may have room to improve as it relates to addressing certain fundamental aspects. In our experience conducting over 200 verifications, fund managers are often motivated to learn where their strengths and gaps lie and pursue improvements based on independent feedback.
We are excited to shepherd this system into the world of impact investing, and believe that the Fund ID, like the credit rating system, will enable it to maintain growth without sacrificing accountability, integrity, and transparency.
*The Fund ID will be released, alongside a whitepaper reviewing our pilot program findings, on October 23, 2024.