ESG data tell how high a company scores on Environmental, Social, and Governance issues, whereas impact data measure how much a company’s products and/or services contribute to one of the seventeen UN Sustainable Development Goals.

Flawed by nature

Does a high sustainability score guarantee the best contribution to the transformation to a more sustainable world? The answer is short and simple: no, it does not.

First, it is an illusion to think that the metrics we currently use cover everything that is important regarding sustainability. This begins with the simple fact that there is no agreed-upon standard for these metrics. ESG-scores of different data-providers differ markedly, resulting in a company scoring high with one provider and low with another on the same issue. In addition to that, companies ranking high on ESG are often not sustainable companies at all. Larger companies, for example, simply score better because they have more time and money to create sustainability policies and report on them.

For impact-metrics the situation is even worse. Several providers do not measure negative effects, meaning that companies always contribute positively to the SDGs. Another option for ‘impact-washing’ is to always rate companies positively on SDG8 (decent work and economic growth), as they all create jobs. Apart from being flawed by what they measure, they are often also flawed in the ranking of what they measure. Industries that are unsustainable at their core, such as oil and gas, and fast fashion – both highly polluting, are known to receive high ESG scores, and even high scores on social impact. These ‘positives’, however, don’t make up for the extreme negative effects of pollution, resource use, waste and overconsumption that drives their profits. The truth is, it is extremely difficult to measure impact, let alone comparing and balancing impact of different nature (social vs environmental).

A final disadvantage of looking only at impact metrics: at best they represent the sustainable impact at a given moment in time. In most cases, however, they are backward-looking. And this is completely at odds with what you want to achieve: forward-looking impact that leads to a more sustainable society. It is strange that there is so little progress in this field, because for all financial metrics we have been performing all kinds of forward-looking exercises for years, including scenario-analysis to check whether an investment will pay off. When it comes to impact, we are just ticking the boxes. Why? I think it is a matter of conventions and traditions. Nothing more than that. For financial analysis, we have well-established methods, as taught in any finance course. Hence, the ‘good’ way is accepted and known across the whole industry. Yet anyone who ever made such analysis knows it is more about good assumptions than about reality.

Forward looking investing

There is a way forward in investing, however. It takes three steps, and the first step might be very familiar to people who never got used to the idea that only numbers and short-term gain should guide investment decisions: to fully understand the purpose and the strategy of the firm. Is the company an ‘agent of change’ in a sector with a superior technology, or in terms of their policies, processes, or product? And what does that mean for their impact on that future and what does it mean for their business model? Like Tesla was an agent of change in the automotive industry, and different solar panel and wind turbine manufacturers in the renewable energy industry, other companies raise the bar in terms of good practices on board diversity or responsibility in the value chain. Recognising the agents of change can be guided by available date. However, it has also a forward-looking qualitative component: what will the strategy deliver in the future. This approach resembles Bill Burckart’s system level investing.

The second step can partly be metric-based: what does the investment deliver in terms of risk-return and impact? And not impact as described above, but does the investment really contribute to a transformation of the system? This obviously is a very difficult question, but if we can answer that question for the risk-return profile with some assumptions, why not also for impact? The answer lies in the setup of our financial system, where we have a lot of tools, guidelines, rules, and training how to do the financial analysis, but not for the forward-looking impact analysis. To solve this is in our common interest.

The third step concerns the intention of the investor. Does the investor deliver added value to the investment itself? Does he, for example, make up a contract or an engagement plan to improve in terms of ambitions or impact? Let’s be clear on this: the impact of an investor is not the outcome of the investment itself. The added value lies in how he steers investments in a more sustainable direction.

As the academic Ted Trainer said: “To save the planet, we do not need miraculous technical breakthroughs, or vast amounts of capital. Essentially we need a radical change in our thinking and behaviour.” This kind of radicalism is also what we need in the investment industry: rather than on scores of the past, we should take our investment decisions based on their contribution to a more sustainable future, with the aim of contributing to solving the challenges that lie ahead.