Responsible Investing Research Measuring contribution to Sustainable Development Goals The KBI Approach Introduced in September 2015, the UN Sustainable Development Goals (‘SDGs’) are a universal call to action to end poverty, protect the planet and ensure that all people enjoy peace and prosperity. The SDGs followed on from the Millennium Development Goals, which were set in 2000, aiming to tackle extreme poverty and hunger, prevent deadly diseases, and expand primary education to all children, among other priorities.
Eoin Fahy, Head of Responsible Investing
In fact, the Millennium Development goals were highly successful – something that is perhaps not well known to the public - taking more than 1bn people out of extreme poverty, halving child mortality, and reducing the number of out-of-school children by more than half. The Sustainable Development Goals represent the “next steps” for the global community. They set 17 Goals, each having a number of specific Targets (most with a 2030 deadline) for the eradication of poverty and hunger, the protection of the environment, the provision of clean water and sanitation, and prosperity for all. They add the areas of climate change, economic inequality, innovative sustainable consumption, peace and justice, to the priority areas already identified in the Millennium goals. The 17 goals are set out in the graphic below.
As already mentioned, each of the 17 has a number of specific Targets (they can be thought of as sub-goals), which are typically quite specific and – importantly – measurable. For example, SDG 6, Clean Water and Sanitation, sets out eight Targets, six of which (including universal access to safe and affordable drinking water) are to be achieved by 2030, and one by 2020 (one is undated). 1
While they originally received little attention in investment circles – and were not intended for use by investors – since about early 2017 we have seen a trend where many asset owners and investment managers have been considering whether the SDGs could be used for an entirely different purpose: could investors use the SDGs as a way to measure and report on the Impact achieved by investment portfolios? Impact Investing Before answering that question, we should explain, for the benefit of those not already familiar with the concept, what is meant by ‘Impact” and “Impact Investing”. Impact Investing refers to investments made with the intention of generating a measurable, beneficial, social or environmental impact alongside a financial return. Impact, in a Responsible Investing context, means the effect that an investment portfolio has on the environment or on society. For example, investing in a healthcare facility is expected to have a positive impact on the health of the community in which it operates. The Difficulties of Measuring Impact Measuring that Impact is, however, often exceptionally difficult. It is, for example, clear that a company improving food safety is generating a beneficial social impact – preventing death and illness – but how material is that impact relative to the size of an investment in that firm and/or to the size of the total investment portfolio? This is an issue that has been exercising investors’ minds for some time. Some companies (an increasing number) do try to report on their own Impact. This is a welcome trend and investors and stakeholders of all kinds should encourage this development.
However, many companies still do not even attempt to report on the Impact of their operation, and for the companies that do report, it has been nigh impossible to compare the results with those reported by other firms. It is very rare to find any two companies measuring their Impact in the same way. Data suppliers have recognised this gap and are beginning to provide investors (and asset owners) with reports on the extent to which investment portfolios are aligned with the SDGs. But to date, this has not been fully satisfactory. Data does not seem to be available at the right level of granularity (particularly for smaller companies), and in our opinion this kind of work faces considerable challenges if not carried out by portfolio managers or analysts who know ‘their’ companies extremely well.
The KBI Global Investors Approach* One of our principal goals as an investment firm is to be first to market with value-adding investment themes of the future. 2
In the late 1990s, we were amongst the earliest investors to recognise the inherent source of alpha from investing in companies providing solutions to sustainability challenges related to the provision of food, energy, water and the mitigation of and adaptation to the impacts of climate change. Having identified a compelling clear need for investment in companies providing solutions to the global shortages of clean water and energy, we began by researching and then launching strategies first in Water and Clean Energy in 2000. Building up our team and intellectual capital in these themes, we added a climate change strategy in 2007, a sustainable impact agribusiness (food) strategy in 2008, and a sustainable impact infrastructure strategy in 2017. Our investment process has evolved over almost 20 years since we launched the first strategies to a higher conviction approach which we believe is the best way to capture market inefficiencies and generate alpha in these sectors. 2017 Measurement Initiative In the autumn of 2017 we reached the conclusion that in the absence of any agreed or common approach to Impact reporting, or Impact measurement, we would measure it ourselves, for our Natural Resources equity strategies. We quickly reached two conclusions. The first was that there clearly is no single correct methodology for measuring Impact. No matter what method we or any other investor chooses to measure Impact, it can be challenged on the grounds that it may have flaws and imperfections. But we decided not to let this deter us. Reporting Impact is much too important to wait several years, perhaps, for an agreed industry methodology and databank to emerge. If we can come up with a methodology that we can stand over (while recognising that it may not be perfect, and may certainly evolve over time), we can make a valuable contribution to the Responsible Investing cause. Our second conclusion was that a company-specific approach would not be sufficient for this project. A single company may be engaged in many different types of business activity. One business line of a company might be contributing to the achievement of a particular SDG, another might have no positive impact at all on any SDG, another might also contribute positively, but to a different SDG, while still another might actually be detrimental to the achievement of the SDGs. It would be quite wrong to in some way aggregate or average out these effects and then decide in some arbitrary fashion that the company as a whole was contributing to a particular SDG. Instead we opted to examine each particular business line (business activity) of each company in our portfolios, and firstly determine the amount of revenue accruing to each business activity, and secondly assess the extent to which each activity contributed, or not, to the achievement of each SDG. 3
The Analysis The first part of the analysis – determining the quantity of revenue for each business activity of each company in the portfolio – was a significant piece of work, involving identifying close to 200 different business activities, and the revenues accruing to each. This was relatively straightforward for a small number of companies with only one business line. But for the considerable majority of companies, there were quite a number of different business activities (up to 10 in some cases), and so the work required a very detailed knowledge of the companies in which we invest. This was work that in our view could only be carried out by our portfolio management team, who alone have the required level of detailed knowledge that is required to do this type of extremely detailed analysis. The second part of the analysis was to determine (for each of the almost 200 different types of activity) whether the activity was helping to achieve the SDGs, was neutral to the achievement of the SDGs, or was detrimental to their achievement. Also, where there was a positive or negative impact, it was necessary to allocate that impact to a particular SDG. The graphic indicates the process followed:
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Judgmental Input
The decision on whether an activity was a positive contributor or not was straightforward for some types of activity (e.g. healthcare is clearly positive, coal-powered electricity generation is clearly negative), but required a considerable degree of judgement in some cases. Our firm’s Responsible Investing committee oversaw this process. Below are three examples of several that could be regarded as controversial or debatable: • Should renewable energy generation be determined to positively impact on the achievement of SDG 7 (Affordable and Clean Energy), or SDG 13 (Climate Action)? • Should fertilisers be seen as a negative contributor to SDG 6 (Clean Water) or a positive contributor to SDG 2 (Zero Hunger)? • Should electricity transmission be seen as a positive contributor to SDG 7 (Affordable and Clean Energy), or as being neutral, with no net positive or negative impact? We reached our own judgement on each item, but we are of course well aware that not every investor will fully agree with us on every issue. We don’t claim that our judgements on these issues cannot be questioned and we are happy to discuss our approach with interested investors and others. That said, we should not forget that the vast majority of business activities were not, in our opinion, particularly controversial. So while investors might well disagree with our opinion on a handful of designations, it seems unlikely that this would materially change the general conclusions of our Impact reporting analysis.
Results For the first iteration of this Impact reporting exercise, we analysed our Natural Resources portfolios based on the holdings in those portfolios at the end of December, 2017, using the most recent available data at the time the exercise was carried out during the first quarter of 2018. For our Global Resource Solutions strategy (which is the most representative as it combines our Water, Energy Solutions and Agribusiness holdings), the results are outlined in the graphic on the next page. The analysis showed that a very high 78.5% of revenues were contributing to the achievement of the SDGs. That is a net figure – after deducting the negative contribution number of 1.8%. Looking at the breakdown of that 78%, the SDGs to which the portfolio contributes most are SDG 9 (Infrastructure and Innovation), SDG 6 (Clean Water and Sanitation), SDG 11 (Sustainable Cities), SDG 2 (Zero Hunger) and SDG 7 (Clean Energy).
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It should be remembered that our Natural Resources equity strategies invest in companies providing solutions to the global shortages of clean water, clean energy, and safe food. So we would very much have expected these portfolios to have a high level of Impact, particularly in the areas of energy and climate change, water, and food/hunger. The high level of Impact for SDG 9 (Innovation and Infrastructure) results from the substantial exposure in the strategies to infrastructure and to innovative technologies. In overall terms, therefore, the results are in line with what we expected. However, rather than having an anecdotal sense that investments in these strategies contribute to the achievement of the SDGs, we have been able to quantify this in a replicable and transparent methodology. We will repeat this exercise from time to time and it will of course be interesting to track the quantity of Impact in the different strategies over time. Next Steps The thought leadership on avenues of Impact brought about by the significant body of work and groundswell of support for SDGs helps advance the quantification of Impact from the previous situation of interesting, yet disjointed company-level anecdotes to one which can be more broadly applied at the portfolio level. It is clear that investing in companies providing solutions to the global shortages of clean water, clean energy and safe food creates Impact and equity owners in businesses providing solutions play a key role. 6
We are still diving into the numbers and are open to the evolution of the methodology. We see this methodology as something that can be more broadly applied. In fact, we argue that our methodology would also provide a framework for companies to report their own Impact as well.
- May 2018
*Calculations are based on KBIGI’s own methodology and are not independently verified.
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