Is my money helping solve the world’s problems or making them worse? An increasing number of the beneficiaries of public funds, globally, are asking such searching questions about where and how their retirement funds are invested. Retail investors already have a great deal of transparency into the financial characteristics of their retirement plans due to regulation. But understanding how investments have an impact on societal issues can be much more complex and difficult to identify for institutional investors.
We propose a systematic framework that institutions can use to 1) evaluate and communicate their portfolio’s net societal (or external) impact and 2) address any gaps they identify.
SDGS TAKE CENTER-STAGE
Many institutional investors we work with have stated a preference to see their portfolio’s net external impact (positive minus negative) as a holistic picture that accounts for the different ways that individual portfolio companies can have positive or negative impacts. They increasingly want to see this for each of the 17 UN Sustainable Development Goals (SDGs).1
The SDGs define the goalposts for delivering global sustainable development by 2030. They address a wide range of interrelated problems ranging from poverty to gender inequality to climate change. The world is full of problems that need solutions, and institutional investors often cannot easily assess the opportunity cost of the contributions to solving one problem against another. As a starting point, they may need to see how companies and portfolios stack up against each one, in order to consider their impact on the particular SDGs that their specific institution is seeking to prioritize.
MEASURING NET EXTERNAL IMPACT
We believe that a framework to measure net external impact should incorporate the following four elements:
- Products and services with positive impacts
- Products and services with negative impacts
- Operational conduct with positive impacts
- Operational conduct with negative impacts
This kind of analysis would be done for each of the 17 SDGs, and, in turn, allow for the fact that different types of companies may be able to contribute to the goals in different ways. Each company held up to a specific SDG would then fall somewhere along a spectrum ranging from most aligned to neutral to most misaligned, depending on what the company does and how it does it.
The exhibit below illustrates how MSCI ESG Research used this approach to calculate a net external impact for each constituent company in a portfolio that tracks the MSCI ACWI Index. While most companies fell into the middle range on most goals, there were outliers in virtually every case.
For example, with a business built on renewable energy, Vestas Wind Systems is highly aligned with SDG 7 (Affordable and Clean Energy) and SDG 13 (Climate Action), though it is neutral relative to many other SDGs. In contrast, while Altria Group Inc.’s water management record makes for reasonable alignment with SDG 6 (Clean Water and Sanitation), with nearly all its revenue derived from tobacco, it is inherently highly misaligned with SDG 3 (Good Health and Well-being).
SDG ALIGNMENT DISTRIBUTION OF THE MSCI ACWI INDEX
Data as of May 8, 2018.
ADDRESSING SDG GAPS
For many institutions, a snapshot measurement of their portfolio’s net external impact could be the first step towards making investment decisions that could be more aligned with the SDGs. This is an important consideration for some institutions, as there is an estimated annual funding gap of USD 2.5 trillion, to achieve targets set out in the SDGs by 2030. Publicly traded companies that contribute to the SDG goals – through their products, direct investments or operations – could help close this gap. Accordingly, the United Nations and other development agencies see a role for institutional investors in helping direct more capital, through their public equity holdings, toward the achievement of the SDGs objectives.
Proposed framework for addressing SDG challenges in portfolios
- Reduce negative impact by shifting capital away from business activities, strategy and operational involvement not aligned with achieving the SDGs
- Increase positive impact by shifting capital towards companies that provide products & services that serve needs defined by the SDGs
- Promote improvement by shifting capital toward companies that improve operations, develop long-term & forward-looking strategy, and report on progress
The Organisation for Economic Cooperation and Development (OECD), for example, has embarked on an ongoing initiative in partnership with MSCI to explore options for supporting institutional investors seeking to direct larger scale investments towards the SDGs. A Senior Advisory Group convened by our two organizations met in Paris in early November for a first round of discussions.
RISING TO THE CHALLENGE
There is little doubt that measuring and augmenting a company or portfolio’s contribution to achieving SDGs is challenging. Companies and investors that are committed to doing so typically must deliver on their financial objectives while demonstrating that the way they achieve these financial returns can also create collateral benefits for society. This is a tall order.
We believe that an important first step is having a systematic framework that considers both positive and negative impacts. This approach would allow public funds to offer greater transparency on not only the risk and return of their portfolio performance, but also the increasingly important third dimension of “impact.” With this information in hand, they can begin the work necessary to better align portfolios with the SDGs.
The author thanks Gaurav Trivedi for his contribution to this post.
2 United Nations Conference on Trade and Development (UNCTAD). (2014). “World Investment Report 2014 Investing in the SDGs: An Action Plan.” United Nations.