The fundamental but avoided question of attribution in impact investing

In the rapidly evolving impact investment field there is an increased focus on adequate impact measurement and management – and justifiably so. However, one fundamental question still is largely avoided: the question of attribution.

Below I explain what is meant by attribution in the impact investment universe, why it is important, why it is so complex (and hence avoided), what aspects should be tackled, and how we could move forward. It is largely based on a study conducted with the DCED and IFC, with the involvement of almost 30 leading impact investors.

What is attribution?

Impact investors make investments that have a dual objective: to generate (i) a financial return as well as (ii) outcomes that are beneficial to environment and society (such as CO2 avoidance, improved health, access to energy). Measuring and reporting on this dual objective should be engrained in the investor’s standard operations. Measuring the financial performance is relatively straightforward, as there are a number of core indicators that can be quantified (e.g. IRR, company financials). Measuring the results on the benefits to society is less straightforward. It involves, strictly speaking, two steps.

The first is measuring all results that have taken place to which the investor contributed through its intervention (e.g. an equity investment combined with informal management advice). In other words, if an investor holds a 10% stake in a pharmacy chain that employs 200 people and makes healthcare more affordable and accessible for 10,000 people, it can state that through its intervention it supports 200 jobs and improves access to healthcare for 10,000 people. This is generally referred to as the contribution approach. This currently is general practice among investors.

However, the contribution approach might as well be considered just the starting point. This single investor is not the only one helping this company to operate and grow. Another 90% of equity capital comes from other investors – and there may again be others that provide loans or advice. An investor could also opt to measure and report the part of the results that can be reasonably linked to its own intervention, while taking into account the inputs of other investors (leaving regulatory or macro-economic factors outside the scope here). This is the attribution approach.

Why is it relevant?

The contribution approach is currently general practice because of its simplicity. At the same time, it probably does not fairly reflect the results that are due to the intervention of this individual investor. In fact, it leads to overclaiming and double counting of results. Just think of the example above. If all investors in the pharmacy chain report back to their capital providers on these same societal benefits, it is as if ten pharmacy chains are supported. In even more simple terms: it is as if you paid for 10% of the ingredients of a pie, as did nine other friends, but all ten at the table claim that whole resulting pie is thanks to them.

What is more, a dollar or euro in the impact investment field may trickle down several layers of investors. This is particularly the case for government donors, development finance institutions or other fund-of-fund investors, who may be two or more layers away from the company receiving the investment. Every layer of investors may report on the same results.

So the attribution approach provides more accurate and hence better insights into the effects of investments and non-financial support. These “net effects” give a clean picture of an investment’s result and avoids double counting with other investors. It also provides improved insight into the efficiency and effectiveness of funding. Knowing this may help steering investments towards maximum effects. And an impact investor can improve accountability towards its capital providers, which may in turn positively influence its fundraising opportunities.

What makes it so complex?

Ok, so why doesn’t every investor follow the attribution approach? Well, that’s because applying attribution in results measurement is complex. The core hurdle concerns the methodology – or rather the absence of a generally accepted one. To date, no standardised methodology has been developed that allows for simple, generally accepted attribution rules. This is not surprising, because there are a number of factors that make results measurement in itself, and attribution in specific, a more complex exercise for impact investors compared to ‘traditional’ development interventions. In impact investment there usually are a number of different investors, who invest different capital volumes through different instruments at different times. Moreover, the portfolio of a fund manager may not always be centred around one single investment focus.

The most recognised approach to attribute results to different investors is through prorating. This concerns a simple calculation based on the share of invested capital divided by total shareholders capital (e.g. 10% share in the pharmacy company means 10% of the results can be attributed to the investor). The simplicity of these prorating is considered both a strength and a weakness: on the one hand it is quantitative and objective (like financial ratios), but on the other hand it omits a number of relevant factors in the equation.

These factors include the investors additionality (the extent to which the input of an investor filled a market gap and/or was a fundamental to the company), the catalytic effect (extent to which the capital itself or any personal efforts of an investor led to additional financing), or non-financial support (various forms of advice and assistance offered to a company such as technical assistance or advice by an experienced Board member). These aspects are complex to integrate in a methodology, as they are not or only partly measurable and need validation from third parties. However, impact investors often see these aspects as an integral part of their intervention.

In addition to the methodology, there are three other hurdles. The first is the lack of formal expectations on attribution in agreements between Limited Partners and fund managers. This creates little incentive for fund managers move from the contribution approach to attributed results. The second is challenges in datacollection. Collecting complete and reliable impact data for attribution is challenging in itself, and becomes even more difficult when there is also (qualitative) input required from third parties such as clients or beneficiaries. The third is limited resources. Whereas ‘traditional’ more traditional donors or NGOs usually have 5-10% of the project budget earmarked for results measurement, monitoring and evaluation, impact fund managers only have their management fee.

How could we move forward?

If the impact investment industry wants to move forward with attribution, there are several steps in the medium term:

• Menu: the development of a menu of approaches that are relevant and applicable to different financial instruments and circumstances;
• Demand: a joint effort by capital providers to stimulate fund managers to report attributed results;
• Resources: recognition that advanced results measurement is resource-intensive and may require increased resources for the fund manager (through technical assistance or the management fee);
• Support: assistance to fund managers in effective and efficient data collection from investee companies.

To progress these issues, an authoritative platform should be the driving force. Potential platforms could be the Global Impact Investors Network (GIIN), World Economic Forum (WEF), DCED or a coalition of IFIs/DFIs. As a concrete next step in the short term, a practical guide on attribution would fill a knowledge gap and provide clarity on the definition, an overview of the rationale, and a deep-dive into (potential) approaches.

Although complex, knowing the “net effect” of investments by means of attribution in results measurement is a next step for results measurement in impact investment. It will improve accuracy and accountability, and ultimately provide a more fair reflection of the environmental or societal ‘bang for the buck’ of an investor.