This page is one of a series that describes the important role of thresholds in impact management:

1. Thresholds and allocations: the role of thresholds in assessing performance on a social or environmental outcome as ‘sustainable or unsustainable’.
2. Sustainability performance classifications: how thresholds are core to assessing performance against existing classification methodologies (the ABC, the EU taxonomy) and how this logic also drives assessment of SDG contribution.
3. Investment classifications: the relevance of classifications for investors, who can combine the asset classification with the contribution they make, to classify the investment and portfolio.

Impact classes

The impact of an investment is a function of:

1. The impact of the asset that the investment supports (assessed as A, B or C), and
2. The contribution that the investor makes to enable the asset (or intermediary investment manager) to achieve that impact.

Together, this information enables the investor to identify the impact class of the asset and portfolio.

1. Classifying an organisation or asset as A, B or C

The overall impact of an organisation is the combination of all its significant positive and negative impacts. Assessing an organisation’s performance on each of its significant impacts enables classification of the entire organisation. Investors may carry out this classification to understand which of their assets are meeting their impact objectives.1

Practitioners identified the following logic for classification which enables consistent application of the ABC categories:

• All organisations should at a minimum be Acting to reduce harm (A’s) for all significant negative impacts. Organisations causing significant negative impacts that are not improving are classified as Does cause harm. Until performance on that outcome improves (becoming an ‘A’) the organisation cannot be classified as A, B or C overall.
• Organisations with at least one Benefit stakeholders impact are classified ‘B’ overall if all other significant negative impacts are ‘A’s’.
• Organisations with at least one Contribute to solutions impact are classified ‘C’ overall if all other significant negative impacts are at least ‘A’s’.

Figure 1: Classifying the impact of a whole organisation

Examples

An Act to avoid harm organisation:
A clothing company that historically paid employees at or below minimum wage and had instances of human rights abuse in its supply chain. Its operations were inefficient and carbon intensive versus peers. Two years ago, the company made a commitment to clean up its act. Since then, the company has reported meaningful increases in workforce salary and it is on its way to becoming a living wage employer. Management have taken responsibility for eradicating human rights abuses across all business relationships. This initiative is not yet complete but there has been a marked improvement year-on-year. The company has set targets to reduce its carbon emissions and has made substantial investments in new carbon efficient technologies across its manufacturing plants.

A Benefit stakeholders organisation:
A carpet manufacturer that produces carpet tiles through use of environmentally friendly materials and production methods. Through various initiatives, the company has achieved net-zero carbon emissions across its operations. It is celebrated as a leading employer in terms of workforce diversity and well-being. It is the buyer and seller of choice in its industry because of its fair practices.

A Contribute to solutions organisation:
A soap company that manufactures a range of personal hygiene products from natural ingredients. All ingredients are naturally occurring and ethically sourced. Aside from the quality of its products and service, the company’s focus is on providing quality employment and training to those who otherwise find it difficult to secure a job. Over 90% of the employees are either previously long-term employed or registered as disabled.

2. Investor contribution

Investors commonly describe four strategies – or actions – by which they can contribute to the impact of the assets they invest in. These strategies can be used individually or in combination. They represent roles that investors may choose to play in the market, depending on their financial and impact goals, opportunities and constraints.

These strategies are the most common forms of investor contribution observable in the market, but not all investors will be able to implement all of them and it is not normative that all investors should try to do so. Not all investor contribution is positive. Investors themselves – separately from the enterprises they finance – may engage in practices that result in social and/or environmental harm, and amplify systemic risks.

Four common strategies

• Signal that impact matters: investors employ this strategy when they proactively and systematically consider measurable positive and negative impacts of assets as part of their investment decision-making processes, and communicate this consideration to assets and the market at-large. These considerations should affect the investment decision, meaning that impact considerations could lead to a different investment decision. If all investors implemented ‘signalling’ strategies, it would ultimately lead to a ‘pricing in’ of social and environmental effects by the capital markets. Often referred to as values alignment, this strategy expresses the investors’ values and is an important baseline. But alone, it is not likely to advance progress on societal issues when compared to other forms of contribution.
• Engage actively: investors may go beyond Signalling that impact matters to proactively support or advocate for assets to reduce negative and increase positive impacts. This might involve, for example, filing a shareholder resolution, joining the board, providing consulting or mentoring, or participating in industry-level or regulatory efforts to promote considerations of sustainability in financial markets. Investors that are engaging actively typically have a systematic process for selecting assets with which to engage, a well thought-through engagement strategy, and a rationale for why the chosen strategy is expected to affect the impact of the asset.
• Grow new or undersupplied capital markets: investors can anchor or participate in new or previously overlooked opportunities. This may involve more complex or less liquid investments, or investments in which some perceive risk to be disproportionate to return. Investments directly cause or are expected to cause:
  • a change in the amount, cost or terms of capital available to an asset that enables it to deliver impact that would likely not otherwise occur; or
  • a change in the price of the asset’s securities, which in turn pressures the enterprise to improve its impact and/or rewards it for doing so.
• Provide flexibility on risk adjusted financial return: a sub-set of investors who are Growing a new or undersupplied capital markets will be able to accept a lower financial return than they could obtain in investments with similar risk, liquidity, subordination, size, and other financial characteristics (or, equivalently, accepting the same financial return but with more risk, less liquidity, etc) in order to generate certain kinds of impact. E.g. a cross-subsidisation business model that enables access to a critical product or service to an underserved portion of the population.

The use case of impact classes

To align their portfolios with their intentions, all investors need to be able to understand the impacts of the assets or investment products/funds available to them. In addition, the intermediary investment managers and the assets seeking investment want to identify aligned investors and avoid being compared inappropriately to assets with different impact intentions, or avoid being judged on just financial performance alone.

Impact classes group investments with similar impact characteristics based on their impact performance data (or, in the case of new investments, their impact objectives). Impact classes bring together the impact performance (or objectives) of the assets being invested in (x-axis) and the strategies that the investor uses to contribute to that impact (y-axis). They can be used to define boundaries within which comparisons of impact performance are likely to be possible and sensible.

Impact classes are not intended as a replacement for progress towards a global performance measurement standard that could enable the impact of individual investments to be compared. Instead, impact classes offer an immediate and complementary solution for differentiating the type of impact that investments have, even when very different measurement approaches are used. 

The matrix below illustrates the range of impact classes currently identified in the market. Much like financial asset classes, these impact classes – represented by each box on this matrix – are an equivalent shorthand for conveying whether the impact characteristics of an investment opportunity match an investor’s impact intentions and constraints.

Figure 2: Matrix of impact classes

Classifying a portfolio by impact class

An investor who has articulated their impact goals using the ABC and has chosen its investor contribution strategies can then look to construct a portfolio, or adjust an existing one, to match these goals.

Assigning each underlying asset to an impact class, and then calculating the present value of assets under management (AUM) in each of these categories, provides an investor with a view of the portfolio’s allocation to different types of impact. This analysis can be repeated across many levels of intermediation.

For example, a large asset owner that invests through a mixture of investment products including direct equity, funds, and fund-of-funds etc. can aggregate the impact class allocation to the multi-asset portfolio level, as shown below. It can use this analysis to inform future asset allocation decisions.

Figure 3: Classifying a portfolio by impact class

Not shown in this diagram is how the investor contribution strategies might be aggregated at each level as there is as yet no guidance on this practice. However, investors in investment products/funds are increasingly considering investor contribution at each link in the investment chain – both:

• Their own investor contribution to the asset managers with whom they invest; and
• The investor contribution of those asset managers to the underlying assets.