In a financial landscape where ESG has become a contentious term, fraught with political implications, the need for objective metrics and a clear demarcation from political discourse is ever more critical. Natasha Franks, the head of Client Reporting at Alpha Associates, developed an internal impact monitoring tool, and during our conversation in Vienna at Zero One Hundred Conferences, she delved into this complex topic, highlighting the challenges and potential solutions to depoliticise ESG and realign it with its core objective of risk mitigation and value creation.
Depoliticizing ESG: The Empirical Approach
“ESG has undeniably been entangled in political debates, detracting from its foundational role as a risk mitigation tool,” Franks observes. She advocates for a pragmatic approach, emphasising empirical evidence that demonstrates the direct correlation between robust ESG practices and superior financial performance. “ESG has certainly been politicised, particularly in the US, where it is often reduced to a partisan debate that overshadows its initial use case as a risk mitigation system. The EU is not immune to this sentiment, although the bloc has been able to enact numerous regulations aimed at improving transparency and standardisation in the private sector. It can be difficult as a manager to navigate the complexity of these evolving regulations, which run the risk of reducing ESG to a series of boxes to be ticked. On a day-to-day basis, we need to remember that ESG should be embedded into our investment value creation toolbox. By grounding the conversation in empirical evidence that highlights the correlation between strong ESG practices and enhanced financial performance, we can help depoliticize ESG, spotlighting its importance in any well-performing investment portfolio” she asserts.
Navigating SFDR: From Constraints to Clarity
The European Union’s Sustainable Finance Disclosure Regulation (SFDR) Article 8 and 9 classifications, intended to foster transparency, have inadvertently stifled market dynamism, according to Franks. “A fundamental issue with the current iteration of SFDR lies in the market’s interpretation of it as an ESG ranking system, rather than a disclosure regime. This false sense of security might cause LPs to limit their due diligence to box-ticking an SFDR classification during their selection process, at the expense of conducting a thorough analysis of a manager’s ESG and Impact capabilities. It’s critical for LPs to vet all investments with equal rigour from a sustainability perspective. Equally, it’s critical for managers to implement robust monitoring practices that go beyond just adhering to the minimum SFDR requirements. Our impact monitoring tool seeks to do exactly that – remove the subjective noise, and just focus on the quality of the data.” she explains. Franks calls for a reevaluation of these classifications to encourage a more nuanced understanding and application, enhancing both market fluidity and the depth of ESG assessment.
The Private Markets Conundrum: Transparency and Data Challenges
Contrary to the perception of opacity, Franks posits that private markets offer a unique transparency advantage, facilitated by the direct data flow between Limited Partners (LPs) and General Partners (GPs). “We prioritise the implementation of robust, efficient systems that can withstand the test of time, rather than focusing on the appearance of a short-term image boost. In terms of trends, we find that investors in the private markets are increasingly requesting more detailed sustainability data on their investments. This growing investor demand is a major driver to improving transparency, as investment managers seek to gather data that has the most relevance for their investors. Combined with regulatory developments, we’re seeing a greater availability of data provided by fund managers; however, there is still a way to go to achieve standardisation of methodologies and benchmarks, particularly across geographies and asset classes.” she notes. This scarcity is further exacerbated by greenwashing risks, which the private markets are strategically positioned to mitigate through their long-term investment horizons and emphasis on substantive, rather than superficial, impact.
Leveraging Technology for ESG Evolution
Alpha Associate has harnessed technology to refine its ESG processes significantly and Natasha Franks played a key role by creating and developing their tool. “Over the past few years, we’ve transitioned from basic email requests to using customised software to collect data, allowing managers to input their metrics in a simple, standardised format. To assess and analyse this data, we use our own in-house methodologies. Our ESG data is validated through an algorithm that processes the data and converts it to a single aggregated percentage score, which allows us to standardise the ESG performance of our entire portfolio and internally benchmark our investments against each other. ” Franks highlights. This technological pivot is instrumental in evolving Alpha’s ESG framework, enabling a more dynamic and responsive approach to sustainability assessment.
The Potential of Machine Learning in Impact Measurement
Machine learning (ML) offers a promising avenue for advancing impact measurement, with its ability to digest complex data sets and uncover non-linear relationships. Natasha Franks is optimistic about ML’s role in impact assessment, albeit with a caveat regarding inherent biases. “While ML can streamline and potentially de-bias impact analysis, the human element in model creation introduces an unavoidable subjective layer,” she acknowledges and adds: “That said, there will always be some level of bias inherent in modelling, because these models do need to be created by us, i.e. the human. This can actually benefit the process of analysing impact, as models can be trained to overweight the importance of the impact goals of a specific investor or manager. This allows us to isolate the specific drivers behind our targeted impact goals and optimise our portfolio to achieve our targets.” Considering this, she envisions ML as a critical tool in isolating and optimising impact drivers within investment portfolios.
Transparency and Technology: Twin Pillars of Impact Management
For Franks, transparency is not merely a regulatory requirement but a fundamental principle underpinning the GP-LP relationship. “Our impact monitoring tool exemplifies this philosophy, offering a transparent, data-driven view of our impact initiatives, thereby reinforcing accountability and investor confidence,” she states. This tool, powered by technology, has been pivotal in quantifying and communicating the tangible impacts of Alpha’s investments, marking a significant advancement in impact reporting. “Transparency is a fundamental duty of a GP towards its LPs. As a fund-of-funds manager, we can understand this dynamic from both perspectives: We seek detailed reporting from our managers in our capacity as an LP, and simultaneously fulfil these transparency obligations to our investors as a GP. Our impact monitoring tool is designed to facilitate this feedback loop. It processes and verifies data from our managers, tracking the impact performance of our investments from inception. This enables us not only to quantify the tangible impact generated by our portfolio, but also to visualise this impact and communicate it effectively to our investors” she comments and concludes: “We find that investors are increasingly interested in seeing “under the hood” of impact, rather than just the final result, and we seek to programme our tool to accommodate this desire”.
Bridging Impact and Financial Performance
Addressing the confluence of impact success and financial returns, Natasha Franks advocates for a holistic view where the two are inextricably linked. “A successful impact investment inherently presupposes financial viability; the two dimensions are complementary, not contradictory,” she clarifies. This perspective challenges the conventional dichotomy between financial returns and impact, suggesting a more integrated approach to investment assessment. “A key distinction with impact lies in its bespoke nature. Unlike financial multiples such as EV/EBTIDA, which can be universally applied across mature companies, impact metrics require customisation for each entity. Moreover, the full extent of an impact investment’s success often transcends what we can measure, given its long-term and far-reaching effects. For example, consider an online education company that enables a stay-at-home parent to earn a degree, which can be leveraged for a high-paying job. This job can then finance their child’s education at a top university, which cascades into greater opportunities for the child in the future. This is “impact” to a degree that we could not adequately capture in our lifetime” she concludes.
Envisioning a Future of Tech-Driven Impact
Franks is a fervent believer in technology’s role in amplifying impact investing, arguing for a broader conceptualisation of impact beyond the narrow confines of ESG. “Technology, particularly AI, can significantly enhance our understanding and measurement of impact, transcending traditional ESG parameters to encompass a wider spectrum of societal and environmental contributions,” she concludes. This vision for a tech-enhanced impact investing landscape promises not only greater efficiency and precision but also a deeper, more nuanced appreciation of the myriad ways investments can contribute to a sustainable future.
As we stand at the crossroads of impact and financial gain, the true measure of investment success is being redefined. The critical role of technology in this shift cannot be overstated, offering a lens through which the full spectrum of an investment’s impact is brought into focus. This evolution challenges us to think critically about what we value in our investments, pushing beyond traditional financial metrics to embrace a broader, more impactful vision of success.
