Engagement and investor additionality in impact investing

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What is ‘additionality’?

The concept of 'additionality' gets to the heart of the central purpose of impact investing – using capital to tackle challenges in a way that it isn’t currently used, or tackling problems that aren’t currently being addressed. It refers to the contribution made by an investor or a company in tackling a societal challenge, where the positive outcome would not be achieved without that contribution (i.e. without the investor's role or the actions of the enterprise).

The topic is rising up the agenda, supported by recent regulatory developments, such as the FCA's Sustainability Disclosure Requirements in the UK. These emphasise that investor contribution needs to be central to how a fund's impact is articulated, while the additionality of the underlying investment as a 'solution provider' is also important.

In thinking about investor additionality, two primary aspects are usually considered:

• Financial additionality: the impact is generated by financing a project or activity which would not have occurred without the allocation of capital
• Non-financial additionality (e.g. via engagement): the impact is driven by the investor's activities in contributing to the positive outcome (beyond simply investing in the company)

For public market impact funds investing in listed equities, which generally deal in secondary markets where the direct funding of a project is not usually possible, investor additionality tends to centre on the role we can play in supporting, enabling or challenging the company on the overall impact it can generate. It should be repeated that we also focus on the additionality of the underlying company in tackling an under-addressed challenge or supporting under-served groups or regions. After all, how a company allocates its own significant capital can be an excellent driver of additionality. We believe the combination of the two aspects can be especially powerful.

For every investment in our public equity impact funds, we lay out an impact thesis or ‘Theory of Change’, which sets out how the investment is tackling a specific societal challenge. This potential positive impact is primarily driven by the company’s products and services, but we increasingly believe that investor contribution can play a role in achieving the impact, for example, through impact engagement (see below).

The role of impact engagements

Multiple parties, including the Global Impact Investing Network and Impact Frontiers (previously the Impact Management Platform), highlight that engagement is not just an important part of impact investors’ toolkit, but a necessary demonstration of investor additionality.

Impact engagements differ from more generic ESG engagements. They focus on supporting or challenging the company to protect or increase its primary positive impact. These engagements can cover a variety of topics, but may involve pushing companies to set more ambitious targets for the impact achieved, supporting it to allocate capital more actively to impactful activities, or encouraging it to report more clearly on its potential positive impact. 

Within M&G’s public equity impact fund range, impact engagements may form part of our approach to ‘net impact’ or ‘impact balance’. This usually involves identifying impact risks or actual negative impacts, and working to manage or improve these. For example, a company’s products may help to improve the energy efficiency of buildings, and therefore reduce emissions, but these are somewhat offset by the operational emissions from developing the products. In this case, the engagements will focus on the company improving efficiencies and reducing the emissions from its manufacturing processes, hence improving its overall footprint, or 'net impact'. Our impact engagements may also focus on linking executive remuneration to impactful outcomes (see below).

In all cases, impact engagements focus on how investors can support the achievement of the company's core positive impact, rather than on aspects that are peripheral to its business. Again, they go further than ESG-orientated engagements, which may focus on aspects such as principles and processes, and issues such as board diversity or cyber security. However, we should note that these issues are important in their own right, and ESG engagements remain a key aspect of our role as sustainable investors.

Engagement programme: driving impact via incentives

Within M&G’s public equity impact fund range, we are implementing an impact engagement programme focused on improving impact measurability, developing more robust KPIs to directly measure each company’s impact, and linking executive remuneration to these KPIs.

The linking of compensation to impact helps to evidence how intentional or purposeful a company is, as reflected through its governance structures. This is one of the three pillars of our core ‘Triple I’ framework for assessing whether a company is eligible for investment in the funds. Linking remuneration to impactful outcomes also gives us confidence that the company will continue to prioritise and expand its positive impact, rather than potentially diverting its activities elsewhere.

Furthermore, if there is a structural alignment between the company’s core business and the positive impact it generates, the company can reinvest the returns it generates directly into activities that produce further positive impact. We call this ‘double compounding’ – the potential for simultaneous growth of both financial returns and impact. This alignment is a feature of what we consider to be ideal impact companies.

Identifying companies for engagement

When identifying companies for this type of engagement, we consider how we can ‘move the dial’ and make a notable difference to the impact being targeted. We consider both the existence of impact-related metrics in the current compensation plan, and how material the impact is to the company’s core business – usually measured by the proportion of company revenues generated by impactful activities.

To visualise this, we can then map investee companies on a quadrant graph (see example below) based on these two factors. Companies sitting in the ‘D’ quadrant are our highest priorities for impact engagements.

These companies will have a small or non-existent link between executive compensation and impact delivery, alongside a materiality that is below where it could be. In such cases, engagement can be a powerful tool for increasing the scale of impact, or the likelihood that the core impact objective is achieved. Specifically, by encouraging greater alignment between impact and executive compensation, increasing the ‘intentionality’ of the impact and reducing the possibility that the business deprioritises the impactful activities to focus on other areas.

However, it is important to note that we will still engage with companies in other quadrants where we see the opportunity to support impactful outcomes, and our engagement efforts are not limited to the topic of executive remuneration.

Example engagements

Safaricom

As part of a wider discussion with Kenyan telecommunications company Safaricom, we encouraged the development of enhanced metrics to help us better measure the positive societal impacts the company is delivering; i.e. quantification of how use of products leads to better life outcomes for customers. The company was very receptive to the idea of enhanced metrics, and confirmed that there were additional areas it could consider quantifying that had not yet gone into its own impact reporting. We subsequently held a separate meeting with the company's head of sustainability to discuss the potential here, and encouraged annually updated social return figures, to which the company was receptive.

Bank Rakyat Indonesia

We made a similar request to Indonesian financial institution Bank Rakyat Indonesia, particularly considering a social inclusion metric (related to, for example, micro loan provision), and for that measurement to form a specific KPI against which remuneration can be linked. The company confirmed that it was currently undertaking research to fully understand the social impacts it was delivering, and planned to publish this in a report in 2024. To support this, the company asked us to share best practice on impact reporting and minimum standards. We subsequently sent through case studies, including examples of best practice in linking impact KPIs to remuneration, which it would take under consideration. We will contact the company on this topic once the initial report is published. 

In conclusion

Additionality is a core tenet of impact investing, which is rising up the agenda. While the additionality of investee companies’ products or services is important, public equity impact investors are increasingly expected to demonstrate their own additionality, via impact engagements. By supporting companies’ impactful ventures in this way, investors can also contribute towards the ultimate aim of tackling the world’s most pressing social and environmental challenges.

The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.