Carbon Equity's Impact investing Approach

What is impact investing?

When we talk about impact investing we mean ‘investments made with the intention to generate positive, measurable, social and environmental impact together with a financial return’. Impact investing is premised on three ideas:

Intentionality refers to an investor having the intention to have a positive social or environmental impact with its investments. Why is this important? Because when an investor only starts to think about impact post-investment, its impact is likely to be only incremental. If you invest in a random company you can still help it reduce its GHG (greenhouse gas) footprint, but the impact is likely to be limited. In contrast, first deciding what you want to achieve (e.g. reducing GHG emissions) and designing your investment strategy to meet this objective (e.g. analyzing what the biggest problems are and searching companies that help solve those) is likely to have much better results.

Additionality is about doing something for the world that would not have happened without your specific action. In investing this means that had the investor not made a particular investment, a certain impact would not have happened. An investor can be additional by investing in areas that are generally underfunded. Also, an investor can be additional in how it supports portfolio companies, either by helping them scale better than another investor would have, or by helping a company above and beyond in further improving the impact of its products. Because additionality is a very difficult thing to prove, some investors prefer to talk about contribution rather than additionality.

In impact investing, being able to measure and report the GHG impact of investments is paramount. For a couple of reasons. By measuring the impact an investment has, the investor increases its transparency and accountability. Even more importantly, data can improve decision making. For one, by measuring the GHG impact of a company and its products, an investor can identify further improvement areas. A plant-based burger for example may be produced with soy that has a large GHG footprint. Data also allows for comparing the realized to the intended impact, which creates a feedback loop from which the investor can learn and improve future investment decisions.

So how does carbon equity go about investing in impact?
At Carbon Equity, impact is integrated throughout the investment process. That means that from searching for investment opportunities, to assessing and selecting them, managing them and reporting on them, impact considerations are taken into account just as thoroughly as financial ones.

Deal search: Impact investors

Carbon Equity believes intentionality is key to getting impact investing right. Sure, any investor can have some GHG impact by investing in random companies and helping them reduce their emissions, but Big Impact (which we need to get to net-zero) can only be achieved by being very intentional about what you think the world needs and translating that into an investment strategy. Hence we actively search for funds that position themselves as impact or decarbonization funds, e.g. that claim to invest with the goal of reducing GHG emissions and halting climate change. Carbon Equity has done a full market scan through which it has identified 700+ impact private market funds, and continues to add to this list on a weekly basis through referral, media and impact investing networks.

Screening: proof of intentionality

Because Carbon Equity believes intentionality is key, we assess whether a fund has a solid underpinning of its intention to realize GHG reduction impact through its investments early on in the process. During the ‘quick scan’, the first assessment of a fund based on its pitch deck and an initial conversation with the fund managers, we assess whether the fund has any of the below five proofs of intentionality. A fund needs to have at least one, and preferably multiple, to continue on to the next phase.

  • Impact mandate: does the fund have a strong and clearly defined formalised climate impact ambition? E.g. does it promise to focus 100% of its investments on decarbonization?
  • Impact goal: does the fund commit to an absolute target of how much GHG emissions its investments will avoid or reduce?
  • Impact sourcing: does the fund have a problem-based sourcing strategy, and focus on finding companies tackling specific and specifically tricky GHG emission challenges (e.g. concrete)?
  • Impact incentives: are the fund managers rewarded for impact next to financial returns (through carry or bonus structure)?
  • Impact threshold: has the fund defined the minimum GHG impact each investment should have in order for the fund to invest?

Impact analysis: impact scorecard

If a fund has sufficient proof of intentionality (and is also sufficiently attractive from a general diligence perspective) Carbon Equity continues with a full impact diligence. We do this with our proprietary impact scorecard, where we look in much more detail into the fund’s intentionality, as well as its additionality and impact measurement. For this, we analyze how impact is integrated throughout the entire investment process based on all documents provided by a fund and multiple conversations with the management team. The scorecard focuses on six dimensions:

Investment mandate
An investment mandate is a set of instructions for how an investment manager may invest money for a particular fund. Firstly, we look at how committed the fund manager is to impact investing and getting to net-zero, for example by having joined net-zero initiatives and being active in the impact investing community.  This is important because as best practices on impact investing are still rapidly developing, we want the fund manager to continue to be informed of new developments. Secondly, we look at what a fund commits to in legal documentation. Does it state to focus its investments on decarbonization? And do the investment focus areas, incentives structure, legal (SFDR) status and partners (LPs, co-investors) align with these goals?

Impact organization
In order to be able to make the right investment decisions, a fund team needs to have sufficient knowledge of the overall decarbonization challenge, as well as what it will take to get its focus areas to net-zero GHG emissions, so this is something that we assess. Additionally, we look at whether the fund has the right experts in its network, and engage these experts on deals, to ensure that they are able to pick the winning technologies of all the innovations out there. We also look at how impact is formally structured within the fund team: does the head of impact have a role on the investment committee, e.g. have influence over the investment decisions made? And do the people leading the impact and general due diligence of deals work together well, in order for them to integrate both types of information into one consistent investment advice?

Investment selection
Does a fund have a solid approach for searching for and selecting impactful investments? At Carbon Equity we believe that this is one of the most crucial aspects of impact investing. Specifically, we assess whether the fund has defined what problems it wants to solve (e.g. GHG emissions from concrete) and actively searches for companies that have technologies to do so. We also look at whether a fund quantifies the impact potential of an investment, e.g. what is the GHG reduction potential of a company on the longer-term? This is especially important in venture capital and growth equity, as most of the impact of a company will come in the future. Lastly, we assess whether a fund has a consistent and high-quality approach of integrating the impact information in the actual investment decision, for example by having defined a ‘materiality threshold, e.g. the minimum impact potential a company needs to have.

Impact management
Having made the investment, how much does a fund motivate and support a company to scale its impact? We assess this by looking at whether the fund sets impact targets for portfolio companies and monitor these targets well. Just as importantly, we analyze the ‘impact creation’ approach of the fund manager, e.g. the depth of the support a fund manager offers to portfolio companies to help them improve their impact further. We look at two types of impact: does the fund manager actively support the impact performance of a company’s product, e.g. by doing an LCA (life cycle analysis) to fully understand its GHG impact and further improvement areas. We also look at the depth of support a fund offers to help companies grow, and scaling impact in its process.

Impact reporting
Does the fund report transparently and in detail on its GHG impact, and its contribution towards achieving this impact? And on the expected future GHG impact of the portfolio, as well as on realized impact? We think that it is important that a fund is transparent on these things in order to know for certain that it collects and monitors this information, as well as to see if the proof is in the pudding.

In most of the impact scorecard, Carbon Equity’s analysis is focused on the policies and commitments a fund makes to investors on its future actions. After all, funds have to raise money before they can invest it. However, we do look for any kind of proof we can find that they will put their money where their mouth is. A fund can show evidence in the form of the portfolio of a previous fund, or by having made some first investments with money from a first close or that they have borrowed from the partnership. We assess how exciting we believe these investments will be from a decarbonization perspective. Additionally, we assign a score to how convinced we are of the motivation of the fund manager to substantially contribute to the decarbonization challenge.

Investment management

Once Carbon Equity has made an investment in a fund, we actively support funds improving their impact approach. So far, all the funds we have invested in are eager to improve their score on our scorecard. They tell us: “We want to get our score to a 4, how do we do that?” As we see this as one of our core additionalities, we actively engage and support funds in getting there, by having conversations, sharing best practices and connecting them to others in the field. As we believe that a better impact approach will lead to better outcomes, we believe that this is one of the ways we are accelerating the global decarbonization of our economy.