Why financial analysis has been wrong for 100 years or more

Channels: ESG, IMPACT

People: Chris Wigley

As well as risk and return, impact should be taken into consideration, argues Christopher J Wigley

Anyone who has completed the CFA course will be familiar with the classic approach to asset allocation, security selection, efficient frontiers, etc. I would like to contend that this approach, in itself, is wrong, in that it misses something very important.

In the past, investment has focused on risk and return. Consequently, in financial analysis it was easy to set up classic graphs as follows:

Not the whole story

Financial analysts and portfolio managers alike would be seeking the highest historical or expected return for the lowest amount of historical or calculated risk.

However, I would like to contend that such analysis misses an important dimension, that of impact. Every investment has environmental and social impact. Consequently, analysis rather than being two dimensional, should be 3D. Therefore, an analytical graph should look like this:

This is important, as it informs analysis. Analysts and portfolio managers working in Responsible Investment, unlike traditional analysts and portfolio managers, naturally wish to anticipate and quantify the environmental and social impact of their investments.

Positive, negative and net impact

Before developing this further, it is useful to examine impact a little further. An investment doesn't simply have an impact. It has both positive impact, negative impact and net impact.

Take for example, a wind farm. It has a positive impact in terms of clean energy generation, but also a negative impact in terms of construction emissions, decommissioning emissions, etc.

Consequently, relevant graphs for a green project may look like the following. With financial risk and return unchanged, the graphs depict the degree of impact:


This analysis may be helpful to analysts and portfolio managers seeking the highest possible net impact for the same risk and return as mainstream investments.

Green, Social and Sustainability Bonds (GSS bonds) are particularly helpful in this analysis, as GSS bonds disclose the use of proceeds, so facilitating easier impact analysis.

Specific and aggregate impacts

Naturally, more than one impact may be applicable to one potential investment. Therefore, separate analysis needs to be made for each impact. For example, a new building may have positive impacts in energy savings and water savings.

However, the two positive impacts cannot be added together as they are different in nature. Consequently, with aggregate impacts, it is normally only possible to come to a qualitative judgement of the total positive, negative and net impacts. This is a specialist skill of a Responsible Investment analyst.

The aggregation of numerous different impacts also makes the monetisation of impact extremely difficult.
Social impact

The above example outlines the environmental impact of a security, but it is equally applicable to social investments. For example, healthcare. A hospital, for example, may offer high quality facilities such as a high number of intensive care beds, which is very valuable in times of pandemics. This would be a positive impact. However, a high cost of healthcare may well limit access to healthcare, and this would be a negative impact.

Again, for the investor, what is important initially is the net impact of the investment with the same risk and return of a 'mainstream' investment. However, the question arises as to what to do with net environmental and social impact.

Environmental and social

Naturally, projects will have both environmental and social impacts. Additionally, these different impacts may appear to be in conflict. A coal mine may have negative environmental impacts but may also have positive social impacts in terms of employment, for example.

Clearly, there are multiple net environmental and net social impacts to consider. This is the real world, and all impacts need to be considered and a qualitative judgement initially formed.

Impact is dynamic

Please note also that impact is not static. A 3D graphical depiction, hopefully, highlights this. Each axis is a sliding scale. Of course, we know that risk and return are variable. However, impact is variable too.

First, impact is nuanced. That is, it occurs at degrees – projects are rarely identical. A 3D graph illustrates this. The impact can be anywhere along the impact axes. Secondly, impact can change over time – a project may be either improving or declining. Again a 3D graph can also illustrate this.

Significant Harm

This approach has other implications also. For example, is there such a thing as Significant Harm (SH)? Well, clearly there is negative impact. Most likely Significant Harm would be the same as high negative impact.

However, the problem with Significant Harm and with Do No Significant Harm (DNSH) is that, as such they are seen as static. Significant Harm would sit at an extreme end of a 3D risk-return-impact graph. However, as the graph implies, negative and positive impacts are dynamic.

This approach captures an impact that is active in varying degrees and over time. This 3D image of investments capture this while a static concept of DNSH does not.


One point to note at this point on ESG, is that impacts are said to be environmental and social. In ESG, governance is important but may not be considered an impact but rather a controller and enabler of impacts.

Measuring impact

So, what of impact? How does an analyst or portfolio manager quantify them? There are various sources of impact metrics available. It is possible to look at:

  1. Science Based Targets Initiative (SBTi)
  2. Green Bond Principles – Harmonised Framework for Impact Reporting
  3. EU Sustainable Finance Disclosures Regulation (SFDR) – Annex 1
  4. The Global Reporting Initiative (GRI)
  5. The Global Impact Investing Network (GIIN), etc

However, to avoid being held back by potential negative implications of large protocols, perhaps it is better to make a fresh start.
Indicative Impact Metrics could be as follows:


  1. Annual Absolute GHG Emissions tCO2
  2. Annual GHG Emissions / enterprise value
  3. Annual GHG Emissions / US$ revenues
  4. Annual Avoided Emissions / enterprise value
  5. Annual renewable energy generation MWh/GWh
  6. Capacity of renewable energy plants constructed or rehabilitated.

Energy efficiency

  1. Annual energy savings in MWh/GWh
  2. Building area of Energy Efficiency Improvements

Water sustainability

  1. Absolute water before and after project m³
  2. Reduction in water loss in water transfer / distribution
  3. Number of people benefitting from measures to mitigate the consequences of floods and droughts.
  4. Level of Water Stress – Low (<10%) to Extremely High (>80%)

Waste management

  1. GHG emissions from water management before and after a project – tCO2
  2. Recycled Materials
  3. Waste water treated

Air pollution

  1. Reduction in air pollutants – SOx, NOx, carbon monoxide CO, etc

Green transportation

  1. Number of green vehicles deployed
  2. Estimated reduction car use
  3. Estimated reduction in fuel consumption
  4. Total km of new or improved rail lines

Green buildings

  1. % of energy reduced versus local baseline
  2. kgCO2/m2 of Gross Building Area


  1. Increase in protected area in km2
  2. Absolute number of predefined target organism and species per km2
  3. Changes in CO2 nutrient and / or ph levels for coastal vegetation, and coral reefs in %
  4. Area of land deforested
  5. Area of land reforested
  6. Area of trees planted
  7. Length of coastline present
  8. Length of coastline restored
  9. Number of threatened species
  10. Species area of habitat
  11. Species extinction threat


  1. Patients reached
  2. Number of bed
  3. Life expectancy
  4. Patient / Doctor ratio
  5. Patients screened
  6. Worker safety record


  1. Students reached
  2. Number of textbooks supplied
  3. Student / teacher ratio
  4. Classroom space per student
  5. Educational resource to student ratio
  6. Learning hours
  7. School meals ratio
  8. Student attendance rate

Employment generation

  1. Number of jobs created
  2. Number of jobs created for disadvantaged groups
  3. Number of Vocational Training opportunities provided
  4. Job placements
  5. Vocational training

Affordable housing

  1. Number of affordable dwellings
  2. Number of people benefitting from affordable housing
  3. % of affordable housing

Food security

  1. Number of people reached
  2. % of population with inadequate food supply

Access to finance

  1. Number of people provided with access to financial services
  2. Number of people provided with access to microfinance


  1. Female unemployment rate
  2. Ethnic group unemployment rate
  3. % of disabled people employed
  4. % of child labour
  5. Youth unemployment rate
  6. Board of Directors – female
  7. Board of Directors - minorities
  8. Gender wage equity
  9. Stakeholder Engagement

A lot of further development is needed in this space. Due to differences in, for example, regions, sectors, etc ultimately it would be preferable to establish baselines for each impact in a standard or full set of impacts.


As the need for future development is clear, it needs to be appreciated that simple impact is not the complete picture either. To fully appreciate impact, it is also important to consider the sensitivity of impact. For example, a wind farm in an area open to change, may have more positive impact in the short term – acting as a catalyst – than an identical wind farm in an area resistant to change. Although it may also be said, the wind farm in the area resistant to change may have more positive impact in the long term, as the area gradually transitions.


In making an investment decision, we cannot ignore impact. Every project has an environmental and social impact.

An oil company may have a net negative impact while a renewable energy company may have a net positive impact. But investors need to calculate the degree and also differences over time and then a qualitative judgement formed in total.

Additionally, there are both environmental and social impacts. Impacts may also be made more complex by sensitivity.

Different impacts may not be compatible or possible to aggregate simply, but they all need to be taken into consideration. This aggregation is important, particularly if monetisation of impact will be involved in the future. All these factors need to be considered and be part of a complete investment decision process.

Christopher J Wigley

This is the first of four articles Christopher Wigley will write for Environmental Finance in coming weeks. The other three will be tackle the following subjects:

  • In Responsible Investment, ESG is not enough
  • The Holy Grail - how Responsible Investment can deliver consistently above index returns
  • A new type of Responsible Investment fund which could replace the ETF