Pre-Investment Considerations: Guidance for forward-impact smart Limited Partners (“LPs”)

When it comes to investing for climate, how can LPs be sure that their investments are actually supporting the large-scale positive impacts our planet and its people need? 

Ten years ago, the indicators of strong commitment to impact looked different than they do today. In 2014, climate tech funds were few and far between. Today, fund options are more abundant and the risk of greenwashing is higher than ever. To sort wheat from the chaff, LPs and impact-centered investors must hold higher standards to ensure that investment managers’ methodologies in practice align with their stated intentions. 

LPs hold the responsibility to ask different questions than direct investors as they often channel capital to managers independently making investments in climate solutions on their behalf. LPs entrust the teams they are placing their capital with as those best positioned to deliver impact along with financial returns. 

Project Frame’s methodology guidance, Pre-Investment Considerations, is the work of more than 45 leading climate investors, advisors, and thought leaders who gathered to provide insight into and advice for conducting pre-investment forward-looking emissions assessments. In addition to the guidance, Frame also works with community members to develop Investor Profiles and host small group discussions on more complex topics such as linking investment manager compensation to impact. 

To help put consensus  best practices into action, the Project Frame team has prepared the suggested list of questions that LPs should—and do—ask, and that GPs affiliated with Frame should be ready to answer based on the discussions and content we have developed collectively as a community of practitioners.

Click each question to view context for the responses an LP can expect from a GP.

• Does the investment manager transparently describe and document its methodology for measuring and reporting impact?

  All investment firms should have a clear and publicly documented methodology and examples of the methodology in practice.

  Methodologies can also evolve over time as firms grow and change, and such changes should be documented and explained when they occur.

  Transparency is one of Project Frame’s core values. Examples of how other investors describe and document their methodologies can be found through Project Frame Investor Profiles.

• Has the investment manager dedicated resources, tools, and knowledge to develop and execute their impact measurement and management methodology?

  All investment firms who claim to pursue impact should ensure that their firm has the dedicated resources to conduct a robust and transparent effort around impact measurement and management. LPs should assess if the firm has a dedicated team or employee at an appropriately senior level in the firm, regularly hires third-party consultants due to a lack of internal knowledge, or if a firm expects employees to execute on impact management as a secondary function. The resources dedicated should match the level of ambition and results expected from the firm around impact.

  Examples of how other firms have approached this can be found through Project Frame Investor Profiles.

• Does the manager's methodology align with accessible language and common definitions or is it bespoke to the firm?

  While there is no one standard global approach to impact methodology and management, there are multiple bodies releasing guidance including Project Frame, GFANZ, VCA, etc. Firms should be able to identify and transparently communicate where they are aligned to global standards, which standards, and how they plan to implement them.

  Bespoke approaches can potentially deviate from global standards, and make it difficult to assess the impact methodology for rigor, transparency, and success. When bespoke approaches are utilized transparency and rigor of explanation are particularly important.

  Project Frame is working with investors and climate experts to build consensus-based common terminology and methodology best practices including time frames, baseline construction, data selection and more.

• Does the firm assess forward-looking impact and/or realized impact? If so, how and when would different approaches be applicable?

  There is currently no globally accepted guidance on how to assess forward-looking emissions impact. Project Frame is meeting the need and the challenge by working with investors and climate experts to build consensus-based common terminology, methodology and best practice. Based on this guidance, investors should be able to differentiate between whether they apply a potential or planned impact methodology.

  Generally, potential impact is most appropriate at the earliest stages of a company. As the company develops commercial business plans, investors can use planned impact, which provides a more realistic forecast of impact. As the company begins to show results, tracking realized impact is essential.

• Are third-party experts employed to audit the investment manager's impact methodology, implementation, and/or reporting?

  LPs can look for signs that companies are structured to ensure impact integrity or incentivize impact over profit motives. One way to do this is to rely on a third-party evaluation. Even though third-party verification is a new and emerging field, Frame recommends that all investors work towards third-party evaluation, a hallmark of objectivity. However, recognizing that third-party evaluations come with additional costs, LPs should advocate for and support this practice in context with an understanding of its financial impact.

  Examples of how other firms have approached this can be found through Project Frame Investor Profiles.

• Is there a clear, structured process for the investment manager to engage and help portfolio companies center impact during hold periods?

  Stewarding impact is a daily process that begins after the investment is made. Climate investors structure processes to ensure that they and their companies keep impact at the center of decisions as the company grows and changes over time, and to capture impact value creation opportunities. Hallmarks of structured impact management may include: requiring companies to get on the path of B Corp certification, linking specific impact achievements to portfolio manager compensation, or setting up guardrails pre-investment to ensure that the company technology cannot be sold to buyers that may use the technology at odds with its impact intentions.

  Examples of how other firms have approached this can be found through Project Frame Investor Profiles.

• Is compensation, either short-term or long-term, linked to impact, and if so, is the investment manager using the appropriate impact metrics and methodology to align incentives?

  While it is not necessary for firms to link their compensation structures to impact, when GPs make the decision to do so, they should bias towards utilizing realized impact methodologies and consider deploying a capitalization adjustment, also known as a vertical attribution approach. This helps to ensure that the internally reported impact used for compensation is in sync with the ownership share the investor has in the company. For example, an investor who owns 5% of a company should consider using 5% of the realized impact of that company for the impact measurement used for compensation to avoid inflation of impact targets and goals.

  More information and resources can be found in the Project Frame discussion and on Tying Compensation to Impact, Investor Profiles, and the attribution section of the methodology.

• What global organizations, frameworks, working groups, etc. does the investment manager participate in to stay up-to-date and to advance the state of impact measurement and management?

  LPs should ensure that those who claim to be leaders in the impact space are involved and active in the larger impact measurement community.

  Examples of how other firms have approached this can be found through Project Frame Investor Profiles.

• What processes has the investment manager put in place to try to facilitate a just transition?

  Topics outside of GHG impact quantification, including the nuances of environmental justice, were discussed during an in-person Project Frame meeting in April 2023. Some insights shared by Dr. Margot Brown from the Environmental Defense Fund that are important to consider are:

  The managers you’re evaluating are making investment decisions today that may have unintended social and environmental consequences. Their impact assessment processes can help mitigate the risks of unintended consequences and help them become even more knowledgeable about the application of their portfolio companies’ products and services.

  Climate investors can begin building their awareness of climate justice issues by setting aside time to read.

  We encourage you to ask whether the investment managers have visited and spoken to people most affected by their portfolio companies’ solutions.