What is a theory of change? A guide for fund managers and impact investors

Are some investment products exaggerating their sustainable credentials?

The Financial Conduct Authority (FCA) are concerned enough to have published a consultation paper on Sustainability Disclosure Requirements (SDR) and investment labels.

By the end of 2024, UK-regulated asset and wealth management firms will need to comply with the new naming and marketing rules for non-labelled products using sustainability-related terms. This is designed to maintain trust in the UK’s sustainable finance market.

One of the new requirements is that all fund managers develop a ‘theory of change’ ‘describing how the manager expects its investment activities and product’s assets to contribute to achieving a positive and measurable impact’.

You might be wondering what this means for you and your business.

NPC are experts in theories of change, with a strong track record of developing them for a range of organisations. We can help you navigate these new rules and maximise your impact.

What is a Theory of Change?

A theory of change (ToC) links an organisation’s goals to its activities. It explains how what you do achieves the impact you want. This includes setting out the intermediate steps and causal links needed for the final aim to be achieved.

A theory of change is immensely powerful. It encourages us to reflect on our aims and plans, to discuss them with others, and to make them explicit.

At NPC, we tend to think of a theory of change as the foundation of an organisation’s strategy, evaluation, communication, and measurement.

Theories of change for asset and wealth management firms

We believe theories of change are applicable to any project or organisation that is trying to do good. This includes asset and wealth management firms.

Start by asking yourself some key questions:

• If your goal is to expand investment in sustainable and impactful strategies while generating financial returns, how are you going to get there?
• What impact are the investments going to target?
• Which investments will deliver this impact?
• What will be measured to know if the impact is on track to be delivered?

A theory of change requires a different way of thinking. We often use it with clients to test the logic behind their activities. For example, what’s the best evidence for what you’re doing? What assumptions are you making?

Once the logic is defined, you can think about how you are going to measure the intended outcomes. Taken together, you’re creating an evidence base of your impact.

Our experience creating theories of change for impact investors

This isn’t a new idea in the social investing and impact investing sector. At NPC, we have lots of experience of developing theories of change with organisations in this area.

For example we worked closely with The Man Group, supporting them to develop a theory of change for their Responsible Investment Community Housing Fund. (This fund was delivered in partnership with Sheffield Hallam University’s Centre for Regional Economic and Social Research.)

We supported the Man Group to identify a series of output indicators (what they did, e.g. new homes built) and outcome indicators (what they achieved, e.g. the number of people living in affordable housing). These helped define the overall long-term impact of the fund.

Theory of Change diagram for the Man Group showing the connection between Outputs, Outcomes, and Impact.

Equally importantly to defining your outputs and outcomes is deciding what and how you will measure.

The new FCA guidance states that ‘managers will be expected to apply industry-standard approaches to performance measurement, reporting against rigorous, evidence-based KPIs (Key Performance Indicators) that capture portfolio impact and, subject to additional guidance, investor contribution’.

For The Man Group’s Community Housing Fund, we aligned the output indicators to existing metrics such as the IRIS+ Core Metrics Set and Big Society Capital outcomes matrix (alongside internal metrics) to capture a longer-term impact.

Innovation in measurement – and getting started

Sometimes, measuring your work will require new or innovative measurement frameworks. For example, as impact partners for the KL Felicitas Foundation who invested all its assets for impact while achieving market-rate returns, NPC created a new framework to understand and measure impact – starting with a theory of change. (Read more about this work.)

In improving impact measurement across the entire spectrum of impact investing, we are pleased to note innovative approaches coming from partners like Net Purpose who specialise in impact measurement for public equities.

So, how can you get started? At NPC we’ve developed 10 steps for creating a theory of change that provide a launching pad for your thinking. We would be happy to support your organisation in taking the next steps – from compliance to achieving lasting impact. Please reach out to us for a conversation.

Photo by Daria Nepriakhina on Unsplash