Will impact investing hinder potential profits?
Is there a correlation with impact investing and earning fewer profits? I am a strong believer in socially responsible investing, but I don’t want my portfolio to suffer because of it.
It's a tough question. There are a few studies out there that have looked at that correlation between SRI and expected returns.
My opinion is that if you are interested in SRI, you should be prepared to sacrifice some short-term gains. However, in the long-run, your investments will have comparable returns.with the markets. As we have seen time and time again, companies with strong workforce ethic and satisfaction, customer driven products services, and environmentally friendly practices have done very well in the long-run. But it's not always very easy. If you run a solar energy company right now (except for Tesla), you are probably just trying to survive. But those who survive will certainly make history and bring great returns for their investors.
As always, there's no one answer to this, for two reasons that spring to mind.
The first reason this is hard to answer is that "impact investing" is variable. Are you only avoiding alcohol, tobacco, and firearms (the traditional "sin stocks")? Or are you avoiding fossil fuels, companies that exploit their workers, poison the environment, have outsized executive compensation, and boards that have no diversity? That puts far more variables into the mix!
Many mutual fund managers who don't view themselves as socially responsible investors, see these issues as one more factor to take into consideration when they pick out their stocks. If you are torn between a company that will likely have to pay EPA fines versus one that won't, it makes sense to invest in the one that one.
Another reason that this is a complex question is that timing is everything. If you have a fossil fuel free portfolio and oil prices are low, you're going to come out looking pretty good! If oil prices surge, the fossil fuel free portfolios might not look as great.
In my personal experience, there are both good and bad impact investments, the same as every other type of investment. And, again in my personal experience, Socially Responsible Investing (aka impact investing) tends to perform as well and occasionally better than conventional over the long term, especially as things that were considered bleeding heart decisions come to be viewed as sound fiscal decisions. For example, it's come to look as though companies with diverse boards generally perform better than companies with homogeneous boards, broadly speaking.
Great question. There used to be a compromise in returns for making socially responsible investments, but there is no longer if you choose among established companies with a track record of competitive returns. Outstanding options to consider are Parnassus, Pax, Calvert, and Domini.
A little background - socially responsible investing was introduced in the 1970s, and was premised on screening out problematic companies or industries based on values choices. The socially responsible investment universe was small at that point in time. By 2000, socially responsible investing had begun to evolve into sustainable investing, which was premised on screening in companies based on positive environmental, social, and governance criteria. By 2010, sustainable investing had evolved even further, to impact investing, which you mention. Impact investing insists on two things - one, that sustainable investing strategies must provide competitive returns, and two, that impact investments must be designed to produce positive environmental, social and governance changes.
To provide some hard evidence that there is no longer need for compromise, with my portfolio management firm, our socially responsible portfolios actually beat our mutual fund portfolios' returns in 2016, and year to date 2017 have matched them. So by all means, look seriously into your impact investing choices!
It is a really interesting question, and in my reviews of the data there are not strong conclusions to offer yet. But there are a few things to consider that may help inform your approach to this issue:
- What "cause" are you pursuing? It may be reasonable to assume that certain types of restrictions on investment choice will have more effect on returns than others. For example, screening for companies that have more diversity on their corporate boards or employment rolls would not necessarily suggest any economic advantage or disadvantage to the company, but screening for companies that are committed to donating X% of their revenues or profits to charity would be selecting for companies that do have an economic disadvantage vs companies without that "extra" expense
- If you are pursuing this investment goal via products like mutual funds, how do the fees within those funds compare to the options without a socially responsible approach? It is generally the case that the more specifically tailored or actively managed a fund, the higher the expenses.
- There are implications for diversification and volatility in this quest; applying a meaningful screen to the universe of available stocks (or funds) necessarily results in fewer choices, which may lead to risks of concentration by region, industry, and individual companies; concentration risk also tends to lead to higher expected volatility.
A few thoughts:
(1) Companies are in the business of maximizing value for their owners (shareholders). It's good PR to come across as kind and caring, but please understand that it's mostly PR.
(2) If there are people who recoil from owning shares in a particular company, that makes absolutely no difference to the company. You are not supporting a company's share price by holding their stock, nor do you depress the company's share price by not owning. I always get a chuckle when I hear of students demonstrating against their school's endowment holding shares in some cause-celebre company. The market does not care.
(3) If a company "reforms" and starts paying its workers more, or uses raw materials in a way that is less polluting but more costly, or refrains from raising prices, or whatever, the company won't be around long. Its competitors will eat its lunch.
(4) Business ethics does make a difference. If a company's management cuts corners with accounting, regulatory compliance, aggressive lobbying, etc. it's a red flag. Stay away. "If you lie down with dogs, you get up with fleas."
I think that if you invest normally but hold aside some of your profits for donation to worthy causes, you will make more impact on the world than if you avoid good investment opportunities out of a sense of self-sacrifice.