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.
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.
Most current studies show that there is no correlation between "impact" investments and lower performance or return. I would suggest just googling up academic studies on socially responsible investing and performance or feel free to contact me directly for more information on performance comparisons. However, “impact" investments can be considered as just one area under a broader category called SRI (Sustainable, Responsible, Impact) investing. This is becoming the widely accepted acronym to mean Sustainable, Socially Responsible, and Impact investing. SRI investing also happens to be one of the fastest growing trends in finance. If you are looking to review market related investments such as mutual funds, Exchange Traded Funds (ETFs), and individual stocks, the standard form of analysis for SRI is measuring environmental, social, and governance (ESG) factors. A process that is becoming more and more mainstream. In 2016, Morningstar (a leader in mutual fund financial data), teamed up with a company called Sustainalytics to produce sustainability scores on mutual funds and make it available to the public. In short, they add up positive data points across ESG, then subtracts points for a portfolios potential for controversy (the controversy score) resulting in a final Sustainability score. It’s a good place for investors to start finding out how sustainable their mutual funds actually are.
To be more specific to “impact” investments, it is important to know that there can be different definitions of what “impact” means. For instance, our firm Conscious Capital Management and the USSIF define impact investing as more of an alternative, direct investment choice. Common examples would be Community or Microfinance Investments. These types of investments are usually run by an organization (often a non-profit) that raises investment capital to be lent to communities, either locally or globally, that are impoverished or underserved. It typically gives the investor both a financial return and the ability to see their investment directly help someone in need. These types of investment can have different risks than you may be used to and need to be understood before making an investment in such an area. I highly recommend using a professional who understands impact investments before making the decision to invest in one. However, there can be additional financial benefits to holding these types of investments such as greater diversification and reducing rising interest rates.
One final point I would make about SRI investing, is that SRI analysis is not a replacement for financial analysis. All investments should be analyzed for their financial factors and how suitable they are to you and your financial situation along with any SRI analysis. At Conscious Capital Management, we run a rigorous analysis of Financial and SRI factors to make sure they meet our client’s financial needs, circumstances, personal preferences, and are in the best financial interest of each client before including them as part of a portfolio. Of course all investments can lose value and past performance is never a guarantee for future returns for any investment, SRI or not. But with the right approach there is no reason you cannot achieve the financial performance you need and live within your beliefs of making a greater impact on the world around you! I hope this has given you enough resources to get started and happy SRI investing!
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.
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.