Societal Impact vs. Financial Return: A Case of “Either/Or” No More

Partner Content What is Partner Content? Investopedia hosts articles from other investing and financial information publishers across the industry. While we do not have editorial control over their content, we do vet their articles to make sure they are suitable for our visitors. By James Lumberg | March 18, 2018 — 12:29 PM EDT

“Doing good” and “doing well” – in the world of investing, does striving for one inevitably mean sacrificing the other?

Many investors who find impact investing potentially appealing have at the same time struggled with a notion that investing for the “greater good” will always be “concessionary,” that is, accompanied by some loss of financial performance.

They need struggle no longer.  Indeed, a new class of impact investments has emerged, specifically designed to get investors over the “profit vs. purpose” hurdle -- offering the opportunity to achieve a benchmark return, at relatively low cost, with a basket of assets that are optimized based on environmental, social and corporate governance factors.

The approach has already proven to be possible, and on the horizon there are prospects for enhancements that will empower investors to align portfolios ever more closely with impact goals, while continuing to meet performance objectives.

These impact portfolios represent an adaptation of the “smart beta” approach, which offers investors the low cost of passive index investment along with actively-managed exposure to certain attractive stock fundamentals.  The smart beta approach is now well established, with Morningstar reporting in mid-December 2017 that smart beta assets had exceeded the $1 trillion mark.

A smart beta portfolio typically represents a sub-set of a well-known index, comprised of securities selected because they embody key “factors” – such as value, momentum and sector overweights – to deliver returns in excess of an index over time. 

On behalf of impact-oriented investors, the impact portfolios take the smart beta approach a purposeful step forward, by carefully reducing a benchmark-based portfolio -- for example, based on the Russell 1000 – to a smaller number of securities that track the “parent” benchmark but also have strong environmental, social or governance (ESG) characteristics.

Within the range of options available today, an investor can choose an index-based portfolio focusing explicitly on companies with demonstrated ESG priorities such as labor and human rights, gender diversity and impact, climate change and environmentally conscious technology, or strong policies regarding transparency, anti-corruption, executive pay, or political involvement.

The emergence and evolution of these portfolios has gathered force from the increased availability of highly sophisticated, security level research that enables close assessment of dozens of metrics that precisely define how strongly a company “scores” on a range of ESG characteristics – providing unprecedented visibility into company-specific impact investing opportunities.

Such insight combined with the expertise of quant-focused managers has been critical to the practical design of portfolios that can be fine-tuned according to many impact objectives, but that still offer the investor the prospect of a consistent benchmark return.

Because the portfolios are index-based, they can be very cost-efficient. Another key driver of the sector’s growth has been the increasing availability of portfolios with minimums considerably below the levels available up to now for similar, focused investments, with many products available at the $100,000 level or even lower.

Going forward, the level of insight that’s available regarding a company’s ESG “profile” will continue to be essential to the development of even more sophisticated impact portfolios.  As this portfolio approach gains traction, we believe companies will more and more recognize that they can earn a premium by being highly transparent regarding their socially relevant policies and practices – which will help build a growing set of readily identifiable impact opportunities within appealing indexes.

Today, there need be no doubt that it’s “either/or” no more – and, in fact, doing good and doing well can be completely compatible.  As we enhance our ability to look deep inside a benchmark portfolio and pinpoint its most “impactful” constituents, advisors and investors can look forward to even greater choice in customized, cost-effective – and return-focused -- solutions for deeply-held, impact-investment objectives.

The information, analysis, and opinions expressed herein are for general and educational purposes only. Nothing contained in this piece is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice.