Impact Investing has continued to gain popularity with investors across the globe. In this whitepaper, Managing Director Glen Macdonald and SVP Lauren Martin explain what it is, why it is important to investors, and how it can be integrated into your financial plan.
Impact investing is on the rise among investors around the world, so much so that The World Economic Forum, Barron’s and leading Wall Street money managers alike have all pronounced that “impact investing has gone mainstream.” This view is backed by evidence of growing demand among investors: at the beginning of 2018, assets under management in the U.S. that used impact investing strategies totaled $12 trillion dollars, representing 25% of total U.S. assets. This also represented a 38% increase since the beginning of 2016.1
While the term “impact investing” was coined just over a decade ago, all investments have always had some form of social and environmental impacts whether or not those impacts are fully known, desired, or can be measured with precision. In many respects, it is surprising that the investment community took so long to consider such impacts since we, through multiple feedback loops, have a material effect on the underlying value and performance of the securities in which we invest.
So just what is “impact investing”? We define impact investing as the incorporation of an individual’s or an institution’s values and an investment’s intended impact on people, places and the planet into the asset allocation and security selection process. It is important to underscore that impact investing is not a stand-alone asset class. Rather it is a lens that can be applied to all public equity, fixed income, private equity, private debt and venture capital investments alike. As the Principles for Responsible Investing (PRI) points out, such responsible investing “… does not require the use of specialized products. It is primarily about bringing additional data and analysis into existing approaches.”
In sum, impact investing is integral to a holistic investment decision-making framework in which values, mission and measure of impact are considered in concert with, and enhance the assessment of, investment return and risk parameters.
Why Impact Investing Matters for Investors
There is increasing evidence that investing with an impact lens, i.e. considering environmental, social and governance (ESG) factors, enables investors to spot companies with an ethos of long-term value creation. Such enterprises are better at innovating, cost management, employee retention, and mitigating risks to their operations, reputation and brand that arise from causing environmental damage (E), the unequal treatment of employees (S), or the violation of safety regulations (G). Over time, brand reputation helps such companies attract the best talent and establish a loyal customer base, with a corresponding enhancement of its financial performance.
There is also growing evidence of a correlation between high ESG scores and risk mitigation. A November 2017 MSCI study found strong evidence that companies with strong ESG profiles are better at managing both investment risks and opportunities. Savita Subramanian, head of U.S. equity and quantitative strategy at Bank of America Merrill Lynch, is another proponent of using ESG to assess investment risks. As Ms. Subramanian stated in a recent Robb Report: “An investor who only held stocks with above-average ranks on both environmental and social scores would have avoided 15 of the 17 bankruptcies we have seen since 2008.”
Investors are generally becoming more conscious of the ill effects of climate change, the benefits of cleaner sources of energy, the importance of product safety, and the benefits of social inclusion, workplace fairness and community development. With this growing awareness, more individuals and institutions seek to align their investments with their core values and/or mission. In many respects, values alignment is similar to risk tolerance. Through values alignment, investors can have greater comfort in the investments they own, especially when the financial performance is equal to non-aligned investments.
History, Timeline, and Trends
“Responsible investing,” a precursor to impact investing, and consideration of the social impacts of investing dates back at least to the late 1890s.2 The timeline below provides an overview of the key events in the evolution of impact investing.
This timeline depicts both the evolution of and the foundation for today’s accelerating demand for impact investing. While women and millennial investors are fueling much of this demand, many investors are taking part. According to a recent Morgan Stanley study, 86% of millennials and 85% of women report being interested in sustainable and impact investments.
BlackRock’s chairman and chief executive has posited in a recent Financial Times interview that “We are only at the early stages.” Mr. Fink estimated that assets in ETFs that incorporate these ESG factors will grow from $25 billion to more than $400 billion in the next decade.
Most Common Myths About Impact Investing
Myths and labels have discouraged some individuals and institutions from exploring the benefits of impact investing and incorporating it into their investment practices. The time has come to dismiss these myths and to lever the potential advantages of impact assessments in investment decision making.
Myth #1: Selecting Investments that Align with Values Means a Sacrifice in Returns
Many investors still falsely believe the myth that any attempt to either avoid negative social and environmental externalities and/or to seek positive social impacts when investing automatically means sacrificing returns. In theory, any constraint on an investment universe should present return headwinds and increase portfolio risk. However, empirical evidence has shown that investment funds and strategies that incorporate “restrictive” screens have shown little ill-effect relative to traditional mandates.
In a 2015 study that reviewed 2,200 academic papers on investing that use all or some of the ESG sub-components, nearly half of papers found ESG investing to be a net positive. Roughly 10% found such investing to be negative, and the other 40% mixed or neutral. These findings reinforce long-standing evidence about the relationship between good governance, superior management, quality product and services and bottom-line financial performance.
In fact, increasingly, investors have come to understand that they can achieve market-rate returns not only along-side, but through the very pursuit of investments that yield positive social and environmental returns. For this reason, The Global Impact Investing Network (GIIN), a leading think tank and resource to impact investors, defines “impact investments” as those made into companies, organizations, and funds with the intention to generate social and environmental impact alongside a financial return.
Myth #2: Responsible Investing is not for Serious Investors
With Impact Investing undergoing a “broadening of the tent” in recent years, world-class investors, respected financial institutions, private equity and venture funds have all jumped into the space.
The fact that major pension funds, insurance companies and financial institutions are signatories of the Principles of Responsibility Investing (PRI) and readily use ESG analysis to supplement security selection is further evidence that this type of investing is good business and likely to be enduring. Leading long-time investment professionals have become steadfast proponents of its broader adoption, including Robert Litterman (co-developer of the now widely used Black-Litterman Global Asset Allocation Model), and Jeremy Grantham, who, paying much attention to climate change risks, has incorporated ESG into his investment framework.
“Climate change exposes investments to many types of risks, including both anticipated and unanticipated impacts, and over both short and long run time horizons. In the short run the first type of risk is the direct physical impact of extreme weather on exposed infrastructure. A second type of short run risk is the decline in demand for assets that create emissions because incentives are created to reduce the production of greenhouse gas emissions.”
– Robert Litterman, Crane Institute of Sustainability Board Member and former Goldman Sachs Head of Global Risk, May 26, 2014
Approaches to Impact Investing
The approach to impact investing is similar in many respects to any other kind of investing. The starting point is the client and their wishes, which is no different than considering their performance objectives, liquidity and risk tolerance. In our view, impact investing is grounded in an individual’s values or an institution’s mission. Hence, we believe that the starting point for any approach to impact investing is in the client discovery process.
At the most basic level, the techniques applied to execute on impact investing strategies or approaches can be simplified into owning (inclusionary) and avoiding (exclusionary), i.e., what a client wants to own and what a client does not want to own based on their goals, risk tolerance and values. Both owning and avoiding are fairly straightforward, although the approaches differ on a variety of fronts.
Owning can range from separating the broad investment universe into companies/entities that align with one’s views, to specifically targeting individual themes, impact areas, companies in need of change, and other direct investments. In most cases, owning is not a passive exercise. Funds often exercise their shareholder/ownership rights through proxies, shareholder resolutions, and other mechanisms. To further define all of the strategies, we have sub-divided the universe into the following categories.
Positive Screening / Selection – Investing in securities that closely align with a subset of values and / or that seek a positive social or environmental, e.g., clean energy technologies or social inclusiveness.
Negative Screening / Exclusion – Avoiding securities, companies or industries that do not align with a subset of values or that have negative social or environmental impacts, e.g. securities that finance guns, tobacco, fossil fuels and companies that undermine human dignity, are known for poor governance and safety, or have work place biases against women or selected ethnic groups.
Alignment / ESG Integration – This approach combines elements of positive and negative screening and focuses on the overall materiality of a security’s impacts through ESG factor analysis and scoring. ESG factors are integrated into the overall financial analysis to identify companies that have sound governance, strong workforce policies and resource-efficient practices.
Shareholder / Stakeholder Engagement – Investors are using shareholder proxies to influence corporate policies and practices. Some investors and money managers also file or co-file corporate resolutions with the intent of placing specific issues on shareholder ballots. Activist investors seek, for example, to advance equal pay for women, diverse corporate boards, better benefits for employees and adoption of more environmentally sustainable business practices.
Thematic Intentionality & Direct Investments – Some investors target specific impact themes and scan opportunities to achieve impact across all assets classes, with most thematic alignment often coming from private equity and private debt investments. This can take the form of micro-lending to women in the developing world, equity and debt financing of small businesses establishing new distribution of potable water in Sub-Saharan Africa, or community development debt instruments for inner city affordable housing in the United States. Impact investors are also employing specific screens or lens on public securities such as gender equality and the advancement of diversity and inclusion.
Wealthspire Advisors’ Impact Offering
Wealthspire Advisors focuses on strategies that encompass many of the prevailing impact and ESG themes that have broad appeal. Our impact investment offering encompasses the five approaches mentioned above, all of which enable clients to know the tangible impacts of their portfolios with “investment-level” impact reporting.
We currently only add strategies that could be implemented within our core asset allocation framework and that do not materially affect portfolio return expectations. It is important to note that some components of the investment universe do not currently have compelling options that align well with ESG principles and positive impact outcomes, e.g. commodities. However, we do offer access to customizable separately managed accounts that can accommodate very specific values and impact outcomes.
To begin or to advance your own impact investing strategies, our advisors can engage with you in a comprehensive discovery process to explore options that are most suitable to your personal goals, values and impact intentions.