The Value of Impact Investing

Gordon Gekko has been misquoted. Portrayed by Michael Douglas, the infamous antagonist of Oliver Stone’s film Wall Street actually said “Greed, for lack of a better word, is good.” But those extra 6 words break up a really catchy tagline.

Gekko’s mantra summed up the philosophy of 1980s investors. In the relevant scene, Gekko addresses the officers of a company of which he is the largest shareholder. He declares the supremacy of the shareholder in the company and demands that financial returns to the shareholder become the top priority for not just the company, but the entire US. (Cue the guitar riff and screeching eagles).

However, a new generation of investors has recognized that maximizing profit for shareholders is not necessarily the best strategy for companies. Such practices can result in environmental harm, discrimination, and corporate malfeasance. Prioritizing non-financial factors isn’t just about do-gooding either: after the Enron scandal, a bailout of the auto industry, and the 2008 financial meltdown, investors have started to realize that their money might not be safe with companies driven purely by short-term profit motives.

Impact investing is an investment philosophy that has been gaining steam for years. In this article, we’ll look at its basic terminology, the history of the practice, and where it’s going from here.

Defining Impact Investing

Impact investing seeks to use capital to achieve social or environmental gains in addition to financial returns. The Global Impact Investing Network (GIIN) defines 4 core characteristics of impact investing, which we’ve summarized here:

1. Intentionality: A desire to contribute to measurable social or environmental benefit.
2. Evidence: The use of data when available to drive intelligent investment design.
3. Management: Having feedback loops in place and communicating performance information to support others in the investment chain to manage towards impact.
4. Contribution to the Industry: The use of shared industry terms, conventions, and indicators for describing impact strategies, goals, and performance, sharing learnings when possible to enable others to learn from their experience.

Socially Responsible Investing

You might be saying, “Wait, impact investing means avoiding polluters and firearms manufacturers. That’s been around for a while.” That’s close, but not exactly the same thing.

Socially responsible investing, or SRI, predates impact investing. But SRI is more concerned with harm reduction, like avoiding problematic companies. Impact investing, in contrast, is about actively doing good by investing in positive organizations.

Environmental, Social, and Governance

Environmental, social, and governance, or ESG, is another concept that is similar to—but not the same as—impact investing and SRI. ESG refers to 3 types of criteria that can be considered alongside financial factors when choosing investments. Examples of factors that are considered in each category include:

• Environmental: Carbon footprint, history of pollution, use of natural resources
• Social: Labor/employee relations, inclusion policies, publicly supported causes 
• Governance: Corporate transparency and accountability

ESG is sometimes used interchangeably with “ESG investing,” which defines the practice of choosing investments by combining financial considerations with ESG factors. And sometimes, ESG is used interchangeably with SRI—but again, there are differences. In ESG investing, ESG factors will influence, but probably not veto, an investment decision, whereas in SRI, a company with poor ESG factors would be automatically counted out. 

In other words, ESG criteria are relevant to ESG investing, SRI, and impact investing. The difference is to what degree the criteria are prioritized.

History of Impact Investing

Historically, investors have had 1 goal: maximizing profit. Even profiting less than possible was (and still is) frowned upon. Misinterpretations of Adam Smith and the inaccuracies of Ayn Rand created the belief that self-interest, narrowly defined as profit, should be the best and only guiding principle. Business leaders claimed that considering the public interest should be left to government and philanthropy.

Before impact investing promoted investing to promote good practices, there were (and still are) movements to divest from companies to oppose certain unethical policies and practices. Advocates famously started a divestment movement in the 1960s to oppose apartheid in South Africa. Currently, a major movement is underway to divest from fossil fuel companies to battle climate change.

The term “impact investing” itself started appearing around 2007. The practice has seen explosive growth recently: the GIIN puts total global assets in impact investing at over half a trillion dollars, over double what was previously estimated.

Is Impact Investing Profitable?

Early criticisms of impact investing wrote it off as a feel-good, money-losing venture. But available data shows that impact investing not only tracks with traditional funds, it sometimes outperforms them. An article from CoPeace, an impact investing firm, summarizes some of the recent studies:

A 2014 study conducted by CDP Global 500 Universe found that S&P 500 companies that are leaders on climate change generated an 18% higher return on equity (ROE), lower volatility of earnings, and 21% stronger dividend growth than low-scoring peers. Similarly, a highly regarded 2016 study, led by George Serafeim of Harvard Business School, found that stocks of companies with the strongest performance on ESG issues outpaced those with poor ESG performance.

They also note a Morgan Stanley/Morningstar study that revealed that funds incorporating ESG factors were more stable during volatile periods.

What Is the Future of Impact Investing?

Impact investing is expected to continue growing, in large part due to demographic changes. Millennials are known to be more socially conscious consumers, and that attitude carries over to their investment portfolios as well. 

Millennials have been severely hindered in wealth accumulation, thanks to the double whammy of the 2008 Great Recession and the current coronavirus pandemic and related global downturn. But economists still predict what they are calling the Great Wealth Transfer, a period over the next 30 years as millennials inherit trillions of dollars in wealth from their Boomer parents. And this wealth is predicted to fuel the further rise of impact investing.

You might expect that the coronavirus pandemic would slow impact investing’s momentum: market instability and huge losses of wealth can make investors reach for more tried-and-tested methods. Initial indicators, however, don’t show that. A survey from the GIIN found that a healthy majority of impact investors (73%) plan to maintain or increase their planned capital investments for the rest of 2020. In some ways, the global health crisis might have highlighted the need for impact investing.

As you look at your own portfolio, keep all this in mind: what’s good for the planet might be good for you, too.