Impact Investing: A Year in Review
In a blog post earlier this year, How to Invest with Impact, I went into the details of how impact investing works and how it’s been a growing trend for investors for quite some time. I also made the case that impact investing is a powerful tool we can use to leverage our money for positive change and help to solve some of the most existential issues of our time, all while building wealth.
Over the last several months our society has definitely been dealing with its fair share of existential issues. The global pandemic seemed to put everything into a pressure cooker this year. As we’ve seen with the Black Lives Matter movement and protests across the country, there has been a big collective push against institutions that have not been serving the greater good. COVID has even been dubbed the “Great Accelerator” because of the degree to which it’s speeding up progressions in justice that are already underway. One of these progressions is the increasing demand for and availability of impact investments, also known as ESG and socially responsible investments.
This year we developed and implemented Mana’s very own impact portfolios, which support gender equity and the fight against climate change, while not sacrificing on our investment philosophy. Our aim to exclude fossil fuels proved to be accretive to our impact portfolios as oil prices faced extreme downward pressure throughout most of 2020. The landscape is rapidly changing, and we’re committed to giving clients more options to invest with impact moving forward. In this blog, we would like to give you our take on impact investing as we round into the end of 2020.
What is impact investing?
To recap what impact investing is, I’ll recycle some of what I said in my last post: When we invest in stocks and corporate bonds - whether it’s through a Robinhood account or our employer’s 401k, we are lending money to corporations (and governments) so they can complete projects, grow profits and provide us with a return on our investment. Impact investing occurs when we choose to invest in businesses and projects that benefit society and the planet, when we steer our money away from companies that do harm, or do a combination of both. In essence, our invested dollars are votes we cast on companies, incentivizing them to grow their businesses. Diverting funds away from “bad” industries and companies (and this idea of “bad” can get highly subjective) sends them a wake-up call that they either need to get their act together or start doing something else.
In case you’re new to the concept, impact investing goes by many names, often used interchangeably. But there are three main types, which, in practice, mean different things:
ESG (Environmental, Social and Governance) stands for a company’s environmental, social and governance practices (for example, carbon and other pollutant emissions policies, community engagement, treatment of employees and compliance with regulators). Investors use rating systems to assess the quality of companies’ ESG policies and decide whether or not to invest.
SRI (Socially Responsible Investing) involves actively choosing (or avoiding) investments based on specific, sometimes very strict, ethical guidelines. An example of this is building a portfolio that avoids fossil fuels and/or tobacco companies altogether.
Impact investing directly invests in businesses or organizations that are completing projects, developing programs or taking actions that positively benefit society.
No matter which approach is being used, the goal is the same: maximize investment returns while making a positive impact on society.
Mana continues to focus on gender equity and fossil fuels.
In building our first impact portfolios, our focus was on two major factors: gender equity and fossil fuels. And as a quick reminder (because this term will come up later) our investment vehicles of choice are ETFs - exchange traded funds - because they offer diversification, high liquidity, flexibility, tax efficiency and low fees. In a nutshell, ETFs trade on major market exchanges just like shares of stock do, except a share of an ETF is in reality a fraction of a large pool of equities that is built to track a broad index, like the S&P 500.
The two areas of focus for Mana’s impact portfolios: supporting businesses with strong gender equity and diverting funds away from fossil fuels - not only align with our values and our clients’ values, but they also mitigate downside risk, which is crucial for protecting and boosting returns. Case in point, the global shock of the pandemic this year dealt some of its worst damage to the oil and gas industry, and it’s hard to say if those companies will ever recover. Regardless, we believe fossil fuels are only going to become more at risk from reaching peak oil, waning public sentiment and potentially heavy regulatory changes due to the dire urgency of staving off climate change. When it comes to gender equity in portfolios, studies have shown that companies with a higher proportion of women in leadership are better equipped to manage risk, and that large companies with at least one woman on the board tend to outperform peer companies that have none.
The existence of investment products that are built for these exact strategies, make investing through these lenses much more accessible than they once were, which on a broader scale allows more money to flow towards the companies within the funds, further advancing their impact.
Impact investing is growing (faster) and performing well.
The availability of ESG-focused and socially responsible ETFs is growing so quickly that they’re in all likelihood becoming a new normal of investing.
First, there’s already been a long-established and growing interest in funneling investments towards ESG funds which is expanding rapidly. By the beginning of 2018, $11.6 trillion of professionally managed assets in the United States were using SRI (socially responsible investing) strategies - about $1 in every $4 invested. According to July 2020 research by JP Morgan, the broadly defined ESG market is supposed to reach $45 trillion in AUM by 2020.
Second, COVID, the “great accelerator”, a phrase we originally heard from Scott Galloway, has highlighted just how well ESG funds can outperform their non-ESG counterparts when things get rough. For example, the iShares MSCI Global Impact ETF (Ticker: SDG), which has virtually no fossil fuel exposure, dominated its non-ESG peer ETF so far this year, the iShares MSCI ACWI ex US ETF (Ticker: ACWX), which has a fossil fuel exposure of close to 8% according to As You Sow’s rating system.
Bloomberg provided another interesting example, where they looked at the performance of 38 U.S.-based companies generating at least 50% of their revenue from clean-energy products or clean technology, and found that ESG stocks outperforming the market is a long-term trend accentuated by the coronavirus. This finding is reflected in the huge gap between the performance of BlackRock’s iShares Global Clean Energy ETF, one of the largest exchange-traded funds investing in renewable energy and clean technology, and State Street’s Energy Select Sector SPDR Fund, one of the largest ETFs investing in traditional energy companies - another example of the fossil fuel crowd getting crushed:
A third (and forward-looking) thing to note on the growing trend of impact investments is the coming wave of wealth that will be inherited from the baby boomer generation. We know intuitively that there’s a big difference in values between the two generations, but it’s hard to fully predict just how significantly this will play out in how the younger generations decide to invest their inheritances. Morningstar’s director of passive strategies research for North America, Alex Bryan, when speaking to CNBC pointed to a coming $30 trillion wealth transfer from baby boomers to their millennial and Gen X children as one of the factors that will spur long-term growth in sustainable funds.
What makes an investment “good” is still subjective.
A challenge as always is the subjective nature of impact investing. Differences in opinion can easily arise over just one company - for example, Amazon has been accused of dangerous warehouse practices, but has pledged to become net carbon neutral by 2040. When it comes to both individual companies and investment funds, socially responsible ranking tools could wind up providing a rating you might not agree with. As You Sow casts a wide net for its deforestation-risk evaluation, docking points for a fund that includes any “financial institutions directly and indirectly involved in underwriting and lending to deforestation-risk producers and traders,” as well as any “consumer goods retailers that source palm oil, paper/pulp, rubber, timber, cattle, and soy from deforestation-risk producers and traders and sell it to consumers worldwide.” Costco is a company that falls under that deforestation umbrella, even though they consistently score quite high on the “social” component of ESG rating systems because of how well they treat their employees.
Furthermore, ESG rating systems are still not standardized, and there can be a big disparity between the ratings they give the same investments. A 2019 paper from MIT Sloan School of Management found that the correlation of five raters’ ESG scores averaged 0.61, compared with a 0.99 correlation of credit ratings from Moody’s Investor Services and S&P Global Ratings. No doubt we have a ways to go before the various third-party ESG data providers begin to standardized their rating systems. Either way it will always be the case, at least to a certain degree, that what makes an investment “good” is ultimately up to the investor’s judgment.
Moving forward
In spite of all that’s happened this year, it’s encouraging to see the incredible growth of ESG investments. It means that more people are finding ways to create wealth while simultaneously harnessing the power of the private sector for positive change. I think this is a natural and necessary progression for our financial markets. To create long-lasting, sustainable wealth, business practices around the world will need to shift from being destructive to restorative, and from being exclusionary to inclusive. Drilling for more oil isn’t sustainable. Keeping women out of the board room isn’t sustainable. If we invest money in companies that are friendlier to the environment and value diversity and inclusion, we’re only making the economic pie bigger for all of us. Mana’s impact portfolios are our way of adding that kind of value to the investing experience for our clients. Looking ahead to 2021, we’re eager to see how the socially responsible investment space continues to grow so that we can help our clients do even more good with their money.
If impact investing is something you’re interested in, talk to us! We’d love to hear your thoughts.
Brandon Tacconelli is an Investment Specialist at Mana Financial Life Design. Mana Financial Life Design provides comprehensive financial life planning and investment management services to help clients organize, grow and protect their wealth throughout life’s journey.