What Is Impact Investing and Why Does it Matter?

Impact investing allows you to put your money where your mouth is, and help the world in the process.

by: Brian O’Connell

Impact investing is everything the name implies – it’s all about investments in companies that make a positive impact on society and on their communities.

No question, investing in Environmental, Social and Governance (ESG), the more formal name for impact investing, has both rewards and risks, but that’s not stopping legions of investors from getting involved.

According to the Global Impact Investing Network, the global impact investment market stands at $502 billion in 2019.

Expect that figure to rise as more investors (especially younger ones) decide that “doing well by doing good” is their go-to investment strategy going forward, and as impact investing becomes their investment model of choice.

What Is Impact Investing?

According to the GIIN, impact investing involves investments made with the intention to generate positive and measurable social and environmental impact – hopefully with a financial return.

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Investors can accomplish that task in myriad ways. They can invest in sustainable stocks, or more easily, invest in mutual funds and index funds that focus on specific sustainable living practices, like providing green energy products or services or who are building hospitals and medical clinics in poverty-stricken countries.

Women and millennial investors are the demographics most likely to invest in impactful causes. In fact, the entire market is growing at a pace that would pour hundreds of billions of dollars into investments tied to the environment, public health, education, third-world economic growth and other causes that matter to today’s impact investor.

The data backs that sentiment up.

According to Paces Ferry Wealth Advisors, 77% of wealthy younger investors have engaged in impact investing against just 30% of equally wealthy baby boomers.

That’s similar to women investors, who tend to get more involved than men in charitable giving and who, by 2020 will hold 32% of all privately held wealth in the U.S., making women investors major players in the sustainable investing market.

Impact investing, also known as ESG investing, socially responsible investing, green investing, and ethical investing, is also just as much about what not to invest in. With impact investors, otherwise potentially profitable investment sectors like oil, casinos, tobacco, alcohol or military and defense are generally sectors that are avoided, as they are largely viewed unfavorably by sustainable investors.

With impact investing, the idea is to stand for investment sectors that support positive social gain, while making a buck or two in the process. Thus, impact investors are simply recrafting the American in a call for social progress – and to call their investment advisors when their portfolios grow less robustly than they’d like.

What’s the Formula for Impact Investing?

Impact investing takes the traditional calculus for a successful stock or fund, like revenues, debt, quality of management, and dividend growth (to name a few) and adds a few non-traditional metrics to the mix. Those include tenets that matter to impact investors, like a company’s global ecological footprint, its use of green energies to help build its products and fuel their deliveries, and how much a company gives to charity.

Impact investors also strongly believe in human capital, too. That means companies who might qualify for investment money must treat their employees humanely and ethically, pay a good wage, offer good benefits, and be good neighbors in their home office communities.

There’s a strong belief among impact investors that companies that clear these hurdles and operate as fully vetted socially responsible corporate partners to their communities will generate greater investment returns than companies who don’t measure up in the eyes of impact investors.

Is that true?

Sometimes and sometimes not.

According to data from Morningstar, which compared impact investing to traditional investing via mutual fund performance, impact investment-oriented fund performance hasn’t historically lagged traditional funds – but there’s a caveat.

Morningstar (MORN) – Get Report reports that impact-oriented funds were comparable to traditional mutual fund performance-wise, but only so if impact funds diversified sufficiently, and as long as impact fund managers focused on companies with strong sustainable growth tendencies and didn’t focus on excluding companies that didn’t measure up to sustainable business standards.

A separate study in Money magazine found that, from 2010 to 2015, impact investing funds underperformed the overall Standard & Poor’s 500 Index, although that disparity has tightened in the past few years.

The data does seem to go back and forth on impact fund performance.

Thus, an impact investor’s best move is to consult with a trusted investment professional who can help screen funds, make sense of the relevant numbers, and help select the stocks and funds that both meet the investor’s ethical standards while also providing a solid investment return.

Pros and Cons of Impact Investing

Like any investment strategy, impact investing has its upsides and downsides. Let’s review both sides to help determine if impact investing works for you.

The Pros of Impact Investing

You’re playing by your own rules. Wall Street, like Las Vegas, tends to favor the house and not always the investor, so there’s definitely something to be said for taking a stand and investing based on the ethical standards that matter to you.

By adhering to key core values that you live by, and transferring them to your investment portfolio, you’re taking a personal stand, and that’s to be commended, especially with your financial future on the line. Literally, you’re putting your money where your mouth is.

You’re using your leverage. By deciding who gets your money based on ethical behaviors, you’re the one calling the shots. For example, if you’re anti-tobacco and adamant about keeping your money away from cigarette companies, that’s one less dollar (or more) that the tobacco company has to spend to get a pack of cigarettes in a teenager’s jean jacket pocket.

Your money is going where you want it to go. Conversely, the money you set aside for investments is going to companies who, in general, operate by the standards you favor. Rewarding companies that value, for example, clean air, safe communities, decent employee pay, and good public health, means you’re steering your cash to the companies that can use that money to further those causes.

The Cons of Impact Investing

If you’re not careful, you may sacrifice performance. Having strong ideals and passions about how you see the world is fine – just don’t go overboard and start losing money as an impact investor. Some investors may be so rigid in their belief systems that they exclude companies who may be ethical after all, but don’t make the cut because of some peripheral issue viewed through the prism of a given investor.

Don’t let investment purity rule your portfolio decisions. Make sure you diversify your portfolio, thoroughly vet the stocks and funds you include in that portfolio, and work hand-in-hand with a professional broker or investment adviser to make sure you’re making the best investment decisions, within the parameters of your world ideals.

Some “sustainable” companies may be shading you. Not every company that claims to be socially responsible actually is so.

Make no mistake, marketing plays a big role in upholding the veneer of social responsibility. Image crafting goes back centuries, and it’s easy to fall for a technology company pitch that it will devote itself to a smaller eco-footprint, but behind your back, they’re running sweatshops in Asia or doing businesses with dictators halfway around the world.

Again, do your best research and trust your judgment after you’ve done all your homework. If it turns out you’ve been sold a bill of goods, you can always sell a stock or fund that turns out to harbor some highly non-ethical companies and practices.

You’ll likely make choices you otherwise wouldn’t have to make. When it gets down to brass tacks, impact investors may have to, in tough market conditions, make a choice between making a profit or sticking to their ethical ideals. This won’t happen on a regular basis, but it will happen enough where you may have to compromise your beliefs to save your investment portfolio.

Impact Investing Does Matter

By directing your money to companies and funds that will generate products and services that lead to a better world, and run their organizations ethically, impact investors are making a big difference by holding to their core beliefs.

When impact investment dollars pour into a stock or a fund, the companies that receive the money in higher share values can use the money to benefit their customers, their employees, and their communities.

That could also mean making the world a safer, cleaner and more humane place – simply by investing in a company that provides malaria vaccines to people in developing countries or by pouring your money into a company that makes solar panels or wind farms, thus reducing pollution and saving on energy.

Being an impact investor is certainly an admirable and unique experience. Just make sure that while you’re keeping your eyes on the prize, you’re keeping your eyes on your portfolio’s bottom line, too.

This article was written by Brian O’Connell and originally appeared on TheStreet.com on July 29, 2019.