An Introduction to Impact Investing
The investing landscape is constantly evolving as fund companies and money managers look to develop new products to meet investors’ needs and wants. One corner of the market that has been experiencing immense growth over the last several years and shows no signs of slowing down is the area of “Sustainable” investing. Fund assets in the “Sustainable” category are growing at a much faster rate than the broad investment world as a whole and have attracted plenty of attention and publicity, as well.
But the label “Sustainable” is inherently ambiguous. It is also just a subset of a broader investment philosophy of trying to incorporate values into portfolio design. This area of the investing world can quickly get bogged down in jargon. Here are a few helpful terms to be familiar with that are used often to discuss Sustainable investing.
Socially Responsible Investing
This is the original approach to Sustainable investing. A Socially Responsible stock fund typically starts with a broad array of investment choices, such as large US companies. It then excludes the stocks it deems to be undesirable from the investor’s perspective. Classic examples of these company exclusions may include alcohol, tobacco, or weapons. The end result is a broadly diversified portfolio that avoids certain sectors or industries the investor may not want to hold.
This classic definition of Socially Responsible investing is still what comes to mind for many when they think of values-based investing. They picture a list of stocks with a handful of names crossed out, and what’s left is the portfolio. However, as better tools and research have become available, and more investor dollars have flowed into the space, Sustainable investing has evolved significantly, and more nuanced options have become available.
The availability of better data, as well as the demands of choosier investors, have paved the way for the ESG approach to Sustainable investing. An ESG portfolio will look at Environmental (climate risks, pollution, and waste), Social (product liability, data security), and Governance (quality and effectiveness of the board of directors) factors and assign a score to each company. That score is used to determine which stocks get included in their portfolio and what their weighting is.
The raw data that is used for the scoring has become widely available from different vendors. Some of the inputs are self-reported by the companies themselves, while others are observed by third parties. In every case, the investment manager will have to make their own subjective assessments on how to interpret the data and establish their investing criteria. These funds may also utilize exclusions if a subset of investments just doesn’t fit their mandate. But they’re usually better diversified than their Socially Responsible counterparts because they’re selecting the companies in each industry with the best characteristics of their E, S, and G guidelines rather than excluding broad swaths of the market.
Impact investment projects are structured to have a specific, definable impact in addition to a targeted financial return. They often exist in the format of a private partnership as opposed to a diversified investment vehicle like a mutual fund or ETF. Examples of Impact projects may include an affordable housing development or a clean energy initiative. Because these investments are usually not diversified and capital may be locked up for an extended time, investors must weigh their considerations carefully.
Our next Wealth Watch on Sustainable investing will look closer at BDF’s own “Impact” portfolio. We’ll examine how we’re able to use ESG investments to help our clients who are interested in aligning their values with their investments while staying true to our core investment philosophy.
Drew recognizes that financial well-being is multifaceted and each different area is important in its own way. Working with clients to define their goals and structure a comprehensive plan is the most important thing he can do for a client and is truly rewarding for him as a professional. He also leads BDF's Impact Investing initiative, helping clients align their investment portfolios with their values.