Your investments are a part of a broader ecosystem.
That means your choices in investments have a direct (even if small) impact on the future of the world. The “social investor” understands and embraces this, putting “impact investing” at the center of their investment strategy.
Impact investing is an approach to investing that seeks to generate financial returns while also creating a positive impact. Investors who do so consider the impact of their investments on any mix of:
- The environment
- Social impact
- Politics
In this article, we will go over impact investing and ESG.
What is impact investing and ESG?
Impact investing is an investment strategy that involves specific considerations for any of the three “ESG” factors:
- Environment
- Social
- Governance
An impact investor may consider only one of these factors, all of them, or any combination of two.
Reasons for considering impact investing can vary greatly. Ethical concerns, political beliefs, personal introspection, religious considerations, and more can all fall under the umbrella of impact investing.
What is an example of impact investing?
There are many impact investment strategies. Let’s go over some examples you may come across online or speaking with people you know.
The Environment
Many individual investors believe strongly in human responsibility for the environment, and that we must temper our impact on it. Such people may donate to environmental charities, volunteer for events, or make changes to their diet and lifestyle to minimize their impact on the environment.
An environmentally conscious investment strategy simply means applying environmental considerations before investing in any company.
In the same way they would study a company’s balance sheet, they would also research the company’s environmental impact and plans/policies towards environmental impact minimization.
Environmental impact investing may involve asking questions like:
- How does this company’s/fund’s commitments compare to their competition in this industry?
- Has this company/fund made a rigorous commitment to reduce negative impacts on the environment?
- What is the climate footprint of this company/fund?
An example of this in practice would be the Net Zero Asset Manager’s Initiative. The initiative has 315 signatories and currently manages approximately $57 trillion in assets. They are committed to supporting reaching net zero greenhouse gas emissions by 2050 and limiting warming to 1.5 degrees Celsius.
Social investing
Social impact investing means having social considerations and directing your capital in a way that leads to positive social change. Like impact investing, the specifics can vary.
- One environmental impact investor may care to reduce greenhouse gas emissions.
- Another investor may want to save rainforests.
- Yet another investor may care for both of these goals.
There are a great many social causes as well, and a social impact investor may include some mix of personal social or religious values in their strategy.
Under a similar logic, governance/political impact investing requires the investor to ask whether a given investment is aligned with their own personal political beliefs.
ESG
ESG investors specifically incorporate all three concerns into their investment strategies. They must thus ask themselves a wide range of ethical questions before deciding to make a new investment.
Is impact investing a good idea?
This depends on your personal code of ethics. But when it comes to the cold, hard reality of finance, impact investing doesn’t produce significantly fewer gains than non-impact investing.
Critics will of course point to the fact that impact investing almost always produces poorer returns. But by how much do “sin stocks” outperform ESG stocks in general?
Again, the data varies greatly, but it seems that in terms of funds, management matters. Some impact-conscious funds outperform the market, while others do not.
Looking at the entire “impact investing world” It’s hard to find clear data, as per the various indicators that exist for measuring ESG performance and the differences in performance.
So, it’s up to investors to simultaneously research the financial and ESG performance of each fund or stock they are considering. In some cases, impact investing makes both financial and ethical sense.
According to the Global Impact Investing Network, the majority of social impact investors are looking for market-rate returns.
Impact metrics
There are a few metrics used to measure social investment returns. One you should be aware of is the Social return on Investment (SRI/SRoI).
It’s simple:
First, calculate SRI = Social Impact Value – Initial Investment Value
Next, divide the value above by the Initial Investment Value.
The Social Impact Value (SIV) uses quantifiable indicators to measure social impact, such as:
- New jobs created
- Improved incomes
- Increases to quality of life
- Number of people trained by programs
Of course, as a beginner in investing, these considerations can add a lot of complexity to your process. At the same time, you may not care for or agree with every individual indicator of the SIV or any relevant impact metrics.
As we’ve covered, there are in fact many ways to measure “impact”.
If you are accustomed to delving through comprehensive data continuously, or if you work for a large corporation, some of these broad metrics may be helpful…
But as an individual investor, you may prefer to refer to more specific, easily understandable measurements of positive impact. Of course, you can also opt to simply create a list of questions that you must answer before making a new investment.
Conclusions
In the final result, the purpose of impact investing is essentially to (at least in part) vote with your money, similarly to how you may vote with your ballot. Likewise, every voter will have their own criteria for what makes a candidate or political party worthy of receiving their vote.
This is an element of investments that appears to be increasingly popular. Corporations and individuals are both responsible for this increase. However, there are always differences in beliefs about what exactly constitutes ESG investing.
As always, you have the freedom to choose your investments, using the parameters that align with both your financial and ethical values.
