Is “Impact Investing” the new norm?

Date: Sep 10 2018

Author: 
Paulina Cromwell, CFA, Manager, Knowledge Center, Family Office Exchange

Everyone these days is talking about “impact investing”. A Google search returns over 150 million results for the phrase. There are hundreds of investment managers managing over 1,000 sustainable or impact investment funds.1 But is impact investing here to stay or just a fleeting fad? 

Spoiler alert: Value-aligned investing is the future. 

How it manifests itself will evolve over time and may depend on the role of each of us play in the ecosystem (as a family member/private investor, family office executive, or advisor). But it’s safe to say that impact investing is here to stay and impacts all of us.

Here’s why.

A quick reference on key terms:

  • ESG: Environmental, social, and governance issues; often, an additional layer of screens added to investments (ex: "do no harm" by eliminating investments that have low ESG scores or "seek those who do good" by investing in companies with high ESG scores)
  • Impact Investments: Investments that intentionally seek financial returns and social / environmental returns; expectations for both types of return may vary but are not mutually exclusive (ex: some investments will offer slightly lower investment returns relative to market and/or lower social return relative to philanthropy)

 
 

1. Investors want it 

In a recent survey by U.S. Trust, ultra-high-net-worth individuals and families indicated that living true to their values is their #1 life goal. They also shared that after ensuring financial security for self/family, their primary motivation for creating and building wealth is to help others – through philanthropy and creating economic opportunity.

Six in ten people said that a company’s track record on environmental, social, and governance (ESG) issues was a key factor in their investment decision-making process. It was especially crucial for nine in ten millennials,2 who are committed to aligning their investments with their values.

Why is this important? Well, 69% of Family Offices expect to undergo a wealth transfer in the next 15 years.3 And according to research by Oppenheimer Funds, the first thing millennials are going to do with the family portfolio is increase impact & ESG investments and incorporate ESG factors into the overall benchmark.4

Family Office executives, investment advisors, and businesses seeking investment need to understand investor preferences and decision-making or they will be left behind. Not to worry – we are here to help (and even working on a “How To” guide).
 

2. Transparency is raising the bar across the board

We live in a time where the internet, social media, and 24/7 news coverage means that information travels wide and fast. Just the other day, Elon Musk smoked marijuana during an interview on a live late-night video podcast. The following morning, Tesla stock dropped almost 10% at the market open, costing investors over $3 billion in a day.

It only took two weeks for Volkswagen to lose nearly half of its market value following the admission of cheating carbon emission tests. Three years later, they have yet to recover. 

Today’s increased transparency and speed of information delivery is raising the ethical bar for companies across the board. You better believe that no other organization wants to experience that kind of public humiliation or spend years earning back the trust of its investors.

Additionally, the SEC now requires that every company report set metrics on environmental impact, social issues, and governance practices in their annual filings. This additional information gives investors and others in the business community an objective way to assess and compare public companies. 
 

3. It’s good for business 

The legal obligation of a business is to pursue the interests of shareholders (which are typically to generate a profit). So should they be worried about impact even if shareholders aren’t demanding it? Absolutely – it’s good for business. 

Several studies have shown that the best-performing public companies have better ESG ratings than the worst performers. The jury is still out on which specific metrics are best indicators of future performance, but in general, companies that treat their employees, communities, and investors well should do better in the long run. If you’re still not sold, Larry Fink (founder and CEO of the largest investment firm in the world) wrote a letter to CEOs of public companies earlier this year, reminding them to include impact as part of their business strategy if they wanted to remain competitive and relevant. This was a huge step for the investment and business community – bravo, Larry! (Also, be on the lookout for a deeper dive from us on this topic, coming soon).

But what about private businesses and new ventures? it turns out, “impact-themed” businesses are almost inherent in modern entrepreneurship. Why? It can be partially attributed to the demographics of up-and-coming entrepreneurs – many are millennials with a dual impact and business agenda.

But more importantly, successful ventures solve a problem or fill a gap that others have not yet. Where are those gaps in products or services? We are certainly not short on designer cat sweaters or scented candles. What the world is short of however is clean water, accessible healthcare, and reliable infrastructure. An entrepreneur who can find a way to fill one of those gaps in a profitable way is going to make a lot of money – for themselves and their investors. The bonus happens to be that those products/services enhance the lives of people all over the planet.
 

4. The industry is maturing

Let’s go back to those investors who are actively seeking dual returns (remember, an impact investment intentionally seeks both financial AND social/environmental return). Many of these investments do succeed, but sometimes only on one front (as in, “congratulations, we achieved a 20% return but aren’t much closer to eliminating child homelessness”). Despite their best intentions, many investors end up settling for success on an OR basis, not AND.

But how does one measure AND? Financial return is straightforward, but what about the rest? In the past, many philanthropists and “impact investors” relied on blind faith that their dollars were in fact making a tangible impact. They’d periodically get a postcard with a child’s smiling face on it and have to hope that was representative of the truth.

Over the last several years, there has been an increased focus on measuring the social and environmental impact in a quantitative, analytical way. Experts in the philanthropy and investment fields are working together to apply the same rigor of investment analysis to the impact side. As this continues to develop and the ability to accurately and quantitatively evaluate both types of return becomes achievable and comparable across investments, these factors will become an integral part of the due diligence process. 

So, have I convinced you yet? 

Some things may vary – the definition of impact, opinions on the subject, and the role they play in the investment ecosystem. But one thing is for certain – impact investing is here to stay. 

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Be on the lookout for upcoming publications on value-aligned investing across the family enterprise.

 

Cited Resources

  1. US SIF Foundation: Report on US Sustainable, Responsible and Impact Investing Trends 2016
  2. 2018 U.S. TRUST Insights on Wealth and Worth®
  3. Lenok, D. (2017, September 15). Charitable Giving. Family Offices Anticipate Change. Retrieved from www.wealthmanagement.com
  4. OppenheimerFunds and Campden Wealth - Coming of Age: The Investment Behaviors of Ultra-High-Net-Worth Millennials