The real impact of impact investing

Whether it concerns climate change, supply chains, human rights or corruption, investors increasingly seek to better understand the impact that their investments are having.

One recent Bank of America press release states that three-quarters of investors want to work with an advisor who offers investment strategies that result in competitive returns and positive impact. An even higher percentage of millennials want to make a connection between financial and societal outcomes — as high as 86 percent, according to a recent Morgan Stanley analysis.

But can investors really have a positive impact with their investment dollars while also maximizing financial returns? This is no small matter. It is more than a trillion-dollar opportunity — consider that Bank of America alone has a client base representing over $2 trillion in assets.

What makes this question difficult is that the field of impact investing hasn’t always asked the right questions when it comes to maximizing impact. What’s really needed is a paradigm shift across markets. Impact cannot and won’t be maximized if "impact investing" remains siloed to high-net-worth individuals and foundations. Impact investing needs to factor in all asset classes to be as meaningful as it can.

Consider that the 2017 Impact Investor Survey by the Global Impact Investing Network calculated the amount of money deployed into impact investing as roughly $110 billion, a tiny fraction of the $70 trillion value of public companies. Unless impact investing becomes more inclusive and more accessible to everyday American investors — U.S. mutual funds are in fact the world’s largest component of corporate ownership — we will continue to miss out on 99 percent of the impact that investing can have by affecting existing companies and markets.

While a few ratings, such as from Morningstar, have begun to ask how to have impact within public equities, those attempts miss the mark by a wide margin. In 2016, Morningstar began assigning funds a 1-5 "globes" rating, representing the approximate proportion of companies with high Sustainalytics ESG scores.

We applaud Sustainalytics and Morningstar for taking this bold leap, but merely calculating the degree to which fund managers follow Sustainalytics data comes across as self-serving, especially given that Morningstar has a 40 percent ownership position in Sustainalytics.

Moreover, for public companies, ownership and ESG data aren’t close to the entire impact story. Shareholders also can move companies in positive directions through shareholder engagement. As a result of simply considering all impact categories, a better way emerges to understand how your investment dollars can have the most impact possible.

Beyond marketing spin

To pose just these questions, a group of us recently co-founded Real Impact Tracker. Building on an academic paper regarding the best pathways to impact, Real Impact Tracker recently launched its first Real Impact Fund Rating, scoring the relative environmental and social impact of publicly available U.S. mutual funds and exchange-traded funds, or ETFs.

Rather than cross-referencing fund holdings against a set of pre-determined stocks, we looked at how a fund manager generates impact through levels of ESG integration strategy and execution, as well as through shareholder engagement and public-sector advocacy. This rating goes beyond marketing spin to judge how funds are creating positive impact on top of financial success for their clients.

Rather than rating what companies a fund owns, Real Impact Tracker rates what funds actually do.

Examples of real impact include a 2015 coalition of investors successfully pushing for an end to forced child labor in Uzbek cotton fields, and the 2014 "Aiming for A" coalition pressuring energy companies to disclose climate risk.

This simply isn’t true, or at least it doesn’t have to be. Rather than restricting an investable universe through screening, which is an outdated paradigm, investors can amplify performance when they add ESG data and questions to fundamental analysis. In fact, investment dollars have been moving most rapidly towards value investors such as Generation and Parnassus, which have been outperforming benchmarks at a time when most active fund managers do not.

When you look at Real Impact, an interesting picture emerges. Our initial rating looked at the largest 70 percent of fund managers, ranked by assets under management, that have a U.S.-listed public equity fund, plus traditional U.S. SRI firms and some European fund managers making their mark in the U.S.

The highest impact funds successfully have tracked the returns of their benchmarks, meaning individual investors have had positive impact through their investment choices without sacrificing financial returns.

The top of the list comprises U.S. ESG specialist firms and U.S. offerings from large European asset managers. Even though these funds hit their performance benchmarks, they manage relatively low amounts of assets.

The top two scores, for Walden Equity and Pax Global Environmental Markets sub-advised by U.K.-based Impax Asset Management, each manage under $1 billion. This mismatch of low assets in high-impact funds reveals that investors haven’t yet recognized funds that have allowed for creation of positive impact without sacrificing returns.

Two main differentiators emerged between the Real Impact Tracker ratings and traditional public-equity fund impact ratings:

  • First, there is a significant difference in impact among mainstream U.S. asset managers. For example, BlackRock and State Street stand out for their recent commitments to ESG integration as well as engagement with companies and the public.
  • The second major difference is that a number of SRI- and ESG-branded funds came out towards the bottom of the list. The fact that the rating picked up the low-impact of some specialty funds demonstrates the tool’s ability to cut through marketing spin.

It is important is for investors to understand, arguably for the first time, how they can maximize their own positive impact — and that maximizing positive impact doesn’t mean having sacrificed financial performance at all.

U.S. investors are the world’s largest factor within corporate ownership, making very clear the potential for a positive dynamic to develop from sustainable investing. Companies in all sectors need to be mindful of this developing story: At the end of the day, what investors demand, companies will provide.

That is, the future of investing can be sustainable by choice.

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