Impact Investing: Is it a Priority in Your Portfolio?

You probably don’t know the term impact investing. Yet, more than likely you do know about investing with a socially responsible bent. They are one in the same. Yet socially responsible investing or SRI has not been all that investors had hoped it would be. Could a simple name change create a different feeling? Possibly so.

Socially responsible investing has been around for decades. As folks understood the need to grow their money (most of us since the advent of the 401(k)), some of us wondered if the pursuit of increased wealth couldn’t be done without the appearance of profit at any cost. We wanted companies that aligned with our values. Trouble was, the vast majority of companies were not focused on these goals. They were beholden to shareholders to increase their profits and in doing so, sidelined any concerns they may have had in attaining them.

Proof that investors can influence the typical business model, SRI funds were born to create a place where managers vetted the companies they invested in based on the chartered criterion of their investors. But the choices, at least in those formative years were limited. It was simply too difficult to produce industry average returns when the cost of “doing the right thing” was so high. Not all investors were not willing to take a lower gain for a higher moral stance.

Why did this discussion about “doing the right thing” begin? In the fifties, some individual investors saw the opportunity in the concept of doing good and focused those investment dollars on emerging economies. Even with the risk that these investments often have, these developing countries had the chance to begin their journey in the right direction. Unlike their established counterparts, invested dollars could make a difference in more than just business profits, but in the local economies as well. Yet the definition of emerging markets (which includes powerhouse countries such as China, India, Brazil and Russia) left investors wondering whether all of the socially responsible effort would ever right so many inconsistencies. Can a whole of a government be redirected by simply investing in the business conducted there? Could you be rest-assured that the dollars you invested were doing what you had hoped?

Socially responsible investing takes numerous forms these days with over 250 funds offering something for everyone. You can base you investment on the environmental impact, the religious belief you harbor or even on the underlying human rights of the workers – just to name a few. And in the process, feel good.

From a different perspective, what you are doing when you invest in an SRI is limiting the fund manager, tying her/his hands and as result, you compromise the potential for larger returns. You risk your principled standards for the risk that your money may not beat the market averages. To date, these types of funds have over $300 billion invested, still small when compared to the total market. SRI disagrees with the average investor by making the statement: just because it makes money doesn’t mean I agree with how.

Impact investing takes the initiative further in pursuit of what is socially responsible. Global Impact Investing Rating System was developed to identify more than just the businesses who are trying to make a difference on the surface. GIIRS, according to its website “is a comprehensive and transparent system for assessing the social and environmental impact of companies and funds with a ratings and analytics approach analogous to Morningstar investment rankings and Capital IQ financial analytics.” For all of you who have toyed with the idea of not just simply investing but doing so for the greater good, this has been what this industry has been lacking.

By developing a rigorous and transparent set of independent standards, GIIRS is hoping that investors will have a clearer picture on the good they can do even if the returns on their investments might trend slightly lower. Often, that trade-off is enough to give these investors peace-of-mind. What the GIIRS can’t do is drive the cost of these types of funds down.

Far too many of these funds are actively managed with only a few indexed SRIs available. Yet those indexes, according to a paper written by Meir Statman, Glenn Klimeck Professor of Finance at Santa Clara University in 2005, they do compare favorably. But as Mr. Statman notices, the standards for the indices themselves warrant close scrutiny. While KLD and Calvert, who construct some of the indexes used admit they try to meet the overall standards of social impact, only companies who have attained a negative rating are excluded. Based on that assessment, these indexes may only be reaching part way, leaving in the mix companies who aren’t completely on board with the concept or have some distance to go.

Bottom line, it will still cost more than it should to invest successfully in these types of funds. The fees will still give many investors pause to think. And I wouldn’t expect too many of these investments to show up in your 401(k) any time soon. And even the ETF representation is not a stable as it should be. A rating system although, could improve these offerings.

For a company or fund to be rated, they must , as B Corporation suggests aim higher. B Corporation believes it can help the world by building better businesses – which should make socially responsible investing easier and more cost-effective in the process. Using a simple outline, they seek to untether many businesses from the corporate restrictions they now face. They are offering a list of companies that  meet comprehensive and transparent social and environmental performance standards, meet higher legal accountability standards and in doing so, build business constituency for good business. Combined with GIIRS, the profile of doing the right thing will improve.  (To see a list of B corp companies, click here.)

If the standard catches on, you may be asking your planner/broker/advisor for not only the Morningstar rating of a particular fund but the GIIRS rating as well. And this may give you pause to think: is sacrificing a percentage point of overall return worth it if the sacrifice improves the world? The end-result could be a more vibrant global economy that would make you feel better about your investments and might even close the gap between responsible investing and the rest of the world.

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