Investors looking to make a difference are generating a growing interest in impact investing
Despite the buzz surrounding the topic of impact investing, many people are still not clear on how to define this innovative investment approach. In simple terms, impact investing is investing with the goal of generating positive social and/or environmental impact in addition to financial gain. Whereas socially responsible investing (SRI) aims to avoid investing in companies with harmful effects on society or the environment, impact investing goes a step further to actively support those organizations with a mission to make a positive impact.
Impact investing has gained significant momentum in recent years. Over 450 mutual funds are now focused on environmental, social, and corporate governance (ESG) causes, while a number of exchange-traded funds now feature SRI strategies. What is fueling this growth? Demographics, for one. According to one study, 45% of high-net-worth millennials are interested in using their wealth to help others and consider social responsibility a factor when investing their money. This compares with just over 30% of Gen X investors, baby boomers and seniors. What's more, women -- who are more likely to value impact investing than men -- have taken a more active investing role. Climate change, corporate scandals, and increased availability of information have also helped drive the growing interest in impact investing.
When socially responsible funds were first introduced, fund managers researched and screened each potential investment for its "social rating," applying a unique mix of positive and negative screening methods to include or exclude companies from their investment universes. The process consisted primarily of avoiding negative-impact companies and identifying sustainable ones.
Today, managers go beyond positive and negative screening by engaging in community investing and shareholder resolutions. What's more, an increasing number of corporate issuers are providing sustainability reporting, making it easier for research firms and investors to evaluate the ESG-related risks and opportunities associated with an investment in a company.
In addition, there are now more indexes tracking these investments, such as the MSCI ESG Index, and third-party companies that rank investments for their social accountability. Similar to rating agencies such as Moody's or Standard & Poor's these firms also screen and rate companies, but for their SRI attributes, not their creditworthiness.
Proponents of impact investing have always had to combat the notion that socially conscious investments underperform the broader universe of investments. Yet there is a growing body of evidence that suggests otherwise. In fact, stocks issued by companies defined as socially conscious have provided returns generally comparable to those of the broader market.
Keep in mind that not all companies that fit the socially responsible investment criteria will succeed, and many may still underperform relative to their benchmarks. For instance, many alternative energy companies, which are typically included among socially conscious investments, significantly underperformed the broader market during the most recent recession and demonstrated greater volatility. Just like the broader market, some companies and industries can be riskier than others.
Investing with a conscience is not that different from investing just for profit. It involves another layer of thinking and analysis, but otherwise calls for the same scrutiny that should be applied to traditional investing.
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