Investing for Good

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.

A Growing Trend

Impact investing has gained significant momentum in recent years. Hundreds of 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, 43% 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 33% of Gen X investors and 25% of baby boomers. 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.

Gauging Impact

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 they do so for their SRI attributes, not their creditworthiness.

The Performance Question

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.

Tips for Impact Investing

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.

1. Define your objectives. Being "socially responsible" is a broad mandate. Different funds, companies, and strategies may stress different objectives. Some may focus on environmental factors, some on social or corporate governance. And some may be very specific. So before you choose which best suits your goals, make sure you identify what those goals are.
2. Strike a balance. The most socially responsible investments may not be among the best performing. Although, in the aggregate, socially conscious funds have kept pace with the broader market, many individual funds or stocks have not. When researching candidates, you will want to strike a balance between performance and social objectives and set limits as to how far you are willing to compromise on one objective to meet the other.
3. Diversify. Just like with a traditional portfolio, impact investors should also diversify their portfolios by risk and asset class, targeting an asset allocation that is in keeping with their investing time horizon and appetite for risk. Socially conscious funds can now be found in all major asset classes, permitting investors to diversify while pursuing social causes.
4. Work with a professional. There are hundreds of socially conscious funds and many more that have high sustainability ratings. There are also thousands of companies that promote different social causes. Choosing among them while also adhering to an investment strategy that suits your non-social goals can be complex, so you may want to work with your financial professional to ensure that your choices address your unique circumstances and needs.