Sustainable investing is on the rise, accounting for about $1 in every $3 in actively managed assets.1 And with more investors interested in companies with responsible corporate governance, climate change commitments and long-term sustainability plans, this rise in sustainable or "impact" investing may push many publicly traded companies toward more environmentally and socially responsible decisions.
Here is how to begin impact investing and what you may experience when transitioning into more socially responsible investments.
What is Impact Investing?
Impact investing is often referred to as sustainable investing or socially responsible investing. 2 It refers to an investment philosophy that focuses on companies and funds committed to positively impacting a specific social, environmental or charitable cause. Impact investing funds tend to avoid certain sectors, like tobacco and alcohol producers, entirely. In other industries, like energy and transportation, fund managers may choose only a few select eco-friendly companies for investment.
The World Economic Forum estimates that there is a persistent annual financing gap of $2.5 trillion that hinders the achievement of global sustainable development goals. 3
In addition to sustainable development, clean energy, climate change initiatives, resource conservation and environmental stewardship, there is a wide range of social issues that impact investing focuses on, which include:4
- Human Rights: Protecting and preserving fundamental human dignity and personal freedoms, labor practices, safe working environments and respect for indigenous people.
- Diversity and Equality: Reduction of income inequalities, increased financial literacy, inclusive economies, loans for minority- and women-owned businesses, anti-discrimination standards with gender diversity in upper management and those serving on corporate boards.
- Health and Well-Being: Access to essential medicine and healthcare in underserved communities, reducing toxins in consumer products, lower use of pesticides in agriculture and work safety.
- Community: Protecting public education and healthcare systems, affordable housing, sustainable infrastructure, public transportation systems, anti-corruption with responsible tax laws and political action.
Each company included in an impact investing fund must undergo vetting by the fund manager, based on criteria like management structure and diversity and the long-term environmental sustainability of its product or service. Many popular impact investments focus on eco-friendly technologies, from electric or hydrogen vehicles to solar farms, water purification or sustainable multi-family housing.
Benefits and Drawbacks of Impact Investing
Although impact investing is not solely motivated by the rate of return, some impact investing funds may compare well with more traditional investments.5 Potentially, if companies focus on sustainability and long-term planning issues, traditional and impact investments have a possibility of becoming more aligned – but keep in mind that some believe uncompensated risk or lower returns are part and parcel with impact investing.2
Impact investments, as the name implies, may also directly impact the populations they serve. Companies might focus on providing clean water to areas with lead in their water supply pipes or developing more efficient ways to manufacture energy.
But impact investing is not without some risks, too. Because this investing sector is relatively new for investors and fund managers alike, investors may need to select fund managers who find socially responsible companies for investments.
There is also no guarantee that a particular socially responsible investment will establish the change it intends. This challenge may be true of newer funds and companies with great ideas but struggle with execution or follow-up.
Finally, you will need to keep an eye out for potentially higher-than-average fees associated with impact investments. The higher the fees you pay, the more return your investments will need to earn to cover these increased costs. If your fees are too high, you could end up lagging overall market returns or even paying more money to manage investments than the investments themselves yield.
Getting Started With Impact Investing
There are several ways to begin impact investing, whether you are just interested in sustainable stocks or considering putting your entire investment portfolio into socially responsible investments.
First, you may hand-pick some socially responsible companies yourself. Many stock screening websites, like Morningstar, Motley Fool and others, include corporate governance and social responsibility data that may help you gauge just how sustainable a particular company is. Once you have a basket of socially responsible stocks, you may allocate your investment dollars according to your desired asset allocation and risk tolerance.
You may also look into SRI or Environmental, Social and Governance index funds. These funds are similar to other index funds that might track a particular stock ticker, like the Dow Jones Industrial Average or S&P 500. However, they invest only in selected socially responsible, publicly traded companies.
Although the decision to begin investing in "impact" stocks is an individual one, those interested in impact investing are in good company as the number of impact investors may increase over the next decade or two. Your financial professional may work with you to help you understand the risks and benefits impact investing may have on your portfolio to see whether it is an appropriate choice for you.
Important Disclosures:
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
Socially Responsible Investing (SRI) / Environmental Social Governance (ESG) investing has certain risks based on the fact that the criteria excludes securities of certain issuers for non-financial reasons and, therefore, investors may forgo some market opportunities and the universe of investments available will be smaller.
Dow Jones Industrial Average (DJIA): A price-weighted average of 30 blue-chip stocks that are generally the leaders in their industry.
S&P 500 Index: The Standard & Poor's (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization US stocks.
1 https://www.cnbc.com/2020/12/21/sustainable-investing-accounts-for-33percent-of-total-us-assets-under-management.html
2 https://smartasset.com/investing/what-is-impact-investing
3 https://www.weforum.org/agenda/2020/01/unlocking-sdg-financing-decade-delivery/
4 https://www.domini.com/investing-for-impact
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