Investing for Impact: A Brief Guide for the Perplexed
Discussions about investment strategies that take values or ethical principles into account can be confusing. Several different terms are used, often interchangeably; in fact, they may be converging. The most common terms we hear are socially responsible investing (SRI); environmental, social, and governance (ESG) principles; and impact investing.
SRI strategies usually employ screens to identify companies to include or exclude, based on the manager’s or the investor’s ideas about their social impacts.
ESG strategies are similar but tend to focus on certain areas of concern:
•Environmental factors, including climate change, hazardous-waste disposal, nuclear energy, and natural-resource depletion;
•Social factors, including human and labor rights, consumer protection, and diversity; and
•Corporate-governance factors, including management structure, executive compensation, and shareholder rights.
Some, but not all, ESG-oriented institutional investors are signatories to the United Nations-supported Principles for Responsible investment (PRI).
Impact investing goes further: It seeks to invest (usually privately) in organizations having a positive impact in a particular area, perhaps to revive a blighted neighborhood.
Investors often feel empowered by impact investing, but they should recognize the risks. These investments can be as risky as venture capital. Such investments may be best made with capital that exceeds your target financial capital (the amount of money you need to fund you long-term spending).
Impact on Portfolios
There are many ways to address SRI or ESG concerns. Some investment managers buy or create ESG screening tools to help them avoid investing in companies with undesirable practices or products. We think such tools may be useful but are rarely enough. AB integrates research into potential ESG issues for a company into all parts of our research process, from meetings with company managements, suppliers, and industry experts, to monitoring news reports, as the Displayshows.
But assessing ESG issues can raise as many questions as it answers. For example, if you try to avoid investing in companies with high carbon dioxide emissions or abusive labor practices, do you have to check all the vendors of each company you consider? Many technology and clothing companies are now under attack for the actions of their suppliers, or of their suppliers’ suppliers.
Investors should also recognize that both positive and negative screens limit portfolio managers’ flexibility and may affect portfolio returns. Investors with otherwise identical portfolios are likely to have different results, if one of them imposes restrictions on companies in certain industries.
Some ESG advocates argue that companies with an ESG focus can outperform the broad market over time. Other people argue that narrowing the universe of potential investments is likely to detract from long-term returns relative to more diversified standard benchmarks. Perhaps the arguments of the ESG advocates are true, but it’s too soon to tell. While the number of managers that invest with a social lens is growing, few ESG managers have a statistically meaningful track record. Therefore, we think it is still too early to assess the relative performance of the ESG segment.
Investors whose priority is a portfolio that reflects their personal values now have a range of choices to meet their social as well as financial goals. The goal for such investors should be to work with managers who share their philosophy about social issues, as well as risk and return.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.