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Active investment management’s weekly magazine for fee-based advisors

Impact: The next stage of sustainable investing

by Jan 21, 2016UpClose

Investing in solutions-oriented companies confronting global sustainability challenges.

Investing is no longer about style boxes. In the period ahead, it will increasingly be about goals, and about solutions. It will not be just about equities versus fixed income, or large cap versus small cap, or core versus value versus growth, or correlated versus noncorrelated. We saw a plethora of offerings in the so-called noncorrelated or alternatives bucket following the 2008 downturn—long/short, market neutral, absolute return. The financial services industry will continue to come out with new products, some of which are responsive to actual investor needs, while others are designed primarily to gather assets and revenue. But new products alone are hardly the solution.

The fact is that investors remain somewhat spooked by the market. Once your 401(k) has been turned into a 201(k), you never really forget that—even after the market has surged back and your assets have been restored. Moreover, investors don’t really trust big financial institutions, even if they trust their individual financial advisor. However, they are also cautiously optimistic. So, our industry needs to find ways to be responsive to both their wary skepticism and cautious optimism.

Today, if we want to serve investors, we need to address the question of trust and the related issue of risk—which is always at the heart of investing. One way to do that is to speak to investors’ goals, which go beyond diversification and asset allocation. Their goals ultimately involve the way they want to live and what they want to accomplish—and how their money relates to that. While there is no single answer, I think sustainable investing, particularly as it enters its next stage, can be part of the solution.

Shifting generational and gender attitudes/assets

Not incidentally, we are about to witness a significant generational transfer of wealth to certain emerging demographics—in particular, millennials and women—who indicate they are interested in taking a philosophically different approach to investing.

A recent Merrill Lynch Private Banking & Investment Group report, “Millennials and Money,” found that 29% of investors in their 20s and 30s want their financial advisor to provide “values-based investing.” Of a list of nine priorities, this came in as the third highest.1 A 2013 U.S. Trust “Insights on Wealth and Worth” report found the following among millennials:

  • 69% believe that investments “are a way to express my social, political, and environmental values” (versus 36% of baby boomers).
  • 61% would be willing to accept a lower return in exchange for greater social and environmental impact (versus 39% of baby boomers).
  • 72% would be willing to accept higher risk in exchange for greater social and environmental impact (versus 35% of baby boomers).2

As for women, they start new businesses at twice the rate of men and comprise some 43% of Americans with gross assets of $1.5 million or more, according to the latest government figures. In the U.S., women outnumber men in the attainment of college degrees (by 20%), are already responsible for 83% of all consumer purchases, hold 89% of U.S. bank accounts and 51% of all personal wealth, and are worth more than $5 trillion in consumer spending power.

And women are more inclined than men to want their investments aligned with certain social and environmental values. The previously mentioned U.S. Trust survey of high-net-worth investors found that social, political, or environmental impacts were considered “somewhat” or “extremely” important by 65% of women, but only 42% of men. Significantly, a recently updated survey from the Center for Talent Innovation, “Harnessing the Power of the Purse: Female Investors and Global Opportunities for Growth,” found that 90% of women surveyed say that “making a positive impact on society is important,” and 77% of women want to invest in companies with diversity in leadership.3

We need to offer strategies that are responsive to these aspirations and the growing desire that investments align with positive social and environmental impacts while avoiding problematic ones.


Evolution of socially responsible investing (SRI)

It is no surprise then that there has been a marked evolution in the direction of impact over the last several years in the field of sustainable investing. When my company, Pax World, launched the first socially responsible mutual fund in the United States in 1971, this new model of investing—socially responsible investing (SRI)—was premised on screening out or excluding problematic companies or industries from investment portfolios based upon certain values choices: weapons, tobacco, gambling, alcohol, and so forth. SRI was greeted skeptically in traditional financial circles because the notion that you could achieve market or above-market returns by shrinking the investment universe was counterintuitive.

SRI also included from the very beginning, as a core component, shareholder engagement—from the struggle against apartheid in South Africa to executive compensation (Say on Pay), board diversity, climate change, political and lobbying disclosure, and more. And, of course, it included not only public equities but other asset classes, including community investing in particular, but also some private-equity and venture-capital investing. These aspects of SRI, which were more focused on impact, were significant from the very beginning.

The second stage involved the evolution from what was then called socially responsible investing to what has become known as sustainable investing, where the emphasis is no longer on excluding companies from portfolios based upon problematic products or practices, but rather the inclusion of companies based upon positive environmental, social, and governance profiles (ESG) or performance. Underscoring this evolution from SRI to sustainable investing was an emerging body of research suggesting that ESG factors have financial materiality; therefore, integrating them into portfolio construction was a much smarter investment strategy than simply ignoring them, as was the case with traditional investment approaches.

A growing number of mainstream investors, particularly institutional investors, became more attracted to this approach and began to embrace sustainable investing as an actual investment discipline, rather than just a values choice, premised on the materiality of ESG. Growing numbers of investors began to accept the premise that the financial bottom line, in addition to social and environmental outcomes, could be improved by the inclusion of ESG research and analysis.

The ‘impact’ phase

The third stage in the evolution of sustainable investing, what we might call the “impact” phase, incorporates and builds upon the insights of the first two stages. It has two distinct features: First, it incorporates the premise that sustainable investing strategies should provide market returns, depending on the asset class, and that integrating ESG factors is a strategy for mitigating risk as well as uncovering value that can bolster investment portfolio performance. Second, it insists that investment portfolios, across asset classes, be designed to produce, or at least tilt in the direction of, positive social and environmental impacts.

WHAT YOUNG INVESTORS WANT THEIR ADVISORS TO DO (in addition to providing sound money-management advice)

Impact investing really started with community investing, but has since included private equity, so-called social venture capital (investing in a fair-trade coffee plantation in Costa Rica or a solar start-up in Oregon), and other strategies that did not focus on public equities. It caught on, perhaps because the term “impact investing” seems to capture something that SRI and ESG could not or did not completely capture. It appeals to a growing number of investors for whom screening out bad companies (SRI), or even screening in better companies (ESG), just isn’t enough. The impact component has to be there too.

However, there are limits to the appeal of impact investing and serious constraints on its capacity to have, well, an impact, if its focus remains solely on community and private investments. Simply put, the vast majority of investors are not trust-fund babies or successful Silicon Valley entrepreneurs or large institutional investors who have the capacity, the wherewithal, or even the desire, to allocate a slice of their capital to impact investing.

The vast majority of investors (individual investors, anyway) are invested in the market through their 401(k) or 403(b) plan at work, a rollover IRA from previous employers, or have a financial advisor who has them invested in stocks, bonds, or mutual funds. They own public equities (and bonds), and if their money is going to have a positive impact, it will have to be largely through the public equity (and bond) markets.

This third stage of sustainable investing involves, therefore, an increased focus on investing in high-impact, solutions-oriented companies that are confronting global sustainability challenges—not just start-ups and private placements but publicly traded companies as well. Meeting ESG criteria alone will no longer suffice; there will be an increased emphasis on designing portfolios that include companies whose products, services, and technologies are proactively confronting global sustainability challenges.

Sustainable investing will become more explicitly linked to investing in the future—which is what investing is or should be about anyway. We invest money today hoping that it will grow tomorrow, and increasingly we hope that it not only grows, but that this growth contributes to a safer, saner world.

  1. “Millennials and money,” Michael Liersch, Merrill Lynch Private Banking & Investment Group, 2014.
  2. “Insights on wealth and worth,” U.S. Trust, 2013.
  3. “Harnessing the Power of the Purse: Female Investors and Global Opportunities for Growth,” Sylvia Ann Hewlett and Andrea Turner Moffitt with Melinda Marshall, Center for Talent Innovation, 2014.

Joseph F. Keefe is president and chief executive officer of Pax World Funds and its investment adviser, Pax World Management LLC, as well as CEO of its majority-owned subsidiary, Pax Ellevate Management LLC. Pax World launched the nation’s first socially responsible mutual fund in 1971 and is a recognized leader in the field of sustainable investing—the full integration of environmental, social, and governance factors (ESG) into investment analysis and decision making.

You should consider a fund’s investment objectives, risks, and charges and expenses carefully before investing. For this and other information, call 800.767.1729 or visit www.paxworld.com for a fund prospectus. Read the fund prospectus carefully before investing. Pax World Funds are distributed by ALPS Distributors, Inc. Member FINRA.

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