Many impact investors share some of the same concerns with respect to the environmental, social, and governance (ESG) issues they hold dear. There are certainly significant differences re: the level of urgency and passion people feel about a particular topic, but most people who are inclined to factor in non-financial criteria don’t want to invest in companies that are serial polluters, e.g. those who are engaged in extraction industries that wreak havoc on the planet. Many of those same companies (e.g. mining) also have considerable baggage around social and governance issues. They are often known for low wages, coupled with unhealthy and sometimes dangerous workplace conditions. In many cases, they also have insufficient representation of women and minorities in management, and in the board room.
Most impact investors agree that they don’t want to invest in tobacco companies. Some prefer to avoid other “sin stocks” such as alcohol, gambling, and pornography. Many like to steer clear of weapons and defense contractors.
On the positive or “inclusionary” side, most impact investors agree that investing in companies that treat their employees well is a plus. Companies whose products or services have a positive societal or environment impact are also generally favored. The promise of the renewable energy sector holds great appeal for many but we need to make sure that the higher risk profile of many of these investments is appropriate for their situation.
There are many issues though that represent the grey areas of ESG investing. Is the pharmaceutical industry a primarily positive force that saves lives, or a deceitful industry that engages in unfair pricing practices? It depends on one’s perspective and reasonable people can agree to disagree.
Is natural gas a bridge fuel to help us in the transition to renewables, or is it just a somewhat cleaner burning fossil fuel that is slowing down the transition with the help of governmental policies and subsidies which favor it? Is nuclear power a clean and safe alternative to fossil fuels, or are the environmental questions re: the storage and disposal, a deal breaker? Are the national security implications for such a centralized industry too problematic, or can those risks be adequately mitigated?
Are Developing Markets appropriate for impact investors looking for diversification even though the bar is often set much lower with respect to many key issues? Is directing capital to these companies part of what’s necessary to get them the funding they need to evolve, or are we just supporting enterprises that hurt people and the planet? These are all fair questions and our goal is to make sure that we align our portfolios as closely as possible with a given investor’s risk tolerance.
Once we’re clear on what ESG priorities are to be emphasized, we need to think about the financial impact the implementation of these screens has. While academic studies and our actual “real life” experience suggests that returns are not materially impacted by screening over the long run, we sometimes do see increased risk in the form of heightened volatility. It’s both an art and a science to make adjustments to a portfolio to ensure it remains properly diversified and aligned with a given investor’s risk profile and financial objectives. Advisors and money managers who are experienced in this realm can be extremely helpful since portfolio impact is just as important as ESG impact. The effect of implementing various screens can change the risk profile in fairly dramatic, and not always expected or intuitive, ways. Positive social impact and desirable financial outcomes can go hand in hand but as is the case with many things, the devil is the details.