From your shoes to your car to where you spend your summer vacation, how you choose to spend your money speaks volumes about what you value. Yet when it comes to investing, many people seek only returns without thinking about what their money is supporting. With impact investing, investors are able to be more intentional about where they invest so their portfolios can have positive influence.
“Every portfolio has an impact,” says Kent McClanahan, vice president of responsible investing for RBC Wealth Management-U.S. “But impact investing is about being more conscious of what your money is doing.”
Put your money where your heart is
If you have a cause you want to support, you might donate to a nonprofit organization to back their mission. Impact investing is similar in that you choose companies, funds or projects that align with your values. However, you're also analyzing these investments on their ability to generate a positive, if not competitive, financial return.
Much like finding a nonprofit to support, you start by determining the impact you want to make. Do you want to fund a startup biotech company developing a potential cure for cancer? Or do you want to invest in technologies that can reduce the impact of climate change? Perhaps you want to ease income inequality by financing affordable housing in your city? The goal is to seek investments that directly correlate to your cause so you know your money is going directly to funding their work.
At the same time, impact investing is not charity - you should expect your investment to generate a financial return in addition to a societal return. How much of a return depends largely on your goals.
“One of the dichotomies within impact investing is whether the expected returns are concessionary or market driven,” says Ron Homer, chief strategist for impact investing at RBC Global Asset Management. “There are some impact investment strategies where returns are secondary to the impact. On the opposite side, our strategies are designed to provide the double impact of market returns and social benefits. In some cases, the social benefit can drive excess returns.”
Taking care with responsible investing
Impact investing is a subset of what is known as responsible investing. While each method can generate good returns while doing good, each strategy accomplishes that task differently. In addition to impact investing, the two other approaches of responsible investing include:
- ESG investing: ESG investing involves looking at how companies in your portfolio score on metrics related to their environmental, social and governance commitments relative to their peers. While the score is monitored, it isn't used as a deciding factor for investment.
- Socially responsible investing (SRI): SRI investing takes things a step further by using ESG scores to identify companies that share your overall values, even if their product isn't directly related to improving the world. It's also used to screen out companies that don't fit your values, such as an oil company that also invests in clean energy.
With impact investing, unlike ESG or socially responsible investing, outcomes are key. While a company might have a strong ESG score, that score is generated by how the company affects the environment and the community through its policies and actions, not on the impact of their products or services. Additionally, many ESG or socially responsible funds have a reputation for making an investment first and then measuring the impact after, diluting the potential good you can accomplish. An impact investment must be focused on companies that set out to accomplish a specific goal, such as clean energy or reducing inequality.
How to make an impact in your portfolio
Impact investing is still an emerging approach, with no set standards. This means you may need to dig a little deeper to ensure prospective investments meet your requirements.
The good news is that impact investing is becoming easier for investors. For example, the European Union passed a rule called the Sustainable Finance Disclosure Regulation that requires fund managers to share a measurable plan for how their investments meet their stated ESG goals. This will help create a culture of impact measurement that increases investor expectations for ESG and impact data, which will encourage companies to improve their reporting, McClanahan says.
“Now if an investor wants to have an impact within the public markets, we can measure it a little bit more so they can make an intentional investment,” he says.
How to get started with impact investing
For investors looking to get started with an impact investing approach, the first step is to choose where to focus. According to Homer, the two fastest-growing areas for impact investments are climate change and reducing social inequality through community development and social justice.
Once you choose your areas of focus, you should work with your advisor to measure the impact of your portfolio and make decisions about how you should reallocate investments.
Impact investing allows more of your money to work as one to create the most positive impact. “Think about someone who's using their philanthropic dollars to address an issue because they feel passionate about it, yet their investments might be working to support the problem they're trying to address,” says Homer. “If this is important to me and I'm trying to solve it with my vote, my volunteerism or my philanthropy, putting my money to work on the other side to have an opposite effect doesn't make a lot of sense.”
Your advisor can help you prioritize all of your various passions and causes so you can optimize your portfolio to make the greatest difference.