For most investors, a strong annual return to help grow the family assets is almost always the top priority. But a growing number of investors also want their investments to reflect their social and environmental values.
The two goals aren’t mutually exclusive. In fact, more people are finding they can do both. It’s called “impact investing” – investing in companies, nonprofit organizations and funds with the goal of generating social and environmental impact, as well as a strong financial return.
“Our clients view investment as the economic expression of their thoughts and values,” says Thomas Van Dyck, a financial advisor for RBC Wealth Management-U.S. in San Francisco who consults on $1.8 billion of socially responsible assets. “What you buy at the store, how you vote and what you invest in should align with the values you support.”
A growth area
Although the label “impact investing” only emerged in 2007, it’s part of a broader realm of responsible investing that dates back to the 1970s. Other strategies include socially responsible investing (SRI), which prioritizes investing in companies that are openly committed to having a positive impact, and incorporates environmental, social and governance factors (ESG) into the investment screening process. Impact investing can include characteristics of SRI and ESG.
Today, impact investing is on the rise, but many investors are confused about its value, according to a recent survey by RBC Global Asset Management, the asset management arm of RBC that provides investment products to investors around the world. The inaugural survey, which was released in November 2016 and is entitled Near-Term Uncertainty, Long-Term Opportunity, indicates that investors want more information showing how they can use their capital to achieve positive change while growing their assets.
“So many people are confused by the space,” says Kent McClanahan, a senior research analyst for RBC Wealth Management-U.S. in Minneapolis, explaining that many of the terms used to describe impact investing are vague and therefore difficult to understand. “We really try to define it for our clients.”
It appears to be working. RBC financial advisors and portfolio managers say they’re seeing a significant increase in interest and capital going toward impact investing. The proof is in the data.
Impact investing assets under management in the U.S. nearly tripled – from about $3 trillion in 2010 to $8.72 trillion in 2016, according to the 2016 Report on US Sustainable, Responsible and Impact Investing Trends by the US Forum for Sustainable and Responsible Investment, also known as US SIF. Today, such assets account for more than $1 of every $5 professionally managed.
As well, a 2015 report by RBC Wealth Management and Capgemini found that 92 percent of high net worth individuals say driving social impact is important to them. While high net worth individuals are certainly part of the trend, more often it’s family offices, endowments and nonprofit organizations that lead the way.
One family foundation Van Dyck works with, for example, was already donating 5 percent of its assets to good causes. Eventually the foundation decided to add ESG advisors and criteria to all of its assets. “Investors can start making a significant change with their money,” he says. “They’re also creating a legacy to pass on to the children.”
Risk and reward
Two common misperceptions about impact investing involve risk and returns. Only 30 percent of respondents to RBC’s responsible investing survey believe that environmental, social and governance factors drive greater financial performance, or “alpha.” And only a third think these factors reduce investment risk.
However, investors should not assume that they are sacrificing returns by making investments that reflect their particular values. In fact, impact investing and ESG criteria can both lower risk and drive alpha.
“Many investors may be happy with a lower return for the satisfaction they get in outcomes,” says Jeremy Richardson, a London-based senior portfolio manager for RBC Global Asset Management’s global equity team. “But investors should not expect a lower return.”
To drive alpha using ESG factors, McClanahan suggests looking for opportunities to invest in emerging technologies or new industries looking beyond social and environmental changes. When California required all residents to cut their water usage by 25 percent, for example, this may have been an opportunity to invest in companies developing water innovations.
Studies show that ESG portfolios are less volatile and perform better over the long term than non-ESG companies. Analysis by the research firm MSCI found that ESG strategies outperformed the global benchmark by as much as 2.2 percentage points a year from 2007 to 2015.
Since 1994, gross returns for the MSCI KLD Domini 400 Social Index were slightly higher than the MSCI USA IMI, an equity index of large-, mid- and small-cap companies.
By investing with ESG standards in mind, investors can also lower their risk of being exposed to corporate scandals or environmental catastrophes. That, too, can drive alpha.
Perhaps that’s why more high net worth individuals and institutional investors are investing in mutual funds that incorporate ESG criteria, dedicating 5 percent to 20 percent of their portfolio toward a specific interest or integrating ESG screening across their entire portfolio. Some are filing or supporting shareholder resolutions on social and environmental issues.
Top ESG criteria include environmental issues, regions with conflict risk, weapons production and human rights. Climate change investing, which includes fossil fuel restrictions, is the top environmental factor affecting assets, according to the US SIF.
Risk avoidance is often used to exclude certain types of investments that don’t align with an investor’s values. The RBC survey, however, found that 52 percent of respondents think negative screening is only for mission-driven investors and don’t apply to them, which reflect some ongoing confusion.
“The greatest wealth creation opportunity of the upcoming generation is to identify companies that are embracing the transition to renewable energy across industries from transportation to technology,” notes Van Dyck.
A burgeoning market is bound to have some growing pains. One concern of impact investing identified by US SIF is the lack of information disclosed by companies about the specific ESG criteria used.
Our RBC responsible investing survey showed that 43 percent of respondents are dissatisfied with the amount of ESG-related information from companies. That means wealth managers and portfolio analysts will play an important role in developing and explaining research to investors.
RBC Global Asset Management has been integrating socially responsible investing criteria throughout its investment process since 2014. In 2016, RBC received an “A+” for overall strategy and governance from the United Nation’s Principles for Responsible Investing.
“Why wouldn’t you want to consider environmental resource risk mitigation, employee safety or corporate government practices?” asks McClanahan. “You can always make the world a better place.”