Making a difference goes beyond volunteering and donating money: It can also extend to your investments. Impact investing is a way to put your investment dollars to work, promoting good in the world and in your portfolio.
Impact investing definition
Impact investing is an investing strategy that focuses on investing in companies that create measurable, positive change in the world in addition to generating a financial return. Impact investors often focus on a company or investment fund’s environmental, social and corporate governance (also known as ESG) impact.
Since everyone has different values, where you want to have an impact may differ from someone else. Some investors may use their religion to guide their investment choices, others may feel moved to act by current events. But no matter what your values are, you can find impact investments that align with them.
Impact investing vs. socially responsible investing
The world of impact investing is full of labels, but some mean more than others. Here is what each one actually means and how they are used to create impact portfolios.
General terms for impact investing
Labels such as socially responsible investing and impact investing are often used synonymously, alongside other terms like ethical investing and sustainable investing. They usually refer to a similar idea: Using your investing dollars to make a positive difference in the world.
Environmental, social and governance investing
Impact investors often use environmental, social and governance, or ESG factors, which are a set of guiding principles that focus on environmental, social and corporate governance concerns, when choosing investments.
Many independent research firms use ESG scores to help grade investments along an ethical curve. For example, if you’re creating an impact portfolio focused on the environment, you may look for investments that receive a high ESG score in the environmental category.
Impact investing strategy
Regardless of what you call your form of ethical investing, there are generally three strategies for making your portfolio more impactful:
- Exclude investments in what they consider “unethical” companies.
- Include “ethical” investments.
- Include and exclude particular investments.
That’s why it’s important to understand the methodology behind how investments are chosen for a portfolio.
How does impact investing work?
On a large scale, impact investing works by channeling investor dollars into companies that promote good in the world, or avoiding those that do not. For example, an investor may choose to put their investment dollars toward a renewable energy company over an oil company.
Impact investment fund reports provide information about the real-world changes the fund is making through its investment choices. However, specific investments aren’t the only ways of making an impact; activism can also have an effect.
For example, according to the latest data from BlackRock, the company’s iShares MSCI USA ESG Select ETF (one of the highest-rated ESG funds) has 44.06% lower carbon emissions than its reference benchmark (the MSCI USA index).
Is impact investing a good idea?
Whether impact investing is right for any one person’s portfolio will depend on a lot of factors. But is impact investing profitable? In short, yes. According to the Global Impact Investing Network’s 2020 Annual Impact Investor Survey, 68% of respondents reported that in 2019 their investments met their financial expectations; 20% said they outperformed. In addition, a 2020 analysis from asset-management firm Arabesque Partners found that 80% of reviewed studies demonstrated sustainability practices positively influence investment performance.
As with all forms of investing, impact investing does pose some risk. However, sustainable funds may offer lower risk than traditional funds. Having lower-risk investments can help protect your investment portfolio from market turmoil. In fact, according to Morningstar data, 24 out of 26 ESG index funds outperformed comparable traditional funds during the first quarter of 2020, when the COVID-19 pandemic was ramping up around the world.