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What is impact Investing?

Values-based investors are those that align their financial decisions with their personal ethical principles. Also called “socially conscious investing,” it is a remarkably vibrant trend that continues to grow. In 2020 the total U.S.-domiciled assets under management using sustainable investing strategies grew 42% in 2 years with assets increasing from $12 trillion in 2018 to $17.1 trillion in 2020. This means that nearly 1 out of every 3 dollars under professional management are in values-based funds. This includes retail and high-net worth individuals who have increased their values-based investments by 50% since 2018. Financial industry research further indicates that 85% of the general population and 95% of the millennial population are interested in sustainable investing.

There are 3 general categories of values-based investing:

Socially responsible investing (SRI) can trace its roots to John Wesley, the founder of the Methodist movement, who instructed his flock to not invest companies that engaged in “sin” such as alcohol, weapons, tobacco and gambling. This approach involves actively screening potential investments to exclude financial activities that conflict with the investor’s values such as firearms and fossil fuel. This is an inexpensive method since the screening can be performed easily.

Environmental, social and corporate governance (ESG) investing actively seeks out companies that prioritize positive ESG goals and work to limit their negative ESG impact. These companies have decided that the long-term implications of their business decisions as they relate to the society and the environment are as (or more) important than the need to generate short-term profits. A number of large investment funds are now requiring companies in their portfolio to address ESG considerations because of the potential impact of such issues on the company’s long-term outlook.

Impact investing is usually limited to private funds that can provide more transparency on the impact of the investments on a specific cause and more flexibility in provision of those monies. These funds have a direct connection to the investor’s values-based priorities and the utilization of the provided capital. They typically can quantify the positive impact of the investment with such data as the number of meals provided, measures of economic activity in depressed regions,  and carbon output reduction.

What is stakeholder capitalism?

Capitalism is defined by the International Monetary Fund as, “an economic system in which private actors own and control property in accord with their interests, and demand and supply freely set prices in markets in a way that can serve the best interests of society.”[1]

The types of capitalism differ in whom is most important entity (stakeholder) that can affect or be affected by a business.

In State Capitalism the government is the key stakeholder acting as a steering force in the marketplace and can intervene when it deems necessary. As such, business interests are subservient to the interests of the state.

In Shareholder Capitalism the owners of the business are the primary stakeholders whose principal goal is to increase business profits. Short-term profit maximization is the key driving force and all other considerations are of lesser importance.

Stakeholder Capitalism envisions that all stakeholders, the owners, customers, employees, suppliers, essentially anyone who is impacted by business decisions, matter equally. The key characteristic is the emphasis on improving society and increasing the well-being of everyone rather than to generate a financial return. This form of capitalism focuses on long-term value creation and ESG parameters. In this system, individuals,  private businesses and public corporations can still innovate and compete freely while also being protected and guided to ensure that the general direction of economic development is for the greater good.

“Stakeholder capitalism is a vow to do business in service of all stakeholders, rather than just profits and returns. Shareholders are of course important, but it’s vital that companies also consider workers, communities, the environment, and more when defining success – especially because doing so has demonstrated benefits not just to society, but also the bottom line. This approach is neither status quo nor abandoning capitalism altogether. It’s simply recalibrating the system to take a deeper view of business, and ensure an economy that works for all.” – Paul Tudor Jones, founder of Tudor Investment Corporation and The Robin Hood Foundation, Co-Founder and Chairman of JUST Capital

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[1] https://www.imf.org/external/pubs/ft/fandd/2015/06/basics.htm

What is shareholder activism?

Shareholder activism is a method to influence corporate policies and practices. As partial owners of a corporation, shareholders, also known as stockholders, have certain specific rights including the ability to vote at the annual meetings on such matters as approval of the membership of the Board of Directors, executive renumerations, dividend distributions and mergers. Shareholders with a sufficient amount of ownership (or equity) in the corporation can also submit resolutions for a vote at the annual meeting.

Until recently, shareholder activism was utilized mostly by those who wanted to have more control of a corporation they believed was being poorly run financially. They would purchase a minority position and then utilize a number of methods, including threats of litigation and public relations pressure to compel changes in board composition and corporate policies. Carl Icahn and Bill Ackerman are two of the best known of this type of activists but these methods have had numerous other adherents.

With the increasing public awareness of the role of corporations in the critical environmental and social issues affecting today’s society, shareholder activism has evolved to include those who want to see changes in corporate ESG strategies and activities. The majority of corporations base their business decisions on the short-term impacts on their quarterly financial reports. ESG shareholder activists, including some of the largest investment funds and other organizations, utilize their ownership positions to shift the corporation’s focus toward the long-term implications of their policies and procedures. They also apply a variety of methods, including shareholder resolutions and direct negotiations with management, to achieve these aims. Shareholder activism plays a vital role in well‐functioning capital markets by holding companies more accountable to shareholders, especially those who seek a more ESG values-driven approach to corporate behaviors.

What does “ESG” Mean?

The Environmental, Social and Business Governance (ESG) aspects of a company’s activities are the three main evaluation standards utilized to measure a company’s societal and sustainability policies and practices. ESG criteria are applied most frequently by investment firms and individuals who want to direct their money toward companies that are socially responsible. ESG standards are also used to create the “best” and “most progressive” companies lists published by various rating services that impact consumers purchasing patterns.

Each aspect of ESG embraces a broad range of factors and benchmarks. Environmental considerations include sustainability, renewables, pollution mitigation, waste management, climate change, conservation of natural resources, biodiversity, energy efficiency, regulation compliance and recycling.

Social aspects of business policies comprise the company’s working conditions (including child labor and slavery), employee health and safety, human rights, interaction with local communities (including indigenous communities), diversity in supply chains, human capital development, doing business with despots, engagement with third-party activists, product safety and employee benefits.

Business governance implications include equal opportunity, diversity, structure and independence of directors, executive renumeration, donations and political lobbying, tax strategy, shareholder rights, anti-corruption, risk management, stakeholder engagement, conflicts of interest, accident and safety management, supply chain management, and transparent ESG reporting.

ESG considerations provide a framework for responsible investing that incorporate a values-driven approach that balances financial returns with social outcomes. ESG focused investments include environmental, social and governance risks and opportunities into traditional financial analysis based on a systematic approach and appropriate research sources.

Is ESG a good investment?

There are now over 830 registered ESG investment firms. These values-driven funds seek to balance financial returns with the longer term implications of a company’s environmental, social and business governance policies. The desire for these types of investments is steadily increasing. In 2020, the assets managed by these firms was $3.10 trillion, up 19 percent from 2018. And the number of individual investors that employed ESG-based strategies in at least a quarter of their portfolio decisions increased from 48% in 2017 to 75% in 2019.

In 2005, the UN Environmental Program commissioned a report that looked at the “prudent investor” laws of seven developed world markets, including the US, to determine if the incorporation of ESG strategies was prohibited by the management’s fiduciary responsibilities. They concluded that in the US, incorporating ESG values into a fund’s investment strategies consistent with fiduciary duty, and that ignoring these long-term risks might in fact be a breach of fiduciary duty.

Regardless of the demand and the legality of ESG focused investments, the question remains, “how do ESG funds perform in the marketplace?” Are ESG based investment strategies merely a feel-good proposition or do they have real financial value as well?

As noted by Morningstar, for 2020 overall, 11 of 12 sustainable equity funds beat the S&P 500 index fund, led by IQ Candriam ESG US Equity ETF (IQSU) and Calvert US Large-Cap Core Responsible Index (CISIX), both of which are based on proprietary ESG indexes. The 22.4% average sustainable index fund return easily beat iShares Core S&P 500 ETF (IVV) 18.4% return for the year. [1]

JUST Capital ranks companies based on factors such as whether they pay fair wages or take steps to protect the environment. It created the JUST U.S. Large Cap Diversified Index (JULCD), which includes the top 50% of companies in the Russell 1000 (a large-cap stock index) based on those rankings. Since its inception, the index has returned 15.94% on an annualized basis compared with the Russell 1000’s 14.76% return.

These, and several other studies, document that ESG focused investments easily match or exceed the financial returns of more traditional investment funds. There is no demonstrable performance penalty associated with an investment strategy that includes ESG considerations. It is possible to do be both a responsible investor and to invest responsibly.


[1] https://www.morningstar.com/articles/1017056/sustainable-equity-funds-outperform-traditional-peers-in-2020

How did ESG start?

The origins of modern ESG investing can be directly traced to the 1970s. Its roots were established much earlier when faith-based organizations began to shun commodities and industries that conflicted  with their value systems. In the 18th century the Methodists, a Protestant denomination, eschewed investments in the production of tobacco and liquor and the slave trade. The Quakers soon followed by prohibiting investing in any war related activities as well. The Pioneer Fund was created in 1928, the first socially responsible investing (SRI) fund offered to the US public.

During the Vietnam War era, many US investors followed the SRI paradigm by adjusting their portfolios to eliminate “war profiteering.”  Created in 1971, the Pax World Balanced Fund restricted investments based upon an industry’s negative social impact. It did not invest in any company that produced, or was a part of the supply chain for Agent Orange, a dangerous herbicide used during the war.

Growing public engagement in civil-rights, antiapartheid, environmental and many other policy issues expanded into investment strategies. Despite Milton Freidman’s declaration that, “the social responsibility of business is to increase profits,” other SRI based funds were quickly established.  The First Spectrum Fund (1971) assured that they would base their investment decisions upon a company’s performance in “the environment, civil rights, and the protection of consumers.” The Dreyfus Third Century Fund (1972)  investment focus was on companies that contributed, “to the enhancement of quality of life in America.”

In 1972 journalist Milton Moskowitz published a list of “socially responsible stocks” that included SRI based mutual funds. Moskowitz’s criteria has been subsequently incorporated and adapted to serve as the basis for a host of other SRI based funds. Many of the earlier funds were based upon an “avoidance” screening strategy that sought returns similar to the general market without investments in alcohol, tobacco, weapons, gambling, pornography, and nuclear energy. Other funds with a broader ESG focus employed a “best in class” approach that invested in companies that did not have any deleterious workplace, governance, environment, social justice or other similar practices.

There are now over 800 registered investment companies with ESG assets. Many of these firms have embraced a combination of values-based investing with shareholder engagement that leverages an ownership position with a company to promote changes in their ESG policies and performance. While this type of stakeholder activism has always been a part of socially responsible investing, the growing public concerns over ESG issues has increased its reach and impact. Shareholder resolutions and the access to management that such ownership positions provide remain powerful agents for positive changes in corporate ESG strategies.