DOING GOOD – IS IT GOOD FOR YOU? The Pros and Cons of Impact Investing

 

Over the last thirty years, there has been a boom in the popularity of impact investing, especially the potential to ‘do good while doing well’ with investment portfolios. In 2021, The Global Impact Investing Network (GIIN) estimated that the global impact investing market was worth about $715 billion. In 2022, that figure, according to the American asset management company, Mercer, has ballooned to $12 trillion!  

Impressive sum, right? But here’s the thing: even that figure amounts to less than 1% of the investing ecosystem.

Why is that? One reason is that impact investors while hoping to have a positive social and environmental influence, tend to analyze the market and other factors that are not usually on the radar of traditional investors. Yes, we all want to make the world a better place, but are investment portfolios the right tool to do that?

To answer that question, it is important to step back from the confines of impact investing for a bit, and explore investment goals in general, and how wealth grows fastest.

As an investor, whether you are conservative or aggressive, the principle of compounding should underlie every strategy you adopt. Albert Einstein, though not an economist in the strict sense of the word, described compounding, as the “eighth wonder of the world” – which goes to show what an incredibly important factor it is in wealth management. 

The most important factor in wealth compounding is consistency – i.e. targeting steady growth while avoiding large drawdowns. But the truth is that investment diversification is not so well understood. It is commonly believed that portfolio diversification is about adding exposure to many different investments within many different asset classes – but that’s just half the picture. True portfolio diversification is best created by owning a variety of assets with unique, uncorrelated cash flows that each, individually, offers a promising risk and return trade-off. Consistent, steady returns and no drawdowns are what build wealth most efficiently. The more investment options you have, the better you can diversify and minimize portfolio drawdowns. When options are limited, our ability to manage risk is also limited.

So, again, the question: Is doing ‘good’ good for you?

The cost of impact investing is two-fold. First, by limiting the purchase of certain companies and industries, you forego the potential to buy assets offering a better risk-return tradeoff than other assets in the market. Second, due to the smaller size of your investable pool, your ability to diversify is hampered. The combination of these costs shows up as more volatile returns, which results in a lessened ability to compound. While impossible to quantify, this cost is hopefully more than offset by the feeling that you’re having a positive impact on the world.

To invest with purpose, there are some things you may or may not have considered. Foremost on the list is the question, “Where is your money going?” Former Microsoft chairman Bill Gates has some interesting views to help us understand our potential role in impact investing. In a recent Financial Times article titled, ‘Fossil Fuel Divestment has Zero Climate Impact,’ the billionaire philanthropist argued that environmental change is achieved when we invest in disruptive and innovative companies that tackle environmental problems, not just in dis-investing from those that do not.

If you are interested in impact investing, perhaps you need to consider Bill Gates’ advice of inclusion, rather than exclusion. Use the entire menu of investment opportunities and rigorous analysis to determine which assets are worthy of your investment. If the “disrupters” qualify under your investment protocol, include them in your portfolio and perhaps favour them. However, you should always be cognizant of the cost of shunning companies that are doing things you don’t like.

A well-diversified portfolio with a positive risk/return structure will provide more stability and limit your drawdowns. By growing your wealth as efficiently as possible, you will then be able to invest more into companies that are having a positive social impact – and have more wealth which you can then invest in more direct and more impactful ways.

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