Making Impact Investments

Impact investing seeks to achieve certain social and environmental goals as the primary reason for making an investment. Impact investors oftentimes sacrifice economic profit and liquidity in favour of achieving the investment’s non-economic goals. This post describes what impact investing is and the choices impact investors face.

Impact Over Profit?

We can think of impact investing within a spectrum of investing styles:

• Profit Only
• ESG Investing
• Impact Investing
• Charitable Giving

“Greed is Good”

Most investors seek economic returns as the exclusive reason why they invest. These investors might subscribe to the “greed is good” moto expressed in the movie “Wall Street”. The focus on investing for economic profit above all other goals also underpins the “fiduciary” standard of financial industry regulation. Financial advisors are obligated to act in the best interests of their clients and may be held liable if economic profit is sacrificed.

Growth of ESG Investing

ESG investing is becoming more popular and mainstream. Most ESG investors still seek economic returns. However, ESG investors place some Environmental, Social, and Governance (ESG) goals equal to or ahead of profit. One way they do this is by creating an investment policy that identifies non-economic values to support. A portfolio is then constructed by excluding investments that don’t align with these values. For example, if “environmental sustainability” is a goal, then investments in oil companies can be excluded from an ESG portfolio.

An emerging ESG investing trend is greater “shareholder activism”. This can mean an ESG investor will employ a shareholder advocacy service that will advance their values through activism. Examples of such shareholder advocacy services include the Shareholder Association for Research & Education (SHARE Canada).

Impact Investing

While ESG investors still seek economic gains, Impact Investors often sacrifice economic gains to achieve social & environmental goals. Impact investors will make social & environmental goals the primary reason for investing and will often sacrifice liquidity and take additional economic risk in response. Although impact investors place environmental & social goals ahead of profit, many impact investments still offer economic returns. Many Impact investors will accept no economic profit or even accept negative rates of return if it means achieving other goals.

Examples of impact investments include Social Impact Bonds (SIBs). These investments are ones where the investor provides cash to a charity or government agency for a return tied to the outcome of a social program (e.g. how many students enroll in an after-school activity). Other impact investments might include investment funds that support businesses lead by marginalized communities or that target specific environmental issues.

Charity vs Impact Investing

The key difference between charity and impact investing is the expectation around return of capital. With a charitable donation, a donor cannot legally receive any private benefit. A charitable gift is a type of donation where there is no advantage provided to the donor.  Whereas impact investors often gain an advantage from their capital. Maybe this means their capital is returned or even returned with interest.

Below is a description of how investors incorporate impact investments into their portfolio and some real-world examples of how to do this.

Your Investment Policy

Before considering any investment strategy, successful investors define their values, investing goals, and methods within an Investment Policy. Your Investment Policy will guide your investment decisions in a process-oriented way. This will ensure you minimize your emotional bias and achieve your stated goals.

It also helps to articulate a mission statement for your family or charitable foundation within your investment policy. This is particularly important when investing for impact because the values and mission statement will help you evaluate the qualitative aspects of your impact investments.

Asset Allocation

Oftentimes, investors choose a blended approach to impact investing. This means their asset allocation will consider some ESG investments for profit (such as publicly traded stocks) mixed with other impact investments for a smaller portion of their portfolio.

The degree to which your portfolio is tilted towards impact depends on the investment goals outlined in your investment policy. Investors should also consider their income requirements in their investment policy because it will inform their asset allocation. If you need some income from your portfolio, then you might also need to generate some economic profit to satisfy this requirement.

Sourcing Investments

Licensed investment advisors are the best place to go when it comes to public company investments. A good investment advisor should help identify your values & goals to craft your investment policy. They will then recommend ESG focused investments that meet your objectives.

If you want to sacrifice economic return for other goals, your licensed investment advisor may not be able to help. Most impact investments sacrifice profit for other values. So many impact investments are often excluded from the investments a licensed advisor can offer you.

To source impact investments that sacrifice profit, you’ll need to connect with alternative investors and groups that share an impact investing philosophy. This commonly means connecting with charitable foundations and other groups such as CREO and Impact United. Consultants familiar with like-minded investors can also help you source impact investments.

Impact Investing – Portfolio Examples

The most common way to tilt a portfolio away from profits and towards your values is to scrub your portfolio of the investments that do not align. This can be done by creating an ESG investing strategy. This is usually a “passive” approach because an ESG investor is merely taking things away from their portfolio and tilting the allocation to sectors that align with their values.

Other types of investors, such as wealthy investors who cannot spend down their capital by consuming it, or charitable foundations whose goal is to spend down their endowment, may want to move further towards a completely impactful portfolio.

Retired Couple – Passive

Consider a retired couple with a $20 million portfolio of stocks. They own their own house and a cottage outright, plus a share in a family business managed by a sibling. The couple wants to ensure their stock portfolio reflects their values. So, they engage their investment advisor who discovers their values, lists those values within an investment policy and then modifies their portfolio of stocks to reflect those values.

The couple can sleep at night knowing they do not invest in any company that does not reflect their personal values. They have also made little to no sacrifice of economic returns from this approach.

Retired Couple – Active

What if this couple with a $20 million stock portfolio takes their ESG investing approach a step further towards impact? The couple contacts SHARE Canada about subscribing to their shareholder engagement service. For a small annual fee, SHARE will engage with the companies in the couple’s portfolio on their behalf about the issues the couple cares most about. SHARE will also provide the couple with opportunities to express their views and give them regular reports about the engagements SHARE is undertaking.

By becoming an activist investor, the retired couple has sacrificed some return (equal to the fee for the shareholder engagement service) in exchange for actively promoting their values.

Adding Philanthropy

Taking the example of the retired couple with a $20 million stock portfolio a step further, what if they decide to incorporate philanthropy into their investment plan? The couple meets with their investment advisor to understand the income their portfolio generates. They determine the couple generates $600,000 per year of dividends from their stock portfolio. They also determine the couple requires $240,00 for their personal expenses. The couple decides that any income they earn from their portfolio above $240,000 will go towards philanthropy. Without considering taxes, this means the couple may donate $360,000 to charity each year.

The couple then contacts a representative from the Toronto Community Foundation and learns they can create a donor advised fund that will make impact investments on their behalf. They designate 5% of their fund be donated to a list of charities chosen by the foundation each year.

In this example, the couple has sacrificed more of their economic return in exchange for making a greater charitable impact.

Impact Allocation and Impact Focused

What if the retired couple with a $20 million stock portfolio determine that they no longer require or want a portion of their capital and wish to place the promotion of their values ahead of economic profit? They can decide to take a portion of their portfolio and dedicate it towards making purely impactful investments. This means the investments made with this portion of their portfolio would consider impact first and profit second.

Hamilton Community Foundation

An example of an impact investor is the Hamilton Community Foundation. The foundation allocates 80% of its investment portfolio to public equities managers Jarislowsky Fraser and Connor, Clark & Lunn. These investment managers employ active investing strategies where they screen out investments that do not meet the values criteria of Hamilton Community Foundation. These investment managers also promote ESG and SRI values throughout their portfolios and engage with their holdings to advance those values.

The Hamilton Community Foundation allocates 20% of its investment portfolio to direct impact investments. This means that the foundation is making impact investments that put the promotion of certain social & environmental outcomes ahead or along with economic returns.

Choosing your Path to Impact

Whether you choose to simply invest in ESG funds or whether you start dedicating more of your capital towards philanthropy, impact investing comes in many shapes and sizes. To make decisions about how much impact investing is right for you, the first step is crafting an investment policy that identifies your values and outlines an investing process that reflects those values.

Choosing your Team

Making your investment portfolio more socially & environmentally impactful may require a team of professional advisors. Your accountant will be able to advise you about the tax aspects relating to your financial plan, your lawyer can help you arrange your estate and holding companies, your investment advisor can ensure your investment portfolio reflects your values, and your family office can tie everything together and help connect you with the people who can put your plan into action.