Impact investing is bullshit

Elizabeth Knight has a look today at impact investing and millennials:

Whether or not you subscribe to the view that today’s youth are an entitled, smashed avocado-eating, device-obsessed group, it won’t be that long before they move from being just consumers to being investors. And this they will do very differently from their parents and grandparents.

It seems these investors of tomorrow will have a more of a social conscience.

While companies and funds are now very tuned into the increasing use of the Environmental Social and Governance screening, Impact Investing takes it up a notch.

Rather than the ESG focus of ensuring the avoidance of investing in companies that produce a negative impact – on the likes of health, gambling or carbon footprints, Impact Investing looks to actively generate a measurable, beneficial social or environmental impact alongside a financial return.”

Elizabeth then goes on to talk about how impact investing is taking hold internationally.

My view is that impact investing is about as useful as clicking the “like” button on a Facebook post – there is probably some vague extremely minor benefit, but for all intents, you have done nothing.

What are the different types of ethical investment

There are three different approaches that different ethical funds use to select stocks:

  1. Impact investing: This involves finding companies that are actively contributing to causes that you feel strongly about. It might mean investing in a solar manufacturer, a biotech with a potential cure for cancer or an electric car manufacturer.
  2. Negative screening: This involves excluding companies that do not meet ethical standards. It may mean not investing in any companies that are involved in tobacco, that produce carbon or that make weapons.
  3. Best of breed: This involves ranking companies on a range of metrics and excluding those that don’t meet particular standards. For example, a carbon/global warming strategy may exclude companies involved in brown coal or tar sands (generally considered the most polluting) but include companies that produce natural gas as it pollutes less.

Impact investing is difficult – finding stocks that are good quality and cheap is hard enough. If you find a stock with very positive ethical characteristics that is only average quality and the stock is very expensive should you buy it anyway, expecting a poor return?

Negative screening needs to be customised, which makes investing in an ethical fund difficult. One investor may think that tobacco is a terrible additive product but gambling is an individual’s choice. Another investor may have exactly the opposite view.

Best of breed can be similarly problematic. If you don’t want exposure to fossil fuels, then holding a gas producer with the view that it is “the least damaging, and it is cheap and so I think I can profit from it” can seem hypocritical.

The problem with impact investing

Finding a company that is good quality, cheap and will positively benefit society is incredibly difficult – it is rare to find two of those qualities and so getting all three together is next to impossible.

My weakness with impact investing is that I’m a sucker for a good biotech or green technology story. Hearing these companies talk about how they are curing this disease or that, seeing the pictures of the kids who will be saved if their drug/device works, hearing about how this new technology will produce cheap, clean energy can be an uplifting experience.

“Not only will my investment make me money, I’ll be saving sick kids/the world from global warming!”

If you ever get the chance to hear some of these presentations, its hard not to be moved.

But the focus is rarely on the value of the proposition, its all about the technology/good that it is doing. And that’s a recipe for losing money on an investment. Losing funds don’t last that long.

What are you trying to do?

If there is a cause you are passionate about and you want to support companies in that area, there are four ways you can support that cause, in order of most helpful to least helpful:

  1. Make a donation. Are you trying to help or are you trying to make money? If it is the first then by donating you can feel good straight away, you get a tax deduction up front (rather than waiting to book a capital loss when you sell shares!).  Donating directly to companies is not generally tax deductible – but I’m guessing if your cause is ethical then there will be industry bodies that are tax deductible.
  2. Buy the product yourself. Most companies want more customers rather than more shareholders – and the ones that don’t you shouldn’t be investing in.
  3. Buy shares from the company in a capital raising. That way your money will actually go to funding the company expand or its research and development.
  4. Buy shares on the market. This is the least helpful way of helping the company. All you have done is transferred money to another investor.

Net effect – impact investing is the least useful way that you can help a company and will probably cost you investment wise.

My advice to maximise the social/environmental benefit of your money:

  1. Don’t let your investments don’t make the world worse. Find an investment product that avoids stocks that align with your values or use an investment manager like Nucleus Wealth that allows you to customise your ethical choices.
  2. Use your money to make the world a better place. Make donations to important causes, buy products that you want to support, support politicians trying to make changes.

And acknowledge that impact investing (or clicking the like button on Facebook) should not make you feel like you are contributing to a cause in anything but the most minor of ways.

Damien Klassen is Head of Investments at the Macrobusiness Fund, which is powered by Nucleus Wealth.

The information on this blog contains general information and does not take into account your personal objectives, financial situation or needs. Past performance is not an indication of future performance. Damien Klassen is an authorised representative of Nucleus Wealth Management, a Corporate Authorised Representative of Integrity Private Wealth Pty Ltd, AFSL 436298.

Comments

  1. Damien, what is your take on buying shares in a company then using your right as a shareholder to ask hard questions at AGMs about potential negative impacts of the companies behaviour or activities? This way you can both profit from a good business while attempting (probably in vain) to do something about perceived problems.

    • Damien KlassenMEMBER

      Sure – as long as the part you object to is a small part of the business.
      Buying a coal miner and then turning up at an AGM to complain about climate change and asking them to stop selling coal is probably not the best way to fight climate change in my view.
      If it was a diversified business like Wesfarmers then you have a better chance of getting them to divest coal assets.

      • What about supply chain? What about the use of imported labour that your colleagues (rightly) rally against? The attempt with Whitehaven was a stupid stunt, but there’s plenty of opportunities to up the corporate game through advocacy, even with the one-trick ponies.

  2. Impact investing is bullshit, but here at MB Fund you can use your ethical overlays… are these not the same?

  3. Even more important is to pressure any investing company that has your money not to invest in fossil fuels, or take your money away from them

  4. You guys also didn’t talk about the distortions that occur when funds actively impact invest/negative screen. It means ‘unethical’ investments are low demand and hence yield higher. The reverse happens to ‘ethical’ investments, they are highly sought after and hence the yield drops. It’s lunacy.

  5. Assumption made here is that the most important aspect of an investment is the return.
    But this may not always be the case
    Many people already put large portions their own money in companies that do not return anything, companies that legally cannot return anything – charitable and nonprofit sector.
    I can easily imagine future generations disappointed in current state of “charitable and nonprofit sector” deciding instead to invest in some poorly profitable bussines that does something morally good while not giving anything to charities.

    • I was going to say something similar.

      Most of the larger endowments in the US will now allocated money on the basis of impact – they are less concerned about absolute returns. Indeed, a number of them will only allocate to a manager who themselves show a sufficient degree of diversity – so if you are a bunch of white males doing a pitch for the impact sleeve of the endowment, you might as well not turn up.

      It is a different story in a true fiduciary relationship like a managed fund though – the mandate is almost always to seek the best returns in a given investment universe.

    • Damien KlassenMEMBER

      I guess my point is that investment should be about returns.
      Rather than investing $100 in a company that you think might lose $10, I’m saying stick $90 in companies that will make money and then give the $10 directly to charities to help your cause. You will still have $90 at the end of the day, and rather than donating $10 to other investors you will have donated $10 to something that will help your preferred cause directly.

      • The Traveling Wilbur

        Look! ↑↑↑ Look! Logic!

        There we go again on MB, using logic to explain thingy. It never works. Just sayin’.

        Much better off just saying impact investing will result in lower house prices and taking the win.

        PS I agree completely, however this subject (the effect of investing ethically) has come up before, and not everyone seems to be on this page. Hence the above.

      • Accepting sub-market returns is usually an investment mandate directive reserved for entities such as private foundations. “Investing” in something that you expect to lose 10% is not investing at all. Investing in something that might lose 10% applies to all equity investments, which as a fund manager you would well know.

        Public equities aren’t “impact’ by the generally accepted global definition (that the US funds management industry is trying to railroad).

      • Damien KlassenMEMBER

        You are right that I shouldn’t have shown a negative return as for some people it might complicate the issue.

        However, you get the same result if you use relative returns. Say your chosen cause is curing cancer and you have two options: (1) invest $100 in an impact biotech investment fund and get back $110 (2) donate $2 to a cancer charity, invest $98 in a normal fund and get back $110. In both cases you end up with $110 dollars. In option 1 you have “donated” $2 to other investors by accepting lower returns and buying shares from other investors at inflated prices. In option 2 you have donated $2 directly to the cause you want to help.

        I am contending that this is a better way to help your chosen cause.

      • But option of giving $10 to charity is nat acceptable to many people – I could spend hours listing reasons why peoply dislike charities.
        I can see why somone would invest into a local company that they think may have greater social impact and makes smaller profit because it pays well its workers, or uses resources not mined by slaves, or doesn’t pollute a local river… rather than invest into a dodgy company that makes more profit and than give extra to a charity that makes no longlasting impact just rather keeps status quo.

      • Damien KlassenMEMBER

        doctorX – so don’t give the money to charity. Buy the product that the company sells, donate to a politician that supports the cause, use the money to buy an ad, donate directly to the company that you want to help or pick any other way you want to support your cause.
        My point is that a donation to other investors by accepting poor returns as an attempt to virtue-signal doesn’t help.

      • Aah, now I get it. So what you’re saying is “At Nucleus, we don’t dictate the ethics. You choose from 19 different ethical overlays over your portfolio so that we don’t buy stocks that conflict with your beliefs.” With a subtext of “although we think you’re an idi0t for doing it because basically it’s BS. But hey,we’ve got services to sell and it looks like some people want this utopia of companies actually doing something positive, so fill yer boots.”

        ASX100 compound return since April 2012 – around 9%pa. Strictly screened ASX100 (average 27 stocks) return since April 2012 – nearly 14%pa. Lower vol too. Lies, statistics etc. but there’s plenty of other evidence, including longer term (I can go back 20 years on some portfolios). I’m not claiming that screening can outperform – I don’t think it can over the long term. But I have ample evidence that it doesn’t need to cost returns.

        None of which has anything to do with impact investing, as per my comment above. Even the copied and pasted text from your website relates it to ethical investing not impact investing. Anyway, apologies for the rant, I’ll dial out now.

        Cheers

      • Damien KlassenMEMBER

        Nah – now you are being disingenuous.
        I explicitly say in the post that you should exclude companies where you don’t like what they do. I think this is a good thing and I encourage investors to do so.
        The more important point is I am saying that you shouldn’t buy companies that you think will underperform because you like the ethics.
        But you obviously have decided to interpret my words differently regardless of how I put it. Sorry I couldn’t help.

  6. Damien, the key factors to be considered an impact investment are measurement and intention. There must be an intention to create a positive impact e.g. generation of power without contributing to carbon emissions, reducing the number of homeless people on the street (in the case of a social impact bond). And you need to be able to measure that impact, otherwise how do you know what impact you have created?

    This push to count ESG-screened public market securities as “impact” is a US-driven phenomena. In Europe, intentionality and measurement are still key. As you rightly point out, buying shares on the secondary market is simply a transfer of ownership, it doesn’t create an impact – unless, as Geordie points out, you invoke shareholder activism to try and agitate for positive impact.

    Many ESG-screened investments contain embedded impact in their business model. Cochlear would be a good example. But investing in Cochlear isn’t an impact investment because the intentionality is there but no measurement.

    The distinction in terminology might seem pedantic but it is important to resist for as long as possible, otherwise you end up with a situation where everything has been diluted. This has already happened with many “sustainable” or “screened” managed funds that have incredibly strong ESG policy statements written by a team of well-meaning people, and a portfolio full of fossil fuels, supply chain issues and other trigger points because the materiality clause gives the investment manager – who detests having his/her investment universe reduced – the wriggle room to put these stocks in.

    I recommend looking at the GIIN framework for decision making as a starting point, and I’m happy to discuss further if required as I work in the ESG and Impact space. If you are able to invest outside public equities within your mandate, genuine impact investments can provide a real alternative that mollifies volatility due to lack of correlation with public markets.

    • The Traveling Wilbur

      If a tree falls in a plantation forest and no one from WH&S comes out to measure it, did it still fall?

      • If an anonymous troll tries to prove their superior intelligence with a snide comment, does anyone care?

        Sorry mate, I forgot the name of the comments game is one-upmanship rather than genuine debate. I’ll try harder next time.

  7. Thanks Damien. I consider this one of the more useful things I’ve learned from you guys.

    A few years ago I might have thought to never give someone like private taxfarmers Transurban any investment money. Now I see it as the best way to get some of my toll fees back, while I’m still free to protest about the way infrastructure is funded in other ways.

  8. Hmm

    Not seeing much ROI on virtue signalling.
    Gillette managed to piss a lot of idiots off by trying.
    Betting the ROI is negative.

    Idiots are customers too.

    Does mb have a nihilist ethical overlay?
    Invest in coal, oil, weapons, gambling and vices?

  9. This is actually quite useful thank you. And the note about transurban above os also useful. Never thought to buy into a company i hated.

    • Lenny Hayes for PMMEMBER

      Isn’t the adage never to buy into a company whose products or services you would never use ?.

      Seems like we don’t have much choice with a groups like Transurban or Macquarie when it comes to accessing infrastructure ….

  10. kiwikarynMEMBER

    The “ethical” investing trend is annoying – the sole reason for investing is to make money. Companies should be run to maximise profits for shareholders, not be defacto charities giving away shareholder funds. If you want to donate money, give it directly to a charity – and let the rest of us get on with being shareholders.