The following is an excerpt from "Broke Millennial Takes On Investing: A Beginner's Guide to Leveling Up Your Money," by Erin Lowry
Impact Investing: Making Money Without Compromising Your Ethics or Religious Beliefs
Other than when I saw the cult classic movie Wall Street, I didn’t give the idea of ethical investing too much thought in my early twenties. I also wasn’t actually investing, so it didn’t necessarily need to be a thought yet. Then a serendipitous conversation enlightened me on how an activist viewed the stock market.
I was sipping ice tea while sitting in a rocking chair on a screen porch in Georgia. It was exactly as quaint as it sounds. A rock-n-roll musician, his wife, and the major network news reporter I was shadowing were talking about conservation and other environmental issues. The reporter and I were there on assignment to interview the musician about his tree farm, so the progression to discussing general environmental issues made sense.
The BP Deepwater Horizon oil spill had occurred just a few months prior, so the news had been strewn with images of the damage done to the surrounding beaches and wetlands and of animals being killed or displaced.
Suddenly, the musician’s voice hardened. “Can you believe people are investing in BP now and making money off this horrific event?” he posed to the group.
This got my attention.
I’d spent a lot of that summer teaching myself about how to best handle my money after graduating college in a year, but I’d yet to consider the ethical side of the equation.
One sentence shifted the way I viewed investing. At what cost do you plan to earn and build your wealth? We collectively rail against outsourcing to countries with weak labor laws and get outraged over the systemic, horrifying behaviors of a CEO—and yet many of us still continue to invest in companies that financially benefit from the practices we claim to stand against. In return, we, the investors, benefit.
In many ways, you can be in control of where your money goes as an investor.
Are Your Investments Really Living up to Your Standards?
Unfortunately, investing in a fund, whether it’s a mutual fund, index fund, or ETF, can mean you’re financially supporting and benefiting from a company that partakes in practices you morally or philosophically oppose. It could be that you disagree with the company’s environmental policies or that it builds a product you don’t support or that it’s had a history of poor labor practices. When you invest in a broad index, you can’t opt out of investing in specific companies with which you disagree.
The S&P 500 index includes casinos, and alcohol, oil, and pharmaceutical companies. That may not bug you, and it’s perfectly okay that it doesn’t, but there are those who want to invest in a way that aligns with their values. Buying ETFs and mutual funds without doing thorough research could mean that your money is tied up with something you find unsavory at best and downright unethical or harmful at worst.
What Is Impact Investing?
“Impact investing, by definition, says that a company has to be earning revenue that is aligned with one of the UN Sustainable Development Goals,” says Dave Fanger, CEO and founder of Swell, an impact investing platform. “That’s an important distinction [from] some of the [other kinds of investing] you hear about, like ESG [environmental, social, and governance] or SRI [socially responsible investing], which is really more of a broad umbrella term.”
What Is Socially Responsible Investing?
Socially responsible investing, or SRI, isn’t quite as strict as impact investing, which vets funds in portfolios with a more critical eye than an SRI portfolio would. It’s not unlike the difference between fiduciary and suitability. Impact investing is akin to fiduciary, and therefore looking for the best possible option; while SRI is more like suitability. It’s not harmful, but you can probably do better.
ESG (environmental, social, and governance) compliance is often at the center of SRI portfolios. The problem is it’s not terribly difficult to obtain ESG compliance, as the bar can be set rather low.
“If you think about it on a spectrum, on one side you’d find things like ethical investing or things that would be negative screening,” explains Fanger. “For example, let’s remove anything related to tobacco. Then you’ve got ESG in the middle, where you’re saying, ‘Let’s just find the companies that have good environmental, social, and governance policies.’ There are companies out there with ESG ratings that are quite high, but they could be in the oil sector. So, I think you go then to [the other end of the spectrum], and that’s where you’ll find impact investing. That’s saying, ‘Not only do we want to see a very high ESG rating, but let’s only look at the companies that align with the UN Sustainable Development Goals.’ That will then remove a number of questionable businesses that might be efficient with energy usage or water usage, but other companies are creating products that align with green tech or energy efficiency.”
How to Check Under a Company’s Hood
As a company, Swell specifically looks at its evaluated holdings daily to ensure they remain compliant with the company’s standards by using Morgan Stanley Capital International’s ESG ratings, which rate companies on a scale from AAA to CCC. Fanger points to a company like Tesla as having a AAA rating, while a Wells Fargo or Volkswagen* (*Volkswagen had a major emissions scandal that broke in 2015 while Wells Fargo had a series of scandals from 2016 to 2017, including account fraud and employee mistreatment.) would receive a CCC. You and I don’t have that kind of time or access to the same types of tools to evaluate these on our own. You can turn to companies like Swell or select SRI- and ESG-compliant mutual funds or ETFs from your brokerage of choice. However, that doesn’t always mean you’re getting the crème de la crème of companies.
“It’s kind of like organic food when it first came out,” says Fanger. “Everybody labeled it ‘organic,’ and then you started looking a little bit closer at those ingredients and thought, ‘Uhh, maybe this isn’t what I thought.’ Same thing here with ‘socially responsible’ or ‘impact investing.’ Some of these funds will state what the ESG rating is from MSCI, and you’re looking for something that’s double B and above* (*That means you want to see an ESG rating of BB, BBB, A, AA, or AAA.)—that’s a good, strong indicator of the overall policies and procedures of a company. And then from there you would really look in the prospectus to see if it mentions anything about the revenue they make around the Sustainable Development Goals.”
Companies can also pass ESG compliance without passing your own personal gut check. Casinos can be considered ESG compliant through the use of solar panels, but maybe you don’t want to invest in one because you disagree with gambling.
You can look up the “holdings” (i.e., the companies included) in a particular fund. For example, Morningstar typically gives free access to the top ten to twenty-five holdings in a particular fund. You should also be able to look up all the holdings through a monthly fund report from your brokerage of choice. If you’re having trouble finding it online (because it’s not always easy) try actually giving your brokerage a call.
Can I Still Make a Decent Return on My Investments?
One of the biggest concerns by far when it comes to impact investing or placing restrictions on your portfolio due to ethical or religious beliefs is whether you can still receive a healthy return.
“The main thing we deal with is this idea that I’m going to sacrifice returns,” says Fanger. “The data is showing otherwise.”
One such data point Fanger points to is the comparison of MSCI’s KLD Social Index compared to the S&P 500. The MSCI KLD Social Index started in 1990 and has outperformed the S&P 500, according to Fanger. This isn’t leaps and bounds better, more like a few hundred points.
The expense ratios for SRI funds coming from companies like Vanguard, which is generally touted as having low expense ratios, are higher than their non-SRI-compliant compadres. For example, in the spring of 2018, Vanguard charged a 0.20 percent expense ratio with a minimum investment of $3,000 for its Vanguard FTSE Social Index Fund Investor Shares (VFTSX). The Vanguard S&P 500 Index Fund Admiral Shares (VFIAX), also with a $3,000 minimum, charged a 0.04 percent expense ratio.
So, yes, you can make a decent return—but the fees might do more harm than those attached to non-SRI-compliant funds. So impact investing exclusively could be financially problematic.
“Keep in mind that as your investing program gets more specialized, you’re investing in segments of the market, and that might expose you to a little bit more volatility, for instance, relative to the entire market or the entire global market that holds a lot more securities,” says Maria Bruno, CFP®, a senior investment analyst for Vanguard Investment Strategy Group. The more specialized you become, the more it could reduce your diversification, which exposes you to more risk as you narrow the sectors in which you’re willing to invest.
This isn’t meant to discourage you from building an impact investing or SRI-compliant portfolio, but you must consider more than just the returns of the index. It’s also about the cost of the funds, which impacts your net returns. Adding impact investing–compliant funds can be a way to diversify your existing portfolio, but investing exclusively in such funds may minimize your diversification and increase your risk.
Reprinted from Broke Millennial Takes On Investing: A Beginner's Guide to Leveling Up Your Money by arrangement with TarcherPerigee, an imprint of Penguin Publishing Group, a division of Penguin Random House LLC. Copyright © 2019, Erin Lowry.