Effective Impact Investing

by grissman6 min read27th Feb 201935 comments

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Max Mintz is an impact-focused financial advisor, and a partner at Common Interests. Before entering the financial services industry, he founded the Rutgers Undergraduate Philosophy Journal. Gabe Rissman founded Stake, (lets you use your voice as a shareholder to advocate for corporate social change) and Realimpacttracker.com (scores the relative impact of mutual funds, methodology will be open sourced in 2019).

Disclaimer: Max and Gabe work in the impact investment space (see above). Our views may be influenced by confirmation bias. But the arguments below are what drew us into the field, before we had any reason to care about it.

This post is written in response to Hauke Hillebrandt’s December 2018 post on the EA forum: Donating Effectively is Usually Better than Impact Investing, which summarized his recently released paper, co-authored by John Halstead.

Before we dive in, a quick point of clarity: this response only covers public equity markets (stocks or mutual funds that you might find in your retirement account). Most people and organizations interact with the public markets by investing in a fund. We look at what makes these funds impactful. We mostly agree with John and Hauke’s analysis of impact in private equity, debt, and venture capital, and try to implement his suggestions in our investments in these spaces.

While much of John and Hauke’s paper is correct, the piece led at least a few of our EA friends to believe that all impact investing is ineffective. This outcome is dangerous, because the paper ignores shareholder advocacy, which is the primary mechanism for impact in public equity investing. Shareholder advocacy is when an investor uses her ownership stake in a company to influence corporate policies and practices. We believe that EAs should deeply explore shareholder advocacy as a tactic to accomplish many of the goals of the community.

We also believe that the paper presents a false dichotomy between donating and impact investing, which is predicated on the mistaken assumption that impact investing leads to lower financial returns. On the contrary, there is substantial evidence that thoughtful impact investing has historically helped financial performance. Unfortunately, the piece misses this positive result because it equates the outperformance of sin stocks (companies that sell “sinful” products, like tobacco or gambling companies) with the expected underperformance of all impact investments in public markets. This equivalence is unjustified because impact investing in the public markets is not equivalent to screening out sin stocks. Some funds certainly take that approach, though this screening strategy is actually on the decline, while best-in-class and other strategies are popular and growing.

Finally, John and Hauke argue that because impact investing doesn’t significantly impact stock price, there is no additionality. We agree that impact investing does not create significant impact through direct stock price impacts. On the other hand, while stock price impacts of impact investing would change corporate behavior, other signaling effects of impact investing still do influence corporate behavior change. Additionality comes from a systems perspective - the larger the trend of impact investing, the larger the signal.

Shareholder Advocacy Creates Substantial Impact

A recent academic literature review demonstrated the ability for shareholders to drive corporate change on environmental, social, and governance issues with a fairly high success rate:

“Dimson et al. (2015), analyzing a dataset of over 2152 shareholder engagement requests between 1999 and 2009, report that 18% were successful in the sense that the request was implemented by the company. Hoepner et al. (2016) report a success rate of 28% in a dataset of 682 engagements between 2005 and 2014. Expanding on these results, Barko et al. (2017) report a success rate of 60% in a sample of 847 engagements between 2005 and 2014. Dimson et al. (2018) report a success rate of 42% in a sample of 1,671 engagements between 2007 and 2017. Together, these studies provide strong evidence that shareholder engagement is an effective mechanism through which investors can change company activities.”

Shareholder advocacy is only impactful if the changes that corporations implement are meaningful. There is no comprehensive study of the impact of corporate implementation of shareholder engagements, but some examples give a sense of the scope of investor impact.

Investors have led the charge in getting companies to stop funding climate-denying organizations, protect LGBT workers from discrimination, remove firearms from grocery store shelves, and limit financing of coal power plants. Just this past month, an investor coalition pushed Royal Dutch Shell to commit to comprehensive greenhouse gas reductions. One socially responsible investment manager, Green Century Capital Management, has been particularly successful in moving companies forward on EA priorities of biosecurity and animal welfare. Over the last two years it has pushed several major companies to phase out routine use of medically important antibiotics in supply chains. Two months after Green Century called on Tyson Foods to explore plant-based proteins, Tyson took an ownership stake in Beyond Meat, and launched a $150 million venture capital fund focused on food innovation. Green Century’s advocacy has been so successful that they’ve become a resource for their portfolio companies, collaborating to craft policies when those companies actively want to be better.

Some corporate advocacy campaigns are suited to nonprofits publicizing bad deeds; others are suited to internal shareholder pressure. Several of the most successful campaigns come when nonprofits and shareholder advocates work together, like the wave of cage-free commitments over the last two years.

We believe that a mission-oriented individual or organization should consider whether their problem is well-suited to the shareholder advocacy angle, instead of categorically dismissing the potential of impact investing.

Impact investments in public markets do not entail a reduction in financial returns.

John and Hauke’s piece makes strong theoretical and empirical arguments that sin stocks outperform. While we question the generality of that conclusion (although sin stocks have outperformed historically, it’s not certain that the trend will continue, as consumers become more socially conscious and the risks to portfolios from factors such as climate change intensify), even if it were true, it would still be a mistake to use it as evidence that impact investing in public markets underperforms. Many implementations of impact investing do not screen out sin stocks, instead adopting a strategy of integrating environmental, social, and governance (ESG) factors into investment criteria.

Theoretically, companies that manage their social and environmental impacts are less prone to regulatory and reputational risk. Empirically, most studies find that ESG factors correlate positively with financial performance. A 2015 meta-analysis of over 200 academic studies from Oxford and Arabesque Asset Management found significant empirical support for the theories that good ESG practices led to a lower cost of capital, better operational performance, and positive stock performance. John and Hauke’s piece actually references another meta-study of the influence of impact criteria on corporate financial performance (CFP). The conclusion is that: “approximately 90% of studies find a nonnegative ESG–CFP relation, of which 47.9% in vote-count studies and 62.6% in meta-analyses yield positive findings”. John and Hauke dismiss this result on page 22 of his paper, arguing that it is more likely that the studies showing ESG outperformance are flawed than that sin stocks don’t outperform. But the two (sin stock outperformance and ESG outperformance) are not mutually exclusive.

New studies further demonstrate that focusing on material sustainability factors helps financial performance. Russell Investments recently confirmed Khan et al.’s 2016 study showing that companies with high performance on relevant ESG factors, as defined by the Sustainability Accounting Standards Board, also outperform financially. Perhaps most important, evidence suggests that successful shareholder advocacy on ESG issues, the best pathway to impact, leads to financial outperformance (Strickland et al., Becht et al., and Dimson et al.). This result is likely due to the positive relation between sustainability performance and corporate financial performance.

Impact of investor behavior on corporate decision making

Impact investors likely achieve additionality by building the size of a trend to shift corporate behavior.

Large money managers influence corporate behavior. Since investors choose companies’ boards of directors and vote on executive compensation packages, companies adapt their behavior to meet investor demand, including on social and environmental issues. For example, 85% of S&P 500 companies now produce sustainability reports as a result of demand from asset managers looking for sustainability metrics, up from just 20% in 2011. Sustainability reports are far from perfect, but the quality and quantity of reporting improves over time, and what is measured can be managed.

As money managers feel the need to invest impactfully to grow and retain assets, they have the incentive to demand better social and environmental performance of their companies. The trend has already begun. In March 2016, Morningstar, a major rater of mutual funds, published its sustainable “globes” ratings. Hartzmark & Sussman (2018) analyzed flows of capital into and out of mutual funds. The authors found that being categorized by Morningstar as low sustainability resulted in net outflows of over $12 billion, while being categorized as high sustainability led to net inflows of over $24 billion. Adding to a trend that hits large money managers at the bottom line contributes to system-wide changes in corporate incentives, and thus, behavior.

The increased focus on ESG investing is now also contributing directly to corporate cost of capital. Fitch recently updated credit ratings to include ESG, now directly (albeit slightly, for now) impacting the cost of raising debt, likely shifting corporate behavior. It is likely that more investor attention on ESG will further this trend.

Divestment has also caused large flows of capital based on impact principles, and the shift in assets toward high-performing ESG companies sends a broader and even more actionable signal to companies. It’s much harder for a tobacco company to stop selling tobacco products than for a car company to improve fuel economy. Also, the evidence that ESG helps financial performance only further encourages companies to improve their ESG performance.

Conclusion

We hope to have provided ample evidence that impact investing and shareholder advocacy in the public markets creates impact. We also hope to have provided sufficient evidence that impact investing in public markets has not in general hurt financial performance. Taken together, there is a strong case to invest in funds that adopt both strategies, not as a substitute to nonprofit donations, but as a complement. Individuals who have already set aside a portion of funds for investment should consider directing those funds to impact investing.

In addition to choosing impactful investment managers, you can use your voice as a shareowner directly. Organizations might consider following the lead of the McKnight Foundation to influence your companies and outsourced fund managers. Max and Gabe both work to help individuals exercise their voices to create impact. You might work with impact focused advisors, vote in favor of social and environmental proxies, advocate for more sustainable options within your retirement plan, or support shareholder petitions on Stake.

We end with a plea to the EA community. It would be great to evaluate the highest priorities in corporate advocacy for shareholders to pursue. Could investors, for example, encourage tech companies to do more on AI safety? We both got into this field because of the EA movement, and would welcome feedback from the community to be better at what we do.

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Hi thanks for writing this - upvoted. (Speaking for myself here not necessarily Hauke). I think this picks out some flaws in framing and content in the report, though I don't agree with everything you have said.

1. Framing-wise, a number of people drew the conclusion that impact investing is always ineffective, which wasn't what I wanted the report to convey, and I don't think that is supported by the arguments therein. This is corrected in a more recent reworded version of the report, but unfortunately some of the damage is done from initial coverage.

2. I agree that we should have discussed shareholder advocacy in more depth. (Hauke may have some views on this, and may wish to have input here.)

3. Financial returns. We discuss the counter-arguments to this view in the report. This ultimately comes down to the judgement call of favouring theory over very noisy empirical evidence. An investor who only cares about profit would always want as many options as possible available and so would always prefer to have the option of buying stocks in successful companies that do harm, such as fossil fuel and tobacco companies. Our view also seems to be held by many leading economists, as shown in a recent IGM Poll on SRI - http://www.igmchicago.org/surveys/social-responsibility. We discuss the potential confounds of SRI funds doing as well as or better than socially neutral investors. I pose this question: if what you say is correct, why is there not more capital outflow into SRI? Why would socially neutral investors not only do SRI from hereon in?

4. Impact investing effect on corporate decisions. You are discussing here the total effect of all impact investing efforts on corporate decisions. Even on that measure, the effects you mentioned thus far have been modest: publishing sustainability reports, mild effects on cost of debt. The impact these movements haven't had is more striking. e.g. despite the massive attention devoted to tobacco divestment, this seems to have had basically no effect on the corporate behaviour of tobacco companies, though it may have had some indirect effects by encouraging regulation.

Also, the question we should care about is: what marginal difference will an individual investor make by getting involved in these efforts? We think that effect will be small for the reasons outlined in the report. If the total effect has been pretty modest so far, the marginal effect even on the scale of a few million $s invested must also be small. There might be a tipping point in the future, but it seems a long way away - amounts of actual SRI are small relative to the market cap of major firms, let alone industries

Thank you very much Gabe and Max for the constructive feedback! I really appreciated it and have upvoted your post.

Having said that I disagree with your main arguments and conclusions – I largely agree with John’s response above (hence replying to his post).

Some more thoughts on this, which are mine and also not necessarily John’s.

On my judgment call of favoring theory over very noisy empirical evidence, I wanted to add that:

“Financial economists have found that a randomly chosen portfolio of as few as fifty stocks achieves 90% of the diversification benefits available from full diversification across the entire market. The reason is that once one owns shares of a few dozen of them, the diversification gains from ownership of shares in additional corporations are small.”

John Y. Campbell et al., Have Individual Stocks Become More Volatile? An Empirical Exploration of Idiosyncratic Risk, 56 Journal of Finance 1 (2001). As cited in Weyl’s Radical Markets.

So that means the effects of divestment are likely small and hard to pick up. But absence of evidence is not evidence of absence.

Generally, multi-objective optimization is harder than single-objective optimization, and it is usually probably better to optimize for financial returns without social impact constraints with investments that feed your charitable giving and then to optimize for social impact through non-profits without profit-making constraints. As one of the economists in the survey that John cited says: “Hard to believe that adding constraints on portfolio choice leads to higher returns”.

On shareholder advocacy:

Shareholder advocacy might very well have some impact. The question is how much effective than normal advocacy it is. Shareholder advocacy has costs and I don’t think there’s a free lunch here. For instance, it has time costs and socially motivated shareholder advocacy should theoretically reduce a corporation’s profits because it moves the corporation away from its goal to maximize profits.

I also wonder what the added value of being a shareholder for advocacy is. In other words, in theory, there should not be much reason for corporations to listen substantially more to minority stakeholders (or any shareholder for that matter) more so than non-shareholder advocacy, because their goal is to maximize shareholder value. I also worry that there might be displacement effects: one corporation that does not exploit socially harmful ways of making profits might bow under pressure and change their ways, but another purely financially motivated corporation might fill in.

The examples you cite might mostly be because of a corporation's financial self-interest. Tyson investing in clean-meat is actually an example that I’ve cited in my mission hedging piece. Or it might just be good PR and trivially expensive for corporations. To take your example: “At $7 million in annual firearms sales, the category represents less than 1/175th of 1 percent of Kroger's $123 billion in revenues.” https://eu.cincinnati.com/story/money/2018/03/19/kroger-assault-rifles-magazines/437241002/, given that the profits of this will be quite small it would be hard to see that normal advocacy might not have had the same effect. I feel like you imply that shareholder’s ‘might’ does substantial work here and makes it particularly effective, but there are costs and the effectiveness is unclear.

I think there can be some effective shareholder activism:

“Shareholder activism is an alternative middle ground approach in which investments are used to submit and vote on shareholder proposals that influence firms directly. Due to Securities and Exchange Commission rules, a foundation only has to own $2,000 in market value of the firm’s securities (continuously for one year) in order to submit a proposal to be voted on by all shareholders (U.S. Securities and Exchange Commission (1998)). Thus shareholder activism would be an additional benefit of investing in a firm but is not expected to motivate a sizable investment level.” https://www.federalreserve.gov/econres/feds/files/2017042pap.pdf

This is likely to be effective, but more a clever hack that can be exploited with a few 10s of million dollars and does not warrant SRI on this scale which also uses up a lot of philanthropic bandwidth.

Responding here to John's and Hauke's comments above. I hugely appreciate these comments. Especially the highlighting of the marginal impact of the individual, that's exactly the framework of analysis needed.

I want to focus specifically on the added value of being a shareholder for advocacy.

Nonprofits are able to be more radical, and have the edge in reaching the attention of the mainstream public - which is likely most important in advocacy campaigns focused on consumer-facing brands.

As I see it, both shareholder and nonprofit advocates have the ability to build larger coalitions, influence policy, and generate media attention.

But shareholder advocates are likely to be more effective for some campaigns. Shareholders are more primary stakeholders, can more easily meet with corporate decision-makers, have more credibility in interactions, can promote and frame issues in a business sense (this, by the way, is one of the most effective factors in shareholder engagement).

Shareholders can take established issues and push them over a critical threshold. They can be more effective when dealing with issues that are less obvious to the general public but still present long-term risks to corporations, as well as working with companies that aren't consumer facing.

It is also likely that shareholders hold a particular advantage over advocacy nonprofits in authoritarian countries that are becoming increasingly antagonistic to nonprofits, while welcoming foreign investment.

I would love to more thoroughly map out what scenarios are most effective for shareholders vs. nonprofits, could be a great guide for effective advocacy.

On marginal impact and what an individual can do:

For most individual investors, the decision is which mutual fund to invest in. By investing in a fund that does shareholder advocacy on one's behalf, the individual increases the mutual fund's earnings, which helps it expand advocacy operations. Now if the fund didn't do advocacy, those fees could have gone to a nonprofit so it could expand its operations and conduct more advocacy. But as I explained above I think there are a sufficient number of scenarios where that tradeoff would be worth it (I don't think that shareholder advocacy should replace nonprofit advocacy, but I do think that it is much more neglected, and there are a lot of easy opportunities for shareholder advocacy impact).

The potential of SRI at scale is to have more shareholder advocacy staff to run more and bigger campaigns. Not just to have more assets behind a request.

I had a couple other thoughts but they weren't that relevant and my comment was getting too long.

1. Shareholder advocacy often combats displacement effects because the campaigns often target entire industries (see Farm Animal Investment Risk and Return or Boston Common Asset Management's Banks and Climate Change work as examples).

2. It makes sense for index investors to advocate for corporate policies that benefit their entire portfolio. They have incentives to encourage companies to minimize negative externalities (funny enough, some academics worry that index investors will discourage competition, and want to make them illegal). I'm not making any particular argument here, because if big investors explicitly acted on this line of reasoning it probably would become illegal, but I do find the thought interesting so I wanted to raise the point.

3. More people should be exploiting the clever hack! That's actually how I got into this space :)

John,

Thank you for the reply! I'm excited to have this discussion publicly, and I'm looking forward to hearing what Hauke has to say.

1. Thank you for the clarification on this point. This is one of the primary reasons we posted this response.

2. If there's any way I can help get you better data on shareholder advocacy, or connect you to resources, my schedule will always be open to you.

3. This is where I believe that you are materially wrong on the facts. To your first point: I argue that even thinking theoretically, an investor who cares only about profit does not want as many options as possible, they want as many options as possible that have the highest probability of high returns. My argument is mainly that the markets have mis-priced the risk of (especially climate-related) ESG issues. If you're not yet aware of the Task Force on Climate Related Financial Disclosure, I would check them out. Here's a longer read on linkedin.

Thank you also for pointing out that IGM poll. I will be sharing that with my colleagues. The orthodox view within the community of economists would seem to agree with you, but if you dig into the responses, a significant number of them are based on intuition, and are ignoring (or are unaware of) recent data.

Purely coincidentally, at the same time we posted this article, Morningstar (a purveyor of financial analysis for the uninitiated) published its' annual Sustainable Funds US Landscape Report, which includes the statistic on page 4 that "Despite significant market headwinds, sustainable funds pulled in nearly $5.5 billion in net flows in 2018". Please see the whole report for methodology, as it's quite important.

Finally to your last point in this section, I don't have an answer for you. I believe that socially neutral investors can and should only do SRI, although they should take a different approach to SRI from an investor who has a specific thematic focus (see my blog post on this topic for more).

4. This one is tricky to answer while staying on the right side of the rules that say I'm not supposed to talk about specific investments in this answer. Yes, achievements in the field are incremental, but compared to what? What we're trying to do here is apply pressure and build on each success to drive the movement forward. remember that we're still in the early days of the mainstreaming of SRI. Just look at the trends!

Your last point is the reason I became involved in the SRI industry, so I'll re-state it here because it's so important: what marginal difference will an individual investor make by getting involved in these efforts? My answer (and I suspect Gabe would agree, but don't speak for him) is that on their own, not a whole heck of a lot. My business is based on the premise that while individually, each of our financial impact is small, by forming a community and working together we can magnify the impact of our work.

This is why my firm (which for the record has 2 advisors, an office manager and my dog as our chief morale officer - we're SMALL by industry standards) became a signatory of the United Nations-supported Principles for Responsible Investment. Through our membership in this organization, we have the same seat at the table as the world's largest asset managers. I have personally sat in meetings with Swedish pension fund managers working on sustainable seafood initiatives because a client expressed interest and asked that we try to make an impact on this particular issue. Small investors, by choosing who they work with and how, can punch WAY above their weight class. I would be more than happy to give you a tour of the initiatives currently underway. I think you'll be surprised what we're working on, and how much behind the scenes dialogue occurs that isn't accounted for.

3. One important point that we mention in the report - I strongly suspect that ESG ratings don't track social impact very closely. e.g. a quick glance at Philip Morris' ESG rating puts it in the 72nd percentile in terms of ESG, meaning that it has the same ESG rating as Kellogg's, and Philip Morris scores better on social indicators than Kellogg's. Unless, unbeknownst to me, Kellogg's use the funds from Crunchy Nut Corn Flakes to make cluster bombs for the Saudis, something has gone awry here. As far as I can tell, Philip Morris' climate-friendliness and water preservation receives the same weight as its impact on consumer health: making your cigarettes with fair trade solar panels gets you a bump up the ESG ratings.

Re why the market hasn't moved into SRI, this sort of persistent market inefficiency that would be pretty surprising, and the evidence suggests it is highly unlikely.

4. The trends towards SRI seem less important given that much SRI is not very strict.

Are you saying that your marginal contribution is small, or are you saying that you have a greater contribution by being involved in a wider movement? If the first, then we agree, if the latter, then I don't see the argument for it.

The key issue is what impact you have compared to what you could do by giving to effective charity. I have yet to see the case that investing through the stock market has anywhere near as much impact as donating to effective nonprofits.

John,

One thing that compliance was very clear on is that I'm not allowed to discuss specific investments in a public forum. I'm sorry I won't be able to respond to your first point here other than to say that this is why I spend so much time looking at methodologies behind ESG ratings and the way mangers apply them.

The core of our argument is that your last point makes a critical category error: while donating to effective charities will almost certainly generate higher impact, there is a a HUGE amount of capital that cannot be given away (due to being earmarked to funding retirement or other goals), and that impact investing and ESG are tools to have some impact where otherwise your investments could be funding actual harms.

To the point about our involvement with the PRI and other working groups: our argument here is our marginal impact is significantly higher given this involvement. I hope to have an impact report completed soon with more details.

We say in the report that SRI is probably more impactful than socially neutral investing. I don't think that SRI in stock markets is particularly impactful however, and I think it would be bad if foundations started doing it for the sake of impact.

If you spend so much time looking at ESG methodologies, and you need to do this to have social impact, then this is an additional cost of SRI, and a reason to expect you to get lower returns than someone who doesn't care about impact.

in my view, foundations should be doing ESG investing from a risk management perspective, not an impact perspective. Foundations should examine Impact Investing for a portion of their endowments as both a risk mitigation factor and from an impact standpoint. it's important to differentiate the two approaches. see my blog post on the topic.

the time I spend reviewing ESG methodologies is part of our Due Diligence process. I think it is fairly uncontroversial to state that any investor should have a Due Diligence process, and should, at a minimum, read and understand the prospectus of an investment and have a discussion with the portfolio manager.

I would welcome the opportunity to show you the portfolios I build, and talk about our manager selection process in more depth. Here's my scheduling link: Let's find a time. I have a lot to say about your last point, none of which compliance would be happy about if I wrote in a public forum.

So your due diligence process takes no more time than a socially neutral investor's due diligence process, even though the socially neutral investor would not spend considerable amounts of time looking at ESG rating methodologies and how managers use them? Are you saying you bear the same time cost as a socially neutral investor even though you do more work? Why is this?

Worth noting also that index funds don't have to do due diligence.

"I have yet to see the case that investing through the stock market has anywhere near as much impact as donating to effective nonprofits." - where do you believe the post claimed otherwise?

I see that this post has received a couple of downvotes since the last time I checked. I really wish that those voters would leave a comment to explain why they didn't like the post, or ways in which they thought it could be improved.

I don't necessarily agree with every point of the authors' argument, but they've made an honest attempt to contribute to an ongoing conversation from an angle not mentioned by Halstead and Hillebrandt. They laid out their argument clearly and cited sources, something I'm happy to see more of on the Forum.

Downvotes seem to imply one of the following things:

1. Someone thinks they've made one or more mistakes on the post (but hasn't pointed out those mistakes).

2. Someone doesn't like the way the post was written/formatted (but hasn't explained how in a way that could help the authors improve the post).

3. Someone doesn't like impact investing and downvotes posts that favor it, even if they haven't examined the arguments behind those posts.

I could understand (3) for posts about something either totally irrelevant to EA, or something philosophically opposed to EA, but not for a topic like impact investing, which is at least a plausible path toward impact. Even if someone doesn't think the area is important or tractable enough to be worth discussing, I wish they'd take the time to leave a comment explaining that.

I downvoted because the arguments that impact investing funds would outperform funds purely optimized for profit seemed quite naive, and indicated a lack of some basic microeconomic intuitions that made me strongly distrust the rest of the post.

The study linked helped a bit, though I easily found meta analyses with the opposite conclusion, and also it's a kind of domain where I would expect empirical studies to be pretty easily fudged to give the socially approved conclusion.

Also some general feeling of distrust of someone advocating for an intervention that they are financially benefited by, though that was much weaker evidence and I recognize that people who work in this space are probably also the ones who think most about it.

That feels overly harsh given that many economists apparently accept that SRI doesn't undermine the bottom line. Its weird to downvote something held by a significant chunk of economists for being naive.

I'd like to highlight the distinction between 'impact investing funds would outperform funds purely optimized for profit' and 'SRI doesn't undermine the bottom line'. In markets as efficient as I think publicly traded stocks are, the former is highly improbable and the latter is highly probable.

The blog post appears to make both claims. Habryka's complaint may seem more defensible to you if it is entirely about the former claim.

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Two technical notes on this distinction:

  • Given the existence of some low-quality evidence for the strong (outperformance) claim, you might argue that that too is not so naive.
  • Of course, SRI typically reduces diversification, with an effect somewhere between negligible and substantial depending on the strategy, making the weak (doesn't undermine) claim misleading in some situations, even with efficient markets.

Kit, thanks for making that distinction.

All I (personally, can't speak for Max) tried to convey was that there is substantial evidence that impact investing has not led to underperformance (can't say anything about the future because as every financial disclaimer says: past performance is not indicative of future results).

Of course, studies showing historical outperformance from ESG are useful to make Kit's latter point that SRI has not undermined the bottom line

Thanks for giving examples of advocacy efforts you might see as a good use of investor time and capital! Getting to the concrete outcomes of impact investing seems pretty key for figuring out in what situations it's a good use of time and capital to engage in.

When you say, 'shareholder advocacy, which is the primary mechanism for impact in public equity investing', I find this very much plausible in the sense that it's the part which seems to have the highest potential. Interestingly, though, when I last looked into this, the vast majority of the SRI industry by capital seemed to be not engaging in shareholder advocacy.*

I would expect shareholder advocacy to be worth the time of effectiveness-minded altruists only in very specific situations (perhaps including some of the ones you named), but given that good shareholder advocacy seems so rare even in SRI, I wonder if there is room for getting the entire SRI industry to actually do the part of SRI which seems promising? Is it true that most SRI capital isn't being used for shareholder advocacy? Is it tractable to improve the industry in this way? (Is that already your main aim?)

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*I'm not counting screening/divestment campaigns which don't involve talking to specific companies, because this generally seems not to provide clear incentives for any particular company to do anything in particular. Best-in-class screening might be an exception, but the incentives still seemed super weak to me when I last thought about this. Overall, it looks like there's ${tens of trillions} of assets considered to be SRI and a small number (on the order of 1,000 per year?) of good shareholder advocacy campaigns, which suggests a massive difference between the potential of SRI and SRI in practice today.

Kit,

Thanks for a well thought through response! I agree that the vast majority of "SRI" funds aren't engaging with their portfolio companies in meaningful ways. In fact, since I joined the industry in 2013, there has been a boom in providers claiming to be "sustainable". The hardest part of what I do these days is sifting through the pitches to find investment firms that are taking this seriously and not just "greenwashing" as we call it.

That said, the trend is real and important, and there's another part of it that's worth considering: while there are indeed a limited number of engagements in any given year, the funds that want to be seen as sustainable often follow the leaders in the space into engagements, so while a small number of firms lead engagements, the 'hangers on' magnify the assets behind these proposals. I personally believe that EA minded individuals should look for asymmetric ways to spend their time, where by working on an issue, you can attract more capital/investors/time/energy/effort/utility. I also believe that the trends we're seeing in the SRI industry are the first wave, as firms develop their capabilities and learn what their investors want. as time goes on, I believe we'll see more funds voting their proxies in response to advocacy campaigns (although - this is my personal belief and I could very well be wrong)

I'd direct you to the post I made on my (very new - please be kind) blog on the recent USSIF trends report, which has some additional graphics about WHY asset managers are acting this way (self-reported data) that supports this belief.

https://www.commoninterestsfinancial.com/2018-trends-in-responsible-investing/

Hi all, Max Mintz here (Gabe's co-author). I'm blown away by the quality of your responses so far. This is everything Gabe and I hoped to achieve with this post. I will endeavor to respond meaningfully to these comments, but as I am an investment advisor, I am bound by a set of rules I have to follow when posting in a public forum, so I have to ask that if anyone would like to discuss specific investments or investment strategies, please email me directly at max@commoninterestsfinancial.com (or schedule an appointment through my website) and I'll be more than happy to discuss what I can't talk about publicly.

I’m so glad to see a post from people working in the industry in question - thank you for taking the time, making the post and contributing to the discussion, I strong upvoted.

Impact investing comes up a lot in donor advisory, so have a few points to add:

1 I generally still advise donors not to use their philanthropic, impact maximising, allocation for impact investing. I still do not have a very thorough way of explaining how I came to this conclusion and no existing materials I know of could be sent to a HNW.

2 most large donors only give a small portion of their assets, >90% of their capital is generally invested and impact investing (II) can come from that allocation. This changes the discussion considerably. Eg from ‘II vs donating’ to ‘where are you spending your time’. We could also discuss lost returns but it seems like most II does not have sufficiently lower returns on average to worry about it from an impact perspective. Giving better will make significantly more of a difference than 5-20% more or less profit from their investments. Not always going to be true but generally seems the right view.

3 donor funds are a very different question to an individuals career, the leverage available in some impact investing careers is so high that it requires a separate investigation that I haven’t seen. I would guess that an evaluator could move 10-100x more capital for the same effort in II than in donation evaluation.

4 stepping back, effectiveness minded II might be an important consideration in designing the models orgs within top cause areas consider. If you were comparing two models for your org and one assumed limited philanthropic capital and so maximised its impact per dollar but the other assumed huge swathes of II funding and so took on a much lower impact per dollar, and tried to design a model that would be copied, build IP, be acquired by industry giant etc..

5 bio / ai safety have many opportunities for doing far more damage than good, at face value it does not seem a good fit for larger, IP-driven investment models. However, a big worry is control and trust. If top researchers and strategists in the area felt there was capacity for responsible cautious impact investing the area, that might speed up how quickly market driven approaches emerged.

The paper is co-authored by John Halstead and Hauke Hillebrandt, so should be"John and Hauke's paper" or "Halstead and Hillebrandt's paper" throughout.

Edited to reflect this comment, thank you.

Thanks for the *great* discussion.

One question that was raised is whether there is a trade-off between Impact Investing and donations. I am not sure whether one of the biggest reasons for the existence of such a trade-off has been mentioned so far: People who invest socially responsibly feel more comfortable about owning that money and may therefore be less prone to donations. Conversely, people who feel that they are earning their money in illegitimate ways may feel under more pressure to give it away.

I don't have any data to support this claim. It's merely my personal impression that *a lot* of my non-EA friends who care about poverty, animals, etc. are much drawn to the idea that what they should *really* be doing is aiming at clean hands by investing & consuming ethically. They feel that if they earned & spend their money in a clean way, any donations are then superogatory.

Because of this sense, I often strategically try to undermine people's belief in impact investing -- in order to convince them that it's (at the very least) not a comprehensive solution and that donations are crucial as well. Neither Gabe nor Max claimed that it's a comprehensive solution but I believe that people perceive it as such. And this perception implies that there are significant trade-off in promoting impact investments rather than donations.

P.S.: One solution to that would of course be to promote impact investing but *frame* it such that people don't feel like they can refrain from donations simply because the money was earned in a "clean" way.

Impact investing to encourage companies to do more on AI Safety is a particularly fascinating idea. I'm curious how much your influence depends on the number of shares. Obviously if you own 20% of a company you're likely to be heard, but is there much difference between owning 1 share vs. 100?

I'm glad you're excited about this idea. Making the business case to companies to take AI safety seriously, from an investor perspective, could be an important angle to getting more companies to take it seriously.

Not much difference between 1 and 100 shares. Influence certainly depends on number of shares, but it's more dependent on credibility. There are a number of great examples of smaller investors with issue area expertise substantially affecting corporate operations. And other small investors have raised new issues from new angles to company management. More still have built coalitions, and garnered significant press. All pathways to impact.

James Gifford has done the best work on this, and the executive summary is especially worth a read: https://www.slideshare.net/slideshow/embed_code/key/E28F5ODb5Rk2tu (sorry it's in a terrible format, that's the only version I could find that's not behind a pay wall).

The claim that impact investing does "not entail a reduction in financial returns" is inconsistent with two other claims in the report. The first is that good ESG practices reduce a company's cost of capital. The company's cost of capital is its weighted cost of equity and debt (stocks and bonds). To put it another way, the company's cost of capital is the same as the investors expected return. If a company's cost of capital is lowered, then the ex-ante returns that an investor receives will be lower.

The second inconsistent claim is that divestment has been successful in providing managers an incentive to adopt good ESG practices. In fact, if companies with strong ESG bonafides provide a superior ex-ante return, then the corporation would have an incentive not to adopt ESG policies. It is only when ESG provides lower ex-ante return to investors that corporations will have an incentive to adopt these policies.

These points are explained in more clarity and depth by Cliff Asness here: https://www.aqr.com/Insights/Perspectives/Virtue-is-its-Own-Reward-Or-One-Mans-Ceiling-is-Another-Mans-Floor

The same logic also naturally applies to ESG funds. If a manager is known to outperform because of their superior use of ESG information then, on average, you can expect their fees to rise to reflect this and to neutralize the benefits to incoming investors to the fund.

I don't know if this is necessarily true, because often times outperforming firms get inflows of assets. Then they wouldn't have to raise their fees because they make more money by taking the same (or lower) fees off of a larger pool of assets.

There may be research out there that completely disproves my hypothesis, it is just a hypothesis, but I don't think one can necessarily make that logical jump.

Thanks for the comment! I don't fully understand the point you're making in the second paragraph, do you mind expanding a bit?

On your first p0int, you would be correct assuming efficient markets and that all information is priced in. A lot of ESG research has been making the claim that ESG factors are material, and often ignored by mainstream managers (not priced in). This could lead to the result you describe.

I could understand that you may be skeptical of ESG being material and not priced in. I will say that discussion of ESG factors is showing up in more and more mainstream investment managers reports in the context of "just good business", indicating that investment managers are starting to look more at ESG factors as material.

Thanks for the reply and sorry for the delay. I can see how my second point was unclear. Let me reframe it by saying that the evidence does not support that impact investing has been, in the past, effective at providing corporations an incentive to adopt ESG. The evidence that ESG factors produced above market returns is evidence that fund flows did not raise the price of ESG factors, thus provided no incentive for corporations to adopt ESG (above whatever profit maximization incentives already existed).

On the first point, you are arguing that ESG is not priced into current prices, and that ESG factors will produce higher returns in the future. I guess I disagree. I know there are a few factors that have long track records of overperformance (value, momentum, low vol). I do not think there is sufficient evidence to claim that ESG is a similar factor. It just seams like conjecture at this point. I would say I believe in weak-form efficient market hypothesis. Basically you can get above-market returns, but it is a lot of work, and simple theories are unlikely to work.


Great to see this discussion happening! As a practitioner and researcher who has been thinking about these issues for a while I am still highly uncertain about what conclusions we should make about impact investing (II). So the more thoughtful discussion on this the better.

I have some general comments on this space & EA-bias and also some specific follow-up questions.

In the SRI/ESG/II space there is so much variety that a lot of the time people are talking past each other because they aren't talking about the same thing. So, one way for those who are interested in this debate to contribute to it would be to define one very specific impact investing strategy for analysis at a time. This post by Max and Gabe is a good start in this regard as it is focused on shareholder advocacy. John and Hauke's simple analysis of Acumen vs Donate Now vs Invest to Give is also a good start. Their example would be really useful if it was improved to fully represent each strategy (e.g. as John and Hauke are careful to mention they do not account for 'that [Acumen] could continue to reinvest the profits in socially impactful businesses in perpetuity', nor 'unaccounted for advantages to donating now, such as diminishing returns and compounding social benefits') as well as the risks and uncertainties involved.

Another tricky thing with this space is the varying quality of the arguments and literature. It was a strong choice to base this post on shareholder engagement as studies of this have some of the most compelling results and have been published in the best journals (e.g. Strickland et al., Becht et al., and Dimson et al.). Studies focused on the links between environmental performance, financial performance and investment performance typically have weaker data, they often apply weaker methods, and they generally don't get accepted into the best journals. John and Hauke mention some common short comings of studies of screened funds. More generally, my guess would be that many ESG performance papers get desk rejected by top journals based just on unclear logic in their abstracts. For example, not only does a correlation between ESG and CFP not prove causation, it also doesn't necessarily tell us anything about the link between ESG and investment returns (because CFP != stock returns).

The EA community itself also sometimes makes overly simplistic arguments when discussing this topic. My perception is that a very common mistake is always appealing to a somehow infinite supply of 'socially neutral' investors. I was pleased to see that John and Hauke's report pretty much avoided this (that is, they were careful not to say that buying and selling stocks has no price impact). Heinkel, Krau and Zechner (2001) (https://www.jstor.org/stable/2676219) analyze a simple model for what happens if you correctly model the market as being finite. They find that for realistic model parameters you need about 20% of investors to commit to 'green investing' in order to induce some polluting firms to switch. And they estimated that at most 10% of investors were 'green' at the time. The lesson from this basic model is that it makes complete sense in theory that groups of investors can influence corporate behaviour - the groups just need to be large enough. Another, point is that the threshold number of investors depends on the cost to each firm of buying greener tech. This suggests thinking of other (possibly complementary) ways of inducing the reform you want to see like investing in (or grant funding) R&D to make the switching cost lower.

@Max, @Gabe, some questions in line with my points above to make sure I understand what you wrote:

How would you precisely define the Shareholder Advocacy Impact Investing strategy that you discuss in your post? For example, is the idea that by selecting and investing in a stock, and then using my shares to support an advocacy campaign, that I will marginally increase the success probability of the campaign, and that the success will generate abnormal returns that will reward me for the time involved and give me more ammo to make my next advocacy investment? And that this works out to possibly be a better investment of my time and money than other impact opportunities?

Because if there is no investment reward, why not pursue advocacy by some other possibly more effective means? Or, if there is no investment reward but shareholder advocacy is somehow much more effective than other forms of advocacy, what is the minimum number of shares I (or a like-minded group) need to hold to achieve this level of effectiveness? How much does my impact scale with a greater holding?

You posed some fantastic questions, jjharris!

By using your shares to support an advocacy campaign with an individual stock, I think you will marginally increase the success probability of the campaign. I can't say that you will generate abnormal returns. I did link to a couple studies that correlate successful advocacy campaigns with outperformance, but it's in no way guaranteed.

Separately (or additionally), investing in a mutual fund/ETF run by an impact-focused investment manager gives it more assets, which gives it more operational capacity to pursue more social good, as well as a more powerful voice in all its advocacy campaigns.

How does impact scale with a greater holding: James Gifford has the seminal work on this topic (https://www.slideshare.net/slideshow/embed_code/key/E28F5ODb5Rk2tu). Gifford finds some correlation between assets and effective engagement. But he makes the critical point that successful shareholder advocacy operates primarily on persuasion, not coercion. Having more assets does increase a shareholder advocate's credibility, but it's really about ability to convince management.

Also, Gifford details how smaller investors have been able to raise issues to companies from the shareholder perspective, and build coalitions/generate press coverage to leverage their small stake and still drive impact.

Your question of whether it's the best investment of your time is another good one, and very difficult to answer. There is not sufficient academic research comparing the effectiveness of advocacy from the shareholder angle to advocacy from traditional nonprofit angles. I think this would be a very worthwhile pursuit, and would love to see this happen. I will say that some nonprofits (animal welfare ones especially) have seen the value of the shareholder angle, and have partnered with investors, or used their own endowments as leverage in the past.

The reason why I wanted to write this piece (my perspective, can't speak for Max) was to make the point that shareholder advocacy has been historically successful, and that it is not obvious that one that pursues a shareholder advocacy investment strategy (themselves or investing in a shareholder advocacy fund) will lead to financial underperformance. Therefore, shareholder advocacy should not be written off, and is worthy of consideration of serious EA individuals and organizations.

It's been a few months since Gabe and I posted here, but my firm has just published our first Impact Report, and I wanted to come back to this forum to show you what we've been working on. This report tells the story of the impact our clients chose to create through their investments, the advocacy of my firm specifically, and how we're trying to create change both in the financial industry as a whole, and as a business. here's a link: https://www.commoninterestsfinancial.com/2018-impact-report/