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.
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.