How Impact Investing Can Earn Returns, Peace of Mind

Feb. 18, 2014 — -- As the bull market roared in the 1990s and fortunes were made (and lost in the tech-stock crash of 2000), there came into vogue among some investors a practice known as socially responsible investing, or SRI.

This type of investing had been around for decades. In the late '90s, it became known as "investing with a conscience." This investing philosophy involves avoiding investment in some historically profitable sectors, such as tobacco and oil companies, because their enterprises were deemed by some to be less than socially responsible. The idea is to align perceptions of investment value with one's values — to invest directly to achieve desired outcomes.

Now SRI is widely called ESG (investing for environmental, social and governance goals). A type of ESG that's developing apace these days is impact investing, a proactive investing style that emphasizes helping societies in under-developed nations and economies. This has spurred investment in companies that make micro-loans to start-ups worldwide deemed potentially beneficial to their countries' cultures and economies but that might not qualify for conventional institutional financing — a form of venture capital.

Because the negative (avoidance) side of ESG investing limits the scope of possible investment, this can easily rule out some of the most profitable companies. This has generally been viewed as a sacrifice some investors have made — forgoing potential returns — to assure that their capital isn't employed in a manner inconsistent with their social and environmental values.

The impact on portfolios has been decreased ownership among proponents' of stocks that pay regular dividends and an increase in growth companies, which typically don't. This cuts into total returns.

Today, impact investing is no longer a financial sacrifice that investors must make for moral reasons. There are abundant indications that ESG investing is no less potentially profitable than regular investing, all other things being equal and assuming a well-diversified portfolio.

Studies including a landmark investigation in 2012 have found no real difference between the results of ESG and those generated by standard portfolios in either bull or bear markets.

Some large institutional investors have found that the parts of their portfolios that have done the best have amounted to impact investments. Regardless of whether they may have been disciplined to be impact investors prior to reaping these returns, some of these investors have become de facto impact investors because it can be profitable.

An example is Ron Cordes, a former institutional investor not originally focused on impact investing, who found that positive-impact-related investments in his portfolio did so well that he increased his investment in them significantly. As Cordes and other large investors are realizing, impact investing can be good investment management.

What has changed the investment landscape to make impact investing profitable instead of the values-driven albatross it used to be?

For one thing, there are more investment opportunities for impact investors, spurred by a growing interest in companies whose goals or operations are consistent with it.

Another reason is shifting social values and a cultural sea change. As society has become more accepting of pertinent social and environment goals, so have many major corporations.

More people now favor environmental protection, spurring investment in clean-energy technology in a nation that now burns far less coal than it used to. And some large companies are focused on environmental goals in their operations because this can represent cost-effective management.

Wal-Mart has programs to support energy efficiency within the corporation and among its suppliers.

In the broader corporate workplace, there's far more emphasis on minority recruitment and promotion than there was in the 1990s — and that has opened up stocks in companies following that trend to impact investors focused on this issue.

Another key value for impact investors, corporate governance, received a big boost from negative examples in the early 2000s with the implosion of WorldCom and Enron after the companies misled investors, and from the excessive risk taken by major financial service companies in real estate and mortgage-based investments that contributed to the market meltdown of 2008–09. If they didn't already believe in responsible corporate governance, investors who lost 50 percent of their nest eggs when the markets plummeted became overnight believers in ESG investing's emphasis on managing risk.

Since then, far more investors look for strong risk management, and they've become ESG investors after a fashion. Thus, forgoing investment in what you don't believe in and pursing it among companies you wish to empower is no longer an idealistic investor's costly indulgence. Rather, it's a viable investment strategy that, if skillfully directed, can earn returns while helping you sleep at night, confident that you're not financing those who create what you view as problems or stinting on those who solve them.

This work is the opinion of the columnist and in no way reflects the opinion of ABC News.

Ted Schwartz, a certified financial planner, is president and chief investment officer of Capstone Investment Financial Group. He advises individual investors and endowments, and serves as the adviser to CIFG UMA accounts. Because Schwartz has a background in psychology and counseling, he brings insights into personal motivation when advising clients on how to achieve their wealth management goals. Schwartz holds a B.A. from Duke University and an M.A. from Oregon State University. He can be reached at ted@capstoneinvest.com.