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4 Ways Impact Investors Are Driving Change

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Investors’ interest in SRI and ESG investing is such that companies and policy makers have been forced to address environmental, social and governance challenges, according to a report released in June by the The Forum for Sustainable and Responsible Investment, known as the US SIF Foundation.

Between 2012 and 2014, assets in socially responsible investments increased 76% to over $6.5 trillion, according to the report. US SIF found that in 2014, there were 925 investment funds and 214 separate account strategies that incorporated ESG criteria into their investment management.

Impact investing’s effects have spread from investment companies and advisors who create products and strategies to meet these investors’ objectives, to the actual management of companies, community development and public policy.

1. Investors’ Impact on the Industry

The report noted that as interest and assets in impact investments have grown, even investment companies that aren’t explicitly ESG firms incorporate ESG criteria in their analyses. Managers have applied ESG criteria across investment vehicles, market caps, active and passive styles, and value and growth strategies.

Since the Domini 400 Social Index was launched in May 1990, there has been a “dramatic expansion” of indexes and hundreds of sub-indexes, according to the report, including those from investment and research firms like Calvert Investments, Pax World Management and Sustainalytics, financial services firms like S&P Dow Jones, FTSE, MSCI, STOXX and Thomson Reuters, and global stock exchanges, including NASDAQ OMX, NYSE Euronext, Deutsche Boerse and the Johannesburg Stock Exchange.

The report noted that SRI indexes have comparable returns to traditional indexes. The MSCI KLD 400 Social Index (formerly the Domini index) returned an average 11.51% over the last five years, compared to the MSCI USA IMI’s 11.2%.

Specialized stock exchanges have also been created to serve impact investors, according to the report.

Alternative investments like private equity, real estate and hedge funds are adopting ESG criteria, the report found. Assets in the 212 private equity and venture capital funds that consider ESG factors reached $135 billion in 2014. Real estate is a natural target for SRI investors, according to the report, because “real estate investment entails tangible social and environmental impacts that investors can measure, and those impacts are material to long-term performance and risk assessment.”

Green bonds grew from $11 billion in 2013 to $36.6 billion the following year and almost $42 billion in 2015, the report found. The bulk of those proceeds focus on renewable energy, followed by energy efficiency, low carbon transport and sustainable water.

Morningstar and Sustainalytics started rating ESG mutual funds and ETFs in March, the same month MSCI announced it was launching MSCI ESG Fund Metrics.

Family offices are a new source of interest in impact investing, the report found. “Although publicly available data on family offices is limited, anecdotal evidence suggests that they are making more frequent inquiries to family office membership associations, financial advisors and consultants about adopting sustainable investment strategies,” the authors wrote.

Impact investments in retirement plans are still relatively limited, despite the Department of Labor’s release last year of an interpretive bulletin retracting its earlier charge that fiduciaries use economically targeted investments rarely. Social(k), which provides ESG investments for retirement plans, estimated that between 15% and 20% of 401(k) plans offered socially responsible investments in their lineups in 2014, US SIF reported.

2. Investors’ Impact on Companies

There are several ways impact investors drive change at publicly traded companies, US SIF found, including filing shareholder resolutions, communicating with executives and voting proxies.

These actions create a “ripple effect,” the report found, where “investors urge a few companies to take action on an issue, and other companies take note and adopt more sustainable policies to avoid becoming the targets of similar shareholder action, or being conspicuous for not having industry-leading policies.”

Proxy voting and shareholder resolutions are the primary ways investors affect change, according to the report, and investors file about 50% more shareholder proposals today than they did 10 years ago, including over 400 last year. Although support for individual proposals rarely tops 50% of shareholders, the report found that it’s “no longer uncommon for such proposals to receive the support of 30 to 40% of the shares voted.”

However, US SIF found that even without majority support – and even without voting sometimes – resolutions can be effective as simply filing them can prompt discussion.

In privately held companies, investment managers frequently have direct access to company managers and can engage with them to shape the policies at companies they invest in.

3. Investors’ Impact on Communities

US SIF identified “community investments” as those that focus on marginalized areas that aren’t typically the focus of conventional market activity, like low-income neighborhoods, communities of color and rural communities; have an explicit social benefit, like affordable housing and economic development; and are available in a financial product that can be managed in terms of risk and return.

One such example is a community development financial intstitution (CDFI), which may be a bank, credit union, loan fund or venture capital fund that specializes in serving low-income communities, according to the report. Small-business investment corporations (SBIC) with an impact focus invest at least half of their funds in small businesses in low- to moderate-income areas.

Some community investments aim to support areas outside the U.S. through microfinance. The report cited data from the Calvert Foundation that found almost $3 billion had been invested in microfinance funds by the start of 2014.

4. Investors’ Impact on Public Policy

Sustainable investors and their advocates, of which US SIF is one, have campaigned for various reforms by engaging with government agencies, according to the report.

The report called the Dodd-Frank Wall Street Reform and Consumer Protection Act an “important victory” for sustainable investors for its numerous provisions that directly address ESG issues, such as executive compensation and pay disparity, conflict minerals (Dodd-Frank requires public companies that source minerals like tantalum, tin, tungsten and gold to report on how and where they are sourced), payments to foreign governments and the creation of the Consumer Financial Protection Bureau.

In 2007, investor coalitions, including US SIF, formally petitioned the Securities and Exchange Commission to issue guidance on climate change risk disclosures in securities filings. In 2010, the SEC issued such guidance, urging companies to report to investors on “material impacts” of climate change.

In 2010 and 2011, US SIF successfully advocated for the Environmental Protection Agency to amend or pass rules regarding greenhouse gas emissions by fossil fuel suppliers and minimizing mercury and other toxins emitted in coal- and oil-fired electric generating units.

Impact investors have worked to create several reporting initiatives to aid impact investing, including the Carbon Disclosure Project, now simply the CDP, which administers a climate change database and works with 822 institutional investors holding $95 trillion in assets; the UN Environment Programme Finance Initiative, a coalition of more than 200 global financial institutions to promote sustainable investing; the Global Reporting Initiative, guidelines of which are used by more than 5,000 organizations; and the Sustainability Accounting Standards Board, which is working to develop standards for material ESG disclosures at public companies, and is expected to have identified standards for 80 industries in 10 sectors by the end of the year.  

“A growing number of individual and institutional investors are searching for investments that can address global environmental crises, build community and improve economic opportunity,” the paper concluded. “Ultimately, the path to a sustainable future requires awareness that corporate performance, investment performance, and environmental, social and governance issues are interconnected and inseparable.”

— Read ESG Analysis ‘More Dynamic,’ but Ambivalence Remains on ThinkAdvisor.