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.
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... (read more)