Money Matters: Making money while doing good

Thinking about investing in companies that further causes you believe in—or at least making sure your stocks, bonds, and mutual funds don’t help causes to which you object? If so, you may be wondering whether a so-called socially responsible portfolio can yield attractive returns. The short answer is that it can, but finding the right investments can be tricky.

While funds focusing on specific social ideas and causes have been around for two decades, investors have been selecting companies that align with their beliefs for much longer. Socially responsible investing, also known as impact investing, can involve the use of negative screens, which separate out companies with products or approaches that investors don’t want, such as alcohol or gun manufacturers or businesses with poor environmental records.

Alternatively, investors can screen for characteristics they do want, including strong corporate governance, adequate representation of women or minorities on boards of directors, or family-friendly employee policies. Fund managers and large investors also try to enhance their impact by voting in proxy campaigns and meeting with company management.

A big question facing investors is whether returns on socially responsible funds typically equal or exceed returns for broad market indexes. No clear answer exists, but many academic articles do suggest that firms with high scores on corporate social responsibility measures tend to perform better than firms with low scores, both in terms of profits and stock valuations, says Caroline Flammer, a professor at Canada’s University of Western Ontario. Some examples:

A study by Alex Edmans at London Business School concluded that companies that treat their employees well outperformed the overall market, as a group.

In a 2015 paper in the journal Management ­Science, Flammer showed a correlation between corporate social responsibility and improved operating performance.

A 2015 Harvard Business School working paper by Mozaffar Khan, George Serafeim, and Aaron Yoon found that companies that invest more money in sustainability initiatives have higher stock returns.

In 2012, Deutsche Bank concluded that 89 percent of academic papers looking at this issue found that higher environmental, social, and governance standards at companies led to stock price outperformance.

Chances are, you can find portfolios that address causes that matter to you. For investors who care about placing more women on corporate boards, for example, Eve Ellis and Nikolay Djibankov, who run the Matterhorn Group at Morgan Stanley, created the Parity Portfolio. Starting with a list of the 300 large-cap public companies with three or more women on their boards, Ellis and Djibankov then chose the 40 or so top performers. The group’s clients have about 10 percent of their assets invested in the Parity Portfolio, Ellis says.

Ascent, a wealth-management division of U.S. Bank where clients have a minimum net worth of $75 million, maintains a database of some 400 impact-investing mutual and exchange-traded funds. Some of these funds select companies that meet certain criteria while others exclude stocks with particular characteristics. But Jonathan Firestein, managing director of private capital and impact investing at Ascent, says that about a quarter of the funds in the database charge excessive fees, and of the rest, “only 15 percent are really worth it,” a proportion that is about the same as for regular funds. He adds that it’s important to think of impact funds as you would any investment—not just as a way to do good but as a way to make money.

Investors over age 55 tend to be relatively skeptical about impact investing, Firestein says. But sticking to a philanthropy-only model—just donating money—can lead to missed opportunities both to help and to make money, he says: “There are things you can invest in that you cannot give to, and there are things you can give to that you cannot invest in.”

One Ascent client family that’s heavily involved in social investing, Firestein says, is passionate about affordable housing, education, and healthcare in the U.S. and has also made impact investments in Africa and Latin America. In addition, it is moving all of its investments in several long-term generation-skipping trusts into impact areas, including stocks and bonds, private equity and venture capital, and direct loans.

For the public-market investments, the family expects “to beat the market by a little bit,” Firestein says, and it anticipates that the private equity and venture-capital funds will yield an annual internal rate of return of 20 percent or more.

Some advisors say philanthropy is a better way to aid a cause than impact investing. One reason is that it can be difficult to measure how much social good or bad a company is doing, says Scott Clemons, chief investment strategist at Brown Brothers Harriman. “If a company derives 10 percent of its revenues from tobacco, is that too much?” asks Clemons. “Five percent? Or should we measure as a percentage of profits instead of revenue? It gets tricky pretty quickly.”

There’s also the question of what socially responsible funds should do about companies that some investors think are good and others consider bad. For instance, one investor might avoid Monsanto, which makes genetically modified seeds, while another might seek out the company’s shares, reasoning that the seeds are fighting world hunger. Similarly, an investor who has chosen to eliminate alcohol companies would have to consider whether to invest in Costco, which sells alcohol. This can make it difficult to select a fund that bills itself as socially responsible, leading many investors to craft their own portfolios.

“If you want to be an impact investor, you have to define your terms really carefully and revisit [your portfolio periodically] because business models change,” Clemons says.
Evaluating a manager’s performance is also difficult when the impact portfolio and the regular portfolio don’t match exactly, making it challenging to know when the manager is doing poorly and when the investor’s own constraints are causing lower returns.

“Rather than overlay social goals onto an investment program, we recommend that clients express their social responsibility through philanthropy,” says Clemons.

Chana Schoenberger has been an editor at Forbes, a reporter for Dow Jones and the Wall Street Journal, and a news editor at Bloomberg News.