How to Find Impact Investments for Your Portfolio
These options are on the rise as individuals “want to connect to their investments more,” Morningstar analyst says.
For many individuals who are sustainable investors, impact investing is often at the heart of why they invest.
Impact investing considers how a company, fund, or investment portfolio positively or negatively impacts the environment and society. Typically, impact investors are interested in owning shares, bonds, and funds that produce positive environmental and social impacts, in addition to a competitive return. “The impact investor is looking for ways to create positive, measurable, real-world social and/or environmental outcomes,” says Megan Wallingford, director, ESG research products at Morningstar Sustainalytics. For a good assessment of impact investing, read Megan’s recent piece here.
In the past, impact investing was the purview of institutions or the wealthy. This is changing, too. “Investors are starting to think about impact more especially on the retail side,” says Shila Wattamwar, Morningstar Sustainalytics’ global head of ESG retail and wealth. “They want to connect to their investments more. There is a personalization element that presents itself more now than ever before.”
And it’s growing in popularity. According to the Global Impact Investing Network 2022 market size report, the worldwide impact investing market is about $1.16 trillion, the first year it has gone over $1 trillion. It’s especially popular with millennials and younger investors.
Impact investing isn’t to be confused with environmental, social, and governance investing, in which you account for ESG risks that can affect a company’s business.
There’s no single approach to impact investing. Some individuals’ intention may be to reduce the negative impacts of their investments. Others want to see a clear connection between their investment and global objectives, such as the United Nations Sustainable Development Goals or the Morningstar Sustainalytics Impact themes. Often, impact investors have in mind specific themes that are driven by their interests, experiences, and values, says Wallingford. For example, some individuals are interested in owning shares of companies that are advancing women in the workforce.
You can find a lot of helpful information on Morningstar.com and, through your advisor, on Morningstar Direct. “What do you care about? That’s a great place to start,” says Jean Case, a philanthropist who chairs the National Geographic Foundation and is CEO of the Case Foundation. “What impact does your investment have? How is your capital being used for good or bad?”
The Morningstar Sustainable-Investing Framework is a good guide. For example, you might want to avoid creating the worst negative impacts on society. That might lead you to screen out tobacco investments. You can find out if your fund has tobacco exposure by clicking on the Sustainability tab on the fund’s page, and clicking on “product involvement.” (Read more about product involvement here.) For example, you’ll see that SPDR S&P 500 ETF SPY has 0.7% of assets invested in tobacco stocks, a hair less than the 0.8% for the large-blend Morningstar Category.
You can also find a shortlist of impact equity mutual funds and ETFs in Morningstar Direct. Many are built around particular investment themes. We found 28 equity funds that practice impact investing in Morningstar Direct. The largest, ranked by size, are shown below. As you can see, the funds don’t resemble the S&P 500 or the Morningstar Large Mid Index… much. They represent a grab bag of categories, from natural resources to technology to utilities, though many are large-cap funds. The largest six are specialists in alternative energy or water. (For more on investing in water funds, read this. For more on investing in alternative energy funds, read this.)
So far this year, this small group of impact funds is pacing, or slightly underperforming, the benchmarks. For the year to date, the funds have lost an average 21.2%, compared with 21.6% for the Morningstar Large Mid Index and 20.3% for the S&P 500.
Over the three-year period, the funds averaged an annualized 10.2% return, compared with 9.5% for both the Morningstar Large Mid Index and the S&P 500.
To ensure that the funds are doing what they say they’re doing, you can read the impact statements they provide, or you can also check on Morningstar Direct as to whether the revenue of the shares owned by the fund aligns with impact themes. For this purpose, we use the Morningstar Sustainalytics Impact themes. You’ll see that for the first fund, First Trust Nasdaq Clean Edge Green Energy ETF QCLN, 71.3% of the assets that are analyzed for impact are dedicated to the climate action theme. For the second fund, Invesco Water Resources ETF PHO, 74% is dedicated to the Basic Needs Theme.
A few funds contain “impact” in their names. The Impact Shares exchange-traded funds work with nonprofits to translate their values into funds, and all profits go to the nonprofit partners. For example, Impact Shares works with the NAACP and the YWCA.
Community Capital Management also offers impact funds. CCM Core Impact Equity Fund Advisor QUAGX assesses the positive and negative impacts of companies it’s considering investing in. It also screens out fossil fuel companies. The Goldman Sachs JUST US Large Cap Equity ETF JUST is based on an index constructed by JUST Capital, which includes companies “driving positive change” on the issues that the American public cares about, based on JUST’s polling. Such issues include worker pay and well-being, customer treatment and privacy, beneficial products, the environment, job creation, strong communities, and more.
Another interesting way to get impact into your portfolio is with Calvert Impact Capital’s Community Investment Notes, which finance organizations “creating positive social and environmental impact in communities around the world.” The notes come in denominations as low as $20 online. Brokerages require a $1,000 minimum. So much money has come into the impact space, says Anna Mabrey, a senior officer at Calvert Impact Capital, that “we’ve been deploying faster than ever.” Currently, investors have put some $600 million into the notes. (Calvert Impact Capital is a different company from Calvert Research & Management, the sustainable investment shop now owned by Morgan Stanley). The notes pay out 1% to 4% per year, over one to 10 years. Next year, Calvert Impact is expected to offer notes at a higher rate.
We’ll cover other impact investments in a separate piece, including bonds.
One thing is sure: The need for impact investors is huge. Consider the United Nations’ SDGs, a set of 17 targets intended to be “a shared blueprint for peace and prosperity for people and the planet, now and into the future” and achieved by 2030. The U.N. estimates the financing gap to be $2.5 trillion a year. That suggests that growth in impact investing will continue for the foreseeable future.
Leslie Norton does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.