According to the World Economic Forum, “Impact investing is an investment approach that intentionally seeks to create both financial return and positive social or environmental impact that is actively measured.” The big question is whether you can achieve this definition of impact when investing in the stock market.
For an impact investor looking to create a measurable positive impact on the environment, it is easy to visualize the impact of investing directly into a wind farm or solar company. The capital flows to the company and is typically used to hire employees, research new products, or invest in new infrastructure.
Investing in the stock market is a different story, as the capital invested does not flow to the company itself, but rather to the previous owner of the stock. In this case, the company receives no additional capital that would fund new projects or expansion plans. This does not mean that there is no impact to be had in public equities, just that it takes a different approach.
The stock market will continue to play a major role in investment portfolios. Of the $74 trillion in global assets under management as of 2014, 89% was invested in public markets. There are three ways in which an environmentally focused investor in the stock market can move the needle: shareholder activism, market signaling, and divestment movements.
Investing in a public company provides a potential avenue to influence the company’s management as a shareholder. By working with other shareholders to bring resolutions to the company’s management and voting for the ones already on the table, investors can bring the public’s attention to poor environmental practices and exert pressure on companies to improve. Even if the proposals don’t get majority support, shareholder resolutions often still succeed in persuading management to adopt changes supported by a significant number of supporters.
Investors are increasingly incorporating ESG (Environmental, Social and Governance) metrics in their investment decision-making by tilting their portfolios towards companies that outperform their peers on these standards. As an increasing number of investors take this approach, it signals to management that shareholders value the company’s impact on these non-financial metrics.
Investing for impact in public equities can include divesting from companies considered harmful to the environment, as embodied by 350.org’s fossil fuel divestment campaign. In order to send a message to fossil fuel companies that oil and coal reserves are best left in the ground, the movement encourages investors to sell their shares in these companies. A recent study at the University of Oxford found that the stigmatization of fossil fuel companies caused by divestment can “materially increase the uncertainty surrounding the future cash flows of fossil-fuel companies” and poses as their most far-reaching threat. By April 2016, 515 institutions had joined the pledge, representing, together with the individual investors, a total of $3.4 trillion in assets.
Investing in public equities is not only a significant part of most investors’ allocation, but also the center of the world’s capital markets. The impact that can be created through investing in public markets is less direct, but by influencing the behavior of public companies, who themselves are among the largest owners of resources, users of energy, and influencers of society, investors can create both financial return and positive social or environmental impact.