This post was co-authored by Mike Faloon and Alex Laipple.
Today’s individual investor wants more than just attractive returns. They want to know how their investments can make a difference. They want to maximize rates of return while ensuring the investment will make a positive impact on the world. It’s what we call the impact investment revolution, and it’s just beginning.
Investment advisors who are building their businesses have an opportunity to deepen relationships and capture new assets if they craft the right message, and explain how impact investing can be a natural fit for a well-managed portfolio. Many advisors are using technology platforms to improve efficiency and reduce cost for clients, but impact investing is also an area where technology and data can enable investment advisors to source opportunities that tell a compelling story as well as delivering best-in-class returns.
And it’s not just new clients. The next generation of investors will inherit a total of $59 trillion in assets between now and 2060, the largest wealth transfer opportunity in history, according to the Center on Wealth and Philanthropy at Boston College. That means your existing clients will be passing their assets to a generation of individuals who may think a little differently about investing than their heirs.
The market size of sustainable, responsible and impact investing in the United States was $8.72 trillion as of 2016, or one out of every five professionally managed dollars, according to SIFMA. Meanwhile, the Forum for Sustainable and Responsible Investment offers data that the change is already underway. From 2012 to 2016, U.S. based impact assets under management more than doubled from $3.74 trillion to $8.73 trillion.
So what’s the best way to approach this opportunity? Two terms you hear a lot are ESG and Impact – so let’s dig into the difference between them.
ESG vs. Impact
Environmental, social and governance (ESG) is a framework for integrating these three factors in the risk/return analysis of investment opportunities. As an investment advisor you can still purchase a security (unless it has been explicitly restricted by your client), regardless of its effect on the environment or society. For example, an advisor might assess the probability that big oil companies’ carbon assets become stranded during their holding period. The resultant probability is incorporated into investment’s cash flow projections and discount rate. If the risk/return output is acceptable to the advisor and within client guidelines, the advisor can make the investment on behalf of their client.
Impact investing is the desire to make a difference with your capital. The proceeds of the investment are intended to make a beneficial social and environmental impact alongside strong returns. For instance, considering presenting an investment mandate to fight climate change to your clients – it’s a powerful message. We know that demand for innovative, sustainable investment solutions to address social and environmental issues is increasing every year. As an advisor you can differentiate your practice by providing impactful mandates that support increasing access to clean energy, creating resilient infrastructure, or increasing social and economic mobility of the poor in urban and rural America.
As demand for impact continues to grow, it is important to understand the inherent risks of investing in this space. Investors face capital risk as some investment opportunities may underperform relative to other available options. Some investors may face liquidity risk or difficulty exiting the investment in certain circumstances. Additionally, clients face the risk that the intended social impact might not be successful. Understanding the risks with impact investing is essential when deciding if impact is right for you and your clients.
Neighborly’s Impact mission
For Registered Investment Advisors and family offices this is an immediate growth opportunity for your practice. Each of your clients is unique with different passions, values and ethics. So how do you create a dynamic message that fits a diverse client base? We’ll share more strategies and ideas in our next post.
Our mission at Neighborly is to connect our users to opportunities to help build resilient cities with strong parks, transportation and clean energy. All investors should have the access to invest in the places they live, work and play.
If you have clients who share in our mission by investing in a better world, sign up today to learn more.
Mike Faloon, CFA, FRM is the Chief Strategy Officer of Neighborly. He is the former COO for Standish Mellon Asset Management, where he helped manage $170 Billion, holding positions as the head of risk, portfolio manager and credit analyst. He was a member of ICMA’s Green Bond Principles Executive Committee and designed Standish’s ESG process.