Thinking Critically while Investing Responsibly

Sonia Kowal

Responsible investors combine their financial objectives with environmental, social, and governance-related risks and impacts. This type of investing goes far beyond simple exclusionary screening or even the much-touted “ESG integration” (environmental, social, and governance integration) that considers only risks and opportunities within the investment itself. Responsible investing gets at the heart of how the philanthropic community can use its unique voice to further the systemic changes that are desperately needed in our economy, society, and environment.

Forward-thinking foundations have been investing this way for years, but this more cohesive approach has recently gained momentum in the mainstream. A growing number of philanthropic organizations see their investments as a means to expand their impact beyond grants. Over the past ten years, responsible investing has grown immensely — across all asset classes, styles, and geographies — and at a rate that has outstripped growth in most other investment strategies while showing little regard for downturns in the wider market. The amount of professional money managed using ESG criteria rose sharply, according to US SIF, and now represents 33% of the $51.4 trillion in total U.S. assets under professional management.

While the traditional stance has been to split financial management from grant-making or programming, a more updated view is that this separation is unwise. Indeed, it makes far more sense to use the total assets of an organization to pursue its mission — to mirror the social aims that are embodied in programmatic pursuits in investment activities. In other words, it makes little sense to pursue investment activities that do not support — or that may in fact threaten — the success of programmatic activities supported by such investments.

Philanthropic organizations are coming under fire because they fund solutions to problems that are caused by companies in which they are invested. That kind of unwanted attention and reputational risk is also fueling demand for more aligned ways of thinking about investments. What we’ve also seen is that donors tend to be inspired by this cohesive way of thinking and they like knowing that their contributions are making an active impact, rather than passively sitting in an account somewhere, growing for growth’s sake.

The definition of fiduciary responsibility has also evolved to integrate prudent investment practices with concerns about environmental stewardship, healthy and safe communities, and corporate accountability. Fiduciaries have a duty of obedience to the endowed institution’s mission, which requires use of investment practices that serve its charitable purposes, and applies to both program and investment activities.

In terms of enhancing returns, what we have also found in our investments is that careful consideration of environmental, social, and governance factors can help unearth information that the market is not yet considering. The old thinking — that by investing in a responsible way, returns are limited — has been put to bed by numerous academic studies over the years.

Using Investments for Change

As boards and investment committee members turn over and become younger, more diverse voices are brought to the table and the old barriers melt away. Of course, the usual navel-gazing and promises to “look into it” still abound, but more and more often these days, action follows.

These actions may include rewriting investment policy statements to better signal expectations to investment managers (and then holding them accountable), or engaging new advisors or managers who take impact seriously, especially focusing on diverse managers. One of the most important ways to drive impact on inclusion at the manager level is for their clients to ask for and reward that change.

I have been heartened that in the last six months: the RFPs that we have received from foundations and nonprofits have had a new and significant focus on diversity at the manager level, probed how we use a gender and racial lens in the actual investment process, and sought to understand the impact their dollars will have. The next step is then to actually hire those managers that are contributing to the change that you want to see. Over time, make sure to track the gender and racial diversity of your managers according to the criteria that you outline in your Investment Policy Statement.

To further amplify your impact, discuss this work with your peers. There is no need for most foundations to reinvent the wheel. Deep thinking along these lines has already been done — now find it, emulate it, and talk publicly about the experience. The water is warm — come on in!

A Word of Warning

I think it’s so important for people not to blindly buy into “green” or “socially responsible” labels. Ask pointed questions and know exactly what securities you own and what activities you support in your portfolios. Much like the vagueness of the word “natural” when applied to food products, these days a fund or manager that has an “ESG” or “impact” label should not be relying on those terms without considerable evidence in their work. In addition, merely using ESG as an investment approach without focusing on measurable impact can be a distraction. The veneer of ESG we increasingly see in the investment marketplace is not contributing to the much-needed transformation of our economy and society.

And don’t just focus on private market impact investing — although it’s the easiest place to draw a straight line between cause and effect — I would argue that given the large social and environmental footprints of publicly traded corporations, helping companies improve through investment managers’ shareholder advocacy and engagement can be especially impactful. Also worth considering are cash deposits at community development finance institutions — they’re not flashy but they get the job done.

As you follow the process of responsible investing, remember to also be realistic about what impact investing can achieve. There are many social challenges and organizations that require donations, not invest­ment with an expectation of a financial return. As philanthropists, together we can make money more impactful, more purpose­ful, and more powerful in driving social change.

Sonia Kowal is President of Zevin Asset Management, a boutique investment manager with a focus that integrates sustainability into professional investment management for families, foundations, religious institutions, and nonprofits. Follow Zevin Asset Management on Twitter @ZevinAssetMgmt.

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