My wife asked an interesting question this morning: “What is the difference between impact investing and ethical investing?”
Putting it into words was really good to get absolute clarity for myself. And just to be clear, this is no official explanation, just my own personal thoughts.
The difference seems to come back to the order of consideration.
Ethical Investing
While there is a huge range of ethical investment options, in general terms the main implementation seems to be a negative filter that limits the possible investment horizon.
So a fund that invests in listed equities will still invest in listed equities, it just leaves out any of the ones that fall within the negative screens.
The really progressive ones might have positive screens in addition. Betashares looks at Climate Leaders and Australian Ethical Investments seek out investments that support people, sustainability and innovative technology.
In either case the primary focus is on generating returns for the investors. After all, that is what the funds are judged on and how they are able to bring in more funds to manage.
Impact Investing
The starting point for impact investing are the outcomes that are sought for the community and the planet. How can my funds help in the best way to achieve specific outcomes I am interested in?
It needs clarity on what I actually care about and then it is a matter of finding the best ways to achieve these outcomes. It is only at that point that I would look at the business model to see whether it is profitable and can generate a financial return.
An additional consideration is whether my funds actually help the project or company move forward to achieve their outcomes. I am tempted to think that investments into already listed shares does not actually have any impact. On the contrary, you are freeing someone’s capital (the one selling the shares) to be deployed elsewhere (possibly without any impact consideration).
Is Profit a Sign of Creating Value or Extracting Value?
This brings me to this conundrum: On one hand I strongly believe that most profitable businesses are profitable because they create great value for their clients and are able to manage their costs well.
However, with vulnerable clients (e.g. low socio-economic, remote communities) who might not have much of a choice (or the environment with no choice at all), the question becomes much more important. If profits exist and are returned to investors, couldn’t those funds within the business or project have created even more impact?
Naturally, as an investor, I want my capital to be preserved and earn a return on it. But I want this to happen in such a way that the impact is also achieved. I wrote about this 12 years ago from the perspective of an entrepreneur.
Win – Win – Win – Win – Win – Win – Win
Which brings me to the last point. If I see two impact investments and one of them has a much bigger likelihood of achieving their social outcomes while also considering the environment and their employees, but the financial returns are lower, I will probably go for that one.
It means there is a win for the business, the employees, the clients, the suppliers, the community they live in, the planet and myself.
And I also want to acknowledge the side in me that is interested in profit maximisation and gets excited when I see high returns advertised.
Making a Decision
But I want to hold myself accountable and only do things that have a real impact on all levels. In addition, I want to work with the best prepared people/organisations. So here is my checklist.
The Rating is calculated by adding all the impacts together, multiplying by 100%, 66% or 33% for the likelihood. By also multiplying with each of the Wins, it will go to Zero as soon as one Win is not achieved (such as in Option 4, where the suppliers don’t win).
In the business review, I highlight weaknesses without that necessarily meaning I won’t go ahead. Instead I might help the organisation to work on these gaps.
Finally, in the financial overview, I compare how financial return is generated, over which timeframe and what the minimum required capital investment is.
More for fun, I added the Impact Adjusted Return which multiplies the return by a percentage that shows how close the Impact Rating is to 18 (so Option is 1 is multiplied by 100% because its Impact Rating is 18, Option 2 by 77.78% and Option 4 by 0%.
Conclusion
Impact investing considers the positive impacts and the likelihood of achieving them first. Then it has a negative screen around the financial returns.
Ethical investment usually starts with a negative screen around impact you don’t want to have. Financial returns are the primary considerations.
In either case, a clear framework is essential to hold myself accountable and make it possible to compare options.
Photo by Shane Rounce on Unsplash