Impact Investing Decoded: Your Guide from Basic ESG to All-In Activism

Full episode and show notes at: www.sunnybranchwealth.com/blog/impact-investing-explained 

Tired of feeling like your investment portfolio doesn't reflect who you are? 

You're not alone. 

As a younger inheritor, you want your money to create positive impact. But instead of clear advice, you're bombarded with an alphabet soup of technical jargon. 

My mission is to make your choices clear and provide easy-to-understand information to help you make an informed decision about your investments. 

Listen to learn:

• The ESG myth that won't die 
• The impact investing spectrum
• What impact options make sense for your life, goals, and values 

Whether you're skeptical that any companies are truly "good" or you're ready to take on more risk for greater impact, this episode has something for you. 

Sunnybranch Wealth LLC (“Sunnybranch Wealth”) is a registered investment advisor offering advisory services in the State of Oregon and in other jurisdictions where exempt. Registration does not imply a certain level of skill or training.

The information on this site is not intended as tax, accounting or legal advice, as an offer or solicitation of an offer to buy or sell, or as an endorsement of any company, security, fund, or other securities or non-securities offering. This information should not be relied upon as the sole factor in an investment making decision.

Past performance is no indication of future results. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested. It should not be assumed that any recommendations made will be profitable or equal any performance noted on this site.

Transcript

Hey, I'm Katherine and thanks for joining me at Heir Necessities, the podcast that turns complex financial topics into real talk for Gen X, millennial and Gen Z inheritors. I'm a certified financial planner, a wealth manager and an inheritor, just like you. Each episode of this podcast, I tackle a different topic related to generational wealth and inheritance. On today's episode, we are taking a deep dive into impact investing. What it means, why it matters, and some of the really common myths that I hear about impact investing. If you feel like you want to do better with your money, but you're just confused and overwhelmed when you hear people talk about impact investing, ESG investing, socially responsible investing, whatever, then this is the episode that you need. Let's dive into it.

Impact Investing Within Capitalism: Setting Realistic Expectations for Wealth Management

Before I start talking about creating positive impact with your wealth, I want to put like a million caveats on this entire episode, okay? And the reason that I want to do this is we live in a capitalist society and I am not a person who is out here trying to say that capitalism should be overthrown. I am very much a work within the system to make the system better person. And I think that there is huge value in people that are more agitators, like bring the system down people. I think there's huge value. It's just not where I fall personally or politically. And so when you're a person like me who thinks the way to make capitalism better is to push for reform from within the system, you're probably going to be interested in impact investing and investing in companies that are doing better.

But when you're doing that, you're still participating in a capitalist system, right? And even though I think reform from within is best, capitalism is still fundamentally flawed. So when we talk about doing good with your wealth, there's going to be all these necessary caveats on it that's like, you're still trying to do good within a flawed system. And so instead of thinking about doing good, like, are companies good, you know, is investing in the stock market fundamentally a good thing? I don't know. It's maybe a good thing on an individual level in terms of building wealth. Is it the thing that's best for our society as a whole? Maybe? Probably not. Also a question that's way above my pay grade. So I don't like to think of it necessarily always as doing good with your wealth when we're talking about impact investing in publicly traded markets. I like to think of it as doing better, creating less harm. And there are absolutely places within the scope of someone's individual wealth where we do talk about doing good. And that could be with private investments, it might be in investments in publicly traded companies that are much riskier but much more focused on impact, or it might be with giving.

Personal giving, philanthropic giving, political giving, which is where you really want to push your dollars that are focused on doing good. But for the context in this podcast episode, I'm not going to be talking about doing good so much as I'm going to be talking about doing better and trying to create less harm with the money that you have invested in publicly traded markets.

From Passive to Active: How My Investment Philosophy Evolved at Sunnybranch Wealth Management

And so on that same subject, I want to share a little bit with you all about my background and my philosophy on investing and how it's changed over time. So when I founded Sunnybranch, I was wholly investing my clients' money in passive investments. To give you a little very broad overview of passive versus active investing.

So passive investing is going to be investing in your index funds, your ETFs. They are very low cost funds that track broad indices. And I was focused on ESG investing, environmental, social governance investing. And so I invested in what's called ESG screened ETFs. And I still have quite a lot of my clients and my personal money in ESG screened ETFs.

ESG Screened ETFs Explained: The Beginner's Guide to Socially Responsible Index Funds

So it's not to say that what I'm about to tell you is a bad thing at all. And ESG screened ETFs are basically you have an index, which is a basket of, you know, maybe call it 2,000 different companies. And if you owned an ETF index fund, you would own little pieces of all of those 2,000 companies in one fund. If you own an ESG screened version of that index fund, they're going to take out some of those 2,000 companies based on their ESG philosophy. So commonly that might include screening out or not investing in weapons manufacturers, tobacco companies, alcohol companies, gambling, private prisons, and so those companies are going to be excluded from that ESG index you're investing in.

So maybe instead of 2,000 companies, you're investing in like 1,500 companies. There are 500 stocks that got excluded. And this is really the first level of doing better with your wealth. You're getting out these 500 companies that are maybe like egregious in terms of their pollution or the industry that they're engaged in. But you still own these 1,500 companies and it's a very basic screen that has been applied to your portfolio. So you still have probably a lot of companies that might be doing things that you disagree with on a values-based basis that are in your portfolio. Now, I don't want to say that this is a bad thing. I still have a lot of client money at Sunnybranch invested in these passive ESG screened index funds.

Low-Cost ESG Investing: When Basic Impact Screening Makes Sense for Your Portfolio

And the reason for that is that these are low cost funds and they are going to track the benchmark relatively well because you're still owning such a large number of companies within that individual ETF. And so people have different philosophies about what matters to them from an impact perspective. And this ESG ETF portfolio, which is one option for Sunnybranch clients, is what I call my low cost, lower impact option. So it's good for people who want returns that are probably going to track the benchmark a little bit more closely. It's good for people who want a lot of simplicity in their portfolio. It's good for people who really value tax efficiency because ETFs are very tax efficient.

And it's good for people who are a little cynical and think, well, I don't really know if any companies are good, right? So why don't we try and sort of do less harm, get out the worst guys, and that's okay. And I would rather know that I'm going to track the benchmark a little bit better, and I'm going to focus on doing good with my wealth in different ways.

So that's one option and that's kind of the base option that exists in terms of moving your portfolio away from a traditional portfolio and towards a more impact focused portfolio, a portfolio that's focused on doing less harm.

Debunking the ESG Returns Myth: Do Impact Investments Really Sacrifice Performance?

Before we move on to kind of the next level of impact focused investing that I offer at Sunnybranch, I want to stop and acknowledge this persistent myth about impact and ESG investing.

And this myth is about returns. And if you choose to put your publicly traded investments in ESG funds or impact funds, that you are going to sacrifice returns. So your portfolio that's focused on doing good or doing less harm is not going to perform as well as a traditional portfolio. This is not true, but it is true that there will likely be some divergence between your portfolio and a traditional portfolio, but that does not mean that divergence is necessarily a lower return. Let's think about it. So let's go back to this example where you have 2,000 stocks, right, in a traditional portfolio, but you invested in an ESG screened portfolio, so you only own 1,500 of those 2,000 stocks. There is necessarily going to be some difference between how those 2,000 stocks perform and how your 1,500 stocks perform, right? Because you own 500 fewer stocks. So whatever those 500 stocks are doing, you aren't going to have exposure to. And often with ESG screened funds, this is limited on a sector basis. So in an ESG screened portfolio, you're probably going to have much less exposure to oil and gas companies, say as an example. And if oil and gas is doing amazingly well, then your ESG screened fund is probably going to have a lower return than that traditional portfolio. But the inverse is also true, right? If oil and gas isn't doing very well and the theory sort of underpinning impact of ESG investing over the long term is that companies who have a more focused look at risk and harm reduction, including climate forward policies and socially forward, socially responsible policies are going to perform better over time. So those, again, those oil and gas stocks aren't doing very well, then your portfolio may be doing better than the traditional index. So impact and ESG investing in publicly traded markets does not mean sacrificing returns, but it does mean accepting that there will be some divergence between how your portfolio is performing and how a traditional benchmark is performing and the amount of divergence is going to depend on what you're invested in, how concentrated your positions are, how the portfolio is built, et cetera.

Active Impact Investing: Moving Beyond Basic ESG Screening to Concentrated Portfolios

So I've covered this sort of lower cost, lower impact option. I've covered the persistent myth that impact or ESG investing means you're going to get lower returns. The last piece I want to cover here is if you're listening to this and you think, you know what, that like lower cost, lower impact option isn't really appealing to me, what can I do a little bit more? How can I have a little bit more positive impact with my wealth? Then the answer is that you are likely going to want to move into more active investing.

And active investing doesn't mean that you are doing research and picking out individual companies. It does mean that you are paying experts to do that. And you are paying experts who have a very strong, very clear impact focus to do really deep dives into research and build a portfolio. And then you're looking at the portfolio they've built and you're saying, yep, that's what I want. I want a portfolio where I know that there are individual people who have a clear impact focus and a clear impact mandate who are screening all of these companies and instead of investing in 1,500 companies, I'm investing in 50 companies. And I know that these 50 companies have been chosen for really, really clear impact focused reasons. And again, we're operating in a capitalist society. So it's not to say that I'm going to agree with the decisions of all of these 50 companies. They're big companies across the globe. I'm sure they're doing things that I personally wouldn't agree with, but I also know that they are doing better than the vast majority of companies out there. And those metrics on how they're doing better are really clearly explained to me. And I can really see the impact of my portfolio versus investing in that traditional benchmark index portfolio.

Actively Managed Impact Funds: Understanding the Costs and Benefits of Concentrated ESG Portfolios

Now the benefit of this portfolio, this more actively managed, more concentrated, impact-focused portfolio, is that you do get all of that. You get the research, you get a basket of companies that is much more focused on impact, you get better reporting about the impact statistics of your portfolio, you have a higher impact with your wealth. The downside of it is that it's generally going to be a little bit more expensive than that low cost, lower impact option, because instead of these index funds, which are sort of run by computers and algorithms, you actually have people that are doing the research about those companies and making those decisions, and that is necessarily more expensive.

And then the other piece is that because you own 50 companies instead of 1,500 companies, you might see a little bit more divergence from the benchmark in terms of return. Again, this isn't necessarily a given because over time, these portfolios, these actively managed portfolios, they're still benchmarked and they're still intended to track their benchmarks.

So over time, that's what you would hope to see. But over time with this more concentrated portfolio, there may be times when you see a little bit greater divergence from the benchmark. But again, this divergence could be positive or negative. It's not to say this portfolio is always going to be doing less well than the benchmark. Again, it's very sector-based. So if you have a more concentrated exposure or a lack of exposure to certain sectors within the portfolio versus the benchmark, then you're going to see that play out on the return side.

High-Impact, High-Risk Investing: Climate Solutions and Emerging Impact Companies

In this actively managed space, there's also the option to get even more impact by taking on a greater amount of risk.

And this is where publicly traded markets start to move from doing less harm to doing good. But the trade off there is that you're taking significantly more risk. And that might mean investing in a basket of companies or a fund that's actually focused on smaller companies that are creating solutions to some of the biggest problems that our country and our world faces, especially on the climate side.

The flip side is that these companies are new, they may not be profitable, and so investing in them opens up a significant amount of risk. And this isn't likely what a person is going to build their whole portfolio in, right? Like probably it would be a smaller piece of that. But within this actively managed space, you do also have the option to put a little bit more of your portfolio into these very impact-focused but slightly riskier investments.

Beyond the Stock Market: Alternative Impact Investments and Philanthropic Giving Strategies

And beyond the investing piece, there's what I referenced at the beginning. There's a whole world out there that focuses on doing good with your wealth beyond what you've invested in the stock market. And that could be with off Wall Street investments, with personal philanthropic or political giving.

Your Next Steps: When to Change Financial Advisors and How to Start Impact Investing

The most important thing to note, if there's one takeaway you have from this whole episode, is that if you feel like your portfolio isn't doing what it should be doing, you're not creating the impact you want to create, or you just don't understand what you're invested in, you don't have to stay with that advisor.

It has come through that I really care deeply about this. And even though public markets are flawed and capitalism is flawed, I am out here at Sunnybranch really trying to educate people on their options for impact investing and creating positive impact with their wealth. And if that's something you want to learn more about, reach out to me. You can email me, Katherine at sunnybranchwealth.com, check out my website, sunnybranchwealth.com, find me on Instagram, send me a DM, whatever it is. I'm looking forward to hearing from you and I'll chat with you on the next episode of Heir Necessities.