Impact Investing – A Quick Definition and How to Invest
Did you know that 14 billion pounds of garbage (mostly plastic) is dumped into the ocean every year? Yes, we’re really fcuking up this planet good. That’s why we did our part to help by highlighting in a recent article the merits of “environmental social and governance investing” or ESG investing. This is where we try and feel good about all that first world consumerism we partake in by not subsidizing Asian sweat shops or providing funding to companies that exploit the environment. Now we’re starting to hear this new term called “impact investing” and we’re eager to know more about it.
What is Impact Investing?
The best way to think about impact investing is by first thinking about the whole “feel good investing thing” on a spectrum like the one seen below (courtesy of Oppenheimer funds):
Here we can see that impact investing differs from ESG investing in that it takes a more active approach to stock selection. In finance, we refer to tracking a benchmark like the S&P 500 as “passive investing” meaning that you don’t need to do anything but follow an index. This is how most ETFs work. Then there is “active investing” which means we pay portfolio managers to try and beat a benchmark (and they fail 80% of the time) so now we’re going to replace them all with artificial intelligence. In impact investing, we make active investing decisions by avoiding the “bad” companies and only investing in the “good” companies.
Impact Investing vs. Traditional Investing
This stuff all sounds good on paper but how effective is it? What we’re hinting at here is that while we want to feel good about saving the whales and all that, we also don’t want to miss out on the alpha generated by companies who are doing bad things. Think about that for a second. Would you really stick to your morals if you knew that impact investing produced subpar returns when compared to traditional investing? This is an important question to ask yourself because there is a significant amount of active management taking place here.
When creating an impact investing portfolio, there are companies that will be completely removed from the portfolio because they don’t behave in a manner deemed appropriate. Here are some actual stock selection decisions made for an impact investing portfolio that is environmentally conscious:
If you’re a dividend growth investor, you’re probably not liking the fact that you no longer hold McDonald’s, Exxon, or Coca-Cola. On the other hand, you’re getting some exposure to Tesla along with some other nice stalwarts. If any of the stocks that were removed turn out to be strong performers, you’re SOL. On the other hand, you’re certain not to feel like you missed out because you made the planet a better place, right? The above stock selection exercise is actually one that was performed while building an impact investing portfolio over at Motif Investing.
An Impact Investing Portfolio from Motif Investing
Regular readers know that we’re huge fans of Motif Investing because their platform allows us to create “mini ETFs” that we use to track things like lithium mining companies or 3D printing companies. Next to Interactive Brokers, it’s our favorite brokerage firm out there right now. Just this month, Motif Investing announced their impact investing offering which is called “Motif Impact Portfolios” and they are said to be the first fully automated portfolios to align your financial goals with your values. While active management is taking place as seen above, it is entirely rules based so no humans are involved. How does this work?
The entire impact investment process runs on data provided by a leader in ESG investing data, MSCI (NYSE:MSCI). Run by the legendary CEO Henry Fernandez, MSCI is a renowned firm in the financial industry that builds global stock indices along with market leading ESG research. Motif takes this data from MSCI and then uses it to build portfolios of assets just like you would see at other robo advisors (read this article to learn more about robo advisors). Here’s a model portfolio for a particular age and risk profile:
As you can see, the stocks in the above portfolio are represented by motifs that contain all the “good companies” and none of the “bad companies”. The cost of this portfolio (or any personalized portfolio like this one) is $9.95 a month. In other words, you’re essentially able to buy 130 stocks a month (the actual stocks themselves) and 19 ETFs all for $9.95 a trade. Now here’s where things get a bit fun. Motif Investing is so adamant about impact investing outperforming traditional investing that they’ve made an offer that’s hard to refuse. If after the first year, the performance of the model portfolio with the values filter you select underperforms the corresponding base portfolio by one percentage point of more, they will refund 100% of your subscription fees. So what are these “value filters”?
If you want to create a Motif Investing impact investing portfolio for yourself, you can choose from 3 different “value filters” and pick the one you feel most strongly about as seen below:
You then fill out some information about your risk profile, age, and goals as you would with any other robo advisor. Once your model portfolio is setup, you can contribute to it every month and build your wealth without having to raise a finger. Alternatively, you can also get active yourself and make changes to your stock portfolio (though you’ll likely void that money back promise). Of course Motif Investing isn’t the only player in the impact investing game. Here’s a look at some of the other providers and how they compare to Motif’s offering:
The only thing we were bummed about is having to create a new account with Motif Investing in order to access their impact investing portfolios. Really guys? Two accounts? We love Motif so much though we’ll just have to learn to live with it.
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