Bottom Line: Investing for growth is much harder in the impact world. Crowd-sourced equity investments are coming, but aren’t an adequate substitute for index mutual funds or ETF’s. Local/social equity investments are best viewed as similar to private equity: a small fraction of a diversified portfolio, willingly taking a higher risk to chase a higher return. (Remembering here, that the “return” is a combination of financial and social.)
Mission Related Investing for the Rest of Us series:
- Part 1: Motivation (Using your investments to earn a “social,” values-based, return as well as a financial one)
- Part 2: Background & Investing Theory (Where I’m coming from, and how I used to think about investing)
- Part 3: Banking and Cash Alternatives
- Part 4: Bond-like Alternatives
- Part 5: Stock-like Alternatives
How I currently invest in equities (mostly)
As I mentioned in Part 2, my belief in the Efficient Market Hypothesis means that I’m not trying to “beat the market” with my stock picks, and instead, I choose the cheapest way I can get the very broadest exposure possible, (the Vanguard Total Market Index ETF, (VTI)). That’s about as far from favoring my local community as possible.
Socially Responsible Investing
The basic level of making sure that your stock investments line up with your values is ensuring that you aren’t invested in companies whose business or business practices you find objectionable. Advisors tend to talk about “screens” for alcohol and tobacco, but other industries like military/defense, mining, or companies that have engaged in questionable financial practices or exploitation of their customers (pay day loans, e.g. or the “too big to fail” banks that steered minorities into mortgages that were not the best fit/rate for which they were eligible.)
There are mutual funds that perform this research and ensure that their holdings meet the criteria described in the prospectus. See, for example, the list maintained at www.socialfunds.com.
Going beyond the “negative screens”, you can proactively choose to invest in sectors that you feel will pay off for society if they succeed. Alternative energy investments are an example here, and the socialfunds list includes them as well. The returns over the recent history have not been pretty–make sure you are comfortable that the money you are investing can be subject to the risk that is inherent in these investments.
R. Paul Herman has coined the term “HIP” investing to talk about “Human Impact + Profit” investments. While his writings cover the whole spectrum of this 5-part series, (he’s excerpted his book in a 25(!) part series on Triple Pundit), the focus is on equity investing, and finding companies that will excel based on their commitment to key values:
- Wealth (generating it for the customers)
Within each of these values, he lists demonstrable metrics, and provides a scorecard for rating companies and benchmarking industries. (A lighter-weight “HIP Check” is available for free on their site.) Herman’s thesis is that abiding by these values offers a competitive advantage, and therefore, companies that score well on the HIP metrics will also outperform financially. He connects the dots for some of the examples, showing how the savings in reduction of waste accrue to the bottom line, and compares the return of the HIP fund against two others (a “vice” fund and a socially responsible fund) for a 5-year period ending June 2009, and shows that it has the highest return of the 3. This was an especially volatile period, so is perhaps not the best to extrapolate from, but worth noting his results.
Since equity investments tend to be riskier and harder to evaluate, the government tries to protect prospective investors. The laws requiring security registration and prohibiting the advertising of unregistered securities do provide protection, but they also greatly limit the opportunity for smaller companies to raise equity capital. Generally, a company can sell unregistered securities only to “accredited” investors (those with a net worth of $1M+, not counting their primary home, or annual income of $200K+ individual, $300K+ married), or a small number of “friends and family.” But here again, the combination of risk and low-deal flow makes investing in these types of deals (often called “angel investing”) are appropriate only for a small portion of your portfolio, more akin to lottery tickets than the average growth upward over time of an investment in the broad market indices (and re-investment of dividends, which makes a big difference when compounded over the years.)
One aspect of the investing landscape that is changing with the passage of President Obama’s JOBS acts is the permission of companies to raise a moderate amount of capital (up to $1 million) without registering the security. There will be limits on the amount that individuals can invest per year, and it remains to be seen how it will be implemented (the SEC is supposed to propose rules by January 2013), but there is some chance that it will transform equity raising for small companies in the way that Kiva has transformed fund raising for microcredit. There are certainly plenty of companies that would like to be the platform upon which such investments are made. Realistically, though, with the limits and uncertainty, crowdfunding isn’t a feasible investment vehicle today, and won’t be for some time to come.
Update: Here’s a nice blog status report on the SEC process by Crowd Check: