What do people really mean when they talk about impact investing? Typically they’re referring to investments made with the intention of generating measurable social or environmental benefits in addition to financial return.
An important concept in impact investing is additionality—the idea that the benefit wouldn’t have occurred without the investment. When some investors use the term in this technical sense, they tend to reserve it for private market or fixed income investments, where additionality can be easier to demonstrate.
Although we recognize that others may use the term more loosely, here we focus on the purists who aim for impact investing under the technical definition. These investors want to be able to determine how their investments have directly and exclusively improved environmental and social outcomes.
Let’s look at how two different asset classes tackle the impact investing challenge.
Public equities lack additionality
When we invest in or report about public equities, it can be difficult to attribute the effects of investments to social or environmental outcomes. After all, buying or selling an equity security traded on a public market simply transfers the ownership to another investor, without providing new equity capital to the issuing company. And if there’s a follow-on equity offering, the new capital raised is available for any purpose the company wants.
That’s why public equity investors can’t precisely attribute specific social or environmental change to their investments—particularly in larger companies with diverse business lines. Nor can they say that any social or environmental impact occurred only because of their investment.
Making an impact in public equity markets
Even without additionality, public equity investors can still get to the heart of impact by influencing environmental or social outcomes through active ownership and shareholder engagement. To elevate the issues that matter to them, they can exercise their rights to vote proxies at shareholder meetings and to communicate directly with executives and boards of directors.
According to the United Nations Principles for Responsible Investment (UN PRI), active ownership in globally listed equity is “regarded as one of the most effective mechanisms to reduce risks, maximize returns and have a positive impact on society and the environment—for passive and active investors.”1
As an example, Parametric has been pushing companies to consider more diverse boards and to encourage diversity and inclusion throughout their organizations. We believe the skills required to make great decisions and successfully lead companies are distributed widely throughout the population. We understand diversity of thought and skill can’t be measured by characteristics such as race, ethnicity, gender, religious views, socioeconomic background, sexual orientation or disability, but the homogeneity of these traits throughout the workforce may signal a need for improved recruitment and retention practices. Strategic decisions should be made and overseen by a diverse group that can bring a broader range of perspectives.
That’s why we wrote to 144 companies with all-male boards in the Russell 3000® in 2020 asking them for a dialogue to better understand the hurdles that stood in the way of more gender diversity on their boards. A year later we were pleased that more than 70% of the companies that we’d contacted had added at least one woman to their board. Today, four years later, only 18 of these companies still don’t have a woman on the board, an 88% drop.
Separately, we began our workforce diversity engagement initiative in 2021, reaching out over the next three years to all companies in the S&P 500® and the largest 200 companies in the Russell 1000® who hadn’t provided required disclosures to the Equal Employment Opportunity Commission (EEOC). Today, more than 80% of the S&P 500® and more than 50% of the Russell 1000® have reported their diversity data.
We know we haven’t been the only ones pushing for these changes, but lending our voice has made a difference. These shareholder engagement initiatives aren’t examples of impact investing, but they do show the power of shareholder engagement and the influence that equity investors can have.
Municipal bonds offer additionality
In the municipal bond market, by contrast, most issues finance projects that are intended to serve the public good and provide benefits to the community. When we look at the use of proceeds, however, we find that some bond issues may serve more meaningful social or environmental purposes than others. By focusing on muni issues with positive impact—for example, funding schools in underserved areas, producing renewable energy using solar or wind power, replacing water and sewer systems to deliver cleaner and safer drinking water—investors can reduce borrowing costs and direct more capital toward issuers who are doing good and divert resources away from issuers who aren’t.
That’s why it’s so important to track how muni bond issuers use the proceeds on an ongoing basis. Investors need transparency to confirm that the issuer is funding the purpose disclosed at the time of issue, with no detrimental social or environmental consequences resulting from the project. Through this due diligence process, portfolio managers can help maintain the integrity of impact investing vehicles and ensure that the investments are truly improving outcomes.
Although bondholders may not have the same proxy voting rights as equity shareholders, engagement in the municipal bond market functions through open dialogue between the issuer and investors. Bondholders may highlight material environmental or social risks that the issuer should address. They can also use the engagement process to encourage better reporting and disclosure practices from issuers, which can help to increase transparency in the market regarding these environmental and social risks.
The bottom line
While the term impact investing might have to be used carefully for public equities, it can be particularly applicable to municipal bonds, which directly finance projects that seek positive social and environmental outcomes. Additionality is an important nuance in impact investing that needs to be considered. But we believe that any investor seeking to influence organizations to become better corporate citizens can always look to engagement to make a difference, regardless of the asset class.
1 UNPRI.org, Introduction to active ownership in listed equity, February 27, 2018.
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