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Investing in social good finally becoming profitable

Impact portfolios are significantly outperforming traditional ones, drawing investors.

Philanthropist and vineyard owner Eric Lemelson has focused on clean-energy investments for nearly 20 years, and his portfolio has been almost entirely made up of impact investments for the past decade.

IMPACT investments, which aim to promote a social good or prevent a social ill, have significantly outperformed traditional bets during the coronavirus pandemic. And their returns are enticing hesitant investors to rework their portfolios.

Impact investing typically focuses on three categories: environmental, social and governance, known as ESG. Returns can be tracked through various exchange-traded funds. For example, the S&P 500 technology ETF is up 25 per cent this year, while the S&P 500 energy ETF, which includes oil and gas stocks, is down 34 per cent.

Overall, 64 per cent of actively managed ESG funds beat their benchmarks versus 49 per cent of traditional funds through the first week in August, according to research from RBC Capital Markets.

The private markets are seeing similar interest. Take Vital Farms, which was founded in 2007 in Austin, Texas, to sells eggs from pasture-raised hens.

"A few years ago, venture capitalists scratched their heads at an egg farm," said Dave Kirkpatrick, managing director at SJF Ventures, which was one of the first private investors in the farm. But Vital Farms, which grew through private investment before going public at the end of July, is valued at more than US$1 billion.

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Now, other investors are coming to him with questions about sustainable and profitable agriculture, said Mr Kirkpatrick, who is also a founder of Impact Capital Managers, a trade group that seeks to show that impact investing can be a way to achieve higher returns.

The coronavirus crisis may be a turning point for wealthy investors, whom advisers have long seen as a key constituency to expand the market for investments that aim to do good and still provide solid returns.

"Every time something goes wrong in the world, it's a boost to impact investing," said Nancy E Pfund, a managing partner and co-founder of DBL Partners. "There's a generalised frustration that whatever people have been doing for the last X number of years, it's not working."

This has caused a shift in strategy, she said: "You're seeing people flock to impact investing, and now there are the returns."

Investment dollars have begun to follow returns. In the first half of the year, US$20.9 billion went into impact funds, which was just shy of the amount of new money for all of last year, according to a report from Morningstar. (The 2019 number was, in turn, four times the 2018 total.) The data heartens advisers who see this as a moment when they can stop making the case that individuals need to give up returns to make impact investments (a belief, known as concessionary returns, that has been largely refuted).

"The impact portfolios are very significantly outperforming the traditional ones," said Brad Harrison, a co-head of impact investing at Tiedemann Advisors. "It only escalated in the last year while we've been dealing with this pandemic." Yet like all investing stories, there is some complexity to this one.

Creating an impact portfolio today is easier than it once was, but it takes considerable attention. Eric Lemelson, a philanthropist and vineyard owner in Oregon, has focused on clean-energy investments for nearly 20 years, and his portfolio has been almost entirely made up of impact investments for the past decade.

"I made the decision to decarbonise the entire portfolio," Mr Lemelson said. But the move took time.

"With US markets, it was relatively easy to start the move," he said. "With the developing world, it was more difficult because there was less transparency."

His success with his personal wealth allowed him to steer the foundations he is a part of to change their investment portfolios. One, the Lemelson Foundation, was started by his father, Jerome, an inventor who had more than 500 patents. Now, 75 per cent of its endowment is in impact investments. "I made the case with my family that as a foundation, we have an obligation to lead," he said.

But Mr Lemelson also supported his argument with solid returns. "Increasingly, it will become obvious that well-managed investment portfolios don't give up anything at all," he said.

Even in the face of data, the sector faces headwinds. Just last year, Daniel and Sheryl Tishman, whose wealth comes from the family's real estate companies, sought to put the US$100 million that seeded their NorthLight Foundation into impact investments, but they encountered pushback from managers.

One manager they interviewed said that what they were trying to do was not possible, said Kate Sinding Daly, executive director of the foundation, which focuses on the environment. "That's an old-school view," she said.

Figuring out how to execute on their investment thesis was challenging. For example, the foundation had all its money in impact investments but was still switching among different assets in that sector, Ms Daly said.

"The environmental stuff was easy," she said. "It's the issues around human rights, gender issues, arms, military investments and all that stuff."

That's a difficulty that other investors are going to run into. Excluding oil companies remains a straightforward choice. Investing in ways that promote an idea or a thesis - like equity - is more complex. And it's not always easy for the advisers to do it well, either.

"It seems like the new queries we get are not from the asset managers but the intermediaries - the consultants and financial advisers who struggle to sort the wheat from the chaff," said Joshua Humphreys, president and senior fellow at the Croatan Institute, a think tank focused on investing for social good. "There's a big education learning curve from a lot of advisers."

Not everyone is bullish on this moment. There is some scepticism that impact investments look good because investments like energy and financial companies in traditional portfolios have not performed well over the past nine months.

"The outperformance is pretty explainable by the shock to the oil industry," said Mark Cirilli, a co-founder and managing partner at MissionPoint Partners, a private equity firm. "It has much more to do with the demand shock, as opposed to good companies with high ESG scores are better run in a pandemic."

Mr Cirilli said he believed that more individual investors, even sceptical ones, were moving money into impact investments, but that the driver was sound economic fundamentals. Companies are being forced to respond to investor demands for greater corporate responsibility.

He pointed to the food industry, where several meat processing plants had serious coronavirus outbreaks in their factories, which prompted concerns about the safety and robustness of the country's food supply chain.

"Covid has raised the awareness of the fragility of our economic system, and to me that's an investable trend," Mr Cirilli said.

For some investors, though, the hope is that strong returns will persuade others to remake their portfolios to focus on impact. "The market is changing fundamentally," Mr Lemelson said. "This is not just another challenge. It's the challenge." NYTIMES

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