“Impact investing”—or investing both to benefit society and generate financial returns—has always been around, but it has attracted hundreds of billions of dollars in the last two decades. In 2021, impact investing totaled more than $1.16 trillion, with pension funds, insurance companies, and for-profit mutual funds joining the more traditional base of endowments and nonprofit funds. It’s human nature to want to make the world a better place. But what is the true impact of impact investing?
Impact investing takes three forms. Inclusionary investing directs money to businesses most likely to improve specific social problems, often paying higher prices than would be justified by the resulting financial payoffs. Exclusionary investing entails the selling of shares, or the refusal to buy shares, of firms seen as worsening the targeted social problem. And evangelist impact investing involves buying stakes in businesses viewed as worsening the targeted social problem and using the resulting ownership stake to change the firm’s operations and reduce its negative social impact.
When investors pursue the inclusionary and exclusionary paths, the effects of their choices are revealed in stock prices, which rise or fall as investors buy (or sell), lowering (or raising) corporate costs of capital. The costs-of-funding changes affect these companies’ subsequent investing decisions and growth choices, with “good” companies expanding and “bad” companies shrinking.
While impact investing may be driven by the desire to do good, such choices can have perverse consequences. With inclusionary investing, a danger exists of misidentifying “good” companies, flooding them with wasted capital and increasing barriers to the emergence of better alternatives. With exclusionary investing, private investors can fill the void after impact investors push prices down below “fair” values. With evangelist investing, even if investors successfully dissuade these companies from making “bad” financial choices, they may not be able to stop them from returning cash to shareholders as dividends and buybacks, rather than making “good” investments.
Climate change is tailor-made for impact investing, since many investors are concerned about it, and many of the businesses they view as “good” or “bad” on this subject are publicly traded. The issue therefore offers a forum for examining the impact, positive or negative, of impact investing. On the funding side, impact investing has not only directed trillions of dollars of capital toward alternative energy investments but also convinced many fund managers and endowments to divest from fossil-fuel companies. In the process, the market capitalizations of alternative-energy companies were pushed up to more than $700 billion in 2020. On the fossil-fuel front, while divestments reduced the oil companies’ stock prices between 2011 and 2014, that effect has faded over time, with other, less climate-change-focused investors drawn by these companies’ earnings power stepping in to buy shares.
Fossil-fuel companies have weathered the onslaught of climate-change critics and remained profitable. Their revenues and profit margins bounced back from a slump between 2014 and 2018 and reached historic highs in 2022. As profits have returned, these companies are returning much of their generated cash flows to shareholders as dividends and buybacks, notwithstanding impact-investor pressure to reinvest that money in green energy. Over the last decade, as fossil-fuel companies have collectively spent less on exploration, and divested fossil-fuel reserves, impact investors may be tempted to claim a win, but many of those fossil-fuel-asset sales have been from publicly traded companies to private buyers. Over the last decade, private equity’s biggest players have invested well over $1.1 trillion in fossil fuel, with private buyers profiting from acquiring oil companies’ abandoned wells. In effect, impact investing has just moved the custody and development of fossil-fuel reserves from publicly traded fossil-fuel companies to private investors.
After a decade in which fossil-fuel companies capitulated to impact investors’ pressure to de-carbonize, the Russian invasion of Ukraine laid bare the world’s continued reliance on fossil fuels. In the aftermath of the invasion, the biggest fossil-fuel companies have become bolder about their plans to stay in and grow their fossil-fuel investments, with Royal Dutch, BP, Exxon Mobil, and Petrobras each making commitments to that effect.
The verdict on climate-change impact investing will be ultimately determined by the changes that it makes on climate-change metrics—and it is here that the movement’s futility is most visible. Fossil fuels account for as high or even a higher percentage of overall energy production today than they did ten or 20 years ago, with solar, wind, and hydropower gains being largely offset by nuclear-energy reductions. If impact investors argue that their investments alone cannot stymie climate change without alterations in consumer behavior, I agree. But changing behavior is painful, politically and economically, and impact investing, by offering the promise of change on the cheap, has reduced pressure on politicians and rule-makers to make hard decisions on taxes and production.
Impact investing can be rescued, albeit in a humbler, more modest form. Doing so requires a recognition that being good comes with sacrifice, and that while pursuit of profits may underlie many social problems, the profit motive’s power can also be leveraged to solve those problems. After 15 years, and trillions invested in its name, impact investing, as currently practiced, has made little progress on the social and environmental problems that its proponents intended to solve. Maybe it’s time to try something different.