Socially Responsible Investing Fuses With Alternative Investing

Socially Responsible Investing (SRI) is growing in importance. Advisors who are well-informed about the values and practices associated with this investment trend can offer a point of differentiation from competitors. From 2017 to 2018, the number of sustainable equity and bond funds rose from 235 to 351, according to Morningstar, a 49% increase in a single year. What accounts for this substantial jump? The answer seems simple enough: many investors want their investments to have a social, environmental, or spiritual impact in addition to generating a financial return. As Socially Responsible Investing has grown, investors have begun to look outside of public markets to alternative SRI investments.  

The Business Case for Sustainable Investing 

Many investors demand sustainable investments. In 2018, 26% of AUM in the United States was allocated into some form of SRI strategy, equaling roughly $12 Trillion.  This was up 38% from 2016. SRI is one of the fastest growing investment strategies in the US. This trend is likely to continue as “according to Allianz, 87% of Millennials and 83% of women want socially responsible investments in their portfolios, yet only 6% of financial advisors are engaged in SRI with their clients.” A well-vetted implementation of SRI strategies could be a competitive distinction for an advisor trying to reach new clients. Once the decision is made to implement SRI into your client’s portfolios, it becomes necessary to choose which metrics you will use to assess each investment.  

ESG Factors 

Each SRI strategy uses different criteria to judge their potential investments. The most popular framework, especially in publicly traded investments, is referred to as ESG – standing for environmental, social and governance. These ESG factors depend on firm values, investor demands, and overall investment mission. There is no unified standard for target ESG metrics, but there are some general approaches: 

  • Governance: How the company is controlled 
    • Board diversity 
    • Executive pay 
    • Business ethics 
  • Societal: How the company impacts the community 
    • Labor management 
    • Privacy and data security  
    • Health and safety 
    • Underserved communities 
    • Stakeholder engagement 
    • Faith-based 
  • Environmental: How the company impacts the environment 
    • Carbon footprint 
    • Resource management 
    • Pollution  
    • Renewable energy 

SRI Return 

The list of factors extends well beyond what is listed here. Additionally, each SRI strategy will also weigh the factors differently. The one factor all SRI strategies share is that, although their goals may be laudatory to SRI enthusiasts, they are not donatory in intention but rather a strategy to make sustainable profits; thus, SRI should be distinguished from the idea of “Benefit Corporations,” or “B-corps,” which mix profit- and non-profit goals, without necessarily seeking the highest potential return, as the B-corps seek a blended portfolio of goals,  and they should also be distinguished from charities. 

Getting sustainable and strong risk-adjusted returns is vitally important to any SRI strategy. If the investments do not reliably produce returns, they will not be attractive to future investors, and thus cannot complete their triple bottom line mission. If an impact investment fails, whatever social or environmental good that was sprouting from the underlying assets cannot continue. Fortunately, there is a strong track record of SRI investments having competitive risk adjusted returns when compared to market benchmarks.   

SRI and Alternatives 

SRI is not a one size fits all strategy; each firm uses their own criteria when assessing an investment. The number of alternative ESG assets more than doubled in recent years, growing from $206 Billion in 2016 to $588 Billion in 2018. The number of funds in the alternative ESG space went up 89% from 413 to 780 over that same time period. These trends are likely to continue as investor demand for SRI continues to grow. Alternative investment ESG funds invest in private and public companies, such as: 

These funds invest in these companies through debt, equity, or capital in the middle of the capital stack such as mezzanine financing or convertible debt.  Understanding how alternative assets may fit into an ESG framework is important. Some interesting examples of these alternatives include real estate vehicles such as opportunity zone funds, and private placements in the life sciences industry. 

Real Estate Alternatives 

Opportunity zones (OZs) allow an investor to roll a capital gain into a qualified opportunity fund (QOF). In turn the QOF must invest 90% of its assets into economically distressed areas that have been identified across the country. The goal of the opportunity zone program is to give tax benefits to investors that choose to invest in these distressed communities. If the investments are successful it will bring economic, social, and community benefits to the OZs. Each QOF should still be assessed with a firms’ ESG factors and risk versus return profile in mind, as not every QOF will be created equal. ESG factors are also very important when assessing other alternative real estate offerings. For example, some investors want underlying real estate assets to be powered by renewable energy. Having high energy efficiency standards can reduce the overhead costs for developments. Other alternative investment real estate offerings include non-traditional multifamily living communities like co-living. This new real estate segment is both profitable and meets a strong social need for community living. 

Life Sciences Alternatives 

In the alternative life sciences space, there are many opportunities for SRI. New technological and medical advancements have alleviated patient suffering and increased quality of life. Investors should consider the potential societal impact of the life sciences investments they are considering. The amount of advancement in medicine, biology and chemistry is truly staggering, and the impacts could be transformative. Private offerings allow investors to get in on the ground floor of these transformative advancements. Offerings range from new cancer treatments, bioprinting companies, companies that are implementing AI in medicine, and even lab grown meat and leather. The ethical implications are often difficult to determine, and investors will need to consider whether these innovations, and their applications, fit into their ESG frameworks. 

Responsible investing is likely to continue to rise in importance. Understanding this trend can help advisors communicate with clients and can be a differentiator. Responsible investing does not have to be limited to public markets, utilizing alternative investments can be a way to bring SRI into a client’s portfolio while also increasing diversification.  

This publication is a service to our clients and friends. It is designed only to give general information on the developments actually covered. It is not intended to be a comprehensive summary of recent developments in the law, treat exhaustively the subjects covered, provide legal advice, or render a legal opinion. It does not provide that necessary customization of  advice, tailored to a client, which would be provided by an accountant or tax lawyer.  The views and opinions expressed in this article are those of the author’s and do not necessarily reflect the official policy or position of Holdings, Inc.

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