Posted on February 6, 2024 by Katherine Fox.

Impact and ESG Investing Across Public and Private Markets

The difference between impact investing, ESG, and SRI

Katherine (01:11.471)

As a little bit of background for our listeners, I asked Josh to join me hosting this podcast because as an advisor, I have struggled with the kinds of questions that we're going to be discussing, and that Citizen Mint is really finding solutions for advisors, but more importantly, for me, for my clients, and for the everyday person who is interested in impact investing and wants to feel like their money is really creating positive impact, but just feels stuck because they're invested in public markets and they just see story after story after story of big companies doing bad things and feeling like how, even if I'm in these ESG funds, how is my money actually creating positive impact when I'm just surrounded by bad actors?

I know that's what I hear a lot from my clients, from the investor side of things, but Josh, from your side over on the other side of the table, why do you think that the public markets or the stock market fall short on impact?

Josh Hile (02:16.49)

Yeah, definitely. And I think maybe I can just start us out with kind of this broad understanding of what all these terms mean, because sometimes it can be confusing.

So really, it started with socially responsible investing or SRI, where essentially people said, Hey, I don't want to invest in certain things that are against my values, whether it's an alcohol or gambling or weapons manufacturing, though that was kind of the first. So it was

And then came ESG, which is environmental social governance. And it's like essentially saying what are the negative operating or negative operating externalities of this specific business and how it's impacting like their shareholders or society.

And then trying to assess can this is there some businesses who can do better than other businesses. But ultimately the goal of that business is profit making. It's not actually impact.

Whereas, you know, impact investing to us and why kind of the differential between the stock market and what we're trying to do is really solving these big global challenges that we're facing in so many different areas, whether it's around housing affordability, whether it's around climate change, education, healthcare, and saying, hey, these are massive opportunities that we need to solve over the next few decades.

But you can also say there are also investment opportunities because when there's something that big, there's always investment opportunities to help solve it.

So I’m trying to say we can be the solution, but we can also find financial security in that.

But it's just very different from, you know, just doing screens on companies or comparing them to one another to say, this one's just a tad bit better than this one. And so it should be in this category called ESG or in this fund.

That is just a bigger differential there that compared to say like, we're gonna invest in affordable housing, real estate opportunity, and we're gonna impact affordability in the region and the Portland region and all these other places that have massive inequality.

Impact investing in the stock market versus private markets

Katherine (04:25.935)

Could you give us an example of what that might actually look like? And I'm putting you on the spot a little bit here because I gave you no preview of this.

But so if you have a company that is a publicly traded company that is in some way investing in a clean energy future, like our shared clean energy future, could you give a brief example of kind of how that company might be investing in a clean energy future? And then contrast that to if I was looking at an impact company in private markets. What is that company doing for our clean energy future?

Josh Hile (05:04.266)

Yeah, yeah, I mean, there is a few companies that you could consider broadly impact in the public markets.

It's just fewer and far between. So like one company that usually is talked about within that space is Orsted, a large European company produces a lot of wind energy off the coast of like major European countries. And, but Orsted really was a coal company previously. And then they said, Hey, this industry is dying. We need to reinvest ourselves, reinvent ourselves, have a positive impact and seven impact.

They essentially closed down a lot of their coal mines, sold off a lot of assets, and then said, okay, we're investing fully in renewable energy because we know that's the future of where we're going. So that is more of an impact-like investment.

Some other places within public markets where it's hard to find that impact investment is like real estate. There's just not a publicly traded affordable real estate fund.

Maybe those big REITs have something related to affordable, but it's just a small percentage of the portfolio and then compare this to on like the private market side where you can invest directly in solar and wind opportunities in private markets to have that direct impact to say, you know, let's take like less, let's use less oil and let's electrify our grid and let's use more EV cars that are powered off renewable energy.

And I mean, most of the big companies are investing alongside you in some way in this regard. Like think of Amazon, Microsoft, Google. They're probably the largest purchasers of energy from these private market opportunities that are invested in solar and wind, but they're like ultimately buying the energy off them to power their data centers.

Other kind of investment opportunities that we see in the private markets is really like, hey, let's build more affordable housing and let's house these individuals that don't have housing. So lets do a few deals in that specific area where, you know, we know that housing affordability is an issue where we live and, you know.

But it's an affordability issue across the whole US. Interest rates, when they go up to 7%, most people can't buy that starter home that they thought they might be able to buy, like say a couple of years ago.

Plus at the same time, housing prices have gone up significantly. And so there's gonna be more people renting and there's gonna be, and that causes actually a supply crunch and it actually causes rents to go up.

And so it's like, we need to be able to house our teachers, our nurses, our retail workers near where they live so they're not driving 40, 50 miles at a time to get to a job. And that's what we're trying to really support. But at the same time, be like, hey, we want to find good deals and get opportunities for investors.

The key issues with ESG investing

Katherine (08:05.655)

Moving a little bit backwards and looking more at private markets for those listeners who are just maybe not thinking about alternatives at all but are still kind of focused on impact in the public markets. Let's talk about just ESG investing. Can you talk about the some of the issues in that space? Something that I run into a lot as an advisor, something I really struggle with, is just the lack of data that exists.

To actually appropriately screen companies. And in particular, I'm thinking of a recent New York Times article talking about the use of child labor in American factories and how basically the auditing firms that are supposed to be catching it have no incentive to catch factories using child labor because that would make the companies paying them who are the companies using factories that make use of child labor angry.

And as an advisor who is promoting ESG funds, I have to say to my clients, well, you might not want to invest in companies that use child labor, but we don't have the data. So I can tell you with the data that we have that you're not, but like what the real picture is, I can't tell you. So could you expand on that in a more technical and less anecdotal sense?

Josh Hile (09:26.346)

Yeah, definitely. I mean, I've spent a lot of time looking at this over and like, you know.

There's a lot of different research out there. Like, okay, so there's like Sustainlytics, which is one of the main like research providers for ESG data. And then like there's other providers that do something similar, but what they found is there's no correlation and ratings over these providers. I mean, they're almost uncorrelated, whereas like, you know, the same company will be scored completely differently on the same metrics. And you're kind of like, how are they getting to these like specific scores?

So there's no great industry standards. At the same time, it's a lot of self-reporting by the companies, and they can report what they want, again, because there's no industry standard. Essentially, there's people working on that and thinking about it, but there hasn't been definitive, this is how we're going to do it. So companies have a lot of leeway. And what we have seen is the companies that have the best resources or reporting get marked up higher, even though what they're doing might not be necessarily good. And so, just as an example, Exxon's considered one of the highest ESG companies out there.

And it's obviously like what it's producing, it has like some very large negative impacts. Whereas like it would rate higher than like a solar or wind company. Um, and you're like, why would that make sense? Um, well, it's cause they put a lot of money into their reporting of it. And so they can sway things in certain ways and make things look maybe better than they might otherwise. 

There's a lot of issues around that where it's like, you see, there's the biggest companies having the best scores, um, whether what they're underlying producing is good for the society as a whole. Um, and I think you're going to find that over time, unfortunately, like it's going to take years to get to some level of consistency within the industry.

I think the best way to think about it though is like, because you know it's obviously been in the news a lot, but it's like these are actual risk for the companies and that's how like I see the best investors thinking about this. It's like you know you have brand risk, that's a real risk. You have environmental risk, that is a real risk to your business.

You have like employee risk because it's like employees want to know that their companies are doing good things and they want to work for companies that are doing good things. So like if you want to hire the best employees, you also need to like think about all these things. Those are all risk. They might not be like perfect balance sheets risk that you can understand at the current point in time. 

But it's like if Nike does something bad or Adidas is associated with certain like stars who say not great stuff then you're gonna have a big risk to your brand and it's gonna impact your revenues and ultimately your profitability So you have to think about like all those kind of when assessing ESG risk

Impact investing and risk versus return in public and private markets

Katherine (12:47.699)

I like this discussion of risk and I want to turn to its partner, Return. Right? Can you talk about how from a sort of return risk and return horizon perspective, how that looks different maybe for publicly traded companies who are obviously quarterly, they're responsible to their shareholders, right?

Those short-term profits versus when maybe look in the impact space in private markets, like, what types of different risks are you addressing and dealing with? And how does that change your return horizon?

Josh Hile (13:34.366)

Yeah, yeah, I think a little bit of it is there's this thing between public and private markets called the illiquidity premium. And that's one of the biggest things you deal with.

When you invest in private markets, you have illiquidity. So that means you can't just take your money out like you can the stock market. You're like, I just want to sell this company. I'm done with it. Whereas like in private markets you say, well, here's when we're going to sell or here's when you expect your money back and it's in two, five, 10 years at a time. But you get paid to take that. That's the premium. You get paid because you're taking that illiquidity risk. 

Now companies in the private market have less pressure to perform on a quarterly basis so they can invest in their employees. Like if it's that, they can invest in making a property better and understand that that's going to lead to longer term returns even if it's more expensive in the near term compared to public market companies. You hope they're investing for the future and most great companies do, but not all do.

And they might be saying, hey, we're going to cut employee count because we need to hit this profitability number. Which might have an impact on morale and that might cause us to lose good employees. I mean, those kind of things that need to always come into the understanding of what you're investing in. And so, and like, I think from a returns perspective, just, just to make sure it's very clear, the returns should be a little bit higher in private markets. 

In some cases you will be taking more risks than public markets, but not in all cases, and I think people misassociate risk or illiquidity with higher risk because there is parts of public or private markets where it's like it can be illiquid but it it's gonna be definitely less volatile and less risky then Sometimes like your hot tech stock in public markets that a lot of people might be jumping into So it's just like I just want to make that like distinction

How quarterly returns can work against investor’s impact goals in public markets

Katherine (15:38.123)

Yeah. And can you talk a little bit more kind of talking about that pressure, like those, you know, the decisions that have to be made when you are reporting on a quarterly basis. One of the issues that I run into and that frustrates clients and myself is you're sort of playing this whack-a-mole game when you're in the public markets with impact where it's like, okay, well, you know, I really like this company because I really care about climate. 

And I think that they are, you know, doing more good than bad from a long-term climate perspective, but it's not a diverse company. It's all run by white men, or they have some hiring practices that I don't support. So it feels like you're always sacrificing. So can you talk a little bit more about when you are investing in companies that are impact focused companies, how those trade-offs can be reduced?

Josh Hile (16:44.03)

Yeah, I mean, like it's a little bit more difficult in public markets in the sense of like, you need like shareholder resolutions to essentially like push the management team to do this stuff in a lot of cases. Not all teams, but if you're like really going for impact and you're like, hey, I want more diverse board. I want a more diverse management team. That takes time and you have to have a commitment from management to do that. 

And so that's like a big thing to focus on in public markets and it might not be as fast as you want and it might take time. I think some of the things we look at when we're thinking about private markets is, you know, going into it being like, okay, do they have a diverse investment team? Are they thinking about this? In most cases, like the teams we're working with are thinking about this already. You know, they're reporting on their impact. They have really thoughtful measurement. 

We kind of agree on what we they're going to measure for us going into it so that essentially report that to our investors. And so like you shouldn't see much inconsistency over time. It's like, hey, maybe they won't hit their impact metrics. And that might happen and that's okay as long as we understand why that happened and how we can make it better in the future. But like, and maybe they'll outperform their impact metrics, but at least we have some agreement. We have some understanding with them. 

And like we're on the same page because we're a capital allocator to them and have more, I guess, influence compared to a public market company where, you know, you have to get more buy-in from the whole Invest shareholder group to like really push the company to do something and change their ways.

Let’s take the next step together

Learning how to create positive impact with your wealth is not easy. Investors can encounter a wide variety of different situations requiring knowledge and finesse to manage. If you need more help, you can reach out to Katherine Fox, CFP® and CAP®, a financial planner for inheritors to learn how Sunnybranch can help you build a plan to grow your inheritance sustainably while creating positive impact.