“Impact investing” is built on a simple idea: If you’re going to invest your money, you’ll want to invest it in companies that are doing work that you believe in. Easier access to capital lets companies do more — expand into new areas, build new products, take promising bets. Your investment would allow a company you believe in to do all those things.

Proponents claim that impact investing is good for the individual investor, too, with many funds advertising that they seek results for the world without sacrificing performance for the investor. In other words, they claim that impact investing won’t just do good — it will make you money. It’s not surprising that younger people seem to overwhelmingly want to invest their portfolios in socially responsible companies.

So this is a good way to do good, right? Well, not really.

In particular, when you do the math, impact investing seems worse for the world and worse for your pocketbook than just investing traditionally, earning higher returns, and donating the difference. Impact investments are often marketed as a cost-free way of doing good. But they’re not cost-free, and under typical circumstances it doesn’t look like they’re doing much good.

It’s hard to invest in particularly promising companies or make them better at what they do

Impact investing, or socially responsible investing, is a big deal in the US. The most recent report by the Forum for Sustainable and Responsible Investment estimates that in 2018, $12 trillion was invested in socially responsible investment funds — 25 percent of the $46 trillion in assets in the US that are under professional management. And impact investment is growing quickly; that $12 trillion figure in 2018 is up 38 percent from just two years ago

Economists have historically been more skeptical, though. There’s not a lot of literature out there that suggests that impact investing works. Research has found that socially responsible assets do underperform, though economists disagree on how much. Researchers have also expressed concerns that the social impacts are under-researched — we’re claiming “social impact” without checking if anything works.

And the whole concept rests on some tenuous assumptions. For your money to make the world a better place, two things need to go right, observes an in-depth report on impact investing released last week by John Halstead of Founder’s Pledge and Hauke Hillebrandt of the Center for Global Development. They believe impact investing can do a lot of good. But certain criteria need to be in place which often aren’t.

First, you need to have successfully identified a business that will make the world a better place if it succeeds. That’s more complicated than it sounds. For example, even if you think solar panels will make the world a better place, funding a solar panel company isn’t guaranteed to do it; if the company displaces other solar panel companies and does a worse job, then its success won’t have improved anything.

“It is difficult to identify in advance which social programmes will work,” the report argues. “The path from action to social impact is usually not as you would expect. Socially beneficial businesses have to solve two very difficult optimisation problems simultaneously — turning a profit and having impact. Consequently, finding viable companies with enterprise impact will not be straightforward.” That doesn’t mean it’s impossible — just that it won’t happen by default.

Most of the $12 trillion industry isn’t putting in this work. Many impact investing funds don’t actually do much rigorous research into the expected impacts of the businesses they are funding. Articles about the marvels of social impact investment tend to emphasize the inspiring stories of the founders or the employees, not the expected benefits from the business.

Secondly, Halstead and Hillebrandt write, if you’ve found a business that is definitely having the desired impact on the world, you need what’s called “additionality” — a path by which your investment causes the business to be more successful than it would otherwise have been. That, too, is complicated. In a big stock market, there are lots of investors seeking the investment opportunities with the best-expected returns. If your opportunity has the best-expected returns, it will attract investment from those investors. That means you’re only helping if you are investing in the business when it does not have the best-expected returns.

Many impact investing funds insist they do get better returns than the average fund. This might be survivorship bias. For example, if there are 100 impact funds and 70 of them got worse returns than the baseline, while 30 of them did better by sheer chance, we’d hear from those 30 advertising their successful investment. What it probably isn’t is proof that doing good will also make you rich; if that were true, those investments would be flooded with purely selfish actors until the advantage was gone.

“There is a trade-off between financial returns and social impact,” the report concludes. If you’re getting market rate returns, there’s likely no “additionality.” If there’s additionality, returns will likely be below market rate.

There are circumstances where impact investing might be a good idea

All of that suggests that most ‘impact investing’ funds out there aren’t great — but it also suggests some circumstances where it is a good idea. In particular, Halstead and Hillebrandt point out that in “inefficient markets with fewer investors and with imperfect information,” unlike the stock market, access to investment is a much bigger deal.

Investing in a company makes more of a difference to its financial health and ability to expand its programs, and it’s less obvious that low-hanging fruit will have been claimed already.

If you have access to such illiquid markets, and you have inside knowledge that lets you identify particular companies as companies that will have an unusually enormous social impact, then you might be in a good position to invest with social benefits. People who believe, say, that it’s morally urgent to end factory farming, and know of promising slaughter-free meat alternatives, might get a lot of mileage from impact investments in companies working on those.

Halstead and Hillebrandt think some of these opportunities are great ways to do good, and they are generally optimistic that impact investment can be powerful if done right. Nonetheless, they caution against assuming these investments will automatically be worthwhile. “Even in VC and angel investing, the risk that your investment merely displaces someone else’s remains a fundamental consideration,” they note.

There are other ways social impact investing — or divesting, for that matter — can do good. Divestment campaigns, where people work to convince universities or other organizations to move their money away from problem organizations, can be a source of bad publicity that companies are motivated to avoid, even though they rarely move stock prices much.

But it’s important to be clear about the expected effects. A divestment campaign will not typically damage a company’s access to capital. As a result, while they have the potential to raise publicity and coordinate opposition to an unethical industry, “there is a risk of confusing people—suggesting that divestment will directly hit companies in the pocketbook when the evidence mostly suggests that it won’t,” concludes Oxford professor Will MacAskill in an analysis for the New Yorker. If divestment does good, it’s through its publicity effects, not its monetary ones.

Impact investing doesn’t make a huge difference. Is that a reason to stop?

Impact investing probably isn’t totally useless — it does seem to slightly improve access to capital for social good companies. So if you know you’ll never donate any money to charity anyway, and you’re okay earning worse returns in order to support promising companies, then it might be better than nothing. But anything promoted as a way to do good ought to be held to a higher standard than that.

People ought to know how much their investment returns will differ between an impact investing fund and a general index fund, and decide if they’re willing to lose that amount of money in expectation for the sake of supporting good causes. If they are willing to lose that amount of money in a lower-performing impact fund, they would do significantly more good for the world by keeping the money in the index fund and donating the difference instead.

There’s an obvious objection here: Many people probably don’t put their money in impact investments out of a desire to do as much good with their money as they possibly can. Many of them want to avoid supporting awful companies, or want to symbolically stand for the things they believe in. Are dry economic calculations really an answer to that?

It does seem to me that the calculations should be relevant. Costly gestures with unclear impacts aren’t a good place to encourage symbolic stands. And while avoiding material support for bad actors makes sense, many of these funds don’t change the material support for those actors at all. Activists and individuals should care what works — and the evidence shows that impact investing largely doesn’t.

Editor’s note: The piece has been updated to clarify the study authors’ views on some impact investing opportunities.

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