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Are social impact investments too risky?

Interesting paper out entitled 'A Note on the Role of Social Impact Investments..' in Highlights of Science, an academic open access publisher established in Barcelona, Spain.

The paper addresses a comment we’ve heard from (faith-based) asset owners and impact managers: social impact investments (SIIs) can be too risky or provide too low a return for their risk.

The six academic authors of this brief research paper appropriately consider the definition of ‘risk’ from a total portfolio context – as by themselves SIIs may have these risk characteristics, but SII investments should be evaluated also by how they behave relative to other assets in one's total portfolio. Stated simply as an example; an investment with high risk but a low correlation with other assets held can reduce the overall risk of the total portfolio, a key concept in modern portfolio theory.

Their findings:

“…we show that the ethically-grounded investments present a relevant economic meaningfulness as risk-minimizers, beyond the intuitive positive aspect of fostering social impact targets.”

In other words, SIIs can be good for total portfolio risk.

To evaluate SIIs in the context of a total portfolio, the authors first construct an index of companies classified as ‘social impact firms’ using criteria established by the OECD, along with other measurement requirements (public listing, period of operation, etc). This resulted in only 50 compliant companies worldwide – see appendix A1 of the paper for the full list, the first ten are shown below.

They next use this 'portfolio' of SII companies to test different allocations among SIIs and other asset classes across 10 different time periods – global equities, global bonds – using, for those with an investment background, mean-variance analysis.

They find from this analysis:

The SII portfolio '… is the only one that is always included in all the 10 portfolio allocations, and its average weight is very high (equal to 35.58%), confirming the importance of this asset class in the perspective of risk minimization…'

Many caveats to consider with this research, we’d be happy to talk about them with you, but this should give one pause when possibly initially dismissing SII’s as being inherently 'too risky'.


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