Some sustainability indexes and the mass-market funds tracking them have turned in strong performances, even amid the market’s recent volatility. Ordinary investors show a growing preference for sustainability-themed investments, despite an orchestrated backlash against so-called ESG investing. And younger, climate-minded generations are set to inherit billions of dollars.
It should be a golden time for impact investments by individual investors. Instead, the investment options available to them are few and far between.
“Most retail investors do not have access to impact products,” says Tim Radjy of emerging-markets impact investor AlphaMundi Group in Geneva.
”If we are not able to democratize access to impact, we will never be able to get to the $4 trillion that we need” each year to finance the UN’s sustainable development goals, or SDGs, Radjy says (the United Nations last year raised its estimate of the annual investment needed to more than $5 trillion, an outlay that could yield many times that amount in financial and social returns).
Impact funds are part of the broader landscape of sustainability and environmental, social and governance, or ESG, funds. The gold standard definition of impact investments, by the Global Impact Investing Network, or GIIN, is those made with the intention to generate positive, measurable social and/or environmental impact alongside a financial return, in areas like sustainable agriculture, renewable energy, conservation, microfinance, affordable housing, healthcare and education.
“I could imagine retail investors representing a source of funding that could fill” the financing gap, says Matthew Weatherley-White, of Align Impact, an investment advisor in Santa Monica, Calif.
Market gap
Pension and private equity funds, venture capitalists, sovereign wealth funds and family offices have poured more than $1 trillion into global impact investments, both directly and through funds such as TPG’s $19 billion platform and Climate Investment Funds’ $5.2 billion Clean Technology Fund. Individual investors, unless they’re worth at least $1 million (home not included) and deemed accredited investors under guidelines set by the US Securities and Exchange Commission, are locked out. Public sector capital via grants and tax incentives, is another major financing source.
There’s a potential abundance of private capital. American women, younger Generation X members and millennials will inherit nearly $73 trillion in assets through 2045, research firm Cerulli Associates estimates — equivalent to eight BlackRocks, the world’s largest asset manager that dominates the global sustainable retail funds landscape.
Morgan Stanley reports that more than three quarters of global investors are interested in sustainable investing, with 57% saying their interest increased in the last two years and nearly as many anticipating increases in their sustainable investments in the next year. Retail investors are “the next frontier for impact investing,” the Rockefeller Foundation says. Holding the retail industry back, according to Rockefeller: A “lack of common language to both define and quantify the level of impact achieved.”
Hard rules
Off-the-shelf retail funds whose focus is genuine impact are rare. Banks and asset managers fear running afoul of U.S. securities rules that generally restrict offering high risk, complex products, like impact funds, to ordinary investors.
Radjy estimates that two-thirds of consumer deposits at large global banks — Americans had more than $4 trillion in bank deposits at end-March — are locked out of investing in those banks’ own impact products for institutional and accredited investors.
Global mutual funds and ETFs with sustainability, impact or ESG themes held $3 trillion in assets at end-June, including $336 billion in the United States, Morningstar data shows. Amid a conservative-driven backlash by Republicans, 613 US sustainable funds shed $13.7 billion in the first half of 2024, more than double the amount a year ago, and the biggest outflows since Morningstar began tracking the data six years ago.
Outside of owning shares in a handful of publicly traded companies, mostly in renewable energy and clean technology, authentic impact options for ordinary investors come down to a sprinkling of smaller, specialized funds — and a stomach for volatility.
Buy signal
Returns by many private impact funds are a closely guarded secret. In 2023, publicly traded TPG’s Rise Climate fund, which raised $2.1 billion, had a 27% internal rate of return, or IRR, according to its most recent annual report. The figure reflects investment gains after fees, expenses and carried interest are deducted.
Could mass-market impact funds achieve the same?
Last year, sustainable funds in North America and South America had a median return of 21.3%, nearly twice that of traditional funds, Morgan Stanley says, crediting their mainstream stock holdings of technology companies, not their contribution to climate action. The S&P 500 ESG Index, which excludes companies that extract or generate electricity from coal for more than 5% of their revenue, produce tobacco or deal in weapons like cluster bombs, is up roughly 12% over the last 12 months through Aug. 12.
- Carbon Collective Investment’s Climate Solutions ETF is down more than 8% this year through Aug. 12, after a nearly 15% gain last year.
- AXS Investments’ and Change Finance’s Change Finance ESG ETF, which invests in 100 U.S. companies “that live up to the highest standards” of ESG principles, is up nearly 7% so far this year and has more than doubled since its launch in 2017.
- Amplify Investments’ Etho Climate Leadership U.S. ETF is flat so far this year after double digit gains in six out of the eight prior years.
- First Trust’s Clean Edge Green Energy Index Fund, an ETF, is down more than 23% this year after outsized swings, including a 184% spike in 2020 and losses in most recent and prior years.
Weatherley-White of Align Impact argues that the only “scaled” options for retail investors are interest-earning deposit programs at community development finance institutions, or CDFIs. (CNote, a cash management platform, parks interest-earning dollars in mission-driven and minority-owned banks and credit unions and community finance development institutions.) At any given moment, Align’s roughly 60 clients have 2%–5% of their total $1 billion in assets at the firm in roughly a dozen CFDIs, he says.
“They’re not securities, but they’re a high-impact, low-risk, low-return vehicle,” Weatherly-White says, adding, “We believe impact investing is basically the R&D function for the future of capitalism.”
Some other options: Calvert Impact’s Cut Carbon Notes, investment-grade, fixed income securities for sustainability upgrades for commercial, industrial and multi-family buildings, yield from 5.5% to 7.75%, depending on share class and risk profile. Climatize, a crowdfunding firm in Santa Cruz, Calif., allows ordinary investors to put as little as $10 into small-scale solar energy projects in the US (See, “Solar crowdfunding and ‘purpose rounds’ expand impact options for retail investors”).
A big opportunity for retail investors will emerge in coming years when green startups conduct initial public offerings or are acquired by publicly traded companies — with impact-minded shareholders bringing their wallets and demands.
“We need a very robust secondary market that is eager and waiting to snap up those deals as they go public and get securitized,” says Stein. “Do I think that individual investors have a role to play as impact investors? Yes, absolutely.”
Perception gap
Many retail investors who haven’t retreated appear to think they’re generating impact, even if evidence is scarce. More than 70% of ESG- and climate-themed ETFs fall short of the 2015 Paris Agreement’s goal of limiting global warming to 1.5 degrees Celsius, according to think-tank Influence Map.
“Absolutely, there’s impact washing, along with greenwashing,” says Kristin Hull of Nia Impact Capital, a women-led asset management firm in Oakland, Calif.
Hull argues that “the biggest lever of change in our times” is for employer-sponsored 401(k) plans to include impact investment options: “Retail investors want to be a part of shifting our economy” to a carbon-free future.
Many “sustainability” funds rely heavily on technology stocks for their “low carbon” themes. One of last year’s top-performing, Invesco’s $46 million ESG NASDAQ 100 ETF, rose 55%, after a nearly 32% drop in 2022. Its top holdings: Microsoft and Apple. State Street’s $1.7 billion Fossil Fuel Reserves Free ETF focuses on technology’s “Magnificent Seven” (Apple, Microsoft, Google parent Alphabet, Amazon, Nvidia, Meta Platforms and Tesla), and also owns shares in fossil fuel companies Marathon Petroleum, Phillips 66 and Valero Energy Corp.
“Wall Street takes ESG or sustainable products, sticks an impact label on them, and pulls a little smoke and mirrors,” says Weatherley-White.
The newest retail sustainability theme is “climate transition funds,” which own shares in renewables and clean energy but also in polluting companies with plans to reduce their emissions — a category not considered impact by the GIIN. Assets in global climate transition funds spiked 25% last year to nearly $210 billion, including a year-on-year tripling to $10 billion in the US, where they are still the most popular sustainability theme, despite slipping in the first half of this year, Morningstar Direct data provided to ImpactAlpha shows.
“You can kind of twist it into whatever way that you want,” says Zach Stein of Carbon Collective, one of the few advisory firms offering an ETF that invests in US publicly traded companies dedicated to solving climate change. “We need to change the narrative that fossil fuels are a necessary evil.”
