ImpactAlpha, Nov. 27 – Even as Wall Street traders get ready to pop the Champagne corks on another year of record results, there are indicators that the bull market party won’t last forever.
How impact investing will fare in the inevitable event of the next economic downturn is the topic of the most recent instalment of ImpactAlpha’s podcast Returns on Investment. Roundtable regulars Brian Walsh, David Bank and your “loveable curmudgeon” all agree that a slowdown, and possibly even a crash, is inevitable in the not-so-distant future.
Is the proliferation of ESG and impact investment funds itself a product of the long bull market?
“How will impact investing fare, and what impact will a recession have on the challenges impact investors care most about?” asks Walsh, head of impact for the New York-based financial services company Liquidnet. Channeling the Sage of Omaha, Walsh wonders if impact investors will be found to be swimming without their shorts when the tide goes out.
The fears may appear misplaced as the U.S. stock market reached record highs this week, on favorable news on trade negotiations with China. The S&P 500 index and the Nasdaq Composite both closed at all-time highs. The S&P 500 is up over 25% for the year to date.
The rally has been driven by tech stocks, as well as record low unemployment and low interest rates. “Easing in financial conditions suggests not only that global growth is likely to pick up somewhat in absolute terms, but also that growth may come in stronger than currently predicted by the forecaster community,” Goldman Sachs’ Jan Hatzius and his team write in “A Break in the Clouds.”
But it’s never too soon to worry. Among the reasons for pessimism are concerns over growing economic inequality, the diminishing credit quality of low-grade bond issuance, and on-going uncertainty and instability around the globe from Washington D.C. to the U.K., Hong Kong and Chile. The climate emergency is only getting more dire. So, ImpactAlpha is turning its attention to how it all ends.
Flight to safety
In the podcast discussion, I predicted, “You’re likely going to see a flight to safety.” In a recession, investors will pull assets out of seemingly “risky” assets, like stocks, or illiquid ones, including alternative investments. Capital will shift to more low-risk, stable, assets such as treasury bonds. This is likely going to have an impact on impact investments; the majority of assets are still in alternative private market investments, the majority of which are perceived to be at higher risk.
This pull back from ESG (environmental, social and governance) and impact investments was apparent after the 2008 economic collapse. In 2012, the U.K.-based ESG investment management firm Generation Investment Management published a research paper in response to the subprime mortgage global and global financial crisis.
Generation argued that the basic principles of sustainable investment were more important than ever. But the paper’s very publication was a tacit admission that investors had taken their eye off the ESG ball while they dealt with short-term funding, capital calls and other immediate needs. Something similar could happen next time around, and even more dramatically given the increased size of the impact investing marketplace.
Will impact performer the same, better, or worse than non-impact investments in a downturn?
Uncorrelated returns
Bank believes that at least some impact investments will perform better than the markets as a whole. During the 2008 global crisis impact investment, some assets (like microfinance) proved themselves to be uncorrelated to the major markets. Even impact asset classes that were correlations, such as in real estate, investments better aligned with social impact, such as low-income housing, performed better than their overall asset class or sector.
“In a downturn, people are not trading up,” Bank explains. “Vacancy rates and even the rent- payment rates are actually pretty good in affordable housing, just because people really want to stay in that house.” While a recession likely will not be good for anyone, some impact investments may at least do less poorly.
I argue that impact investing’s growth has diminished that advantage. ESG and impact investment are much more integrated into the overall financial services industry and are therefore likely to be more correlated. More worrisome: Some of the investment products developed more as exercises in marketing than true impact may underperform, putting off investors and reinforcing skepticism around impact investing.
But Walsh suggest that such a selloff could be good for impact. “There could be creative destruction,” he says. “You would be able to see who are the ones who are not just slapping an ESG or an impact label” – which impact managers, in other words, have been skinny dipping.
Both Bank and I rushed to agree – as sure a sign as any that the apocalypse is nigh.
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