Parsing Prepositions: part I in a multiple-post series on pursuing Impact in public markets

The idea of pursuing Impact via public markets is compelling. Liquid, efficient, accessible and relatively cost-effective, the public markets offer low-hurdle, low-friction access almost anyone who has an itch to express a specific investment theme in their portfolio. Impact investing, a “theme” by anyone’s definition, seems to fit the bill perfectly. Clean tech, water, sustainable forestry, enlightened labor practices… given enough time and a deep enough database, one could slice and dice the public markets with whatever knives one wants. But how did the idea of thematic investing develop, and what does it offer impact investors?

Fidelity first realized the potential for thematic investing in the late ‘80’s when they launched sector-specific mutual funds, a massively successful and transformative development in the financial landscape. So successful were these funds, and so unexpected was the way their customers were inserting them into their portfolios, that Fidelity had to develop a draconian (at least compared to their other products) rulebook governing their use.

But such was the attraction of the concept that retail investors – despite the restrictions, tired of letting those grey-suited fund managers have all the fun and driven on by the ever-more breathless financial media – heaved huge amounts of money into the funds, and set about trading them like mad. [*We’ll leave the discussion on investor performance to numerous scholars and research institutes, but I’ve posted a particularly juicy quote below.] This explosion in thematic investing led, in my mind, to the even more transformative invention of the Exchange Traded Funds (ETF): since they were introduced in 1996, more than 2,000 ETF’s have been launched, four times the number of stocks in the S&P 500 if one needs a bit of help with the math. What to bet on Egypt’s economy surviving The Muslim Brotherhood? China-oriented industrial metals? Cocoa? There is an ETF for any theme you could imagine. And if there isn’t, just wait a week.

Which brings us to the non-sequitur at hand: can an investor pursue impact via the public markets?

Given the potential for narrow thematic investing, and the compellingly-titled ETF’s circling the impact community (“Global Echo”, “Nile Pan Africa”, “Osmosis Climate Solutions”, etc.), one could be forgiven for thinking the answer is “yes”. But let’s think about this for a moment…

What, technically, happens when you invest in public markets? You are buying a security from someone who is…selling a security. That’s it. You are not providing direct funding for a cool, new company that promises to solve the world’s energy demands. You are not providing low-cost capital to a frontier entrepreneur working on providing clean, safe water to the world’s poor. You are not even buying fair trade coffee.

Last time I checked, buying 100 shares of a company from someone doesn’t exactly have any impact. Remember that the definition of “impact investing” is to generate financial return while simultaneously creating social or environmental return. Investing in the public markets is not an “impact” strategy.

So what did I mean by the title of this blog: Parsing Prepositions? Now that I’ve stated my case that there is no legitimate rationale to think of public markets offering Impact, I’m going to reverse course and explain how it is actually possible… in my net post.

* Dalbar recently concluded its 15th annual study of mutual fund investor behavior and the study once again has found that the average investor receives a fraction of index-based returns due to buying and selling at inopportune times. To follow is a summary of the report’s findings:

For the 20 years ended December 31st, 2008 the S&P 500 has returned 8.35% and on the fixed income side, the Barclays Aggregate Index earned 7.43%. Conversely, equity fund investors had average annual returns of 1.87% and fixed income fund investors 0.77%.[1]

[ed. note: These numbers are absolutely astonishing, particularly for fixed income markets. Ponder these well, for they imply a universe of meaning outside the scope of this blog.]

[1] 2009 Dalbar Study, Summary Analysis