What is the key differentiator between ESG based investing and impact investing?
The Difference between Impact Investing and ESG Investing
While ESG investing operates as a framework to assess material risks and opportunities for firms, impact investing is an investment strategy that seeks to first and foremost create a specific, measurable social or environmental benefit.
The most common types of sustainable investing are socially responsible investing (SRI), which excludes companies based on certain criteria, and ESG, a more broad-based approach focused on protecting a portfolio from operational or reputational risk.
In summary, it can be said that for the same social effect, thematic investment suggests that it may be achieved in a diffuse and non-measurable way, whereas impact investment will prove it. These impact investments are not yet available to individuals because the associated risks are significant and multiple.
While ESG Reports focus on metrics, Impact Reports dive into qualitative narratives. They tell the story of a company's social and environmental efforts through case studies, impact assessments, and compelling narratives.
The key difference between sustainable finance and impact investing is that sustainable finance tends to be more focused on ESG integration and risk management, while impact investing is focused on generating positive impact and creating change.
| Pros | Cons |
|---|---|
| Can help investors diversify their portfolio | ESG funds may carry higher than average expense ratios |
| May reduce portfolio risk | ESG investing is still a fairly new concept and there isn't a ton of reporting on performance |
While impact investing focuses on investors doing good by investing only in certain companies or areas of the market, ESG looks at the potential negative impacts a company may face as a result of poor environmental, social or governance policies.
This type of ethical investing strategy helps people align investment choices with personal values. ESG stands for environment, social and governance. ESG investors aim to buy the shares of companies that have demonstrated a willingness to improve their performance in these three areas.
- Intentionality. Impact investing is marked by an intentional desire to contribute to measurable social or environmental benefit. ...
- Use Evidence and Impact Data in Investment Design. ...
- Manage Impact Performance. ...
- Contribute to the Growth of the Industry.
Why is impact investing important?
Key Takeaways. Impact investing is an investment strategy that seeks to generate financial returns while also creating a positive social or environmental impact. Investors who follow impact investing consider a company's commitment to corporate social responsibility or the duty to positively serve society as a whole.
Characteristics of impact investing
These four characteristics are (1) Intentionality, (2) Evidence and Impact data in Investment Design, (3) Manage Impact Performance, and (4) Contribute to the growth of the industry.
ESG reporting is all about disclosing information covering an organization's operations and risks in three areas: environmental stewardship, social responsibility, and corporate governance. Consumers look to ESG reports to figure out if their dollars are supporting a company whose values align with theirs.
Among other advantages, executing ESG effectively can help combat rising operating expenses (such as raw-material costs and the true cost of water or carbon), which McKinsey research has found can affect operating profits by as much as 60 percent.
ESG reporting comes in many forms, some being: Impact reports on environmental waste, damage, and conservation. Reports on company culture, data protection, and community involvement. Boardroom decision making, transparent accounting, and voting rights.
Whereas impact measurements concentrate on certain social or environmental outcomes, ESG ratings comprehensively evaluate a company's sustainability performance in the present. While making investment decisions, investors should take the measures used to assess sustainability performance and effect into account.
The same report introduced the three pillars or principles of environmental, social and economic sustainability, also known as ESG (Environmental, Social, Governance).
It's a measured assessment using benchmarks and metrics. So, sustainability is a broader concept that encompasses environmental, social and governance considerations, whereas ESG specifically refers to a set of criteria within these three areas that are used to evaluate the performance and behaviour of companies.
There is a potential for “greenwashing”
Some companies may make claims about their ESG practices that are not fully supported by their actions which can lead to “greenwashing”. This may make it difficult for you as an investor to identify truly sustainable companies.
However, there are also some cons to ESG investing. First, ESG funds may carry higher-than-average expense ratios. This is because ESG investing requires more research and due diligence, which can be costly. Second, ESG investing can be subjective.
What is the problem with ESG investing?
Fundamentally, there is a principal-agent problem in ESG investing. This is because investors – be it institutional or retail – delegate investment decisions to portfolio managers who are supposed to be superior not only in picking stocks that will outperform the market but also at assessing firms' ESG credentials.
Investors not only want to know in what way they are having an impact, they also want to be able to compare parties with each other. And there is one more reason for the increasing demand for impact investing: the good feeling it gives investors who consciously choose to invest this way.
Retail investors do care a lot about the ESG-related activities of the firms they invest in, but only to the extent that they impact firm performance, independent of ESG performance.
ESG means using Environmental, Social and Governance factors to assess the sustainability of companies and countries. These three factors are seen as best embodying the three major challenges facing corporations and wider society, now encompassing climate change, human rights and adherence to laws.
One of the biggest criticisms of ESG is that it perpetuates what it was partly designed to stop – greenwashing.
