ESG vs Impact Investing vs SRI: What Are The Differences?

More and more people today want their investments to reflect their values—in a sense, "putting their money where their mouth is"—while also providing a good financial return. Professional investment firms have responded by creating mutual funds, exchange-traded funds and other vehicles to respond to the demand.

According to the Forum for Sustainable and Responsible Investment, or US SIF, there were US$17.1 trillion invested in sustainable investing strategies at year-end 2019, "or one out of every three dollars under professional management in the United States." The group counted 836 registered investment companies with ESG assets in 2020, including 718 mutual funds and 94 ETFs.^[1]

There are three main types of value-driven investment strategies.

Environmental, Social And Governance (ESG) Investing

Probably the largest and best known of these strategies is ESG, which stands for environmental, social and governance. While financial return remains the paramount goal of ESG funds, these funds believe companies can achieve superior results through their hiring practices, environmental policies and corporate governance procedures.

By the same token, they believe companies that fail to take ESG factors into consideration may subject themselves to increased financial risk. Research suggests that companies that adhere to ESG policies do as well or better than those that don't.^[6]

Socially Responsible Investing (SRI)

Socially responsible investing is a subgroup of ESG, but goes one step further by avoiding companies according to specific ethical guidelines. Most commonly these are manufacturers or retailers in so-called "sin" businesses such as alcohol, tobacco, firearms, pornography and gambling, as well as fossil fuels and other industries that some consider contributing to the destruction of the environment. By contrast, some ESG funds will buy stock in some companies that SRI funds would avoid if they fulfill other aspects of ESG principles.

As a result, SRI is sometimes called "exclusive" while ESG is regarded as more "inclusive."^[2] Both ESG and SRI prioritise financial performance in their investment choices.

Impact Investing

The third type of value-driven or socially conscious investing is impact investing. As the name implies, these types of investments channel money to projects geared to have a positive impact on society.

For example, impact funds invest money in projects to build schools and other infrastructure in impoverished areas or in other community development projects. These are projects that private businesses are not always set up to address. As a result, these projects are often done in association with government agencies, nonprofit organisations and public-private partnerships.

Unlike ESG and SRI investing, financial performance is secondary to impact investors compared to the good they hope to achieve. The measuring stick for success is how many schools have been built, for example, as opposed to their financial return. In that sense, impact investing is closer to philanthropy than to traditional investing.

On the positive side, impact funds usually have more influence on the outcome of these projects than ESG and SRI funds because they are more directly involved in the execution and management of them. As a result, impact funds also tend to be more transparent in informing investors how their money is being used.^[3]

One impediment to impact investing is that these funds are usually not publicly traded, unlike ESG and SRI, in which there are hundreds of such funds easily accessible to most people. Rather, they are often run by private equity firms, which are usually open only to so-called accredited investors, those with a high net worth or high incomes, or are able to demonstrate some level of financial sophistication.^[2]

However, one growing area of impact investing is green bonds, which are used to fund climate, environmental and sustainability projects such as renewable energy and water efficiency projects. The repayment of the bond is tied to specific performance outcomes. These bonds are available from many investment firms.^[4]

Green bonds were first issued in 2008 by the World Bank. In 2019, US$254 billion in green bonds were issued, followed by US$312 billion in 2020.^[5]

Summary

Socially conscious investing has become a popular way for people to choose investments based on their personal values. There are three main types. Environmental, social and governance (ESG) funds believe companies can achieve superior results through their hiring practices, environmental policies and corporate governance procedures.

Socially responsible investing (SRI) funds avoid investing in companies for ethical or religious reasons, such as alcohol, tobacco, and firearms. Impact investing, which is more akin to philanthropy, invests money in projects that will have a positive impact on society, such as renewable energy, while the financial return is of secondary importance.