For the first time in history, businesses are presented with market opportunities of over $12 Trillion by adopting sustainable practices and capturing its market value, according to the Business & Sustainable Development Commission – and the impact investment industry, as described by investors who aim to achieve both social/environmental and financial returns, was estimated to have a current market size of USD 715 billion, based on Annual Impact Investor survey conducted by GIIN.
With such staggering figures, it should not come as a surprise that we are seeing terms like – Impact Investing, ESG Investing, Social Investing, and Responsible Investing – following whenever and everywhere we go.
But what are they exactly? How can we make sense of all these terminologies? That is the aim of today’s article in which we will be discussing the key differences between Socially Responsible Investing(SRI), ESG, and Impact Investing.
Basic Terminology
ESG refers to a non-financial framework from which investors can evaluate a company’s social, environmental, and governance risks and practices. ESG criteria do not represent a standalone investment strategy, but rather constitute factors which are core parts of an investment evaluation process.
On the other hand, socially responsible investing (SRI) looks at investments through the lens of ethical criteria. It uses the UN’s framework which has set ten core principles of social responsibility, covering labor practices, anti-corruption, the environment, and human rights. SRI can also use ESG reports generated by companies as part of their ethical screening process.
Lastly, unlike both ESG and SRI, Impact investing is a complete investment strategy. It is used by organizations, enterprises, and funds that strive to create a substantial, measurable, social, and environmental impact before financial returns for investors.
When They Started
SRI began in the late 1960s, and is the earliest form of ethical investing. It was established to respond to the rising demand for investment funds, which were favoring certain investment sectors that were considered ethical and avoided the others that were thought to be unethical.
ESG is more recent than SRI and was coined with the publication of “Who Cares Wins” in 2005. During that period, an index provider MSCI, defined ESG as the consideration of environmental, social, and governance factors alongside financial factors in the investment process. The investment strategies of a growing number of ethical banks are informed by their assessments of all these factors
Impact investment is the most recent subset of the sustainable investment spectrum. It started in the early 2000s and is presently gaining popularity at an increasing pace.
Core Focus
ESG is mainly about economic value and aims to maximize financial returns for the investor. It only looks at any other factors related to investments after financial returns have been maximized.
SRI is different from ESG and impact investing because while it doesn’t focus on maximizing financial returns like ESG or maximizing social impact like impact investing, it tries to create a more balanced approach between the maximizing of financial returns and the creation of social impact.
Although both ESG and SRI aim to deliver social and ethical benefits without completely sacrificing financial returns, They differ from impact investing because they do not prioritize social and environmental impact before financial returns. Impact investments can even fund ventures which do not aim to acquire a financial return such as social projects, charities, and other non-profit organizations.
Investment Method and Accessibility
While socially responsible investing (SRI) aims to screen out sustainable companies or investment vehicle which are perceived to have negative social impacts using pre-selected screening criteria that would enable them to achieve this, ESG focuses on companies that are either making effort to produce benefits for society or trying to reduce their negative impact on society or both.
Companies that incorporate the ESG criteria pay attention to the other non-financial risks posed to sustainability after profit margins have been maximized.
Impact investing, the funds actively try to make measurable positive social and environmental effects with the investment vehicles they decide to use. It is characterized by the direct connection between the use of an investor’s capital and the value-based priorities that the fund or enterprise has set.
While SRI focuses on negative screening to avoid investments that are deemed unethical or negatively impactful, impact investing focuses on positive screening as it seeks to invest only in companies with positive social and environmental impact.
The ESG framework and SRI have mostly been adopted by public markets with a few private funds beginning to adopt it while Impact investments are very prominent in private market investments with limited access for smaller investors.
SRI can be easily accessed by all investors since they are mostly used in public markets. SRI mutual funds are one of the ways SRI investments can be accessed. On the other hand, impact investments are implemented in closed-end PE, VC funds, and debt funds, which are not generally accessible to the public.
Financial Statements
SRI is used as a screening criteria based on an investor’s perspective and hence, no report is given by companies to their investors quantifying social or environmental impact. On the other hand, firms that use the ESG framework must provide ESG reports at the end of the required period which includes the impact of their investments on the environment and the other risks associated with their investments.
Unlike ESG and SRI approaches, since Impact investing is characterized by the direct connection between the use of an investor’s capital and the value-based priorities, funds, and enterprises that use impact investing strategies do not only provide their investors with statements on financial performance. They also try to both generate and quantify their positive societal impact as part of their financial statements.
A good example of an ESG investment would be buying shares in technology companies which both produce cost benefits and create positive environmental impact by converting some of their data centers to use renewable energy.
Common SRI Portfolios would exclude firearm manufacturers and fossil fuel producers, while impact investing portfolios could include how much their economic activities have affected people in a low-income community or the number of hospitals built.
Conclusion
Broadly speaking, while companies that use ESG are more concerned with maximizing profits before considering any other factors; the SRI and impact investing are more mission oriented and both social and environmental impact as well as financial returns for investors. Also while the SRI tries to balance between social impact and maximizing profits, impact investing is more concerned with the social impacts of investments before the bottom line.
Trees growing on coins – csr – sustainable development -DepositPhotos
