21 October 2019
Fiona Reynolds outlines her thoughts on the differences and similarities between ESG and impact approaches to investing
Though the terms ESG and impact investing are often used interchangeably – and one could argue that the end goal is the same, namely, a more sustainable investment approach – there are both similarities and differences that investors need to appreciate.
In the past, socially responsible investing was often seen as a process of negative screening – not investing in companies that engaged in producing firearms, tobacco, gambling and nuclear energy, for example.
In recent years, both ESG and impact investing have moved firmly into the ethos of mainstream investing, fuelled by investor concerns over the material risks around issues such as climate change and the desire of many high net-worth individuals, millennials in particular, to ensure their capital has a positive effect on society and the world in which they live. Investors have also been buoyed by numerous studies showing that long-term investing strategies using sustainability measures can help them meet or exceed market benchmarks.
Between 2016 and 2018, sustainable, responsible and impact investing grew at more than 38%, rising from $8.7 trillion in 2016 to $12 trillion in 2018, according to the US Forum for Sustainable and Responsible Investment.
From an investment perspective, both ESG and impact investing require robust investment analysis.
Holding up an ESG lens can help investors look at both the risks and opportunities around their investments. One of the key lessons of the 2008 economic downturn was that financial data in isolation does not tell you whether a company is being well run or well governed. Consideration of additional factors such as whether the company is addressing climate change, if they treat their workers fairly, is the board held accountable etc, along with financial data, is a more holistic way of analysing a company's performance and its suitability as an investment.
"It is worth repeating, because we still struggle with this message in some geographies, that ESG and impact investing do not represent some kind of niche, 'do gooding' approach to investing"
Impact investing, which targets specific projects that have an impact on a particular country or region, also uses ESG criteria to assess the risk/return of a particular initiative.
It is also worth repeating, because we still struggle with this message in some geographies, that ESG and impact investing do not represent some kind of niche, do gooding approach to investing, rather both are an extension of traditional investment processes that allow investors to support companies that foster sound, responsible business practices and projects that have a measureable, positive social or environmental impact on the lives of others while also providing financial returns.
Looking at ESG factors, in addition to benefitting investors, also helps to promote a more sustainable financial system, where speculative practices are discarded in favour of more long-term sustainable options that build wealth and stability over many years, ensuring that generations of investors benefit from this approach.
Where ESG and impact investing part ways is that ESG encourages investment in companies with good ESG practices. You could say that ESG is focused on how the company operates, while impact investing looks more specifically at the products and services a company produces and how those can be harnessed in some beneficial way. With impact investing, companies still need to have effective ESG applications in place across their operations. But they also need to offer products or services that can contribute to sustainable outcomes.
Impact investing initiatives often follow the United Nations Sustainability Development Goals (SDGs).
Impact investing traditionally focuses on investing in companies or organisations to create a measurable societal benefit and generate a financial return. Typical projects focus around addressing a social issue, such as poverty or education, or an environmental issue, such as clean water. This is a different strategy than moving your portfolio away from companies that pollute the environment or don't pay workers properly.
In impact or thematic investing, the focus is on positive outcomes or impacts. The main objective of impact investing is to help businesses achieve targeted goals that are beneficial to society-at-large or some aspect of the environment. For example, investing in a non-profit that focuses on clean energy or a start-up company that can bring remote learning to rural communities.
Impact investing can be extremely valuable as the world struggles with poverty, disease, income inequality and other grave issues. Many governments do not have the resources to address these issues in their own countries; therefore, outside private capital is badly needed. Impact investing can harness the power of private capital and bring it to bear to try and address societal and environmental ills.
"You could say that ESG is focused on how the company operates, while impact investing looks more specifically at the products and services a company produces and how those can be harnessed in some beneficial way"
Impact investment management firms offer a wealth of investment vehicles that offer varying levels of risk-return. For example, investors can use a fund such as Impact Ventures UK, which invests only in UK-based businesses tackling social impacts (such as youth unemployment or mental health support). Investors can also use impact exchange-traded funds (ETFs), which are assessed by fund managers using impact criteria.
Impact investing is also not limited by asset class, so investors can still invest across asset classes such as fixed income, debt or private equity/venture capital. And both individuals and institutional investors can make use of impact investing strategies through fund managers, pension funds, insurance companies, development finance companies and diversified financial organisations.
For investors who want to target specific projects that benefit society, there are myriad opportunities for doing so. For example, there are UK-funds that provide loans to small businesses in emerging markets such as Latin America and Asia. Funds might invest in Fairtrade initiatives, with revenue generated used to sponsor local projects.
Other impact investing projects include low-income housing for rural communities and providing clean electricity to rural communities in developing countries with limited access to energy, and providing health and education services to disadvantaged communities.
Investors are becoming increasingly aware of the benefits derived from investing responsibly, whether through companies that uphold good ESG practices, or investing in companies that achieve a positive impact on society. Whichever option they choose, the end result will benefit both peoples and societies.
Fiona Reynolds is CEO of the Principles for Responsible Investment
Five impact investing platforms for investors
- Wealthsimple: Wealthsimple is a RoboAdvisor from Canada that offers six different impact investments, each with a different focus: Low-carbon, gender diversity, clean technology, local initiatives, social responsibility and affordable housing.
- Swell: Swell (from Pacific Life) is an impact investing platform that lets you invest in portfolios of publicly-traded companies innovating in high growth industries, including: renewable energy (wind turbines and solar panels), clean water (water filters and pipe repairs), green technology (electric cars and LED lights), disease eradication (immunisations and research), zero waste (recycling and repurposing) and healthy living (nutritious food and health products).
- Motif: Motif is an investing platform that offers three impact-based portfolios: Sustainable planet invests in companies that actively practice sustainability to reduce their carbon footprint. Fair labour invests in companies that promote fair wages, safe working conditions and job security. Good corporate governance invests in businesses with strong ethical track records.
- OpenInvest: OpenInvest is a largely progressive investment platform that allows investors to mix and match companies representing different values to create a portfolio that represents what is important to them. Choose from investments in healthy hearts, women's rights in the workplace, ethical supply chains or companies supporting refugees.
- Coin: Coin is a sustainable investment platform that offers investments in causes that include: gender equality, climate action, health, clean water, waste reduction, sustainable and inclusive workplaces, modern cities and shared prosperity.