More people want their money to make a positive impact on society and the world, so consider impact investing. According to a survey from the U.S. Forum for Sustainable and Responsible Investment, socially responsible investing and a subset of it—impact investing—has accounted for more than $1 out of every $4 under professional management in the United States. This equals more than $12 trillion in assets under management every year.
Along with this growing trend, there are many funds and strategies that integrate ethical considerations into the investment process. Environmental, social, and governance (ESG), Socially responsible investing (SRI), and impact investing are terms often used interchangeably with the assumption that they all have the same meaning and approach. However, there are many differences that affect how portfolios should be structured and which investments are best for meeting social impact goals.
What is ESG?
ESG refers to the environmental, social, and governance practices of an investment that can have a material impact on the performance of that investment. The integration of these factors is used to enhance traditional financial analysis by identifying potential risks and opportunities beyond just technical valuations. The main objection remains financial performance, however, even though there is an overlay of social consciousness. Investments with good ESG scores have the potential to drive returns. Some common environmental factors are energy consumption, pollution, climate change, waste production, natural resource preservation, and animal welfare. Some social factors are human rights, child and forced labor, community engagement, health and safety, stakeholder relations, and employee relations. The governance factors are quality of management, board independence, conflicts of interest, executive compensation, transparency and disclosure, and shareholder rights.
What is SRI?
Socially responsible investing goes farther than ESG investing by actively eliminating or selecting investments that correspond to certain ethical guidelines. Underlying motives can include religion, personal values, or political beliefs. Unlike ESG analysis which shapes valuations, SRI uses ESG factors to apply positive or negative screens on investments. For instance, an investor might avoid any fund that invests in companies that are linked to firearm production. An investor might also opt to allocate a fixed portion of their portfolio to companies that give to charitable causes. Other negative SRI screens include human rights and labor violations, environmental damage. Others include terrorism affiliations, gambling, production of weapons and defense tools, and alcohol, tobacco, and other addictive substances. Making a profit is still important, but it has to be balanced against principles. The goal is to make returns without going against one’s social conscience.
What is Impact Investing?
In impact investing positive outcomes are important. Investments need to have a positive impact, so the goal for impact investing is to help an organization or business meet certain goals that benefit society or the environment. Investing in a non-profit that is dedicated to the development and research of clean energy is an example of impact investing. People don't care about the success of this and whether they earn money to the same extent as social and ESG investing.
An example of a tool used in impact investing is a microfinance loan. This helps people with little or no access to capital start a new business. High-net-worth individuals find this attractive and are willing to take some risk to invest in them. Businesses started with microfinance loans are helping to provide competitive returns to their investors through the bonds that back them. Sometimes impact investing has been able to make higher returns for their investors than the overall market did.
In conclusion, around half of investors own responsible investments. In addition, around the same number are willing to change their entire portfolio to be responsible. The desire to invest ethically is only growing. Given the growing complexity of investment concepts and products, the implementation of this desire is not easy. This is why educating yourself and getting advice from knowledgeable individuals is a smart thing to do.