ESG, SRI, and Impact Investing: What's the Difference?

Investing is no longer just about the returns. A growing number of investors also want their money to fund companies as committed to a better world as they are to their bottom line.

Socially responsible investing and one of its subsets, impact investing, have attracted more than one-third of the assets under professional management in the U.S., according to a 2020 survey by the U.S. Forum for Sustainable and Responsible Investment. That amounted to more $17 trillion in assets under management based on socially responsible criteria, an increase of 42% from 2018.

The growing demand has fueled a proliferation of funds and strategies that integrate ethical considerations into the investment process. Environmental, social, and governance (ESG), socially responsible investing (SRI), and impact investing are industry terms often used interchangeably by clients and professionals alike, under the assumption that they all describe the same approach. However, these terms have subtle differences of meaning.

ESG

ESG refers to the environmental, social, and governance criteria for evaluating corporate behavior and screening potential investments. The ESG evaluation supplements traditional financial analysis by identifying a company's ESG risks and opportunities, which is to say the money they stand to lose by not acting on ESG risks and the money they stand to gain from seizing ESG opportunities. Financial returns remain the primary objective of ESG investing.

SRI

Socially responsible investing goes one step further than ESG by eliminating or adding investments based solely on a specific ethical consideration. For example, an investor might opt to avoid any mutual fund or exchange traded fund (ETF) that owns the stocks of firearms manufacturers. Alternatively, an investor might seek to allocate a fixed proportion of their portfolio to companies that donate a high proportion of their profits to charitable causes.

• Alcohol, tobacco, and other addictive substances
• Gambling
• Weapons production
• Human rights and labor violations
• Environmental damage
  

Impact Investing

In impact or thematic investing, positive outcomes are of the utmost importance—meaning the investments need to produce a tangible social good. The objective of impact investing is to help a business or organization achieve specific goals beneficial to society or the environment. For example, an impact investment might fund nonprofit research in clean energy.

The Bottom Line

Approximately 38% of investors in a recent survey reported allocating assets to a responsible investing strategy, while 66% said recent climate disasters have made them more interested in responsible investing. The desire to invest ethically is especially pronounced among millennials, the study showed.

Accommodating that desire to do good remains no easy task given the growing complexity of ESG analysis and the proliferation of financial products marketed as socially responsible. Luckily, investors don't need to go it alone. Several rating agencies score publically traded companies on their sustainability goals. The agencies include Morningstar, Bloomberg, MSCI, and others.