Comparison of ESG Investing and SRI and Impact Investing
Many of today’s leading investors care about more than just the raw return to capital. An increasing number also want to be sure that the companies in which they invest are also doing good in the world.
In recent years, we’ve seen the emergence of a range of acronyms, including ESG, SRI, and impact investing. But what do they mean, and what are the differences between them?
What Is ESG Investing?
ESG stands for “environmental, social, and governance.” Thus ESG investing focuses on building portfolios based around companies that do well relative to these criteria. An ESG investor, for instance, takes into consideration factors such as a firm’s energy consumption, pollution, human rights performance, health and safety, governance conflicts of interest, and quality of management.
The financial community mainly uses ESG measures as an indication of overall company performance instead of social consciousness. Firms that do better on standards of ESG also tend to yield higher returns.
Differences Between ESG And Other Types Of Investing
ESG vs. Impact Investing
ESG differs from “impact investing” in a significant way. Typically, ESG investors put money into ESG-weighted funds because they believe that they will ultimately yield higher returns in the future based on historical performance. The primary motivation, therefore, is choosing progressive companies that have positioned themselves according to ESG criteria, which are themselves indicators of future financial success.
Impact investing is different. Here, investors actively look for opportunities to create positive outcomes in society, not just make money for themselves. Thus, returns are secondary. For instance, an impact investor might plow money into a company building electric cars, not because he or she believes that the firm will be highly profitable, but that they want to use their wealth to accelerate the transition to sustainable transport.
ESG vs. SRI Investing
SRI stands for socially responsible investing. It is different from ESG approaches in the sense that it actively excludes individual companies from portfolios if they fail to meet the investor’s ethical standards.
An SRI investor, for instance, might refuse to include a company in his or her portfolio if it maintains a significant gender pay gap for like-for-like work. SRI-focused investors will also avoid putting any money into companies that cause excessive environmental damage, violate human or labor rights, sell harmful products like alcohol or tobacco, or promote gambling. People may have objections to investing in companies for a variety of personal, political, or religious reasons.
ESG vs. Ethical Investing
There’s another difference between ethical investing and ESG investing: many ESG products are based on low-cost ETFs that automatically adjust according to the scores churned out by rating agencies like MSCI or Sustainalytics. Expense ratios for these products are exceptionally low: around 0.25 percent per year. Thus, in most cases, the cost-adjusted returns are likely to be relatively high.
The same is not, however, often true of ethical investing. Socially responsible investing requires a lot of detailed research and qualitative analysis performed by dozens of analysts. Expense ratios for these funds, therefore, can sometimes be as high as those you see in mutual funds or hedge funds – upwards of 1.5 percent.