Today, an investment is not only valued in terms of financial but also social returns. However, the concepts of ESG investments vs Non-ESG investments are still complex for many. This piece offers a comprehensive guide of the two concepts and their differences.
According to TIAA, about half of the worlds’ investors today hold responsible investments. In addition, about the same number of investors would consider converting their investments portfolios to hold responsible investments.
This huge desire to invest ‘ethically’ is not only among the baby boomers but has also seen an increase among the millennials, the study showed.
While a growing desire may be only the first step towards responsible investing, understanding the different value-based investments models is something most haven’t grasped.
- Can ESG investments perform better than Non-ESG investments?
- Is a nonprofit considered ESG? (I think we know the answer there…)
These are some of the questions that still seem to bother a majority of these investors.
Fortunately, advisors are fully prepared to explain these concepts to beginners and, this piece will offer a general overview of what consists of ESG investments vs Non-ESG investments to get you started:
Table of Contents
ESG Investments vs Non-ESG Investments
Selecting an ideal value-based portfolio starts with understanding what each model of investment involves. There is a difference between what one would consider ESG investments and Non-ESG investments.
What is ESG Investing?
ESG investing is an approach that involves focusing on companies that are actively making efforts towards either limiting negative societal impact or working towards the delivery of positive societal impact (or both). ESG factors, including environmental, social, and governance practices are integrated to enhancing conventional financial analysis by identifying potential opportunities and risks beyond technical valuations.
How companies report their ESG criteria to investors is standardized by the Sustainability Accounting Standards Board (SASB). That includes the determination of ESG issues that companies should give priority to based on industry and sector.
A perfect example of ESG investment includes buying stocks of a tech company that helps convert their infrastructure towards the reliance on clean energy resulting in cost-benefits and a positive environmental impact.
What are Non-ESG Investments?
Any other form of investment that does not rely on environmental, social, and governance principles may be considered a non-ESG investment.
What is SRI- Socially Responsible Investing?
SRI model goes a step further when screening different investments. It involves picking the responsible investments and eschewing those that conflict with your values and beliefs. The underlying motive of investing in them could be personal, political, or religious beliefs.
This investment concept dates back to 1758 when the Quakers avoided supporting ‘sinful’ companies. Later, John Wesley, the Methodist movement founder, preached the same concept to his followers. He urged them to avoid investing in ‘sin’ stocks like gambling, tobacco, weaponry, and alcohol. SRI is the simplest form of the value-based approach of investments.
Most SRI investors exclude companies involved in:
- Alcohol, gambling, pornography, tobacco, and other addictive substances
- Production of firearms and defense tools
- Human rights and labor violations
- Terrorism affiliations
- Environmental damage
While profits still matter for socially responsible investing, they must balance against beliefs and principles since the goal is to generate financial returns and avoid violation of social conscience.
ESG vs SRI: What’s the Difference?
ESG is a broad approach whose main focus is to protect a portfolio from reputational or operational risk. It considers a more extensive set of due diligence based on environmental, social, or governance factors and how they impact performance both positively and negatively.
For example, an Oil and Gas Company may be a responsible investment if it works incessantly to reduce emissions during its operations, giving back to society and holding a strong safety record.
On the contrary, SRI is a sustainable form of investing that screens investments to pick and exclude companies based on certain criteria. With SRI, investors choose the funds and stocks based on a set of positive or negative screening criteria and the level of stakeholder involvement in impact or community investing.
With such screening, the investor eliminates those companies going against ‘good’ values and chooses those making a positive societal impact.
According to the 2016 Global Sustainable Investment Alliance (GSIA), screening held the largest sustainable investments worldwide, valued at around $15-trillion.
ESG integration followed with investments valued at about $10.4-trillion, and next was a corporate engagement or shareholder action, which was almost $8.4-trillion.
See related: Wunder Capital Review
What is Impact Investing?
This is a thematic model of investing characterized by a direct connection between the use of capital and value-based priorities. With this model, the positive impact is what matters, meaning the aim is to help a company achieve specific goals beneficial to the society or environment.
With impact investing, the report must have both the financial performance of the investment and its positive societal impact (in quantity form) –like X number of people received quality education after investing in this area, or there was an increase or decrease in X number of units after the adoption of clean energy in this venture, etc.
Impact investors set out their funds towards a certain cause not directly addressed by the public financial markets, for example, poverty alleviation and community development. These funds also tend to impact on management and execution of portfolio companies than other investment vehicles.
Impact investing includes private funds, while ESG and SRI investing involve publicly traded assets. This makes impact investing more transparent and attractive to investors who want transparency in their investments.
ESG Investing vs Impact Investing: How is Impact Investing Different from ESG?
ESG is a framework that evaluates different companies based on environmental, social, and governance principles and not a standalone investment strategy like impact investing. ESG is a model of identifying non-financial risks that may cause a material impact on assets’ value, whereas impact investing seeks to make measurable positive social and environmental impact.
In simple terms, impact investing is all about the type of investments a manager targets, whereas ESG factors, that is, environmental, social, and governance, are typically part of the investments’ assessment processing ESG investments.
Types of Investments: ESG Investments vs Non-ESG Investments
ESG Investments Companies to Invest in
Here are some of the best ESG investment funds to invest in:
Parnassus Core Equity Fund Investor
With $20.0 billion assets under its management, Parnassus Core Equity Fund Investor is a great ESG portfolio. Its dividend yield is 0.4% with expenses of 0.86%.
For over a decade, Parnassus Investments has been a basis of ESG investing trends for People’s United Advisors. This firm holds onto the idea that firms with strong social, environmental, and corporate governance practices can better understand and manage risks and reduce the probability of adverse outcomes and controversies.
Its upside and downside capture are key drivers for the funds’ strong and lasting track record. PRBLX has captured about 89% of the index’s upside compared to around 81% of its downside.
The downside protection of this fund and market rallies participation has made it perform well over the long term with lower risk.
iShares ESG MSCI USA ETF
iShares ESG MSCI ETF has $16.5 billion assets under management with a 1.2% dividend yield and 0.15% in expenses. This iShares ESG ETF is a Blackrock ESG investing fund, passively managed, and it keeps track of the MSCI USA Extended ESG Focus Index.
This fund shapes the MSCI USA Extended ESG Focus Index of big and mid-cap American companies to fit positive ESG companies. It also excludes those involved in controversial businesses like civilian weaponry, tobacco, and more.
Then it helps maximize the exposure an investor gets to firms with strong ESG intangible value assessment (IVA) scores, which help analyze the firms’ exposure to risk to the core ESG issues within its industry. For example, exposure to data insecurity in financial firms or wastage production in the food industry. All firms are also subjected to a corporate governance review regardless of their industry.
Vanguard FTSE Social Index Fund Admiral
The assets under Vanguard management are around $12.0 billion with a dividend yield of 1.1% and expenses of around 0.14%, or $14 on a $10,000 initial investment. Vanguard is one of the broadly diversified portfolios with low fees.
Being one of the least expensive SRI funds, Vanguard FTSE Social Index Fund Admiral (VFTAX, $40.42) has and continues to gain popularity to date. In the second half of 2020, Vanguard gained nearly $3 billion in assets under management and amassed up almost $720 million or so in 2021.
Vanguard targets investors who want a diversified portfolio with minimal exposure to companies operating in controversial industries. Vanguard tracks the FTSE4Good US Select Index (a market-capitalization-weighted index that screens ESG firms) using a passive strategy.
Vanguard fund doesn’t directly screen for environmental impact beyond a simple fossil fuel involvement or the corporate governance of its holdings, unlike most of its actively managed peers and ESG index.
While it does make SRI exclusions, including firms with significant ties to tobacco, firearms, alcohol, gambling, fossil fuels, adult entertainment, etc., it does not confine itself to perfect ESG firms. It nixes companies with labor and human rights, environmental and corruption controversies.
This slices off around 30% of the US large-cap market resulting in a well-diversified market-cap-weighted portfolio that must deliver similar market performance in the long run.
Some of its top holdings, including Microsoft (MSFT), Apple (AAPL), and Amazon.com (AMZN), are higher than many conventional blue-chip funds.
ESG Investments vs Non-ESG Investments: Socially Responsible Investments
SRI investors can choose from a variety of investments, including:
Mutual Funds and ETFs
There are plenty of mutual funds available today based on ESG criteria. The US SIF has listed over 200 socially responsible funds with their financial performance information and the criteria each member firm has used to choose the investments.
According to the US SIF 2010 report, social investing trends have 26 exchange-traded funds (ETFs) that utilize social and environmental criteria. Some of the excellent platforms to use when investing in SRI funds include Ellevest, Earthfolio, and OptInvest, and more.
SRI investors also participate in community investments, including lending money directly to community organizations. A perfect way to achieve their goal is to put their money into community development financial institutions (CDFIs), such as credit unions, banks, and loan funds. Then, these institutions offer credit products and other financial services to low-income groups.
Investing in microfinance is another ideal way for SRI investors to put their dollars into a good cause with a positive societal impact. These financial institutions offer micro-loans or small loans directly to startup businesses. Good examples of these organizations include Kiva and Zidisha that offer microloans to entrepreneurs in developing countries, or Kabbage whose focus is on small businesses in the US.
Investing in alternative investments like hedge funds and property funds can also be a perfect SRI strategy. According to US SIF, around 177 alternative SRI funds in the US managed nearly $38 billion in assets. By 2014, the number had more than doubled to 336 funds with around $224 billion in assets.
See related: 12 Worst ESG Companies | Stocks to Avoid
Examples of Impact Investing
Unlike ESG and SRI, impact investing is more of making private investments to make a positive societal impact. Here are excellent examples of impact investing:
The Gates Foundation
Bill & Melinda Gates Foundation is one of the widely known forms of impact investing. Launched by the Windows pioneer with an endowment of almost $50 billion, the Gates foundation engages in philanthropic missions.
Also, it holds a strategic investment fund with about $2.5 billion under its management. This is invested in ventures believed to align with the foundations’ goals of improving health, gender equality, and education. The strategic fund supports projects or organizations that would benefit the world’s poorest and those that conventional investors would overlook.
The Ford Foundation
Launched in 1936 by Henry and Edsel Ford, the Ford Foundation had an initial endowment of $25,000. Today, it has around $14 billion under its management, making it one of the largest private endowments.
Most of its funds are used as grants to support causes that align with the foundations’ values. In 2017, however, the foundation announced its plans to support business ventures aligned with its missions with $1 billion.
Soros Economic Development Fund
George Soros, a billionaire philanthropist, launched the Soros Economic Development Fund as part of the Open Society Foundations. He contributed around $18billion to the Open Society Foundation, where $90 million was invested in impact ventures.
The Soros Economic Development Fund supports ‘open societies” by promoting legal reforms, democracy, journalism, higher education, and more.