At first glance ESG, SRI, and impact investing seem the same. However, they have completely different approaches, which might affect your portfolio construction as an investor. Check out the differences to make an informed decision.
While values-based investment is not a new concept, there has been significant growth in such investing trends in the past few years.
Specifically, research shows that SRI, ESG, and impact investment assets have grown from $3 trillion to $12 trillion from 2010-2018.
What’s more, other research shows that 95% of all millennials today are willing to participate in socially conscious investing trends based on their personal values. This trend is here to stay.
However, incorporating SRI, ESG, and impact investing assets into your portfolio takes more than just belief and conviction.
There are various factors involved that influence these investing strategies based on your values. If you’re a beginner, you probably wonder what SRI, ESG, and impact investing mean. Most importantly, what makes them different from each other?
Don’t worry; my ESG vs SRI vs impact investment discourse has you covered. Read along for further details.
TLDR; ESG vs SRI vs Impact Investing
Investment Strategy | Description | Pros | Cons |
ESG Investing | Focuses on environmental, social and governance. |
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Socially Responsible Investing | Values and socially conscious based investing. |
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Impact Investing | Investing for a positive impact. |
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Today, people are looking at the broader picture regarding investment deals. Previously, financial performance, annual returns, and capital appreciation were the only factors used to determine an investment’s profitability, but that’s not the case anymore.
As more investors look to positively impact society through their money, many funds and strategies exist today to facilitate this movement.
That’s where terms like socially responsible investing (SRI), environmental, social, and governance (ESG) investing, and impact investing come in.
Usually, these terms are used interchangeably by investors and organizations alike, but they entail completely different investment formats and approaches.
Knowing the differences between these three investment trends will help you understand your options and formulate your investment portfolio accordingly.
Why Indulge in the SRI vs ESG vs Impact Investment Debate?
Before we start listing out the differences between SRI, ESG, and impact investing, you’ll need to know why the debate matters in the first place.
The main reason is that these concepts shape responsible investing trends and work with a mutual aim of offering benefits beyond financial returns for investors.
New opportunities are bound to arise every minute to facilitate the alarming number of millennials willing to invest in the ethical investment sector.
This makes it necessary for potential investors to be aware of the choices they have at hand.
While all three terms are mainly used to describe ethical investment options, there’s more to them than that. While ESG centers upon rating companies using three different criteria, SRI considers its social impact, and impact investing gauges its influence on a single issue.
Mind you, with the increasing demand for socially responsible investments, companies are rushing forward to comply with the requirements of mindful investors.
The situation has its advantages, but it makes things confusing and challenging for someone willing to invest his funds.
So, if you’re interested in making an informed decision when choosing the ideal investment stream for yourself, you should be able to tell the difference between these three approaches to investing.
This will help you organize your options into separate categories and pick the ideal option according to your priorities.
So without further ado, let’s get started.
See Related: Ethical Dividend Stocks to Invest in Today
What is Environmental, Social, and Governance (ESG) Investing?
ESG, abbreviated from environmental, social, and governance, is a criterion for evaluating investment options in these three areas. The system introduces certain fundamental viewpoints that every company should comply with to reduce risks to sustainability.
Although the concept gained quick popularity in Europe during the GFC, it took time to gain acceptance in the US, which can be attributed to the global financial crisis.
However, throughout the last decade, investors have begun to realize the risks beyond the boundaries of materialism.
For example, if a company they’re associated with makes a profit only because it doesn’t dispose of its waste responsibly, there’s a risk of legal intervention.
Similarly, if a company you invest in has promoted inequality in terms of race or gender, it could face strikes and lawsuits. This will ultimately harm your financial return.
To give you further insight, let’s consider the three aspects of ESG individually. Take, for instance, a company that manufactures and sells sugar.
See Related: AerCap Holdings N.V. ESG Profile (AER): Is It Sustainable?
Environmental
Environmental investing continues to be at the forefront of the three tiers. This prong includes informed investment decisions on clean energy and avoiding fossil fuels.
Considering the environmental aspect of food producer that uses sugar as an ingredient, for example, the issues that require attention based on ESG are:
- How and from where do they source their sugar?
- If it’s extracted from sugar cane, how is it grown?
- Do the agricultural processes handle the biodiversity crisis properly?
- Is the manufacturing process using renewable energy, avoiding fossil fuels, or finding ways to reduce or offset carbon emissions?
Similarly, the environmental part of ESG would look into factors like sustainable packages, harmful emissions, and toxic waste from the factory site.
See Related: Philanthropic Investors vs Impact Investors: What’s the Difference?
Social
After that comes the social factor, you’ll need to find out how your sugar company interacts with its local supply chain for this part.
Do they provide fair trading prices? Are their means of sourcing raw materials ethical?
Another social aspect is the treatment of employees. Does the company hire diverse workers? Do all of them receive equal benefits and have equal chances of growth?
See Related: Aptiv PLC ESG Profile (APTV): Is It Sustainable?
Governance
Lastly, there’s the corporate governance factor. This includes thorough scrutiny of the decision-makers who run your target company.
What are their primary goals regarding their company apart from material profit? Do any owners or board members have serious lawsuits against them?
Considering all three aspects, ESG-compliant investments take measures to limit negative impacts on society.
If you invest in a company that aims to use renewable energy, you’re participating in an ESG investment.
However, the terms of ESG investments are not clear. Although many organizations, namely the SASB(Sustainability Accounting Standards Board), take measures to regulate specific terms for ESG compliance, the system has not yet been adequately standardized.
Does this investment strategy outperform?
ESG investing seems to be the bright future of modern investing. Gradually, it has shifted from just a niche to the new normal concept of investing. It was recorded that one in every four dollars in 2018 was invested in an ESG-compliant fund.
But is it that profitable? Here’s my list of pros and cons to help put things into perspective.
See Related: Angel Investing vs Venture Capital: What’s the Difference?
Pros of ESG
Since the ESG investment trend aims to bring about positive change, let’s start with its advantages.
Ethical Fulfillment
Apart from material profits, ESG investments let investors achieve something you can’t put a price tag on.
When the company you invest in complies with your values as a person, your money brings you internal peace and the ethical fulfillment you need.
High Growth Potential
As more investors are looking toward positive impacts on the environment, ESG investments are becoming more profitable.
Hopefully, nobody will soon want to associate themselves with ethically irresponsible companies, no matter how profitable they might be. This will encourage everyone to comply with ESG terms, growing the industry into the new normal.
Availability
Nowadays, people who want to follow ESG investment trends don’t have to look far. Many ESG funds, ETFs, and mutual funds are available for investors to pool their funds.
Besides that, information about these funds is becoming more accessible through financial advice representatives who display them as a profitable asset allocation option.
Best of Both Worlds
While investing responsibly, investors don’t have to worry about revenue loss anymore. Due to increasing awareness, ESG investment options are performing well in the market financially and working to improve society.
See Related: What is the Sustainability Accounting Standards Board?
Cons of ESG
Although minimal, the ESG investment concept has some disadvantages. As an informed investor, you should know these risks before jumping on the bandwagon.
Long-Term Targets
Sustainable investments, like ESG, are gradually creating a global space for themselves, but establishing sustainable investing trends is still a long-term target.
Until then, investors will have to diversify their portfolios to mitigate the risks associated with ESG strategies, as they are currently vulnerable to market sentiment.
See Related: Teva Pharmaceutical Industries Limited ESG Profile (TEVA): Is It Sustainable?
Lack of Data Availability
Although data regarding sustainability is available in the US, the same cannot be said for other countries. This makes it difficult for investors to make the right choice.
High Fees
Investment fees for ESG investment options might be higher than those for other options. That’s because ESG investments require rigorous research and investigation, which adds to the costs.
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What is Socially Responsible Investing (SRI)?
If ESG investments investigate options based on all three components, what is socially responsible investing (SRI)?
The answer is simple. While ESG provides a more general outlook on potential investments’ sustainability, SRI investing considers the investor’s specific concerns, taking a more values-based approach.
Mainly, SRI helps screen investment options based on the investor’s moral, ethical, and religious values. To get the difference straight, let’s look at it this way.
If you’re an investor who wants to make a difference by contributing positively to society, you go for ESG.
On the other hand, if you’re a PETA member looking for companies that avoid animal testing, you go for socially responsible investment options.
For instance, the Methodist Movement preached to its followers against investing in ‘sin stocks.’ These included companies that generated revenue by selling alcohol, firearms, or tobacco.
Apart from that, SRI funds facilitate religious demands as well. As a Muslim investor, you can go for SRI products that help you include only Sharia-compliant investments in your portfolio. This means that according to your values, you won’t be dealing with any companies getting revenue from pork, alcohol, or firearms.
Another aspect that distinguishes SRI funds’ investment strategies from ESG funds is the lack of a gray area.
While ESG investments rate the options according to the three aspects, a company can still practice unethical means while staying within the allowed percentage.
However, SRI completely excludes a company that doesn’t match your ethical values from your portfolio. This means it’s more straightforward but less reward-focused in the long run.
See Related: Ethical Dividend Stocks to Invest in Today
Is SRI the Ultimate Choice for You?
If you have a particular set of moral values and ethics you can’t compromise on while investing, going for SRI is the ideal option.
To make things more precise, I’ve listed SRI’s pros and cons to give you an honest representation.
Pros of SRI
SRI investing is a great way to earn revenue while maintaining your morals and beliefs. Here are some advantages of SRI.
Inner Peace
If anything, investing through SRI will help you stay at peace. You know you aren’t investing in companies that work unethically according to your beliefs.
Specific SRI Funds
Many sources make these strategies available due to the increase in demand for socially responsible investments. Today, you can specifically sign up for an SRI vehicle designed for your moral values.
For example, the Amana Income Fund lets Muslim investors create Shariah-compliant portfolios.
Cons of SRI
Although SRI funds are beneficial if you have a certain moral value in mind, they have some disadvantages.
Lack of Transparency
As far as SRI is concerned, some of them are easy to measure, like avoiding tobacco or alcohol.
However, if you want to invest in a stock or fund that supports the pro-life movement or you’re against obesity promotion, there might be very few options that completely adhere to your SRI guidelines. That may not mean that is oriented around sustainable investing.
High Fees
This is a common disadvantage between ESG and SRI. The fees for socially responsible investment funds are higher than their counterparts. That’s because portfolio managers charge a high price for constantly monitoring the company’s activities.
See Related: Humana Inc. ESG Profile (HUM): Is It Sustainable?
What is Impact Investing?
As I mentioned above, ESG is a criterion to evaluate investment options based on three factors, while SRI focuses on the investors’ ethical needs.
In summary, both of these aspects involve excluding investment options that do not comply with the investors’ standards.
Impact investing stands out in the comparison debate of these investment strategies. This strategy helps investors seek companies that pledge to have a positive impact on society and the environment.
So, instead of excluding companies with harmful practices, you’re looking for ones with positive long-term goals as an impact investor.
As an example, let’s return to the sugar company we discussed in the ESG description. Now, let’s say the company participates in deforestation to make room for sugar cane plantations.
That’s a negative impact on the environment. On the contrary, if the company finds a way to employ communities displaced by natural disasters, that’s a positive impact.
Impact investing strategies also consider a company’s ethical priorities. These include reducing its overall carbon footprint and establishing a number of charitable organizations.
Furthermore, impact investors can also provide direct funds for the causes that most financial markets do not address.
They can also influence the management of their portfolio companies, which is not possible with other investment vehicles.
See Related: Under Armour, Inc. ESG Profile (UAA): Is It Sustainable?
Is Impact Investing the Better Choice?
Impact investing allows investors to support businesses that are making a difference and a positive impact by seeking sustainable and responsible investment options.
They also get a chance to influence their portfolio companies’ policies directly and contribute to the causes they believe in.
However, it still has its advantages and disadvantages. I’ve listed them below so you can decide whether it’s the ultimate option for you.
See Related: Royal Caribbean Group ESG Profile (RCL): Is It Sustainable?
Pros of Impact Investing
Impact investing helps you support the people who are trying to make a difference. Let’s discuss the advantages of participating in this investing technique.
High Revenue Potential
Impact investments usually generate higher revenue as they tend to follow developing market trends.
So as an impact investor, you can expect to get high returns from your sustainable investment.
New-ish Investing Option
This is a relatively new investment option. Usually, new investment sources help you reach your goals easier as compared to legacy options.
Private Sector Investments
If you want to make impact investments, you’ll likely need to invest your funds in private funds focused on this strategy rather than publicly traded assets like mutual funds or exchange-traded funds.
See Related: Veeva Systems Inc. ESG Profile (VEEV): Is It Sustainable?
Cons of Impact Investing
Although impact investing has many advantages, you should check out this list of cons before you invest.
Limited Data Available
Impact funds require accurate data to derive more result-based investment strategies. Only some impact funds have enough data to provide large-scale projected returns.
Prioritizing Monetary Benefits Can Have an Adverse Effect
An investor has to prioritize the cause and impact above material benefits like financial gains. If monetary benefits are given more importance, the investment can negatively impact society.
See Related: Best Jobs in Corporate Social Responsibility
Difference Between ESG, SRI, and Impact Investing – The Final Showdown
All three of these options let you look at the bigger picture other than material benefits when investing your money. In our eyes, these are a way to conduct sustainable investing. Your money should be used relative to what you believe, so at the end of the day, your money can deliver benefits and more influence on society.
However, each of them facilitates a different approach. The question isn’t about which strategy you should choose. Instead, it’s about which values you prioritize and which causes you to want to support.
Whether you’re looking to reduce the global carbon footprint or thriving to increase workplace equality, you must choose your investment option accordingly.
If you want to evaluate the options thoroughly, go for ESG investment funds. Similarly, if you have a cause in mind that you want to exclude or include in your portfolio, go for SRI or impact investment options.
In any case, keep the fundamental distinctions of these three options in mind before making a choice.
FAQ
What are the differences between SRI ESG and impact investing?
ESG stands for Environmental, Social, and Governance. This type of investing involves companies that meet certain environmental or social criteria… SRI stands for Socially Responsible Investing. SRIs avoid investing in certain industries, like tobacco or gambling, that they deem unethical or harmful to society… Impact investing goes further than ESG and SRI by actively seeking to create positive social or environmental impact alongside financial returns. Impact investments often focus on sectors like renewable energy, affordable housing, and healthcare.
Is ESG investing the same as impact investing?
ESG investing, or environmental, social, and governance (ESG) investing, is the umbrella term for investments that consider ESG factors when making decisions. ESG factors can include a company’s greenhouse gas emissions, its treatment of employees and human rights record, and involvement in community initiatives.
Impact investing is a subset of ESG that goes one step further. It aims to generate specific social or environmental benefits as well as financial returns. Impact investors might target companies or projects that provide affordable housing, clean energy, or healthcare access.
