At first glance ESG, SRI, and impact investing seem like the same thing. 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, another research shows that 95% of all millennials today are willing to participate in socially responsible investing trends. Meaning, 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’re probably wondering 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.
ESG vs SRI vs Impact Investing
Today, people are looking at the broader picture when it comes to investment deals. Previously, annual returns and appreciation were the only factors used to determine an investment’s profitability, but that’s not the case anymore.
As more and more investors are looking to impact society through their money positively, many funds and strategies exist today to facilitate this movement.
That’s where these terms like SRIs, socially responsible investing, ESG, environmental, social, and governance, and impact investing come in.
Usually, these terms are used interchangeably by investors, companies, and organizations alike, but they entail completely different investment formats and approaches.
Being aware of 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, these concepts shape the responsible investing trends and work with a mutual aim to offer 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 of these terms are mainly used to describe ethical investment options, there’s more to it than that. While ESG centers upon rating companies using three different criteria, SRI considers its social impact, and impact investing gauge its influence on a single issue.
Mind you, with the increasing demand for socially responsible investments, companies out there are rushing forward to comply with the requirements of mindful investors. The situation has its advantages, but it makes things quite 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 SRI vs ESG vs to impact investing.
Not only will this help you place your options into separate categories, but it will also let you pick the ideal option according to your priorities. So without further ado, let’s get started.
What is ESG?
ESG, abbreviated from environmental, social, and governance, is a criterion used to evaluate investment options in these three areas. The system introduces certain fundamental viewpoints which every company should comply with to reduce risks to sustainability.
Although the concept gained quick popularity in Europe through the GFC, it took time to gain acceptance in the US, attributing 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 brings profit only because they don’t dispose of their 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, they could end up facing strikes and lawsuits. This will ultimately harm your investment.
Now, to give you further insight, let’s consider the three aspects of ESG individually. Take, for instance, a company that manufactures and sells sugar.
Considering the environmental aspect, the issues that require attention based on ESG are how and from where they source their sugar? If it’s extracted from sugar cane, how is it grown? Do the agricultural processes handle the biodiversity crisis properly?
Similarly, the environmental part of ESG would look into factors like sustainable packages, harmful emissions, and toxic waste from the factory site.
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 factor in the 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?
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 of the owners or board members have any serious lawsuits against them?
Taking all three aspects into account, ESG compliant investments are the ones that take measures to limit negative impacts on society. This means 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 there are many organizations, namely the SASB(Sustainability Accounting Standards Board), who take measures to regulate specific terms for ESG compliance, the system has not been adequately standardized till yet.
Is ESG Investing Profitable for Everyone?
ESG investing seems to be the bright future of modern investing. Gradually, it is shifting 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.
Pros of ESG
Since the ESG investment trend aims to bring about a positive change, let’s start with its advantages first.
Apart from material profits, ESG investments let investors achieve something that 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 towards positive impacts on the environment, ESG investments are becoming more profitable.
Hopefully, nobody will want to associate themselves with ethically irresponsible companies in the near future, no matter how profitable they might be. This will encourage everyone to comply with ESG terms, growing the industry into the new normal.
Nowadays, people who want to follow ESG investment trends don’t have to look far. There are many ESG investment funds, ETFs, and mutual funds available for investors to pool in 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 facing the loss of revenue anymore. Attributing to the increasing awareness, ESG investment options are performing well in the market financially and working to improve society.
Cons of ESG
Although minimal, there are some disadvantages to the ESG investment concept. As an informed investor, you should be aware of these risks before you jump on the bandwagon.
ESG investments are gradually creating a space for themselves globally, but establishing sustainable investing trends is still a long-term target.
Till then, investors will have to diversify their portfolios to mitigate the risks involves with ESG strategies as they are vulnerable to market sentiment at the moment.
Lack of Data Availability
Although data regarding companies’ 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.
Investment fees for ESG investment options might be higher than other options available. That’s because ESG investments require rigorous research and investigation, which adds up to the costs.
What is SRI?
If ESG investments investigate options based on all three components, what are SRIs?
The answer is simple. While ESG provides a more general outlook on potential investments’ sustainability, SRI looks into the investor’s specific concerns.
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 investments. On the other hand, if you’re a PETA member and are looking for companies that avoid animal testing, you go for SRI investment options.
For instance, the Methodist Movement preached its followers against investing in ‘sin stocks.’ These included companies that generated any of their 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 into your portfolio. This means according to your values, you won’t be dealing with any companies getting revenue from pork, alcohol, or firearms.
Another aspect that makes SRI funds different from ESG investments is the lack of a gray area.
While ESG investments rate the available options according to the three aspects, the companies can still practice unethical means while staying within the allowed percentage.
However, SRI completely excludes the companies that don’t match your ethical values from your portfolio. This means it’s more straightforward but less reward-focused in the long run.
Is SRI the Ultimate Choice for You?
If you have a particular set of moral values and ethics that you can’t compromise on while investing, going for SRI is the ideal option for you. To make things more precise, I’ve listed down SRI’s pros and cons to give you an honest representation.
Pros of SRI
SRI, or socially responsible investing, is a great way to earn revenue while maintaining your morals and beliefs. Here are some advantages of SRI.
If anything, investing through SRI will help you stay at peace. You know that you aren’t investing in any companies that work unethically according to your beliefs.
Specific SRI Funds
Attributing to the increase in demand for socially responsible investments, many sources make these strategies available. 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 quite beneficial if you have a certain moral value in mind, it has some disadvantages.
Lack of Transparency
As far as SRIs are concerned, some of them are easy to measure, like avoiding tobacco or alcohol.
However, if you want to invest in companies that support the pro-life movement or you’re against obesity promotion, there might be very few companies that completely adhere to your SRI guidelines.
This is a common disadvantage between ESG and SRI. The fees for socially responsible investment funds is higher than their counterparts. That’s because portfolio managers charge a high price for monitoring the company’s activities constantly.
What is Impact Investing?
Coming to the final part of my ESG vs SRI vs impact investing, what makes impact investing different from its contemporary options described above?
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 a nutshell, both of these aspects involve excluding investment options that do not comply with the standards set up by the investors.
That’s where impact investing stands out in the ESG vs SRI vs impact investing debate. This strategy helps investors seek companies that pledge to put 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 go back to the sugar company we discussed in the ESG description. Now let’s say the company takes part 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.
Apart from that, impact investing strategies also take the ethical priorities of the company into account. These include the overall carbon footprint reduction and the number of charitable organizations they’re affiliated with.
Furthermore, impact investors can also provide direct funds towards the causes that most financial markets do not address. Also, they can influence the management of their portfolio companies, which is not quite possible with other investment vehicles.
Is Impact Investing the Better Choice?
In contrast to ESG and SRI, impact investing options let investors support the companies making a difference. Along with that, they 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 down below so you can decide whether it’s the ultimate option for you or not.
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 investment.
Impact investing is a relatively new funding option. Usually, new investment sources help you reach your goals easier as compared to aged options.
Private Sector Investments
Going for impact investments can help you pool your funds into the private sector, ultimately a profitable venture for you.
Cons of Impact Investing
Although there are many advantages of impact investment, you should check out this list of cons before you dive in.
Limited Data Available
To derive more result-based investment strategies, impact investing funds require accurate data. Currently, only some impact investment funds have enough data to provide large-scale projected returns.
Prioritizing Monetary Benefits Can Have an Adverse Effect
When going for impact investing options, an investor has to prioritize the cause above material benefits. If monetary benefits are given more importance, the investment can do more harm than good for the intended cause.
Difference Between ESG, SRI, and Impact Investing – The Final Showdown
Concluding my ESG vs SRI vs Impact investing debate, it’s time to highlight the differences to give you a clear perception of the three options available. In a nutshell, all three of these options let you look at the bigger picture other than material benefits when investing your money.
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’ll have to choose your investment option accordingly.
If you want to evaluate the options available thoroughly, go for ESG investment funds. Similarly, if you have a cause in mind which you want to exclude or include into 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.