Difference Between ESG Investing and Impact Investing

What is the difference between ESG investing and impact investing? At first glance, they seem similar in incorporating environmental and social responsibility.

However, after my dad got cancer likely from environmental toxins at his workplace, I dug deeper to align investments to my values.

The differences proved stark – ESG seeks to mitigate risks by screening out harmful sectors while impact investing directly funds solutions benefiting people and planet.

As I dealt with grief and anger, only impact investing gave me a sense of hope, catalyzing real-world change on issues I newly cared about.

I’ll explain further distinguishing ESG versus impact across strategies, returns and motivations to determine the right fit for those desiring money making positive change.

Diving Into ESG Investing

ESG investing incorporates assessments about environmental, social, and governance factors into investment decisions and ownership practices. Some key things to understand about ESG investing:

• Definition: ESG investing is an umbrella term for investment strategies that select companies/assets based on environmental sustainability, societal impact, and ethical governance.
• Background: Institutions have deployed ESG investing since the early 2000s as awareness of climate change and other systemic risks grew. The UN Principles for Responsible Investment launched in 2006 to formalize ESG considerations.
• Goals: Seeks to mitigate risks, negative externalities, and pressures on issues like climate change through changes to capital allocations and pressure from shareholders/investors. Can also aim to improve diversity, employee relations and more through shareholder advocacy.
• Approach: Can utilize techniques like negative screening (exclusions), ESG integration (factor assessments), thematic investing (e.g. clean energy), corporate engagement/shareholder resolutions, and best-in-class selections.
• Examples:
  • Negative screens to exclude fossil fuel companies, tobacco, gambling, weapons, poor governance risk
  • Select companies with good performance on emissions reductions, water use accountability, board diversity

So in summary, ESG investing incorporates a wide toolkit of strategies investors can use to manage and reduce issues stemming from environmental, societal, and governance concerns. It is frequently used as a risk management technique.

Which companies and assets perform well on the key ESG criteria? The detail and reporting varies significantly at this stage, though standardized frameworks are developing. Common areas of assessment include:

• Environmental – GHG emissions, climate vulnerability/resilience, natural resource usage efficiency, waste and recycling programs, clean operations
• Social – worker health, safety and wellbeing, diversity and inclusion, gender equality, employee training and development, product safety, privacy concerns
• Governance – executive pay alignment, board accountability, transparency, anti-corruption policies, whistleblower programs, cyber risk management

Now let’s compare this to impact investing – where the specific intention is to drive positive change on societal and sustainability issues.

Understanding Impact Investing

While still falling under the sustainable investing umbrella, impact investing has some defining components that differentiate it from ESG investing. A brief primer:

• Definition: Impact investments actively contribute money to projects/companies delivering social/environmental solutions while still seeking financial returns.
• Background: Impact investing emerged in 2007 when investors started aligning assets to intentionally solve problems like climate change and poverty by directing funds.
• Goals: The core purpose of impact investing is measurable positive impact aligned to sustainability issues like clean water as well as economic growth for underserved communities. Financial returns are second to the impact mandate – investors accept higher risk and potential below market returns to achieve more transformational change.
• Approach: Impact investors contribute capital to mission-driven companies, funds, products and initiatives that can provide evidence they are intentionally addressing environmental/societal issues.
• Examples:
  • Invest in a solar mini-utilities bringing clean affordable lighting to remote villages in Africa
  • Provide growth financing to an agtech startup with soil products regenerating land

The key factor differentiating impact investing is intentionality of impact – directing money specifically to solve problems and improve communities beyond what regulations and ESG screens already work to avoid.

It requires setting impact goals, thoroughly measuring impact through defined metrics, maintaining accountability to stakeholders, and often entails engagement well beyond pure capital allocation.

Type of Investing	Motivations	Approach
ESG Investing	Risk mitigation, ethical principles	Negative screening, integration, shareholder advocacy
Impact Investing	Maximize measurable impact aligned to values	Contribute capital to intentional impact solutions

Another lens highlighting the difference – ESG investing says “do no harm”, while impact investing says “actively do more good”.

Motivations and Objectives: Risk vs. Impact

As highlighted already, ESG investing frequently focuses on limiting negatives and risks. It answers investor demand to align capital allocation with personal values by allowing people to screen out issues they find morally concerning like tobacco or modern slavery.

Alternatively, it can apply an analytical risk focus via ESG integration to minimize exposures – like avoiding companies without emissions reduction plans as climate regulations and costs shift.

Either approach stems from limiting downside harm to returns or society.

In contrast, at its core impact investing pursues intentional positive outcomes for people and planet. This distinction separates them as impact investors accept some tradeoff in returns or liquidity to fuel positive solutions tackling pressing issues like:

• Advancing renewable energy infrastructure
• Creating economic opportunity for disadvantaged groups
• Building Climate Change Resilience

Many impact investors utilize methodologies like IRIS from the Global Impact Investing Network to catalogue and quantify the positive effects of their funds using evidence-based assessment like: lives touched, trees planted, children educated, jobs created for marginalized people, tons of CO2 averted.

This focus on intentionality and additionality means directing money to areas not already served by existing funding flows.

While a wide spectrum from ESG to pure philanthropy exists, the key insight is motivations differ – avoiding negative externalities versus solving systemic issues.

Implementation and Strategies

Building on the distinct motivations, ESG investing and impact investing utilize some different approaches:

ESG investing leverages positions as equity shareholders and debt holders to encourage better alignment of externalities with corporate governance and strategic direction. Techniques like:

• Shareholder resolutions/proposals to prompt changes from firm leadership on ESG issues
• Divestment from sectors creating material risks like coal and oil sands
• Investor activism collaborations to reform governance issues

Instead of avoiding areas of concern, impact investing directs money towards measurable solutions:

• Financing innovative startups building affordable cleantech solutions
• New impact-aligned real assets like community solar farms
• Anchor funding for developing world infrastructure meeting sustainability standards
• Direct private debt to overlooked entrepreneurial ventures supplying basic needs

While investments focused on women, minorities, and underserved groups increasingly fall under both umbrellas, the way capital gets deployed does differ.

ESG looks to boost diversity and representation, while impact investing specifically finances those demographic segments directly as a targeted impact goal.

Financial Return Expectations

Perceptions on whether investors must make financial tradeoffs for values alignment sparks debate. On ESG investing, the data increasingly shows strong performance as better sustainability management indicates strategic positioning for future externalities and mitigating downside legal, regulatory and reputational risks.

Numerous academic studies have shown market-rate returns or outperformance from ESG methodologies focused on picking sustainable leaders while avoiding laggards.

However, some nuanced studies indicate limitations once controlling tightly for other performance drivers like momentum, quality, volatility, sector biases and geography. So no definitive conclusion exists yet in the data that ESG elevates market returns (or detracts).

Alignment to ethical principles so far does not require losing money – especially as leading companies demonstrate superior responsiveness to shifting societal expectations.

For impact investing the expectations differ – by targeting overlooked segments like financing off-grid solar in remote villages or funding social entrepreneurs, increased risk exists.

The returns can be below commercial benchmarks as investors accept concessionary positions to catalyze innovation and unlock capital to neglected regions.

Additionally, impact startups often hold equity more akin to venture capital and many impact bonds/funds are illiquid or have longer durations limiting withdrawal flexibility.

This means impact investors tend not to prioritize maximizing financial gain. But market-rate returns do accrue for impact exposure in listed equity funds focused on segments like renewables, gender diversity, and community development projects in growing regions.

So while ESG need not hamper returns and increasingly correlates to outperformance, impact investing has baked in expectations for some financial concession but aims to optimize balance of impact alongside money – with impact leads decision making.

Common Ground On Difference Between ESG Investing And Impact Investing

Despite differences in motivations, tactics, and return expectations – ESG investing and impact investing both represent evolution in deploying capital towards solutions for large societal and planetary needs. Awareness continues growing around topics like:

• Biodiversity loss
• Ocean health deterioration
• Lack of access to clean water
• Growing waste
• Soil degradation threatening food supplies
• Persistent gender and income inequalities

Both ESG and impact investing acknowledge capital markets and investor influence should align more to addressing these sustainability challenges.

And flows into these approaches keep increasing rapidly:

• ESG assets under management recently topped $40 trillion
• Impact AUM sits near $715 billion and growing over 15% a year

So whether avoiding risky externalities or directly funding solutions, ESG and impact investing make tangible improvements.

Companies know attracting investment increasingly relies on showcasing commitments to cut emissions, foster diversity, protect natural resources and more.

Capital flows signal societal expectations on issues that regulations continue playing catch up on.

The market momentum and consensus on moving investment towards sustainability steadily marches forward even as tactics between ESG integration and impact funding diverge.

Collaboration also frequently occurs between ESG and impact investors on initiatives like:

• Supporting shareholder resolutions asking companies to adopt science-based emissions reductions targets
• Creating industry standards for impact measurement and reporting
• Building new structures like sustainability-linked loans and bonds
• technology to track supply chain integrity on issues like child labor

So while distinct differences exist between ESG and impact investing, they work in tandem towards capital markets playing a more constructive role supporting healthy societies, environments and economies.

Which Approach is Right For You?

With increased options comes increased complexity around how to allocate investments in aligned ways. Ultimately, motivations matter most – are you more concerned with mitigating risks and avoiding areas of concern or actively funding measurable solutions even if financial concessions occur?

• Leading wealth platforms now incorporate ESG options to screen out certain sectors or only buy companies with diverse boards and proven sustainability processes. This allows participation without overhaul of entire portfolios.
• For those compelled to have money directly fund positive change as the priority, community investing notes, microfinance funds, and vehicles financing off-grid renewables bring targeted impact opportunities.

In practice, many investors use hybrid approaches – core passive holdings screened for ESG risks combined with carving out 5-10% of assets for impact fund exposure targeting issues they particularly care about.

This balances financial sustainability with making tangible social differences.

• Take gender equality – you could screen investments on diversity metrics while allocating to funds supporting female entrepreneurs and education in developing countries.
• For climate action – cut exposure to fossil fuel holdings while directly financing solar infrastructure and regenerative agriculture projects.

The spectrum has expanded allowing expression of values no matter your assets or risk tolerance by mixing ESG and impact methodologies.

Key Takeaways: Assessing Your Position

While adoption trends show sustainable investing broadly becoming standard practice, drilling down shows some nuance between ESG and impact investing. When assessing your own positioning, reflect on few key questions:

• Do you want to avoid objectionable sectors/practices or directly fund measurable solutions contributing positively to global needs?
• Should societal issues factor prominently in picking investments or focus solely on financial metrics?
• Are you willing to sacrifice some financial upside or liquidity to further positive change?
• What specific issues like climate, diversity, health, education matter most to you?

As the landscape rapidly evolves with new funds, products and reporting capabilities the toolkit expands to match convictions and use cases.

Whether mitigating risks or funding transformational innovation remains an individual choice – but collective momentum points toward society expecting more from our financial system across the board.

Consulting sustainable investment advisors can further help tailor optimal approaches aligning your money with priorities and ethics while still meeting return needs over the long-term. The old maxim of doing well while doing good rings truer than ever.

Your investments can foster the change you want to see while supporting personal and family goals.

FAQs

How Is Esg Different From Normal Investing?

ESG investing incorporates assessments about how companies manage environmental, social, and governance (ESG) factors into investment decisions – unlike traditional investing which focuses solely on financial returns.

ESG investors believe that issues like climate change, diversity, and business ethics should be considered when making investment choices. This approach seeks to encourage businesses to improve sustainability, equity and business practices.

By scrutinizing things like energy usage, board diversity, supply chains and more, ESG investment managers can identify risks, opportunities and impacts traditional analysis overlooks.

The core difference comes from this expanded scope looking not just at profits, but also influence and externalities created by corporations.

What Is The Difference Between Esg Investing And Ethical Investing?

While often used interchangeably, a difference exists regarding motivations:

• Ethical investing focuses on aligning investments to personal values by excluding objectionable sectors like tobacco, weapons or gambling based on social or moral criteria.
• ESG investing emphasizes managing risks, harnessing opportunities, and influencing corporate behavior on issues like climate change, shareholder rights, diversity through analysis and shareholder engagement – though values frequently shape preferences.

In practice, social responsibility drives both approaches in shaping investment universes according to things investors care about rather than pure earnings metrics.

But ESG holds wider scope across three core areas: environmental impacts, contribution to social issues, and governance behaviors.

What Is Esg Investing Also Known As?

ESG investing also commonly gets described as:

• Sustainable investing
• Responsible investing
• Socially responsible investing (SRI)
• Values-based investing
• Ethical investing

The terminology often gets used interchangeably as incorporating environmental and social considerations underpins each concept. Subtle differences exist but expect these terms to emerge as you explore options.

What Is The Difference Between Esg And Impact Reporting?

• ESG reporting focuses on policies, processes, risks monitoring across a wide range of measurable environmental metrics like emissions and resource efficiency to social indicators like employee safety and diversity numbers to governance best practices.
• Impact reporting numbers specifically track how company products/services directly solve social or environmental challenges – like acres of land preserved, number of patients treated, students educated, jobs created for those with barriers. Impact prioritizes the tangible outcomes delivered.

So while ESG reporting addresses operational inputs to limit negative externalities, impact reporting spotlights quantifiable positive impacts from outputs. Many advocate combining these frameworks for a comprehensive view.

What Are The Disadvantages Of Esg Investing?

Like any approach, ESG investing comes with a few potential drawbacks:

• Added complexity in analysis requiring looking beyond financials to assess sustainability processes.
• Possible limitation in universe, sectors, markets though options expand constantly.
• Potentially higher fees for specialized research and reporting – but costs equalizing as adoption accelerates.
• Perceived performance limitations excluding certain high emitting sectors like oil and gas – though risk reduction arguments abound.

While research on returns proves inconclusive, a longer-term perspective emphasizing risk mitigation and societal sensitivity shows ESG holds strong merit.

What Are The Pros And Cons Of Esg Investment?

Pros

• Align investments to your values on issues like climate action and diversity.
• Incorporate wider range of risks into decisions using ESG data.
• Support and influence businesses positively improving communities and the environment.
• Increasing correlations to positive returns and downside resilience.

Cons

• Limitations on investment universe, though rapidly expanding options in market.
• Potentially higher fees for specialized managers and reporting – costs declining with scale.
  *Indirect relationships between ESG standards and financial materiality still debated.
• Perceived performance lag in high emitting sectors.

On balance, I see pros outweighing cons as leadership on material ESG factors increasingly associates with prudent management.

Who Invests In Esg Funds?

The popularity of ESG continues to grow rapidly across individual and institutions:

Individuals

• Millennial investors highly favor ESG options aligning money to values.
• Women investors also overindex in adopting ESG preferences.
• High-Net-Worth and Ultra HNW increasingly adopt ESG across portfolios.

Institutions

• Public pensions funds globally now view ESG as indispensable.
• Sovereign wealth funds incorporate ESG to protect national assets over long-term.
• Endowments/foundations align grant-making to investments with ESG and impact.

I expect this broad pool to expand further as research and reporting bolsters the link between sustainability and returns.

What Is The Difference Between Esg And Impact Metrics?

As mentioned earlier, ESG metrics focus on operational inputs measuring policies, programs and risk monitoring – like tracking greenhouse gas emissions reduced, water usage efficiency improved, and employee turnover/safety trends.

Impact metrics directly quantify the societal and environmental outputs tied to products, services and projects invested capital enables – like acres of wildlife habitat protected, clean energy delivered to those previously without access, number of people provided access to financial services. Impact metrics highlight real world change not company practices.

Combining ESG and impact measurement frameworks creates a robust view into the sustainability initiatives of a corporation or investment. But the differentiation remains important in setting targets and evaluating progress.

How Does Esg Investing Work?

While a range of approaches exist, commonly ESG investing works by:

1. Screening potential investments against benchmarks for material environmental, social and governance risks and performance.
2. Analyzing disclosures, targets, policies and incidents to determine adequate commitments exist on issues identified.
3. Comparing against sector, geographic and category peers using ESG ratings and scores.
4. Building portfolios tilted towards leadership while avoiding laggards and holding others accountable through proxy voting and engagement.
5. Tracking chosen investments against ESG indicators which increasingly link to financial outperformance and downside resilience.

This continuous cycle pushes the market towards properly accounting for externalities and ethics alongside profits.

What Are Examples Of Impact Investing?

Some examples of impact investing in action:

• Financing solar mini-grid electrification in rural villages of developing countries
• Funding projects conserving biodiverse wetlands or rainforests under threat
• Microloans designed to foster female entrepreneurship globally
• Investing in health centers providing underserved communities access to care
• Depositing cash in community development financial institutions financing affordable housing

Impact investing directly deploys capital to fund solutions improving lives, communities and the environment – driving intentional and measurable social and environmental impact.

Conclusion

ESG investing and impact investing represent promising paths forward for aligning capital allocation to societal needs while still generating financial returns.

Perfect solutions remain elusive but continued accountability, transparency and innovation point the market in a direction benefiting people and planet.

Both ESG and impact investing move beyond exclusion lists while empowering investors large and small to have real influence on issues from climate change to justice and equality.

Understanding their motivations, tactics and return profiles allows you to determine the right fit for your money and convictions. Ask questions, review reporting, and define targeted outcomes realizing no approach is perfect or a silver bullet.

Combining strategies also makes sense for many interested in using money to nurture systemic change. The key remains participation – every investment today goes towards shaping further progress benefiting society and the environment for future generations.