ESG investing versus Impact investing
What’s the difference and where did it begin?
Forms of sustainable investing have expanded over the years as investors and consumers alike want businesses to do more about issues such as climate change, human rights, and creating prosperity for all. ESG investing and Impact investing have become popular options for investors looking to expand and diversify their portfolios in a meaningful and purposeful way. Coined in 2004, ESG emerged as a joint effort by the United Nations (UN) and The International Finance Corporation (IFC) to support the financial industry’s consideration of ESG issues in mainstream investment decision-making. Impact investing came later, when the Rockefeller foundation along with philanthropists, investors, and entrepreneurs put a name to investments that had direct links to social impact as well as financial returns. The Global Impact Investing Network (GIIN) emerged from this which is now the leading network of practitioners promoting the framework, research, and education on impact investing.
Fast forward to 2022, the terminology has created confusion over how ESG investing and Impact investing differentiate. To clear this up we have laid this out in one simple sentence: ESG investing is a framework and impact investing is a strategy.
In other words, ESG investing is a set of criteria whereby environmental, social and governance risks and opportunities can have material impacts on companies’ performance and value of investments. Strong ESG credentials can be used to mitigate risk which in turn future proofs investments and creates financial stability for investors. Over time, ESG credentials can also optimise resources, for example a reduction of water and energy consumption and an improvement in employee retention, for example a more engaged and productive workforce. ESG investing can thus create virtuous processes that optimise current investments and help attract new investors.
Impact investing on the other hand, is used to define the types of investments an investor is targeting which would normally align with one or more of the Sustainable Development Goals (SDGs). Impact investing usually focuses on positive and/or environmental change, however there are some areas where the outcome/reward will take longer, or the financial return could be lower due to the type of problem being solved. For example, investments in companies or projects that are benefiting a particular group of people. This form of investment usually refers to the merging of profit and purpose, for example Tony’s Chocolonely striving for 100% slave-free chocolate. However, Impact investing really varies in terms of intensity and immediacy of impact and so it is ultimately down to the preference of the investor in whether they would like to invest in immediate impact or support strategies that generate long term change.
In the emergence of the EU taxonomy, and regulations such as the Sustainable Finance Disclosure (SFDR) and Corporate Social Responsibility Directive (CSRD), understanding and clearly defining the difference between impact and ESG investing is critical for investors to produce efficient portfolios and align with global sustainability standards. However, for this ecosystem to be successful, advisors, fund managers and the underlying companies must continue to mitigate and adapt their portfolios. Just like the concept of “fiduciary duty”, we can say it is “impact fidelity” that is needed to shape the sustainable world we strive for.
At E.S.G Solutions we are built on a drive that pushes us and our clients to make a positive impact in life and on the world. That push is about awareness in every step we build towards closing the sustainability gap. As 2023 closes and a new year begins, investors need to be prepared for more changes in regulations. The broader ESG landscape can be confusing, but companies should not let the sustainability reporting landscape distract them from fulfilling their obligations and investing choices. And if it does get overwhelming get in touch and we will be happy to support you!
Standford Social Innovation Review (2022) ESG is not impact investing and Impact Investing is not ESG: https://ssir.org/articles/entry/esg_is_not_impact_investing_and_impact_investing_is_not_esg#
Harvard Business Review (2016) “Making Sense of the Many Kinds of Impact Investing: https://hbr.org/2016/01/making-sense-of-the-many-kinds-of-impact-investing
Tony’s Chocolonely annual FAIR report (2020/21): https://tonyschocolonely.com/us/en/annual-fair-reports/
S&P Global “What is the difference between ESG investing and socially responsible investing?” https://www.spglobal.com/en/research-insights/articles/what-is-the-difference-between-esg-investing-and-socially-responsible-investing
de Jong, M., Rocco, S. ESG and impact investing. Journal of Asset Management 23, 547–549 (2022). https://doi.org/10.1057/s41260-022-00297-7