ESG, SRI & Impact Investing: Explaining the Difference to Clients

The value of an investment is no longer just about returns. An increasing share of investors are also calling for their money to make a positive impact on society and the world at large.

In fact, socially responsible investing, and one of its subsets, impact investing, now accounts for more than $1 out of every $5 under professional management in the U.S., according to a 2016 survey by the U.S. Forum for Sustainable and Responsible Investment. This amounts to over $8 trillion in assets under management, an increase of 33% from 2014. (For more, see: How ESG, SRI and Impact Funds Differ.)

Accompanying the growing demand is a proliferation of funds and strategies that integrate ethical considerations into the investment process. Environmental, social and governance (ESG), socially responsible investing (SRI) and impact investing are industry terms often used interchangeably by clients and professionals alike, with the assumption that they all match in meaning and approach. However, distinct differences exist that will affect how client portfolios should be structured and which investments are suitable for meeting social impact goals.

ESG refers to the environmental, social and governance practices of an investment that may have a material impact on the performance of that investment. The integration of ESG factors is used to enhance traditional financial analysis by identifying potential risks and opportunities beyond technical valuations. While there is an overlay of social consciousness, the main objective of ESG evaluation remains financial performance.

The table below lists common ESG factors that are considered. Investments with good ESG scores have the potential to drive returns, while those with poor ESG scores may inhibit returns.

Socially responsible investing goes one step further than ESG by actively eliminating or selecting investments according to specific ethical guidelines. The underlying motive could be religion, personal values or political beliefs. Unlike ESG analysis which shapes valuations, SRI uses ESG factors to apply negative or positive screens on the investment universe. For example, an investor may wish to avoid any mutual fund or exchange-traded fund (ETF) that invests in companies engaged in firearms production because he/she holds anti-conflict beliefs. Alternatively, an investor may opt to allocate a fixed portion of his/her portfolio to companies that contribute to charitable causes. (For related reading, see: Impact Investing: Making a Difference and a Profit.)

Other negative SRI screens include:

• Alcohol, tobacco and other addictive substances
• Gambling
• Production of weapons and defense tools
• Terrorism affiliations
• Human rights and labor violations
• Environmental damage

For clients engaged in socially responsible investing, making a profit is still important, but must be balanced against principles. The goal is to generate returns without violating one’s social conscience.

In impact or thematic investing, positive outcomes are of the utmost importance - meaning the investments need to have a positive impact, in some way. So the objective of impact investing is to help a business or organization accomplish specific goals that are beneficial to society or the environment. Investing in a non-profit dedicated to the research and development of clean energy, regardless of whether success is guaranteed, is an example.

About 30% of investors currently own responsible investments and of those who do not, nearly half plan to start soon, according to a 2016 survey conducted by TIAA. The desire to invest ethically is especially pronounced among Millennials, the study showed. Implementing that desire however may be no easy task, given the growing complexity of investment concepts and products catering to this sector, which is why advisors must be well prepared to step in and help. (For more, see: How Social Impact Investing Works.)