Discover how impact investing and environmental, social, and governance (ESG) investing differ, including their unique objectives, and why one may suit you more than the other.
Impact investing and ESG investing have similarities and differences that set them apart.
The main differences between impact and ESG investing are in their goals and measurement systems.
Both ESG and impact investing focus on socially responsible investing that aims to improve the world.
The style of investing you choose will depend on your risk tolerance, goals, and financial independence.
While references to impact investing and environmental, social, and governance (ESG) investing are often used interchangeably, they are actually two separate investment styles.
What is impact investing?
According to the Global Impact Investing Network (GIIN), impact investing is defined as investments made to generate a positive, measurable social and environmental impact alongside a financial return.
Impact investors typically focus on specific issues or sectors that relate to vital infrastructure or development efforts, such as healthcare, affordable housing, and clean energy initiatives.
What is ESG investing?
ESG investing is a more targeted, specific approach to impact investing and is seen as more structured.
It incorporates environmental, social, and governance factors into its decision-making process.
An ESG investor will analyse the ESG performance of a business to understand its risk profile and overall level of sustainability.
Both impact and ESG investing are forms of socially responsible investing that seek to improve the world around us.
What are the differences between impact and ESG investing?
There are differences between impact and ESG investing that should be taken into account when considering which option better suits your needs.
Two key differences include measurement and objectives.
Impact investing includes conducting independent research and data gathering to understand the environmental and social impact of an investment.
ESG investing, on the other hand, uses a company’s existing ESG performance report as a means to evaluate the potential of an investment.
While impact investing is primarily focused on achieving measurable, optimal outcomes for social and environmental issues, the goal of ESG investing is to incorporate ESG factors into investment decisions and risk regulation.
What are the similarities between impact and ESG investing?
Despite their unique objectives and measurement systems, there are common features between impact and ESG investing.
They are both forms of investing that focus on ethics, sustainability, social responsibility, and opportunities and risks associated with long-term investments.
Another key similarity between impact investing and ESG investing is collaboration.
Socially responsible investing often requires the input and combined effort of stakeholders, including government entities, non-profit organisations, management, and investors.
Impact and ESG investing are also similar because of what they don’t invest in.
Both ESG and impact investing strategies involve avoiding investments that are unsustainable or considered unethical, such as tobacco, casinos, alcohol, or military and defence organisations.
They often focus on growth, renewable energy, and health and aim to initiate projects that support positive social and environmental gains.
What are the pros and cons of impact investing?
All investments come with pros and cons, and neither impact nor ESG investing is the exception.
To gain a clearer perspective on what makes these investment strategies unique, let’s take a look at the pros and cons of each, starting with impact investing:
The pros of impact investing
- Independence: Anyone can become an impact investor – you don’t need to be affiliated with any particular program or company. This can allow for more freedom and independent investment decisions.
- Leverage: Being able to invest in projects that mean something to you and benefit the world is powerful. It allows people to use their financial leverage to improve the lives of people and the planet in a way that resonates with them on a personal level.
- You can support essential industries: When you become an impact investor, you have more control over which companies and industries receive funding.
The cons of impact investing
- Laborious research: Unlike the fully established ESG analysis system, impact investing can require a lot of self-motivated comprehensive research.
- Mismanagement: If you aren’t able to do your research properly, there is a risk that your funds can be mismanaged.
- Risk of loss: In the event that a project fails to reach completion or recipients of the investment are found guilty of mismanagement or fraud, impact investors can lose money.
What are the pros and cons of ESG investing?
Over the past few years, ESG investing has become one of the most popular styles of socially responsible investing.
With its highly recognisable name and power in the corporate world, this type of investing can be very advantageous for investors.
The pros of ESG investing
- Strengthens your investment portfolio: If you don’t already have ESG investments in your portfolio, now is a good time to add them. Diversification can make you a stronger investor.
- More established grading system: Although ESG guidelines are still considered somewhat loose, they are much more established than impact investing.
- Strong returns: Some studies suggest that ESG investing can produce returns on par with traditional investing, making it a surprisingly lucrative investment strategy.
The cons of ESG investing
- “Greenium” fees: All investments come with certain fees and expenses, but ESG investments, in particular, tend to have higher-than-average expense ratios. This can lead to underperformance.
- Risk of alienation: While both impact and ESG investment strategies are growing in popularity, some corporations or stock traders may not want to associate with investors focused on sustainability sectors due to the fear of being exposed to unethical systems.
- Having to pick your battles: As an ESG investor, you can’t fund every important sector. You can aim to reduce carbon emissions, empower female leadership, or remove plastic from the ocean, but all three can be difficult to navigate from a single perspective.
Is impact investing or ESG investing best for you?
Whether you choose impact investing or ESG depends on your values, goals, and risk appetite.
Some people prefer the integrative, corporate approach of ESG investing, while others prefer the freer, more self-led style of socially responsible impact investing.
Ultimately, the best choice varies depending on your circumstances and objectives.
Want to learn more about investing?
Both ESG and impact investing are important forms of socially responsible investing that focus on making ethical and sustainable decisions for the future.
A financial expert can help you build your investment strategy or portfolio.