Investors today are looking beyond their headline investment gains. They also want those returns to make a positive impact on society.
Enter sustainable investing, a strategy meant to ensure that financial gains do not compromise a sustainable future. That, in turn, is typically judged on environmental, social, and governance (ESG) factors.
With rising attention on investing for impact, ESG investing, Socially Responsible Investing (SRI), and impact investing have emerged as similar investment options. Here are their subtle differences.
What is environmental, social, and governance (ESG) investing?
ESG investing is when an investor uses a set of socially conscious standards to screen potential investments. Investors are looking for companies that actively work to reduce their negative societal impact, raise their positive societal impact, or both.
Investors want to know if companies are stewards of nature. They are scrutinising the way a company manages relationships with employees, customers, suppliers, and the communities that it operates in. They also demand companies to properly navigate conflicts of interest, and the disclosure of its business practices. That’s the world of ESG investing, in a nutshell.
For example, an oil production company can be considered a sustainable investment if it works continuously to reduce emissions in its business operations (E), has a strong employee safety record (S), and has a diverse and corruption-free board of directors (G).
How is corporate ESG performance evaluated
Companies committed to their ESG efforts should publish regular sustainability reports. These outline measurable goals, and the companies' progress towards these goals. Reports that follow the ESG standards established by the Global Reporting Initiative (GRI) and/or the United Nations Principles for Responsible Investment (PRI) have stronger credibility.
Closer to home, in 2016, the Hong Kong Exchanges and Clearing Limited (HKEX) introduced a requirement for listed companies to publish annual ESG reports with specified mandatory disclosures or else companies will have to publicly justify why they do not comply.
ESG rating sources such as MSCI ESG Ratings and Sustainalytics ESG Ratings can help investors quantify a company’s ESG performance.
What is socially responsible investing (SRI)?
With SRI, an investor deliberately selects or eliminates investment based on certain ethical or sustainable guidelines. Negative SRI screening can mean cutting out investments involving alcohol, tobacco, gambling, fossil fuels, human rights violations, or environmental damage.
An SRI advocate who cares strongly about the environment may invest more in renewable energy companies, and exclude companies that are part of fossil fuel production. Passionate about supporting marginalised communities? You may find yourself investing in funds that focus on women-run companies. Since SRI is as much about the investments you exclude as the ones you include, you may choose to remove a company from your portfolio if you learn that it discriminates against LGBT employees.
Since everyone has different values they hold dear, how investors define SRI will differ from person to person. As such, some investors may find it difficult to invest in a mutual fund or ETF that perfectly fits their values.
Potential drawbacks of socially responsible investing
Socially responsible investments tend to reflect the political and social climate of the time. This poses an important risk to investors, because if the social value that an investment is based on falls out of favour with society, then the investment may suffer as well.
Shunning certain companies with business practices that do not align with their values may result in lower returns. There is also the risk of weaker diversification when certain sectors are excluded from the portfolio.
What is impact investing?
Impact investing is often considered a sub-sector of SRI. It aims to generate positive and measurable social or environmental impact alongside a financial return. Impact investing also attempts to quantify the positive societal impact — for instance, by the number of schools built, reduction of carbon footprint by X units, or the number of employees from marginalised communities employed. Impact investors can deploy funds to causes that are often not addressed by the public financial markets, such as community development and poverty alleviation. Investors’ approach to impact investing will also depend on their own objectives and focus.
The Gates Foundation by Bill & Melinda Gates is a prominent example of impact investing. The foundation has a strategic investment fund invested in ventures that align with the foundation’s goals of improving health, education, and gender equality of the world’s poorest.
Sustainable investing: the bottomline
Broadly speaking, if you are a supporter of ESG practices while also being concerned about how they affect your investment returns, ESG investing would be the optimal choice for you.
If you believe very strongly in certain values and do not mind forgoing specific investments or market returns in view of the causes you believe in, then SRI might be a better fit for you.
Whatever your choice may be, sustainable investing now offers access to investors who want their returns to also support a better world.
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