Private markets have the capacity to improve societal outcomes, advance social equity, and raise awareness of the environmental impact caused by anthropogenic activity. One way traditionally has been through impact investing, investments made with the intention to generate positive, measurable social impact alongside financial returns.
In recent years, ESG-focused investments have risen in popularity, with PwC predicting an 84% increase in institutional investments focused on ESG assets from 2021 to 2026. Impact investing and ESG investing are often used interchangeably to refer to investments that deliver financial returns while also contributing environmental and social benefits. However, there are key differences that determine how and where investors allocate their funds.
Stanford’s Social Innovation Review puts it aptly that all impact funds consider ESG, but not all ESG funds are impact. If you currently manage an impact fund, you’re probably already collecting ESG data in addition to your impact evaluation metrics. As private markets continue to move toward ESG standardization, it is increasingly important to discern the differences between ESG investing and impact investing.
What Is ESG Investing?
ESG is a set of criteria across environmental, social, and governance dimensions that may have material effects on business performance. Investors use ESG considerations to assess the risks and opportunities present in potential investment decisions. Incorporating an ESG approach is additive to a firm’s financial performance, with over 70% of LPs incorporating ESG into valuation decisions.
ESG investing is a framework by which firms can maximize financial returns and minimize risk while aligning with socially responsible business practices. There is increasing evidence that businesses that embrace ESG outperform their peers. ESG investing can be forward-looking, for example, if a fund manager chooses to divest from funds that use fossil fuels and only invest in businesses aligned to a net-zero strategy. However, ESG investing also focuses on identifying areas of growth from doing ‘business-as-usual’, through screening for emerging risks at companies. At Novata, we believe that ESG investing leads to more effective risk management and long-term value creation for firms.
What Is Impact Investing?
While ESG investing operates as a framework to assess material risks and opportunities for firms, impact investing is an investment strategy that seeks to first and foremost create a specific, measurable social or environmental benefit. Financial returns are an added benefit to impact investing but are not a required component — impact investors are often willing to forgo some amount of financial return (concessionary investments) in exchange for achieving specific social and environmental outcomes.
A core principle of impact investing is intentionality, an explicit aim to generate a specific outcome from investments. It is inherently forward-looking. Impact investing is focused on carrying out a particular goal and usually does not consider an organization’s past activities. Another core component of impact investing is the commitment to measure and report on the impact of their investments, prioritizing transparency and accountability.
Creating Long-Term Impact
While both ESG and impact investing can be used to advance social and environmental impact, impact investing’s primary focus is to achieve a specific social and/or environmental outcome. Understanding the differences help investors make better investment decisions and generate long-term value creation. Whether you’re focused on impact investing or ESG, learn more about how Novata can help streamline your data management.
FAQs
ESG looks at the company's environmental, social, and governance practices alongside more traditional financial measures. Socially responsible investing involves choosing or disqualifying investments based on specific ethical criteria. Impact investing aims to help a business or organization produce a social benefit.
How does ESG investing differ from impact investing? ›
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.
What is the difference between ESG risk and ESG impact? ›
These ratings attempt to quantify a company's positive or negative contributions to issues such as climate change, biodiversity, human rights, or community development. In terms used by global sustainability regulations, ESG risk ratings focus on financial materiality while impact ratings focus on impact materiality.
Does ESG investing actually make a difference? ›
As mentioned, ESG investments could act as a hedge against negative climate news. However, unless there's another unexpected surge in environmental worries, green stocks might not outperform 'brown' (less environmentally friendly) stocks in the future.
What is the difference between ESG and sustainable investing? ›
ESG refers to a set of criteria used to assess a company's environmental, social, and governance impact. In contrast, sustainability is the capacity to maintain or endure, focusing on the interplay of environmental, social, and economic factors.
What are the disadvantages of ESG investing? ›
Disadvantages of ESG investing
The pool of businesses that adhere to ESG standards could be smaller than that of all publicly traded companies. As a result, investors may have fewer investing possibilities.
Why do investors prefer ESG? ›
Investors increasingly believe companies that perform well on ESG are less risky, better positioned for the long term and better prepared for uncertainty. Companies that realign to the stakeholder capitalism agenda may have a competitive advantage over those that try to return to business as usual.
What is an example of ESG in real life? ›
Costco: Creating a Sustainable Supply Chain
According to Costco's 2020 ESG Report, "Our goal is to create a sustainable supply chain that benefits our members, our suppliers, and the environment." Also, the retailer has made a commitment to sustainability through its “Sustainable Business Strategy” program.
Why is ESG risky? ›
Environmental, social, and governance (ESG) risks are the potential negative impacts that a company's operations or supply chain can have on the environment, society, and its own governance practices. ESG risks can have a significant impact on a company's financial performance, reputation, and ability to operate.
What is meant by impact investing? ›
An impact-investing strategy is an investment strategy that targets companies or industries that produce social or environmental benefits. For example, some impact investors seek to support renewable energy, electric cars, microfinance, sustainable agriculture, or other causes that they believe to be worthwhile.
One of the biggest criticisms of ESG is that it perpetuates what it was partly designed to stop – greenwashing.
What is ESG for dummies? ›
ESG refers to the three key areas of assessment used to evaluate the sustainability and ethical impact of an investment in a company or business: Environmental, Social, and Governance.
Do investors really care about ESG? ›
Nearly half of all respondents say that ESG criteria play a very important role in their investment decision process.
How is ESG different from impact investing? ›
ESG looks at the company's environmental, social, and governance practices alongside more traditional financial measures. Socially responsible investing involves choosing or disqualifying investments based on specific ethical criteria. Impact investing aims to help a business or organization produce a social benefit.
How do you tell if an investment is ESG or not? ›
You can search for a specific stock or exchange-traded fund (ETF) on Yahoo! Finance and then click on the “Sustainability” tab to see the ESG scores. MSCI ESG Ratings: MSCI offers a free search tool that allows you to check the ESG rating of select companies or funds.
What is ESG investing in simple terms? ›
Environmental, social, and governance (ESG) investing is used to screen investments based on corporate policies and to encourage companies to act responsibly. Many brokerage firms offer investment products that employ ESG principles.
How is ESG investing different from traditional investing? ›
Traditional investing may focus primarily on financial risks, such as market volatility or credit risk. ESG investing, on the other hand, may also consider non-financial risks, such as reputational risk or regulatory risk. Finally, ESG investing can also provide investors with a way to diversify their portfolios.
Is ESG investing the same as ethical investing? ›
What is ESG Investing? Unlike ethical investing, where you exclude companies associated with negative outcomes, in ESG investing, you choose to invest in companies with high environmental, social and governance scores regardless of whether these companies are associated with negative outcomes.
Is ESG investing impactful? ›
ESG investing seems like a good idea, but its usefulness depends on your objectives. The ability of ESG divestment to have real impact on how companies behave through the cost of capital channel is somewhere between limited and counterproductive.
What is the difference between impact investing and thematic investing? ›
In summary, it can be said that for the same social effect, thematic investment suggests that it may be achieved in a diffuse and non-measurable way, whereas impact investment will prove it. These impact investments are not yet available to individuals because the associated risks are significant and multiple.
