The propensity for investors to seek out investments that provide some good to the world is growing. The area of ethical and socially responsible investing isn’t new but it is enjoying a greater degree of interest and this article sets out to break down the key differences between two key areas; ESG and impact investing.

Environmental, Social and Governance (ESG) Investing

Environmental, Social and Governance (ESG) investing relates largely to the internal operations of a company and the nature of their products.

The concept sets out to find companies that are acting in an ethical and responsible manner at board level which is then transfer throughout the organisation and into the wider business ecosystem.

ESG Investing aims to seek out companies that are acting in a way deemed to be responsible and avoiding companies that are not.

In its most simplest form ESG investing involves avoiding companies seen to be unethical such as tobacco, defence and alcohol shares.

More advanced ESG Investing can include the adding of filters in a screening process that seek out companies taking care to ensure their business processes are highly ethical and that they operate in responsible supply chains.

Impact Investing

Impact Investing takes the concept of ESG Investing to the next stage by seeking out investments that are making a measurable positive impact and a financial return.

The Global Impact Investing Network defines impact investments as ‘investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return.’

Impact Investing differs from ESG Investing in as far as the external positive impact of the business is the key element of Impact Investing, as opposed to just ensuring internal processes are conducted ethically and responsibly.

Impact Investing focuses on particular sectors in which an impact can be made, whereas ESG Investing can span most sectors and industries as long as the individual companies demonstrate ESG responsibility.

Sectors receiving capital investment in the way of Impact Investments include renewable energy, housing, Microfinance, healthcare, education and recycling.

What makes impact investing particularly interesting is the need for a measurable impact as an outcome of the investment.

For example, the number of children educated by an investment in an African education solution provider or the amount of energy produced by a hydro electricity facility.

Portfolio Construction

Looking at the portfolios of Impact Investing funds and comparing them to the portfolios of funds designated ESG, the difference between the two becomes more apparent through the types of companies included.

ESG funds, that tend to include ‘Sustainable’ or ‘Responsible’ in their names, commonly have shares such as Microsoft, Apple, Procter & Gamble and Prudential in their top ten holdings.

These shares are included not because they are setting out to tackle a particular problem, rather their business practises are deemed to be sustainable, ethical and responsible.

Now compare this with funds designated as ‘impact’, you will see companies such as Rayonier, a sustainable timber company, and healthcare company Novo Nordisk, whose core business operations are focused on making a positive impact.

Impact Investing Guide

To learn more about Impact Investing, you can download a guide to Impact Investing here