The financial services market is forever evolving; new concepts and principles come forth ever so often and if you’re not adopting them, at the very least you can be aware of them. Over the years we have seen the need to shift towards responsible and sustainable forms of investment. While those are strategies that can be individually defined, the focus of this discussion will be on ESG and Impact Investing; both of which are not new concepts but are certainly coming to the fore as a fresh takes on how companies can future-proof their businesses and how investors use capital to positively shape the world.
While traditional investing is solely focused on achieving one primary objective – creating maximum returns for shareholders – ESG and Impact Investing fall under the umbrella of Socially responsible investing. Impact investing and ESG investing are often used interchangeably to refer to investments that deliver financial returns while also contributing environmental and social benefits. There is a clear distinction however; ESG is a framework for assessing material risks and opportunities whereas impact investing is an investment strategy put in place to drive positive outcomes.
ESG (Environmental, Social and Governance) Investing
This is a framework that helps organisations assess their risk and opportunities around factors that may affect its sustainability, looking beyond the financials and looks at the business activities that can potentially impact the organisation.
ESG investors are typically concerned with E, S and G risks and opportunities that may have financial materiality: those risks and opportunities that may affect the financial performance of the enterprise in the medium term. For example, a firm may choose to improve their labor practices as a deterrent to employee turnover. That is a net positive for the firm, its employees and can be impactful but it’s not intentionally impactful, it rather contributes to improving business sustainability.
The framework is inherently forward-looking, focusing on areas of growth and screening for emerging risks leading to more effective risk management and long-term value creation for firms. This can lead to ESG investors tending to be more profitable and generate above-average returns, providing opportunities for more cash to be returned to shareholders over time.
Impact Investing
Unlike ESG investing, impact investing intentionally seeks measurable social and environmental impact alongside a financial return. By investing where capital or engagements seek to contribute to solutions to one or more of the world’s greatest challenges. Most of these problems are summarized by the UN SDGs, and impact investors seek to solve these problems beyond the financial materiality concerns of traditional investors.
The GIIN has defined four core characteristics of Impact Investing:
- Intentionality (intent to create positive change)
- Use of evidence and Impact Data in Investment Design
- A commitment to managing Impact performance
- Additionality (contributing to the growth of the industry)
Intentionality is the first-line guard against impact-washing, crucial to ensuring that investments seek to generate solutions, and generally aligns with one or more goals from global frameworks like the UN SDGs or IRIS+ frameworks.
The supporting principle of additionality speaks to the notion that investments should contribute to a company’s impact, either through financing their growth in selected impact areas or by influencing the company to generate impact.
Neigh sayers are of the opinion that impact investing cannot give market-rate returns but on the contrary it can! 80% of impact investors report a portfolio performance in line with or outperforming expectations on both financial and impact metrics.
In summary, 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 helps investors make better investment decisions and generate long-term value creation.
