Why impact investing goes further than ESG investing (2024)

The concept of responsible investing is not new but has witnessed tremendous growth in recent years, fuelled by rising consciousness around climate change. Although responsible investments are not restricted to climate alone and operate across an array of sectors, they can be primarily categorized into two often-confused investment approaches – ESG investing and impact investing.

Despite being multi-trillion-dollar industries practiced for over a decade, the understanding of the distinctness between the two concepts of ESG investing and impact investing remains ambiguous to most. So, if you’re using the terms ESG and impact investing as substitutes, you’re not alone. This can be majorly attributed to the blurred boundaries of how the two categories of investments are defined, leading to industry stakeholders having less clarity, funds not being deployed efficiently, and activities like greenwashing becoming commonplace.

It is important for investors to understand that ESG is not a sub-set of impact investing, and their investments will not necessarily create a direct impact with it. In fact, it is the reverse that is true – impact investing is a sub-set of ESG investing. In order to comprehend this notion, the following are a few actualities about the two approaches.

Let’s start with the definitions of the two approaches. ESG investing refers to the infusion of funds in companies that meet ethical considerations of environmental, social, and governance standards. Impact investing, on the other hand, refers to funds allocated to businesses driving environmental or social change, thereby creating impact.

Having understood this, we can say that ESG investments are based on the records of the past performance of any company in consideration, while impact investments are based on a company’s plans to generate impact in the future wherein the investor can decide what kind of impact they intend to invest in through the company.

Furthermore, all impact investments comply with ESG standards, but not all ESG funding can be said to be impact investments. This can be comprehended by observing the due diligence processes for both types of funds. ESG assessments typically focus on business practices, whether the enterprise has appropriate internal policies and procedures favourable to attaining ESG standards. On the other hand, impact due diligence also needs to include extensive data and assessment on the impact outcomes of the actions and products of enterprises.

Undoubtedly, both categories of investments seek to offer positive solutions to environmental and social challenges, and both require capital infusions. Hence, it is necessary for conscious investors to understand the scope of both and invest in the approach that aligns with their goals. One emphasizes not supporting businesses harming the environment, while the other focuses on supporting businesses that are proactively working toward creating a change in the status quo.

For example, ESG funds will avert investments in companies that create non-biodegradable waste and harm the environment by not managing the waste it creates while an impact fund will invest in companies actively aiding in the reduction and management of waste.

With this clarity, investors must define their investment goals and direct their capital accordingly. While we need ESG investors to aid responsible businesses, we also need impact investors to achieve the UN’s Sustainable Development Goals.

Speaking practically, ESG investing should have been a reality today, with no business being allowed to operate without a working ESG policy. This would also have strengthened the position of the impact investing sector, with funds being channelled to the right resources. Understanding this notion will help investors allocate funds more efficiently and understand the kind of impact their investments are essentially creating, further augmenting the development toward achieving sustainable development goals and warranting great returns for investors, people, and the planet.

Arvind Agarwal is co-founder and CEO of C4D Partners, an impact fund manager. Views are personal.

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Published: 10 Apr 2023, 11:10 PM IST

Why impact investing goes further than ESG investing (2024)

FAQs

Why impact investing goes further than ESG investing? ›

Also, whereas ESG investors have a more holistic approach to sustainability, impact investors are sector or theme focused, looking to invest in particular problems and solutions (e.g., combating climate change, promoting gender equality, or increasing the availability of education in developing countries).

Is impact investing better than ESG? ›

While impact investing may have higher risk and lower financial returns but deliver significant social and environmental benefits, ESG investment may have reduced risk and the possibility for outperformance. While choosing a strategy, investors should consider their risk tolerance and investing goals.

What is the key differentiator between ESG-based investing and 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.

Why are people against ESG investing? ›

Critics of ESG — such as a group of Republican states that banned Blackrock and other “ESG friendly” asset managers from their state pension plans — argue that considering environmental and social factors violates the fiduciary duty that asset managers have towards their clients.

What is the difference between ESG and impact reporting? ›

While ESG Reports focus on metrics, Impact Reports dive into qualitative narratives. They tell the story of a company's social and environmental efforts through case studies, impact assessments, and compelling narratives.

Is ESG part of impact investing? ›

No, impact investing is not equal to ESG investing, although they are often used interchangeably.

What are the disadvantages of ESG investing? ›

However, there are also some cons to ESG investing. First, ESG funds may carry higher-than-average expense ratios. This is because ESG investing requires more research and due diligence, which can be costly. Second, ESG investing can be subjective.

What is the opposite of ESG investing? ›

The term anti-ESG investing is somewhat subjective. For some proponents, anti-ESG investing is about maximizing profits without regard to a company's governance factors or its impact on society and the planet. These investors often argue that a company should be evaluated solely on the basis of financial performance.

Does ESG investing lead to lower returns? ›

However, the table below shows that we also saw an inverse relationship between ESG score and monthly return: The Better ESG portfolio had a monthly return of 0.89%, compared with 1.06% from the Worse ESG portfolio.

What are the pros and cons of ESG investment? ›

Pros:
  • Potential for Higher Returns. ESG investing offers an opportunity to capitalize on long-term returns while supporting sustainable and ethical practices. ...
  • Positive Impact. ...
  • Reduced Risk. ...
  • Improved Corporate Behavior. ...
  • Limited Investment Opportunities. ...
  • Potential for Lower Returns. ...
  • Subjectivity. ...
  • Lack of Standardization.
Mar 30, 2023

Why do Republicans dislike ESG? ›

Why have some Republican officials criticized ESG investing? Republican politicians have criticized ESG because they say they consider it an effort to use financial tools for the purpose of advancing liberal political goals.

Why did ESG fail? ›

Many point to the prevalence of greenwashing, which is when companies exaggerate the environmental benefits of their actions. Other criticisms focus on the way fund managers rank companies by how they're performing on ESG factors.

Why does ESG not work? ›

One of the main challenges is that ESG scoring methodologies tend to focus on how well companies manage their internal processes, rather than the real-world impacts of their products and services.

What is ESG and impact? ›

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.

Why is impact reporting important? ›

An impact report offers businesses a tangible way to communicate the benefits of their efforts to different stakeholders, investors, consumers or people in the community.

What is the impact score of ESG? ›

ESG Impact Ratings. Discover comparable and science-based impact ratings that align with evolving sustainability goals. Based on extensive research, our ESG ratings provide insights into the ecological and social impact of investments across asset classes.

What is the difference between Sri ESG and impact investing? ›

It's important to note that impact investing refers to private funds, while SRI and ESG investing involve publicly traded assets. For investors who seek transparency about the specific ways their capital is being applied to a particular cause, impact investing might be a more attractive vehicle than ESG or SRI.

Is ESG investing less profitable? ›

ESG Investing is Typically Less Profitable

As mentioned above, highly-rated ESG companies tend to be less profitable than lower-rated companies.

Are ESG investments more profitable? ›

As seen in the performance chart, companies with higher ESG ratings outperformed those with lower ESG ratings. The bottom line is that ESG leaders tend to be more profitable and generate above-average returns, providing opportunities for more cash to be returned to shareholders over time.

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