What’s The Difference Between SRI, ESG, And Impact Investing?
With any kind of movement, one of the core aspects for it to gain traction comes down to messaging and the clarity of that message. Over the years, as the environmental movement has become mainstream in the face of the incontrovertible evidence of anthropogenic climate change, people recognise that drastic and systemic changes need to be made. Sustainable investing efforts have, as a consequence, risen in popularity.
And while interest in this area is a good thing, there is perhaps a steep barrier to entry for beginners. There is a lot of research that needs to be done, as is the due diligence with any concerted investment effort, to attain a general understanding. And even those who have been in sustainable investing for months or years will stumble upon new definitions, concepts, and acronyms. All of this combined can be rather confusing, and this is especially the case in the US.
To help, let’s focus on the broader umbrella of sustainable investing and explain what the difference is between each category. Those categories are SRI, ESG, and Impact Investing.
What Is SRI?
SRI stands for socially responsible investing. As the name suggests, investors use screening methods and shareholder activism in order to create good social or environmental outcomes. Many public markets commonly use these so SRIs are freely available to investors.
A prime example of an SRI would be investing in a fund that only invests in companies that support biodiversity, protect animals or marine environments, have a strong workers union, and so forth. In other words, a specific cause. They would also bar companies that deal in tobacco, firearms or alcohol through their screening process.
SRI was the first iteration of sustainable investing and it came about in the 1990s. For a time, a number of investors considered these strategies, but eventually went back to making portfolios the way they always had. Today, the only echoes of this are through marketing efforts where you might see a fund presented as “socially responsible”. A solid guide to hit the ground running is available here.
What Is ESG?
Short for environmental, social, and governance, the term is a metric that’s used to measure a company’s risks beyond its profitability or other financial metrics. You can think of this metric as an expansion of socially responsible investing since it is broader in scope.
Think of SRI as companies ticking off very specific and narrow checkboxes, whereas ESG is a multiple-choice test where the answer to each question provides a score within that area.
Unlike SRI, if a company doesn’t treat their workers right (or not as well as others), this doesn’t necessarily preclude them from a listing in ESG-related funds. Rather, that risk factor is going to be made public through the reflection of a score. And the idea is that the price and how we view that company should be reflected in that score, even when a risk exists.
ESG ultimately creates a framework where it considers risks to sustainability, and then stretches beyond the financial statements. ESG is an enhanced version of SRI, because ESG creates a ripple effect and the values in each area can serve as a warning both to investors and to the company. Key outcomes involve a company’s willingness to publicly report sustainability assessment scores, from a range of differing indices, to outline where progress has been made or obstacles encountered in the transition to sustainability.
For example, if a large energy company has poor governance, its decisions could result in worker strikes. This in turn would result in fewer electricians maintaining, repairing and monitoring power lines. Worse, it can result in some electricians rushing those jobs, leading to safety protocols being overlooked, damaging property, environmental issues, and compromising worker safety. An ESG framework should reveal, through transparent reporting, this series of unfortunate consequences could have been avoided if the electric company had prioritised better governance in the first place.
Today, and markedly compared to the state of play only ten years ago, ESG is the face of sustainable investing, and it is gaining traction across the planet as a mainstream framework adopted to increase transparency, reduce climate-related operational costs, and to build brand strategies around sustainability values.
What Is Impact Investing?
Lastly, impact investing is best described as a strategy, one that focusses on creating both financial returns and measurable social and/or environmental impact. Another term that’s been used is “double bottom line”, which mimics an accounting term that expresses how both aspects should be measured and reported. Many impact investments are made through closed-end PE and VC funds, with debt funds getting more traction lately.
The main struggle with impact investing is tracking the “impact” part, as there is a lot of uncertainty over what classifies as a positive impact. Asking this to investors, they’ll have varying definitions and will use unique metrics based on their own goals and interests. Questions will vary as to what defines impact in different circumstances.
For example, one investor might say a company provides good environmental sustainability based on the number of trees planted. Another might look at the company’s greenhouse gas from their products and services and see if the company reduced their emissions, increased, or maintained the same level. You can apply this to other fields, such as women’s empowerment, infrastructure development, income generation for workers, access to essential services, and more.
Based on such examples, you would think impact investing is the same as ESG, but it is not. Again, ESG is a term, but more importantly a framework for evaluating companies. For example, investors could look at an ESG score and determine whether that company is making a positive impact. Another way to look at it is that impact investing is looking at a measurable positive environmental/social effect for a company to invest in, while ESG is identifying non-financial risks that could have a material impact on the value of the investment.