The Big Difference Between Impact Investing and ESG Investing

ESG Investing

Its easy to mistake investing in ESG funds and ETF’s as impact investing that can actually make real positive difference with social and or environmental impact. ESG investing is essentially not bad if you are looking to avoid investing in the oil or weapons industry for example.

But that’s about it, a good avoidance tool but not particularly…impactful.

Environmental , social and governance (ESG) investing has been around for decades under different names like socially responsible investing (SRI) or responsible (RI), its essentially offers similar funds as already on the market Eg: Global index fund but with a lot of screening to avoid putting money directly into certain areas deemed unethical on many levels.

There are many definitions of ESG and many are more specific sector targeting areas funds and ETF’s.

While its great that many platforms offer more desirable ESG options and it may in some ways help push large capital companies to conform to such standards except where they don’t want to or is not possible given the nature of their business (weapons manufacturers and distribution, military tech, big oil, tobacco etc).

The problem in some ways with ESG is that you are often still just investing majorly in amazon, google, microsoft or whatever other market leader there is of the sector because the funds primary aim is to get returns, and the model is a risk vs return so they often hold large percentages of these. They also don’t consider or measure impact so you don’t really know what effect your money is making.

After reading Bill Gates book How To Avoid a Climate Disaster, I decided to do some research on impact investing and the options available as a retail investor other than ESG and this is what I found.

Impact Investing

Impact investing models look to actively address issues of access to housing, food, water and electricity, healthcare, clean energy implementation, gender and opportunity equality, education access and many more.

Successful development in these areas increases quality of life, creates jobs and helps improve and implement clean energy supply and infrastructures in most needed demographics around the world in both developing and developed countries.

Impact investing sits somewhere between ESG investing, philanthropy and charity and aims to make measurable difference and offer returns on investment.

Measuring Impact

There has been a shift to measuring risk, return and impact which is more complex and importantly requires a third set of metrics of difficult to measure impact data which may include longitudinal scientific health studies and clinical trials (epidemiology), environmental studies, employment or other data which is especially difficult to obtain quickly in lower income and inaccessible areas.

Extra measures of impact are ongoing and need to be publicly available to avoid whitewashing or greenwashing with the term impact investing where there is no evidence.

Consideration should be given to additional impact specific risks such as lack of no credit history, inaccessible regions, difficulty collecting risk and impact data, political risks (Eg: policy changes that affect taxes or restrictions for short term domestic/political gains).

These risks can be considered along with the risk/return based on area, sector.

The Global Impact Investing Network (GIIN) has set out 17 social development goals that can be used to measure impact alongside financial performance.

Strategy and Returns

Impact investing does not mean no financial returns, returns are expected along with impact on society and or environment though returns can also be seen as be social impact, capitol gains or both depending on the approach.

Financial returns obviously vary but mostly aim to be in the region of 1 – 7% which if also making a positive impact is pretty amazing.

SGB’s (small and growing businesses) and start up IPO’s are the primary target area for equity investments of larger growth.

Investments with clear impact goals that serves social or environment development stand the test of time and often outperform in the long run.

Different initiatives or impact funds have different strategies based on levels of focus on:

Impact mission strategy
Sector strategy (specific expertise in single area)
Investment stage (from startup growth to seed stage or capital raising to growth stage)

All strategies require different investment types and will differ in how the investment is offered and how accessible it is for retail investors also.

For more detail and guidance on different strategies check out these guides from GIIN.

Options

Equity, blended equity/bond funds or purely impact bonds are available but investing in debt in a new project or area can carry more risk if the lending term of the loan is longer or not government backed.

Equity and debt (bond) models are suited to different areas of impact more than used for diversifying investment as they are in a traditional risk return viewpoint.

Impact investing is still a bit of a grey area but there is way more available than ever before and it is also the growth area of the future. Where there is strong demand and a realistic model these areas will likely outperform.

If you are looking to start impact investing you can find funds that fulfil the above guidelines. Or you can find your own investments by looking into initiatives in regions or sectors such as Energise Africa that offers loans for solar and clean water installation projects through bond schemes offering roughly 6% returns.

Another option could be to build your own diverse portfolio by dividing your investments across different initiatives such as the above alongside for example government sustainable development bonds like Green+ GILT which are lower on the risk score and available through FSCS investment platforms.

In the UK unclaimed assets contribute to many social initiatives through Big Society Capitol which unites social development projects, investors, and advisers to go beyond ESG.

There are many specific funds such as Impax AM (£IPX) that invest in a selection of companies and initiatives that align with different aspects of the GIIN goals, or Renewables Infrastructure (£TRIG) that focuses on renewable energy.

Other broader funds also exist which could help make up an personalised impact portfolio such as the Nomura – Emerging Market Sustainable Impact Fund (NOAESFU) or Vanguards – ESG Emerging Market All Cap Equity Index Fund however the Vanguard ESG funds still hold a lot of large cap companies that aren’t necessarily aiming for GIIN goals and so won’t impact in the same way as others mentioned above.

So if you are taking an active interest in your investments either through a pension, ISA or general account. Are looking to compliment ESG investing or replace it for more meaningful use of capitol, definitely check what is available through your platform provider or consider switching to one with more impact options.

Imagine if everyone able allocated even the smallest personally insignificant percentage of their pension investments or long term savings, beer money, holiday saving, subscriptions or whatever into impact investing it would equal billions or trillions, and the combined effect would make a huge difference to global and domestic development and actually address what people may think they are addressing by investing in ESG funds.

Be sure to check these links for further information:

Here’s a great free short course that that helped me gather a lot of information:

https://www.futurelearn.com/courses/impact-investing

Finally you should obviously consider your own circumstances and take them into account before making any decision. *Life Build Learning does not offer financial advise and intended for educational and reference purposes only. Use of this site is entirely at your own risk. You should always carry out your own research and take specific professional advice.

Looking for finance related books? Check out the best selection post.