According to US SIF: The Forum for Sustainable and Responsible Investment, total global sustainable investment assets grew exponentially from US$3trn in 2010 to US$12trn in 2018. This encompasses the full spectrum of sustainable investing, including investments made in line with environmental, social and governance (ESG) criteria, and impact investing.

Against a Covid-19 backdrop and new data on climate change trends, sustainable investing is maturing faster and generating greater interest in private markets than ever before. However, despite the popularity and significance of investing in this area, there has been a lot of confusion around terminology.

Understanding the concepts of ESG and impact investing is key to avoid falling in the ‘greenwashing’ trap. In this article, we shall seek to define these related yet distinct terms, considering the specific characteristics and applications of each sphere and how they differ.

What is ESG investing?

In a nutshell, ESG refers to a framework or set of criteria used to evaluate a company’s environmental, social and governance risks and practices. Indeed, the data related to these factors can be useful in analysing the ultimate worth of a company. ESG is typically associated with mitigating downside exposure of a business (i.e. risk management and adaptation).

The practice of ESG investing actually began in the 1960s as socially responsible investing, with investors excluding stocks or entire industries from their portfolios based on business activities such as tobacco production or involvement in the South African apartheid regime. Since then, the practice has gained currency among both individual and institutional investors who have begun to track ESG metrics, especially since the founding of the United Nations Principles for Responsible Investing (PRI) in 2006, for which signatories commit to six voluntary principles:

1. To incorporate ESG issues into investment analysis and decision-making processes

2. To be active owners and incorporate ESG issues into ownership policies and practices

3. To seek appropriate disclosure on ESG issues by the entities invested in

4. To promote acceptance and implementation of the Principles within the investment industry

5. To work together to enhance effectiveness in implementing the Principles

6. To report on related activities and progress

Most recently, at the fourth annual Sustainable Development Impact Summit in September 2020, the ‘Big Four’ accounting firms released their own ESG reporting metrics in collaboration with the World Economic Forum. This took the form of a white paper titled, Measuring Sustainable Capitalism: Towards Common Metrics and Consistent Reporting of Sustainable Value Creation.

These new ESG metrics are organised around four pillars of principle: Governance, planet, people and prosperity. Their aim is to align the disparate array of existing standards, enabling companies to report consistently on non-financial disclosures, thereby adding new weight to ESG as a key tenet of modern investing.

What is impact investing, and how does it compare?

The term ‘impact investing’ was coined by the Rockefeller Foundation in 2007 to describe investments made with the intention to generate a positive and measurable social or environmental impact alongside a financial return. While ESG is a framework, impact investing is a strategy with specific end goals.

To look at it another way, impact investing is about the type of investments a manager is targeting, while ESG criteria is considered as part of an investment assessment process.

Further, in terms of purpose, impact investing seeks to achieve a tangible social or environmental impact through the investments made, while ESG is an approach to identifying and enhancing nonfinancial factors that may affect an asset’s value. ESG looks at a company’s environmental, social and governance practices – alongside more traditional financial measures – while impact investing sees investors helping a business or organisation fulfil an endeavour that benefits society in some way.

It is also important to note that until recently, in terms of methodology, impact investing was most commonly undertaken through private funds, while ESG investing involved publicly traded assets. There is now a strong ESG drive for private equity and real estate funds.

Where do ESG and impact investing converge?

Although it is clear that ESG and impact investing are not the same, there can certainly be overlap. Both ESG and impact descend from a similar sustainability and ethics agenda and can work very well in parallel. For example, financial services firm Fidelity has launched a set of ESG funds, three of which focus on investing in companies that advance key sustainability themes: Delivering access to safe water, prioritising women’s leadership, and developing alternative/renewable energy sources and environmental technologies. Fidelity’s other ESG funds, meanwhile, specifically support the integration of ESG factors into investment decisions to better identify risks and opportunities.

Over time, it is likely that ESG monitoring and reporting will become the status quo for businesses – especially with the aforementioned new metrics introduced by the Big Four accounting firms, paired with the more conscientious Millennial generation rising to the fore and taking over decision-making positions. ESG criteria will increasingly become standardised and crucial measurements of a company’s worth alongside other more traditional metrics, with impact investing serving alongside as a powerful way of giving back.