Private markets have the capacity to improve societal outcomes, advance social equity, and raise awareness of the environmental impact caused by anthropogenic activity. One way traditionally has been through impact investing, investments made with the intention to generate positive, measurable social impact alongside financial returns.
In recent years, ESG-focused investments have risen in popularity, with PwC predicting an 84% increase in institutional investments focused on ESG assets from 2021 to 2026. Impact investing and ESG investing are often used interchangeably to refer to investments that deliver financial returns while also contributing environmental and social benefits. However, there are key differences that determine how and where investors allocate their funds.
Stanford’s Social Innovation Review puts it aptly that all impact funds consider ESG, but not all ESG funds are impact. If you currently manage an impact fund, you’re probably already collecting ESG data in addition to your impact evaluation metrics. As private markets continue to move toward ESG standardization, it is increasingly important to discern the differences between ESG investing and impact investing.
What Is ESG Investing?
ESG is a set of criteria across environmental, social, and governance dimensions that may have material effects on business performance. Investors use ESG considerations to assess the risks and opportunities present in potential investment decisions. Incorporating an ESG approach is additive to a firm’s financial performance, with over 70% of LPs incorporating ESG into valuation decisions.
ESG investing is a framework by which firms can maximize financial returns and minimize risk while aligning with socially responsible business practices. There is increasing evidence that businesses that embrace ESG outperform their peers. ESG investing can be forward-looking, for example, if a fund manager chooses to divest from funds that use fossil fuels and only invest in businesses aligned to a net-zero strategy. However, ESG investing also focuses on identifying areas of growth from doing ‘business-as-usual’, through screening for emerging risks at companies. At Novata, we believe that ESG investing leads to more effective risk management and long-term value creation for firms.
What Is 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. Financial returns are an added benefit to impact investing but are not a required component — impact investors are often willing to forgo some amount of financial return (concessionary investments) in exchange for achieving specific social and environmental outcomes.
A core principle of impact investing is intentionality, an explicit aim to generate a specific outcome from investments. It is inherently forward-looking. Impact investing is focused on carrying out a particular goal and usually does not consider an organization’s past activities. Another core component of impact investing is the commitment to measure and report on the impact of their investments, prioritizing transparency and accountability.
Creating Long-Term Impact
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 help investors make better investment decisions and generate long-term value creation. Whether you’re focused on impact investing or ESG, learn more about how Novata can help streamline your data management.
FAQs
ESG Investing VS Impact Investing Objectives:
ESG investors hope to push businesses to adopt more sustainable practices in this way and to help create a more sustainable future. On the other hand, impact investing's primary goal is to provide favorable social and environmental effects and financial returns.
Does ESG investing actually make a difference? ›
“ESG characteristics are important, but so are more traditional metrics like cost,” he says. “Expense ratios for ESG funds have decreased over the years, but they are still higher than other funds on average.” That means you may be paying a slight premium to invest in funds that are targeting ESG criteria.
What is the difference between ESG and impact report? ›
Impact investing requires investors to measure and report the social or environmental impact of their investments. ESG investing, on the other hand, focuses on evaluating a company's ESG performance and practices through data analysis and reporting.
How is ESG investing different from sustainable investing? ›
ESG, therefore, looks at how a company's management and stakeholders make decisions; sustainability considers the impact of those decisions on the world.
What is the difference between ESG and impact finance? ›
While impact investing is primarily focused on achieving measurable, optimal outcomes for social and environmental issues, the goal of ESG investing is to incorporate ESG factors into investment decisions and risk regulation.
What is the difference between ESG fund and impact fund? ›
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.
What is the controversy with ESG investing? ›
Critics portrayed ESG investing as primarily motivated by political concerns and a potential drag on returns. Additionally, some critics have raised concerns about the complexity and reliability of ESG metrics.
What are the criticisms of ESG? ›
In contrast to much of the positive reception ESG has received, some evidence suggests that it isn't even offering financial benefit for investors and businesses. A study conducted by researchers at the University of Chicago found that high sustainability funds hadn't outperformed any of the lowest rated funds.
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 ESG investing also known as? ›
ESG Investing (also known as “socially responsible investing,” “impact investing,” and “sustainable investing”) refers to investing which prioritizes optimal environmental, social, and governance (ESG) factors or outcomes.
Impact investing is the act of purposefully making investments that help achieve certain social and environmental benefits while generating financial returns.
How risky is ESG investing? ›
ESG risks, when poorly managed, can have a significant impact on a company's reputation, finances and long-term viability. The effect of these risks can range from fines and legal penalties to loss of customer, employee and investor confidence.
Are impact investments and ESG investments all that they say they are? ›
While impact investing focuses on investors doing good by investing only in certain companies or areas of the market, ESG looks at the potential negative impacts a company may face as a result of poor environmental, social or governance policies.
