Further definition of key ideas can help describe changes in this vital field as the sustainable investment domain matures and generates increased interest in the private markets. Despite the popularity and importance of investing in this sector, uncertainty about terminology has hampered adoption.
Environmental, social, and governance (ESG) risk factors, as well as impact investing, are two major categories that fall under the umbrella of sustainable investing. Each has its own set of characteristics and applications.
What is ESG?
ESG investment refers to socially responsible investing that considers a company’s influence on the environment, its stakeholders, and the planet in addition to financial rewards.
Investors have recently become interested in the financial performance of ESG stocks. Many companies with good ESG track records demonstrated lower volatility than their non-ESG rivals during the market upheaval caused by the COVID-19 epidemic.
That outcome, for many investors, justified ESG investment and its premise: that good corporate behavior leads to greater financial results.
ESG stands for:
The environmental component examines a company’s impact on the environment by looking at:
- Government policy on climate change
- CO2 levels in the atmosphere
- CO2 intensity and footprint
- Overfishing, trash disposal, and water use and conservation
- Energy derived from renewable sources
- Disposal and recycling methods
- Green infrastructure, products, and technology
- Carpooling, public transportation, bicycle commuting, and other modes of mobility are all encouraged through employee incentives.
Employees, customers, consumers, suppliers, and the local community are all affected by the social aspect of ESG. Among the many examples:
- Compensation and employee treatment.
- Turnover and employee engagement.
- Preventing sexual harassment among employees is a priority.
- Hiring, promotions, and salary raise that are diverse and inclusive.
- Sourcing from a trustworthy supply chain.
- Higher purpose or mission
- The level of customer service.
- Suits, recalls, and regulatory penalties are examples of consumer protection acts.
- Efforts at lobbying and a public stance on issues of social justice.
The governance component is concerned with the independence of the board of directors, leadership effectiveness, and business ethics. The following are some examples of specific topics:
- Compensation, incentives, and perks for executives, as well as if they are linked to long-term corporate value.
- Ethical corporate practices are defined and enforced through policies.
- The board of directors and executive staff are diverse.
- Potential for board members to have conflicts of interest.
- The ability of shareholders to nominate candidates for the board of directors.
- Whether board members’ terms differ in duration.
- Separation of the positions of chairman and CEO.
What is Impact Investment?
Impact investing is the process of making financial investments in firms that have a verifiable positive, social, and environmental impact. You might start by investing in firms that support sustainable business practices or have animal cruelty-free programs to get started with impact investing.
Because everyone’s values are diverse, where you want to make an impact may be different from where someone else wants to make an impact. Some investors may be motivated to act by current events, while others may be influenced by their religious beliefs. You may identify impact investments that align with your values no matter what they are. To know more, visit ColoradoCapital.
What is the Process of Impact Investing?
Impact investing works on a big scale by channeling investor cash into companies that promote good in the world while avoiding those that do not. For example, investors would prefer to put their money into a renewable energy company rather than an oil corporation.
Impact investment fund reports detail the real-world changes that the fund is making as a result of its investment decisions. Specific investments, on the other hand, aren’t the only method to make a difference; advocacy can also have an impact.
Impact investing, like any other type of investment, has a certain risk. Sustainable funds, on the other hand, maybe less risky than standard funds. Having lower-risk items in your portfolio can help protect your portfolio from market volatility.
What Distinguishes Impact Investment From ESG Investing?
Although ESG has been synonymous with sustainable investment in recent years, it is a framework for analyzing firms rather than a stand-alone investment approach. ESG considerations are part of the investment assessment process, whereas impact is about the type of investments a manager is seeking.
Furthermore, impact investing aims to have a measurable beneficial environmental/social impact with the investments a fund manager purchases. In contrast, ESG is a method of identifying non-financial risks that could have a significant effect on an asset’s value.
ESG is frequently employed in public market strategies, and it might include weeding out investments that do not match ESG requirements. Because ESG criteria require corporations to track and report on how they are performing on a variety of problems, including pollution and worker safety, they allow for increased stakeholder advocacy.
Impact investing, then again, is presently generally utilized in private market procedures that look for speculations that give quantifiable responses to worldwide concerns.
All sections of a community are impacted by social and environmental issues. When members of a community work together to address social and environmental issues, they can generate greater resources as well as innovative and successful solutions like impact investing.
Impact investing allows groups to move away from relying heavily on contributions and government subsidies, and it motivates corporations to help by alleviating their concerns about profit loss. While corporations continue to produce profits, social and environmental concerns can be overcome.
Values are extremely personal, and there are several approaches to value-based investing. Fortunately, the wide range of vehicles and techniques available means that investors and advisors may tailor a portfolio to their own priorities and goals while also taking volatility, liquidity, and income requirements into account.
Newcomers to values-based investing may want to change their portfolios gradually. Depending on whom you ask, values-based investment is characterized in a variety of ways. Understanding the underlying differences between ESG and impact investing, on the other hand, can assist investors and their advisors put together a portfolio that matches their unique aims and values.