2021 has been a year marked by uncertainty, but also by conviction – and as a result, many investors are looking to align their portfolios with their principles.
Values-based investing is not an overnight sensation. According to US SIF: The Forum for Sustainable and Responsible Investment, socially responsible investing (SRI); environment, social and corporate governance (ESG) investing and impact investing assets grew from $3 trillion in 2010 to $12 trillion in 2018 to $17.1 trillion by the start of 2020.
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The trend shows no signs of subsiding anytime soon. Financial industry research further indicates that 85% of the general population and 95% of the millennial population are interested in sustainable investing.
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There is a wide variety of values-based investing approaches and strategies. But deciding how to incorporate them into a portfolio depends on a number of individual factors.
SRI, ESG and Impact Investing: What's the Difference?
When it comes to choosing values-based investments, investors and their advisors need to understand the differences among SRI, ESG and impact investing:
- Socially responsible investing (SRI) entails screening investments to exclude businesses that conflict with the investor's values. SRI dates back to John Wesley, the founder of the Methodist movement, who urged his followers to avoid investing in "sin stocks" that generated profits through alcohol, tobacco, weapons or gambling. Common SRI exclusions in modern times include fossil fuel producers and firearms manufacturers. SRI is the simplest (and often the least expensive) values-based investing approach.
- Environmental, social and corporate governance (ESG) investing focuses on companies making an active effort to either limit their negative societal impact or deliver benefits to society (or both). The Sustainability Accounting Standards Board (SASB) aims to standardize the ways companies report on ESG criteria to better inform investors, including determining which ESG issues companies should prioritize based on sector and industry. An example of an ESG investment might be buying stock in a technology company that converts one of its data centers to use renewable energy, resulting in cost benefits as well as a positive effect on the environment.
- Impact investing is characterized by a direct connection between values-based priorities and the use of investors' capital. These funds not only report on financial performance, but they also try to generate and quantify a positive societal impact — for instance, number of schools built, measures of economic activity in a low-income community, or reduction of carbon footprint by X units. Impact investors are often able to deploy funds in service of causes that are not directly addressed by the public financial markets, such as community development and poverty alleviation. These funds also tend to have more influence on the execution and management of portfolio companies than do other investment vehicles.
It's important to note that impact investing refers to private funds, while SRI and ESG investing involve publicly traded assets. For investors who seek transparency about the specific ways their capital is being applied to a particular cause, impact investing might be a more attractive vehicle than ESG or SRI. Determining the direct impact of money invested in a broadly diversified mutual fund can be challenging.
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Additionally, public companies still have the ultimate mandate of generating shareholder value through stock price appreciation, which may conflict with values-based priorities.
That said, due to their private nature, impact investing vehicles tend to be less easily accessible than publicly traded options.
One Size Doesn't Fit All
For investors looking to explore values-based investing, the first question to ask is "Which values do you want to prioritize and reflect in your portfolio?" Is the investor more concerned with a company's environmental footprint, or their social footprint?
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Values are deeply personal, and there are a number of ways to approach values-based investing. Fortunately, the variety of vehicles and strategies available means that investors and advisors can customize a portfolio to suit their individual priorities and goals – while also taking into consideration factors like volatility, liquidity and income requirements.
Investors who are new to values-based investing may also want to take a gradual approach to adjusting their portfolios. A good place to start is by making values-based changes to equity allocations, and then reflecting after a year or two: Are the returns in line with your expectations? Is aligning your investments with these values still a priority?
Values-based investing can be defined in different ways depending on whom you ask. But understanding the fundamental distinctions between SRI, ESG and impact investing can help investors and their advisors construct a portfolio that reflects their specific goals and beliefs.
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FAQs
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 difference between SRI ESG and impact investing? ›
It's important to note that impact investing refers to private funds, while SRI and ESG investing involve publicly traded assets. For investors who seek transparency about the specific ways their capital is being applied to a particular cause, impact investing might be a more attractive vehicle than ESG or SRI.
Is impact investing better than ESG? ›
Impact investing allows for a more direct and measurable impact on specific issues, while ESG investing provides a broader framework for considering sustainability factors across a range of investments.
Is ESG an SRI? ›
While ESG investing focuses on integrating a company's environmental, social, and governance factors into investment decisions, SRI goes beyond by aligning investments with specific values or ethical criteria. Both strategies have demonstrated the potential for financial gains while positively impacting the world.
What does SRI stand for in impact investing? ›
Socially responsible investing, or SRI, definition
Socially responsible investing (SRI) is an investing strategy that aims to generate both social change and financial returns for an investor.
Do SRI funds outperform the market? ›
In this article, we use a meta-analysis to examine the performance of socially responsible investing (SRI). We find that, on average, SRI neither outperforms nor underperforms the market portfolio. However, in line with modern portfolio theory, we find that global SRI portfolios outperform regional subportfolios.
How is impact investing different? ›
Impact investing is an investment strategy that seeks to generate financial returns while also creating a positive social or environmental impact. Investors who follow impact investing consider a company's commitment to corporate social responsibility or the duty to positively serve society as a whole.
Why is impact investing not ESG? ›
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.
Why are people against ESG investing? ›
Critics of ESG — such as a group of Republican states that banned Blackrock and other “ESG friendly” asset managers from their state pension plans — argue that considering environmental and social factors violates the fiduciary duty that asset managers have towards their clients.
What is the difference between ESG and Sri? ›
SRI is a type of investing that keeps in mind the environmental and social effects of investments, while ESG focuses on how environmental, social and corporate governance factors impact an investment's market performance.
One example of socially responsible investing is community investing, which goes directly toward organizations that both have a track record of social responsibility through helping the community, and have been unable to garner funds from other sources such as banks and financial institutions.
How do I know if a fund is ESG? ›
While it's true that there's no universally used system for rating ESG companies, there are still many tools that rate and score companies based on their adherence to ESG criteria. Companies that offer these services include S&P Global, Sustainalytics, MSCI and Refinitiv.
What is better than ESG? ›
Whether you choose impact investing or ESG depends on your values, goals, and risk appetite. Some people prefer the integrative, corporate approach of ESG investing, while others prefer the freer, more self-led style of socially responsible impact investing.
Why are more Millennials investing in SRI? ›
This mostly highly educated and culturally diverse group has an investment ethos in which they feel comfortable making money only if, in doing so, some greater social or environmental good aligned with their values is achieved as well. This is what's created unprecedented demand for SRI investments.
Why should you invest in SRI? ›
This is because companies with sustainable practices tend to be better managed and take environmental, social and governance risks into account in their operations. With good practices, investors who choose responsible companies can therefore benefit from higher financial returns over the long term.
What is the relationship between SRI and ESG? ›
SRI versus ESG
The most common types of sustainable investing are socially responsible investing (SRI), which excludes companies based on certain criteria, and ESG, a more broad-based approach focused on protecting a portfolio from operational or reputational risk.
What is the difference between ESG and ethical investing? ›
Often, it means filtering out certain types of companies and sectors – usually 'sin stocks' like tobacco products and companies involved in animal testing. The significant difference between ESG and ethical investment is that the latter focuses more on subjective, moral judgements than performance considerations.
Is ESG investing the same as ethical investing? ›
When you choose ESG investing, you're putting your money to work in companies that strive to make the world a better place. This type of ethical investing strategy helps people align investment choices with personal values. ESG stands for environment, social and governance.
