Ethical, Sustainable or Impact Investing: What’s The Difference?

Should your investments fund a company that supplies military-grade weapons? Is a company in your portfolio directly harming the environment? Should you move your funds to companies trying to make a positive difference? These are the questions investors have been increasingly grappling with in recent years.

According to fund house Schroders, 56 per cent of UK investors having upped their allocations to ethical funds over the past five years (MYRON JOBSON, THIS IS MONEY, 2 October 2018). At the same time, the number and types of these funds have expanded. There’s no doubt that wealthy investors are taking responsibility for the social and environmental impact of their investment decisions. The wealth management industry has started to take notice, giving rise to an industry trend some like to call socially responsible investing.

However, the three most popular subsets of this emerging investment class could be confusing. Here’s an overview of the three key terms the wealth industry uses to differentiate these types of investment strategies:

Environmental, social and governance (ESG)

Accounting for a firm’s environmental, social and governance policies is a basic version of ethical investing. Investors who’ve adopted this strategy tend to seek out companies with great boards, high integrity management, good employee welfare policies, and a small carbon footprint.

The underlying thesis is that strong, socially-conscious policies could have a positive impact on long-term performance. Investors may subscribe to the philosophy that companies driven by ethical policies will be able to better retain talent and brand reputation, which will ultimately trickle down to the bottom line.

Unlike other ethical investment strategies, the focus here is squarely on financial performance.

Socially responsible investing (SRI)

SRI goes one step further than ESG. This form of investing involves actively cutting out opportunities which clash with the investor’s religion, personal values or political beliefs. This means the financial performance could sometimes take a back-seat to ethical considerations.

For example, an investor may decide to avoid alcohol, gambling, and tobacco stocks regardless of how lucrative the opportunity seems. Similarly, Islamic bonds and financing fall under this category of ethical investing for Muslim investors seeking investments that align with their faith.

According to a report by Morgan Stanley, the amount of money invested in SRI crossed $6.5 trillion in 2018.  84% of millennials are interested in responsible investing, which means this trend is likely to continue (Kate Stalter, US News, June 7, 2018).

Impact investing  

Finally, impact investing is the most proactive of them all. This strategy involves seeking out and investing in companies that are trying to have a positive impact on society. This could include investing in a social enterprise that offer microloans to entrepreneurs in the developing world, a sustainable energy producer or a low-cost medical supplies manufacturer.

According to the Global Impact Investing Network (GIIN), investment professionals in this rapidly expanding industry currently manage over $114 billion (GIIN's 2017 ANNUAL IMPACT INVESTOR SURVEY).    

Regardless of the strategy, an increasing number of investors are taking social and environmental factors into consideration before making investment decisions. This trend could have monumental implications not just for the wealth management industry, but for society at large.  

The value of investments and income from them may go down as well as up and you may not get back the original amount invested.