Responsible investing, though not a new concept, has only recently gained popularity among a meaningful portion of the investment community.
In the past, investing with a purpose was largely focused on avoiding the stocks of companies that engaged in morally questionable activities—these may have included alcohol and tobacco companies, firearm manufacturers, and gambling-related stocks, among others. Since these stocks tended to perform well, responsible investing became associated with sacrificing financial gains.
Today, the landscape has changed dramatically. A multitude of new investment opportunities have emerged that allow investors to “do well by doing good.”
In other words, investors no longer need to separate investing with a purpose from financial gains—these two goals can be achieved simultaneously. As such, socially responsible and impact investments now account for $1 out of every $5 under professional management in the United States, according to a 2016 survey by the U.S. Forum for Sustainable and Responsible Investment, and this number is rising.
Investors interested in doing well by doing good can achieve this goal in many ways, but the three primary approaches to incorporating this concept into an investment portfolio tend to be ESG, socially responsible, and impact investing. While all three approaches seek to invest in companies and organizations that follow a prescribed set of best practices, each philosophy is unique in its subtleties and motivations.
ESG—which stands for environmental, social, and governance—is a set of criteria used to determine the value of a company. Based on a set of pre-determined ESG factors, which may include things like energy consumption, community engagement, and executive compensation, companies that score well—or engage in positive ESG practices—are believed to be better potential investments than companies that don’t score well.
Typically, ESG factors are used as an overlay to traditional investment approaches, enhancing the process by identifying a unique set of potential risks and opportunities. Although companies that follow environmental, social and governance best practices are often rewarded using this approach, the primary goal of ESG investing is to generate the highest possible financial return.
Socially Responsible Investing
Socially responsible investing (SRI) differs from ESG investing in that instead of complementing an existing investment strategy, it seeks to actively avoid or invest in companies based on explicit ethical guidelines. These guidelines may be shaped by the investor’s religious beliefs, personal values, or political leanings.
Whereas ESG investing is a performance-driven approach, SRI is principles-driven. Good performance is still a goal, but the strategy sets strict criteria around the types of investments it will and won’t own, regardless of their potential financial merits.
Impact investing seeks to effect outcomes by investing in businesses, organizations, or funds committed to corporate social responsibility. In other words, impact investing is a results-driven approach—the goal is to generate positive societal or environmental change in addition to financial returns—for example, investing in innovative enterprises in sectors such as sustainable agriculture, affordable housing, healthcare, energy, clean technology, and financial services for the impoverished.
Impact investing has become extremely popular over the last several years, especially among younger generations. Assets in impact investments have more than doubled since 2010, according to the Global Impact Investment Network. As Millennials are expected to benefit most from the multi-trillion-dollar wealth transfer set to take place over the next few decades, it is likely that there will be an even greater push for impact investing moving forward.
Investors who choose to invest with a greater purpose have many options, ranging from passive to active in their approaches. Ultimately, the choice comes down to each investor’s preferences and motivations. Regardless, those who wish to invest responsibly no longer need to do so at the expense of financial returns.
If you’re interested in ESG, SRI, or impact investing, discuss your options with a trusted financial advisor to determine the best approach given your preferences, financial circumstances and goals.