ESG, SRI, and Sustainable Investing: What’s the difference?
ESG, SRI, and Sustainable Investing: What’s the difference?
ESG (Environmental, Social, Governance) investing, socially responsible investing (SRI), and sustainable investing; these terms are becoming widely used in today’s investment world. But what’s the difference between them and which investment methodology is best? Regardless of what term you use, statistics show that a company’s sustainability and ESG efforts can be directly linked to stronger business outcomes while making the company more attractive to new hires, consumers, and investors alike.
While socially responsible and sustainable investments have often constituted a small percentage of total funds invested by corporations, that’s rapidly changing. A 2018 survey by the U.S. Forum for Sustainable and Responsible Investment found socially responsible investing and one of its subsets, impact investing, accounted for more than $1 out of every $4 under professional management in the U.S. Additionally, sustainable, responsible, and impact investing grew at roughly a 38% rate between 2016 and 2018, rising from $8.7 trillion in 2016 to $12 trillion in 2018.
With the expeditious growth and interest in sustainable investing, ESG investing has taken the main stage. However, a lack of standardized terminology has created confusion over how to differentiate ESG investing, sustainable investing, and SRI. While it may seem like a small matter of semantics, understanding the difference between these three terms is extremely important.
ESG, SRI, sustainability: They aren’t the same
ESG, SRI, and sustainability are often used interchangeably; however, these investment approaches are each very different.
Socially responsible investing is thought to have started with the Religious Society of Friends (Quakers) in 1758 when the Quaker Philadelphia Yearly Meeting prohibited members from participating in buying or selling humans as part of the slave trade. One of the early adopters was Methodist founder John Wesley, whose sermon "The Use of Money" outlined his basic tenets of social investing: not to harm your neighbor through your business practices and to avoid industries like tanning and chemical production, which can harm the health of workers.
In general, SRI investors encourage corporate practices that are morally grounded and promote environmental stewardship, consumer protection, human rights, and racial or gender diversity. For example, some socially responsible investors avoid investing in businesses perceived to have negative social effects such as alcohol, tobacco, gambling, pornography, weapons, and fossil fuel production. Essentially, for socially responsible investors morality trumps the bottom line.
As a blanket investment term, sustainability has become a catch-all for a company’s efforts to “do better” or “do good.” This investment approach is best defined by the three pillars of sustainability: economic growth, environmental protection, and social progress, also referred to as “people, planet, and profits.” In a nutshell, sustainable investing directs capital to companies fighting climate risk and environmental destruction, while promoting corporate responsibility.
Sustainable investors, ranging from global institutions to individuals, utilize a combination of traditional investment approaches together with ESG insights to pursue their investment goals. Sustainable investing seeks to find companies that are positioned to grow while also doing good and pioneering better business practices. This approach blends a focus on return with a desire to do good.
In contrast, ESG focuses on three specific, foundational pillars that are crucial to today’s corporate management and investors alike. Environmental issues can include pollution, climate risk, exposure to extreme weather, carbon management, and use of scarce resources. Social issues can include product safety, human rights, worker safety, customer data protection, and diversity and inclusion. Governance issues can include factors such as accounting standards compliance, succession planning, anti-competitive behavior, and a strong ESG management process.
ESG data and metrics are used to gain insights into the success and value of a company’s performance and policies in order to mitigate risk and identify superior risk-adjusted returns. Essentially, the focus of ESG investing is on increasing the bottom line through investments in responsible companies that are being well managed.
ESG investments: What really sets them apart
SRI and sustainable investors place a premium on positive social change and weigh both financial returns and moral values in investment decisions. This method of investing is based on selecting socially responsible companies and building portfolios and excluding companies negatively impacting society or the environment or that have a morally corrupt value system.
ESG investors base decisions on a broader set of criteria that are not influenced by moral decision making or exclusive to environmentally and socially conscious business practices. Rather than completely rule out companies and industry sectors based on blanket criteria such as alcohol, animal testing, or weapons, ESG investors identify and rank businesses based on data and consideration of how ESG risks and opportunities can impacts the company’s performance.
This approach often supports sustainable investments while also ensuring the same level of financial returns promised by a standard investment approach. In fact, Barclays Research reported over $100 billion flowed into specialist ESG funds globally between 2018 and 2020. Time and again, statistics like this prove that within all industries, from construction to health care to petroleum, companies with strong ESG profiles continue to perform better than their peers. This evolution marks a stark difference between ESG investing and the early days of ethical investing.
Graduating to ESG investing
Over the years, sustainability efforts have often been measured using KPIs (Key Performance Indicators) which provide relevant data that is used in annual corporate sustainability reports meant to showcase the positive impact a company has on its employees, consumers, the environment, and the community at large. However, investors and board members paid little attention to these reports because KPIs were often unavailable and, even if they were, the data wasn’t standardized or required.
Today, sustainability has matured in value to both board members and investors. Many companies now include corporate social responsibility at an executive level or have entire departments devoted to sustainability. However, it’s no longer enough to simply follow environmental laws, volunteer, and give donations.
Because of sustainability's rapidly growing importance, companies are shifting from a voluntary “feel good” reporting model to a standardized practice of reporting quantifiable ESG metrics to demonstrate responsible business operations. The positive transition from sustainability to ESG performance marks an important shift in business practices and provides clearer measurements of company management and portfolio performance.
Rather than rule out entire sectors or companies under the broad umbrella of SRI or sustainability, investors are now using measurable ESG rubrics and looking at quantifiable metrics that can be easily monitored and tracked against a baseline, such as energy consumption and carbon emissions. While ESG investing promotes investment opportunities that also generate social and environmental benefits, the primary focus is on portfolio performance. ESG initiatives help investors future-proof their investments against emerging sources of risks.
Disclosures matter: ESG benchmarking versus sustainability tracking
Today’s investors are demanding more transparency from companies which means corporate sustainability and corporate social responsibility need to evolve to ensure competitive differentiation. As the demand for clear data and metrics grows, standardized reporting efforts and requirements are becoming more sophisticated. Here enters ESG policy.
One of the biggest differences between ESG and SRI or sustainability investing is the disclosures and benchmarking data used for defining ESG’s scope, practices, and relevance to capital opportunities. While most ESG disclosures are still voluntary, transparency demands are creating a substantial shift in the way companies measure and disclose their performance and this information is quickly becoming required by key stakeholders.
Sustainability managers have often tracked results focused on the environment using metrics such as gallons of water consumed, carbon equivalents, or energy intensities. However, with the rise of ESG, investors are increasingly expecting high quality and accurate ESG-specific data suitable for investment decisions that place equal importance on environmental activity, social factors, and corporate governance. In turn, companies must collect data that is timely, accurate, complete, as well as auditable.
In short, the key differentiation between SRI, sustainability, and ESG performance is measurability. The ability to measure, analyze, and compare company metrics and data has allowed investors to benchmark performance and evaluate the potential strength and sustainability of companies.
This approach is not only effective; it’s also profitable. According to S&P Global Ratings, ESG investments will likely create a rapid increase of green, social, and sustainable bonds worth $700 billion worldwide in 2021.
The future is ESG
The statistics are undeniable. According to The Forum for Sustainable and Responsible Investment, socially responsible investing, ESG investing, and impact investing assets grew from $3 trillion in 2010 to $12 trillion in 2018.
While SRI, sustainability investing, and ESG investing each offer a way to incorporate sustainable practices into decision-making and investment strategy, ESG investing is proving to be the most effective method. Because ESG investing considers the key aspects of an organization's environmental, social, and governance risks and opportunities, investors are able to enhance traditional measurements of company operations that have a material impact on its performance.
Investors who utilize ESG investing are equipped with metrics that quantify financial risk and opportunity and companies with high ESG performance have shown lower risks, higher returns, and are more resilient in times of crisis.
ESG materiality assessments
With investors inquiring more and more frequently about what your company is doing in regard to responsible investment, how you treat employees and vendors, your dedication to sustainability initiatives, and other activities that fall under the ESG umbrella, it’s important to have answers to these questions.
An ESG materiality assessment empowers you to easily report on your current state and outline future initiatives while taking into consideration your business goals and risks. Download our guide to creating and extracting the maximum strategic value from an ESG materiality assessment.