With the rapid rise in investors wishing to include non-financial factors in their investment decisions by ‘investing responsibly’, there’s also been an emergence of inconsistent terminology being used. This can be confusing if you’re trying to navigate the responsible investment sector for the first time, so here’s how we would explain the difference between ‘ESG investing’ and ‘sustainable investing’ – two important and distinct terms that are often confused.
ESG (Environmental, Social and Governance) investments are those where the investor’s criteria include an analysis of a company’s non-financial policies and performance. ESG funds only allocate capital to companies that measure various ESG metrics and demonstrate that they meet or exceed the fund’s ESG benchmarks. Some funds may exclude investments scoring low on ESG performance (negative screening), others may look to optimise for ESG scoring and financial metrics (positive screening). ESG investors aren’t necessarily aiming to make a major positive impact on the world, but hoping to invest in businesses implementing best practices for their stakeholders, community and environment - avoid investing in businesses that are causing excessive harms eg. through significant carbon emissions or unfair labour practices.
ESG investing doesn’t have to result in lower returns; in fact, research has shown that companies with a strong focus on ESG issues are often more profitable long-term and resilient to short-term crises.
Many ESG funds invest in large, listed companies that use an ESG reporting framework to monitor their non-financial performance. Various organisations oversee ESG frameworks, including the Sustainability Accounting Standards Board, the Global Reporting Initiative and the International Standards Organisation. However, there’s also widespread acknowledgement that ESG reporting standards need to converge, which seems likely in the next few years.
‘Sustainability’ has various definitions, which can encompass everything from cutting climate emissions to improving access to education. Sustainable investing involves allocating capital to companies with the potential to generate a financial return for investors, whilst making a positive and measurable contribution to addressing global sustainability challenges. The environment and society benefit more as these companies grow. Companies tackling sustainability challenges regularly have massive addressable markets, driven by regulatory pressures and consumer demand for more ethical products and services. So, as with ESG funds, selecting sustainable investments need not lead to lower financial returns.
To summarise, the difference between ‘ESG’ and ‘sustainable’ investments is essentially the difference between ‘aiming to minimise harm’ and ‘aiming to make a positive difference’.