Private markets have the capacity to improve societal outcomes, advance social equity, and raise awareness of the environmental impact caused by anthropogenic activity. One way traditionally has been through impact investing, investments made with the intention to generate positive, measurable social impact alongside financial returns.
In recent years, ESG-focused investments have risen in popularity, with PwC predicting an 84% increase in institutional investments focused on ESG assets from 2021 to 2026. Impact investing and ESG investing are often used interchangeably to refer to investments that deliver financial returns while also contributing environmental and social benefits. However, there are key differences that determine how and where investors allocate their funds.
Stanford’s Social Innovation Review puts it aptly that all impact funds consider ESG, but not all ESG funds are impact. If you currently manage an impact fund, you’re probably already collecting ESG data in addition to your impact evaluation metrics. As private markets continue to move toward ESG standardization, it is increasingly important to discern the differences between ESG investing and impact investing.
What Is ESG Investing?
ESG is a set of criteria across environmental, social, and governance dimensions that may have material effects on business performance. Investors use ESG considerations to assess the risks and opportunities present in potential investment decisions. Incorporating an ESG approach is additive to a firm’s financial performance, with over 70% of LPs incorporating ESG into valuation decisions.
ESG investing is a framework by which firms can maximize financial returns and minimize risk while aligning with socially responsible business practices. There is increasing evidence that businesses that embrace ESG outperform their peers. ESG investing can be forward-looking, for example, if a fund manager chooses to divest from funds that use fossil fuels and only invest in businesses aligned to a net-zero strategy. However, ESG investing also focuses on identifying areas of growth from doing ‘business-as-usual’, through screening for emerging risks at companies. At Novata, we believe that ESG investing leads to more effective risk management and long-term value creation for firms.
What Is Impact Investing?
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. Financial returns are an added benefit to impact investing but are not a required component — impact investors are often willing to forgo some amount of financial return (concessionary investments) in exchange for achieving specific social and environmental outcomes.
A core principle of impact investing is intentionality, an explicit aim to generate a specific outcome from investments. It is inherently forward-looking. Impact investing is focused on carrying out a particular goal and usually does not consider an organization’s past activities. Another core component of impact investing is the commitment to measure and report on the impact of their investments, prioritizing transparency and accountability.
Creating Long-Term Impact
While both ESG and impact investing can be used to advance social and environmental impact, impact investing’s primary focus is to achieve a specific social and/or environmental outcome. Understanding the differences help investors make better investment decisions and generate long-term value creation. Whether you’re focused on impact investing or ESG, learn more about how Novata can help streamline your data management.
FAQs
Impact investing is more focused and deliberate in seeking investments with a specific social or environmental outcome. In contrast, ESG investing considers a company's ESG factors and traditional financial metrics. This is one of the main differences between ESG and Impact investing.
What is the difference between ESG and impact report? ›
While ESG Reports focus on metrics, Impact Reports dive into qualitative narratives. They tell the story of a company's social and environmental efforts through case studies, impact assessments, and compelling narratives.
Does ESG investing actually make a difference? ›
Thousands of studies by academics and asset managers have sought to conclusively demonstrate the relationship between high ESG companies and equity returns. More than two thirds of such studies show at least a non-negative correlation between ESG and financial returns.
What is the difference between ESG impact and risk? ›
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.
What is the difference between impact and sustainability? ›
In short, the difference between impact and sustainability lies in the core focus of the organisation. An impact organisation seeks to solve a social or environmental challenge with its products and services, while a sustainable organisation manages its impacts, but its primary goal is economic success.
How is ESG different from impact investing? ›
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 ESG and sustainability reporting? ›
While both ESG and sustainability are concerned with environmental, social, and governance factors, ESG focuses on evaluating the performance of companies based on these factors, while sustainability is a broader principle that encompasses responsible and ethical business practices in a holistic manner.
What are the flaws of ESG investing? ›
This means that it's hard for investors to compare companies and funds from an ESG standpoint. Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments.
Why is ESG criticized? ›
One of the biggest criticisms of ESG is that it perpetuates what it was partly designed to stop – greenwashing.
What are the downsides of ESG? ›
However, there are also some cons to ESG investing. First, ESG funds may carry higher-than-average expense ratios. This is because ESG investing requires more research and due diligence, which can be costly. Second, ESG investing can be subjective.
Recent research suggests that ESG investing can offer comparable, and sometimes higher, returns than traditional investing. This is particularly true in the long run, as companies with strong ESG practices often demonstrate better risk management and resilience to market volatility.
What is the difference between ESG and sustainable investment? ›
It's a measured assessment using benchmarks and metrics. So, sustainability is a broader concept that encompasses environmental, social and governance considerations, whereas ESG specifically refers to a set of criteria within these three areas that are used to evaluate the performance and behaviour of companies.
Which pillar of ESG does human capital? ›
Human capital management has evolved as a significant component of the “S” pillar in the ESG framework, since a business cannot operate without qualified human capital to run it.
What are the three pillars of sustainability vs ESG? ›
The same report introduced the three pillars or principles of environmental, social and economic sustainability, also known as ESG (Environmental, Social, Governance).
What is your understanding of ESG and sustainability and how they are different? ›
Sustainability and ESG (environmental, social and governance) are initiatives that have become imperative in business with the threat of climate change and climate risk. The main difference between these two frameworks for business is ESG is a measured assessment of sustainability using benchmarks and metrics.
What is ESG vs CSR vs sustainability? ›
CSR focuses on corporate volunteering, lowering carbon footprint, and engaging with charities. ESG provides a more quantitative measure of sustainability. ESG considers environmental, social, and governance factors. ESG improves the valuation of the business.
Is social impact the same as ESG? ›
While there is some overlap between environmental, social, and governance (ESG) management and social impact, they are distinct concepts woven together by what is referred to as “double materiality.” ESG refers to the consideration of environmental, social, and governance factors in investment and business decisions.
What is ESG impact analysis? ›
Impact analysis involves the tangible effect of a company's operations on the environment it operates. It measures the positive or negative effect the companies have on ESG-related factors.
What is an ESG report? ›
ESG reporting is the disclosure of environmental, social and corporate governance data. As with all disclosures, its purpose is to shed light on a company's ESG activities while improving investor transparency and inspiring other organizations to do the same.
How ESG will impact reporting and strategy? ›
ESG Reporting is structured around three fundamental pillars: Environmental, social and governance. The Environmental aspect includes management of the environmental impact of the company, including carbon emissions or waste and resource management.
