Ethical investing vs impact investing – it’s all ESG to me…

If you’re trying to cut through the ESG investment jargon and understand how you can invest in a better world, It’s important to dig deeper and do your research. To start, you need to understand the differences between the main terms.  Ethical investing, impact investing and ESG investing are understandably used interchangeably, but they are not the same.

In this article we run through what each entails and explain the differences in how these closely related areas of ESG investment strategy select funds.

What is ethical investing?

Ethical investment funds exclude companies associated with unethical things, so any company making cigarettes or manufacturing guns etc. They use negative screening to exclude controversial sectors. This is quite blunt as an approach, but for investors who have issues with specific types of companies, it works.

There are passive ethical investment funds that exclude sectors such as tobacco, thermal coal and controversial weapons. There are also active ethical investment funds that screen out certain companies.

What is ESG investing?

An ESG fund selects companies based on its robust policies around environmental risk (E), how it treats its employees (S) and how well looked after the shareholders are (G). If ‘ethical’ means taking companies out, then ESG means operating a ranking system based on their ESG performance. And here, the devil is in the detail. Although most specialist ESG investment managers will have blanket bans on sectors like tobacco, negative screening is not really the philosophy of this approach. So investors might be surprised to see certain companies included in ESG exchange-traded funds (ETFs), for example petroleum producers may be justified on ESG grounds because of their investment in renewables.

Active approaches tend to work better with ESG, where the investment strategy can be more nuanced and varied. 

What is impact investing?

Impact investment funds are the real deal. If you are interested in putting your money in companies that make the world a better place, then impact funds are for you. But ‘better’ is a relative term and can mean different things to different people, so you have to think what’s important to you. 

Most impact investment funds are ‘thematic’, which means they are built around a particular strategy and they track the impact they are making by adhering to the United Nation’s 17 sustainable development goals (e.g. clean water). 

There are impact funds that aim to deliver long-term returns and contribute to a more sustainable and inclusive world. Investing in high quality, large-cap growth companies, which deliver positive change through social inclusion and education, environment and resource needs, healthcare and quality of life, and addressing the needs of the world’s poorest nations.  

Other impact funds aim to deliver attractive returns by investing in smaller companies that make a positive impact on the world and are aligned with the UN’s sustainable development goals framework. There also lots of single theme funds that focus on making a positive impact, for example agricultural funds that focus on creating better nutrition for the world, for example. 

There are some passive ESG ETFs too – investing in electric vehicles and battery technology, renewable energy and companies with progressive diversity policies, to name a few..  

It is in this third group of impact funds where we are seeing real innovation. Investors now have the option of investing in funds that make a difference to the world and also deliver on performance. For investors, the main takeaway is that you have to do your homework. Just because a fund says ‘ethical’ or ‘ESG’ on the tin, does not mean it’s going to make the world a better place. And it’s down to you to decide what a better world means for you.  

Find this useful? Read more about ESG investing:

• Responsible investing is here to stay
• ESG Investment trends

For expert guidance on aligning your investment portfolio with your values, arrange a complimentary consultation with an ESG investment manager now.

Investment involves risk. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested.

This is not a recommendation to invest or disinvest in any of the themes or sectors mentioned. They are included for illustrative purposes only.

The information provided is not to be treated as specific advice. It has no regard for the specific investment objectives, financial situation or needs of any specific person or entity.