As environmental and social problems have taken center stage, there has also been greater demand from investors to do more than just return profits. Inflows into sustainable funds, for example, rose from $5 billion in 2018 to more than $50 billion in 2020—and then to nearly $70 billion in 2021; these funds gained $87 billion of net new money in the first quarter of 2022, followed by $33 billion in the second quarter (McKinsey).
In this post, we will define what ESG investing and impact investing are, and characterize differences between the two concepts.
Impact investments are investments that contribute to measurable positive social or environmental impact as well as financial return. Impact investors look at a company’s products and services, and see if it creates positive social and/or environmental impact with them. Impact investors therefore seek measurable impact as well as profits.
ESG investments are investments that are concerned with how a company is performing against key ESG criteria. It helps investors identify areas for improvement and track their progress. ESG factors help investors avoid companies that could pose greater financial risk due to their environmental risk or other practices. There is growing research on how a better ESG score contributes to better risk management or lower loss of capital for funds and investors. Founders of early-stage companies should consider implementing ESG policies in order to be future ready for the upcoming regulations and better attract investors who pay attention to the ESG landscape.
ESG and Impact Investing are two different concepts. They both derive from sustainability related principles, yet the core questions they answer are different.
A company’s performance may be great ESG-wise, yet would not necessarily be an impact investment. If an investor is making an “impact investing,” it means that s/he is investing in a company whose products or services directly generate environmental or social benefits, rather than only focusing on company ESG measurement.
Impact investing communities must re-base their work on traditional values of investment or economic growth. One community example that is changing how they invest is Alphabet. Alphabet requires that each of its investments should address a significant real-world issue that stems from unmet basic needs such as food, shelter, sanitation, clean water, or transportation. Alphabet designs inclusive new cities around the world through its partnerships with Sidewalk Labs.
Larger players are also dealing with systemic problems and initiating change through their direct investments. For instance, Amazon, J.P. Morgan and Berkshire Hathaway announced that they plan to streamline the U.S. healthcare economy. These are not standard investments to penetrate a particular market or update an existing product. These are larger, longer-term investments that target specific social benefits, covering issues such as achieving improved health outcomes at a lower cost.