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What is the difference between ESG investing and socially responsible investing?

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What is the difference between ESG investing and socially responsible investing?

Highlights

A lack of standardization in terminology has created confusion over how ESG investing and sustainable investing differentiate, and about which is the best action for investors to take.

Through ESG investing, market participants consider in their decision-making the ways in which environmental, social, and governance (ESG) risks and opportunities can have material impacts on companies’ performance. Investors who use ESG in their decision-making are able to invest sustainably while maintaining the same level of financial returns as they would with a standard investment approach.

Sustainable investing, sometimes known as socially responsible investing (SRI) or impact investing, puts a premium on positive social change by considering both financial returns and moral values in investments decisions. This strategy emphasizes financial returns as a secondary consideration after the investors’ moral values have been accounted for in their decision-making.

As companies and investors continue to prioritize decision-making that benefits stakeholders alongside stockholders, environmental, social, and governance (ESG) investing has emerged as a competitive alternative to sustainable investing. However, a lack of standardization in terminology has created confusion over how the strategies differentiate and which is the best action for investors to take.

ESG refers to a broad range of environmental, social and governance criteria on which companies are measured. It reflects consumers' growing sensitivity to how companies operate as factors in their buying decisions, and it is of increasing interest to investors who are concerned about companies adopting practices that will mitigate risk and ensure their long-term sustainability. As a result, ESG issues are increasingly shaping the way companies do business around the globe.

ESG investing offers a pragmatic approach to addressing financially material issues through a broader information set. ESG-focused investment products record returns on par with or better than those built purely for risk-weighted performance, a trend that runs counter to the notion that taking ESG into account detracts from performance. Accounting for climate risks and environmental challenges, investments in physical and human capital, and good governance characteristics, among other factors, can greatly improve companies; performance through an ESG-minded investment strategy.

Since the term was first popularized in 2005, investors have increasingly seen value in the idea of using ESG factors to guide investment decisions. The idea of ESG investing is an evolution of the trend toward socially responsible investing, but ESG provides a broader framework for looking at social impact beyond simply excluding companies associated with negative outcomes.

Comparatively, socially responsible investing allows market participants to conduct positive and negative screens to invest in companies that they believe are engaging in sustainable practices such as environmental stewardship, consumer protection, human rights, and racial and gender diversity. This strategy emphasizes financial returns as a secondary consideration after the investors' moral values. Socially responsible investors actively avoid investing in companies or organizations whose businesses run counter to their nonfinancial values and ethical principles or those they perceive to have negative effects on society; including businesses across the alcohol, tobacco, fast food, gambling, weapons, fossil fuel, or defense industries.

Using ESG factors to steer investment decisions is now becoming much more widely accepted. Globally, the most popular form of sustainable investing strategy has come from negative and exclusionary screens, through which investors elect not to invest in a specific company based on their business line. That model has drawn some criticism from ESG skeptics, who say it can detract from investors' returns. And yet, the second-most popular form of sustainable investment strategy is in ESG integration, which grew 69% from 2016 to 2018, largely thanks to growing interest in the model within the U.S.

As ESG investing has emerged as a competitive alternative to socially responsible investing, investors are increasingly searching for forward-looking metrics as a means of assessing portfolio risk beyond traditional financial measures. S&P Global Ratings' ESG Risk Atlas provides a comprehensive view of relative ESG risks facing various sectors and geographies. The ESG Evaluation weighs potential ESG risks to determine an entity's capacity to operate successfully, and along with a preparedness assessment of a company's capacity to anticipate and adapt to a variety of long-term disruptions, determines the company's final ESG score. S&P Global's additional ESG solutions provide comprehensive company-level ESG metrics, vital data, market benchmarks, and analytical tools and standards to help customers create resilient strategies to maximize financial performance, build a sustainable future, and meet the expectations of an evolving market.

Because ESG investing considers an organization's environmental, social, and governance risks and opportunities that could have material impact on its performance, these factors are used to comprehensively expand upon and enhance the traditional measurements of company performance in informing investors decision-making.

While socially responsible investing and ESG investing both are a testament to the various ways sustainable practices can be incorporated into decision-making and investment strategy, ESG investing has proven to be the contemporary and exemplary choice. Those who take the ESG route are equipped with metrics that quantify financial risk and opportunity, while socially responsible investors engage in decision-making primarily on principle. To facilitate long-term, sustainable growth, it is imperative to analyze companies' ESG performance and examine how activity in the markets influences the world in which we live.

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