ESG, SRI and Impact Investing: What's the Difference and What's Best for Your Portfolio?

Did you think ESG, SRI and impact investing all meant the same thing? Sorry to burst your bubble. Here's what each means and how you could short your...

By Melissa Brock contributor/ via MarketBeat

This story originally appeared on MarketBeat

When it comes to "conscience-based" investing, you might find it a little confusing to understand the exact differences between environmental, social, and corporate governance (ESG) investing, socially responsible investing (SRI), and impact investing. Aren't they pretty much the same thing?

No, they're not — and not understanding the differences can leave you with gaps in your portfolio. Let's discuss the definition of each and how they can be profitable — and when you need to be careful.

Socially Responsible Investing

Socially responsible investing (SRI) means thumbing through investments that affect your values. For example, if you avoid investing in stocks that earn profits through alcohol, tobacco, weapons, marijuana/cannabis, sex-related industries, or gambling, you're an SRI investor. Also called "sin stocks," a few companies you might avoid include Smith & Wesson Brands (NASDAQ: SWBI) (weapons), Anheuser-Busch InBev (NYSE: BUD) (alcohol), Altria (NYSE: MO) (tobacco/cannabis), Penn National Gaming (NASDAQ: PENN) (gambling), Tyson Foods (NYSE: TSN) (meat).

Sometimes SRI depends on your own perspective. For example, vegans might classify shares of any company that tests products or treatments on animals as a sin stock. You could even consider Netflix as a sin stock if you believe binge-watching shows represents one of the seven deadly sins: sloth!

How it Can Be Profitable

A 2020 research analysis from asset management firm Arabesque Partners found that 80% of the reviewed studies demonstrated that sustainability practices have a positive influence on investment performance. In addition, diligent sustainability business practices correlates to positive economic performance. In fact, 88% of reviewed sources have better operational performance and cash flows.

In addition, SRI mutual funds often beat traditional mutual funds and evidence persists that finds that SRI funds may be less volatile than traditional funds.

The bottom line: Finding the right SRI funds can be really good for your portfolio.

Ways You Could Leave Money on the Table

Here's where you need to tread carefully: If you only take a look at the societal impact and nothing else, you could miss out on other, better investment opportunities.

Environmental, Social and Corporate Governance Investing

Companies that work toward efforts to limit their negative impact on society fit into the category of environmental, social and corporate governance (ESG) companies. The SASB Standards help identify environmental, social, and governance issues most relevant to financial performance in 77 different industries. These standards help companies disclose sustainability information to investors.

Depending on which factors (environmental, social or governance) or all factors, you may want to invest in companies that tout these characteristics:

  • Environmental: Greenhouse gas emissions, carbon footprint, water usage, use of renewable energy, recycling, green products, and more.
  • Social: Employee development, safety policies, diversity and inclusion, ethical supply chain sourcing, responsive customer service, responsiveness to social justice issues, and more.
  • Governance: Executive compensation, ethical business practices, board diversity, shareholders' ability to nominate board candidates, shareholder communications transparency and more.

A few acclaimed ESG funds include Vanguard FTSE Social Index Fund (MUTF: VFTAX), iShares MSCI USA ESG Select ETF (NYSEARCA: SUSA), and iShares Global Clean Energy ETF (NASDAQ: ICLN).

How it Can Be Profitable

An ISS study linked ESG corporate rating as more profitable because good ESG initiatives drive up financial performance. In addition, companies with positive ESG ratings generally show less volatility.

Here's how it can work, according to the study: Firms that get in trouble may face higher costs due to regulation, and in addition, investors may choose not to invest in a firm that has poor ESG. Customers, knowing the company's tendency toward poor ESG, can lead them to avoid the company altogether.

Ways You Could Leave Money on the Table

You might miss out on opportunities by not acknowledging that there's some gray area here. For example, let's say that a company doesn't have the best carbon footprint or water usage policies. However, it is really responsive to social justice issues and diversity and inclusion. Just because you dislike its water usage, does that mean you neglect to invest in what's otherwise a sound investment opportunity?

Ultimately, you need to determine the litmus test for your own preferences in terms of the balance between performance and ethical investing.

Impact Investing

Impact investing connects values-based priorities to investors' capital. These companies prove a correlation between their actions and positive societal impact. In other words, they may showcase reports of the number of businesses they create for low-income communities or prove how they've reduced water usage by a certain number of gallons throughout the year. They identify and follow through on clear metrics such as community development and the fight against poverty.

How it Can Be Profitable

The most recent Global Impact Investing Network (GIIN) study showed that the market today exceeds $715 billion. The report also found that a majority of respondents reported that their impact investments were meeting or exceeding their financial expectations and hit returns similar to the broader market.

How You Can Leave Money on the Table

Businesses and investors must develop better ways to assess social and environmental impact.

Research has also found that socially responsible assets underperform, and these researchers have also expressed concerns that certain social impacts remain woefully under-researched.

Do your due diligence to understand how investment returns differ between an impact investing fund and a general index fund. You might do better to keep the money in the "regular" index fund and donate more money to causes you care about instead.

Are You Choosing Ethics Over Returns?

Wrestling between "the right thing to do'' and making money can become a major hurdle for investors. However, investors (especially younger people) refuse to see them as mutually exclusive.

Consider using an investment app to invest in the right fund. Did you know that they also have ESG, SRI and impact investing standards themselves? You already know you don't have to stick to a financial advisor to prescribe funds that meet your ethical standards, so why not rely on apps with excellent ethical standards themselves, especially when the world of ethical investing might seem rife with conflicting research.

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