Impact isn’t ESG

While responsible investment is hardly a new concept, there is a fair degree of confusion around some of the more recently introduced terminology – namely what is meant by ‘ESG’ (environmental, social and governance) and how this fits into the spectrum of traditional ‘ethical’ investing, ‘sustainable’ investing and ‘impact’ investing.

I think the confusion arises as these different concepts are often conflated or used interchangeably, with many commentators typically painting ESG with an ethical brush. It’s probably worth forcing the point that ESG does not equal ethical.

Ethical investing is about aligning one’s investments with one’s values. In practice, ethical funds tend to focus on excluding certain controversial sectors like tobacco, alcohol, weapons or gambling and increasingly ‘black’ sectors such as thermal coal or even fossil fuels in general.

ESG, by contrast, applies to all sectors: it’s predominantly a risk framework, examining how companies might be exposed to environmental, social and governance factors and how they’ve deployed specific strategies to mitigate these risks (or not). While environmental factors might be more relevant to certain sectors than others, social and governance factors are as applicable to a mining company or an oil major as they are to a drinks producer or a bank.

To add to the cacophony, new funds with a ‘sustainability’ label have gathered steam over recent years. These also seek to enhance returns and mitigate risks, but with more of a positive slant: their modus operandi is to identify companies ideally positioned to take advantage of sustainability challenges such as climate change or resource scarcity. By nature, these funds tend to be more thematic in their approach; focusing specifically on clean energy, sustainable infrastructure or water scarcity, for example.

Focusing on impact

Impact funds, meanwhile, are the newest kids on the block, and (from a low base) they’ve experienced the fastest rate of growth of any responsible investment strategy over the last few years. Impact, though, is fundamentally different from other forms of investing, as it seeks to generate measurable positive impact on society and the environment in addition to delivering attractive financial returns. This dual objective is part of what differentiates impact from traditional funds.

Once the preserve of institutional or high net worth investors in private markets, impact via listed equities is helping to democratise the impact space, giving retail investors a stake in the game. Impact includes the analysis of ESG factors in the investment process, but it goes further, and there are several conditions that impact investors must adhere to.

One of these is the idea of ‘intentionality’, meaning a company specifically sets out to deliver a particular impact, with that goal being part of the company’s mission statement, strategy and actual day-to-day operations (accidental impact doesn’t count). This means investors must actively pick stocks delivering that positive impact, rather than screening out companies or picking the least bad from each sector. This is part of what separates impact from wider ethical or ESG investing.

In traditional impact investing, the ‘additionality’ of the investment is also considered, identifying and reporting the resultant impact of every euro, pound or dollar invested in a project. As listed equity impact funds are generally dealing in secondary markets, and the directing of that funding is not possible, additionality is considered in other ways, generally focused on understanding the additionality of the company. To do that, we might ask how the world would be different if that particular company did not exist or if it were not adequately funded, or how replicable its products or services are. Linked to this is the ‘materiality’ of the impact – what is actually being accomplished and its magnitude.

Another key differentiator between impact and other forms of responsible investment is ‘measurability’. This is one of the central tenets of impact investing, and also one of its most challenging aspects, especially so for investors in public equity markets where measurement can be less clear. Quality of data and the measurability of intangible elements are key challenges here, but they need to be overcome for public market impact investors to be taken seriously, and to fend off potentially valid criticisms of ‘green washing’.

Measurement isn’t the only challenge facing impact investing: better definition/segmentation of the market, appropriate capital across the risk/return spectrum and suitable exit options were listed as the most challenging areas lacking progress in the 2018 Impact survey conducted by the Global Impact Investor Network. Encouragingly though, the survey pointed to improvement in the availability of professionals with the right skills set.

While listed equity impact investing is a relatively new, but fast-growing, approach, I think that in a changing world, where regulation and stakeholder demands will see ever-increasing scrutiny and pressure on investment firms to ‘do the right thing’, it is likely that impact investing will become increasingly mainstream – this should help improve the image of capitalism, as well as the health of our planet.


The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.