In This Post:
Definitions matter. Shared understandings are how we collectively turn words into actions.
Was that recent news article talking about ESG or Impact Investing? And why were they using the terms interchangeably? (Hint: Because they don't understand what they are writing about).
From RI to SRI to Green Funds to Sustainability Investing--is it all just the same thing? (Hint: Close, but no).
ESG vs. Impact Investing
This newsletter is going to be a little bit different.
First, our last newsletter was way too long and if you made it through that one then we are rewarding you with a much shorter one this week.
Second, there is so much going on with ESG in the news and so much we want to talk about…but there are so many confusing uses of the term ESG in the news right now that we think it best to take a moment this week to explore some definitions and use-cases before our conversations go any deeper.
So let’s get into it.
The trigger for this newsletter is three-fold:
A handful of political primary candidates in the USA latched on to attacking ESG as ‘woke socialism’ as part of their campaign pitch. That ESG made it into primary campaign platforms--even if just to be attacked--shows just how much this space has grown over the last three years!
Elon Musk came out swinging that ESG was ‘broken’ only later to discover that Tesla had been removed from the S&P 500’s ESG index while Exxon remained in the top-10. Musk, directly and indirectly, influences many supporters and observers for whom ESG suddenly became a central fixation.
HSBC’s head of responsible investing declared climate crisis warnings to be ‘unsubstantiated’ and ‘shrill’...they are now suspended but it is hard to believe other HSBC executives were not previously aware of these perspectives within the organization.
With all of this happening, media outlets are tripping over themselves to keep up--there’s blood in the water and no one wants to miss out. The challenge is that many of these outlets don’t have much experience or background in ESG and so terms such as ESG, impact, sustainability, responsible investment, and so on are being used interchangeably with little regard to any actual definitions. You can start reading an article on ESG which transitions unknowingly to sustainability then, again unknowingly, on to social responsibility to ultimately trying to make a point about democracy. It’s an absolute circus out there right now…and it isn’t helping anyone.
ESG, impact investing, sustainability funds, green funds, socially responsible investing, and even responsible investing, are all closely related but they are certainly not interchangeable. Definitions matter, it's how we collectively turn words into actions.
If you’ve been following the news, or are working in this space, here are a few simple financial market-oriented definitions we use at Motive to help us stay focused…and to be able to tell if the author of something we are reading has taken the time to inform themselves of what they are writing about. Admittedly, these are generalizations, but they do cover the vast majority of use-cases.
A Few Definitions
ESG: ESG is a universe of data pertaining to corporate environmental, social, and governance policies, programs, outcomes, and performance. That’s it, that’s all. ESG is simply data--no value hierarchy, moral compass, or discernable objectives--simply information about corporate performance on issues that have long been omitted (on account of not being considered material, as we discussed in our last newsletter) from regular financial reporting.
ESG Investing: The conceptualization of ESG, and the term, originated in financial markets largely from the perspective of institutional investors and this still carries great influence over how ESG is practiced today. As predominantly observed throughout financial markets, ESG as a practice is the broadening of the investment decision-making process to include considerations of a correlation between corporate environmental, social, and governance data with observed and expected financial performance.
This results in a predominant risk management and/or opportunity identification framework aiming to identify how environmental, social, and governance developments are likely to impact corporate financial performance and how well corporate management is prepared to deal with these risks and/or opportunities. In this sense, ESG is about understanding how events and developments are likely to impact companies.
Impact Investing: Impact is the correlation between corporate environmental, social, and governance data to external environmental, social, or governance developments and events. Whereas ESG investing frames external events as a risk or opportunity to corporate financial performance, impact investing frames corporate operations as a risk or opportunity to external events. Analysis of impact draws heavily on ESG data but typically frames it in reverse to how it is framed by traditional financial market practice: operations as a contributor to climate change vs. climate change as a threat to profitability.
The values associated with different impacts are wholly determined by the proponents of the analyses as there is no external hierarchy of impacts everyone ascribes to. Impact investing operationalizes the phrase of ‘the investments you make today become the world we live in tomorrow’. Today, impact investing has largely been practiced as purposefully investing in the companies that can optimize the positive impacts you want to see. Avoiding investments in companies perpetrating impacts you don’t want to see materialized would also be considered impact investing, however, this framing receives much less popular discussion. In this sense, impact investing is about understanding how companies are likely to impact events and developments we care about.
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Now...Back to it!
Sustainability Investing: Sustainability investing is a sub-category of Impact Investing, but in this case, it is impact investing with a generally agreed-upon values framework. It refers to the correlation between corporate environmental, social, and governance data to specific external environmental, social, or governance developments and events. Whereas the impacts to be optimized under Impact Investing are at the discretion of each individual investor, the impacts to be optimized under Sustainable Investment are largely expected to fit a generally agreed framework. This values framework is not explicitly codified by anyone regulatory body, but it is observable in the investment decisions of investors who proudly identify themselves as Sustainability Investment specialists.
Today, the observable values framework would suggest that impacts on climate change, access to freshwater, deforestation, and global geographic representation are top of mind in sustainability investing, yet issues such as diversity and inclusion or community development, although inherent to sustainability, are not. It seems sustainability leans very heavily on the environmental sphere of sustainability while a focus on impacts in the social or governance spheres are left to be identified as Impact Investment instead. As you can see, sustainability investment is a form of impact investment, but not all impact investment is openly recognized as sustainability investment.
Green Investing: Green Investing is another sub-category of impact investing, and also a further sub-categorization of Sustainability Investing. Green Investing is another concept with no explicit definition, but rather a practical definition observable from the actions of leading investors keen to identify themselves as ‘green’. Green Investment is simply a further refinement of the values framework of Sustainability Investment: it is Impact Investment with an explicit focus on carbon reduction and renewable energy technologies. There is nothing stopping you from focusing on impacts on freshwater and calling your approach Green Investment, but most others in this space would instead refer to your approach as Sustainability Investment. In this sense, all Green Investing is Impact Investing, but not all Impact Investing is Green Investing.
Socially Responsible Investing (SRI): Socially Responsible Investing (SRI) is another sub-category of Impact Investment. SRI is the application of a moral lens to investment decision-making. In short, it entails the creation of a values framework of what is good and what is bad in society and investing to avoid the bad and/or optimize the good, and typically, although not necessarily, irrespective of consequences on rate of return.
Most commonly, this means not investing in companies that operate in certain industries, such as weapons manufacturers, nuclear energy, or adult entertainment (a negative filter approach), but it can also include avoiding companies that demonstrate certain data thresholds on key metrics or investing in these companies but in turn engaging with them to improve performance within those metrics.
What sets SRI as a distinct sub-category of Impact Investing is that the values framework is typically developed along the guidance of faith-based or well-established cultural organizations rather than personal preferences or moral compasses. In this sense, all SRI is a form of Impact Investing, but not all Impact Investing would be recognized as SRI.
Responsible Investing (RI): Again, Responsible Investing (RI) is another sub-category of Impact Investing. RI grew to prominence on the heels of SRI before Impact Investing had yet come to term. RI is very similar to SRI, however, it seeks to operate with an arguably more objective rather than a moralistic framework.
Where RI differs from impact investing is more in practice than in definition. Whereas Impact Investing today has a large focus on investing for the impacts you want to see, RI still retains an SRI-infused perspective of negative screening so as to avoid the impacts you don’t want to see. In this sense, all RI is a form of Impact Investing, and all Impact Investing could arguably be a form of RI…however as the more positivity-aligned terms and practices of Impact Investing have grown in popular appeal and discussion, the term RI is slowly falling from use.
In the end, ESG is a universe of data reflecting corporate environmental, social, and governance performance. ESG investing uses this data to understand how external developments and events are likely to impact corporate operations and profitability whereas Impact Investing uses this data to understand how corporate operations are likely to impact external developments and events. Everything else is a sub-category of Impact Investing.
All of these terms are so closely related that trying to distinguish one from the other may seem simply to be an exercise in semantics…but that would be an unfortunate assumption, and one too many media outlets seem to be making today.
What differentiates one from the other is the values framework employed throughout the investment-decision process…and values frameworks matter. The values frameworks reflect the intentions of the investment process and, as we said above, the investments we make today become the world we have tomorrow.
If news articles are discussing ESG but their examples are about Green Investment then of course ESG will appear broken. If news articles are diving into the outcomes of Impact Investing but their examples are about ESG investing, then of course Impact Investing will appear hypocritical. If news articles substitute SRI for Sustainability Investing then of course it will appear that capital markets will never contribute to a more sustainable future.
ESG data underpins all of this, but it is in the distinct intentional values frameworks of each approach that words are transformed into actions. Get the words right.
What This Means for CSOs: Quite likely what you do is understood as ESG, Sustainability, or Impact depending upon who you are talking to, but when you structure your programs and policies, set your organization’s strategies, and contribute to business development you quite likely have a particular values framework for what it is you are doing in mind. How you disclose data, report on progress, and communicate about programs goes a long way in ensuring external audiences also understand what you are doing from this same values framework.
We see a lot of extremely long and comprehensive Sustainability of ESG reports touching on absolutely everything that is not included in the more focused financial reports. Transparency and disclosure are great, but there is nothing that says you can’t issue an ESG Report prepared within one particular values framework, a Sustainability Report prepared within another values framework, and an Impact Report prepared within yet another (or some other combination of reports that best fits your objectives).
Sharing information is great, but sharing information within a values framework you want it to be understood is even better. Just remember, many audiences, and media outlets, in particular, will not put in the time to identify values frameworks that are not already identified for them…and this simply leads to misunderstandings, misrepresentations, and missed opportunities.
In the end, definitions matter...and definitions shift. Work in ESG and Sustainability is inherently collaborative and collective, and so it is critically important that we communicate with shared understandings. We are focused on this space and will have more to say in our next edition, in the meantime, please connect with us on Twitter and LinkedIn, or from our website to continue this discussion.