Investors seeking to ‘do good’ with their investments while generating a financial return, perhaps through a sustainable investing strategy, could be forgiven for finding the language of sustainable investing confusing.
Tribe Impact Capital was established to help its clients achieve financial returns whilst bringing about positive change for people and planet. Here, Amy Clarke, Tribe’s Chief Impact Officer, explains the differences between ESG and impact investing, and how Tribe harnesses both in its sustainable investment process.
Why impact investing?
The Financial Conduct Authority (FCA), the UK financial services regulator, found that 81% of adults surveyed would like the way their money is invested to do some good as well as provide a financial return i.
At the same time, a report by Make My Money Matter found that UK pension funds are estimated to invest over £88 billion into the fossil fuel industry. While 70% of the representative funds in the schemes disclosed Shell among their top holdings, not one renewable energy stock was listed in those holdingsii.
From these two reports, it’s clear that there is a mismatch between how individuals in the UK would like to invest and how their money is actually being invested on their behalf, particularly in the context of pensions
From these two reports, it’s clear that there is a mismatch between how individuals in the UK would like to invest and how their money is actually being invested on their behalf, particularly in the context of pensionsiii.
Impact investing seeks to address this mismatch, by creating a mechanism to reconnect wealth holders to their wealth and empower them to make the decisions to invest in the things they care about. Impact investing focuses on addressing major social and environmental challenges while generating financial returns. From climate change to gender equality, sustainable cities to government policy change, the range of these challenges are varied but interconnected. Impact investing is often a way for investors to express their personal values through their investments: using business to solve social and/or environmental problems.
The difference between ESG and Impact
Given the widespread use of new acronyms and terms in finance associated with sustainable investing, it’s not hard to understand why there may be confusion as to the differences between the various labels and language used. Without a clear understanding of these differences, investors who seek to broadly ‘do good’ with their wealth run the risk of not achieving the positive impact they may have hoped for.
The strength of impact investment strategies lies in the clarity of the goal: to invest in well-run businesses seeking to solve global problems
The strength of impact investment strategies lies in the clarity of the goal: to invest in well-run businesses seeking to solve global problems. Many environmental, social and governance (ESG) investment strategies position themselves as having the same ambition. However, whilst ESG provides a helpful framework to begin the assessment of risks, it also presents significant limitations which impact investment strategies seek to solve. Like impact strategies, ESG strategies have an innate insight at their core – risk management. They favour management teams which are thinking beyond the next quarter’s earnings and considering the possible operational risks that could arise from their business’ position and interaction with the wider world. In a purely monetarist, free-market system, ESG considerations would have limited appeal. Governments would be unlikely to hold businesses to account for their poor polluting, working or management practices and so investors would be unlikely to take notice.
Knowing that no company operates in such a theoretical vacuum, ESG has become a powerful framework for businesses to consider their operational risks using a shared language developed alongside investors
Knowing that no company operates in such a theoretical vacuum, ESG has become a powerful framework for businesses to consider their operational risks using a shared language developed alongside investors. This provides shareholders with a more detailed gauge of businesses’ awareness and treatment of a broader suite of risks that could undermine financial performance.
A reliance on ESG data in isolation, however, has significant limitations. The biggest ‘risk’ being assertions of ‘sustainability’, ‘responsibility’ or ‘impact’ obtained from a single, publicly available ESG data source. Even Investopedia makes the mistake of assuming that funds with high ESG scores are automatically impact funds. They aren’t iv.
An impact strategy can’t be passive, it requires active and considered management along with a detailed understanding of an industry in order to understand the potential challenges and the opportunities that investing brings
Genuine sustainability and approaches to creating long term social and environmental benefits involve engagement and intention. These allow an investor to better understand the direction of travel for a business and whether it is positively contributing to society and the environment. Detailed engagement with a business’ products and services, along with its corporate history, enables investors to get a more informed view on its ability to transition to be a positive contributor. That ability to contribute informs the benefit a business should receive from the opportunity from new customers, new markets and regulatory fitness. Data needs to be acquired from multiple sources and a range of specialists. This data then needs to be interpreted and used alongside the qualitative experience of engagement to inform the decision-making process. An impact strategy can’t be passive, it requires active and considered management along with a detailed understanding of an industry in order to understand the potential challenges and the opportunities that investing brings.
The risks of separating ESG and Impact
Tribe is an impact investor, incorporating both ESG and impact analysis into our investment process. At Tribe, we use the UN Sustainable Development Goals (SDGs) as our framework to help us towards that goal v.
We’ve seen examples of businesses that would never be recognised as responsible or sustainable – due to certain business practices which would be identified and flagged in our impact due diligence process – appearing in active and passively managed funds under an ESG banner. This has occurred across industries. For example, in the finance sector, we’ve seen a bank getting exemplary scores for governance while investing billions of dollars into tar sands exploration businesses. Within the retail clothing sector, we’ve seen large gaps in data and scrutiny on both the environmental and social impact of production overlooked.
The addition of an impact lens, alongside ESG, creates this more holistic view of a company by considering how well-run a business is from an inward-looking perspective (ESG), as well as the impact its products or services have on the wider world (impact).
From this, problems arise in both hoped-for impact and financial returns. This misrepresentation is misleading and opens investors up to the exact risks they were seeking to protect themselves from with a sustainable investment strategy. Therefore, it’s important that false comfort isn’t taken in ESG data’s ‘protective blanket’, and a business’ strategy is interrogated in a more holistic manner.
The addition of an impact lens, alongside ESG, creates this more holistic view of a company by considering how well-run a business is from an inward-looking perspective (ESG), as well as the impact its products or services have on the wider world (impact). As a result, investors gain greater clarity and comfort over whether they are truly achieving their financial and sustainability objectives.
i Financial Lives Survey 2022, FCA
ii Fossil Fuels in UK Pensions, Make My Money Matter
iii Funded occupational pension schemes in the UK: July to September 2021, Office for National Statistics
iv Best Impact Investing EFTs, Investopedia
v Our approach, Tribe Impact Capital
The investment strategy and financial planning explanations of this piece are for informational purposes only, may represent only one view, and are not intended in any way as financial or investment advice. Any comment on specific securities should not be interpreted as investment research or advice, solicitation or recommendations to buy or sell a particular security.
We always advise consultation with a professional before making any investment and financial planning decisions.
Always remember that investing involves risk and the value of investments may fall as well as rise. Past performance should not be seen as a guarantee of future returns.