The Difference Between ESG and Impact Investing: Explained
We talk often about the importance of environmental, social, and governance (ESG) factors in investment decisions. However, what exactly is ESG, and how does it differ from impact investing? That’s actually an incredibly important question—in fact, it’s one of the key reasons that Lebec Consulting exists. And if you don’t know the answer, you’re not alone.
What do we mean by “doing no harm”?
If we think of socially responsible investing (SRI) as an umbrella, ESG integration is one of the key mechanisms that upholds it. Often, it falls into this category of “doing no harm.” In other words, a lot of investment firms purported to be socially conscious—in fact, the majority of them—focus simply on making investments that screen out a series of broadly-defined negative factors. These are investments in equities or companies with direct or indirect ties to things like fossil fuels, weapons, nuclear stocks, fur, and “sin” stocks—namely tobacco, alcohol, gambling, and pornography.
The idea here is to implement exclusionary screens (i.e., incorporate ESG considerations) into investment decisions to help enhance risk-adjusted returns—regardless of whether or not a strategy has a sustainable mandate. To many investors, these exclusions remain critical—as they view the exclusion of negative factors to be a form of acting responsibly. In fact, for this reason, nearly one-fifth of all professionally managed assets now exclude companies based on their involvement in controversial products or services. And the numbers keep growing.
But let’s be honest. Though ESG integration is a nice idea, if the best investment returns are to be generated by those companies providing solutions to environmental and social challenges—investment managers are selling themselves short by focusing on exclusionary tactics alone. This strategy merely adds a decorative glaze to a problem that goes much, much deeper—primarily serving the purpose of allowing investors to feel good or uphold a positive reputation.
While ESG integration is arguably better than directly contributing to factors that harm people and the planet, it also doesn’t help them. From another perspective—and we see this in other areas, like racial equity—not taking direct action is akin to actually doing harm, because failing to block the path for those controversial products and services means that they continue to exist and move forward.
How can we actually “do good”?
This brings us to the key question: If ESG isn’t enough, what is? What truly moves the needle on massive global issues? The answer is impact investing—and we mean impact investing that is truly creating transformation for the billions of people still living in poverty, with the end goal of generating systems change. In other words, making investments that focus on the root causes of the largest, most intractable issues facing people and the planet—primarily poverty, inequality, and the global water, energy, and climate crises. Arguably, all other issues—health, education, hunger, and housing, to name a few—stem from them. This is exactly why the 17 United Nations (UN) Sustainable Development Goals (SDGs) were created—to act as a "blueprint to achieve a better and more sustainable future for all.” If we can solve these key global issues by 2050—making great headway no later than 2030—then we finally have a shot at getting our environment and humanity back on the right track.
To do this, we can no longer focus on Band-Aids for problems. We need solutions aimed at tackling the underlying issues. To put this in context, let’s consider an issue that we quite literally face every day: homelessness. If you see a homeless man on the street, and you choose to ignore him—does it do him harm? Not necessarily. Now, what if you give him your leftovers from a restaurant you just visited? Does it solve his problems? Not even close—but you’re alleviating some of his concerns for a night. What if, instead, you immerse yourself in the life of this man—providing him with food, housing, education, job training, substance abuse rehab (if necessary), psychological therapy, and assistance with roadblocks like lack of identification? Now we’re talking.
In short: Soup kitchens are among the most popular means of providing assistance, when it comes to homelessness. But even if we give time and funds to soup kitchens for the next century—it won’t make a dent in the issue. Instead, if we focus on immersive, full-scale solutions, it’ll get us a lot closer to reducing the gaps and getting people off the streets. That’s a watered-down way of explaining a multi-layered, extremely complex issue. But that’s exactly what we’re dealing with on a global scale, across several nations and straights and ecosystems.
Impact investing is one of the most tangible and scalable ways to solve global issues like these. It’s all about taking specific, proactive steps toward “doing good”—making intentional investments with the goal of generating measurable, scalable social or environmental impact alongside a reasonably attractive financial return. In this way, by tapping into global capital markets to help generate systemic change, it achieves what traditional investing cannot.
“Align your intentions with your impact and the decisions you make,” says Justin Fox, former Editorial Director of Harvard Business Review. “In the end, when you make a lot of money and that money just sits in a bank account, or perhaps buys you a luxury good—which, in the end, doesn’t give you a sense of fulfillment—then that money is not serving its purpose. Impact investing is, in part, reconciling what markets may not be serving well. But the bigger picture is that it is reconciling the dissonance between what we think money can do, and what it can actually do for us” and the planet.
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