Some investors today aren’t satisfied with just the bottom line and financial returns on their investments. Many are now investing not only to grow wealth but also to preserve the planet and improve society. This new investment strategy continues to increase momentum as individuals invest their money in companies committed to improving the world through social and environmental initiatives.
Coupled with financial performance, they have the potential for a win–win, meeting their financial, environmental, and societal goals. Two more popular types of this new investing strategy are environmental, social, and governance (ESG) and impact investing. Though similar in their push for change, these strategies are slightly different.
What is ESG?
ESG is a non-financial sustainable metric that measures the health of a company’s operations and employee welfare, including diversity and inclusion initiatives, the makeup of the board, the strength of the company oversight, and the overall environmental footprint. It considers the environmental, social, and governance factors toward the betterment of society and the world.
Over nearly a decade, studies indicate that companies that continually scored high on ESG factors recognized 2.6 times greater shareholder returns than average ESG scorers. Not only that, higher ESG scores were linked to a 10% lower cost of capital. ESG is broken down into three components:
Companies committed to sustainable environmental practices.
Companies focused on promoting an inclusive and diverse work environment.
Companies dedicated to establishing a diverse board, sound corporate oversight of operations and management, and more shareholder-friendly practices.
What are the pros and cons of ESG investing?
- Improved innovation and adaptability.
- Enhanced diversity and inclusion practices.
- A focus on the positive impact on environmental issues and initiatives.
- More companies are transitioning toward an ESG business model and mission with sustainability goals.
- Attracting new talent and generating new jobs.
- Fees and costs. ESG funds can potentially subject the investor to higher than average expense ratios.
- The Securities and Exchange Commission (SEC) doesn’t yet follow a set of standards specifically for ESG while regulating the reporting for publicly traded companies. The International Sustainability Standards Board (ISSB), a third party agency, is working to formulate a comprehensive set of standards to regulate ESG reporting and metrics.
- ESG companies may underperform during energy stock booms.
- Potential of becoming under-diversified because of your ESG investment motives.
- There is risk involved with any investment, especially one that is not yet sufficiently regulated.
What is impact investing?
Impact investing involves investments made into companies, funds, and organizations to make a social and environmental impact on the world while generating financial returns. Like ESG investing, impact investing is broader than just investing in companies that align with your values. It is also about refraining from investments in funds or companies that do not meet your social and environmental expectations.
It is interesting to note, according to Fidelity, that the impact investing initiative has become very popular among the wealthy and women. Over 40% of millennials claim to have participated in impact investing compared to 20% of baby Boomers.
What are the pros and cons of impact investing?
- You can be a part of combatting some of society and the world’s most pressing issues including poverty, climate change, and limited access to healthcare and education.
- Along with bettering the world you also have the potential to grow your wealth through your investments.
- This approach to investing can help diversify your portfolio.
- Potential for enhancement in job creation.
- Potential of being under-diversified due to your impact investment approach.
- Risk of uncertainty without set standards.
- There is a lack of set standards for reporting and metrics. Investors have to be wary of getting caught up in enthusiastic investing that is not yet monitored through well-tested professional investing standards and principles.
- There is risk involved in any form of investing.
How are ESG investing and impact investing different?
The core difference between the two is that ESG, as stated above, is a non-financial metric of a company and its overall health, including how well it is run, the makeup of the board, the diversity and inclusion of employees, general employee welfare, and the company’s environmental footprint. Impact investing, on the other hand, involves investments in companies and focusing on the products and services of the company and how they drive environmental and social change, creating an impact.
Due to the complexity of this relatively new investment approach, the risk of investing in general, and aligning your financial short- and long-term strategies, consider consulting a financial professional before making any financial decisions.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.
Environmental Social Governance (ESG) / Socially Responsible Investing (SRI) investing has certain risks based on the fact that the criteria excludes securities of certain issuers for non-financial reasons and, therefore, investors may forgo some market opportunities and the universe of investments available will be smaller.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
This article was prepared by LPL Marketing Solutions
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