The Differences Between ESG/SRI/CSR, Impact Investing and Philanthropy
By Dr. Laura Starks, The Charles E. & Sarah M. Seay Regents’ Chair in Finance
Co-Executive Director, Social Innovation Initiative
People often become confused over the differences among responsible investing concepts (ESG, CSR and SRI) as well as over the differences between these concepts and the concepts of impact investing and philanthropy. While all of the concepts are related, each has its own definitive goals and characteristics. In addition, the interest and the money flows into ESG, Impact Investing and Philanthropy have been increasing substantially in recent years.
ESG (Environmental, Social and Governance) refers to the ways in which corporations consider these dimensions in their operations and the ways in which investors consider these dimensions in selecting assets for their portfolios (e.g., stocks, bonds, real estate). Two major alternative terms for similar approaches are: For corporate actions (CSR, Corporate Social Responsibility) and for investing (SRI, an acronym used for several phrases — Socially Responsible investing, Sustainable and Responsible Investing, Sustainable, Responsible and Impact Investing). In addition, there are a number of other terms that are often used for responsible investing approaches.
The major goals of most of these investing approaches are to do well while doing good. That is, the investors want to receive both a financial return and a positive social outcome (social return). The characteristics of the investing approaches can vary quite a bit from negative screening approaches to positive tilt approaches and even ESG momentum approaches. SRI investing originated with a negative screening approach in which investors omit certain types of firms from their portfolios. For example, firms that have poor environmental ratings, firms that have poor practices with regards to human rights or animal rights, or firms that deal in certain products (alcohol, tobacco, gambling, weapons). On the other hand, many ESG investing approaches tend to have a positive screening approach in which the investor tilts their portfolio, i.e., greater portfolio weights, toward firms that have higher ESG ratings with lower or no portfolio weights on firms that have low ESG ratings.
ESG investing has grown rapidly across the world over the past two decades. According to the SIF Foundation, in 1995, the U.S. sustainable and responsible investment universe had approximately $639 billion in assets under management. At the beginning of 2018, there existed about $11.6 trillion in US-domiciled assets in which managers apply various environmental, social and governance (ESG) criteria in their investment analysis and portfolio selection. ESG investing has been growing even more rapidly in Europe. According to a survey by RBC of institutional investors and consultants, 77% of those in Europe think that an ESG approach to investing mitigates risk and 51% think that it is a source of alpha.
ESG investing is no longer a niche strategy nor is it a strategy based solely on one’s preferences or beliefs. Many “traditional” institutional investors are now employing ESG strategies because they think that it will help them understand the risks of the firms in which they invest. For example, ESG can give insights into a corporation’s systematic risk, relative risk, reputation risk, litigation risk, supply chain risk, corruption risk, estimation risk, downside (tail) risk, political risk and climate risk. Traditional institutional investors are also starting ESG funds, both mutual funds and ETFs, in order to attract younger investors such as millennials who have strong preferences toward investing in high ESG corporations.
A number of third parties such as MSCI, Morningstar, Bloomberg, Thomson International, are providing ESG ratings for corporations and for mutual funds. Morningstar reported last year that investors are avoiding traditional mutual funds that have low ESG scores. The interest in ESG investing has grown so high that corporations are even hiring ESG specialists to help them in talking to their investors and to the rating firms. In addition, the integration of ESG into the investment process has been added as a component to the CFA exam. What is even more exciting about this field is that there still exists ambiguity regarding the parameters and weights defining ESG for a company or portfolio and there exists ongoing development and conversation around the structure. Thus, the field is growing in terms of job possibilities and making a difference.
Impact investing is similar to ESG investing in that the investor has an interest in the ultimate environmental or social outcome of the investment. However, impact investing is centered on intentional social or environmental impact while earning a financial return. According to the latest Global Impact Investing Network (GIIN) survey in 2018, impact investments among their survey participants totaled $228 billion. This number has also grown dramatically over time and is expected to keep growing.
Just as there exists diversity in preferences across ESG investors, there also exists diversity in preferences across impact investors, both in terms of the types of environmental or social projects they want to support but also in terms of their desired returns on the investments. While some impact investors are willing to relinquish financial returns, that is, earn below market returns, in order to further their impact, according to GIIN, more than half of impact investors expect to earn a market return or greater on their investment.
Finally, in philanthropy or charitable giving, the individual or corporate donor pays for some type of environmental or social outcome, but does not expect a return. The money is often “freely” given, although some donations are subject to certain stipulations. According to Giving USA, in 2017, charitable giving exceeded $410 billion, with 70% coming from individuals, 16% from foundations, 9% from bequests and 5% from corporations. It grew by over 5% from the previous year.
This semester I am teaching about these topics. I am teaching “ESG Investing” MW 12:30–2:00 and in collaboration with Professor Drumwright “Investing in Philanthropy” TUES 3:30–6:30 pm. Both courses will have segments on impact investing.