Understanding the difference between ethical and ESG investing

The Fund Management industry uses many terms to describe investments that aim to achieve more than just financial returns. Some of the most common ones include ESG, ethical, responsible, sustainable and impact investing. To help you work your way through the different terms, we have set out some of the major – or not – differences between these types of investing.

What is ESG

Environmental, social and governance (ESG) investing is a strategy that puts your money to work with companies that strive to make the world a better place. Using a set of standards to assess a company’s operations, socially conscious investors can screen potential investments to make sure that they only hold assets that align with their values.

• Environmental: Considers how a company performs sustainably.
• Social: Examines how it manages its relationships with employees, suppliers, customers, and the communities in which it operates.
• Governance: Focuses on a company’s leadership, executive pay, audits, internal controls, and shareholder rights.

ESG could also be described as sustainable or responsible investing, as it considers the short- and long-term impacts of the companies you choose to invest in. With ESG, it is important to secure a financial return, while also making a positive difference to the world and its people.

Is ESG investing ethical?

It may be, but it depends on your own, or your organisation’s specific ethics.

Many ESG Funds will tolerate some exposure to industries or companies that your organisation may not wish to support. At the same time, however, the revenue earned may be incidental, or that company may be striving to improve its environmental and social impact. 

For example, a packaging firm with excellent ESG credentials overall may derive some revenue from the tobacco industry or an energy firm that may be investing heavily to transition itself from fossil fuels to renewable energy sources. 

If your organisation has strict ethical criteria, you may not want to take on any exposure to such companies or industries. In this case, your specific ethical consideration might exceed any benefits that the company could be delivering on a wider level.

What about impact investing?

ESG or ethical funds can have an impact, if they avoid investments in certain types of companies or have a certain focus on a desired outcome. For example, they may contribute to tackling climate change by avoiding investments in coal-powered electricity generation. However, the funds may not invest specifically to achieve that impact. 

In comparison, impact funds prioritise achieving the desired result over generating a financial return. For example, the goal could be to improve access to basic healthcare for 10,000 people in a specific area, which would outweigh considerations of generating a return on the money committed.  

Why is there no common definition of ESG?

Every industry has different, and often confusing, terms. But work is underway in the financial services sector to rationalise those under discussion here.

In the UK, the Financial Conduct Authority (FCA) has introduced the Sustainable Disclosure Requirements (SDR) to make sure that regulated funds adhere to a set of rules. Funds can also choose to apply for one of four investment labels for their products with sustainability objectives, which aim to improve or pursue positive outcomes for the environment and/or society. You can read more about this evolving work on the FCA website.

How do we know if out investment aligns with ESG principles?

Fund names or headline descriptions will only tell you so much about the investment options you are considering. Therefore, you also need to read any potential fund’s investment policy fully. This includes any separate ESG or ethical policy they provide, before you make any investment decisions.

Under the SDR Rules, any regulated fund making sustainable claims must produce a short summary of its approach. As an example, the disclosures for the IFSL CAF ESG Growth Fund can be found on the IFSL website. The FCA is also assessing whether to extend the SDR regime to other types of investment, and recently consulted on whether they should be applied to portfolio management services.

If you are thinking of investing as a charity then our guide to charity investment may help get you started.