Positive impact: should you swap ESG for other ethical alternatives?

The rapid rise of envi­ron­men­tal, social and gov­er­nance (ESG) invest­ments should be viewed as a remark­able suc­cess. But amid the excite­ment, crit­ics have cast doubts on the trans­paren­cy and mea­sur­a­bil­i­ty of ESG, warn­ing that some list­ed busi­ness­es may be abus­ing the label. 

Investors and con­sumers alike want busi­ness­es to do more about issues such as cli­mate change, diver­si­ty and human rights abus­es. The cor­po­rate world is respond­ing. Accord­ing to Bloomberg, mon­ey held in sus­tain­able mutu­al funds and ESG-focused exchange-trad­ed funds rose glob­al­ly to $2.7tn (around £2.35tn) last year – up by 53%.

How­ev­er, there are a range of con­cerns. For exam­ple, the rat­ings agen­cies that grade ESG per­for­mance tend to focus on a firm’s efforts to off­set harms and risks linked to sus­tain­abil­i­ty, rather than its actu­al prod­ucts and ser­vices. This explains why elec­tric car­mak­er Tes­la was exclud­ed in May from a list of the most social­ly respon­si­ble com­pa­nies in Amer­i­ca – the S&P 500 ESG Index – while the likes of Ama­zon and oil and gas giant Exxon­Mo­bil remained in place.

Rat­ings agen­cies also rely on ESG data pro­vid­ed by com­pa­nies them­selves to make their assess­ments, mak­ing it hard­er to avoid so-called ‘green­wash­ing’. Researchers at Colum­bia Uni­ver­si­ty and the Lon­don School of Eco­nom­ics recent­ly com­pared the ESG records of US com­pa­nies in 147 ESG fund port­fo­lios with those in 2,428 non-ESG port­fo­lios and found the for­mer group had worse com­pli­ance records when it came to labour and envi­ron­men­tal rules. 

Even the finan­cial per­for­mance of ESG invest­ments is being called into ques­tion, at a time when ris­ing infla­tion and inter­est rates are rat­tling mar­kets. Some investors are seek­ing alter­na­tive ways to invest eth­i­cal­ly. 

Avoiding contradictions

One increas­ing­ly pop­u­lar choice is ‘impact invest­ing’. Unlike an ESG invest­ment, where finan­cial returns and risks take pri­or­i­ty, impact invest­ments first and fore­most aim to pro­duce a tan­gi­ble and mea­sur­able social good. That could mean back­ing com­pa­nies that are help­ing to roll out clean ener­gy, sus­tain­able agri­cul­ture or micro­fi­nance, or pub­lic ser­vices such as health­care and edu­ca­tion. 

“Impact invest­ing means focus­ing your invest­ments on com­pa­nies and activ­i­ties deemed to be active­ly solv­ing the world’s prob­lems,” says Becky O’Connor, head of pen­sions and sav­ings at the invest­ment plat­form Inter­ac­tive Investor and author of The ESG Invest­ing Hand­book. “Focus­ing on impact is a neat way of avoid­ing some of the con­tra­dic­tions and dis­ap­point­ments that can ensue from ESG labels, which are far less pre­scribed.”

Accord­ing to the Glob­al Impact Invest­ing Net­work (GIIN), a US non-prof­it advo­ca­cy group, impact invest­ing offers an effec­tive alter­na­tive to phil­an­thropy and can be deployed in both emerg­ing and devel­oped mar­kets. Invest­ments are expect­ed to make a return, but these will vary depend­ing on an investor’s goals. Accord­ing to a 2020 sur­vey, GIIN found 67% of respon­dents were tar­get­ing risk-adjust­ed mar­ket-rate returns, 18% were con­tent with below mar­ket-rate returns, and 15% expect­ed some­thing clos­er to cap­i­tal preser­va­tion.  

Yet the mar­ket, while grow­ing, remains small. At the end of 2019, GIIN esti­mat­ed that around 1,720 organ­i­sa­tions glob­al­ly had about $715bn of impact-type invest­ments under man­age­ment.

Big players 

This may change as big play­ers dip their toes into the impact mar­ket. In 2020, the glob­al asset man­ag­er Schroders part­nered with Big Soci­ety Cap­i­tal, one of the UK’s lead­ing impact investors, to launch the Schroder BSC Social Impact Trust (SBSI). This Lon­don-list­ed fund invests in firms tack­ling “press­ing social prob­lems” and aims to achieve a sus­tain­able return. 

“We are tar­get­ing the deep­est lev­el of impact and find organ­i­sa­tions who use all their resources to con­tribute to solu­tions to social chal­lenges such as home­less­ness, men­tal health, unem­ploy­ment and fuel pover­ty,” says Andrew Beal, man­ag­ing direc­tor of investor engage­ment at Big Soci­ety Cap­i­tal.

About two-thirds of the trust’s invest­ments are linked to infla­tion, he says, and it is tar­get­ing returns equiv­a­lent to CPI plus 2% once it is ful­ly invest­ed over three to five years. “The trust’s invest­ments are large­ly uncor­re­lat­ed to main­stream mar­kets so we would expect the port­fo­lio to show resilience in times of mar­ket volatil­i­ty,” Beale adds. 

Anoth­er well-known impact investor is Nes­ta Group, which was set up by the gov­ern­ment but now oper­ates as an inde­pen­dent char­i­ty. It tar­gets pri­vate equi­ty-style invest­ments in areas such as ed tech, food tech and cli­mate tech, invest­ing both from its endow­ment and on behalf of pri­vate investors.

Lisa Bar­clay, its exec­u­tive direc­tor of invest­ments, says a wave of impact funds have launched over the last few years thanks in part to the “main­stream­ing of ESG”. But while impact isn’t high­er risk than oth­er asset class­es, she says, it does come with “a dif­fer­ent sort of risk” and won’t be for every­one. 

“We do expect impact invest­ment to grow, but it will like­ly remain a rel­a­tive­ly niche invest­ment strat­e­gy.” 

In truth, the market’s chal­lenges are many. Impact investors are under greater pres­sure to report and mea­sure the social and envi­ron­men­tal per­for­mance of their invest­ments, which can be com­plex. Some com­plain of a lack of suit­able exit options for impact invest­ments, a shared def­i­n­i­tion of what con­sti­tutes an impact invest­ment, rel­e­vant pro­fes­sion­als with the right skills to man­age these assets, and research on mar­ket trends, prac­tices and per­for­mance.  

“The pool of invest­ments that match true impact cri­te­ria is of course nar­row­er [than ESG], so this can mean it is hard­er to diver­si­fy, which is one of the gold­en rules of invest­ing,” O’Connor says. “How­ev­er, if you are com­mit­ted to plan­e­tary bet­ter­ment and you want all of your mon­ey to be too, this may be a risk you are will­ing to take.”

ESG battles on

Glen Yel­ton is head of ESG client strat­e­gy for North Amer­i­ca and EMEA at the fund man­ag­er Invesco. He agrees that impact strate­gies are “only tru­ly action­able in a lim­it­ed num­ber of asset class­es and mar­kets”, even if impact invest­ing often has a “clar­i­ty to it” that oth­er cat­e­gories of ESG invest­ing may lack. 

Eoin Mur­ray, head of invest­ment at the fund Fed­er­at­ed Her­mes, says that no one form of sus­tain­able invest­ing is bet­ter than the oth­er; it very much depends on what clients want to achieve. 

“Impact can be made through engage­ment and invest­ing in com­pa­nies that are capa­ble of addi­tion­al trans­for­ma­tion, where­as inte­grat­ing ESG will be suf­fi­cient for oth­ers and is equal­ly capa­ble of play­ing a role in the nec­es­sary tran­si­tion.” He accepts that ESG as a con­cept is fac­ing a back­lash as firms jump on the band­wag­on, but he thinks there will be a shake­out that leaves the indus­try “in a far bet­ter place”.

In truth, every type of eth­i­cal invest­ment strat­e­gy comes with trade-offs, and pro­fes­sion­als must be hon­est about this. But experts warn that a lack of clar­i­ty over terms and labels in the indus­try can lead to dis­ap­point­ment. 

City reg­u­la­tor the Finan­cial Con­duct Author­i­ty is look­ing into sus­tain­able fund labelling and will pub­lish a con­sul­ta­tion paper in Sep­tem­ber. It hopes to cat­e­gorise funds and make more explic­it options avail­able to investors, includ­ing impact. Until then, those who wish to put their mon­ey to work respon­si­bly would be wise to do their own research thor­ough­ly.