What Is the Difference Between Sustainability and ESG Investing? (Beginners guide)
If you are an investor, you are probably starting to hear and think about the impact of your investments on the world.
You may have started taking not only financial factors into consideration when considering your investment options. Environmental, social, and governance standards or ESG and sustainability are now also key considerations in making the right investment for your and the planet’s future.
However, sustainability and ESG investing are not exactly the same, even though the term ESG literally has ‘environmental’. ESG policies centre around financial risk and reward. In comparison, sustainability uses specific metrics to measure the environmental impact and the sustainability of the interventions.
What investing strategy should you give preference to – sustainability or ESG investing?
Let’s dive a little deeper into the topic to find out “what is the difference between sustainability and ESG investing?”.
What Is Corporate Sustainability?
When people mention sustainability, they usually refer to the sustainable use of resources, ‘reducing their carbon footprint’ and becoming more ecologically friendly. Nowadays, this term is also often linked to gender equality and social responsibilities.
And that’s where some of the challenges with sustainability start. The term sustainability has started meaning a lot more than what the word actually means (‘the ability to avoid the exhaustion of natural resources while maintaining an enterprise‘).
Corporate sustainability can be a vague term that can’t easily be monitored or quantified. Even though the world’s top companies chose to report on sustainability, there are concerns that it is impossible to measure the environmental impact of an enterprise by monitoring only these three common areas:
- The risk of the loss of biodiversity
- Carbon reduction reporting
- Reporting on the UN’s Sustainable Development Goals
In theory, companies should be able to implement a sustainable business strategy, but in reality, the majority of corporations end up exaggerating their sustainability simply because it is not clear how sustainability has to be measured.
As a result, plenty of organizations came up with strategies, policies, and incentives that are not exactly focused on sustainability’s main object.
The main terms that can be used to describe corporate sustainability include (you can use those to conduct further research):
- CSR (Corporate Social Responsibility)
- Sustainability strategy
- Sustainability program
- Sustainability plan
- Sustainability framework
- Economic sustainability
Sustainability investing is based on exclusively selecting socially responsible shares. The portfolios don’t include the companies with questionable practices (from the moral point of view) and those that have a negative environmental impact.
Such an investment strategy might sound like a good idea, but the majority of asset managers agreed on the fact that such funds would actually end up performing worse than the market’s average.
What Is ESG?
The term ESG was first used in a study called “who cares wins” in 2004 after the then UN Secretary made a proposal to the biggest financial institutions to partner with the United Nations in identifying the paths that would include the Environmental, Social, and Governance concerns in the financial markets.
The ultimate aim was to set specific criteria that could be used in the future to define a certain system as ‘sustainable’. ESG made it possible to remove ambiguity from the term ‘sustainability’ that became way too broad and vague over the years.
What is the difference between sustainability and ESG investing? ESG is more data-driven and specific, and it focuses on three areas:
- Environmental – revolves around improving the business’s environmental performance (reducing waste, complying with regulations, etc.)
- Social – focuses on the impact of the company on its clients, employees, and community (customer satisfaction, employee engagement, etc.).
- Governance – this area involves the company’s structure and leadership (the shareholders’ rights, the executives’ salary, etc.).
The main terms that can be used to describe ESG include:
- ESG investing
- ESG metrics (non-financial data, for example, greenhouse gas emission metrics and employee health and safety)
- ESG policy
- ESG framework
- ESG reporting
- ESG certification
What Is ESG Investing?
Today, businesses can use the ESG criteria to mitigate risk and prepare for the future. This kind of data helps identify businesses’ political, environmental, social, economic, and technological risks.
ESG-oriented investing has skyrocketed in the last few years. That is mainly because the investors realize that an effective ESG strategy can safeguard the business’s long-term success.
The numbers speak for themselves:
- Nearly 80% of US individual investors are interested in sustainable investment (when it comes to millennial investors, the percentage is higher – 99%).
- A strong ESG strategy can significantly reduce costs and influence operating profits by up to 60%.
- By 2025, ESG-mandated assets might make up 50% of all professionally managed investments.
ESG investing is not simply screening out the companies profiting from unsustainable or harmful practices. An ESG investment strategy aims to identify and then rank businesses in accordance with desirable environmental, social and governance characteristics and associated risks.
Far more categories fall under the ESG umbrella when compared with environmentally sustainable investing.
What Is the Difference Between Sustainability and ESG Investing?
- When people talk about sustainability investment-wise, they mean the relationship between the business and the environment. ESG is not only about how the company affects the environment but also about decision-making, identity, and stakeholders.
- Sustainability focuses on the funds that the actual company can invest into making the business more environmentally friendly, while ESG screening also helps investors assess the company and the risks it faces.
- ESG involves sustainability but is not limited to it.
- The set of criteria provided by ESG can be used by businesses to measure and report against.
- A company that has achieved environmental sustainability (is carbon neutral, doesn’t produce any waste, and so on) might not be able to meet the ESG criteria if the governance or social aspects are neglected.
What are the potential cons of ESG investing?
The issue with ESG investing is that there is no agreed way to access the three factors.
Which ESG factor is important or more important is a personal choice and not weighted equally.
A company might receive a high ESG score but be involved in unethical practices or practices that you personally find unethical.
ESG judges the risks a company faces across environmental, Governance and Social lines, but it does not judge the morality or positive impact of the company.
ESG is not about values; it is about managing risk.
This is why investors need to understand what and how ESG factors are being considered in any potential investment.
Final Thoughts: What Is the Difference Between Sustainability and ESG Investing?
So, what is the difference between sustainability and ESG investing?
ESG policies use specific metrics. This allows the investors to evaluate the potential and risks of a company with more precision.
In fact, the development of ESG ratings and scoring has made it easier for potential investors to make up their minds as businesses are now ranked in accordance with their governance, social, and environmental policies.
But to be clear, ESG is not necessarily about values or ethical concerns but about managing environmental, social and governance-related risks.
ESG factors can be a good filter in an investment decision-making process as a company’s ESG strategy may determine its long-term success or otherwise.
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