Over the last couple of years, there has been a notable shift in the way people invest. Most of these changes arise from investors preferring strategies that are more ethical and responsible. The two most notable of these strategies are environmental, social, and governance (ESG) and socially responsible investing (SRI). With the new trend showing no sign of ebbing out, it is time for you to also join, but which one do you select between SRI vs ESG?
It is not surprising that SRI and ESG get confused because both factor in environmental and social impacts. However, there are notable variations between them that you should know. This post takes a deeper look at SRI vs ESG to help you determine the main differences.
SRI vs ESG Investing: A Deeper Look
By the start of 2020, ESG and SRI investing assets shot up to USD17.1 trillion from USD3 trillion in 2010, according to US Social Investment Forum (SIF). This trend is getting amplified by stock markets, such as Hong Kong Stock Exchange (HKEX) and London Stock Exchange (LSE), which are pushing for more responsible company operations. Their demand for regular and accurate non-financial reports has provided investors with a new way of pinpointing the most sustainable companies to target.
This is a method of investing used by investors to identify and exclude organisations that conflict with their values. It can be traced back to the founder of the Methodist Movement, John Wesley, who called his followers to stay away from “sin stocks” that generated profits via tobacco, gambling, alcohol, and tobacco. Today, this SRI list has been extended to include the following:
- Stocks and investments associated with fossil fuels.
- Firearms manufacturing enterprises.
- Equities of businesses that accelerate damage to biodiversity. Good examples are companies involved in open water whaling and those dealing with animal trophies that increase the risk of extinction.
- Companies that release a lot of harmful pollution into the environment. The most notable of these are the firms with a high carbon footprint.
Environmental, social and governance (ESG) is a relatively new concept that gained prominence from around 2006 when the UN released its Principles for Responsible Investment.
Like SRI, it is still driven by ethical values, but the focus is relatively broad.
Instead of only looking at how a particular investment or company adheres to ESG requirements, it further targets two crucial things: how the same business is impacted and future preparedness to operate more sustainably.
Investors with a lot of focus on global warming will not just check how the company is cutting down the emissions but also how the same phenomenon of climate change is impacting it. For example, is the company of interest suffering from the impact of high cost of supplies because of global warming?
Another notable difference between SRI vs ESG is that the latter targets progressive improvement in companies. This means that a company will not just be screened out of a fund because it is making pollution, but based on its plan to progressively reduce it and responsible operations. For example, a company with a higher MSCI score or other ESG rating will be considered a more preferred investment option than another one with a lower score.
SRI vs ESG: Drawing the Right Strategy for Investment
Once you have determined the difference between SRI vs ESG, the next item is the preferred strategy.
Crafting an SRI Investment Strategy
SRI investing is an active investment method where you screen the non-preferred options from your financial portfolio based on the preferred standards.
So, how do you craft a good socially responsible investing (SRI) strategy? Here are the main steps to follow:
- Start by evaluating your targets and risk tolerance. This is crucial because it will help you to determine the expectations for the targeted portfolio companies.
- Select the preferred SRI fund for investments. Consider identifying several options and narrow it down to the portfolio that aligns with personal values. Common screens you should consider are avoiding companies that make excessive emissions and have rampant labour malpractices.
- For investment fund managers, it is prudent to capture the decisions with accurate data and provide regular reports for your investors or other stakeholders. Remember to include regular assessments to demonstrate that the ethical targets, whether it is helping to address child labour or reducing carbon footprint, are being improved with time.
Common ESG Investing Strategies
ESG investing has already been integrated into a large number of institutional investors in Europe, the Middle East, America, and Asia. According to a recent report by Price-Water-Coopers, companies with higher ESG scores outperform those with poor sustainability performance. This is one of the realities driving the growing demand for ESG in different investment fields. Here are some of the common ESG investment strategies that you should consider:
- Thematic ESG investing: This model focuses on a specific theme in any of the three core areas of ESG. The idea is to include companies with strong values and that target addressing specific niches, such as labour issues, climate risk, and clean energy.
- Inclusionary screening: This strategy involves using filters to exclude or include companies to target based on the preferences of investors.
- ESG Integration: This method entails incorporating sustainability data alongside conventional/ traditional financial analysis when selecting securities for investment.
SRI vs ESG: Which One Should You Use?
Broadly speaking, if you are an investor with strong support for socially and environmentally friendly investment, ESG investing would be a more comprehensive approach. This is because this investment approach also considers how the selected companies/ entities of interest are impacted upon.
Today, the recommended ESG models are also focusing on crafting strategies for addressing future challenges.
However, SRI investing might be a better option for investors who do not mind foregoing specific considerations because it does not fit into their beliefs. This could mean avoiding specific mutual funds and exchange traded funds (ETFs), because they go against your beliefs. It could also imply a lower potential for returns.
This SRI vs ESG investing post has demonstrated that these are the fastest growing trends today. However, ESG investing came out as a stronger model because it is more comprehensive and further looks at the ways the selected companies or equities get impacted by ESG factors. This extensive scrutiny requires companies to adopt good sustainability & financial management practices and report them based on core principles such as materiality, accuracy, and continuity. Make sure to select the right sustainability reporting software and get expert assistance from Diginex.com to impress the targeted investors.