ESG (Environmental-Social-Governance) oriented investments focus on environmental, social and governance factors and measurements. The environmental, social and governance factors of an ESG oriented company ensure that the financial return is adjusted for ESG risks. The reason of this adjustment is that the cost of non-financial challenges is usually reflected in the financial outcomes over the course of a company’s lifecycle. Therefore, creating a holistic company profile with ESG factors provides a more effective picture for the investors to see and evaluate the weak and strong sides of the business.
Although ESG factors are also important in impact investing, what makes an investment an impact investment is not the ESG profile. ESG-oriented investments are about the activities (health and safety of employees, transparency of supply chain, structure of board, etc.) of a business. It is a matter of participating to overcome a social or environmental challenge while producing goods or services. The ESG method is a compliance model to avoid harm whereas impact investing is an intentional investment to do good.
For example, a company running an oil exploration business reduces the risk of compensation or financial loss by setting high-security precautions, mandatory maintenance procedures and strong health and safety regulations in case of an oil spill or accident. Such a company can be considered “perfect” within the ESG perspective and become a center of attention for investors due to its reduced risks. However, a business producing revenues from fuel can not be an impact investment although it has a very strong ESG report. Impact investments are based on the targets of sustainable development goals and have intentionality of generating good as the first step.
It is crucial to remember that, there is an audit mechanism that prevents a potential environmental, social and governance-related harm in ESG investments. On the other hand, there is an intention to create positive impact from day one for impact investment project.
