Friday, 10 August 2012

What is the difference between ESG and Ethical Investing?

This post will deal with the difference between ESG (which stands for Environmental, Social and Governance) and ethical investing.  They are actually very separate ideas although people tend to use them interchangeably.

At a high level the difference comes down to the following
  • ESG is a positive screen for companies which consider the environment, their social obligations and promote good governance
  • Ethical Investing is a negative screen which eliminates investments based on certain criteria (common examples include no gambling, tobacco, mining etc)

What is ESG?

When you invest using ESG you are investing in firms which operate in the 'best possible way'.  It can therefore be though of as a 'positive screen' for those firms and investments which operate in ways which
  • Minimise damage to the Environment
  • Promote Social well being
  • Are proactive about good Governance
Note that every investor that considers ESG will place a different emphasis on ESG considerations.  Further when considering ESG factors one can either look for firms that avoid the bad outcome or promote the good outcome.  For example:
  • Some investors will look for firms which minimise damage to the environment while others will look for firms which actively promote environmental well being
  • Some investors will look for firms that do not cause social harm while others will look for firms which promote social values
  • Some investors will look for companies which do not have any glaring governance issues while others are particularly concerned about good governance
If you are particularly concerned about ESG and are looking for a fund that invests using ESG principles have a look at the language in their documentation to see where on the scale they are.  Some funds are primarily value funds who see the downside for firms not investing in ESG principles while others truly believe that investing in ESG conscious firms will result in higher long run returns. 

What is Ethical Investing?

Ethical investing, quite simply is investing only in those companies which meet a strict criteria for investment.  It is often considered a 'negative screen' because there is a very definite idea of what sort of companies should not be included. 

The type of investments chosen will depend on the criteria used.  There are several common types of ethical funds / approaches including
  • Christian funds which only invest on a biblical basis and excludes investments in things like weapons manufacturers among others
  • Islamic funds which do not invest in companies involved in usury or alcohol among others
  • Environmental funds which do not invest in mining operations etc
There is no real limit to the number of ways that ethical funds can be cut.  In fact most of us probably have some things we would never invest in because we do not feel comfortable doing so and so in our own way we have an ethical criteria for investment

What is the difference between ESG Investing and Ethical Investing?
The difference therefore comes down to the following
  • With ESG you can really invest in any company but you are looking for a best in class company which adheres to ESG values to the greatest extent possible
  • Ethical Investing has strict criteria about what can and cannot, or should and should not be invested in
ESG can therefore be though of as having many shades of gray while Ethical Investing is a lot more black and white.  That is not to say that managed funds (or even your own investment portfolio) cannot have a combination of both.  But if you are looking for a fund which shares your social values and which considers those things you consider to be important make sure you are aware that the terminology does matter and ESG and Ethical Investing refer to very different things.

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