The difference between ESG and Sustainability investing. Picture Getty
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- The difference between ESG and Sustainability investing
- Which should ethical investors choose, and why
- ESG and Sustainable ETFs on the ASX
While the terms ESG Investing and Sustainability Investing overlap, they each have different scopes and focuses.
It’s crucial that investors are able to distinguish the difference between the two related concepts.
ESG (short for Environmental, Social and Governance) refers to a set of criteria used to assess a company’s environmental, social, and governance impact.
ESG investing assumes these ESG factors impact a company’s overall performance – and that by considering those factors, they can get a more holistic view of the companies they back.
ESG investors therefore typically seek to invest in companies that score highly on the ESG scoreboard – such as those that reduce their environmental impact, treat their employees well, and value corporate diversity.
Sustainability investing, on other hand, is about investing in areas of developments that meet the needs of the present, without compromising the ability of future generations to meet their own needs.
According to Tom Montagino, the founder of DeFi ESG, there are two elements to this.
“Firstly, the concept of needs should refer in particular to the essential needs of the world’s poor, where an overreaching priority should be given,” said Montagino.
“And secondly, sustainability investing is about being aware of the limitations on the environment’s ability to meet present and future needs.”
Montagino says this could be issues such as how non-renewable resources should only be used at a rate equal to, or less than, the rate at which substitutes are created. Or issues that focus on addressing the plight of minorities and women.
More on ESG versus Sustainability
Montagino adds that while sustainability pertains to every person, every company, and every country in the world, ESG is a bit different.
“ESG is a little deeper and has very specific guidelines for businesses, whereas sustainability is more general – and that’s the big difference,” he said.
Montagino pointed out that ESG is effectively just sustainability guidelines for businesses – which were created by trade unions back in the 1960s to ensure investments for their pension funds were being invested into ethical businesses.
On the other hand, sustainability investing (sometimes also called socially responsible investing or SRI) tackles more general global issues.
As such, sustainability investing effectively emphasises financial returns as a secondary consideration after the investors’ moral values have been accounted for in their decision-making.
ESG ‘meaningless’?
While some believe that ESG Investing would trump over Sustainable Investing when financial returns are prioritised, others have concerns about using the term ESG as the rallying cry.
“On the level of language, which can guide behaviour and outcomes, the term ESG is fairly meaningless,” said Andrew Winston, an expert on sustainable investing.
“It’s an acronym for categories of things companies should work on anyway.”
Winston argues that having ESG as part of a company’s goal is really not a goal at all.
“When a company announces, in essence, ‘We’re doing ESG,’ what does that tell you?
“It’s like saying ‘We do HR.’ OK, so you have a human resources department and a senior vice president running it, but what are you doing with your people?” said Winston.
Winston argued that shareholders should do well, yes, but only after a company has served a purpose and helped protect the world and resources we all rely on to survive.
“But investors aren’t well positioned for this approach,” he said.
Focus of ESG funds vs Sustainability funds
According to RBC Wealth Management, funds focusing on Sustainability should pick stocks based on a set of standards such as positive or negative screening.
“With screening, for example, investors may eliminate a company from a portfolio if it’s involved in weapons contracting, tobacco or gambling,” said the note from RBC.
“On the other hand, a company might be included if it has a gender-diverse board of directors, or a strong track record of reducing greenhouse gas emissions.”
Screening is the largest sustainable investment strategy worldwide, valued at about US$20 trillion.
ESG funds, meanwhile, mainly focus on protecting a portfolio from operational or reputational risk.
“For instance, an oil and gas company might still be considered a responsible ESG investment if it’s working continuously to reduce emissions in its operations, has a strong safety record and is giving back to the communities where it operates,” said RBC.
ESG and Sustainable ETFs on the ASX
On the ASX, funds that define themselves as a Sustainable include Betashares’ Global Sustainability Leaders ETF (ASX:ETHI).
ETHI aims to track the performance of an index that includes a portfolio of large global stocks identified as “Climate Leaders”.
These stocks have passed screens to exclude companies with direct or significant exposure to fossil fuels, or engaged in activities deemed inconsistent with responsible investments.
Betashares Australian Sustainability Leaders ETF (ASX:FAIR) on the other hand aims to track the performance of an index that includes Australian companies that have passed the usual ‘sin stock’ screens.
The Fund’s methodology also preferences companies classified as ‘Sustainability Leaders’ based on their involvement in business activities aligned to the United Nations Sustainable Development Goals.
Funds that call themselves ESG meanwhile include Blackrock’s iShares Core MSCI Australia ESG Leaders ETF (ASX:IESG).
The objective of the Fund is to provide exposure to large, mid and small cap segments of the Australian market with better sustainability credentials relative to their sector peers.
Another so-called ESG fund is State Street’s SPDR S&P/ASX 200 ESG ETF Fund (ASX:E200).
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