Investment-speak makes most people outside the industry feel like they're drowning in alphabet soup, and responsible investing is no exception. In this article, we take a look at two responsible investing terms known mostly by their initials—ESG and SRI. The two are often used interchangeably but actually mean different things. By the end of the article you’ll be able to tell the difference, which will help when researching your responsible investment options and having conversations with a portfolio manager.
WHAT DOES ESG MEAN?
The initials “ESG” stand for environmental, social and corporate governance. In an investing context, ESG refers to the environmental, social and governance practices of a security issuer. These practices are examined in an ESG analysis, which goes beyond traditional financial metrics in order to better understand the impact of a corporate issuer’s operational characteristics in the areas of environmental stewardship, social awareness and governance practices on the economic value of the issuer. This analysis usually results in an ESG factor score, which is then compared on a relative basis to scores from other issuers.
Common ESG evaluation factors include
Environmental Stewardship
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Climate change awareness
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Controlling and limiting greenhouse gas (GHG) emissions
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Limiting resource depletion
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Reducing pollution
Social Awareness
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Providing favourable working conditions
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Measuring the corporation’s impact on local communities
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Complying with health and safety regulations
Governance Practices
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Measuring the diversity and structure of management and board
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Evaluating employee relations and diversity
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Assessing policies for political lobbying and donations
WHAT IS SOCIALLY RESPONSIBLE INVESTING (SRI)?
Socially responsible investing builds on the ESG concept by either eliminating or selecting investments according to specific guidelines. SRI uses specific factors to apply negative or positive screens on an investable securities list. The results of the screening process then determine potential candidates for inclusion in an investment portfolio.
Common corporate factors for negative SRI screening include
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Alcohol, tobacco, and other addictive substances
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Gambling and pornography
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Production of weapons or military paraphernalia
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Human rights violations
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Fossil fuels
WHAT'S THE DIFFERENCE BETWEEN SRI AND ESG INVESTING?
The goal of each type of investment strategy is what makes them different.
The goal of an ESG investment strategy is to maximize portfolio performance. Examining a security issuer’s operations or reputation according to environmental, social or corporate governance criteria reveals risks and opportunities that may have consequences on the value of an issuer. As a result, Issuers with higher ESG scores may be considered a better investment and more likely to be included in a portfolio than issuers with low ESG scores.
The goal of an SRI strategy is social change, not just portfolio performance. Certain sectors, industries, countries, commodities and companies are excluded from a portfolio because of ethical, moral, environmental and social concerns. Investors don’t want to support those areas, so they eliminate them from their portfolio. On the flip side, other sectors, industries and companies may be included in a portfolio because they’re involved in solving societal problems. By screening the issuers, an SRI strategy is able to direct financial support to areas that match the investors values.
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