SRI, ESG: Not the Same Approach

As with most nascent disciplines, language used by sustainability professionals is still a bit sloppy.  I routinely read sustainability focused blog posts, white papers, and news articles and even among my sustainability peers we often aren’t very precise. That imprecision hurts our ability to communicate.

So, lets clear up one misconception.

Socially Responsible Investing (SRI) and Environmental-Social-Governance Investing (ESG) are not the same thing.

True, they are kissing cousins and sometimes even people working in this niche conflate the two.  Both methods are founded on two core ideas:

• Some equities are better investments than others, and
• “Better” is based on non-financial reasons

But that’s where the similarity ends.  Here’s your primer on the differences.

SRI first emerged in the 1960’s as an ethics-based counter-weight to traditional investing analysis. Through the 1980’s SRI investors screened out companies they found offensive – tobacco, weapons, or alcohol, to name a few.  In the early 1990’s SRI fund managers added a “risk and return” analysis to their tool kit, but the primary goal of SRI remains a values-driven avoidance of certain stocks.  Historically, performance of SRI funds has been neutral or mixed and their share of the fund market has been small, though it has grown in recent years.

Despite appearances, ESG investing is not primarily values-driven.  In fact, it is often values-neutral – choosing to divest from oil, for example, not for virtuous reasons but because fossil fuels may be a lousy investment with values based on phantom stranded assets.

ESG investing emerged in 2003 – 04, in part in response to the governance scandals of the early 2000’s – Tyco, WorldCom, and Enron. The global economic meltdown that began in 2008 increased its relevance.  The emphasis on environmental, social, and governance performance arises because evidence shows that companies with strong ESG performance will perform better with lower risk, now and into the future.  ESG fund managers screen-in companies with strong business models and best-in-class records at identifying and managing non-financial business risks.  ESG investors' focus on long-term value creation is an antidote to short-termism.

Sometimes ESG risks are blindingly obvious.  For instance, the agricultural commodity industry faces significant challenges related to water access and management.  For them, water is a key environmental risk.  Companies in heavily regulated industries face special governance challenges – Volkswagen, anyone?  Consumer-facing brands need to stay on top of their social license to operate, knowing that corporate value can be damaged by a few Tweets.

The question is, are the companies in your portfolio rooting out, measuring, and managing their unique ESG risks?  ESG investors choose to invest only or primarily in companies with a demonstrated ESG-management track record (adding the nice side benefit of increased transparency).  With our economy increasingly threatened by climate change and the novel environmental, social and governance challenges it brings, these are the best companies to invest in.

We know that high-sustainability companies outperform their less sustainable peers. ESG investors intend to capture this outperformance in their portfolios.  And that’s why you need to know the difference.