Socially responsible investing, ethical investing, environmental, social, and governance (ESG) criteria, impact investing—these terms now appear regularly in the media and in investment prospectuses, with interest levels reaching all-time highs in 2020. Investors plunged an estimated four times more cash into ESG investment funds in 2020 than they did in 2019. Meanwhile, dedicated impact investing funds have grown exponentially in the past few years, jumping from $502 billion in assets under management in 2019 to $715 billion in 2020.

Yet the plethora of terms noted above (and others like them) has blurred the boundaries among different investment products and strategies, causing confusion for many investors. Indeed, a remarkable 96 percent of impact investing professionals consider a lack of clarity about what constitutes an “impact investment” to pose a challenge. And the fact that both ESG investing and impact investing are growing so rapidly—and in tandem, as it were—may lead some to conflate those two terms. So it seems important to draw a clear distinction between the two.

While both impact investing and ESG investing can deliver compelling financial returns while helping to build a better world, there are some key differences. Understanding these differences can help impact investors not only make better investment decisions but also avoid the potential for “impact washing” by providing transparency and clarity about the nature of the impact being achieved by a given investment.What Is ESG Investing?

ESG investing is an investment approach that incorporates environmental, social, and governance factors into decisions throughout the investment life cycle. Using a variety of approaches, a rapidly growing number of funds now do this. Bain & Company helpfully distinguishes between those funds that are ESG “risk mitigators” and those that are ESG “opportunity seekers.” Risk mitigators use ESG considerations to a limited extent to assess and manage potential risks during diligence and ownership, while opportunity seekers proactively look for investment opportunities that support environmental, social, or governance progress.

There is increasing evidence that an opportunity-seeking approach to ESG, in particular, leads to investments in businesses that are more successful over the long term. Businesses that are envisioning a net-zero future are proactively transitioning to a low-carbon footprint and reducing their energy costs. Businesses that are making their workplaces fully inclusive and supportive of employees are developing workforces that will be productive in the long run. And businesses whose boards have truly independent and diverse voices, particularly along racial and gender lines, will make better risk-management decisions and more efficiently allocate capital. Now, more than ever, the market has reason to believe that doing the right thing can also be the profitable thing.

Read the full article about ESG and impact investing by Stephanie Kater, Ben Morley, Jill Detrick-Yee, Sebastian Gonzalez at The Bridgespan Group.