ESG vs Non-ESG Investments: What's the Difference in 2024 (2024)

Today, an investment is valued in terms of financial and social returns. However, the concepts of ESG and non-ESG investments are still complex for many. This piece offers a comprehensive guide of ESG vs non-ESG investments.

According to TIAA, about half of the worlds’ investors today hold responsible investments. In addition, about the same number of investors would consider converting their investment portfolios to hold responsible investments.

The study showed that this huge desire to invest ‘ethically’ is not only among the baby boomers but has also seen an increase among the millennials.

While a growing desire may be only the first step toward responsible investing, understanding the different value-based investment models is something most haven’t grasped.

• Can ESG investments perform better than non-ESG investments?
• Is a nonprofit considered ESG? (I think we know the answer there…)

These are some of the questions that still seem to bother a majority of these investors. Fortunately, retail investors and advisors are fully prepared to explain these concepts to beginners, and this piece will offer a general overview of what consists of ESG vs Non-ESG investments to get you started:

Understanding ESG and Non-ESG Investments

The Concept of ESG Investing

ESG investing stands for Environmental, Social, and Governance investing. This approach considers how well companies perform along these standards while making investment decisions. ESG investors seek businesses actively striving to minimize negative societal impacts or working toward positive societal outcomes.

A significant aspect of ESG investing involves choosing companies to prioritize sustainability and ethics in their business practices. Examples of typical criteria used to evaluate ESG investments include:

• Environmental: Climate impact, resource management, and pollution control
• Social: Human rights, employee relations, and customer security
• Governance: Corporate governance, executive compensation, and ethical business practices

ESG funds pool invests in ESG stocks that fulfill ESG criteria and exposes investors to portfolios adhering to these socially responsible principles.

ESG companies report their ESG criteria to investors as standardized by the Sustainability Accounting Standards Board (SASB). That includes the determination of ESG issues that companies should give priority to based on industry and sector.

A perfect example of ESG investment includes buying stock in a tech company that helps convert their infrastructure towards reliance on clean energy, resulting in cost benefits and a positive environmental impact.

The Concept of Non-ESG Investing

On the contrary, non-ESG investments and funds typically do not prioritize environmental, social, and governance factors in their decision-making and investment process.

These investments mainly focus on traditional financial metrics such as revenue growth, earnings potential, and market share. In other words, non-ESG investing is agnostic to the company’s corporate responsibility and ethical standards.

Some examples of industries, global markets, or sectors that might not meet ESG criteria include:

• Fossil fuel production and distribution
• Tobacco and alcohol firms
• Businesses with poor labor practices or human rights violations

While not incorporating ESG factors into their approach, non-ESG investments can offer different risk and return profiles and provide diversification opportunities to an investor’s portfolio.

The Importance of ESG and Non-ESG Investments

Benefits of ESG Investing

ESG (Environmental, Social, and Governance) investing focuses on societal welfare when selecting investment opportunities. This methodology evaluates companies by scrutinizing their commitments towards sustainable practices, addressing social concerns, and adhering to ethical governance.

Investors adopting the ESG lens prioritize not only financial returns but also the long-term impacts of their investments. Key areas examined include climate risk mitigation, human rights protection, and firm leadership integrity. By allocating funds toward ESG-oriented companies, investors align their assets with their values, promoting ethical industry standards for future generations.

Advantages of Non-ESG Investing

Non-ESG investing concentrates primarily on financial returns, neglecting ESG elements. While ESG integration encourages responsible practices, its exclusion may offer potential benefits. Investors adhering to non-ESG principles employ traditional financial metrics like profitability and valuation ratios to evaluate company performance.

This approach prioritizes financial strength and growth potential over sustainability considerations. By concentrating on non-ESG investments, investors typically capitalize on a broader spectrum of assets—without constraints set by ESG criteria. Consequently, this investing style may provide opportunities for greater diversification and potential value realization in overlooked sectors.

Analysing ESG and Non-ESG Investments Performance

Comparing Returns

When examining ESG and non-ESG investments, comparing their financial returns is valuable. In the first half of a recent year, the Eurekahedge ESG Fund Index witnessed a 10.31% return, closely trailing the Eurekahedge Equity ex-ESG Fund Index, which produced a 10.72% return. This observation implies that both investment types hold the potential for significant gains.

However, it’s important to remember that ESG funds are structured differently than their non-ESG counterparts, leading them to behave distinctively in the market.

As a result, there is no convincing evidence supporting the possibility of either underperformance or outperformance when it comes to ESG investing.

Risk Analysis

Part of a balanced analysis of ESG and non-ESG investments includes considering the associated risks. While ESG investments typically promote sustainable practices, focusing on environmental, social, and governance factors, some investors may perceive them to be riskier than traditional alternatives due to the relatively new emergence of the ESG concept.

However, several factors may counterbalance these perceived risks. First, an ESG-based approach to investment often includes assessing potential corporate externalities.

By limiting negative societal impacts or actively promoting positive ones, ESG stocks with high scores may demonstrate a reduced overall risk profile.

Furthermore, in a survey conducted among corporate issuers and investors across the Americas and Europe, over half of the respondents reported neither overperformance nor underperformance between their ESG and non-ESG investments, suggesting that the two investment types share comparable risk.

Types of Investments

In general, through private markets, investors can build an investment strategy with ESG or without it through a variety of ways, including:

Mutual Funds and ETFs

There are plenty of mutual funds available today based on ESG criteria. The US SIF has listed over 200 socially responsible funds with their financial information and the criteria each member firm has used to choose the investments.

According to the US SIF 2010 report, social investing trends have 26 exchange-traded funds (ETFs) that utilize social and environmental criteria. Some excellent platforms to access and use when investing in SRI funds include Betterment, M1 Finance, and SoFi.

Community Investments

Investors also participate in community investments, including lending money directly to community organizations. A perfect way to achieve their goal is to put their money into community development financial institutions (CDFIs), such as credit unions, banks, and loan funds. Then, these institutions offer credit products and other financial services to low-income groups.

Microfinance

Investing in microfinance is another ideal way for SRI investors to put their dollars into a good cause with a positive societal impact.

These financial institutions offer micro-loans or small loans directly to startup businesses. Good examples of these organizations include Kiva and Zidisha, which offer microloans to entrepreneurs in developing countries, and Kabbage, which focuses on small businesses in the US.

Alternative Investments

Alternative investments like hedge and property funds can also be a perfect SRI strategy, depending on your investment objectives.

According to US SIF, around 177 alternative SRI funds in the US managed nearly $38 billion in assets. By 2014, the number had more than doubled to 336 funds with around $224 billion in assets.

A great way to get exposure to alternative investments is by using a platform such as Yieldstreet or FarmTogether for agriculture investing, depending on your risk tolerance.

See related: Worst ESG Companies

Market Overview of ESG and Non-ESG Investments

ESG Market Overview

ESG investments have gained significant traction recently. These investment strategies emphasize the importance of businesses addressing non-financial factors that positively affect society and the environment. ESG investments span various asset classes, like equity, bonds, and ETFs.

Many asset managers, including those at Morningstar, have incorporated ESG evaluation into their investment decision-making process. The growth of ESG investments is evident in the assets under management (AUM), which continues to rise, reflecting the increasing interest of investors.

Non-ESG Market Overview

Non-ESG investments, on the other hand, represent traditional investing approaches that prioritize financial returns without considering environmental, social, or governance factors. These investments can be found across equity, bonds, and mutual funds, holding a major market share.

In non-ESG investment decisions, financial analysis, corporate performance, and economic metrics are primarily considered rather than evaluating a company’s wider impact on society or the environment.

ESG Factors and Criteria

ESG factors and criteria encompass various topics investors analyze when assessing a company’s performance. These include:

• Environmental: Climate change, pollution, waste management, resource utilization, and biodiversity conservation.
• Social: Employee relations, diversity and inclusion, supply chain management, community engagement, and customer satisfaction.
• Governance: Board composition, transparency, compensation, shareholder rights, and risk management.

Investors employ these criteria to evaluate businesses and make informed decisions about including them in their ESG portfolios.

Investment Screening and Decision-Making

Both ESG and conventional investments employ a variety of screening processes to determine which companies meet their objectives. However, their screening criteria differ.

ESG screening generally comprises three main approaches:

1. Negative screening: Excluding companies that engage in harmful activities or industries, like weapons manufacturing or tobacco production.
2. Positive screening: Including companies that demonstrate strong ESG performance or contribute positively to society and the environment.
3. Impact investing: Seeking businesses that actively work towards making a significant positive social and environmental impact.

On the contrary, non-ESG investment decision-making focuses primarily on financial performance and growth potential, with little regard for the wider implications of a company’s activities.

Investment Portfolio Integration of ESG and Non-ESG Investments

ESG vs Non-ESG Mutual Funds

Incorporating ESG factors into investment portfolios has become increasingly popular among sustainable investors.

ESG investing seeks to generate positive societal impact alongside financial returns by selecting companies with strong ESG ratings. This approach differs from traditional, non-ESG investing, which primarily focuses on performance without considering a company’s environmental or social contributions.

An array of ESG and non-ESG mutual funds are available to meet the growing demand for responsible investing. ESG funds target companies with sustainable practices or industries contributing to a greener future, while non-ESG funds invest in stocks solely based on economic growth potential and profitability. As an experienced impact investor, it’s crucial to acknowledge the distinctions between these investment options.

In recent years, studies have shown that ESG portfolios can perform comparably or exceed non-ESG counterparts in terms of returns. When integrating both investment types, a balance must be struck between meeting impact goals and attaining financial objectives.

Socially Responsible Investing (SRI) and impact investing are two additional facets of ESG investment strategies. SRI specifically avoids businesses with potentially harmful practices, such as tobacco or weapons manufacturing.

In contrast, impact investing funds seek investments with a measurable, direct, and positive societal influence, ensuring that investments align with an investor’s values and mission.

See Related: ABM Industries Incorporated ESG Profile (ABM): Is It Sustainable?

Examples of the Best ESG Funds

Here are some of the best ESG funds to invest in:

Parnassus Core Equity Fund Investor

With $20.0 billion in assets under its management, Parnassus Core Equity Fund Investor is a great ESG portfolio. Its dividend yield is 0.4%, with expenses of 0.86%.

Parnassus Investments has been a basis of ESG investing trends for People’s United Advisors for over a decade. This firm believes that firms with strong social, environmental, and corporate governance practices can better understand and manage risks and reduce the probability of adverse outcomes and controversies.

Its upside and downside capture are key drivers for the funds’ strong and lasting track record. PRBLX has captured about 89% of the index’s upside compared to around 81% of its downside.

The downside protection of this fund and market rally participation has made it perform well over the long term with lower risk.

iShares ESG MSCI ETF has $16.5 billion and is a Blackrock ESG investing fund that is passively managed and keeps track of the MSCI USA Extended ESG Focus Index.

This fund shapes the MSCI USA Extended ESG Focus Index of big and mid-cap American companies to fit positive ESG companies. It also excludes those involved in controversial businesses like civilian weaponry, tobacco, etc.

Then, it helps maximize an investor’s exposure to firms with strong both ESG scores and intangible value assessment (IVA) scores, which help analyze the firm’s exposure to risk to the core ESG issues within its industry.

For example, exposure to data insecurity in financial firms or wastage production in the food industry. All firms are also subjected to a corporate governance review regardless of their industry.

See Related: Best ESG Rating Agencies – Who Gets to Grade?

Vanguard FTSE Social Index Fund Admiral

The assets under Vanguard management are around $12.0 billion and are one of the broadly diversified portfolios with low fees. Being one of the least expensive ESG funds, Vanguard FTSE Social Index Fund Admiral (VFTAX, $40.42) has and continues to gain popularity to date.

Vanguard targets investors who want a diversified portfolio with minimal exposure to companies operating in controversial industries. Using a passive strategy, Vanguard tracks the FTSE4Good US Select Index (a market-capitalization-weighted index that screens ESG firms).

Vanguard Fund doesn’t directly screen for environmental impact beyond a simple fossil fuel involvement or the corporate governance of its holdings, unlike most of its actively managed peers and ESG index.

While it does make exclusions, including firms with significant ties to tobacco, firearms, alcohol, gambling, fossil fuels, adult entertainment, etc., it does not confine itself to perfect ESG companies. It nixes companies with labor and human rights, environmental, and corruption controversies.

This slices off around 30% of the US large-cap market, resulting in a well-diversified market-cap-weighted portfolio that must deliver similar market performance in the long run.

Some of its top holdings, including Microsoft (MSFT), Apple (AAPL), and Amazon.com (AMZN), are higher than many conventional blue-chip funds.

See Related: Angel Investing vs. Venture Capital

Challenges and Risks in ESG and Non-ESG Investments

The Role of Institutional Investors in ESG and Non-ESG Investments

Institutional investors play a crucial part in both ESG and non-ESG investments. These entities influence market trends by allocating capital to companies following environmental, social, and governance standards or firms that don’t prioritize these values.

However, discerning investors face challenges in evaluating ESG-focused companies due to the lack of comparability of ESG metrics and ratings, making it difficult to assess material risks and potential trade-offs in performance.

Another concern is the prevalence of greenwashing, where companies might exaggerate or falsely promote their sustainable practices and what truly goes into said ESG funds.

Consequently, this issue hinders investors from identifying genuine ESG commitments. Additionally, some ESG investments might come with higher fees and expenses, necessitating that investors weigh the benefits of supporting ESG strategies against the potential costs.

Regulations Impacting ESG and Non-ESG Investments

Regulators worldwide increasingly focus on sustainable investing practices, which can impact ESG and non-ESG investments. Stricter regulations may force companies to enhance transparency regarding their environmental, social, and governance performance. Such regulations could result in businesses adopting more robust ESG reporting standards or being penalized for non-compliance.

However, the growing demand for ESG reporting can also create challenges for corporations relying on self-reported data, which might not always be accurate or complete. Inaccurate reporting can inadvertently expose investors to downside risk as they base their investment decisions on incomplete or misleading information.

Overall, navigating the challenges and risks inherent in ESG and conventional investments requires investors to stay informed, observe regulatory changes, and scrutinize investment options. By doing so, they can make informed decisions that better align with their values and financial objectives.

ESG vs SRI vs Impact Investing: What’s the Difference?

ESG is a broad approach that mainly focuses on protecting a portfolio from reputational or operational risk. It considers a more extensive set of due diligence based on environmental, social, or governance factors and how they positively and negatively impact performance.

For example, an Oil and Gas Company may be a responsible investment if it works incessantly to reduce emissions during its operations, gives back to society, and holds a strong safety record.

On the contrary, SRI is a sustainable form of investing that screens investments to pick and exclude companies based on certain criteria. With SRI, investors choose the funds and stocks based on a set of positive or negative screening criteria and the level of stakeholder involvement in impact or community investing.

With such screening, the investor eliminates those companies going against ‘good’ values and chooses those making a positive societal impact. According to the Global Sustainable Investment Alliance (GSIA), screening held the largest sustainable investments worldwide, valued at around $15 trillion.

ESG integration followed with investments valued at about $10.4 trillion; next was a corporate engagement or shareholder action, which was almost $8.4 trillion.

What is Socially Responsible Investing (SRI)?

The SRI model goes a step further when screening different investments. It involves picking the responsible investments and eschewing those conflicting with your values and beliefs. The underlying motive for investing in them could be personal, political, or religious beliefs.

This investment concept dates back to 1758 when the Quakers avoided supporting ‘sinful’ companies. Later, John Wesley, the Methodist movement founder, preached the same concept to his followers.

He urged them to avoid investing in ‘sin’ stocks like gambling, tobacco, weaponry, and alcohol. SRI is the simplest form of the value-based approach to investments.

Most SRI investors exclude companies involved in the following:

• Sin stocks such as (alcohol, gambling, p*rnography, tobacco, and other addictive substances)
• Production of firearms and defense tools
• Human rights and labor violations
• Terrorism affiliations
• Environmental damage

While profits still matter for socially responsible investing, they must balance against beliefs and principles since they aim to generate financial returns and avoid violating social conscience.

See Related: Philanthropic Investors vs Impact Investors: What’s the Difference?

What is Impact Investing?

This is a thematic model of investing characterized by a direct connection between the use of capital and value-based priorities. With this model, the positive impact matters, meaning the aim is to help a company achieve specific goals beneficial to society or the environment.

With impact investing, the report must have both the financial performance of the investment and its positive societal impact (in quantity form) –like X number of people received quality education after investing in this area, or there was an increase or decrease in X number of units after the adoption of clean energy in this venture, etc.

Impact investors set out their funds towards a cause not directly addressed by the public financial markets (i.e., the stock market), such as poverty alleviation and community development. These funds also tend to impact the management and execution of portfolio companies more than other investment vehicles.

Impact investing includes private funds, while ESG and SRI investing involves publicly traded assets. This makes impact investing more transparent and attractive to investors who want transparency.

See Related: Best Investments for Young Adults

Examples of Impact Investing

Unlike ESG and SRI, impact investing is more about making private investments to impact society positively. Here are excellent examples of impact investing:

The Gates Foundation

Bill & Melinda Gates Foundation is a widely known form of impact investing. Launched by the Windows pioneer with an endowment of almost $50 billion, the Gates Foundation engages in philanthropic missions.

Also, it holds a strategic investment fund with about $2.5 billion under its management. This is invested in ventures that align with the foundations’ goals of improving health, gender equality, and education.

The strategic fund supports projects or organizations that would benefit the world’s poorest and those that conventional investors would overlook.

The Ford Foundation

Launched in 1936 by Henry and Edsel Ford, the Ford Foundation had an initial endowment of $25,000. Today, it has around $14 billion under its management, making it one of the largest private endowments.

Most of its funds are used as grants to support causes that align with the foundations’ values. In 2017, however, the foundation announced its plans to support business ventures aligned with its missions with $1 billion.

Soros Economic Development Fund

A billionaire philanthropist, George Soros, launched the Soros Economic Development Fund as part of the Open Society Foundations. He contributed around $ 18 billion to the Open Society Foundation, where $90 million was invested in impact ventures.

The Soros Economic Development Fund supports ‘open societies” by promoting legal reforms, democracy, journalism, higher education, research, and more.

See Related: Most Unethical Banks You Need to Avoid

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