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ESG and impact investing: Worthstone’s Gavin Francis discusses the differences.

Worthstone’s Gavin Francis discusses why the lack of standardisation on definition and reporting means that advisers face a huge challenge when trying to accurately assess sustainable investment funds.

The way investors think about money is changing. Increasingly, people want their capital to make the world a better place. It’s a trend that’s surged since the COVID-19 pandemic, and with the UN climate change conference COP26 taking place this month, it’s in the spotlight now more than ever.

In our experience, the question from advisers over the last couple of years has changed from ‘should you look at these investments?’ to ‘how good are these investments?’.

ESG funds are widely seen as the de facto option when it comes to investing “ethically”. By some estimates, a third of all assets under management now take into account some ESG aspects in their investment strategy. And, according to Bloomberg, the value of the market is set to rise to $53 trillion by 2030; currently it’s worth around $37 trillion. By Worthstone’s last calculation in October 2021, the total assets under management available to UK retail investors (and daily traded) that incorporate sustainable mandates is £230 billion – up from £87 billion in June 2017. Focusing solely on ESG, however, can blinker an adviser’s view of the wider landscape, with a far more complete picture provided by impact investing.

ESG aims to do no harm, but is this enough?

ESG investing considers the ethical impact of funds, ostensibly eschewing harmful practices like arms, oil and alcohol. The aim is to avoid doing harm (well, most of the time anyway) but is simply doing no harm good enough anymore?

Climate change and increasingly extreme weather events have caused a surge in natural disasters over the past 50 years. We’ve lost millions of lives and spent untold figures on trying to rebuild cities and societies. The panic is palpable: people are anxious and want to take action.

Investing in impact allows people to do just that: it goes beyond doing no harm, and actively supports activities that aim to make a positive change in the world, both on a social and environmental level.

Impact investing incorporates financial and non- financial returns

The bottom line in ESG is purely commercial, and a fund manager reserves the right to maintain financial return at their discretion. This means potentially ploughing capital into the very activities ESG is meant to avoid. ESG stands for environmental, social and governance, but perhaps employ scepticism generously would be more apt.

Impact investing also seeks financial return, but rather than the bottom line it’s a dual-purpose alongside a focus on specific outcomes – aka “doing good”. And return is viewed as a long-term project. By creating positive change, the aim is to combat damaging consequences that harm the world and hit individuals and communities financially, whether this is natural disasters, war or corruption.

There are non-financial returns too, like creating a fairer more inhabitable world. These are emotive elements that really resonate with consumers.

Tapping into your clients’ values is key here. What “returns” do they want to see? By investing in impact, clients have the opportunity to address some of the world’s most pressing challenges, whether that be through renewable energy, sustainable agriculture or sustainable infrastructure development. The scope is huge here; by asking the right questions advisers can get to the crux of what it is their clients care most about.

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