How Do ESG, SRI, and Impact Funds Differ?

A growing number of investors are demanding investment choices from their advisors that do more than provide them with a rate of return.

Younger investors, in particular, are seeking out options that will not only help their assets to grow but also benefit society at large in some respect. This is referred to as responsible investing.

A 2021 survey of investors by financial services organization TIAA revealed that 53% of those polled own some form of socially responsible investment (SRI).

Furthermore, investors polled strongly believed that financial advisors should be knowledgeable about SRIs. Of the total group, 79% stated that they would be more loyal to a financial advisor who helped them make positive impact investments.

There are several categories of investments that do this, including SRIs, environmental, social, and governance (ESG) options, and impact funds. Advisors and investors need to be able to recognize their differences to invest funds appropriately.

Key Takeaways

  • Types of investments that are intended to benefit society include socially responsible investments (SRIs), environmental, social, and governance options (ESGs), impact funds, and philanthropic investment opportunities.
  • Morningstar provides investors with social impact ratings of funds that it covers.
  • Greenwashing is the false claim by a company that its products are environmentally sound.
  • Integrated investing refers to combining a focus on financial return with the need to take ESG factors into account.
  • Impact investing refers to investments where social impact takes precedence over financial return.

Similarities and Differences Between Responsible Investments

The broad category of investments that provide more than a rate of return can be classified according to the emphasis that is placed upon the investment’s financial performance.

Range of Socially Responsible Opportunities

Patrick Drum, a portfolio manager at Saturna Capital, led an effort by his firm to help advisors understand these investments. He created a spectrum of socially dimensioned investments called the Sustainability Smile.

On one end of the spectrum are purely traditional investments that are purchased solely for their profit potential, regardless of a lack of social impact.

Integrated Investing

The next category is integrated investing, which takes ESG impact into account but still makes a point of generating investment returns.

“ESG is about financial performance but takes into consideration a broader set of due diligence questions on how environmental, social and governance facts drive or inhibit performance,” Drum told ThinkAdvisor in an interview.

ESG is a focus, but the ultimate goal is to produce optimal results with the invested money.

Ethical Investing

The next step along the spectrum and away from a pure profit motive is labeled as ethical/advocacy investing. This approach attempts to balance profit with the investor’s beliefs by excluding certain segments such as sin stocks (e.g., companies involved with alcohol, tobacco, or firearms).

In the Saturna Capital white paper, Drum gave an example of this type of investment, citing a movement called the Carbon Divestment Campaign. It challenges and encourages companies that deal in carbon, such as oil companies, to move further into the realm of renewable energy.

The return on capital still matters here, but Drum says there is a “level of ‘return forgiveness’” present as well.

Impact Investing

Drum labels the next option as thematic/impact investing, where financial performance is secondary to the investment’s social theme or impact.

The main objective is for companies to accomplish social goals. The investor may still seek to generate an investment return, but this is unconditionally subordinate to the social aspect of the investment.

Philanthropic Investing

The final category of investment is purely philanthropic, where no thought is given to the rate of return that is earned, if any.

Corporate social responsibility (CSR) involves a company establishing a guiding code of conduct to make sure that it remains true to the ethical values it sets for itself.

Government Involvement

In late October 2020, the U.S. Department of Labor released a regulation intended to limit or eliminate SRI in retirement plans. While the rule was revised to remove explicit references to ESG factors, it mandated that fiduciaries of retirement plans must choose investment strategies based entirely on how those strategies affect financial performance.

In October 2021, a new proposal was made to help retirement plan fiduciaries safeguard workers’ savings by allowing fiduciaries to consider climate change and other ESG factors when they make investment decisions.

How does socially responsible investing (SRI) work?

Socially responsible investing (SRI) employs strategies that can lead to a positive social change as well as provide a financial return to investors. It involves investing in companies that support ethical standards of living such as environmental sustainability or social reform and justice.

What’s an ESG investment?

ESG investing stands for environmental, social, and governance investing. It concerns investing in, for instance, companies, or funds that adhere to certain environmental and social standards that affect their overall performance. The company (or fund) should have a positive impact on the environment and social factors. Corporate officers and management should advocate for positive changes for people and the environment.

Why is SRI important?

First, SRI is designed to focus investment money on socially responsible companies that strive to have a healthy, positive impact in the world. Second, SRI gives people with certain ethical values a way to invest their funds in companies that align with those values.

The Bottom Line

In 2021, the CFA Institute surveyed more than 700 financial advisors and research analysts about ESG integration. The survey revealed that about a third of respondents believed that ESG integration should always occur. About 48% believed that ESG integration should only occur if an advisor finds it financially relevant to making a particular investment.

While 80% of respondents believed there should no market regulation or government mandates concerning ESG integration, 62% believed there should be a “globally consistent product disclosure standard” to prevent greenwashing. Greenwashing occurs when a company claims falsely that its products are environmentally sound.

Since 2016, Morningstar Inc. has assigned to investments a globe rating that measures social impact. Advisors and investors who are interested in socially impactful investing can use this rating to help determine whether a given investment choice satisfies their social criteria.

Article Sources
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  1. TIAA. “Sixth Annual Responsible Investing Survey,” Page 3.

  2. Saturna Capital. “The Sustainability Smile: An Advisor’s Guide to Defining Sustainable Investing Strategies,” Pages 4 and 10.

  3. ThinkAdvisor. “Investing in ESG, SRI or Impact Funds? Do You Know the Difference?

  4. Saturna Capital. “The Sustainability Smile: An Advisor’s Guide to Defining Sustainable Investing Strategies,” Page 4.

  5. Saturna Capital. “The Sustainability Smile: An Advisor’s Guide to Defining Sustainable Investing Strategies,” Page 5.

  6. Saturna Capital. “The Sustainability Smile: An Advisor’s Guide to Defining Sustainable Investing Strategies,” Page 6.

  7. U.S. Department of Labor. “U.S. Department of Labor Announces Final Rule to Protect Americans’ Retirement Investments.”

  8. U.S. Department of Labor. “Notice of Proposed Rulemaking on Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights.”

  9. CFA Institute. “Survey of CFA Institute Members on Latest ESG Matters,” Pages 8–10 (Pages 13–15 of PDF).

  10. Morningstar. “Morningstar® Globe Rating for Companies: An Overview.”

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