Abstract:

Private markets can make things better for everyone, promote fairness in society, and make people more aware of how human activities affect the world. One way has been through impact investing, which means making investments with the goal of having a good, measurable effect on society along with making money. ESG-focused investments have become more popular in recent years. From 2021 to 2026, PwC predicts that institutional investments in ESG assets will grow by 84% (de jong and Rocco, 2022). People often use the terms “impact investing” and “ESG investing” to refer to businesses that make money and help people and the environment at the same time. But there are important differences that affect where and how buyers put their money. It is getting more and more important to know the difference between ESG investing and impact investing as private markets continue to move towards ESG standardisation.

Context:

The term “ESG” was created in 2004 by the UN, the International Finance Corporation (IFC), and the Swiss Government to encourage the financial industry to include ESG issues in normal investment decisions. Its roots can be found in the “socially responsible investing” (SRI) movement (Foroughi, 2022). This is not a surprise since governments, especially those in the EU and the UK, have been a big part of the progress made in spending in ways that are good for people or the environment over the last 15 years.

The Rockefeller Foundation and other philanthropists, investors, and entrepreneurs came up with the term “impact investing” in 2007. This was the first time that investments were made with the goal of making a measurable positive social effect as well as a financial return. The Global Impact investment Network (GIIN), which is made up of professionals who work to improve infrastructure, research, and education around impact investment, was started by this group.

So, while the public sector pushed for ESG, it was the private sector that made impact investment possible. Because of this, ESG tries to help people understand environmental, social, and governance issues. At the same time, the fact that impact is done for profit gives people a reason to work for these interests and directs money towards them. As a type of responsible investing (Starks, 2023), both ESG investing and Impact investing fit under this term. By looking at environmental, social, and governance issues, they hope to create good results that go beyond making money. Both types of investors want to make the world a better place by making it healthier and fairer.

 Now that we know that let us look at how ESG and impact investment are different (Foroughi, 2022; Seghir,2024):

Table: Key Differences Between ESG and Impacting Investing

ESG Investing	Impact Investing
ESG is a methodology for managing risk and identifying opportunities related to sustainability challenges.  Backward-looking measure, similar to an assessment or scorecard of past activity.	Impact investing is a method that delineates the specific assets an investor seeks, characterised by a deliberate objective to produce quantifiable social or environmental benefits: intentionality.  Represents an alignment with one or more of the UN Sustainable Development Goals, serving as a fundamental element of the investment strategy.  Outcomes: specific performance indicators.
ESG faces fiduciary scrutiny. It requires discretion by asset managers in its application. A trustee is required to act sorely in the interests of the beneficiary (Fiduciary Law)	Impact investing does not face the same scrutiny because funds employing this approach stand alone. Investors opt into these funds knowing the investment manager’s intention before investing.
ESG might serve as a risk mitigator or a potential opportunity.  ESG can decrease risk by enabling investors to eliminate or filter investments in companies that fail to comply with established standards.	Both elements are present in impact investment.  A company’s value and performance can be enhanced by making investment decisions that take social and environmental aspects into account. This is true for both market-wide systematic risks and asset-specific idiosyncratic risks.  Capital expenditures, volatility, and accounting problems could all rise if these risks are not adequately managed.
As a whole, ESG is a framework that puts money first.  Financial return is the main source of value for ESG-focused investors.  Despite the fact that these metrics can guide future investments, they are only utilised to assess the environmental and social benefits of a project after it has already been funded.	In a typical impact investment, monetary, social, and environmental outcomes are all given equal weight.  As long as the investment yields a profit, it may even give precedence to social and environmental benefits in the early stages.  Furthermore, impact investors are aware of the collinearity concept, which states that a company’s financial performance and social/environmental performance are frequently linked and can even reinforce one another.
Public market firms are the mainstays of ESG-focused investments.  There are a lot of ESG-focused investments in the public markets, and that’s because ESG metrics depend on data that is publicly released.  As long as there is data to analyse the company, any company can get an ESG rating—positive or negative.	Private market impact investments predominate.  Impact investments have typically occurred in private markets, where innovative solutions to some of the world’s biggest issues demand skilled and patient finance and active promotion of ethical business and sustainable value.  As the startup financing cycle progresses, more impact investments go public.  Research shows that market efficiencies make it difficult to achieve additionality in public equity markets, but Impact Management Project suggests that systems change could accelerate growth in the number of investors strategically “signalling that impact matters.”
Not all ESG funds are impact.	Every impact fund is ESG-compliant.  The past must inform the future, but the future cannot be incorporated into it.  Impact investing is forward-looking, thus ESG-focused discoveries can be applied in future investments.

Conclusion:

Impact investing and ESG investments are different in how they work and what their main goals are. ESG and impact investing are both ways to improve social and environmental effects, but impact investing aims to achieve a specific social and/or environmental outcome. Investors can make better decisions about their investments and create long-term value by understanding the differences.

References:

1. de Jong, M., & Rocco, S. (2022). ESG and impact investing. J Asset Manag 23, 547–549. https://doi.org/10.1057/s41260-022-00297-7
2. Foroughi, J. (November 10, 2022). ESG is not impact investing and impact investing is not ESG. Stanford Social Innovation Review.
3. Seghir, M. (October 8, 2024). Sustainable Finance: Impact investing and ESG investing. RSM Global. Netherlands.
4. Starks, L.T. (June 19, 2023). Presidential Address: Sustainable Finance and ESG Issues—Value versus Values. Journal of Finance, 78(4), pp.1837-1872. https://doi.org/10.1111/jofi.13255.