BY Ben Baier & Melissa Fifield Bank of the West

Image Credit: Illustration by: Alex Beuge

Dec 2nd 2021

Financial PerspectivesInvestment

How to Tell Your ESG from Your CSR: Our Guide to the ABCs of Impact Investing

Dec 2nd 2021

When something new comes along, it is sometimes human nature to pretend we know more about it than we do. In our roles as Bank of the West’s Lead Investment Officer and the bank’s Head of CSR we’ve seen that in the emerging world of sustainable investing, it’s not the best time to take a “fake it till you make it” approach to language.

Sustainable investing terminology is tricky. It’s a relatively new concept, and there is no single recognized industry lexicon. To help you navigate this fascinating field, here is our guide to some of the commonly used terms and concepts in the world of sustainable investing.

INVESTING TERMS

Impact Investing

Very simply, impact investing is when you invest your money to align with your values—and make a profit.

In our daily lives, people are increasingly making choices with the good of society and the planet in mind, from decisions on what they buy to how they commute. You can also take this approach to investing by making sure your portfolio includes companies with the same values you have—and avoids companies that work against your values.

Impact investors may look for companies that work to improve gender equality, combat climate change, or address racial injustice. They may avoid companies that grow tobacco or damage the environment. Anyone can be an impact investor; you don’t have to be wealthy or obsessively track the stock markets. It’s really just a way of aligning your portfolio with your values and beliefs.

No government regulations exist to formalize the term “impact investing,” so you may see people use it in different ways. Some boutique investing outfits use impact investing only to describe “pure plays:” investments for which impact is the primary driver, not returns. But at Bank of the West, we use the broader definition: Impact investing is any investment that you make with the hope of a financial profit for you, and either a societal or environmental benefit.

Sometimes impact investing is used interchangeably with other broad, unregulated terms, such as purpose-driven investing, values-driven investing, or socially responsible (SRI) investing.

ESG

ESG stands for environmental, social, and corporate governance. What does that mean?

ESG is a way of measuring or evaluating just how sustainable a company is before investing in it. Investors look at a business’s policies and outcomes around the environment, social involvement, and their corporate governance—how well they follow their own rules. By measuring the same three factors across all companies, investors can determine which ones are more sustainable than others, which helps guide their investment decisions.

For example, the “E” might look at how an organization manages its waste or whether it is a polluter; the “S” might be its community initiatives or how it treats workers in its supply chain; and the “G” might be the independence of its board or its approach to executive pay. When you invest with ESG criteria in mind, you are still looking to achieve a financial return, and in fact, some research shows that the highest-scoring companies for ESG factors1 tend to be better performing than those with lower ESG scores.

Green Bonds

A bond (or debt security) is basically an IOU: When you invest in a bond, you are lending money to a company or government in exchange for the return of your money after a set period (when the bond reaches maturity) plus interest. As with all investments, no returns are guaranteed, but bonds are considered fairly low-risk compared to stocks. When you invest in a green bond, the issuing organization commits to using your money to fund projects that help the environment. Green bonds are a type of sustainable bond, which are broader in nature and can invest in other themes beyond just the environment, such as social equity.

Social Impact Bonds

We’ve talked about traditional bonds above but, confusingly, a social impact bond is something a bit different. Despite the name, a social impact bond is not actually a bond in the sense of a debt security; it is really an outcome-based contract. This means that the bond aims to deliver a positive social outcome and then repay private investors with the state funding it receives if and when it achieves its goal. Social impact bonds bring together the public, private, and voluntary sectors and commit to tackling a particular social problem such as homelessness or youth unemployment in a certain area. These bonds are considered high-risk because investors may not get their money back if the project fails.

Synonym: Pay-for-success bond

Benefit Corporation

A benefit corporation is a relatively new type of business model that is available for legal incorporation in some states. The purpose is to distinguish a standard for-profit business from those that have a substantial positive impact on society and the environment and make a profit. A benefit corporation will consider the effect of its activities not just on its customers and shareholders but also on its workers, the wider community, and the environment. It will have very high standards of accountability and transparency, publicly reporting its social and environmental performance every year.

Certified B Corporations (B Corps)

While ‘benefit corporation’ is a broad term for a certain type of business, a certified B Corporation, or B Corp, refers to something more specific. It identifies a company that has third-party certification from the creator of the B Corp concept, a non-profit organization called the B Lab. However, a company can still be a benefit corporation without this accreditation, or it can be both a benefit corporation and a B Corp.

It’s important to know if a company is a benefit corporation, a B Corp, neither, or both because each has different requirements to meet. This means you can’t make the same assumptions about the sustainability standards of a benefit corporation from one particular state and a B Corp. But, whether a company is one or both of these things, what matters to investors is that the requirements and reporting needed for B Corps and benefit corporations can be a way to pre-screen them, making analysis and monitoring easier for impact investors.

Positive and Negative Screens

In order to invest with impact, an investor or fund manager might use positive or negative screening as a way to narrow down the universe of possible investments. Think of positive and negative screening like the filter you might use when online shopping to sort products by the size or color you’re looking for.

For example, a mutual fund manager might apply an ESG filter to a range of companies and exclude those scoring poorly on broad environmental, social, and corporate governance issues relative to their peers. They would then avoid companies with accounting scandals, known polluters, or have not treated their workers well. Depending on their goals, their fund might screen out whole sectors or industries, such as gambling businesses, companies that test on animals, or those involved with fossil fuels. These are all examples of negative screening.

A positive screen could help an investor choose those companies whose products and services make a positive difference in the world or have the highest standards of corporate governance and social responsibility and can demonstrate ethical business practices.

An individual investor might screen out certain investment strategies using both positive and negative criteria, according to our own values and priorities. For example, you might want to avoid investing in companies that make tobacco products while also choosing to invest in renewable energy tech, like electric car makers.

Restrictive Financing Policies

Making a positive impact is not just about where you invest; it’s also about where you bank. As an investor, you can direct your portfolio or investment manager to invest in line with your values, but do you know what’s happening to your cash savings?

Banks use customer deposits held in savings and checking accounts to finance various activities, some of which may be environmentally damaging. For example, the four biggest US banks are among the main funders of the dirtiest fossil fuel activities.

But there’s no reason you can’t vote with your feet and choose a bank that has publicly committed to avoiding financing activities that harm the planet by making it part of their policy. Restrictive financial policies are where financial institutions spell out the things they won’t fund with customers’ money.

At Bank of the West, we use our own negative investment screens to avoid funding Arctic drilling, fracking, palm oil production, or tobacco.

CSR

CSR stands for corporate social responsibility, meaning the way corporations consider their impact on the economy, environment, and society and hold themselves accountable. It’s about more than just feel-good gestures like a token charitable donation each year or a bit of recycling. CSR is actually now guiding business transformation as companies realize they have to do more than just pay lip service to ESG.

Generally, the term CSR is used when companies are striving to go beyond the basics demanded of them by regulators or environmental protection groups and are trying to actively improve society and the environment. CSR activities might include philanthropy, ethical product sourcing, or green initiatives like waste reduction or carbon offsetting. Impact investors can look at a business’s corporate social responsibility policies to inform their investment decisions.

Strategic Philanthropy

Strategic philanthropy is when you make a long-term plan for giving or investing with specific, measurable goals in mind. It is different from traditional philanthropy, such as simply making a charitable donation, because it takes a more disciplined approach: In consultation with an advisor, you will be aiming for measurable results, including milestones to meet along the way. You’re not just looking to address a short-term need, like feeding homeless communities today, but focusing on the long-term challenge, like programs that aim to end or reduce homelessness.

Strategic Philanthropy can help bring about systemic changeand it is a great compliment to impact investing. Purpose-driven investing and strategic philanthropy both aim to create more sustainable systems and tackle problems at the roots, which is the only way we as a society will be able to deal with huge challenges such as climate change.

So there you have it, a quick and simple guide to some of the key concepts in sustainable and impact investing. Now that you know what’s what, are you ready to invest? Contact us today at Bank of the West to find out how we can help you.

Footnotes

1. From the Stockholder to the Stakeholder: How Sustainability Can Drive Financial Outperformance. https://arabesque.com/research/From_the_stockholder_to_the_stakeholder_web.pdf

Disclosures

Impact investing focuses on investments in companies that relate to certain sustainable development themes beyond traditional financial factors and demonstrate adherence to environmental, social and governance (ESG) practices. Therefore the universe of investments may be limited and investors may not be able to take advantage of the same opportunities or market trends as investors that do not use such criteria. This could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market

The discussions and information set forth herein are for informational purposes only. They do not take into account the exceptions and other considerations that may be relevant to particular situations. These discussions and information should not be construed or used as legal or tax advice, which has to be addressed to particular facts and circumstances involved in any given situation. The discussions and information contained in this article should not be construed or used as a specific recommendation for the investment of assets of any customer of Bank of the West or its affiliates and is not intended as an offer, or a solicitation of an offer, to purchase or sell any security or financial instrument, nor does the information constitute advice or an expression of the Bank’s view as to whether a particular security or financial instrument is appropriate for you and meets your financial objectives. Economic and market forecasts reflect subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. Nothing herein should be interpreted to state or imply that past results are an indication of future performance. This information is given without regard to the specific investment objectives, financial situations, or particular needs of any person who may review this article. Investors should seek financial advice regarding the appropriateness of any securities or strategies mentioned here. Bank of the West does not guaranty the results obtained from use of any information contained in this article and will not be liable for any investment decision based in whole or in part on the information contained herein. Bank of the West nor its affiliated entities shall be held liable for any content, regardless of cause, or the lack of timeliness of, any information contained in this article. THERE ARE NO WARRANTIES, EXPRESSED OR IMPLIED, AS TO THE ACCURACY, COMPLETENESS, OR RESULTS OBTAINED FROM ANY INFORMATION IN THIS ARTICLE OR FROM ANY “LINKED” WEB-SITE.

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