Environmental Investing vs ESG Investing in Australia
Australia’s sustainable finance landscape has undergone significant growth over the past decade, creating a complex ecosystem of approaches, strategies and terminology. Environmental investment, ESG investment, ethical investment, responsible investment, impact investment and sustainable investment are terms which have gained popularity in Australia over the past decade. However, these are not necessarily synonymous, with key differences in both the investment opportunities they consider, and the investment implications they present.
Environmental investment and ESG investment in particular have seen a dramatic increase in popularity amongst Australian investors, with the emergence of a broad range of related funds, vehicles and strategies.
This guide aims to explain the difference between environmental investing and ESG investment in Australia, identify what distinguishes them, which overlaps with the other and what potential implications each approach has for Australian investors.
What is Environmental Investing?
Environmental investment involves the allocation of capital into specific projects/assets/companies/funds which directly target environmental outcomes in addition to a financial return.
Unlike ESG investment, which takes a multi-criteria approach to assessing the sustainability of an asset, environmental investing focuses purely on those assets which specifically target environmental outcomes. These can include Australian Carbon Credit Units, carbon markets, energy generation, nature repair, biodiversity, water, circular economy, sustainable forestry, environmental infrastructure, cleantech and climate risk adaptation.
In Australia, this form of investment has become increasingly formalised within carbon markets, with a growing number of environmental assets being bought and sold through the Clean Energy Regulator as well as the anticipated launch of Nature Repair Markets, renewable energy investment and other related opportunities. The distinguishing characteristic of environmental investing is the direct targeting of environmental outcomes.
What is ESG Investing?
In contrast, ESG investing falls under the broader umbrella of sustainable investment, incorporating a triple bottom line perspective which considers both governance, social and environmental factors when allocating capital.
In practice, ESG investing involves considering social, environmental and governance factors when making an investment decision. From an environmental perspective, this includes climate change, carbon emissions, energy, water, biodiversity and waste management, while on a social level it incorporates workers, communities, gender diversity, human rights and supply chains. Meanwhile, governance covers executive compensation, board independence, shareholder rights, ethics and risk management.
Therefore, unlike environmental investing, ESG investment considers broader questions about how an organisation operates beyond its environmental impact.
The Difference between ESG and Environmental Investing
Put most simply, the difference between ESG and environmental investing is that the latter specifically targets environmental outcomes, whereas the former considers a range of environmental, social and governance factors when making an investment. In contrast to environmental investing, ESG investment does not specifically target environmental assets or outcomes, instead analysing each asset according to its ESG characteristics. As such, while all environmental investing falls within the broader category of sustainable investment, not all ESG investing is environmental investing.
The fundamental difference between ESG and environmental investing is that the former falls under the umbrella of sustainable investment, whereas the latter is a specific investment style within that category. Therefore, although ESG investment incorporates a consideration of environmental outcomes, it does not specifically target them in the same way that environmental investing does.
Why are ESG and Environmental Investing Often Confused?
One reason why ESG and environmental investing can be confused is that some of the investment opportunities which fall under these categories can overlap. For instance, an investment in a renewables company could be classified under both categories, as it falls under the category of an environmental investment, but one that does not incorporate a consideration of wider social or governance aspects.
At the same time, an ESG fund could incorporate a wide range of different industries which meet the ESG criteria of that fund, even if none of them specifically target environmental outcomes. ESG investment also frequently overlaps with ethical investment, impact investment, sustainable investment, responsible investment, and even general investment. In effect, any particular investment fund could meet multiple categories depending on the specific opportunities it utilises.
How do ESG and Environmental Investing Selection Criteria Vary?
The selection criteria for environmental investing are likely to be driven by environmental objectives, and will centre around whether an opportunity directly targets emissions, biodiversity, water, or other environmental outcomes. In contrast, selection criteria for ESG investment are more likely to be driven by financial considerations, with ESG factors incorporated in order to mitigate risk.
As such, when considering an opportunity for ESG investment, an investor is likely to ask whether the firm has strong governance, treats its workforce well, has responsible supply chain practices, accounts for climate risks, has appropriate risk management, or meets other ESG considerations. By contrast, an investor considering an opportunity for environmental investing is likely to centre their considerations around direct emissions reductions, biodiversity, water, renewable energy or other specific environmental outcomes.
Can You Give Examples of ESG and Environmental Investing?
An example of an environmental investment might be an investor allocating capital to a solar farm, an Australian Carbon Credit Unit project, biodiversity, or regeneration of native forests. Alternatively, an example of an ESG investment would be an investor allocating capital to an ESG fund which incorporates a range of different industries which meet the ESG criteria for that fund. Therefore, in this instance the ESG fund might include banks, supermarkets, healthcare, transport, manufacturing, and renewables, but none of these specifically target environmental outcomes.
What are the Key Differences between Environmental and ESG Investment Risks?
Environmental investment typically carries specific project or market risk, particularly in relation to the development of particular projects as well as carbon pricing, but can also incorporate a degree of social risk depending on the specific opportunity. In addition, many environmental assets tend to be illiquid when compared to more traditional investments.
By contrast, ESG investment tends to carry similar risks to general investment, with the specific characteristics of the opportunities dictating the risk profile.
What are the Potential Environmental Impacts of ESG and Environmental Investing?
The environmental impact of these two forms of investment would be dictated by the specific opportunities which an investor chooses, but in general, environmental investing tends to have a direct impact, whereas ESG investment tends to have an indirect impact.
As such, an environmental investment, such as a direct allocation to a renewables project, would directly target specific environmental outcomes, whereas an ESG investment, such as an ESG fund, would centre around ensuring that the fund incorporates responsible investment practices without specifically targeting environmental outcomes. Although the allocation to an ESG fund might indirectly have a positive environmental impact, this would be less direct than the impact of the direct allocation to the renewables project.
What are Australian Investors’ Main Concerns around ESG and Environmental Investing?
One of the main concerns around both ESG and environmental investing is the risk of greenwashing. Australian regulators have been cracking down on unsubstantiated environmental claims, with the Australian Securities and Investments Commission (ASIC) defining greenwashing in financial markets as the presentation of an investment product or strategy in a more environmentally beneficial manner than is justified. As such, regulators have issued guidance to funds on labelling practices, as well as taking enforcement action against misleading claims. At the same time, the Australian Competition and Consumer Commission (ACCC) has been warning businesses about making misleading environmental claims, and has issued guidance to businesses under Australian Consumer Law.
Therefore, when considering any form of ESG or environmental investing, it is vital that investors conduct their due diligence in order to ensure that any claims being made are legitimate and evidence-based. Both ASIC and the ACCC provide guidance in relation to substantiating sustainability claims, and investors should read these to ensure that any fund or product they consider meets these standards.
Is there one Investment Approach that is Better than the Other?
Neither of these forms of investment are inherently superior to the other, but rather, they serve different functions. ESG investment tends to be focused on building diversified portfolios which consider a range of environmental, social and governance factors, whereas environmental investing tends to be more narrow in focus, targeting opportunities which specifically centre around environmental outcomes.
As such, ESG investment can be utilised by Australian investors looking to build broadly diversified portfolios with an increased focus on responsible investment considerations, whereas environmental investing can be utilised by those looking to specifically target certain environmental outcomes. In effect, many investors might use a combination of ESG and environmental investing in order to build a more balanced portfolio with both diversified and targeted opportunities.
FAQs
Is environmental investing the same thing as ESG?
Environmental investment focuses on opportunities to specifically target environmental outcomes, whereas ESG investment considers environmental, social and governance factors when making an investment.
Can an ESG fund contain fossil fuel companies?
An ESG fund can contain fossil fuel companies depending on the specific ESG criteria utilised by the fund, since ESG investing falls under the broader umbrella of investment, screening opportunities according to a range of criteria.
Are all renewable energy investments ESG investments?
All renewable energy investments contain ESG characteristics, but do not necessarily meet the full criteria of an ESG investment, since ESG investment also considers social and governance factors.
Which type of investment has a bigger environmental impact?
An environmental investment tends to have a bigger environmental impact since it specifically targets environmental outcomes, whereas an ESG investment contains opportunities across a range of industries.
How can Australian investors avoid being misled by greenwashing?
Australian investors can avoid being misled by greenwashing by conducting their own due diligence when considering any form of ESG or environmental investing. By reviewing the Product Disclosure Statement and the specific investment opportunities contained within any ESG or environmental fund, Australian investors can ensure that the fund meets the standards set by the ACCC and ASIC.
Disclaimer
EnviroInvest Pty Ltd ACN 685 107 957 (“EnviroInvest”) is an Authorised Representative of Daylight Financial Group Pty Ltd ACN 633 984 773 (“DFGPL”) which is the holder of an Australian Financial Services Licence (AFS Licence No. 521404).
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