This post is adapted from a recent episode of the Scholar Financial Advising podcast. Listen here for the full discussion.
A listener asked:
“We’re interested in impact investing. What do we need to consider when picking funds to add to our portfolio?”
It’s a big topic with a lot of nuance. “Impact investing” can mean many different things, depending on the strategy and how you define success. Let’s start with the basics and the key considerations to keep in mind.
What Is Impact Investing?
At its core, impact investing means aligning your investments with your values. You want your money invested in companies or sectors that are doing good in the world—or at least, that reflect your personal priorities.
There are many ways to approach this. Some investors build “inclusion” lists, investing in companies that support the causes they care about. Others take an exclusionary approach, choosing to avoid industries or companies they find objectionable. Many people start exploring this concept through charitable giving, but it has now moved into personal portfolios as well.
ESG, SRI, and Thematic Investing
When it comes to investment products, you’ll see two main acronyms:
- SRI – Socially Responsible Investing
- ESG – Environmental, Social, and Governance
SRI funds focus more on social responsibility, while ESG funds balance environmental, social, and governance factors. Over the past 6 to 7 years, ESG has become the more popular term, largely because Wall Street saw strong interest and demand. Any time fund flows grow, the financial industry responds by launching new products.
In fact, ESG and SRI can be thought of as forms of thematic investing—just like funds focused on AI or renewable energy. The idea is to tailor a portfolio around a theme that resonates with the investor.
How These Funds Actually Work
Most ESG and SRI funds fall into two categories:
- Active funds: A fund manager selects companies they consider ESG-friendly, often based on proprietary criteria.
- Passive funds: These follow a set of rules or rankings to determine which companies make the cut.
Here’s the catch: the criteria for what counts as “good” varies widely.
Take Tesla, for example. Some ESG indexes rate it highly for producing electric cars. Others rate it poorly because of the environmental impact of battery supply chains.
The same goes for Apple. High marks for environmental efforts and governance, but lower scores when labor practices are factored in.
Even energy companies like ExxonMobil sometimes score well on certain lists—thanks to corporate sustainability efforts—while scoring poorly on others.
Performance: Don’t Expect to Beat the Market
Because of these shifting definitions, ESG and SRI funds don’t follow a consistent formula—and their performance can vary.
A common trend:
- Overweight tech stocks (Apple, Microsoft, Nvidia, Tesla)
- Underweight energy stocks (Exxon, BP)
In strong tech markets, ESG funds can outperform the S&P 500. But when energy or utilities outperform—as they did in 2022—these funds often lag.
It’s important to remember: impact investing is not about beating the market. It’s about aligning your values with your portfolio. Any performance difference should be viewed as the cost of that alignment.
What to Consider Before You Invest
If you’re thinking about adding ESG or SRI funds to your portfolio:
- Understand the fund’s rules. How does it define ESG? What companies are included or excluded?
- Know what you’re paying for. This is about values, not pure performance.
- Be realistic about returns. Over the long term, expect some underperformance relative to the broad market—and be okay with that.
Final Thoughts
Impact investing can be meaningful when done intentionally. But it’s important to know what you’re investing in—and why.
If you’re clear about your goals, and if the values alignment matters more than the performance, then these funds can be a good fit. Just go in with eyes open about the tradeoffs.
To hear more on this topic, including examples of ESG fund performance and industry trends, listen to the full podcast episode here.