Head-to-head: ESG integration versus ‘impact investing’

Put simply, ESG integration involves incorporating environmental, social and governance (ESG) factors as part of the investment process to enhance financial outcomes, while impact investing actively targets measurable, positive social or environmental outcomes alongside financial returns.

More specifically, ESG integration strategies are typically used by investors who seek to manage ESG risks and opportunities within traditional financial frameworks, aiming to improve long-term, risk-adjusted returns. These strategies assess material ESG factors – such as carbon emissions, supply chain ethics, or board diversity – as additional lenses within fundamental or quantitative analysis, but without necessarily altering return expectations or requiring direct societal impact.

In contrast, impact investing goes further by making intentional investments into companies, projects, or assets specifically designed or chosen to deliver measurable positive change, such as reducing global emissions, improving access to healthcare, or advancing education outcomes. Impact investors set dual objectives: competitive financial returns and verifiable real-world impact, often aligning portfolios with frameworks like the United Nations Sustainable Development Goals (SDGs).

While ESG integration has become a mainstream approach across equities, fixed-income, and multi-asset strategies, true impact investing remains a more specialised domain. It requires deeper diligence, outcome reporting, and sometimes a longer-term investment horizon. Both approaches play important roles in sustainable investing, but understanding the distinction is critical for aligning investment choices with clients’ values, regulatory requirements, and long-term financial goals.

Head-to-head

Below are two Australian equity funds that have been randomly selected to go head-to-head in a comparison of their styles and approach. Note that their suitability for portfolios has not been considered.

Investment Approach

• Pendal Sustainable Australian Share Fund: This fund employs an active, bottom-up investment approach with a strong emphasis on ESG integration. The investment team seeks to construct a diversified portfolio of Australian companies across various sectors by applying traditional fundamental analysis alongside ESG considerations. The fund applies negative screens, excluding sectors such as tobacco, fossil fuels, gambling, and controversial weapons. ESG risks and opportunities are assessed within the research process to bolster long-term outlook. The objective is to achieve competitive capital growth relative to the S&P/ASX 300 Accumulation Index, without directly targeting measurable social or environmental impacts.
• Melior Australian Impact Fund: This fund adopts a thematic, bottom-up stock selection approach with a dedicated impact investing mandate. It focuses on investing in listed Australian and New Zealand companies that make a measurable positive contribution to environmental and social outcomes, aligned with the United Nations SDGs. Investments are assessed not only for financial strength but also for intentional impact potential, with strict eligibility criteria and ongoing impact measurement. The fund aims to deliver competitive financial returns while achieving tangible improvements across areas such as climate action, healthcare access, and social inclusion, with detailed annual impact reporting provided to investors.

Performance

Pendal outperformed Melior and the S&P/ASX 300 over one and three years, with the funds returning 8.3 per cent and 5.7 per cent respectively. Over five years, Pendal remained ahead of Melior but trailed the index, while on a ten-year basis, Pendal modestly underperformed the benchmark.

Risk Metrics

Volatility is the most common measure of risk, with Pendal Sustainable and Melior Impact showing modest differences at 10.4 per cent and 12.0 per cent respectively. This suggests that while both funds maintained relatively controlled risk profiles, Melior experienced slightly higher fluctuations in returns over the year, reflecting its more targeted impact investing approach.

Both funds demonstrated high market correlation, with Pendal recording a beta of 0.95 and Melior slightly higher at 1.11, while r-squared values of 0.97 and 0.98 respectively indicate that their returns were closely aligned with broader market movements over the past year.

Why distinguishing the two matters for investors and advisers

Understanding the distinction between ESG integration and impact investing is critical for investors and advisers, particularly when comparing strategies such as Pendal’s Sustainable Australian Share Fund and Melior’s Australian Impact Fund.

Regulatory risk is an increasingly important consideration. Regulators like ASIC are closely monitoring how sustainability claims are presented, with ‘greenwashing’ penalties becoming more common. A fund like Pendal’s, which integrates ESG risks into its financial process but does not directly target measurable outcomes, must ensure that its marketing accurately reflects its investment intentions. Meanwhile, Melior’s impact mandate, with transparent SDG alignment and annual impact reporting, must demonstrate that its investments genuinely lead to real-world positive change – a higher evidentiary bar.

Setting the expectations of clients is equally crucial. Investors wanting to “invest responsibly” may assume that any sustainable fund produces tangible impact. Without clear explanations, advisers risk the presence of mismatches between client values and fund outcomes. Pendal’s offering suits clients who want ESG risks managed within a traditional return-focused framework, whereas Melior’s suits clients explicitly seeking investments that drive environmental and social improvements.

Investment strategy suitability also differs. ESG-integrated strategies like Pendal’s are typically benchmark-aware, and may offer return profiles closer to conventional Australian equity funds, appealing to clients focused on balancing sustainability with portfolio performance. Impact strategies like Melior’s, however, often display more thematic sector concentrations and different volatility patterns, requiring a longer investment horizon and a stronger alignment with clients’ impact goals.

Ultimately, advisers must ensure they match the client’s intent – whether it is managing ESG risks or actively contributing to societal change – to the appropriate investment vehicle.

Conclusion

Selecting between ESG integration and impact investing is not merely a matter of product preference; it reflects a deeper alignment between client values, regulatory realities, and portfolio construction objectives. Pendal’s Sustainable Australian Share Fund and Melior’s Australian Impact Fund illustrate two distinct philosophies – one focused on improving risk-adjusted returns through ESG considerations, the other on achieving measurable real-world outcomes alongside financial returns.

Careful due diligence is essential. There is no one-size-fits-all solution, and the right approach depends on understanding what the investor really wants to achieve – better-managed investment risks, or a tangible contribution to a better world. Making this distinction clear will be key to building trust, meeting regulatory obligations, and delivering portfolios that genuinely reflect client aspirations.

Nick Hatzis is an investment analyst at Atchison.

*Important Note: Historical performance is not a true indicator of future performance. Conduct your own due diligence regarding underlying strategies, holdings, market conditions, along with understanding your clients’ goals and risk tolerances prior to making investment decisions. Expecting a fund to maintain their top position can often leave an investor underwhelmed in future periods. Data sourced

Nick Hatzis