An externality or external effect is an uncompensated cost or benefit to an uninvolved third party that arises due to other economic agents’ activities.

A prominent example for a negative externality is air pollution, and more generally, environmental damages. An example for a positive externality is the creation of knowledge.

Externalities are estimated as the damages or benefits, in monetary terms, to society and environment. They are calculated by measuring a physical impact driver, such as greenhouse gas emissions, and multiplying by a monetary valuation factor.

Sustainable return is the key metric of sustainable investing. It corrects traditional, financial return by the externalities associated with the investment.

Taking into account externalities is the essence of sustainable investing. Significant externalities are likely to attract government attention, e.g. taxation, or product market reaction, e.g. consumer activism, with associated effects on future cash flows and security prices.