Exclusion Based Investing
Negative screening is the oldest and most popular approach to Environmental, Social and Governance (ESG) investing.
A colossal $30.7 trillion is invested in this approach globally (Vanguard & Global Sustainable Investment Reviews 2016 and 2018), although its growth is slower than other strategies, such as ESG integration and impact investing.
Negative screening excludes individual stocks or sectors based on specific ESG criteria. Which companies it excludes depends on the criteria used. For example, some approaches might exclude all fossil fuel companies; others only those that fall below a range of ESG scores.
Benefits of exclusion
The negative screening approach would suit investors who want to take a moral stand by withdrawing funds from specific sectors, such as the tobacco industry or oil extractors.
The approach is easy for investors to understand. An exclusion strategy can start with a broad market benchmark and simply remove companies that do not meet the specified criteria.
Exclusion strategies tend to correlate more closely with benchmarks, when compared to impact investing. It could therefore work for an investor looking to align closely with a large-cap equity allocation.
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Investors must always diversify fully. Excluding investments on face value negative criteria could still lead to high concentrations in some sectors at the expense of others – for example, large weightings in technology and limited exposure to energy companies. It is worth recalling how much wealth was destroyed when investors piled into one sector, technology stocks, and the subsequent ‘tech wreck’ crash in 2000.
Another pitfall of exclusion is that, if there is always someone else willing to invest in excluded stocks, screening them out of your client’s portfolio arguably has no ultimate impact.
EBI’s Earth Portfolios protect investors by incorporating ESG concerns into an existing strategy for preserving wealth and capturing growth.
ESG investing must be done with caution. Investors who focus on social goals at the expense of prudent investments will likely achieve neither.