Exclusion Based Investing
Exclusion based investing is the oldest and most popular approach to Environmental, Social and Governance (ESG) investing
Exclusion based investing, or negative screening, is the oldest approach in sustainable investing.
$15 trillion is invested in the approach globally (Global Sustainable Investment Review 2020). However, it’s compounding annual growth 2016-2020 was 0%. A stark contrast in growth compared to other strategies such as ESG integration.
Exclusion 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.
Jargon Buster – ESG Scores
An ESG score is a quantitative metric, such as a letter rating or numerical score.
It is used to evaluate and measure the environmental, social, and governance (ESG) initiatives implemented by particular companies.
Benefits of exclusion investing
The 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.
Challenges
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 Dot-com buddle 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.
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