ESG investing: What is negative screening?
ESG investing provides an opportunity for your investments to reflect your values across three broad areas – environment, social, and governance. Negative screening, where you avoid investing in companies that engage in certain sectors, is one approach to ESG investing, but it could present some challenges.
Read on to find out more about negative screening and other ways you might make ESG factors part of your investment strategy.
Negative screening with zero tolerance could exclude more businesses than you expect
On the surface, negative screening is straightforward. You simply avoid investing in companies that engage in activities that don’t align with your personal values.
For example, you might want to avoid investing in businesses that operate in sectors you consider to be unethical, such as weapons or alcohol. Indeed, it can be a good option if you strongly object to some industries.
However, if your exclusion filter removes all businesses operating within an industry, you could unintentionally exclude far more companies than you intend.
Let’s say you want to avoid investing in tobacco. You might initially state you want to exclude all businesses that derive any of their profits from tobacco. This wouldn’t just exclude tobacco companies, but those within the supply chain too, such as supermarkets or delivery companies.
As large companies are often complex, with subsidiaries and connections you might not be aware of, you may exclude businesses that could otherwise fit your investment criteria.
From an investment perspective, this presents several challenges. For example, your options for investing may be limited, and it can make it difficult to create a diversified portfolio that reflects your risk profile.
So, you might want to explore alternative ways to incorporate ESG values into your investments.
3 approaches to ESG investing
1. Add some tolerance to your exclusion filter
Using a negative screening approach but adding a tolerance to your exclusion filter could remove some of the challenges mentioned above.
To go back to the earlier example, you might exclude businesses that derive more than 10% of their profits from tobacco. This would remove tobacco companies from your portfolio, while still allowing you to invest in firms that may be part of the supply chain.
2. Focus on positive screening
Positive screening means you’d actively search for investment opportunities that score highly on ESG factors relative to their peers. So, you’d invest in the companies that are considered “best in class” within a specific sector.
For instance, if you’re investing in the energy sector, a best in class approach could mean your money is invested in the businesses that are focused on renewable energy rather than fossil fuel companies.
This approach doesn’t exclude entire industries, making it easier to create a diversified portfolio.
3. Active ownership
Active ownership involves investing in a company that might not align with your ESG values now, and using your shareholder power to encourage change. For example, by voting for stronger ESG policies at an annual general meeting.
This approach to ESG investing is typically used by large shareholders, such as pension funds, but smaller investors can also band together to have an impact.
Get in touch to talk about your values and investing
Aligning your investments with your values could help you have a positive impact on the world while generating returns. Please get in touch to talk to us about the values that are important to you and how you might incorporate them into your wider financial plan.
Please note: This blog is for general information only and does not constitute financial advice, which should be based on your individual circumstances. The information is aimed at retail clients only.
The value of your investments (and any income from them) can go down as well as up, and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.