What is “Positive and Negative Screening”?
There are various approaches to investment selection that can be applied, but when it comes to Environmental, Social, and Governance (ESG) related strategies, there are two most common types – positive and negative screening.
In positive screening, investors normally consider the “best in class” company within a specific sector, which means that stocks operating in sectors such as Oil and Gas or Mining could still be included in the portfolio as long as they can demonstrate the best ESG credentials in their area of business. On the other hand, negative screening excludes companies working in sectors that might be harmful to the environment or society.
Key Learning Points
- The two main types of investment selection in ESG investing are positive screening and negative screening.
- Positive screening could include companies from “controversial” sectors such as Oil and Gas, as long as they can demonstrate strong ESG commitments and a potential to improve.
- Negative screening use exclusions to come up with potential investment opportunities. Companies that do business in sectors harmful to the environment or the society are not considered.
What is Positive Screening?
The process of positive screening usually begins with identifying an issue where investors want to have a positive impact. Also, it needs to be determined what would be the best way to measure the company’s performance against that criteria. For example, an investor who is concerned about climate change might screen the universe for companies with the lowest carbon footprint (or carbon risk) in each sector. That would result in a “best in class” selection of companies.
Other approaches may include investing in companies that might not currently score high on their ESG credentials but have the potential to improve materially. Through a number of mechanisms such as shareholder engagement, investors may exert pressure on company executives to improve policies on relevant issues.
What is Negative Screening?
Negative screening has a long history of being applied by socially responsible investors such as charities, religious organizations, and endowments. This approach excludes entire sectors or industries from the investable universe depending on the asset owner’s requirements. For example, faith-based investors are likely to avoid “sin industries” such as tobacco, alcoholic beverages, armaments, or gambling. In addition, negative screening could also be employed on a geographical level should investors feel that a political change is required (for example against oppressive or hostile regimes).
The main argument about negative screening is that the exclusionary method has a negative impact on the potential returns of a portfolio. As an example, should energy perform well, investors that have screened out the entire sector could underperform relative to those with a traditional allocation that might include energy stocks? However, ethical investors who are usually applying this method do not focus solely on financial returns, but would rather like to positively contribute to the environment and society.