#LCAW2022: Why ESG screening demands a positive approach – Alex Sumner

by | Jun 28, 2022

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Celebrating London Climate Action Week, this article features as part of IFA Magazine’s editorial campaign throughout this week, which aims to highlight key issues, news and views in the field of climate action.

The recent ‘boom’ in environmental, social and governance (ESG) portfolios has increased awareness of ESG factors, but it’s important to consider the consequences of different screening approaches.

Negative screening is the most common approach by fund managers and discretionary fund managers (DFMs), but does it always do good? Advisers keen to address investor concerns over ESG may ask questions like “what do you object to?” or “which industries do you wish to avoid?” and then select an investment solution that negatively screens out these areas.

The downside of this approach is this it can adversely affect both the client’s investment and ESG outcomes in the long term.

Many investors consider fossil fuels as environmentally unsound, and therefore expect it to be screened out of their portfolio. However, fossil fuels remain a necessary global resource that cannot be ignored. While some oil companies are focused on drilling for oil and investing in the associated infrastructure, others are directing greater proportions of capital towards greener areas of industry, such as renewable energy.

Mining is another example. For net zero carbon emissions targets to be achieved, vast quantities of lithium and copper required for electric cars must be mined. Some mining companies are improving staff working conditions, (often responding to shareholder voting and pressure) and reducing their negative environmental impact by sourcing alternative minerals which are aiding the transition to greener energy storage.

Divesting from all mining companies risks cutting off the capital they need to help deliver on broader net zero emissions targets, and arguably makes them less likely to improve working conditions, or reduce the environmental impact of extraction methods. Privately run companies face very limited accountability, and therefore are under no real pressure to change.

We strongly feel investors should stay invested in areas of industry where they (or the relevant fund manager) can impact the way such businesses are run. More forward-thinking companies are looking to eventually pivot into greener industries. They should also remain highly relevant and attractive from an investment perspective. Those who stay invested in these companies will hold far greater sway in terms of voting rights and positive ESG outcomes.

Moreover, a positive screening process can unearth and support forward-thinking companies focused on future improvements to ESG factors, and promote greater investment from responsible fund managers who actively engage and monitor their ESG targets.

By negatively screening out great swathes of industry, divestment diminishes shareholder power, potentially reducing positive ESG outcomes in the future. Plus, investors can miss out on some real gems. It is therefore essential for financial planners to ensure client fact-finds and research into ESG
investing are both comprehensive and considered.

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