ESG Vs Negative Screening: An Overview
Definition of ESG negative screening ESG negative screening refers to the process of finding and excluding stocks of companies, whose operations are seen as unsustainable from an environmental, social or governance (ESG) standpoint [3].
We define weapons stocks as investments in companies that produce military weapons.
The relationship between ESG negative screening and weapons stocks
The idea behind ESG negative screening is to find and exclude stocks of companies whose operations are seen as unsustainable from an environmental, social or governance standpoint. Some investors may view companies that produce military weapons as unsustainable and therefore apply negative screening to exclude such stocks. On the other hand, some ESG funds may still contain exposure to military weapons [1].
Overview of Popular ESG Negative Screening Practices
ESG (Environmental, Social, and Governance) negative screening is a practice used by institutional investors to assess the sustainability of a company’s operations. It helps investors understand the risks and opportunities that companies present in regard to sustainability issues [2].
Explanation of Excluding Stocks of Firms Involved in the Production of Controversial Industries
One popular version of ESG negative screening is to exclude stocks of firms involved in the production of controversial industries such as alcohol, tobacco, gaming, pornography, coal, gas, and oil. This type of screening is referred to as “sin stocks” or “excluded industries” [1]. This practice is widely practiced by institutional investors who are sensitive to ESG considerations and seek to minimise the negative externalities caused by a company’s operations [3].
Results of a study on the presence of weapons stocks in ESG funds [1] According to a study by Capital Monitor AI, 52% of ESG funds contain exposure to military weapons. This is compared to 67% of regular funds that contain exposure to military weapons.
Comparison of the presence of weapons stocks in ESG funds vs. regular funds [1] The study shows that ESG funds are generally less exposed to military weapons compared to regular funds.
Explanation of the low score for exposure to major military contractors in some ESG funds [1]
According to the study by Capital Monitor, nearly one in ten ESG funds score the lowest possible grade for exposure to major military contractors, compared with almost two in ten across all funds. This shows that some ESG funds have a low level of exposure to major military contractors.
One example of a company that decided to not allow its funds to touch defense stocks can be found in various countries, including Australia, Brazil, Germany, Japan, and South Korea, which have chosen not to pursue weapons programs. According to MIT News [2], recognising these different paths to proliferation is an essential part of arms control, and grasping how one country is pursuing nuclear weapons can help other countries constrain that pursuit.
Attitudes, according to the definition provided by Verywell Mind [3], are a set of emotions, beliefs, and behaviors toward a particular object, person, thing, or event. Attitudes can change over time and can be influenced by various factors, including experience and upbringing. A change of mind in allowing some of its funds to touch defense stocks could be due to a change in attitudes, such as a shift in beliefs about the importance or necessity of defense stocks, or a change in behaviors that are in line with these beliefs.
ESG has evolved from past movements focusing on health, safety, pollution reduction, and philanthropy. ESG metrics, such as environmental and social impact, are important to investors as they present both risk and opportunities for long-term value creation. Studies have shown a link between ESG and financial performance, with 81% of sustainable indices outperforming their peer benchmarks.
According to a study by Harvard Law School, more ESG proposals are being submitted and passed by investors, leading to higher pressure on firms to improve their ESG performance. This may result in a decrease in investment in weapons stocks, as they are considered to have a negative ESG impact.
The growth of ESG as a factor in investment decision-making is a reflection of changing values and priorities among investors, as well as increasing awareness of the long-term impact of investment on society and the environment.
As ESG continues to gain importance in the investment world, it may lead to decreased investment in weapons stocks, which have negative environmental and social impacts. It remains an open question as to the effectiveness of ESG negative screening in achieving desired outcomes, but the trend towards ESG-conscious investing is a significant shift that investors should consider in their decision-making process.
This also includes investors' relationships to the returns that they are making for their greater stakeholders.
