As the impact and sustainable investing markets expand and develop, different investors are employing different investment selection strategies. The Global Sustainable Investment Alliance provides a helpful characterisation of these different approaches[1]. Those approaches to investment selection do not have to be applied in isolation from each other. Here we compare two; positive selection and negative screening.
At AIM, we use our proprietary SPECTRUM Bond® analysis to assess the impact of issuers and issues. SPECTRUM is predominantly a positive selection methodology, but it also incorporates elements of the other approaches detailed below.
Global Sustainable Investment Alliance, ‘2018 Global Sustainable Investment Review’, pg.7
Negative screening relies on exclusionary criteria and filters. Thresholds are applied based on various data points, and organisations are assessed for compliance with the exclusionary screens. Organisations breaching any screens are excluded from the investment universe. It is a passive screen based on historical data, that is only as good as when last updated.
What is positive selection?
Positive selection for impact investment involves a detailed assessment of a potential investment in order to understand its environmental, social and governance performance and the impacts—desired and undesired; direct and indirect—that could be associated with that investment. It requires detailed research and engagement with the organisation under assessment. It is an active, forward-looking approach and is judgement based.
Negative screening allows an investor to robustly apply chosen ethical views across holdings without subjectivity, but it also removes the context specific, judgement-based element of the research. It filters out unsavoury activities, but it does not go further by selecting investments that are likely to have positive impacts. Negative screening is a relatively quick check and can be automated depending on access to third party data. However, it is based on a point in time dependent on the data available. At best it reflects up-to-date data, but it is not a forward-looking tool. The result of negative screening is a binary outcome, entities are either included or excluded. Negative screening tends to apply the same thresholds across all investments. This can be both a pro and a con. It results in consistency across all issuers/issues assessed. However, a consistent screening threshold is not always the best approach to take. It removes the ability to make a judgment-based context specific decision about the most effective assessment tools to employ. Negative Screening requires a strong data set with good availability or disclosure of KPIs across the opportunity set. A challenge for a varied market like the impact bond universe.
Positive selection for impact investments ensures that all investments meet the highest standards and generate measurable, positive social and environmental impacts. It allows a context specific approach to be taken and promotes detailed research, giving a better understanding of the issuer from an intended impact and externality point of view. The analyst must take a multi-layered approach, as it requires research on specific parts of an organisation and a review of the organisation from a holistic point of view. Positive selection lets the analyst assess based on current performance and direction of travel, i.e. transition strategy. Engagement with the issuer often forms a useful part of this research, allowing relationships to build. This also creates accountability between the investor and the issuer as goals and milestones will be discussed. It is a nimble approach, meaning that assessments can incorporate evolutions in the market, sector knowledge, and technology as they happen. Positive selection allows judgement to be made based on the direction an organisation is travelling in, whereas negative screening assigns a judgement based on past performance. It is a more time-consuming process that requires deep expertise, but the result is a detailed understanding of the investment. The outcome of positive selection allows entities researched to be placed on a performance scale.
Example: Ørsted
Ørsted was once one of the most coal-intensive energy companies in Europe but has now transitioned to become a leading renewable energy company. This year, it ranked #2 (in 2020 #1) in Corporate Knights’ index of the world’s most sustainable corporations and received a AAA rating from MSCI ESG Ratings and a B+ from ISS ESG (ranking it #1 among electric utilities)[2].
Ørsted is a longstanding green bond issuer and publishes an annual green bond report and annual sustainability report that update us on its use of proceeds from its green bonds, associated impact metrics, and any new or updated company targets[3]. For example, in 2017 Ørsted had a stated target of achieving 95% of generation from renewables by 2023. It has subsequently updated that target to carbon-neutral energy generation by 2025 and is well on its way to meeting its 2023 target with 92% of power generation from renewable sources in 2019[4].
Relying on a negative screen on Ørsted in 2017 (when it first published its green bond framework) would have been likely to conclude the company should be excluded from an impact universe. At the time it had a power generation mix of 15% coal, 13% natural gas, 51% wind and 21% biomass, therefore exceeding thresholds we commonly see for coal-based power generation[5]. However, positive selection and in-depth research would have recognised that Ørsted was committed to a low-carbon transition, had a track record of positive progress that looked set to continue, had stated targets relating to decarbonising and therefore was a good candidate for inclusion in an impact universe.
Conclusion
Negative screening is becoming increasingly common, particularly among asset owners, rating agencies and consultants, as it is an easy way to ensure that ESG values are being applied to investments.
However,
negative screening alone does not ensure that positive environmental and social
impact is delivered. To achieve this, the more nuanced, in-depth and forward
looking approach of positive selection is needed. We believe this approach
serves our clients better and delivers on our undertaking to manage fixed
income portfolios that generate positive environmental and social impact,
without compromising financial returns.
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[1] Global Sustainable Investment Alliance, ‘2018 Global Sustainable Investment Review’, pg.7
[2] Ørsted, ESG ratings and reporting: https://orsted.com/en/sustainability/esg-ratings-and-reporting#esg
[3] Ørsted, Green bond investor letter 2019
[4] Ørsted Summary 2020, Annual report and sustainability report, pg.12
[5] S&P Market Intelligence Platform