Simple positive screening: Whereas negative screening is designed to remove companies or other assets from the investable universe on an exception basis (by excluding ‘worst offenders’), simple positive screening is designed to ensure that all companies or assets meet certain minimum ESG standards in accordance with the investor’s top-level policy or principles. Common positive screens include measures of energy efficiency, environmental management or employment standards. Increasingly, these factors are deemed desirable attributes for both financial and non-financial measures.
Provided that these standards are met, the rest of the investment analysis and decision-making process is typically carried out in a conventional way: ESG information is not systematically used to identify potentially material risks and opportunities that may affect the investment valuation or the size of the holding. Once the investment has been made, on-going monitoring of ESG compliance may lead to investor engagement if problems emerge.
Best-in-class: The best-in-class approach uses ESG metrics or ratings to assess a company against others in the same peer group (e.g. the same industry sector or sub-sector) and rank them according to their relative sustainability performance. The company’s position in the ranking then plays a part in determining whether it is included in the investment portfolio (e.g. best of breed), and/or whether the investor will go under-weight or over-weight on that company compared to others in the same sector (e.g. portfolio tilting). For example, companies active in the oil and gas sector are analysed according to environmental and social criteria in order to find a leader in the sector, ie those that have historically performed better than their peers. As such, sustainability leaders in each sector are selected and sustainable investment universe is created. The best-in-class approach is mainly used in relation to listed equity portfolios.
Positively screened funds only select companies that meet a prescribed level of ESG performance and/or seek out investment in companies that contribute positively to social or environmental benefit, such as those that build social/affordable housing or are involved in renewable energy. ‘Best in class’ or ‘best of sector’ funds select only those companies that attain the highest ESG performance in their sector, again using standards established by the fund. These funds are often based on the thesis that companies with good/best in sector ESG performance will outperform those with poor ESG performance.