Thought Leadership

Demystifying negative screens: the full implications of ESG exclusions

In this paper we explain the complexities and biases around implementing screens and investigate the pitfalls investors should be aware of.


Sustainable Investment Team

Screening out investments that do not meet environmental, social or governance (ESG) criteria is superficially simple but fraught with practical challenges. Understanding the complexities and biases screens create before they are implemented and appropriately assessing performance afterward is crucial for investors. In this paper, we investigate the pitfalls when implementing different screens.

Negative screens that sieve investments on environmental, social and governance grounds remain critical to many investors. One-tenth of the assets we manage exclude companies based on their involvement in controversial products or services. Widely-used broader definitions put the share of screened investments closer to one-fifth of all professionally managed assets1. And screening continues to grow, with assets subject to screening having increased by 16% annually over the last four years2.

Of course, negative screening is only one aspect of sustainable investment, and serves a different purpose to activities such as integration and engagement. While the last two are designed to help investors reach better investment outcomes, exclusion policies reflect investors’ choices to avoid activities they consider unpalatable. We firmly believe ESG integration and engagement, effectively implemented, can lead to better investment decisions. We recognise, however, that this is not the only concern for many investors, and so the practical considerations presented by screening almost certainly warrant more attention than they currently receive.

Even if decisions on screens are taken separately from investment analysis, it is vital to understand their effect on investment goals. Typically, this is discussed in terms of the impact of screening on historical performance, a rearview focus that distracts from more important questions. History tells us there is no reason to expect exclusions to systematically reduce long-term returns. But by increasing volatility and inhibiting investment styles, choices over how exclusions are applied and defined can make it significantly harder for managers to execute certain strategies.

The chart in Figure 1 shows the extent to which typical negative exclusions constrain managers. Implementing screens may be mechanical, but assessing their impact on portfolios is a complex task.

In this paper we explore the role of screening, the activities typically targeted, the different ways that exclusions are defined, and their effects on investment strategies. Our aim is to help both those investors with exclusion policies already in place and those considering them to understand the options available and the full implications of their choices.

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1 Global Sustainable Investment Review 2016, Global Sustainable Investment Alliance.
2 Global Sustainable Investment Review 2016 as above.


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