ESG Screening: A Dynamic Tool for Modern Sustainable Investing

September 25, 2024

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ESG screening has evolved into a vital and versatile component in the toolkit of responsible investors looking to align their investment portfolios with Environmental, Social, and Governance (ESG) principles. While it originated primarily as an exclusionary practice, ESG screening has transformed into a customized, sophisticated tool for both exclusion and inclusion, particularly relevant in today’s market for creating thematic sustainable portfolios and funds.

It helps investors achieve a variety of objectives, including but not limited to:

- Mitigating ESG risks

- Developing Article 8 or 9 funds

- Supporting business models that address ESG issues

- Developing regulatory-aligned portfolios

- Improving or maximizing a portfolio’s overall ESG rating

The Evolution of ESG Screening

Initially, ESG screening was primarily used as a negative screening tool, allowing investors to systematically exclude companies that conflicted with their ethical standards or sustainability goals. This approach has deep roots in responsible investing, dating back to faith-based investment strategies.

However, as sustainable investing has matured, so has the application of ESG screening. Today, it serves not only as a method for exclusion but also as a powerful tool for positive screening, enabling investors to actively select companies aligned with specific sustainability themes or goals.

The positive screening itself can be utilized for various investment strategies:

1. Best-in-Class: This approach focuses on companies that outperform their peers in ESG measures within their respective sectors

2. ESG Improvers: This strategy targets companies that are improving their ESG measures more rapidly than their peers, capitalizing on positive change.

3. Thematic Investing: This involves selecting companies that are actively addressing specific ESG challenges, such as climate change or gender diversity.

4. Impact Investing: Selecting specific companies that have a positive sustainability impact

The Essence of Modern ESG Screening

In its contemporary form, ESG screening involves evaluating companies based on various parameters such as their products and services, ESG controversies, and alignment with global regulations and frameworks. All sustainability data can be effectively utilized for screening based on different priorities by simply setting the relevant thresholds. This evaluation can lead to either exclusion or inclusion in investment portfolios, depending on the investor’s objectives and the nature of the company’s ESG profile.

Inrate has provided various clients with screening capabilities based on UNGC compliance, SDG Impact, ESG Controversies, Product Involvement and more in order to align with varying sustainability priorities.

Impact ratings also act as a positive screening tool, enabling FMPs to identify top performers in various sectors and select them in a portfolio or specific fund accordingly. Such ratings can be utilized for Best-In-Class portfolios and Impact Investing strategies.

Conclusion

As sustainable investing continues to evolve, ESG screening has transformed from a simple exclusionary tool into a sophisticated instrument for portfolio construction. Its ability to support both negative and positive screening makes it particularly valuable in today’s market, where investors increasingly seek to create thematic portfolios that not only avoid harm but actively contribute to sustainable development.

Positive screening, in particular, offers a powerful means to build portfolios with enhanced sustainability profiles. It’s especially useful for thematic strategies and impact investing, allowing investors to concentrate their capital on companies and sectors that are considered leaders in ESG performance.