Applying exclusion screens can improve the weighted average ESG scores of indices, indicating that exclusions can complement ESG integration by refining portfolio quality without detracting from ESG performance, according to the latest study conducted by researchers from the EDHEC Business School.
The study – Do ESG Scores and ESG Screening Tell the Same Story? Assessing their Informational Overlap – examines the informational overlap between ESG scores and ESG exclusionary screening strategies within equity portfolios. It found, while ESG scores are widely used for integrating sustainability considerations in portfolio management, they may not fully align with exclusion criteria targeting companies engaged in controversial activities or behaviour.
By comparing the results of both approaches, the analysis reveals that reliance on ESG scores alone omits a substantial proportion of companies that fail to meet ‘do no harm’ criteria. However, the findings highlight the potential for exclusionary practices to reinforce ESG integration, supporting the creation of more sustainable and resilient investment portfolios, according to the study authors.
Co-authored with ValueCo, the study relies on their unique database that aggregates ESG scores from multiple asset managers to address some of the shortcomings of ESG scores documented in the academic literature.
“We find that weighted-average ESG scores do not fully characterise the sustainability of an equity index strategy. For instance, equity indices with high ESG scores are not necessarily free from ‘harmful’ stocks – stocks that fail to meet widely accepted ‘do no harm’ ESG criteria. In some high-scoring indices, the weight of harmful stocks can exceed 25%,” explained Vincent Bouchet, co-author and ESG director of Scientific Portfolio – an EDHEC venture.
He added: “Using ‘do no harm’ criteria to implement sustainability-driven screening policies remains broadly consistent with ESG scores. Excluding harmful stocks does improve average ESG scores, which suggests potential complementarity between the two approaches.
“Investors aiming to construct sustainable equity portfolios may consider incorporating ‘do no harm’ screens in their security selection process before choosing to applying ESG scores or other sustainability data in portfolio allocation decisions.”
In conclusion, the authors noted that the natural next step would be to anticipate the financial impact of such exclusions. A previous EDHEC study found that applying exclusions either based on consensus criteria or climate criteria has a relatively low impact on the financial risk profile of indices, and that this impact can be further reduced with an optimised reallocation.
