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The Landscape of ESG Exclusionary Strategies

Environmental, Social and Governance (ESG) investing accounts for more than US$35 trillion AUM1 globally. The increased focus on ESG and upscale of the sustainable investing market was undoubtedly accelerated due to international developments like the Paris Agreement and national carbon neutrality pledges as well as impacts of the COVID-19 pandemic.

Investors adopt a range of ESG investing strategies, including exclusionary screening, positive screening, thematic investing, impact investing and others. Each of these strategies consider ESG issues at different depths and breadths, and are often complementary to each other hence one or more strategies are commonly applied.

Exclusions, also known as negative screening, was one of the more commonly used strategies in previous years. However, in recent years, ESG integration became the most common strategy, primarily driven by the increasing availability and quality of ESG data, and companies in ESG “controversial” sectors transitioning their business to cater for the demands and pressures of the 21st century where ESG plays a significant part.

What are Exclusions?

In brief, exclusionary screening removes specific assets from an investment universe or strategy based on an investor’s investment philosophy considering ethical, religious, environmental or social values. Common exclusions include weapons, coal and tobacco, due to the damaging impacts their products or business activities have on the society and the environment.

It is a fund managers’ fiduciary duty to act in the clients’ best interests, that is to maximise financial returns. There are often debates around whether exclusions compensate financial returns; some argue exclusions screens out assets hence somewhat constraining potential investment opportunities. In a recent investor survey, results showed mixed views on this front: 20% investors indicated they believed exclusions had a positive impact on performance whilst 22% indicated they believed exclusions had a negative impact on performance2.

What is Mirae Asset’s Approach to Exclusions?

Mirae Asset has established an ESG Restrictive List (previously called ESG Negative List) since 2015. Since 2015, we have had in place ESG investment restrictions on weapons and tobacco stocks. Recently, we further introduced restrictions on thermal coal mining and unconventional oil & gas to the firm-wide ESG Restrictive List.

Regarding weapons for example, we consider a company’s total involvement in conventional weapons such as weapon-related systems, components, products and services. For tobacco, we focus on the upstream, restricting investments in companies that manufacture tobacco products.

At the same time, we carefully consider market developments and the evolution of businesses that are typically perceived as “controversial” or belong in commonly excluded sectors.

Considering Alternative Products as “Positive Offsets”

Tobacco is commonly excluded in investments, for obvious reasons of it being a public health issue. Tobacco products are addictive and kills more than 8 million people each year3. There is increasing regulations globally on tobacco products and growing consumer awareness on the dangers of smoking. However, we see an evolution in the tobacco sector that is creating a “positive offset” to the traditionally controversial business. We see the emergence of alternative tobacco products such as e-cigarettes and other next-generation nicotine delivery products; scientific evidence regarding the health benefits of such products are currently still inconclusive but are commonly seen as relatively less harmful to human health when compared to cigarettes4.

New market entrants, such as companies who only sell e-cigarettes, are disrupting the tobacco market. For example, 100% of revenue from Smoore International Holdings is from the e-cigarettes business, offering vaping technology solutions through the research, design and manufacturing of vaping devices and vaping components5. Leading tobacco companies are also diversifying their products to include e-cigarettes. For example, British American Tobacco (BAT) acquired e-cigarettes company Vuse in 2017. BAT also announced Vuse’s achievement of becoming the world’s first carbon neutral vape brand this year6.

Considering Companies’ Low Carbon Transition Plans

Fossil fuels and climate change is also a focus area when it comes to exclusions, primarily driven by regulatory pressures transpired from the Paris Agreement and national decarbonisation pledges. Commitments from the investment community to decarbonise investment portfolios, such as the Net Zero Asset Owner Alliance and the Net Zero Asset Manager Alliance, will also drive capital allocation away from fossil fuels and emissions intensive sectors and companies.

When it comes to excluding fossil fuel companies, we carefully consider whether and to what extent companies set low carbon transition pathways as part of their business plans. We see conventional oil & gas to be key to a low-carbon transition; natural gas has the lowest carbon intensity out of all fossil fuels and oil is still used significantly used in transportation and industrials sectors. However, considering Paris Agreement goals and low carbon policies worldwide, oil demand will likely peak in the next decade. We therefore encourage oil & gas companies to reduce activities in fossil fuel exploration and shift to low-carbon energy sources such as renewables.

For example, Reliance Industries, despite operating the world’s biggest refining complexes, has been actively transitioning its business away from fossil fuels with carbon net zero goals set for 20357. Not only will Reliance invest $10.1 billion in clean energy, but is also developing technologies to create bio-crude oil from algae and piloting carbon capture, utilisation and sequestration at refinery and power plants8.

Energy Saved

1 Global Sustainable Investment Alliance, July 2021
2 AlphaWise, Morgan Stanley Research, July 2021
3 World Health Organization, July 2021
4 Centers for Disease Control and Prevention, April 2021
5 FactSet, September 2021
6 British American Tobacco, May 2021
7 Reuters, June 2021
8 Reliance Industries Limited, June 2020
Holly So, CFA
ESG Specialist

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