Negative screening is a common practice in sustainable and ESG (environmental, social & governance) funds and used to rule out companies based on a set of social and environmentally friendly criteria. But when asked if this alone was enough to call a fund sustainable, BMO GAM’s Nick Henderson said the market has moved beyond these measures alone.
Negative screening is the process by which investments are excluded based on a set of criteria. The most traditional exclusion sectors or ‘sin stocks’ are areas such as alcohol, tobacco, gambling, adult entertainment, weapons and animal testing.
Indeed, when BMO launched its first sustainable fund in 1984, and the BMO Responsible Global Equity fund in 1987, Henderson said that at that point “it was purely a negatively screening ethical fund”.
Henderson has managed the £964.3m BMO Responsible Global Equity fund and its Luxembourg-domiciled cousin as well as the four FE fundinfo Crown-rated BMO Sustainable Opportunities Global Equity since 2016. He has worked on all three since 2008.
But over the last 30 years Henderson said the fund has evolved beyond just running negative screens. And this is indicant of how the entire sustainable investment space has progressed beyond simple screening requirements, said Henderson.
He said: “I think that the market has moved on. I think that the market started with that focus for ethical screening back when we launched this first strategy back in the 1980s that came out of Quaker roots to exclude these stocks.”
Nevertheless, the manager said there is still a place for negative screening within the market, but it shouldn’t be the only tool that is used to invest in sustainability.
The reason why negative screening is not enough is that it doesn’t fully consider potential risks to companies which may pass all the screening criteria.
Henderson said this can be demonstrated by comparing two companies: PepsiCo and Kerry Group. Both pass the screening requirements of the BMO sustainable funds, but only one is included in the portfolio.
The first, PepsiCo, an American food and snack company, was held in the portfolio when Henderson joined in 2008 but is no longer included in the fund.
He explained: “That is a company which still doesn’t technically fail any of our ethical criteria, but it’s not owned in the portfolio.
“I don’t see any anticipation of it being owned in the portfolio right now because we have progressed to that more sustainable focus and really our overriding concerns of that business –which still has very strong brands, I’m not doubting them on that – about potential implications of sugary foods and drinks. Is there regulation coming with that potentially? How would that impact the business?
“We think that the outlook for that business is less exciting because of the consumer awareness and demands upon nutrition,” Henderson said.
On the other hand, Kerry Group an Irish food company, is an example of a business in the same sector which is actually benefitting from the tail winds which pose risks to PepsiCo.
The manager explained that 80 per cent of Kerry Group’s revenues come from its taste and nutrition business.
“The way I look at it, really it’s an outsourced R&D facility for major FMCG [fast-moving consumer goods] businesses like PepsiCo, Nestlé all these sorts of business,” Henderson said, as they invite clients to improve the salt, fat and sugar contents to make the products healthier.
“And so, Kerry are benefiting form that tailwind they’re seeing strong growth and decent margin progression in that business, so that’s another good example,” Henderson said.
Since Henderson joined the BMO GAM responsible funds in 2008 he said he’s “enjoyed the evolution”, of the three strategies.
Today, the process is grounded in the philosophy of “avoid, invest and improve”.
The ‘avoid’ section is the negative screening element. Henderson said himself and fellow manager, Jamie Jenkins, use this to “to avoid companies with a damaging or unsustainable business practice”.
“So we still have those explicit screens that we used to but we really try to embrace this invest and improve philosophy,” he noted.
The second part ‘invest’, involves finding opportunities within megatrends such as ageing demographics, demands on healthcare systems, urbanisation and climate change.
The third part, ‘improve’ refers to BMO’s active engagement whereby they actively work with corporates of the companies they invest in “to improve what they’re doing from an ESG [environmental, social and governance] perspective”.
This “active engagement” is what Henderson thinks drives investment returns as well as fulfilling the responsible investment demands clients have today.
He said: “That engagement activity acts as a virtuous circle for us to enable better, more informed decisions in our own company analysis and in our own portfolio construction, so that’s important.”
This more in-depth process in repsonsible investment has been driven by clients demands to evidence how funds invest in the solutions for social and environmental issues, rather than just avoiding the problem areas Henderson said.
“I think that the market has moved on to absolutely really requiring us and demanding of us – and frankly it’s exactly where I want to be investing – in embracing [those] sustainability issues.
“So, I think that there has been an evolution. I think that that’s here to stay and I think that it will continue.
“I think that client demand will increasingly demand us to really push the boundaries of what we’re doing and to really think about sustainability and to really evidence it.”
Performance of fund vs sector & benchmark over 5yrs
Source: FE Analytics
Over the past five years then BMO Responsible Global Equity fund has outperformed both its MSCI World benchmark (91.90 per cent) and the IA Global sector (84.58 per cent) with a total return of 116.20 per cent. It has an ongoing charges figure (OCF) of 0.79 per cent.