Sin stock exclusions
Sometimes the easiest way to do some good is to remove the bad. Negative screening is just that: excluding the bad stuff to leave you with the better stuff. Unfortunately there isn’t one perfectly ethical and sustainable company out there, but there are ways to wean out the definitively unethical investments and bring your portfolios more in line with your values.
Investing in funds that exclude sin stocks
The funds below use negative screenings to exclude sin stocks from their holdings. These funds still hold a diverse range of companies meaning that there may be some crossover within the responsible investing themes.
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What are in sin stocks?
At their core, sin stocks are investments that are deemed ‘sinful’; with the original trio being alcohol, tobacco and gambling related investments. For this reason, they have also gained the name ‘vice stocks’. However, over time, this group of stocks has broadened to encompass unethical investments, companies that have a negative impact on the environment or society, and businesses involved in controversies. For this reason, sin stock exclusion is a key part of the screening process when looking to invest responsibly.
Nowadays, there are a number of categories included within the ‘sin stock’ group including, but not limited to, companies involved in:
- Nuclear Weapons
The category also includes companies that wouldn’t pass the stock screening of an ethical fund, which could be due to the business having links to Human Rights issues or maybe because they produce high levels of carbon emissions. There are many reasons why an investment could be classed a ‘sin stock’, and it can differ between investors based on their values.
So how are they excluded?
These days, a lot of larger companies no longer work in just one area, and instead can derive profits and turnover from multiple areas of business, especially when looking at conglomerates. This means that screening out sin stocks isn’t always black and white. When a company does only deal in one sector, such as a tobacco company, it is easier for investors to screen them out.
In the instance that a company operates in multiple sectors, each investor or fund manager will set their own criteria for negative screenings. For example, EdenTree state that ‘companies that derive more than 10% of their profits or turnover from [harmful] activities are excluded from our universe of investible stocks.’ Another example comes from fund house Liontrust, who stipulate that ‘From July 2018, all funds managed by the team moved from a threshold of 10% of revenues from activities such as tobacco, gambling, intensive farming, weapon systems and nuclear to 5%’.
MSCI ESG Screened Indexes
The MSCI ESG Screened Indexes were designed for investors who are looking to screen out controversial business areas, but still want to keep a profile similar to traditional benchmarks.
These types of exclusionary screens are used to bring portfolios in line with the investors’ social values whilst complying with global norms, such as the UN Global Compact Exclusions. Use of screens can also be motivated by the wish to lower financial risks: reducing potential liabilities, such as fossil fuels, or removing long-term business risks, such as tobacco production.
The MSCI ESG screened indexes have a specific criteria for exclusions and aim to exclude companies:
- associated with controversial, civilian, nuclear weapons and tobacco
- that derive revenues from thermal coal and oil sands extraction or
- that are not in compliance with the United Nations Global Compact (UNGC) principles
The exclusions have been selected to span the three pillars of Environmental, Social and Governance (ESG) investing which reflect investors’ most common concerns.
Where has sin stock exclusion been used?
Over the years there have been many notable instances where investors have taken a stand against sin stocks, not only to adhere to their values, but also to make a statement. In some cases, this has even lead to positive change within companies or even an entire industry.
Napalm and the Vietnam War
Ethical Investing and Sin Stock Exclusion rose in popularity during the 1960s as the Vietnam War raged and the horrifying consequences of war were broadcast to the world through television. Many were opposed to the use of chemicals Napalm and Agent Orange, which were manufactured by Dow Chemical, and this lead to outcries from investors that wanted to avoid companies involved in the war such as Dow Chemical. In 1971, the PAX World Fund was created as a way for investors to exclude such companies. This fund is considered the first SRI mutual fund, and paved the way for considerable expansion in the SRI industry over the following years.
It took slightly longer in the UK for socially responsible funds to take hold, with the first movement occurring in the early 1980s. The PAX World Fund was the initial catalyst, but it wasn’t until concerns grew around the authoritarian regime in South Africa that the UK began to take action. Investors began to put pressure on the big banks to withdraw from South Africa, as well as boycotting South African goods. The UK’s first ethical fund, Friends Provident, was set up in the early 1980s and included negative screenings for ‘oppressive regimes’.
This type of screening spread across the world, with the level of investments screened for South African connections between 1985 and 1987 rising from $100 million to $400 million. Not only did this negative screening and exclusion cause South Africa to default on foreign loans, but it marked the beginning of the regime’s downfall.
The changing face of sinful companies
There are hundreds, if not thousands, of companies out there that raise red flags when screening for sin stocks. As more and more investors screen out these investments, the companies are losing money and reputation. In an attempt to recover their image and move their businesses into more ethical and sustainable futures, companies are starting to make big changes to their practices, products and goals.
The tobacco industry is frantically trying to shift gears towards a cigarette-free future, especially with tobacco being one of the first acknowledged sin stocks. In December 2018, tobacco company Altria invested $13 billion in e-cigarette brand Juul in an effort to begin their shift away from tobacco. A similar move has been seen with Philip Morris International, who has spent $6 billion developing next generation devices to supersede traditional cigarette products.
Across in the automotive industry, ethical investors have been keeping a close eye on carbon emissions, with many car manufacturers being excluded from ethical funds. To combat this, the industry is moving focus towards electric cars. Volkswagen plans to spend more than €30 billion developing electric vehicles over the next five years, as well as €50 billion on battery technology and production.