FAU Research Finds Investors Are Shifting to 'Positive' ESG Screening

Investors show a stronger preference for positive environmental, social and governance (ESG) screening, especially in times of uncertainty in stock markets, according to a new study from researchers at Florida Atlantic University.

Investors show a stronger preference for positive environmental, social and governance (ESG) screening, especially in times of uncertainty in stock markets, according to a new study from researchers at Florida Atlantic University.

While negative screening, or screening that omits certain "sin stocks," has been more common, retail investors are showing a stronger preference for positive screening, or screening that creates portfolios to include companies with high ESG scores.

"Institutional investors are often more sophisticated in their strategies and have shown a stronger preference for positive screenings," said Anna Agapova, Ph.D., professor of finance in FAU's College of Business. "While it is more complex, investments with higher ESG scores are able to mitigate risk better because of a lower downside exposure."

The study, "Positive versus negative ESG portfolio screening and investors' preference,"was published in the European Journal of Finance, with co-authors Uliana Filatova, Ph.D., assistant professor of finance at Grand Valley State University and Ivan Yuk, first-year undergraduate finance student at the University of Florida's Warrington College of Business.

The study found that despite historical trends of using negative screening mainly due to its simplicity and legal clarity, surveys of investment managers found that while they use negative screening, many acknowledge that it could negatively impact financial performance. On the other hand, positive screening that includes sustainable investment preferences offers better risk adjusted returns due to the increased diversification that helps mitigate risks. Positive screening naturally allows for a broader pool for securities.

"We've found that ESG-focused investments are less volatile and better performers during financial downturns," Agapova said. "Diversification is a key to reducing overall portfolio risk, which ESG investments naturally do. Overall, positive screening picks the best performers on ESG, who are often able to better manage financial risks as they have lower exposure to issues like flooding or property damage."

Both retail and institutional investors showed a preference for positive screenings, as evidenced by their high allocation of funds to mutual funds with positive ESG screening. For managers, while negative screening might present fewer legal issues, positive screening aligns more with investor preferences and their goals for risk management. Fund managers should take this into consideration to evolve their strategies to reflect these preferences and offer subsequent products.

-FAU-