People have been excluding companies on ethical grounds for centuries. In modern investment management, portfolio managers exclude companies engaged in activities deemed unethical or that are contrary to international conventions or agreements. This can be done as acts of demonstration (i.e., climate or animal welfare activism) – or can be to comply with local laws (i.e., exclusion of cluster ammunition), but we do not consider this a meaningful exclusion policy while players in the market do.
Exclusions vary greatly by investment management institutions, though some of the most frequently excluded products and practices are alcohol, tobacco, pornography, weapons, nuclear power, gross violations of human rights, or companies doing business in or with sanctioned countries. Exclusions can be based on any ethical consideration or on global or regional agreements such as the UN Global Compact, ILO standards, or the Paris Climate Agreement.
Where exclusions become more interesting is in setting the tolerance / acceptance levels. Investors set maximum levels for exposure to such activities or products. Most portfolios that exclude specific behavior tolerate between 5-15% of company revenue to come from such activities, yet some are much more lenient allowing for sometimes up to 50% or more of company revenues to come from the “excluded” activities.
Portfolio managers also need to consider how far up or down the value chain they want to assess companies for exclusions. Some investment managers only examine revenue or activities directly within the companies, while others broaden their scope to also assess the company for the excluded activity (1) in its supply chain, or (2) in the use of its products.
Finally, exclusionary criteria might also include companies’ business practices and policy robustness.
Application: Based on revenue
In 2019, Waste Management, a company previously held in the Triodos Impact Equities and Bonds portfolio, merged with Advanced Disposal, a key competitor in the waste management sector. This company runs a specialised unit for oil and gas waste. While Advanced Disposal does not extract or sell oil and gas, and this particular business unit is not a core competency of either company in the merger, it does yield significant enough revenue to push the newly merged firm over the maximum revenue percentage threshold for activities in the oil and gas sector.
Application: Based on new investments
The Nordic Swan Ecolabel requires exclusion of companies with more than 5% of revenue from oil and gas. Power producers must have less than 5% of its power generated from non-renewable sources, unless the company meets all of the following:
- At least 75% of the company’s energy sector investments (actual or committed and budgetted) in new capacity, on average for three consecutive years, are in the renewable energy sector.
- Revenue from renewable energy comprises at least 50% of the company’s total revenue from power generation or at least 50% of the company’s energy production capacity is based on renewable sources.
- New investments over the last two years in renewable energy solutions. This exception is to support companies actually transitioning the business model, but there are only a handful companies in the world with this profile.
There are only a handful of companies that would qualify under these exceptions.
Application: Based on practices and policies
For example, Triodos IM excludes companies that use animal testing for cosmetic purposes – or outside of purely medical uses. For companies active in the development of medicine, it is allowed under strict criteria. In this case, our analysts would need conduct stringent policy assessments and also likely need to discuss with the company directly to confirm that its policies are implemented effectively.