The Return and Risk Characteristics of Controversy-Driven Exclusions
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In recent years, investors have sought to balance financial performance with values-based objectives, raising the question of whether exclusions can achieve both. This paper explores whether exclusions-based approaches — removing companies involved in environmental, social, governance or overall controversies — can align investor values with financial performance.
Using MSCI ACWI IMI data (2015–2024), we compared hypothetical portfolios that applied targeted exclusions (removing only the most severe cases) against broad exclusions (removing a wider set). Targeted exclusions consistently resulted in a small increase in tracking error and small but mixed active returns: environmental, governance and overall controversies showed slight outperformance, while social exclusions detracted. Broad exclusions, however, raised tracking error more and generally hurt risk-adjusted returns, largely by tilting portfolios toward smaller caps.
The analysis suggests that when carefully applied, exclusions do not necessarily compromise financial outcomes and in certain cases, particularly environmental controversies, may even enhance performance.
Data from January 2015 to December 2024. The border style indicates portfolio type (solid border for portfolios excluding controversy scores 0-1; dashed border for portfolios excluding scores 0-4). Colors represent the type of controversies excluded: blue for all controversies, green for environment, magenta for social and orange for governance controversies. Circle size corresponds to the number of companies excluded (larger circles indicate more exclusions). Information ratios (active return divided by tracking error) are shown above each circle. Source: MSCI ESG Research
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