Responsible investing is an evolving space that covers a diverse set of considerations and priorities. And yet, there’s only a short list of portfolio construction methods from which investors can choose. Here we’ll explore the “screen” method. A screen builds a portfolio out of a subset of the eligible investment universe that meets specific environmental, social and governance (ESG) criteria.
ESG Investing: Definition of a Screen
A screen divides an eligible universe such that items with acceptable characteristics remain, and those with objectionable features are excluded. In terms of SRI screening (social responsible investment screening), companies with acceptable business involvement or behaviors would be included and those with objectionable attributes would be left out.
With a screen, you can:
● Define what will pass the screen
● Define what will fail the screen.
Portfolio Screens: A ‘Fruitful’ Example
Let’s consider a non-investment example for illustrative purposes. As shown below, our starting universe (or exposure) is “all fruit.” To determine what goes into our basket, we could set up a screen to say either “red fruit passes” or “anything that isn’t red fruit fails.”
Say we use the “red fruit passes” screen and apply it to the “all fruit” universe.
● What would be included in the basket?
Red apples, red strawberries, red nectarines, red plums and red pears
● What would be screened out of the basket?
Green apples, green grapes, yellow pears, (orange) oranges, and yellow bananas
● What would be the resulting weight of the red fruit included in the basket?
We don’t know. A screen doesn’t tell us anything about the included holdings, other than they pass the screen.
It’s important to understand that exposure matters: Suppose instead of starting with “all fruit” we began with a universe of “all pets”:
Note that the screen “only red fruit fails” would remove nothing from this “all pets” starting universe. On the other hand, the screen “dogs fail” would remove two of the five constituents.
Investors should also recognize that screens can be complex: There are as many ways to define a screen as there are measurable data points available. For example:
✔ “Fruit with seeds on the outside fail”
✔ “Fruit grown in California pass”
✔ “Fruit sourced from sustainable farms pass”
✔ “Delicious fruit passes” – while measurable, this is highly subjective; you may want to define it for yourself. Metrics where you have a clear notion of a threshold are typically better suited to become screening criteria.
Multiple criteria can also be used to build the final fruit basket. In this case, fruit would need to pass all the screens jointly to remain eligible.
Ready to move beyond an imaginary universe of fruits and pets? Explore our ESG Screen Analyzer to see how screens and restrictions might shape portfolio performance. Use this powerful tool to evaluate how characteristics—including expected tracking error and percent of market cap excluded—shift as your clients express their views.
Potential Parametric solution
Parametric has been offering client-driven, index-based portfolios that incorporate ESG criteria for more than 15 years. Our robust and continually evolving menu of ESG screens and licensed indexes gives investors a wide range of portfolio design choices. In many cases, however, investors are well served by a standardized portfolio with minimal modifications. With this in mind, we’ve designed a series of risk-controlled, index-like exposures that can be used as a core equity portfolio allocation while aligning with common responsible investing themes.
Martha Strebinger, CFA, Senior Investment Strategist (emeritus)
Prior to leaving Parametric in December 2019, Martha was responsible for assisting in the continued evolution of Parametric’s Responsible Investing capabilities. Prior to joining Parametric in 2016, she was an investment specialist at Truepoint Wealth Counsel in Cincinnati and worked in Boston at Wellington Management Company and Grantham, Mayo, and Van Otterloo (GMO). She earned a BS in human biology, health, and society from Cornell University. A CFA charterholder, Martha is a member of the CFA Society of Seattle.
The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Parametric and its affiliates disclaim any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Parametric are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Parametric strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results. All investments are subject to the risk of loss.