Responsible investing is a strategy and practice to incorporate environmental, social, and governance (ESG) information in investment decisions and active ownership. This is the definition used by the United Nations Principles for Responsible Investment (UNPRI) and aligns with Parametric’s thinking and approach. One area of work, ESG incorporation, involves considering ESG issues when building a portfolio. The other area of work, active ownership or stewardship, involves trying to improve the ESG performance of the companies that make it into the portfolio. These concepts are interconnected and lead to consequential decisions that can affect the performance of an investment portfolio, as well as real-world outcomes such as climate change or human rights.
This paper focuses on the first area of activity and tries to clarify two common incorporation techniques: screening and integration. Both are used to enhance the portfolio’s overall ESG characteristics but are quite different in terms of implementation and outcomes. The term integration is particularly misunderstood: When the UNPRI first launched, integration was used to describe the use of ESG characteristics in a security valuation process. Since then the term has broadened to include quantitative approaches that reweight securities using ESG characteristics. These approaches are very different from security valuation in process and outcome, despite sharing the same name in UNPRI’s nomenclature. Furthermore, any ESG incorporation, whether screens or integration, is a somewhat uneasy fit when the goal is being the market rather than beating the market. Although many investors have found ways to reconcile these conflicts, many may still look to active ownership as their primary responsible investing practice and try to use ESG incorporation quite sparingly, if at all.