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Screening Your Portfolio

Introduction to screening

Anyone who has ever pondered the activities of companies they own through their stock portfolio, mutual fund, or pension plan, is able to find at least one corporate practice that they would rather not profit from. Depending on the individual investor, this may be animal testing, producing military weapons, poor environmental performance, or supporting inhumane labor conditions overseas. Because the diversity of potential issues is so broad, and so pressing in many people's minds, screening is the most common entry point for socially responsible investors.

Screening is the process of selecting companies to invest in based on their social and/or environmental performance. Researching the records of individual companies is usually beyond the capacity of most individual investors, but is readily performed by certain public pension funds, mutual funds, and money managers offering screened portfolios. That leaves individual investors to decide which screens align with their social values and choose their investment products accordingly.

The process of screening can be easily broken down into two very different methods, negative and positive screening. Negative (or avoidance) screening refers to excluding companies that manufacture certain products that are objectionable, such as weapons or tobacco products. Positive (or affirmative) screening is more proactive, selecting companies that show leadership in product design, employee policies, environmental protection, human rights or other practices. Although positive and negative screening are easily distinguished, they are best considered as complementary tactics that can effectively be used to select socially responsible companies.

Social and environmental criteria have to be weighed together with financial performance as well. The goal, using a set of criteria, is to arrange companies on a continuum from least responsible to most responsible, and invest in the latter.

Negative or avoidance screening

Negative screening is the simplest method used by socially responsible investors. Some mutual funds have been screening companies that participate in the production of alcohol, tobacco, or gambling products, known collectively as the "sin" screens, for over 60 years. Tobacco products are now so publicly reviled that tobacco screens are being used by nearly 200 mutual funds. Other popular negative screens include military weapons production, firearms, and nuclear power. They are fairly simple to apply, and often require a simple "yes" or "no" analysis.

Critics of negative screening charge that merely excluding companies for their socially repugnant practices has no net impact, because there is always someone out there that willing to buy their shares instead. They assert that screening offensive companies may make the investor feel better about where they are putting their money, but they are not helping encourage social change and environmental improvement. But negative screening still has an appropriate place in the quiver of tactics used by socially responsible investors, to be complemented by positive screening and shareholder activism, and will remain the most palatable starting point for many.

It is also important to note that while one investor excluding their investment from a company because of a particular activity will not make that company mend its ways, its the cumulative effect that's important. This is analogous to voting in a national election, where individual votes collectively create a "voice." For example, the recent struggles of the tobacco industry illustrate the cumulative and emergent effects of investor and consumer advocacy over its health effects.

Positive or affirmative screening

As a more proactive approach, positive screening is being employed by a growing number of investors. Rather than merely excluding companies with objectionable products, the investor methodically supports companies that set positive examples of environmentally friendly products or production methods and socially responsible business practices. Unlike negative screens, which are generally more black and white, positive screens require an analysis of complex issues such as pollution, workplace practices, diversity, and product safety. Analytical methods are being refined all the time, and promise some day to make these issues clearer for both businesses and shareholders.

Most people imagine that the majority of companies included by positive screening are smaller companies embarking on products that may contribute to the world's future economic and environmental sustainability. Alternative forms of energy that produce less pollution, such as solar power, wind power, and hydrogen fuel cells, constitute a rapidly growing and potentially profitable area for many investors. Natural food and healthy living products, fiber products that conserve forests, environmental cleanup and recycling, are all areas that can benefit the sustainable future, and are fertile ground for positively screened investments. However, it is difficult to create a well-diversified portfolio of the smaller companies.

Large and medium sized companies are also subjected to and included by positive screens. Larger companies, and the problems they face, are more complex. They tend to have more history, usually stretching back long before any culture of corporate responsibility, and old habits can be difficult to change. Positive screening can help discern which of these large companies are heading in a positive direction. But all companies, small and large, can make progress in the areas of social and environmental performance covered by positive screening.

Mutual funds and other institutions often use a "best of class" approach to positively screen companies. They may chose to include a company that has demonstrated leadership in their industry as the best representative, despite the overall record of that particular industry. Forward thinking leaders are often receptive to dialogue regarding social and environmental issues important to shareholders. While some investors may be disturbed by past social or environmental performance of a particular company, there is much to be said for examining more recent positive trends of a company's record to determine how the company is positioned for the future. Rewarding industry leaders or companies that have made significant progress with carefully placed investments can encourage other companies in their industry to improve their social performance.

Whether employing negative or positive screening, it is important to remember that screening can be just one aspect of an individual's or institution's involvement in responsible investing. Shareholder activism is another growing tactic used by institutional investors, including initiating dialogue with companies concerning their record or filing shareholder resolutions pertaining to some aspect of corporate social responsibility. Shareholder advocacy efforts of socially responsible investors have greatly increased the awareness of many important issues and resulted in significant changes at some companies.

Screening has come a long way, from the most basic sin screens to broad positive screens applied through complex analytic frameworks. We can expect them to continue to evolve, including new issues to accommodate the evolving corporate and social landscape. The other key areas of socially responsible investing, shareholder activism and community investing, continue to grow as well. But it is likely that screening will provide the backbone of socially responsible investing, comprising the central method for meeting the social and environmental goals of concerned investors.

Screening is the process of selecting companies to invest in based on their social and/or environmental performance. Social mutual funds are examples of investments that use screening techniques. Individuals can also use screening in addition to traditional financial criteria in making investment decisions.

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