Definitions: Negative/Exclusionary Screening

Negative screening (or exclusionary screening) is the process of screening specific assets out of an investment universe or strategy. Implementing these screens is called divesting and results in divestment.

Divesting does connotate excluding something that one would otherwise own. For instance, a large-cap fund might not own tobacco stocks or small-cap stocks. Intentionally screening out tobacco stocks would be considered divestment, because it is something the fund would own otherwise. However, the fund would not be considered to have divested from small-cap stocks though, as they fall outside a large-cap fund’s investment universe. In other words, divestment is the intentional act of excluding assets that one would otherwise own.

There are purely economic reasons to divest from assets, but I will focus on values-based divestment here. Values-based reasons to exclude assets may include not wanting to be associated with or derive any benefit from specific activities/products/services. Values-based screening has ancient roots as various religions have forbidden debt with very high interest (or any interest at all) for thousands of years (see here). More recent examples include the Quakers divesting from the Atlantic slave trade or US investors divesting from Apartheid-era South African assets. Today, hot topics include tobacco, weapons, and fossil fuels.

It should be noted that there are arguments that even non-economic considerations can also be economic ones. For instance, as energy consumption shifts towards renewable energy, the returns from fossil fuels may suffer. A mass shooting may bring unwanted publicity and legislation upon a firearm manufacturer. These are cases where values issues may become value issues.

There are a wide variety of objectives and approaches to divestment, each with a unique set of benefits and drawbacks. Exploring all of the applications of divestment is beyond the scope of a blog post, but we will look at some common examples in the coming weeks.

Yield Curve Inversions

As the yield curve continues to flatten, there has been increased focus on the potential for “inversion” which means that short-term rates are higher than long-term rates. Central bankers have begun mentioning it, we have seen an increase in media mentions, and we have even received a few questions from clients. Below is a chart of the difference between the 10-year US Treasury yield and the 2-year US Treasury yield. The 10-year yield is usually higher than the 2-year yield, but short-term rates surpass long-term rates every now and then. Historically, these inversions have occurred prior to recessions (as indicated by red vertical bars).

A few observations:

  • The yield curve may very well invert, but has not inverted yet. The curve almost inverted in 1994, but did not and the next recession was not until 2001.
  • The recessions charted above have began 12-24 months after the curve first inverted, while it was nearly 3 years after the 1998 inversion.
  • With rates at historically low levels, there are good reasons to doubt that a flat or inverted yield curve is as predictive as in the past. We have our opinions, but it always pays to see multiple sides of an issue and no indicator should ever been overly relied upon or used in isolation.

The above being said, we do not think that the yield curve is indicating an imminent recession. Of course, the shape of the yield curve does have implications for risk/return dynamics and portfolio positioning and investors should adjust accordingly.

Parenting 101

“Do you have any financial advice for new parents?”

A handful of friends have asked me this question in the past week. The question often relates to childcare expenses or college savings plans, but I usually advise new parents to prioritize the below items before anything else. My typical advice sounds something like this:

  • “Buy enough term life insurance to provide for your family if you and/or your spouse die prematurely. There’s no “right” amount, so ask yourself what you would want covered if you passed. Your salary of x years? Your spouse’s salary so he/she wouldn’t have to work for y years? Childcare expenses for z years? Payoff a mortgage? College tuition? Other expenses? Add those numbers up and go get some quotes.
  • “Establish an estate plan, including a revocable living trust and will. The will should appoint a guardian for your children if you pass away while they’re still minors, although the courts do have the final say. The will also directs what to do with assets that were excluded from the trust (or forgotten to be put in the trust, which I have seen several times!). The trust should help avoid probate for assets placed within it and provide for supervision of the assets for the benefit of the children.

Unfortunately, the above is often news to new parents. However, both of the above can be one-time decisions, which is a relief for most new parents who are completely overwhelmed with the chaos of parenthood. Neither action is free, but the reduction in risk is well worth the expense IMO.

An extra disclaimer this week: The above is educational and describes advice I have given others, but is not legal or financial advice for readers. Every situation is different and I’m not an insurance agent or an attorney.