Investors often ask us about the expected impact of certain socially responsible (SRI/ESG) constraints on the risk and performance of a portfolio. In our earlier work, we explored several different approaches for constructing a custom SRI/ESG portfolio to help frame that discussion. Here we take a closer look at short- and long-horizon impacts of a popular industry exclusion when using an optimizer to construct portfolios.
Aperio's investment process seeks to create a diversified equity portfolio that looks and behaves like its benchmark while still respecting SRI/ESG objectives. As a result, portfolios that exclude a specific industry will tend to redeploy that capital in other industries whose fundamental and economic risks are similar to the divested industry’s.
In our earlier work, we referred to this approach as the “Optimized Exclusion” strategy in order to contrast it clearly with a naïve reweighting approach (“Cap-Weighted Exclusion”). The latter approach is simple: it does not require a risk model nor an optimizer. While we expect this approach to outperform if the excluded securities underperform, it also may lead to excessive forecast tracking error.
In contrast, we expect our optimized approach to “cushion” the negative performance impact that could occur when an industry that has been excluded outperforms. However, because other industries are not perfect substitutes for the excluded industry, we expect the customized portfolio to have some amount of variation around the benchmark’s performance. We use forecast tracking error as the primary gauge of how much a portfolio’s performance could vary from its benchmark.
For example, investors who excluded the Oil, Gas & Consumable Fuels (OGCF) industry generally experienced underperformance relative to standard (market-capitalization weighted) benchmarks such as the MSCI ACWI in Q2 2018. To illustrate this, we simulated the historical performance of a nontaxable portfolio with an OGCF exclusion.
If we look at the next quarter’s performance (Q3 2018), we see that the situation has reversed and the custom portfolio outperformed its benchmark, erasing all of the underperformance in Q2.
A quarter is a very short time period to evaluate the performance of a strategy. (Research* has shown that checking performance too often increases the likelihood of making suboptimal investment decisions.) So we examined the performance of the same custom portfolio as far back as 2008. The following chart shows the correlation of the active returns of the custom portfolio against the active returns of the OGCF industry.
While there is a fluctuation in the magnitude of the historical correlation, it is pretty clear that a portfolio that excludes the OGCF industry will generally underperform when the OGCF industry outperforms (the correlation is generally negative).
Aperio’s approach to portfolio construction tries to minimize the impact on performance (relative to a benchmark) from an exclusion, but it cannot completely eliminate it as a driver of risk and return. This is reflected in summary risk statistics such as forecast tracking error, which provides a general guide for the expected magnitude of deviation around a benchmark but does not indicate whether the potential deviations will be positive or negative.
This material is provided for informational purposes only and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are subject to change at any time without notice. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be and should not be interpreted as recommendations.
This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of yields or returns, and proposed or expected portfolio composition. Moreover, any historical performance information of other investment vehicles or composite accounts managed by BlackRock, Inc. and/or its subsidiaries (together, “BlackRock”) included in this material is presented by way of example only. No representation is made that any performance presented will be achieved, or that every assumption made in achieving, calculating or presenting either the forward-looking information or the historical performance information herein has been considered or stated in preparing this material. Any changes to assumptions that may have been made in preparing this material could have a material impact on the investment returns that are presented herein by way of example. Past performance is no guarantee of future results.
The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy.
Aperio is providing this link to a third-party website that displays a research report, article, webcast, video, or other content that we believe may be informational or educational for you. This linked content is presented by a source that we believe to be reliable, but we do not guarantee its accuracy or completeness, including any associated disclosures. Aperio has no control over the nature of the content on, or the availability of, this third-party website.
The inclusion of this link on our website also does not imply a recommendation or endorsement of any views expressed in such linked content and should not be considered: investment, tax, or legal advice; a solicitation; a recommendation of Aperio or any third-party’s services; or an offer to buy or sell any securities or related financial instruments in any jurisdiction.
Your subscription to the Aperio Blog has been confirmed. You will receive an email notification when a new blog is posted.
Your password is now updated.
Thank you for setting the security questions for your account.
User Must Be Logged In
You must be logged in to perform this action.
Invalid token. Please reload the page and try this action again.
You Currently Do Not Have Portal Access
You do not have access to the Aperio Client Portal.
Please note that if you just registered, it may take up to 24 hours after your registration form has been approved before you are able to log in.
That answer does not match our records. Note that responses to security questions are case sensitive. Please try again or contact Aperio at operations@aperiogroup.com or 415.339.4590.
Your portal user profile does not have provide access to this page. Please contact your administrator if you believe you have receieved this message in error.
Please select a request type.
Your account is temporarily locked because you repeatedly entered wrong answers to security question. Please try again in an hour.
There was an error sending the email to your new user. Please try again.
There was an error sending your email. Please try again.
There was an error sending the email to reset your password. Please try again.
There was an error sending the verification email for your portal account. Please press “Send Verification Email” to retry.
There was an error sending your Contact Us form to Aperio. Please try again.
Would you like to set up Multi-Factor Authentication (MFA) for your account? If yes, click here. If not, you are able to enable MFA for your account at anytime in your Profile by clicking Edit Profile.
With Multi-Factor Authentication (MFA), an extra layer of security is added to your account to prevent unauthorized users from logging in, even if they have your password. This extra security measure requires you to verify your identity using a randomized code we will send you each time you attempt to log in. MFA reduces the risk of unauthorized requests from your Aperio Client Portal account and provides extra security for your data.
You can choose to receive your security code through one of three ways: by text message/SMS, voice call, or the Okta Verify app. Through Aperio’s partnership with Okta, you can access their free Verify app to receive your MFA token on your Apple or Android device.
Are you sure you want to remove this factor from your account?
The factor has been successfully removed from your account.
You are enrolled in SMS MFA.
You are not enrolled in Text/SMS MFA. To learn how to enroll, click here.
To enroll in SMS MFA, please enter your mobile phone number.
Enter the code received on your mobile phone below.
You have successfully enrolled in SMS MFA.
This phone number was previously set up for SMS MFA for this account. The number and your portal account are now re-enrolled in SMS MFA. If this is incorrect, please contact Aperio at 415.339.4590.
You are enrolled in Voice Call MFA.
You are not enrolled in Voice MFA. To learn how to enroll, click here.
To enroll in Voice MFA, please enter your number and extension if applicable.
Enter the code from the automated voice call you just received.
You have successfully enrolled in Voice MFA.
You are enrolled in Okta Verify MFA.
You are not enrolled in Okta Verify MFA. To learn more on Okta Verify MFA, visit the Okta Verify enrollment guide here.
Please ensure you have downloaded the Okta Verify App prior to clicking Enroll.
After opening the Okta Verify App on your mobile device, press Add Account and scan the QR code shown on the screen. Enter the code shown in the app in the box below.
You have successfully enrolled in Okta Verify MFA.
Confirm Subscription
Ben Schneider, CFA
Senior Investment Strategist and Tax Economist
What are your key responsibilities? As an Investment Strategist and Tax Economist at Aperio, I support and advise clients on asset allocation, taxes, risk management, and other complex investment questions. I also work closely with the portfolio management and research team to develop analytical tools and materials that help our clients understand the trade-offs of various investment decisions.
Describe your key previous work experience. Before Aperio, I worked as an Investment Strategist for BlackRock, Inc.’s systematic global macro hedge fund and discretionary tactical asset allocation teams, where I supported BlackRock’s strategic institutional partnerships in the United States, Asia, and South America. I was also responsible for developing software to support signal research and target risk optimization for multi-asset, long/short investment strategies. Previously, I worked as an Investment Banking Analyst at Lazard Ltd.
Describe some noteworthy projects you have worked on that directly impact Aperio’s clients. While strategists typically focus on the non-investment support we provide clients, sometimes we get to contribute to the investment process too. One example is the work we’ve done on American depositary receipt fees. In addition to providing some insight into the trade-offs among the different ways to get exposure to non-US companies, we also use the output of that work to shape our investible universe and reduce transaction costs for our investors.
What are some non-work-related things we should know about you? I enjoy yoga, swimming, and kiteboarding.
What postsecondary degrees and/or professional certifications do you possess? BS in Business Administration from the University of Southern California; Master of Accounting from the USC Marshall School of Business; MFE from the University of California, Berkeley, Haas School of Business.
In a White House press briefing in August, US President Donald Trump said he is “considering a capital gains tax cut.” While the administration has discussed a straightforward reduction of the long-term capital gains rate, the impact of such a change...
As part of a broader tax plan, US presidential candidate Joe Biden has proposed changes to the treatment of capital gains. Because Aperio manages portfolios designed to increase investors’ capital gains efficiency, we explored the impact of the proposed changes...
Investors often ask us about the expected impact of certain socially responsible (SRI/ESG) constraints on the risk and performance of a portfolio. In our earlier work, we explored several different approaches for constructing a custom SRI/ESG portfolio to....
