Market Musings Blog

ESG Series: Part I

The latest trend in investing is ESG. ESG stands for Environmental, Social and Governance. About 25% of every investing dollar these days is going to ESG strategies. More than just a version of socially responsible investing, ESG is a broader look at capital allocation, with the aim of making investments to better the world. ESG is still evolving, but it has made a big impact on companies already. Most companies, especially larger ones, publish detailed sustainability reports now, making it simpler to evaluate their impact on the world. That said, because ESG is so popular, companies have an incentive to emphasize the positives and hide the negatives. Meanwhile, there are not yet any industry standards for evaluating ESG factors; instead multiple ranking firms have cropped up, publishing ESG ‘scores’ for hundreds of companies.

ESG has attracted hundreds of investment advisors who offer it as a product, partially because with the market so hot over the trend, fees can be significantly higher. Furthermore, to clients asking for ESG, performance is less important. They want to follow a set of values as a primary consideration. The perfect product is shaping up – fees can be high but demands for performance are soft.

Heretofore, ESG has relied heavily on technology companies, which are considered to be more green and diverse than, say, industrial companies. When the market is carried upward by tech stocks, as it has been for about ten years, ESG strategies perform well. However, the jury is out about whether ESG produces incremental performance over simply buying a low cost index fund. The trend is simply too new to evaluate – not enough data is available.

In our next installment, we’re going to take a look at a few specific companies and their ESG reports, using those as a springboard to talk about the philosophies behind ESG.

How Bad Can it Get?

The stock market has declined over 10% due to fears over the economic impacts of Covid 19, aka the new coronavirus. While that number isn’t such a severe reaction – we were down 20% just as recently as the fourth quarter of 2018 – what’s been more interesting is the swiftness off the decline.

The markets have changed dramatically in the last decade, with index funds and ETF (exchange traded funds) providing a much more potent impact on trading. Fast trading, trading by algorithm, and leverage against positions to enhance returns on the upside are all more common today than just ten years ago. Information moves faster, and regulations dictating how and when companies must disclose information have encouraged that. These factors mean that downtrends move faster, finish faster, and may even reverse faster.

If we look at today’s situation, with the Covid 19 virus circulating, there is no question that the virus will deliver an economic slowdown. However, after that slowing, we think pent up demand will cause above trend growth. The question is, how bad will things be, before the market begins to look forward to the rebound?

No one knows the answer to that, but it is tied to the spread of the disease and the number of new cases in countries other than China – where new cases are abating and people are getting back to work albeit slowly. A vaccine will likely emerge in 18 months or so, which we would expect to provide a boost to risk assets. If a compound such as Gilead’s remdesivir proves effective against symptoms, then the rebound could arrive faster. Furthermore, bond interest rates have plunged. Consider that the ten year Treasury now carries a yield only slightly higher than 1% now. Is it possible to fund retirement plans at 1%? The answer is no. In fact, a majority of S&P stocks carry dividend yields higher than that now. Eventually, folks will need to go back to funding retirement plans in a sensible way, and that’s not going to be by using a bond that yields only 1%.

At extremes such as we face now, doing less is better than doing more. This is not a great time for a wholesale allocation change, so try to refrain. But keep this moment in mind the next time you feel frisky about how well your stocks are performing!

What Usually Happens to the Markets During an Epidemic?

So one thing to remember is that we don’t have that many historical opportunities to study, as we try to answer this question. Incidents include SARS, Ebola, Zika, and bird flu. Each of these produced a temporary decline in stocks and a rise in bonds, which six months later was generally reversed – excepting Ebola, which fell during a period of globally slow economic activity spurred by a steep decline in oil prices. Because the economic situations were all different when these epidemics struck – SARS for instance came after the tech bubble burst during a recession – and because the Chinese economy is much larger now than at the time of its last epidemic, results this time around might be different. Today, we have stocks near all time highs and decent if not spectacular growth.

Still, at least we have some data points. And these show that the market does tend to improve sometime after the WHO declares an epidemic, and that stocks do tend to recover by about six months after their first declines.

Bonds, on the other hand, tend to rise in value, and interest rates to fall, as investors gauge the economic impact of the epidemic. In this case, the virus emerged during China’s Lunar holiday, a time when economic activity tends to be suppressed anyway. But there is no denying that Starbucks closing half its stores in China, airlines ceasing flights, Disney closing Disneyland in Hong Kong and so forth is going to have an impact on growth. Bond investors view this as a positive for rates – in fact we may see another round of interest rate reductions worldwide by central bankers.

In short, epidemics tend to produce negative, temporary impacts for stocks and positive temporary impacts for bonds, buttressing the idea that a diversified portfolio that owns both bonds and stocks is usually appropriate for even aggressive investors.

How to Choose a Personal Representative

We recently worked with a client who asked us how she should choose her personal representative. The PR carries out instructions in a will. (An executor is for all intents and purposes identical to a PR.) We realized that this rather common question was worthy of an entry on these pages.

A PR should be young enough to last beyond your lifetime, for one thing. If you want to name a spouse or relative of similar age, go ahead, but do name an alternate.

The PR can be a beneficiary of your will – there’s no law against that. But your PR should be able to get along with your other beneficiaries, and she should be responsible enough to make arrangements that may be needed, such as running an estate sale or hiring it done, investigating your safe deposit box, and so forth. The PR should be trustworthy – in fact in some states PRs and executors must post a bond in order to do the job.

For legal reasons, you cannot name anyone with a felony conviction or a foreign person. It’s better if your PR lives at least within a reasonable distance of you, but that’s not necessary.

Clients often name a son, daughter or in-law to this job, but this can cause strife among siblings. A close personal friend is an alternative; some attorneys (though fewer every day) and some accountants (ditto) will act; or you can hire a professional PR.

Acting as PR, depending on the condition of your estate, can be like having a second job for a while! The PR deserves compensation and more than likely a family member will charge less than a professional. Still, a professional brings efficiency and emotional distance to the equation, which might be desirable.

Keeping in mind the nature of the job, you can do your part by working to streamline your estate – have a will, take care to leave specific instructions for personal items, be as detailed as possible. If appropriate, make sure to discuss the job ahead of time with whomever you name.

Finally, if in doubt, get advice from your attorney. He’s been around this block more than once!

Oregon 529 Tax Deduction is Disappearing in 2020

The Oregon State legislature has decided to limit the tax benefits of contributing to an Oregon 529 College Savings Plan. The new rules go into effect in 2020:

  1. Instead of a tax deduction, which counts against your income, there will be a minimal tax CREDIT. A tax credit directly reduces your tax liability, on a 1 for 1 basis. A deduction, on the other hand, is most valuable if your income is high.
  2. The current deduction for a couple filing jointly is $4865, but this will be reduced to a $300 tax credit in 2020. Even then, if your income is high, you will not qualify to take the entire credit.
  3. Although this is bad news for those who want to save aggressively for one of the most expensive endeavors we ever undertake – college – there is an opportunity to accelerate your saving – IF YOU CONTRIBUTE BY DECEMBER 31, 2019. By contributing about $25,000 now, you can take the full $4865 tax deduction in this year and each of the next four years, with some restrictions. It is possible that you will also be able to take the tax credit in each of the next four years.
  4. Amounts are less for single filers; deductions and credits are totals, so you cannot take the full deduction multiple times for multiple accounts.
  5. Information on the plan changes is here:

Oregon’s plan has become less generous incrementally. When the Tax Act loosened rules for using the 529, allowing the funds to be tapped for grade school and other tuition, this state did not follow. Oregon still restricts the use of the 529 to post secondary education. Several states allow in-state tax deductions for contributions to out of state plans – not Oregon. Our plan has also been through an unusual number of manager changes. The 529 still gives you the benefit of tax deferred savings for college, but it does seem to us that limiting the benefits of saving for college is not a wise direction.

Talk to your accountant posthaste if you intend to pursue the carry forward idea; there are nuances to be aware of.