Mutual Funds

Clean-energy stocks and exchange-traded funds are on a tear this year, sharply outperforming the broader market and traditional fossil-fuel investments. The clean-tech ETFs with the most powerful year-to-date rallies include Invesco Solar ETF TAN, +3.35%, up 81% through Thursday; First Trust NASDAQ Clean Edge Green Energy Index Fund QCLN, +3.54%, up 58%; and iShares Global Clean Energy ETF ICLN, +2.19%, up 41%. Compare that to SPDR S&P 500 ETF Trust SPY, +1.61%, which is up 1.99%, and the Technology Select Sector SPDR Fund XLK, +2.38%, up 23%. The promise of clean tech — creating energy from renewable resources — has lured investors to the space before, only to get burned. After years of underperformance is now different or are buyers once again flying too close to the sun? Energy-market watchers say what makes today different than 10 years ago, when interest in clean tech also was hot, is that these power sources are now economically viable as subsidies fall away. Peter McNally, global lead for industrials, materials and energy at research firm Third Bridge, says aggressive investment by utilities in renewable energy has lowered the cost of clean tech and showed it was viable at scale. Just as utilities invested in natural gas 20 years ago at the expense of coal, they are now doing the same with alternative energy. “Clean-tech businesses are starting to stand on their own, and I think they got a big boost from the utilities,” he says. Data from the U.S. Energy Information Administration, the statistical arm of the U.S. Department of Energy, shows as of 2019, 18% of the U.S.’s electricity generation came from alternative energy, versus 10% in 2009. Some of the big oil majors like BP BP, -0.44% BP, +0.38%  are taking alternative energy seriously, McNally says, pointing to BP’s announcement that it will allow oil production to decrease by 40% over the next decade while investing $5 billion by 2030 in clean tech. “I am less cynical about the whole thing than I had been in the past (because of) big oil,” McNally says. “ In 2019, 18% of the U.S.’s electricity generation came from alternative energy. ” Another difference between now and then is clean tech is rallying as crude-oil flounders, says Jason Bloom, director of global macro ETF strategy at money manager Invesco. Until a few years ago, alternative-energy prices were significantly higher than fossil-fuel prices. Users would seek alternatives when fossil-fuel prices rallied, switching back when prices fell. While the cheapest fossil-fuel generation still beats out clean-tech energy, in some areas of abundant sun and wind, unsubsidized new-generation wind and solar prices are competitive at utility scale as clean-tech prices plummeted over the years, Bloom says. Over the past 10 years, the cost of solar panels has plunged 82%, while onshore wind costs have skidded 39% and the cost of offshore wind has fallen 29%, according to the International Renewable Energy Agency. Solar names are leading this year’s rally, says Angelo Zino, senior industry analyst at CFRA, a research firm. He attributes some of it to investor interest in Tesla’s TSLA, +5.04% electric vehicles and the ripple effect on other industries, plus increasing interest in environmental, social and governance investing. There may also be some investor bets that Joe Biden will win the White House in November and increase initiatives around clean energy, specifically solar. The First Trust NASDAQ Clean Edge Green Energy Index Fund has Tesla as its second-biggest holding, while the Invesco Solar ETF and iShares Global Clean Energy ETF have SunRun RUN, +9.61%  as their No. 3 and No. 1 holding, respectively, according to their websites. Biden’s platform has ambitious targets to increase renewable energy production, including establishing national goals of 100% clean energy by 2035. “You’ve got the potential with him at the helm to really accelerate a ton of the initiatives and long-term objectives of clean energy,” Zino says. Because clean tech is a young space, investors need to brace for volatility. If a Biden presidency doesn’t occur, Zino expects the valuation of these stocks to fall back because Donald Trump won’t make renewable energy a priority. Read:The West burns, coastlines are threatened, and Trump and Biden are too quiet on climate change, say analysts For now, there are some limits to how much of power generation can come from renewables even at utility scale. Battery technology needs to improve so utilities can tap more stored electricity when the sun isn’t shining or the wind isn’t blowing. “They’re figuring ways to make it more reliable, but it’s not 100%,” Third Bridge’s McNally says. But even if the U.S. slows in renewables adoption, clean tech is a global business. Europe and China are pushing ahead on adoption, which supports the industry as a whole. For example, Germany gets nearly half of its energy from renewables, according to Clean Energy Wire, citing Germany’s energy industry association. McNally says the strength in clean-tech energy is more than just investor money inflating valuations, pointing utility NextEra Energy NEE, +1.55%, the world’s largest generator of renewable energy from wind and solar power. “The utilities themselves have made this part of their portfolio, and they are required to keep the lights on,” he says. “They’re investing real money in all kinds of ways to generate and distribute power to customers.” Now read:Warren Buffett-backed largest U.S. solar project approved as nation’s renewable use on track to pass coal Also:Here are two stocks that stand to benefit from California’s electric-vehicle push Debbie Carlson is a MarketWatch columnist. Follow her on Twitter @DebbieCarlson1.
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For the 55 calendar years from 1965 through 2019, Berkshire Hathaway’s stock rose at an 18.6% annualized pace, versus 11.8% for the S&P 500 SPX, -1.11%  . (Both returns reflect reinvested dividends.) Warren Buffett can take credit for this, and he appears to be very much in charge of Berkshire. But, given that he just celebrated his 90th birthday, it’s clear that Buffett won’t be at the helm forever. But if you invest in Berkshire B, +0.13%   BRK.B, +0.07%  or by following Buffett’s well-known investing principles, your portfolio returns likely won’t suffer after Buffett stops analyzing the markets and offering his insights. How can I be so certain? Because some years ago a group of researchers broke the Buffett Code. They devised a mechanical investing strategy that would have done every bit as well as Buffett over the long term. It is testament to Buffett’s accomplishments that it took many researchers many attempts over many years before they figured out the Oracle of Omaha’s secrets. The researchers who succeeded were three principals at AQR Capital Management, each of whom has strong academic credentials: Andrea Frazzini; David Kabiller, and Lasse Pedersen. The study, entitled “Buffett’s Alpha”, began circulating in academic circles in early 2012. (Berkshire Hathaway did not respond to an email seeking comment about this study.) The exact specifics of the formula the researchers derived are beyond the scope of this column. In general it focuses on what might be called “cheap, safe stocks.” The formula favors issues that have low price-to-book-value ratios, have exhibited below-average volatility, and are from companies whose profits have been growing at an above-average pace and pay out a significant portion of their earnings as dividends. One mutual fund that perhaps comes closest to employing the formula the researchers derived is offered, not surprisingly, by AQR: The AQR Large Cap Defensive Style Fund AUEIX, -1.00%  . The fund’s inception was in July 2012, soon after the research was completed. The researchers don’t expect their formula to replicate a portfolio that is identical to Berkshire Hathaway’s stock holdings, by the way. But, based on the researchers’ results, it should produce a list of stocks that are similar to those Berkshire has owned over the years — similar both in terms of characteristics as well as long-term performance. An example is Kraft Heinz KHC, -2.93%  , which was one of the stocks the fund invested in when it was formed. At the time Berkshire Hathaway had no position in the stock. Not long after, Buffett announced that his company had acquired a 50% stake in Heinz. That’s just one data point, of course. But since inception, the AQR fund has produced a 14.4% annualized return versus 12.5% for Berkshire Hathaway stock, according to FactSet. Both of these returns reflect the reinvestment of dividends. It would be going too far to expect the AQR fund to continue outperforming Berkshire shares over the long term. There are major differences between the fund and Berkshire, and there inevitably will be some periods in which the fund won’t come out ahead. But, assuming the future is like the past, the fund (as well as anyone else following the research) should at least match Berkshire’s stock performance over the long term — with Buffett or without. Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com More:Bill Gates says this might be ‘the most important thing’ he’s learned from Warren Buffett, who just turned 90 Plus: Value stocks will rise again, but we just don’t know when
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Two proposed rulemakings from the Labor Department in the past eight weeks would largely gut sustainable investing options and strategies in retirement plans. These proposals would reverse the Labor Department’s 2015 and 2016 guidance while ignoring the growing consensus among academics, retirement plan fiduciaries and professional money managers that responsible companies are likely to outperform over the long haul. The first measure, “Financial Factors in Selecting Plan Investments,” now in the late stages of the approval process, would discourage 401(k) and other qualified retirement plans from offering funds from managers that consider environmental, social and governance (ESG) factors in their due diligence. The proposal establishes burdensome requirements for analysis and documentation around inclusion of ESG options. The Labor Department currently has no such requirements for any other kinds of funds. Support for the measure has been decidedly underwhelming. A group of investor organizations and financial firms analyzed the more than 8,700 public comments on the proposed rule and found that only 4% of comments expressed support. Some 95% of the comments — across individuals, investment-related groups and non-investment-related groups — were strongly opposed, and 1% expressed neutral views or didn’t clearly express support or opposition. The 30-day public comment period ended on July 30 and the Labor Department is likely to implement the proposal before the end of the year. The second proposal, “Fiduciary Duties Regarding Proxy Voting and Shareholder Rights,” which was announced at the end of August, would restrict the ability of retirement plans to hold company leadership accountable through proxy voting. It alleges that proxy measures are onerous for public companies. A fundamental misunderstanding The reasoning betrays a fundamental misunderstanding of how financial professionals consider ESG criteria in their investments and how proxy voting practices enhance long-term value of investments. Because of inconsistent corporate disclosure rules, investors often file proxy proposals to receive relevant ESG information. Both proposals represent a solution in search of a problem. They imply that investment managers and plan fiduciaries promote social goals over sound investment analysis, but proponents fail to cite a single instance that this has happened or any related enforcement actions they have taken. Moreover, the agency doesn’t acknowledge any of the dozens of studies that demonstrate that consideration of ESG issues may lead to better investment outcomes. Morningstar found that during the stock collapse in the first quarter of 2020, all but two of 26 ESG indexes suffered fewer losses than their conventional counterparts. Studies of longer periods from Morgan Stanley and MSCI have found no financial trade-off in the returns delivered by ESG funds relative to traditional funds. Additionally, a 2018 report from the Government Accountability Office (GAO) reported that 88% of the academic studies it reviewed found a neutral or positive relationship between the use of ESG information and financial performance. Setting aside the academic debates over ESG, the market has already spoken. As of 2018, more than one of every four dollars under professional management was invested using ESG criteria, according to the US SIF Foundation’s 2018 Report on U.S. Sustainable, Responsible and Impact Investing Trends. Morningstar has reported that in 2020, flows into sustainable funds outpaced traditional funds. Read:Sustainable-investing flows have smashed records in 2020. What’s going on? Far from making a concession to ESG, professional money managers increasingly analyze ESG factors precisely because of risk, return and fiduciary considerations. They know that bad policies and practices can harm companies’ reputations, affect consumers and lead to stock-price declines. Climate change is widely recognized as an environmental and financial risk for companies. Similarly, companies that fail to promote racial equity face real and meaningful challenges. Investors are coming to recognize that companies with better policies and practices and more robust corporate governance will outperform over the long term. A 2018 US SIF Foundation survey of U.S. sustainable investment money managers with aggregated assets of more than $4 trillion found that three-quarters of the respondents employ ESG criteria to improve returns and minimize risk over time, and 58% cited their fiduciary duty as a motivation. “ In 2020, flows into sustainable funds outpaced those into traditional funds. ” The Labor Department’s proposals would largely supplant an existing regulatory regime that was already working. In 2015 and 2016, President Obama’s Labor Department carefully considered these issues and issued Interpretive Bulletins clarifying that fiduciaries of ERISA-governed retirement plans “do not need to treat commercially reasonable investments as inherently suspect or in need of special scrutiny merely because they take into consideration environmental, social, or other such factors.” The second Interpretive Bulletin recognized that shareholder rights, including voting proxies, are important to long-term shareholder value and consistent with fiduciary duty. These new proposals are not taking place in a vacuum. They are part of the Trump administration’s broader effort to generate barriers to investment practices that have a focus on environmental, social or governance issues. The Securities and Exchange Commission is currently seeking to create its own barriers on this topic, including the role of proxy voting firms, fund names and shareholder rights. By tipping the scales against consideration of ESG criteria when selecting investments and against the use of proxies to encourage better governance and better disclosure, the Labor Department proposals prevent plan sponsors from fulfilling their fiduciary obligation. It should retain current practices related to the utilization of ESG criteria and proxy voting. Lisa Woll is CEO of US SIF: The Forum for Sustainable and Responsible Investment. Follow her @LisaWoll_USSIF. Judy Mares is former deputy assistant secretary in the Labor Department.
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(A previous version of this column reversed the percentage allocations to stocks and bonds.) iStock Vanguard Wellesley Income Fund celebrated its 50th birthday in July. A mutual fund being in business that long has become about as rare as couples reaching their 50th wedding anniversary, and so the fund’s longevity is noteworthy in its own right. But, by analyzing this mutual fund’s performance, we can draw important investment lessons for the future — especially about the wisdom of the so-called 60/40 portfolio of stocks and bonds. First, though, a walk down memory lane. Wellesley Income VWINX, -0.64% ] was created in July 1970 by the Wellington Management Co., at which a gentleman by the name of John Bogle was working. Bogle would later create the Vanguard Group of mutual funds, and the Wellesley Income fund became one of its offerings. Wellington Management continued to manage the fund. The fund falls in the “Balanced” category, averaging about a 35% allocation to stocks over the decades and 65% in bonds. Despite therefore being rather conservative, it has produced a quite respectable 9.7% annualized 50-year return through this past July 31, according to investment researcher Morningstar.  Over this same period, the entire U.S. stock market, as measured by the Wilshire 5000 Total Return Index, produced an 11.0% annualized return. Long-term Treasurys, intermediate-term Treasurys, and long-term corporate bonds produced annualized returns of 8.8%, 7.0%, and 8.3%, respectively. Vanguard Wellesley Income is slightly ahead of a strategy that had a constant 35%/65% stock/bond allocation over the past 50 years and invested the bond portion in an index benchmarked to either intermediate-term Treasurys or corporate bonds. As you can see from the accompanying chart, however, the fund would have slightly lagged a hypothetical index fund portfolio that allocated the bond portion to long-term Treasurys. Since the vast majority of mutual funds don’t even match their benchmarks, much less slightly beat it, Wellesley Income’s return puts it well-above average. In any case, it’s unfair to compare it to a portfolio of index funds, since such funds didn’t even exist in 1970. The Vanguard 500 Index Fund VFINX, -3.49%, Bogle’s landmark invention, wasn’t created until 1976. According to an article in Barron’s several years ago, furthermore, the first bond index fund wasn’t created until late 1986 (the Vanguard Total Bond Market Index Fund VBMFX, +0.08% ). Given that, Wellesley Income’s achievement is even more impressive. Another way of appreciating Wellesley Income’s achievement is to focus on the attrition rate among mutual funds. I am unable to find out how many mutual funds existed 50 years ago, so I can only estimate how few of them exist today. Researchers have found that, between 1962 and 1995, the average annual mutual-fund attrition rate was 3.6%. If we assume that rate for the entire 50 years of Wellesley Income’s life, that means that just 16% of the funds that were in existence in 1970 are still around today. Another estimate of attrition comes from S&P Dow Jones Indices. In their year-end 2019 SPIVA U.S. Scoreboard, they report that just 44.53% of all domestic funds that existed at the beginning of 2005 were still in existence at the end of 2019 — equivalent to an attrition rate of 5.25% annualized. Assuming that was the actual rate each year since 1970, only 7% of that year’s funds would still be in existence today. Regardless of which attrition rate you assume, it is clear that Wellesley Income is among a small minority. Mixing stocks and bonds All of this begs the question about how this 50-year old fund will perform in the future, however. Index funds are widely available now, and if the fund is so closely correlated with the long-term returns of a blended stock-bond benchmark index, you could very well ask if it’s worth the effort. Your answer will rest in part on whether you’re willing to bear the risk of lagging that benchmark in order to preserve the possibility of outperforming it. What I want to focus on, however, is whether the 35%/65% stock/bond split pursued by Wellesley Income is out-of-date. Many argue that it is, including such investment legends as Burton Malkiel, the Princeton University economist and author of the famous book, “A Random Walk Down Wall Street.” Recently Malkiel told MarketWatch reporter Andrea Riquier that there no longer is justification for even a 60%/40% stock-bond portfolio, much less a 35%/65% split. I’m not so sure, however. Consider a recent analysis completed by Joe Tomlinson, a financial planner, actuary and retirement researcher. He focused in particular on the impact during retirement years of moving from a 60% stock/40% bond portfolio to one that is 75%/25%. He found that, on average across thousands of simulations, this move led to a surprisingly small increase in the amount the median retiree could withdraw each year. But what that move did do was greatly expand the range of possible outcomes — from very good at one end of the extreme to very bad at the other. One of the major implications of Tomlinson’s analysis is that increasing equity exposure may not be worth the risk. If you do, he adds, you should have a separate “solid base of secure lifetime income” with which to pay for basic needs. “Relying on stock-heavy portfolios to meet basic needs carries a lot of risk.” If you’re persuaded by this analysis, Wellesley Income may be an attractive consideration. Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com More:Should I still use the 60/40 investing rule for retirement? Also read: Vanguard opposes a tax on Wall Street its founder John Bogle favored — and the reason may surprise you
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A century after winning the right to vote and in the midst of a pandemic, female fund managers are outperforming their male colleagues on Wall Street. That is according to a team of equity strategists at Goldman Sachs, who crunched the numbers in honor of 2020, which marks the 100th anniversary of the 19th amendment’s ratification, which affirmed a woman’s right to vote. Goldman found that year-to-date, 43% of female-managed mutual funds outperformed their benchmarks on a year-to-date basis, versus 41% of funds beating their benchmarks with no female managers. From the start of the year, up to March 28, when markets were swinging wildly on pandemic panic, Goldman found the median female-managed fund outperformed its benchmark by 50 basis points, whereas the typical fund lacking a female at the top, underperformed its benchmark by 20 basis points. And the reason for the better performance comes down to stock picking, said chief U.S. equity strategist, David Kostin and the team: “Men may be from Mars and women from Venus, but female-managed funds tilt toward Info Tech while non-female managed funds prefer Financials,” said the strategists. “At the stock level, female—managed funds have higher relative exposure to highfliers Amazon AMZN, +1.44%, Apple AAPL, +3.39%, Microsoft MSFT, -1.47%, AbbVie ABBV, +1.68% and Tesla TSLA, +12.56%, but lower exposure to Berkshire Hathaway BRK.B, -0.41% Wells Fargo WFC, -2.26%, Visa, UnitedHealthcare UNH, -0.57% and Exxon Mobil XOM, -1.84%, which have underperformed those buzzier names. Clearly, betting on tech has paid off so far this year, with the tech-laden Nasdaq Composite COMP, +0.68% up 30% versus roughly 9% for the S&P 500 and a slightly negative Dow industrials DJIA, -0.78% (but it ended last week trade in positive territory). The SPDR S&P Bank ETF KBE, -1.72% and Energy Select Sector SPDR ETF XLE, -2.16% are each down over 30% year to date, representing to of the weakest sectors of the S&P 500’s 11. Read:Now that Apple and Tesla’s stock has split, here’s what individual investors should know before they jump in To qualify as a female managed fund, at least one third of managerial positions had to be held by women. Of the 496 large-cap U.S. mutual funds with $2.3 trillion in assets under management, 13% of the total, with $261 billion in assets exceeded that threshold. Only 14, or 3%, have an all-female fund manager team, managing just 2% of total assets. That is against 380 funds, 77% of the total, which are run by an all-male team, accounting for 57% of domestic equity mutual fund assets. The outperformance by female-led funds seems to have something to do with the historic nature of 2020. From 2017 to 2019, Goldman found that return volatility and the Sharpe ratio, which measures the risk-adjusted returns of a fund, were even across funds run by all women, men and a mix of the two. But portfolios with more women, year-to-date, have seen stronger Sharpe ratios. After adjusting for volatility, the median all-female managed fund returned more than 2 times that of the typical all-male fund. Males did have a slight edge when it came to outflows. The median female-managed fund saw slightly larger outflows year-to-date of around 5.7% of starting assets under management since the beginning of the year. The median fund with no female managers saw outflows of 5.5%. Meanwhile, female-managed funds oversee more than twice the assets as those without women at the helm — $1.1 billion versus $500 million. Opinion:New bull market in stocks could last three years and produce another 30% in gains, say veteran strategist
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In the wake of widespread outrage and protests about racial injustice, many people are looking at their stock portfolio and wondering: what can I do to support racial justice with my dollars? If you are an investor of any type — whether you have a 401(k), IRA, or trading account — there are a few things you could do to promote racial equity. ESG investing: the basics You may have heard of ESG investing, which stands for “environmental, social and governance.” It is also often called sustainable, socially responsible or simply “values” investing. It’s an investment strategy that selects stocks and bonds based not only on traditional financial criteria, but also based on the impact of different companies on society and the environment. Proponents of ESG investing point to a growing body of evidence that suggests sustainable investing may actually improve a portfolio’s performance, while also serving the greater good. Over the past five years, sustainable funds have outperformed their conventional peers in both up and down markets, according to a Morningstar report. Also, as markets tumbled during the first quarter of 2020, almost 60% of the biggest U.S. sustainable mutual funds and exchange-traded funds lost less in market value than the S&P 500. The popularity of socially responsible investing has exploded in recent years. In early 2020, around 74% of global investors said they plan to increase their ESG allocation over the next year. In the first quarter of 2020, U.S., sustainable funds saw inflows of $10.5 billion, according to Morningstar — a more than 10-fold increase from the first quarter of 2010. And even as markets tumbled due to the coronavirus crisis, global demand for ESG proved resilient. The global sustainable-fund universe saw inflows of over $45 billion in the first quarter, while the overall fund universe saw outflows of more than $380 billion, according to Morningstar. The challenges of measuring social impact What exactly goes into an ESG portfolio? Environmental factors often include things like carbon emissions and water usage. Social impact may involve working conditions for a company’s employees and gender or racial equity. And governance criteria often have to do with board oversight and transparency. In light of recent events, the “S” — or social — part of ESG has come into focus, as more and more people are looking at the social impact of large corporations, specifically from a racial justice standpoint. That’s where things get a little tricky. There are more than 300 funds marketed as ESG in the U.S., according to Morningstar. But there’s no official definition of “socially responsible” investing. To further complicate the issue, there are dozens of different companies that issue ESG ratings, ranging from large data providers, like MSCI and Sustainalytics, to smaller companies and even nonprofits that focus on topics like gender-pay equity and civil liberties. Unlike accounting standards, there is not one unique methodology. Some of the data is self-reported by the companies, and some of it is done by third parties, who are often estimating. There are of course some broad principles, like how the company treats its workers — but these are often hard to quantify. For example, companies can get a high score for having anti-harassment policies in place, without tracking how well the policies are actually implemented. “There are not yet clear apple-to-apple comparisons across the board even for public companies, let alone private companies,” said Andrei Cherny, CEO of Aspiration, an online “financial firm with a conscience,” which offers a variety of banking and investing products focused on environmental and social impact. Cherny has called for regulators to require public companies to report ESG-related data, such as carbon emissions, diversity of their workforce, and how they pay their employees — just like they have legal obligations to report their financial performance. “Those are factors that investors need to know just as much as they need to know the price-to-earnings ratio,” he said. Other industry leaders echo Cherny’s thoughts. For instance, in the wake of recent events, Calvert Research & Management, a prominent sustainable-investing shop, called for companies to “accurately assess their racial diversity” and make it public, provide pay equity disclosure across race and gender, and publicly state what they are doing to combat racism and police brutality. Meanwhile, some asset managers have decided to influence change from the inside. Neuberger Berman, which manages $330 billion, decided to use its shareholder status to drive governance and sustainability practices. In April 2020, the company announced that it would publicly disclose and explain the firm’s voting rationale and intentions at more than 25 key annual shareholder meetings. “Normally shareholders vote quietly behind the scenes,” said Jonathan Bailey, Head of ESG at Neuberger Berman. Instead, by providing advance vote disclosure, Neuberger Berman intends to educate investors and the public on “why we’re voting a particular way,” Bailey said. For example, ahead of Marriott International’s MAR, -1.01% May 8 shareholder meeting, Neuberger Berman announced it intended to vote in favor of a proposal to enhance diversity reporting, along with an explanation of why that could affect the company’s financial performance. “We have a responsibility, as market participants, to take [these issues] seriously; they’re financially material issues,” Bailey said. The proposal did not end up passing, as it gathered about 30% shareholder support, according to a Neuberger Berman spokesperson. Niche products focusing on racial justice While there are currently no industry-wide standards around social impact, a few companies have launched niche products specifically targeted at race and equality. For example, OpenInvest, a company that builds indexes and other investing tools around social causes, has created an index specifically on racial justice. It screens for metrics like board member inclusion, workforce diversity and which companies pollute the most in communities of color. Similarly, Impact Shares, a nonprofit provider of exchange-traded funds, partnered with the NAACP to launch a first-of-its-kind racial empowerment ETF. But what the ESG industry has been missing is that “your social priorities may be drastically different from my social priorities,” said Ethan Powell, CEO of Impact Shares. For example, some ESG funds hold shares of liquor or gaming companies. These holdings might be a problem for some investors, but not others. Powell envisions a future where “effectively every social issue will be reflected with a separately investible fund,” so that investors can create portfolios that are reflective of their individual social priorities. Partnering with nonprofits could play a key role in the development of such products, according to Powell, because social-advocacy organizations are in a better position to understand the particular social issues at hand. What many experts agree on is that growing investor demand will inevitably push the industry to innovate. Years ago socially-responsible investing offered just a few options to cover a small piece of investors’ stock portfolios. Today, there are hundreds of different mutual and exchange-traded funds to pick from, not just in equities but also in fixed income and even junk bonds. One study showed that around $12 trillion of assets in the U.S. are managed under some sustainable investing strategy. So while you wait for the industry to establish widely-accepted standards, you could start building your own socially-responsible portfolio by looking at the ratings and methodology of different funds and companies and picking what aligns best with your values and financial goals.
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The shocking death of Alex Kearns, a 20-year-old day trader who recently died by suicide, highlights a broader caution to young people: do not get sucked into digital trading platforms — no matter whether they have noble-sounding names or are “free.” You will most likely lose your money or worse. There are better ways to make money. With the exception of people like Warren Buffett, humans are poor investors and even worse traders. Sure, the occasional human might get lucky, but in general, the odds are heavily stacked against you. Unless you have some special information or expertise, you are best off investing in a market index as early in life as possible and enjoying the benefits of compounding. Read:The rise of mom-and-pop investors in the stock market will ‘end in tears,’ warns billionaire Cooperman I have been teaching and engaging in systematic investing for over 20 years. My core message to all students and professionals is to not overestimate their competence or the quality of their beliefs, but to continually challenge them. The second reason for caution is more sinister. It involves the “objective functions” of the platforms where you park your money. How do they make money if they are free to users? Digital trading platforms make money through a complex web of rebates for funneling trading activity downstream to various venues, and collecting interest on money flowing through the system. Their objective is to therefore maximize the flow of dollars through the system, period. All accounts of any size are welcome. How you perform is largely irrelevant to their business model as long as there are some “intermittent rewards” for the user, like a winning trade. Indeed, the experience created is one of gamification. It is fun, like being in a casino, which is pumped with oxygen to stimulate flow. As a former designer of Google recently remarked “if you’re an app, how do you keep people hooked? Turn yourself into a slot machine.” But digital platforms are worse than casinos, where most games are relatively simple and easy to understand. And the casino doesn’t loan you money to make your bets. The trouble is that most people, including professionals, don’t often understand the subtle but important nuances of the financial products they trade, which increase in complexity by the day. Many products, for example, provide “free leverage,” like a triple-levered version of the SPDR S&P 500 ETF Trust SPY, +1.39%, an exchange-traded fund that tracks the S&P 500 index. A common misconception is that the triple-levered version, which is called a “derivative” product, will result in triple the performance of the single-levered ETF. In reality, however, performance can diverge considerably even over a few days, depending on how the product is managed, which is typically in fine print that retail investors don’t read. The marketplace is full of ways to harm yourself. A student from my most recent Systematic Investing class at New York University gleefully shared how the class had helped him make 150% on his investment and pay off his student loan. I congratulated him, but told him he could just as easily have lost more than that amount, and to be cautious about leverage. A less cheerful account from 10 years ago involved a more experienced trader, whose family money was wiped out during the flash crash of May 2010 due to how his orders were executed. He never recovered it. The bottom line is this: don’t trust digital platforms that appear to be “free.” You will pay the price one way or another and may not be aware of it. Over the long run, the more you trade, the more you will lose. And do not trade products you don’t understand, especially if they involve fine print. But what if you really want to trade? Perhaps it is an addiction you cannot control. Perhaps it is the rush of making money, or engaging with the markets for its own sake and taking risk intelligently. In this case, one path I recommend is to apply the scientific method to the problem using large amounts of data. This requires a conceptualization of the problem, hypotheses, data and algorithms. Specifically, it requires a process that is applied consistently to the data and is not impacted by emotions or preferences. This is more involved in terms of setup than making discretionary day-trading calls, but if it done properly, will provide you with outcomes that are based on applying a concept consistently instead of becoming a victim of fear or greed. A second path I recommend requires an analysis of fundamental factors like the economy or the company’s business prospects. For example, there are significant opportunities created by crises like the current pandemic. We might analyze, for example, what changes COVID-19 will induce in human behavior that are likely to be permanent. One such irreversible trend is “virtualization,” which favors entities and sectors where products and services can be delivered digitally, and punishes those with large physical assets and heavy debt burdens. In my analysis, I drew parallels with the previous crisis of 2008-09 and teased out what is likely to be different about the recovery this time. For example, commercial real estate rebounded incredibly strongly after the financial crisis, but this would be surprising with the increase in remote work. Such an analysis can be supported by data, but there is no getting around the hard work of poring through financial statements and assessing economic trends, and then picking the investments most likely to profit if you are right about your assumptions. There are very few things in life that are more important than money. Acquiring it is difficult and growing it is challenging. The last thing you want to do is gamble. Do not trust the “objective functions” of digital trading platforms since their objectives are unlikely to align with yours. Think deeply and invest wisely. Vasant Dhar is a professor at New York University’s Stern School of Business and the director of the Ph.D. program at the university’s Center for Data Science. He is the founder of SCT Capital Management, a machine-learning-based systematic hedge fund in New York City.
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