Incorporating Environmental and Social Values into Your Merriman Portfolio

Incorporating Environmental and Social Values into Your Merriman Portfolio

 

Investors like you are, by definition, actively planning for your financial future. At Merriman, we understand that you also want to make sure the world is bright for future generations.

To help align your investments with your values, we offer our Values-Based Investing portfolios. These portfolios are built in a manner consistent with our overall investment philosophy and designed to deliver similar after-fee, after-tax returns while offering you the ability to have an impact through your investment choices. One of these values-based options is our Sustainability portfolio. The UCLA Sustainability Committee defines sustainability as “the physical development and institutional operating practices that meet the needs of present users without compromising the ability of future generations to meet their own needs, particularly with regard to use and waste of natural resources.”

Our Sustainability portfolio focuses on including and overweighting companies that score high on sustainability measures. By choosing this portfolio, clients have the ability to shift money away from companies that have negative environmental impacts and into companies that rank better than their peers.

For the equity allocation in our Sustainability portfolio, we have selected funds managed by Dimensional Fund Advisors. When it comes to determining environmental impact, Dimensional’s approach to sustainability investing stands out. While many asset managers offer binary screening to exclude certain securities, Dimensional tilts toward companies that rank high on its sustainability framework while reducing the weight of companies with negative scores. This approach ensures a company doing better than its peers is rewarded even if it lags behind other companies in different sectors. This process is important because while a software company won’t have a very large environmental impact, investing in an energy company that has better environmental business practices than its peers can end up being more impactful on reducing carbon emissions in the future.

Incorporating sustainability considerations is a complex task. The sustainability funds we have selected use a Sustainability Scoring Framework on an industry level. The table on the right shows how the sustainability scores are determined, taking into account both the greenhouse gas emissions the company reports as well as potential future emissions from their fossil fuel reserves. This process penalizes companies that enable others to emit more or will themselves emit more in the future.

Dimensional also screens out companies with particularly negative practices around factory farming, cluster munitions, tobacco, and child labor.

Equities aren’t the only asset class where our portfolio includes sustainability considerations. Real estate has a high environmental impact and is an asset class where we are able to successfully incorporate sustainability considerations with minimal impact on investment returns.

Per the UN Enviroment Programme (UNEP), “The construction and operations of buildings account for 40% of global energy use, 30% of energy-related GHG emissions, approximately 12% of water use, nearly 40% of waste, and employs 10% of the workforce.”

As shown in the graph below using data from the Intergovernmental Panel on Climate Change, buildings have the lowest cost to reduce emissions. A great example of this comes from the iconic New York Empire State Building, which in 2010 underwent a retrofit. Windows were rebuilt, HVAC was replaced, and reflective insulation was installed. These changes resulted in the building having an annual energy reduction of 38% which translates to a cost saving of $4.4 million per year. This type of cost saving is also beneficial to the investment as profits from these endeavors are passed through to the investors.

Source: VERT Asset Management

We are partnering with some of the most informed individuals in the field of sustainable real estate investing by using the groundbreaking Global Sustainable Real Estate Fund from VERT Asset Management. This fund targets companies that meet a threefold criteria of environment, social, and governance factors. These include both positive and negative screening and tilts. The fund overweights REITs with energy, GHG, and water reductions and also screens out prisons, businesses, or companies with environmental fines. The Venn diagram below shows how VERT incorporates a multi-dimensional scoring methodology. VERT focuses on companies that exhibit “Comprehensive Excellence,” those that fall in the middle of the Venn diagram. After this, VERT targets “Focused Excellence” REITs which fall into two of the Venn diagram categories. In this way, VERT builds a portfolio targeting the best of the best first.

Source: VERT Asset Management

 

 

There is more than one way to invest in line with your values. Whether by using sustainable funds like those from Dimensional and VERT, or one of our other investment offerings, Merriman is by your side. We want to make sure your investments not only fulfill your financial goals but also allow you to live fully, knowing that you are making a difference for future generations.

 

Consider an 83(b) election for your new vesting agreement

In the start-up world, founders create a company and hire a business attorney to compile incorporation documents. Once the company is formed, if the founders elect to vest into their ownership over time, the attorney will send the founders a reminder email saying, “Don’t forget to file your 83(b) election! You have 30 days to make this happen.” Then a week later, the founders receive another reminder email, and maybe a few more down the road, but they let the chance to file the election pass on by.

So what is all the fuss about?

The 83(b) election is often forgotten or ignored at the critical moment when a startup begins to gain traction. Or, an employee who obtains a stock vesting agreement for the first time can easily miss it. When used wisely and in the right situation, the 83(b) election can be invaluable.

What is it?

The 83(b) election is available in stock compensation agreements with a substantial risk of forfeiture (a.k.a., restrictions). This is usually seen with stock vesting agreements for founders and executives of newly created companies and does not apply to phantom stock (RSUs, phantom units, etc.). Rather than paying tax each year upon vesting, this election allows you to pay all taxes up front based on the value of the stock at the time of award/grant. Then, when you dispose of your stock years later, you will be subject to capital gains tax rates. (more…)

83(b) election in action

Every time I meet with a tech executive or founder holding restricted stock, I ask them if they made their 83(b) election. By this point, many have heard the phrase but few can point to an example that is easy to follow. There are both potential risks and rewards in making this choice.

Example of 83(b) Election in an Optimal Situation

You receive a grant of 90,000 restricted shares vesting over three years. The price per share at grant is $0.01. Assume you hold the vested stock and sell at the beginning of Year 5, your marginal income tax rate is 39.6%, your long-term capital gains tax rate is 20%, and net investment income tax rate is 3.8%.

  • End of Year 1, the company received angel investment and the value per share is $1.
  • End of Year 2, the company picks up steam and the value per share raises to $5.
  • End of Year 3, the value per share is $10 and the company prepares to go the venture capital route.
  • Beginning of Year 5, the price per share jumps to $20 due to funding valuation.

Without an 83(b) election, you will recognize taxable income each year on the vested portion. The taxable income will be equal to the fair market value less the grant price. Over time, if the value of the stock increases, you will pay more tax at each vesting event.

Restricted Stock Vesting - No 83(b) Election

Share PriceTaxable IncomeTax Liability
Total Tax Paid$504,098
Grant Date - 12/31/Year 0$0.01--
Vesting - 12/31/Year 1$1$29,700$11,761
Vesting - 12/31/Year 2$5$149,700$59,281
Vesting - 12/31/Year 3$10$299,700$118,681
Sale Date - 2/1/Year 5$20$1,320,900$314,374

If you make an 83(b) election, you will accelerate your vesting for tax purposes to the current year and realize income on the current value now.

Restricted Stock Vesting - 83(b) Election

Share PriceTaxable IncomeTax Liability
Total Tax Paid$428,542
Grant Date - 12/31/Year 0$0.01$900$356
Vesting - 12/31/Year 1$1--
Vesting - 12/31/Year 2$5--
Vesting - 12/31/Year 3$10--
Sale Date - 2/1/Year 5$20$1,799,100$428,186

This example displays the benefits in an optimal situation. It assumes one income tax rate across multiple years with the sale of stock occurs more than one year after full vesting. Depending on your particular situation, the impact of an 83(b) election may change substantially. Discuss the implications with your tax accountant and/or financial advisor to find out if this option is right for you.

The Merriman Research Team discusses our TrendWise Investment Program

Recently, our Research Team of Dennis Tilley, Rafael Villagran, and Alex Golubev got together with Financial Advisor Mark Metcalf to discuss our TrendWise Investment Program. Many of the program’s details were covered, including the following:

  • Harnessing market momentum using objective data
  • Rules based trend following
  • Limiting subjective interpretation
  • Dealing with whipsaw trades
  • Small/Value tilt in the program

Enjoy!

Merriman on High-Frequency Trading

If you’ve been tuned into financial news lately, you’ve no doubt heard about High-Frequency Trading (HFT). HFT is not new. In fact, it’s been around for over 20 years. Investopedia defines HFT as:

A program trading platform that uses powerful computers to transact a large number of orders at very fast speeds. High-frequency trading uses complex algorithms to analyze multiple markets and execute orders based on market conditions.

So why is it news now? Last week, a 60 Minutes interview with Michael Lewis suggested that the stock market was “rigged” by high frequency traders. I want to provide my thoughts, as Merriman’s Chief Investment Officer and as a hedge fund manager, on how HFT is affecting Merriman client portfolios. While we will monitor developments over time, the bottom line is that we believe HFT has minimal impact on our client portfolios.

Here’s why:

HFT firms are the new market markers in the stock market. Market makers, who’ve been active in markets ever since stock exchanges have existed, act to provide liquidity to stock trading by offering to buy stock at the bid price, and sell stock at a slightly higher ask price. While providing liquidity to the market, market makers have always strived to maximize their profits at the expense of institutional investors and the average person buying and selling stock in their brokerage account.

The transaction cost to investors can be viewed as an expense (paid to market makers) for providing liquidity, and has never and will never impact the fundamental value of the stock market. The cost only comes to bare when buying or selling a stock.

Two forces help protect us from market makers making excessive profits.  The first force is the competition among market makers.  As with any business, large profits attract competitors. iStock_000024621112SmallCompetition among market makers drives transaction costs lower as they fight amongst each other to provide this service. The battle among market makers is very similar to an ever increasing arms race, where whoever has the best technology wins. Over the last 10 years, computers have replaced the Wall Street traders and NYSE specialists – who in the old days were just as keen to profit from investors.

The second force limiting market maker profits are the countermeasures institutions use to trade large blocks for their clients. Attentive investors should be monitoring their trading and adjusting their investing/trading approach to minimize transaction costs. HFT is just the next story in the everlasting interaction between market makers and institutional investors. While the SEC and other government agencies will eventually catch on to illegal trading activities, the smartest investors generally take a buyer-beware approach to their trading.

In our MarketWise portfolios we take into account the sensitivity to trading costs when selecting investment managers. Dimensional Fund Advisors is obsessive in monitoring their trading costs and minimizing turnover. Their approach is to trade like a market maker by buying and selling stocks with limit orders and they are agnostic about what stocks they buy or sell (as long as a stock fits that fund’s investment approach). This trading approach is much less sensitive to HFT. Stock-picking active managers, and index funds, are typically demanders of liquidity when they trade stocks, which is much more susceptible to exploitation from market markers whether using HFT or via the old specialist system on the NYSE.

In our TrendWise portfolios, we also carefully track our ETF transaction costs to ensure that our approach is as cost -efficient as possible. And finally, individual investors, trading small quantities of stock in their own accounts, have benefited greatly from HFT as bid-ask spreads have narrowed significantly over the last decade or so.

If you have any additional questions about HFT or its impact on your portfolio, please don’t hesitate to speak directly with your advisor.

All that glitters is not gold

Merriman does not include a specific allocation to gold in our standard portfolios. This article, by Bryan Harris of Dimensional Fund Advisors, discusses why gold has not been an ideal long-term investment. It includes the following key concepts:

  • Gold has done well since the year 2000 and in the 1970s, and can potentially be a safe haven during times of political and economic stress. However, for the entire period of 1971 – 2011 gold performed worse than the S&P 500, U.S. small-cap stocks and non-U.S. stocks on an inflation-adjusted basis.
  • From 1980 – 1999, gold experienced a negative return after inflation of -6.5%, vs. strong positive returns for stocks.
  • While gold has held its value against long-term inflation, there have been extensive periods when gold did worse than inflation. Gold is also much more volatile than inflation, and can add substantial volatility to a portfolio.
  • Unlike stocks, which are productive assets which generate growing levels of income and dividends over time, gold has no cash flow and costs money to own.

For more detail and some illuminating graphs, please see the article.