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.

 

The Coronavirus & Market Movements

The Coronavirus & Market Movements

 

 

Global equity markets have moved down sharply over the past couple of days. The immediate cause has been the spread of the coronavirus disease 2019 (COVD-19). Capital markets react in real time to aggregate predictions of the future and, on average, price in an overly pessimistic view compared to the ultimate outcome. Currently, there is growing fear of a large drop off in global business activity due to the spread of COVD-19 outside of China.

When we look at the most recent response of the S&P 500 to epidemics over the past 20 years, we see that the market generally has fallen sharply during outbreaks and then rebounded within 6 months. This response follows a pretty typical market pattern where there is overreaction due to uncertainty in the outcome and then a strong bounce back.

The more uncertain the scope of an event, the higher the volatility. The scope and impact of disease outbreaks on economic activity is incredibly difficult to predict. First, there is the uncertainty associated with how the disease will spread and how severely it will impact global citizens. COVD-19 is different than several of the most recent disease outbreaks (SARS, MERS, Zika Virus) in that most patients do not experience severe symptoms and recent data suggests that some people may be infected without showing any symptoms. These characteristics make the probability of a tragic outcome much less but also make it much more challenging to control the spread. Technology and communication have also advanced and are being leveraged to extents not previously possible. How these factors will influence the spread of disease is truly unknowable.

Even if we did know exactly who would be affected and how, the tie between the human cost and the economic cost is indirect at best. Government and business response will vary and may have profound or very little effect.

When there is a very limited data set, it is important not to jump to the conclusion that the past predicts the future. Just because markets have rebounded quickly in the past does not mark this as a buying opportunity. As discussed above, each epidemic is unique, and the ultimate impact is uncertain.

We are well into an economic expansion that is long, by historical standards. Bear markets typically have a trigger that is not necessarily the underlying cause, but more like the straw that breaks the camel’s back. The divide between the performance of US growth stocks and the rest of the global equity markets (US small and value stocks, international and emerging stocks) has reached levels not seen since the late 1990s. At some point, these large divergences have always closed. Whether a decade from now we will look back on COVD-19 as the triggering event for a major shift, no one knows.

Our investment approach, during market pullbacks and always, is to stay true to our disciplined rebalancing strategy. We don’t predict the future direction of the market or specifically buy or sell based on recent market movements. Rather, we consistently monitor your portfolio for under or overweight positions and execute trades to bring the portfolio back to target. Because of the continued relative outperformance of US growth stocks, many clients have reached the point where they are overweight in this asset class, which has resulted in sells in these positions and buys of underweight asset classes in the portfolio, typically bonds.

As the market has swooned, we have also been selling partial or full positions to capture unrealized losses which are used to offset taxable gains and reduce your overall tax bill. The cash generated from the sells is reinvested in a substitute position in the same asset class. Entering a substitute position maintains the target investment objective of the portfolio, keeping you positioned to achieve your long-term financial goals while locking in the tax savings.

We hope that through these times, you can find peace of mind in knowing that we are constantly monitoring your portfolio to ensure the best chance of success in achieving your goals. If you have any questions about activity in your portfolio, please don’t hesitate to reach out.

Lessons From The Lost Decade (2000-2009)

Lessons From The Lost Decade (2000-2009)

“Past performance is no guarantee of future results” is a required compliance disclosure used by money managers when reporting performance. Unfortunately, it is truer in the world of investments than almost anywhere else. When you find a 4.5-star restaurant on Yelp, there is a high probability that you will have a positive experience. Statistically, funds that had the best performance over the past three years (or one year) are no more likely to outperform the following three years than any other fund.

The same is true at the portfolio level. In the late 1990s, U.S. growth stocks were the best performing asset class and investors flocked to the S&P 500. We introduced the Merriman MarketWise All-Equity Portfolio in 1995 in the middle of this period. After the first five years, the cumulative return of the Vanguard 500 Index Fund was more than 2.5 times that of MarketWise, as Figure 1 shows. What happened over the next decade from 2000 through 2009? The exact opposite.

 

Over the tumultuous decade from 2000 to 2009, the MarketWise All-Equity Portfolio (after fees) was up 70% compared to the Vanguard 500 Index fund which had lost -10%, as Figure 2 shows. That 10-year period during which the S&P 500, cumulatively lost money is commonly referred to as the lost decade. It was a painful period for many investors. Their faith in the S&P 500 had been strengthened by nine straight years of positive returns (six years exceeded 20%) and by watching it outperform major indices around the globe.

While it was a difficult period, the investors who suffered most were those who switched investments based on past performance. Figure 3 starkly illustrates the effect of “chasing” good recent performance. The blue and orange lines show the cumulative returns of the MarketWise All Equity Portfolio and the Vanguard 500 Fund. The gray line shows the cumulative growth of funds invested in the MarketWise All-Equity Portfolio from the 1995 inception through 1999 and then in the Vanguard 500 fund from 2000 through 2009. While after fees, the MarketWise All-Equity Portfolio slightly outperformed the Vanguard 500 Fund, investing in either approach yielded solid growth. The investor who switched from MarketWise to the Vanguard 500 Fund at the top of 1999 ended up with less investment growth than the investor who stuck with either strategy throughout the whole period.

2009 to 2017 the S&P 500 again delivered nine straight years of positive returns and outperformed most major world indices. In 2018, the index was down -6.6% but has quickly rebounded in 2019. No one knows what the next ten years will bring. History suggests that past performance is no guarantee of future results and that tides turn, but when that will happen is anybody’s guess.

IMPORTANT DISCLOSURES: The performance results shown are for the Merriman-managed MarketWise All Equity (100%) Portfolio and the nonmanaged Vanguard 500 Fund, during the corresponding time periods. The performance results for the MarketWise All Equity Portfolio do not reflect the reinvestment of dividends or other earnings, but are net of applicable transaction and custodial charges, investment management fees and the separate fees assessed directly by each unaffiliated mutual fund holding in the portfolios. The performance results do not reflect the impact of taxes. Past performance is not indicative of future results. No investor should assume that future performance will be profitable, or equal either the previous reflected Merriman performance or the Vanguard 500 Fund’s performance displayed. The S&P 500 is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the U.S. stock market. The Vanguard 500 Fund is a core equity index fund that offers investment exposure to the companies represented by the S&P 500 index. Source of VFINX data is Morningstar.

 

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!

Stop worrying about rising interest rates

There is practically universal opinion that interest rates will rise in the future, and that bond portfolios will suffer painful losses when this happens. At Merriman, we think the financial news media has blown this story way out of proportion, with inflammatory headlines designed to capture attention. Narratives include “the coming bloodbath for bond holders” and “the imminent bursting of the 30-year bond bubble.”

Our Chief Investment Officer, Dennis Tilley, recently wrote an article detailing three reasons why we’re not worried about rising interest rates. Here’s a quick summary:

1. The Experts and Consensus Are Often Wrong

History provides countless examples of when experts and/or a super-consensus have been wrong about the future of stock and bond movements. This is why we don’t use market predictions to manage client portfolios.

2. A Portfolio Duration of Four to Five Years Is Optimal

The sweet spot duration for Merriman investors holding bonds is in the maturity range of four to five years. This intermediate duration provides a nice compromise of offering overall portfolio stability, market crisis/deflation/recession protection, a long-term real return above inflation and – perhaps most importantly – the ability to quickly adapt to a rising-rate environment. With this duration, we believe our clients don’t have to worry about rising interest rates. The article provides more detail and charts illustrating this point.

3. Rising Rates Signal an Improving Economy

Finally, rising interest rates are likely to coincide with an economy that is improving, which is generally good for stocks. Yes, temporarily, bonds will lose value due to rising yields. However, we expect only single digit losses from our bond portfolio, not the “bloodbath” that some pundits seem to think will happen.

Read the full article here to get more insight.

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.