Products May 3, 2018

Investment Products and Services Launches

Russell Investments Discusses New ESG Finding; Merrill Lynch Brand Designs ESG Portfolios; and EDHEC-Risk Institute Examines Retirement Products and TDFs. 

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Russell Investments has created research findings in environmental, social & governance (ESG) investing with a material ESG score, which more accurately identifies ESG factors that could impact the financial performance of publicly-traded companies. The paper, titled “Materiality Matters: Targeting ESG issues that impact performance,” presents research that material ESG scores are better predictors of stock return compared to traditional, non-material ESG scores.

“Our new material metric allows ESG investors to differentiate between companies in a more precise way than a traditional ESG score,” says Scott Bennett, director, equity strategy and research, at Russell Investments and an author of the research paper. “We can now distinguish those companies which score highly on ESG issues that are financially material to their business and profitability.”

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Bennett added that the relevance of ESG issues varies industry to industry and company by company, undercutting the effectiveness of a one-size-fits-all ESG scoring system. For example, fuel efficiency has a bigger impact on the bottom line of an airline than an investment bank.

“We have found that traditional ESG scores are composed of many issues that are not material to the business being scored,” Bennett says. “Using a diverse market sample in the Russell Global Large Cap Index universe, we found that less than 25% of the data items in the traditional ESG score are considered material for two-thirds of all securities in the index.”

To create the new scoring methodology, the research team began with comprehensive ESG scores from data provider Sustainalytics—which are used for a wide variety of reasons beyond investment selection—and the industry-level materiality map developed by the Sustainability Accounting Standards Board.

“Our material scores are positively correlated to traditional scores, but they are meaningfully different,” Bennett says. “We now have research which indicates that investing in companies based on high material ESG factors is significantly better than those with greater immaterial factor.”

The team back-tested the new scores between December 2012 and June 2017, using the Russell Global Large Cap Index, and found that a firm’s material ESG score offers a promising signal for informing investment decisions.

The early results also have encouraged Russell Investments to incorporate the new material ESG scoring approach into its current decarbonization strategy, which serves as the foundation for low carbon investment funds available in several markets globally.

Merrill Lynch Brand Designs ESG Portfolios

Merrill Lynch and Merrill Edge have launched five new portfolios incorporating environmental, social and governance (ESG) factors in response to growing demand for investments with the potential to produce positive societal outcomes without sacrificing financial returns. 

Designed by the Global Wealth and Investment Management (GWIM) Chief Investment Office (CIO), the new CIO Core Impact Portfolios incorporate the CIO’s disciplined investment process, portfolio construction views, portfolio management and oversight routines.

They consist primarily of exchange-traded funds (ETFs), require a minimum investment of $5,000 and range from conservative to aggressive. These offerings expand upon an existing array of impact offerings on both the Merrill Lynch and Merrill Edge platforms.

“The demand for ESG-integrated investment options has increased, as more investors are seeking a ‘double bottom-line’ approach to investing and a way to add an environmental or societal impact objective to a financial return,” says Chris Hyzy, chief investment officer for GWIM.

“These new portfolios are part of the ongoing expansion of our investment offerings and build upon a broad platform of both solutions and thought leadership in the impact arena,” adds Keith Banks, vice chairman of GWIM and head of the CIO and the Investment Solutions Group for Merrill Lynch and U.S. Trust.

EDHEC-Risk Institute Examines Retirement Products and TDFs  

 

In a new publication entitled “Applying Goal-Based Investing Principles to the Retirement Problem”, EDHEC-Risk Institute and Professor John Mulvey of the Operations Research & Financial Engineering Department at Princeton University outline the shortcomings of existing retirement products, and lay the academic foundations for a new generation of risk-controlled target-date funds (TDFs).

The research efforts towards the design of more meaningful retirement solutions, with the support of Bank of America’s Merrill Lynch Global Wealth Management group, have led to the design of the EDHEC-Princeton Retirement Goal-Based Investing Index Series.

Commenting on the research publication, John Mulvey, professor of Operations Research and Financial Engineering in the ORFE Department at Princeton University, says “Applying Goal-Based Investing Principles to the Retirement Problem discusses important issues with developing the index series and its practical usage. Many developed countries are moving to a society with greater personal responsibility for financial decisions. This trend is evident with the shift from defined benefit (DB) to defined contribution (DC) plans. Unfortunately, most people do not have the tools nor the training to help themselves with the critical decisions about asset allocation, about savings, and about spending during retirement. The EDHEC-Princeton index series is aimed at informing the decision process. It provides superior information to the popular target-date funds, which do not distinguish among investors within an age category.” 

Offering a perspective on the applicability of these indices, Anil Suri, managing director and head of Portfolio Analytics and The Innovation Development Center in the Chief Investment Office of Bank of America’s Global Wealth and Investment Management group, says “the EDHEC-Princeton Goal-Based Investing Index Series are an important innovation that can help individuals, and the institutions they rely on, to achieve critical retirement goals in a more efficient and effective fashion.  Importantly, by using a very strong analytical foundation and demonstrating the practical feasibility of such an approach, the EDHEC-Princeton Retirement Goal-Based index series can help in the design and management of the next generation of retirement investment solutions that use liquid asset classes to generate income in retirement, while managing the effect of uncertainty on this very broadly applicable goal.”

The Markets May 3, 2018

Volatility, Strategic Thinking, and Long-Term Perspective

PLANADVISER presents an impromptu Q&A with John Diehl, senior vice president of strategic markets for Hartford Funds, on the subject of market volatility and keeping a long-term perspective amid big equity price swings. 

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John Diehl, senior vice president of strategic markets for Hartford Funds, spends a lot of time talking and strategizing with retirement specialist financial advisers; in a sense he is an adviser’s adviser.

Recently, Diehl sat down for a wide ranging conversation with PLANADVISER, following up on a previous interview he offered in February, when U.S. equity market volatility came back onto the scene in a big way. Since then, markets have remained volatile, but asset prices have not in fact dropped precipitously when viewed on a preceding-year basis. Still, as Diehl lays out, volatility remains a top concern for advisers and their plan sponsor clients.  

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PLANADVISER: Even with the bouts of equity market volatility we have faced, as of this morning the S&P 500 is still up over 9% for the preceding 12 month period. With that number in mind, have advisers and their clients been keeping the latest bouts of volatility in perspective? Are they remaining strategic and focused on the long-term, or is there evidence of poor portfolio decisions?

John Diehl: When we spoke in February, we were talking about the return of volatility in U.S. equity prices. One of my main comments then was to the effect that, rapid two-way swings in equity prices obviously will not impact people the same way as big negative swings that are not followed almost immediately by a rebound. What we have continued to see since that time is how these strong negative drops in equity prices have almost all been quickly followed up by corrections upward, and so people have not really had enough time to react to the volatility and make many trades.

Investors have taken some comfort in the fact that the volatility all seems to be revolving around a market return of zero or greater for the first half of 2018. So we go down 3%, then up 2%, then down 1%, then up 3%—that sort of thing. Now, I also want to stress that this is not something we can be complacent about. The market can surprise us in either direction, but generally speaking I don’t think the average investor out there is really feeling the sting from this volatility. You think about how strong 2015, 2016 and 2017 were in terms of returns, and that also helps people feel better. One thing that could derail confidence would be if we happen to end a quarter down, say, 5% or 10%, and people saw those numbers reported on their statements. But again, the swings have been too rapid for most people to process or act upon.

One more factor to mention here is that the employment picture has remained quite positive in the last several years, and I believe this has had a strong impact on the sentiment and confidence of investors. Job security seems to be okay right now, the sentiment goes, and there is opportunity out there. So we’re not feeling the double hit of, am I about to lose my job while my portfolio is falling significantly? That’s an entirely different scenario. Right now people are so busy that they might not even have the time to pay attention to daily portfolio moves.

PA: I’d also like you to respond to another figure. The average annualized total return for the S&P 500 index over the past 90 years is 9.8 percent. Yet from 1928 to 2016, only six years finished with a gain within 5% and 10%.

JD: This kind of a statistic can offer another way to think about volatility, as a positive rather than a negative aspect of the markets. But it also shows how challenging it is for advisers to educate their clients about how returns will vary over time and how individual years or even decades can differ from the long-term return average.

One of the things we have done to respond to this challenge is to build out new and creative ways to illustrate the longer-term action of the markets. One presentation that has been very successful is called, ‘Beyond Investment Illusions.’ We find that this terminology of ‘illusions’ really helps people understand some of the signaling that they see around short-term market performance. The main illusion we tackle is that volatility must be feared; as these statistics show, volatility is in fact an opportunity.

Especially when we talk about workplace retirement savings plans, where people will have a consistent flow of new money coming in as they progress through their career, they stand to gain from volatility, not lose. We help people see the danger in sitting on the sidelines or trying to time the markets. Our effort is to try to broaden the perspective of the investor to go look beyond what has happened today or in the last week, and to truly be strategic about their investing.

While we have had a lot of success, I will say it is a challenging effort. People who do not work in this world of retirement investing can have a hard time understanding how volatility can be positive. When they see the market fell 2% in one day, they naturally fear that, and they might want to pull out their money, especially those people who are very near or even within retirement. It’s always going to be hard for advisers to make sure their clients understand the positive aspects of volatility.

PA: Looking forward, do you expect much of the same for the rest of 2018 and beyond? There are many factors to consider in terms of the levers that could influence equity asset prices. Interest rates, for example, are starting to move upward in a more reliable way they have not enjoyed for some time.

JD: That is another difficult aspect of this conversation. It has been some time since institutional investors have had to ask, what happens in an interest rate cycle where rates are gradually increasing? It has just been so long since investors have had to deal with that scenario. Personally, I started working in this area in the late 1980s and early 1990s, and that is really the only time during my career that we were in an interest rate environment where rates were gradually increasing. So helping to educate investors about the basics of what this environment means is going to be a good use of time right now.

It doesn’t mean that it is time to start dumping fixed income. It’s time to learn about the different types of fixed income and why different types of fixed income are important. We have to teach investors about how diversification matters on the fixed income side of the portfolio as much as it matters on the equity side. It is a pressing issue, I should add. I have recently heard investors say to me that they did not understand that their fixed income investments could lose money. They wanted to know, this is a government bond portfolio, and how could its book value drop?

Given that we are generally an active manager of fixed income, we’re really pushing hard to educate investors about the differences between floating rate securities and your core bond holdings. How do these behave in relation to each other and in different environments? How do you spread your exposures across U.S. fixed income, corporate bonds, emerging market fixed income, and all the other flavors? These are important conversations right now, going beyond talking about fixed income as one big lump.

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