Improvements made and challenges in investing for the long-term
In 2020 CFA Institute convened a panel revisiting the topic of short-termism and commissioned Fund Governance Analytics to quantitatively analyze the issue as we found many companies reluctant to step away from the short-term earnings guidance game.
Issuers and investors have begun to understand the importance of issuer–investor communications in getting both sides on the same page on many long-term strategic issues. In the years since our 2006 report was published, investors and issuers have increasingly invested in resources dedicated to fostering engagement. Both parties realize that building a trusting relationship can increase understanding and avoid the adversarial relationships that often existed between the two groups in the past.
These improvements in the short-termism and long-termism landscape should indeed be celebrated, but more work remains to be done. Many companies have traded in short-term earnings guidance for either long-term guidance or a more diverse set of metrics that better informs investors.
ERISA plan fiduciaries select investments to make (1) directly on behalf of plan participants and beneficiaries, or (2) indirectly on behalf of plan participants and beneficiaries by selecting investment options to offer them. The DOL describes ESG investments as including socially responsible investing, responsible investing, and sustainable investing (ESG/sustainable investing). The DOL proposed regulation would direct those fiduciaries to look askance at ESG/sustainable investments. In particular, the proposed regulation would provide that
(1) ESG/sustainable investments are only permitted if the plan fiduciary overcomes burdens not applicable to other investing approaches regardless of the economic value of the investment, and
(2) ESG/sustainable investment alternatives for self-directed plans, regardless of their economic values, may not (a) be a qualified default investment alternative or a component of such an alternative, or (b) include alternatives if the fiduciary acknowledges having used any ESG/sustainable investment considerations that are not “objective risk-return criteria.”
Many commenters suggested that the proposed regulations be significantly revised, and there appeared to be broad agreement on two revisions:
• The regulation should permit an investment alternative may be a qualified default investment alternative for a self-directed plan regardless of whether the alternative makes any use of ESG/Sustainable consideration, such as using the S&P® index; and
• The regulation should distinguish between the use of ESG/Sustainable considerations to determine the economic value of an investment, i.e., the incorporation approach, which may be judged in the same manner as any other valuation tool, and cases in which consideration are used for other purposes.
There was a strong factual disagreement about whether ESG/sustainable considerations are only used to value investments, including as a risk-management tool, in which case there is no reason for any special scrutiny of those considerations. If those considerations are ever used for other purposes, such as to have positive effects for the environment, society, or enterprise governance, some argue ERISA not only prohibits such consideration, but special scrutiny is needed to avoid these so-called abuses. even if the pursuit of those goals does not reduce the economic value of the plan’s investment or plan’s choice of an investment alternative to make available to plan participants and beneficiaries.
There was also a strong legal disagreement about whether the regulation should, as it does in very narrow circumstances, ever permit fiduciaries to use any ESG/sustainable considerations that do not determine an investment’s economic value to decide between direct investments which have the same expected economic value.
The paper argues that it is advisable for the DOL to revise the proposed regulation to be consistent with ERISA, the usual practice of prudent ERISA fiduciaries exercising due diligence in making plan investment decisions, prior DOL guidance, and the reasonable preferences of many ERISA plan fiduciaries, participants, and beneficiaries to reflect not only the commenters’ broad consensus but also :
• Delete any additional reporting or review requirements on ERISA plan fiduciaries that the rule would impose only if the name of the investment and/or the investment approach includes an ESG/Sustainable reference;
• State that because multiple options often have the same best expected economic value, ERISA plan fiduciaries making investments need not, and often may not, consider only the investment’s expected economic value ; and
• Permit, but not require, ERISA plan fiduciaries to choose and retain “ethically beneficial” investments that do not sacrifice any economic value by using any non-pecuniary consideration to select or monitor investments if such consideration is not illegal, and does not reduce the expected economic value of the investment.
Delighted to share the following announcement as we work toward a global standard on ESG investing. I’m proud of the effort our working group has put into this much needed area over the past eight months. Public comments from across the industry are welcome and encouraged. #ESG#standards#sustainabilityhttps://lnkd.in/eATPWYE
This week we focus on the U.S. consumer. Consumer spending represents over two-thirds of gross domestic product (GDP) in the U.S. and is therefore a critically important force in the economy and markets, both for U.S. and global companies. The good news is that consumer spending, supported by federal stimulus measures and a recovering job market, has defied expectations throughout this recession and has recovered substantially from its lows in April.[1] While consumer spending has held up, there have been some recent headwinds from the continuing drag from the pandemic and the prospect of a “no-deal” stimulus package in the near term.
Total U.S. Consumer Spending (as of 6/30/2020)
There is also no doubt consumer spending has shifted during the pandemic, with significantly more shopping occurring online. The increase in ecommerce has been breathtaking to say the least with the growth in ecommerce over the last several months outpacing the growth over the prior 18 quarters combined.[2]
And while this has clearly manifested itself in the performance among a core set of retailers, it has also been supportive to small business:[3]
And the future bodes well given the current position of U.S. consumers, with savings up 54.6% from one year ago:[4] Measures of new orders and PMIs (Purchasing Manager Indexes) we referenced in last week’s letter also reinforces this point. According to a recent statement from the research firm, Markit, “Total new business rose for the first time since February and at a solid rate. Manufacturing firms registered a steeper expansion in new order inflows than in July, while Services signaled a renewed increase in sales.”
Despite continued cautious notes from the Fed (see below), James Bullard, the St. Louis Fed President, had this to say about the outlook for the rest of the year (excerpted from a Reuters interview this week):[5]
Though the situation seems chaotic, with federal, state and local officials laying out competing ideas about what activities are safe and under what conditions, Bullard said that shows adaptation in process, and will allow the country to fine-tune behavior and economic activity to what a “persistent” health threat allows. “I think Wall Street has called this about right so far,” he said, noting how firms like Wal-Mart, with its mandatory masking and other rules, have found ways to operate that others will copy. “There is a lot of ability to mitigate and proceed and most of the data has surprised to the upside…So I think we are going to do somewhat better…I expect more businesses to be able to operate and more of the economy to be able to run…successfully in the second half of 2020.” Bullard said he sees the U.S. economy shrinking 4% for the year, substantially more optimistic then the -6.5% median projection his colleagues made in June, and also less dire than the median forecast of economists polled by Reuters in mid-July. That saw a 5.6% hit to GDP for the year, with a catastrophic annualized decline of 32.9% in the April to June period offset by what will likely be similarly outsized growth numbers in the third and fourth quarters.
[1] Chetty, Friedman, Hendren, Stepner [2] Baird-Strategas [3] Bloomberg [4] Bloomberg, quoted from Craig Johnson, president of Customer Growth Partners [5] Reuters.
The pandemic has persuaded some investors of the potential financial damage from global warming
As 2020 kicked off, Dan Gocher at the Australasian Centre for Corporate Responsibility, a shareholder advocacy organisation, was feeling “pretty optimistic” about its plans to force big Australian energy companies to tackle climate change.
BlackRock, the $6.8tn asset manager, and other large investors had proclaimed an urgent need to arrest global warming. With the renewed focus on climate change following the devastating bushfires in Australia, the ACCR was hopeful several climate-related resolutions filed at oil and gas producers Santos and Woodside would gain strong shareholder support at their annual meetings in April.
The second quarter GDP number came out this week and it was the worst on record, contracting -32% on an annualized basis. The projection for the third quarter is now estimated at +18%, which we expect will be one of the best on record. We have been saying since March the data in the short run will look horrific, but the upswing will likely be equally dramatic. However, the shape of the recovery continues to remain dependent on the path of the virus..
The probability for a successful vaccine, perhaps as early as the end of this year, remains high given current developments. A study out this week by the National Institute of Health (NIH) regarding the Moderna vaccine brought further welcome news on that front.[1] In addition, the FDA is about to approve emergency use of antigen treatments from the blood plasma of recovered patients, which is anticipated to open the way for one of the most promising treatments for COVID-19 patients.
Here in the U.S., despite increasing cases, we continue to see the level of hospitalization and ICU utilization remain well within capacity limits. Cases in the Sunbelt appear to be leveling off. As of the most recent CDC report (see table below) only 8% of hospital capacity is estimated to be COVID-19 related (about 64,500 patients), and total unused capacity for both hospital beds and ICUs is about 40% (approximately 320,000 inpatient and 50,000 ICU beds). As we have noted before, from the point of view of the markets, it is not the headline number of cases that is the issue, but rather the hospital utilization numbers and mortality rates.
So, we ask the question this week: at what level would new daily case counts overwhelm the hospital system? Given the ratio of hospitalization to current cases is about 3% nationally, and the average hospital duration is 11 days, we can impute the maximum daily case level from current available capacity figures noted above. Based on the hospitalization rate, cases could surge another 11 million before we would hit capacity from the current base of 2.3 million, representing a growth rate of 500%. Factoring in hospital stay duration results in the following: 11 million total cases divided by 11 days = 1 million new cases per day.
The Institute for Health Metrics and Evaluation (IMHE) current projection of daily infections at current levels of social distancing projects daily infection rates of 115,000 (the seven-day average is closer to 66,700), a number they forecast declining into October. In contrast, the worst-case, upper end of their projections, assuming continued easing of restrictions, is 317,000 per day, or less than a third of our estimated maximum daily threshold. Short of a complete abandonment of any social distancing policies or practices, this level of new daily cases is unlikely to be realized.[3]
Why is this important? Business restrictions and consumer activity will remain sensitive to these factors, and so as long as the medical sector can handle caseloads and the need for further shutdowns or greater restrictions lessens, the path of the economic recovery will continue. To the extent that hospitalization and mortality metrics improve through better treatments, the sharper the “V”, as shown in the figure below. The steeper the recovery, the better performance from equities, particularly across the many sectors that have lagged information technology this year.
Markets and the Next Stimulus Package
For now, equity markets appear to be in a period of consolidation, although still up since the end of the quarter, as Congress determines the next fiscal stimulus package. With the additional $600 per week unemployment benefits set to expire today, Congress has been pushing forward on a plan to extend those benefits, albeit at potentially reduced levels.
The municipal market is anticipating that some portion of the bill will bring relief to current budget shorfalls. Since the May 12 HEROES act, the municipal market AAA scale has rallied by almost 50 basis points (0.50%). Democrats have proposed an additional $1 trillion of support, and the Republican side has proposed no support. Wall Street is estimating that they will compromise and settle around $400-500 billion of support for states and cities.
The NY transportation system, one of the largest municipal issuers, recently stated that they need an additional $3.9 billion to keep operating through the end of the year or it will be forced to implement severe cuts in order to meet the transportation needs of the city. In the meantime, numerous states have enacted temporary spending plans with the belief they will receive additional government support.
The Fed met this week and announced no adjustments to current interest rate policy beyond their intention to remain extremely supportive through 2022. The Fed also announced they will extend emergency lending programs by three months until year end. All but one of the nine programs was set to expire. These programs serve as a lender-of-last-resort and help support the lending function of the corporate and municipal markets.