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Bob’s Journal for 7/14/22

Published on: Jul 14 2022

Buyers of ESG Funds Should Beware

Environmental, social and corporate governance (ESG) stocks and funds are one of the hottest trends in investing.

But as with most investment trends of the past, investors should look past the hype to the facts. To some people, the “S” stands for sustainability.

An ESG investor buys stocks of companies that have good policies and practices on the environment or sustainability, corporate governance and social issues. It is a popular concept.

Investments in ESG stocks and funds accelerated in the last decade. The assets in ESG mutual funds and exchange-traded funds (ETFs) exceeded $2 trillion by the first quarter of 2021, according to a report from Morningstar.

In some studies, but not all, funds with ESG mandates outperformed the broader market over time. One caution is found in a study that concluded the outperformance of ESG stocks and funds in recent years was the result primarily of investment flows into the funds and stocks. Investors wanted to own more ESG stocks. Money was shifted from other investments, and that flow of money pushed up the prices of the ESG stocks and funds in absolute terms and relative to non-ESG counterparts.

The study concluded that the investment shift wasn’t because ESG stocks had higher expected returns than the broad market. If the increased flows into ESG stocks aren’t sustained, the stocks will have negative returns, according to the study.

A recent column in The Wall Street Journal pointed out that most ESG funds don’t differ significantly from the major market indexes.

It also said some differences between ESG funds and conventional indexes and funds aren’t what many investors would expect. For example, Exxon is in the S&P 500 ESG Index, but Tesla recently was dropped from the index.

The column found that there were only minor differences between the S&P 500 and several ESG funds, but the ESG funds charge fees that are five to 15 times the fees of index funds. Recently, the ESG funds have had worse returns than the standard indexes.

Finally, the column cites this article in The Harvard Business Review that found ESG funds underperform market indexes. It also concluded that companies boasting about strong ESG credentials have poor records of complying with labor and environmental rules and have poor business performance.

The bottom line is investors need to tread carefully. Look beyond labels to determine if a company or fund really heeds ESG principles and is a good investment.

Maybe You Should Buy Stocks Late in the Day

The media and most investors pay attention to what happens in the markets during regular business hours. But perhaps the important action takes place outside business hours.

Since 1993, all the gains in the SPDR S&P 500 ETF (SPY) occurred outside regular trading hours, according to Bespoke Investment Group.

An investor who purchased SPY at the close of trading each day and sold it at the opening the next day would have a total return of 853% in the 30 years since the ETF began trading. Doing the opposite resulted in a loss of 10.3%, according to Bespoke.

This analysis doesn’t include dividends. The after-hours trading strategy would do even better if dividends were included.

Other researchers have verified this anomaly and dubbed it “the overnight effect.”

The researchers generally agree that it’s likely that retail investors absorb news and information overnight and in the early morning (most economic and earnings data is released in the morning before markets open), and then buy at the market opening. This pushes prices up briefly.

But there are a couple of cautions to consider before implementing the strategy.

One caution is that the studies don’t include transaction costs. Most of the excess returns from overnight trading occurred before there were zero commissions on the bulk of stock and ETF trades. The researchers estimate that trading costs would have eliminated most of the excess returns.

Another caution is that the overnight effect hasn’t worked so far in 2022. The overnight traders are down more than others so far this year.

Some researchers looked beyond the indexes to individual stocks and concluded that most of the excess returns from overnight trading were in meme stocks and others favored by active individual investors. They also conclude that most of these investors ultimately lose their excess returns when the stocks crash.

Higher Interest Rates Affect Some Gift and Estate Strategies

The tax breaks from some types of gifts, both to charity and family members, can change with interest rates. Some strategies are more valuable when rates rise, but some are hurt by higher rates.

A charitable annuity trust generates a higher tax deduction for you after interest rates rise. In this strategy, you transfer cash or appreciated property to the trust. You receive income for life or a period of years, whichever you designate. After that, the remaining property in the trust goes to the charity.

The trust is assumed to earn higher income and leave a larger remainder to charity after interest rates rise. That gives you a larger charitable contribution deduction when you transfer property to the trust.

In a personal residence trust, you transfer a first or second home to a trust. You live in the home and treat it as your own for a period of years that you set as the term of the trust. Then, ownership of the home is transferred to beneficiaries you designated.

The present value of the amount the beneficiaries will receive is a gift. When interest rates are higher, the value of the gift is less than when rates are lower. That reduces your gift taxes or the amount of your lifetime estate and gift tax credit that’s used.

Two strategies that are hurt by rising rates are the charitable lead annuity trust and the grantor-retained annuity trust.

The important point is that changes in interest rates can change the benefits of some giving strategies, whether you’re giving to charity or family. If you considered a giving strategy in the past but decided not to do it, talk to your estate planner again. The benefits might be greater now than they were when rates were lower.

The Data

The Consumer Price Index (CPI) rose 1.3% in June and 9.1% over 12 months. Excluding food and energy, the core CPI increased 0.7% in June and 5.9% over 12 months.

The 12-month CPI increase is the highest in almost 41 years and is much higher than May’s 8.6% 12-month increase.

The CPI should decline in the next few months. Gas prices have eased significantly in recent weeks along with prices of some other commodities. Also, some major retailers have said they have a lot of surplus inventory and plan significant discounts.

But inflation should remain higher than it was before the pandemic. Higher housing prices are baked into the CPI for at least a few months, and food prices seem likely to remain elevated. Prices for services also aren’t likely to abate.

Small business owners are losing confidence. The Small Business Optimism Index from the National Federation of Independent Business (NFIB) declined to 89.5 in June from 93.1 in May. The June level is the lowest in nearly 9.5 years, and June was the sixth consecutive month the index was below its 48-year average of 98.

The percentage of business owners concerned about inflation increased by six percentage points to 34%, the highest level since the fourth quarter of 1980.

But demand remains strong. Unfilled job openings remained at record highs with 50% of owners saying they have job openings they haven’t been able to fill.

Consumer credit increased at an annualized rate of 5.9% in May from April’s level. Revolving credit, which is mostly credit cards, increased at an 8.1% annualized rate, while nonrevolving credit (student and vehicle loans) increased at an annualized 5.2% rate.

In last Friday’s Employment Situation reports, 372,000 new jobs were created in June. May’s number of new jobs was revised lower to 384,000 from the 390,000 reported last month.

The job increases were broad-based. The only sector that had fewer jobs was government.

Average hourly earnings increased by 0.3% in June, bringing the 12-month increase to 5.1%. Both numbers were lower than the revised numbers reported for May.

New unemployment claims increased by 4,000 to 235,000.

Continuing claims rose to 1.4 million from 1.3 million the previous week.

The Markets

The S&P 500 lost 0.30% for the week ended with Tuesday’s close. The Dow Jones Industrial Average rose 0.08%. The Russell 2000 fell 0.79%. The All-Country World Index (excluding U.S. stocks) declined 0.57%. Emerging market equities dropped 1.69%.

Long-term treasuries lost 1.38% for the week. Investment-grade bonds fell 0.24%. Treasury Inflation-Protected Securities (TIPS) declined 1.04%. High-yield bonds gained 1.16%.

On the currency front, the U.S. dollar gained 1.55%.

Energy-based commodities declined 1.24%. Broader-based commodities rose 0.12%. Gold lost 2.41%.

Bob’s News & Updates

My latest book is “Where’s My Money: Secrets to Getting the Most out of Your Social Security.” It tells you clearly what your benefit options are in different situations and how to determine the best choice for you. You can find it on Amazon.com or Regnery.com.

The number of regular viewers for my Retirement Watch Spotlight Series continues to increase. You should sign up because I make in-depth presentations of key retirement finance topics. You can watch these online seminars from the comfort of your home or office at times you choose. To learn more about my new Spotlight Seriesclick here.

A recent five-star review of my book on Amazon.com said, “A complete retirement guide! One of the best books on this topic!” Click for more details about the revised edition of “The New Rules of Retirement.”

If you’re interested in my books, check my Amazon.com author’s page.

I’m a senior contributor to the Forbes.com blog. You can view my contributor page here.

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