Products March 27, 2014

Achieving Alpha Through Sustainability

Global markets are well past the point where investors can ignore the sustainability profile of the stocks and bonds they’re holding, says Gerrit Heyns of Osmosis Investment Management.
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Heyns is a founding partner at the UK-based Osmosis Investment Management LLC. His firm partnered recently with Calvert Investments to develop the “Calvert–Osmosis Model of Resource Efficiency World Strategy,” which leverages a unique quantitative methodology within institutional client portfolios and separately managed accounts to identify and select sustainably run companies for purchase.

Heyns says the strategy is unique in that it leverages underappreciated and underutilized data related to the use of resources and the production of waste. In basic terms, Osmosis rates security-issuing companies on the types of resources and energy required to produce one unit of value—for instance, how many gallons of water or watt-hours of electricity does it take a manufacturer to create a single unit of product? And how much waste is coming out the back end that must be processed in one way or another?

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The calculation allows Osmosis asset managers to identify which companies are run most efficiently, whether within a single industry or across different sectors of the economy. And when these considerations are merged with more traditional performance and profitability evaluations, a powerful portfolio building model emerges, Heyns says.  

“This methodology gives us an opportunity to do a new type of information arbitrage,” Heyns explains. “We are still investors that are driven by returns, but we’re using sustainability to do that and identify where the best returns are.”

The idea is that, when a stock picker is considering, say, a field of construction firms that all look like relatively attractive investments, the best option is going to be the construction firm that produces the least amount of waste and requires the least amount of energy to produce value. This is true both in the short term, when the company will pay less in energy costs and to process waste, as well as in the long term, as issues like water and resource scarcity become ever-more-material to the daily operation of companies and economies.

Heyns says that, by making stock selections based on these factors, Osmosis can reliably deliver between 400 and 500 basis points of uncorrelated alpha in client portfolios. That’s probably the most important detail to consider within the retirement planning space, as the Department of Labor (DOL) has affirmed in a number of advisory publications that sustainability factors must be considered secondarily to the economics of any investment being contemplated by a plan regulated by the Employee Retirement Income Security Act (ERISA).

In other words, according to the DOL, noneconomic factors such as resource efficiency can serve at most as a tiebreaker when retirement plan fiduciaries are considering investment choices. That holds true even for plans at issue-dedicated nonprofits and other social organizations, where participants may be more willing to consider ethics during the investment process.

Despite the fiduciary hurdle, experts anticipate certain sustainability factors—namely climate risk, energy pricing and resource scarcity—to become significantly more material in long-term investment analysis and therefore to become more important to retirement plan investors in the years ahead. Heyns agrees wholeheartedly with the assessment that energy pricing and resource scarcity are quickly becoming hugely important to portfolio strategies.

“I am confident that within 10 years, and perhaps even five, everyone will be doing the sort of energy-waste analysis that we are doing within our strategy,” he says. “Water especially is quickly becoming one of the most restrained resources in global markets, and of course there is the carbon issue. You cannot get around these facts when considering company performance.”

Heyns feels that as resource-use efficiency gets factored more and more into various types of active management strategies, it will not be such a significant challenge for plan sponsors and advisers to justify their use of “ESG” investing–short for Environmental, Social and Governance—in the eyes of the DOL or other regulators.

“It’s a pragmatic approach that we are taking to stock selection and it’s motivated by performance,” he explains. “We are not managing portfolios on the intent of corporate management at the companies we buy, but on their current operational efficiency. That is certainly material.”

Data & Research March 27, 2014

Many Unsure 401(k) Will Produce Adequate Income

More than half of employees are unsure their 401(k) retirement plan will provide them with adequate funds for retirement, says a new survey.
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A survey from Pentegra Retirement Services finds that among U.S. adults who are employed and enrolled in a 401(k) plan, 65% do not believe or are unsure that their plan will provide enough money for them to retire when they want to or plan to. Nonetheless, 75% of 401(k) participants still think that 401(k) plans are the most important source of a person’s retirement income, according to the survey.

Survey findings also reveal that 45% of 401(k) participants are contributing only 6% or less of yearly earnings to their retirement account. However, 42% of 401(k) participants say they understand that you do not have to pay taxes on contributions made to the plan.

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“We cannot emphasize enough the importance of putting this money away and taking advantage of a 401(k) plan, not only for retirement but also to save money on taxes,” says Rich Rausser, senior vice president of client services at Pentegra Retirement Services in White Plains, New York. “Tax deferred contributions through a 401(k) plan lower your reported income, so the more you contribute the less taxable income you have. It is a win-win. By saving $20 per week on a $400 weekly salary, you are left with $380. After subtracting the 28% federal tax amount, your take-home pay is $274. Put that same $20 into a (taxable) savings account, and your take-home pay drops to $268. That six-dollar difference may not seem like much now, but multiply it over 52 weeks for 25 years and you are looking at pocketing an extra $7,800.”

The fact that nearly two-thirds of 401(k) participants do not believe or are not sure that their 401(k) plan will provide enough money in retirement is discouraging news, says Rausser. “The fact is that you need to try to save enough to provide income replacement of 80% to 90% of your annual pre-retirement income, for each year in retirement, in order for you to enjoy a lifestyle similar to the one you have now.”

In addition, the survey also reveals that three in 10 (31%) 401(k) participants admit they have no understanding of where or how their plan contributions are being invested. Thirty-seven percent of 401(k) participants say that as long their plan balance is there for them when they want it, they are not concerned with how it is invested.

Rausser encourages people to have a greater understanding of the process. “People really need to have a basic knowledge of how their money is being invested and how the process works. This is your hard earned money and your future. Take the time to sit down, even just once a year, with someone in charge of your plan. Ask questions and get answers you understand.”

On an encouraging note, says Rausser, the survey finds that 63% of 401(k) participants have increased their contributions at some point. Only 19% of participants say they have never increased their contributions.

“Increasing your contribution every year is the key to retirement planning success,” adds Rausser. “Each time you get a raise, increase your contribution by at least 1% or 2% annually. A simple way to do this is to have an automatic escalation feature as part of the 401(k) plan, so that contributions are increased automatically on an annual basis. This puts saving on auto-pilot so that participants don’t have to think about it.”

Other highlights of the survey include:

  • On average, the last time 401(k) participants increased their contribution was 2.4 years ago.
  • For those with a total annual household income (HHI) of $50,000 to $74,900, the last time they increased their contributions was 2.6 years ago. Those with a HHI of $100,000 or more increased their contribution 2.5 years ago. By contrast, those with a HHI of less than $50,000 last increased their contributions only 1.2 years ago.
  • Those who contribute more than 10% of their salary to their 401(k) plan most recently increased their contribution on average 3.3 years ago, significantly longer than the average of 2.1 years ago for those who contribute 10% or less of their salary.
  • Over two-thirds (68%) of 401(k) participants do not expect to use their 401(k) until they are required to take the mandatory minimum distribution (at age 70½).
  • About one-third (32%) of 401(k) participants believe that starting a 401(k) later in life with larger contributions will yield the same results as if they had started at a younger age with smaller contributions.

The survey was conducted online within the United States by Harris Poll, on behalf of Pentegra Retirement Services, from February 10 to 12, among 2,059 U.S. adults ages 18 and older, among whom 446 are employed full-time or part-time and are currently enrolled in a 401(k) plan.

More information about the survey can be downloaded here.

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