August 2019

Debatable, Yet Undeniable —Taking Responsibility for Climate Change

Posted on August 5, 2019 by Sage Advisory

by Bob Smith, President & CIO of Sage Advisory

My recent visit to the Arctic was both breathtaking and disturbing. It is a naturalist’s wonderland, offering many opportunities to appreciate and observe the eco diversity of the region. It is also a place where one can see firsthand the growing adverse impact of climate change and mankind upon its inhabitants.

Although it has long been debated as to what extent humans are contributing to climate change and our ability to adapt, what is undeniable is the fact that the earth is getting warmer. The current warming cycle is occurring twice as fast in the Arctic than anywhere else on earth, and it is causing significant changes in the extent, duration, and conditions of sea ice. The loss of sea ice around the Svalbard, an archipelago in the Norwegian Sea, is predicted by scientists to be particularly profound in the coming decades.

These changes affect all life forms in the Arctic but none more so than the iconic polar bear. An apex predator and the largest species of bear on our planet, the polar bear is very much a marine mammal in that it depends upon sea ice as the platform upon which to hunt and breed. This makes the polar bear the one species in the Arctic that is the most vulnerable to climate change because their land, and the crucial natural bounty it provides, is literally melting beneath their paws.

Unlike humans, the polar bear – and importantly, the food chain it tops – are unlikely to adapt. The U.S. Geological Survey projects that two-thirds of polar bears currently in existence will disappear by 2050 as a result of the melting sea ice.

Source: PolarBearHabitat

Melting ice has an obvious external effect on the hunting patterns of polar bears. But polar bears are facing trouble from the inside as well. Unfortunately, due to their high-fat diet of seals and walrus they have become one of the most contaminated beings on Earth. This is because seals and walrus ingest fish and mollusks, which live on micro-organisms baring persistent organic pollutants (POPs). These man-made toxic substances are recognized carcinogens that never degrade and come from distant industrial factories via air and ocean currents.

While I believe everyone is responsible for climate change– from governments to oil and gas producers, to anyone who is dependent on fossil fuels to live their daily lives – there is a responsibility at the corporate level to curb behavior that exacerbates such negative externalities as climate change.

Just as the polar bear is at the height of its food chain, so are two of companies responsible for the creation and widespread use the pollutants contributing to the polar bear’s demise. 3M (MMM), with $33 billion in annual sales, is ranked No. 216 on Forbes’ 2019 list of the world’s largest public companies, and DuPont (DD) is ranked No. 81, with $86 billion in annual sales.

Minnesota-based 3M originally sold two pervasive and now-controversial compounds, PFOA (perfluorooctanoic acid) and PFOS (perfluorooctane sulfonate). PFOA was an integral manufacturing component for nonstick coating product Teflon that was manufactured by Delaware-based DuPont, and PFOS was a key component of the fabric protectant Scotchgard.

Scientists have found more than 200 halogenated harmful contaminants in polar bear blood samples. These contaminants adversely affect the polar bears’ immune systems, hormones, bone density, growth development, and reproductive organs, and they can lead to brain damage.

PFOS production in the United States ceased in 2002, and PFOA were phased out in 2015, the same year DuPont spun off a new company called Chemours (CC) with several of its chemical businesses. However, PFOA are still widely used internationally and many imported goods, such as textiles and plastics, contain them. The detrimental effects of these substances released into the environment are long lasting and have led to many lawsuits.

Last year, Minnesota won a $850 million settlement against 3M on the basis that 3M knew about the chemical dangers of these substances and continued to pollute natural resources. And this year, in Michigan, 200 families are suing 3M for contaminating the water. Chemours has sued DuPont, which had been facing 3,500 lawsuits in Ohio over exposure to PFOA, for underestimating the extent of its liabilities.

As a sustainable investment manager, it is my responsibility to enable investors to vote with their dollars and invest in the issues they care about. People can curb climate change and mitigate environmental pollution by voting with their money and investing in companies that have policies in place to limit such negative activities.

One key component of our sustainable investment analysis is whether a company engages in operations that either alienate community members or violate their human rights. So, it is interesting to note that while 3M might score well on some ESG factors, we consider it high risk when factoring in its intentionality.

PFOS and PFOA were replaced by 3M and other companies in the United States with different types of PFAS (per- and polyfluoroalkyl substances) that are said to breakdown faster and be safer overall; however, their relative safety is still being debated. We want to know to what extent did 3M know it was polluting the environment and how long has it continued to do so? These are areas of risk for the company that will affect its long-term financial performance, not only from a legal expense perspective, but from an investor and consumer sentiment perspective. We believe the growing interest in sustainable investing will increase the attention on these issues and as a result, create better corporate citizens that better serve their environment.

When we look at the polar bear, we are reminded that we have a responsibility to ourselves and to our children to do what we can to mitigate the effects of climate change and mankind on the environment. The polar bear’s role as the apex predator in the Arctic puts it at great risk to continue to accumulate toxic levels of man-made pollutants. They are the high Arctic region’s canary in the coal mine, and their growing attrition should be a wake-up call for us all.

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

Feeling Insecure about the SECURE Act?

Posted on August 1, 2019August 2, 2019 by Sage Advisory

by Andy Poreda, Research Analyst at Sage Advisory

After the SECURE Act passed quickly through the House of Representatives on May 23 with near-unanimous support, it has unfortunately stalled in the Senate. All signs point to Senator Ted Cruz (R-Texas) as the likely culprit. Cruz has voiced frustration over certain provisions that were removed, such as allowing individuals to use tax-advantaged savings in 529 college accounts to pay for home-schooling expenses, apprenticeships, and other educational programs. However, these provisions were stealthily removed at the last minute from the final bill, causing outrage among certain politicians, including Senator Cruz. Another group that has voiced disapproval, and in some cases – extreme frustration, has been the financial services community.

One area of contention is the safe harbor component of the SECURE Act, which was designed to increase the availability of annuities for retirees. Currently, when a retirement plan sponsor selects an insurer to offer annuities to its retirees, the plan sponsor is on the hook for any liabilities associated with an insurer’s inability to make guaranteed payments. Hence, many plan sponsors are reluctant to offer annuities at all, with only 12% providing annuities as a distribution option, according to a Callan 2019 Defined Contribution Trends Study. The SECURE Act’s safe harbor rule essentially frees plan sponsors of this liability if they select insurers that meet certain guidelines. Many critics have argued this rule essentially grants insurers a license to run away with people’s money. In their minds, annuity products are far too complex and costly, and therefore any benefit from the potential utility they could provide is completely eroded.

While we at Sage can understand this sentiment, we believe it’s important to provide retirees with annuity options, especially deferred fixed income products such as a Qualified Longevity Annuity Contract. A recent Transamerica survey discovered that the average 60-year-old has only $172,000 saved in various retirement accounts. In today’s low-interest-rate environment, $172,000 may not be enough to purchase an annuity that would provide a significant income stream, as $172,000 provides a 60-year-old female about $800 monthly in a single-life-only annuity policy. However, if that same woman withdrew the money from her 401(k) plan, she would likely run out of money sometime in her 80s, depending on the portfolio’s allocation and returns. The Society of Actuaries predicts that men have a 20% chance of reaching age 90, while women have a 32% chance. Therefore, we must enable individuals to pool life longevity risk, and as it stands now, annuities are the only viable option to hedge against a longer life. Limiting them would be a huge mistake.

The other big topic that has negatively swayed public opinion on the SECURE Act is the elimination of the “stretch IRA” provision. Current estate planning laws allow for individuals to pass down IRA accounts to their beneficiaries, who can then continue to accrue tax-deferred returns while being required to take out only minor distributions over their lifetime. The SECURE Act forces non-spouse beneficiaries to withdraw all funds within a 10-year period (though minor beneficiaries get 10 years after turning 18). The SECURE Act’s treatment of stretch IRAs would have resulted in a windfall of tax revenue that was intended to fund other SECURE Act measures; conversely, it would also adversely affect the wealthy – so it is no surprise that it is on the chopping block. President Obama unsuccessfully tried for years during his tenure to kill the policy, viewing it as a tax-break for the wealthy and their heirs. It’s likely that many individuals have factored in the provision when making their estate-planning decisions, and no one likes it when someone changes the rules midway through a game.

Aside from the fairness issue, the retirement situation in the United States is so disastrous for millions of people that we need to find ways to set up the average American for financial success in retirement. Since 73% of inheritance gifts total less than $50,000 (with only 2% being greater than $1 million, according to the Federal Reserve Board’s Survey of Consumer Finance), and because IRA accounts represent only a portion of inheritances, it is likely very few individuals will be severely impacted.

As might be expected, the bottom half of households ranked by wealth are only getting 3% of total inheritance transfers. These families represent those that are least set up for success financially in retirement, not the ones that are receiving large inheritances. Congress must attempt to be revenue-neutral on this bill and not add further to the national debt, so the IRA stretch provision ultimately seems like a reasonable casualty. Financial advisors will likely be able to help their clients adapt anyway, as there are other products readily available in estate planning. Life insurance products and charitable remainder trusts are also tax-deferred investments and may make more sense in the future depending on the situation. Changes in estate planning tactics will likely lead to Congress not fully realizing the anticipated $15.7 billion in tax revenue from elimination of the stretch IRA, but that will be an issue for them to figure out later when the dust settles.

According to the U.S. Government Accountability Office, 48% of Americans aged 55 and older have nothing saved for retirement. We are witnessing a crisis, and we need to act now. The SECURE Act may not be a panacea, but the myriad of benefits certainly outweighs the perceived negative effects. Hopefully the select few who still oppose the bill will try to instead focus on the positives, such as removing barriers for multi-employer 401(k) plans, implementing tax credits for small businesses to encourage 401(k) plan creation, and eliminating age limits on contributions to 401(k) accounts. The longer we wait, the more dire America’s retirement picture will become.