Estate Planning Update: Make Sure to Address Social Media

By: Vidhya Babu

Think twice before guffawing over the idea of addressing social media in your will. Not only can it make life easier for your survivors, a social media will is recommended by the United States Government.

After, or in anticipation of, any lifetime change, we suggest clients review their estate plans. The sale or purchase of a business, a windfall, divorce and marriage are all reasons to update your plan. Ultimately, your estate plan carries on your wishes when you pass away, and if you have personal, musical or other interests online, giving directions and naming an administrator of your online identity is important. (more…)

Climate Change and Asset Prices

KEY TAKEAWAYS

  • Financial markets process complex information every day. The impact of climate change is no exception.
  • Academic research provides compelling evidence that prices in a variety of asset markets incorporate information about climate risk.
  • These findings also suggest that firms have incentives to manage their climate risk exposure, as a higher exposure can result in a higher cost of capital.

The economic effects of climate change may be substantial—and may unfold over decades. Climate change can, therefore, affect the future payoffs of a wide range of assets. Given this strong potential impact, a central question is whether markets do a good job of reflecting climate risk in asset prices. Since the effects of climate change are uncertain and potentially long-lasting, some worry that markets might struggle incorporating information about climate risk. Let’s not forget, however, that financial markets assess many other complex and uncertain events every day. Examples include the potential changes in consumer demand and business practices after the pandemic, the impact of current stimulus spending on future inflation, the evolution of international political and trade relations, and the impact of technological innovation.

Since the pioneering work of Fama et al. (1969), ample academic research has shown that financial markets are remarkably good at processing new information.1 Thanks to intense competition among many market participants globally, prices quickly reflect news about the economy, scientific advances, and geopolitical developments. What about climate risk? It appears to be no exception. As we document in a recent Dimensional paper, research shows that prices in a variety of asset markets incorporate information about Please see the end of this document for important disclosures.

PRICING OF PHYSICAL RISK

Physical risk refers to the direct effects of climate change; a coastal property exposed to increased flooding risk would be an example. Painter (2020) notes that municipal bonds offer an interesting setting to study exposure to physical risk, since, unlike corporations, municipalities cannot relocate to avoid the physical effects of climate change. His study, along with Goldsmith-Pinkham et al. (2020), finds that higher exposure to sea level rise is associated with higher municipal bond yields. Importantly, the relation is mostly driven by long-maturity bonds. These results suggest that investors do consider the long-term effects of climate change.

 
The real estate market offers another important source of evidence. Like municipalities, buildings are essentially impossible to relocate and exposed to physical risk. Bernstein et al. (2019) find that houses exposed to sea level rise sell at a 7% discount to properties with similar characteristics. Interestingly, most of the discount is driven by houses not at risk of being flooded for another 50 years. Even in decentralized, less-liquid markets such as real estate, there is evidence that prices reflect long-run climate risk.
 
The futures market also provides evidence that investors price the physical risks of climate change. Schlenker and Taylor (2019) look at climate futures traded on the Chicago Mercantile Exchange between 2002 and 2018. The key finding of the study is that warming trends predicted from climate models, inferred from futures prices, and measured from observed temperatures all coincide. The study thus shows that investors transacting in the climate futures market have expectations in line with the scientific consensus. The setting also allows the authors to confirm that these investors do not systematically underestimate or overestimate future temperatures.

PRICING OF TRANSITIONAL RISK

Transitional risk arises because of the uncertainty surrounding the transition to a low-carbon economy. There is uncertainty, for instance, around both the timing and scope of new environmental regulations. As a result, firms whose business models depend on high fossil fuel use are likely to have high exposure to transitional risk.

Griffin et al. (2015) find that the stock prices of the 63 largest US oil and gas energy firms fell by 1.5% to 2% after the publication of a landmark paper in Nature (Meinshausen et al., 2009). The latter paper argues that most fossil fuel reserves would need to remain untouched if warming is to be kept under 2°C by 2050; for comparison, the objective under the Paris Agreement is to limit all future warming at 2°C, an even more stringent objective. Therefore, most reserves would become worthless under aggressive mitigation policies. Consistent with the idea that asset prices reflect climate risk, markets reacted in the three days following the publication of the article in 2009, although the article was only publicized by the press a few years later.

Looking at other examples of transitional risk, Chava (2014) finds that firms with negative environmental externalities face a higher cost of capital, while Delis et al. (2019) contend that fossil fuel firms incur higher interest rates on syndicated bank loans. In both cases, the mechanism in question has to do not with the direct effect of global warming on firm performance, but rather with potential regulatory or reputational risk. Ilhan et al. (2021) find that equity option prices reflect climate policy uncertainty and that downside risk is costlier to insure for more carbon-intensive firms. Seltzer et al. (2020) look at regulatory risk specifically and find that the bonds of firms with a poor environmental record were more likely to experience rating downgrades and yield increases after the passage of the Paris Agreement. All these studies suggest that asset prices reflect the potential impact of climate policy or changing consumer tastes.

Overall, a growing body of evidence shows that prices across many different markets (stocks, bonds, climate futures, equity options, and real estate) incorporate information about climate risk. This pattern is consistent with the behavior we would expect in competitive markets: buyers and sellers have incentives to use all the information at their disposal to value assets, and the literature suggests that information about climate change is no exception.

These results are also encouraging news for everyone concerned about climate change. Financial markets seem to pay attention to climate risk despite its complexity. Moreover, competitive market forces provide firms with incentives to better manage their exposure to climate risk to reduce their cost of capital.

Evaluating Fixed Income Through the Lens of Your Goals

KEY TAKEAWAYS

  • The year 2020 saw stark differences in returns between fixed income categories—some of the largest in history.
  • This unprecedented return dispersion is a reminder that fixed income asset classes can behave very differently, so allocations should be tailored to an investor’s goals.
  • A one-size-fits-all approach to fixed income may lead to suboptimal results.

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The Sustainability Opportunity

Sustainability goes beyond reduce, reuse, and recycle. Today more than ever, investors are calling for sustainability opportunities, and markets are answering. But investing isn’t as simple as paper over plastic in the checkout line. For the investor who seeks to hold a portfolio that reflects their commitment to sustainability, Dimensional builds sustainability-focused investment strategies using scientific research and sound investment principles.

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How Does Inflation Impact Investors?

When the prices of goods and services increase over time, consumers can buy fewer of them with every dollar they have saved. This erosion of the real purchasing power of wealth is called inflation. Inflation is an important element of investing. In many cases, the reason for saving today is to support future spending. Therefore, keeping pace with inflation is a crucial goal for many investors. To help understand inflation’s impact on purchasing power, consider the following illustration of the effects of inflation over time. In 1916, nine cents would buy a quart of milk. Fifty years later, nine cents would only buy a small glass of milk. And more than 100 years later, nine cents would only buy about seven tablespoons of milk. How can investors potentially prevent this loss of purchasing power from inflation over time? (more…)

Lump-Sum Investing vs. Dollar-Cost Averaging

Concerns about market downturns certainly come as no surprise. After all, steep corrections and crashes can be alarming for even the most steely and disciplined investors. So, when markets reach all-time highs, investors tend to be concerned about investing their hard-earned money in overvalued stocks. Questions about reducing or even eliminating equity allocations or keeping excess cash on the sidelines soon follow. While these lines of inquiry are completely natural—no one enjoys buying high and selling low—we believe that every day is a good day to invest no matter what the market has done recently.

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How should I think about cryptocurrency?

“Everything you don’t understand about money combined with everything you don’t understand about computers.” ~ HBO’s Last Week Tonight with John Oliver, March 11, 2018

As cryptocurrencies are in the headlines more and more, some investors are wondering if they should dedicate a portion of their portfolio to these new types of electronic monies. Cryptocurrencies represent innovation within financial services, but there are still many uncertainties about the future of their technology and their returns.
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Think Investing Is a Game? Stop.

by David Booth
Executive Chairman and Founder
It’s easy to view the stories of market speculation that have dominated the news recently as cautionary tales for individual investors. But we can also look at the current moment as an opportunity to welcome a new group of investors to the market: those who have been drawn in by all the high-stakes action, and yet may want a consistent, long-term investment solution that doesn’t keep them up at night. This is probably a good time to mention that investing and gambling are not the same thing. (more…)

Tales from the Crypto: How to Think About Bitcoin

“Everything you don’t understand about money combined with everything you don’t understand about computers.” ~ HBO’s Last Week Tonight with John Oliver, March 11, 2018

Bitcoin and related cryptocurrencies (now numbering in the thousands) are the subject of much debate and fascination. Given bitcoin’s dramatic price changes, it is not surprising that many are speculating about its possible role in a portfolio. (more…)

What Is the Social Cost of Carbon?

KEY TAKEAWAYS

  • The social cost of carbon (SCC) estimates the future damages from an additional ton of CO emissions.
  • The number is crucial for environmental policymaking and was just updated by the new US administration.
  • The estimation of the SCC is sensitive to its inputs, and debate continues in the academic community about its appropriate value.

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