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Tech Investing: Exploring the Sector’s Promising Potential

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Tech Investing

tech investing

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Exploring the Potential of Tech Investing

Technology stocks have had impressive momentum. In the first 9 months of 2020, the S&P 500 Information Technology sector had a total return of 28.69%—far exceeding the S&P 500’s total return of 5.57%.

What should investors know about participating in this trending sector? This graphic from New York Life Investments covers tech’s long-term performance, the broad tech universe, and what investors should consider when analyzing tech investments.

Tech’s Performance

Since most tech companies are internet-based, COVID-19 has caused minimal disruptions to their business operations. In a number of cases, tech companies even saw sales growth as they benefited from consumers going online during lockdown.

Over a longer timeframe, however, tech’s performance is quite varied.

 S&P 500 Information TechnologyS&P 500 
201010.19%15.06%
20112.41%2.11%
201214.82%16.00%
201328.43%32.39%
201420.12%13.69%
20155.92%1.38%
201613.85%11.96%
201738.83%21.83%
2018-0.29%-4.38%
201950.29%31.49%

Data based on total returns.

Tech underperformed the general market in 2010, 2012, and 2013. However, the sector has outperformed every year thereafter.

In total, investors who held tech stocks over the last decade would have been rewarded. The 10-year annualized return for the S&P 500 Information Technology index was 20.50%, compared to 13.74% for the S&P 500.

The Tech Universe

While the information technology sector is commonly used to represent tech stocks, the broader tech universe can be broken down into 4 business types:

  • Software – such as application software, fintech, and cybersecurity.
  • Hardware – such as electronic equipment, semiconductors, and self-driving cars.
  • Internet Information – such as social networks, e-commerce, and digital advertising.
  • Telecommunication – such as internet services, telephone operators, and cable companies.

In addition, there are other companies that don’t fit neatly into these categories. This includes businesses involved in biotechnology, blockchain, or even retailers with modern technology such as mobile payment systems.

What Investors Should Consider

There are many factors to consider with tech investing.

  1. Diversification
    To lower potential risk, investors can diversify across industries, geographies, and individual companies. Tech investing should also be part of a broader portfolio strategy.
  2. Risks and opportunities
    Tech stocks have unique risk factors, such as regulatory risk arising from data privacy and antitrust concerns. However, they also present specific opportunities: new applications of technology are always being discovered. For example, GPS was originally used by the U.S. Navy to track submarines, but is now used for things like ridesharing.
  3. Personal objectives
    Investors can consider whether they are seeking growth or income. Growth investors can look for newer companies with high growth potential. Income investors may seek mature companies, some of which offer dividends.
  4. Company financials
    It can be tempting to get swept up in the news hype of a particular company. Instead, investors can pay close attention to company financials and reporting to ground their interest in reality.

With all this in mind, how do the sector’s risks measure up against its returns?

Potential Risk/Reward Payoff

Tech stocks have historically been more volatile than defensive sectors, such as utilities and consumer staples. However, they have also generated higher returns relative to their risk level.

Annualized risk-adjusted returns

 3-yr5-yr10-yr
S&P 500 Information Technology1.371.491.28
S&P 500 Consumer Staples0.650.781.06
S&P 500 Utilities0.520.760.84

Risk is defined as standard deviation, calculated based on total returns using monthly values.

By understanding the landscape and what to look for, investors will be poised to take advantage of tech’s potential.

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Infographics

How Carbon Offsetting Works, and What Investors Should Know

Eliminating all harmful GHG emissions is not yet possible, but carbon offsetting offers a route for businesses and funds to become more sustainable.

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Carbon Offsetting: What Investors Should Know

In 2016, an international treaty known as the Paris Agreement was negotiated by member nations of the UN Framework Convention on Climate Change.

The long-term goal of this agreement is to limit the increase in global temperature to below 3.6°F (2°C) over the next century. Achieving this target will require the world to develop cleaner solutions across all areas of the economy, from energy to transportation.

In this infographic from New York Life Investments, we introduce carbon offsetting, an activity used by both businesses and investment funds that has the potential to accelerate the development of a more climate-friendly economy.

What are GHG Emissions, and Where do They Come From?

Greenhouse gases (GHGs) are a family of gases known to trap heat in the Earth’s atmosphere. The most prevalent among them is carbon dioxide (CO₂), which accounts for 80% of America’s GHG emissions. Common sources of CO₂ include fossil fuel consumption and deforestation.

Businesses are often significant emitters of CO₂, but due to the complexity of their production chains, emissions can be difficult to track. To combat this, a company’s carbon footprint is measured across three scopes:

  • Scope 1: These are direct emissions from a company’s operations. An example would be the CO₂ emitted by company-owned factories.
  • Scope 2: These are indirect emissions from a company’s operations, such as the pollution generated from purchased electricity.
  • Scope 3: These are indirect emissions from the company’s supply chains. Common sources include the extraction of raw materials and business travel.

Although we understand that GHGs are harmful to the planet, our ability to eliminate them is limited by technology and costs. Fortunately, this is where offsetting can help.

How Does Carbon Offsetting Work?

Carbon offsetting is a method of neutralizing one’s emissions by investing in GHG-reducing projects. The benefits of these projects are measured by the amount of CO₂ equivalent (CO₂e) that they avoid or absorb. Then, the company or fund that is engaging in the carbon offsetting project will then receive one carbon credit for every tonne of CO₂e negated.

Below are the three common types of GHG reduction programs.

1. Energy efficiency projects

These projects reduce energy consumption. One example is the distribution of energy-efficient cookstoves in Rwanda, a country where many people rely on firewood and charcoal. By distributing 10,800 cookstoves throughout the country, nearly 60,000 tonnes of CO₂e can be avoided each year.

2. Forestry projects

These projects nurture and protect our CO₂-absorbing forests. One notable example is the Garcia River forest protection program, which ensures the longevity of California’s redwood forests. The program oversees over 9,600 hectares which has been estimated to store almost 80,000 tonnes of CO₂e annually.

3. Renewable energy projects

These projects reduce our dependency on fossil fuels. They are especially effective in economies such as Taiwan, where 75% of electricity capacity relies on fossil fuels. Thanks to its strong coastal winds, Taiwan is able to remove 328,000 tonnes of CO₂e per year with just 62 wind turbines.

How is Offsetting Regulated?

Carbon offsetting in America is primarily a voluntary activity, but some state governments have made it mandatory for significant polluters. Here’s how both markets are regulated.

The Voluntary Market

The voluntary market is regulated by a variety of third-party organizations such as Verra, Gold Standard, and American Carbon.

They conduct audits on GHG reduction projects to ensure each one meets four broad criteria:

  • Measurability: The GHG savings of the project must be measurable
  • Verifiability: The results of the project must be verified on an annual basis
  • Sustainability: Each project should have a minimum lifespan of seven years
  • Additionality: GHG reductions of project must be considered in reference to a baseline scenario

Carbon credits are only issued after a project has passed this verification process.

The Mandatory Market

Some U.S. states have introduced carbon offsetting schemes to meet their climate goals. One of the largest is California’s Cap and Trade program which was introduced in 2013.

The program is targeted at businesses that emit over 25,000 tonnes of CO₂e annually, and works by setting a “cap” on total annual emissions. This cap is reduced each year, and overpolluting businesses must acquire carbon credits to offset their excess pollution. These can be purchased from state-administered auctions or from other firms.

Revenues generated from California’s carbon credit auctions are used to fund various GHG reduction projects, including:

  • 690,000 acres of land preserved or restored
  • 287,000 rebates issued for zero-emission and plug-in hybrid cars
  • 108,000 urban tree plantings
  • 150,000 energy efficiency projects installed in homes

By 2030, California’s emissions cap is intended to reach 200.5 million tonnes of CO₂e, marking a near 50% reduction from its 2015 level.

What Role can Investors Play?

A majority of U.S. investors consider themselves to be values-based, meaning they care about the societal and environmental impacts of their investments. This mentality is increasing the demand for ESG investing and placing pressure on corporations to become more sustainable.

For example, the percentage of S&P 500 firms that publish sustainability reports has risen from just 20% in 2011 to 90% in 2019. More importantly, a growing number of U.S. firms are cooperating with the CDP (formerly the Carbon Disclosure Project) to report their emissions and set formal reduction targets.

YearCompanies with active emissions reduction targetsAll other companies reporting to the CDPTotal
2013322166488
2014335164499
2015365143508
2016378124502
2017385123508
2018389117506
2019419138557

Source: CDP 2020

Some of the world’s largest oil producers are also taking action—a testament to the significance of these shareholder concerns. Royal Dutch Shell announced earlier in 2020 that it intends to fully offset its Scope 1 and 2 emissions.

Does Offsetting Really Help?

Carbon offsetting programs such as the one implemented by California have the potential to generate revenues and encourage innovation. Critics, however, have suggested it has a number of design issues.

One such issue is the fact that California’s carbon credits do not expire. This could allow companies to stockpile credits and ignore future cuts to the emissions cap. Another concern is that the companies covered by California’s cap and trade will simply pass their higher costs to the consumer, although this claim didn’t seem to hold up in a 2016 study conducted by UCLA.

Other inefficiencies within the program may exist, but its benefits are hard to ignore. By the end of 2019, the revenue generated from California’s carbon credit auctions totaled $12.5 billion. Of this amount, over $5 billion has been invested in GHG reduction projects to date.

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Infographics

The Rise of the Values-Driven Investor

Values-driven investing is on the rise, and this in-depth infographic profiles the diverse demographic it appeals to and why.

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The Rise of the Values-Driven Investor

Many consumers today are considered to be “values-driven”, meaning they consider a company’s stance on environmental and social issues before making a purchase.

Such individuals will research a company’s reputation, boycott brands that are not aligned with their beliefs, and avoid products that negatively impact the environment. These types of concerns, however, aren’t just influencing the things people buy—they’re also changing the way people invest.

In this infographic from New York Life Investments, we profile the values-driven investor and examine the different ways their concerns can be incorporated into an investment portfolio.

What is a Values-Driven Investor?

Values-driven investors seek to align their portfolios with their personal beliefs and create a positive impact for society. Because of these goals, they are naturally driven to consider environmental, social, and governance (ESG) factors when selecting investments.

One common misconception is that this type of investing is only for millennials, but survey data proves this is far from the truth.

Age Group
% Interested in ESG Investing
24-3991%
40-5484%
55+80%

Source: New York Life Investments

Although ESG investing is the most popular amongst younger investors, older investors are not far behind, with 80% of correspondents aged 55+ demonstrating interest. This interest also extends across wealth brackets, as shown in the table below.

Personal Assets% Aware of ESG Investing% Likely to Invest in an ESG Fund, if Aware
$100K-$150K41%43%
$150K-$250K43%40%
$250K-$500K31%41%
$500K-$1MM34%37%
$1M+42%29%

Source: New York Life Investments

It’s clear that ESG investing has captured the attention of a very diverse group of people, but what kinds of issues do these values-driven investors actually care about?

ESG Priorities by Age Group

Values-driven investors are likely to prioritize issues differently depending on their age. For individuals between the ages of 25 and 39, longer-term issues such as global warming receive the highest concern. This is likely due to younger investors having more years ahead of them, and thus a greater chance of exposure to the effects of climate-related issues.

Below is a breakdown of each age group’s ESG priorities.

IssueAges 25 - 39Ages 40 - 54Age 55+ 
Global warming34%34%27%
Impact of plastic on the oceans21%30%26%
Sustainability24%23%17%
Data fraud or theft14%20%29%
Gun control13%20%22%

Source: New York Life Investments

For investors with a shorter time horizon to retirement, immediate concerns take the highest priority. For example, 29% of investors aged 55 and over were concerned with data fraud or theft, compared to just 14% among those aged 25 to 39.

How Can a Portfolio Reflect These Concerns?

Values-based investors have two primary approaches to choose from when building a portfolio tailored to their beliefs.

Approach #1: ESG Exclusionary

The first approach is ESG exclusionary investing, also known as “negative screening”. This method is well-suited for investors who want their portfolios to be completely aligned with their beliefs and values.

It involves the reduction, or avoidance, of exposure to specific industries that go against one’s values. Industries that are commonly screened out include tobacco, gambling, alcohol, and fossil fuels, the latter of which has gained significant attention in recent years.

Commonly referred to as “fossil fuel divestment”, this type of exclusionary approach focuses on freezing new investments in the sector while gradually removing existing portfolio exposure. Today, over 1,200 institutional investors representing $14.6T in assets have pledged their commitments to going fossil fuel free.

Institution TypeBreakdown of Total Assets Pledged
Faith-based organization32%
Educational institution15%
Philanthropic foundation15%
For profit corporation13%
Government13%
Pension fund13%
Non-governmental organization (NGO)4%
Healthcare institution1%

Source: Fossil Free (a project of 350.org)

Approach #2: ESG Inclusionary

The second approach is ESG inclusionary, also known as “positive screening”. This method is for investors who believe that companies with strong sustainability practices can outperform over the long term.

Instead of avoiding specific industries, an ESG inclusionary approach seeks to identify the best companies in any given industry. In practice, this involves the analysis of both traditional financial metrics and ESG factors.

Examples of Traditional Financial AnalysisExamples of ESG Factor Analysis
Analyze the company’s financial statementsExamine the company’s waste management practices
Study historical market trendsMonitor the company’s employee relations
Consider the direction of the broader economyGrade the company’s transparency & disclosure

Research on the effectiveness of ESG factor analysis has been overwhelmingly positive, and is a likely reason for the robust growth these types of strategies have seen in recent years. In fact, ESG leaders (companies with strong ESG practices) even outperformed their respective indices during the COVID-19 selloff in Q1 2020.

Building a Well-Aligned Portfolio

Despite several myths surrounding sustainable investment, there is an incredibly diverse group of individuals who want their portfolios to reflect their personal beliefs.

The typical values-driven investor is 48 years old, which means they’re likely in their peak earning years and are able to make larger portfolio contributions. Thus, this growing demographic is one that the investment industry should not ignore.

The types of issues these investors care about, however, can vary depending on age and other metrics. Thus, it’s important for them to learn about the different investment approaches available. Armed with this knowledge, investors can take better control of their finances and feel more confident in their decisions.

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