Singling out concerns in your investments
Joel Dresang: Kyle, I want to talk with you about divestiture. Sometimes investors get concerned about companies or their products or their business practices, and they wonder about their exposure to those companies in their investment portfolios. How do you handle those questions?
Kyle Tetting: Joel, the most important piece is really to listen to investors’ concerns and understand what it is that they’re getting at. And from there, we can then start to get into what exposure they might have to those concerns. And that’s a little bit tricky because we’re talking about typically mutual fund investments with tens or hundreds of stocks within each fund, and likely 10 or more mutual funds within a portfolio. So, to try and get through all that data to figure out what a client’s exposure really looks like can be a bit tricky.
Joel: So how do you do that?
Kyle: Data aggregators like Morningstar allow us to take all of the data that mutual funds give on their underlying holdings and run reports on a portfolio level to understand what exposures clients have. And so, we don’t have to look through on a fund-by-fund basis, but we can actually get reports from those data aggregators that show us what client exposure is.
Joel: What about index funds? Those are very popular because they’re low cost, but they’re exposed to a lot of different industries, a lot of sectors.
Kyle: The challenge with index funds is that because they’re rules-based in the way they’re constructed, often there isn’t a particular set of rules that exclude any type of company. And so, if you have concerns about a particular stock or a particular type of stock, more than likely, those kinds of stocks are going to be included in an index, simply because of how broadly index construction casts its nets.
Joel: Okay, once you and the investor understand what their exposure is to a certain company, what other considerations do you have?
Kyle: You know, if we are going to consider removing a piece of a very well diversified portfolio, diversification is really the key thing to keep an eye on. We need to make sure that we’re not pulling away too many sources of return. Over and above that, anytime you sell something from a portfolio, there can be tax considerations. And then obviously, making sure that asset allocation remains appropriate once we’ve taken that piece away.
I think there is one other concern here, and that is that often times we can be removing companies simply because of exposure they might have, even though they’re actually doing good within a particular industry.
A great example is a power company that might own a coal-fired power plant, and if you’re focused on clean energy, that might not be something you want in your portfolio. However, if that power company holds that coal plant with the eventual goal of shutting it down in favor of clean energy, again, you might be doing more harm by getting it out of your portfolio.
Joel: So what should investors do if they have concerns about the granular holdings in their portfolio?
Kyle: You know, Joel, step one is that conversation. Really making sure that you’ve communicated those things which might be keeping you up at night. And then from there, investors I think have a lot of options available to them. You know, everything from simply selling out of those things that they’re not interested in to finding investments that are tailored to those specific concerns. And so, with greater interest in socially responsible investing in the past few years, clients have been given many more options to find investments that are specific to those concerns.
Clients need to really understand that there are multiple ways to accomplish their objectives. It’s important that they have that conversation with their advisor so they can understand the trade-offs involved.
Kyle Tetting is director of research and an investment advisor at Landaas & Company.
Joel Dresang is vice president-communications at Landaas & Company.
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(initially posted May 11, 2018)