Volunteer of the Month: October 2019

Since joining CFA Society Chicago in May 2019, Marina Viergutz, CFA, CAIA has been actively involved on three advisory groups (CFA Women’s Network, Education and Professional Development). She has been vocal in sharing new ideas and suggestions to enhance Society program and events.

Marina has answered the call to serve as a Mentor in the Society’s Mentorship Program, took a co-lead role in planning the Opportunities in Hedge Funds event scheduled for October 10, 2019 and has stepped up to assist in planning the annual Industry Roundtables event scheduled for February 2020.

Marina, thank you for coming onboard and hitting the ground running! The Society is grateful for members like you!

Investing in the New Space Race

The Educational Advisory group hosted an event on September 12 at the Palmer House Hilton to educate financial professionals, investors, and space enthusiasts on the technologies of space exploration, the geopolitical landscape, and potential winners and losers in the new space race. Attendees learned about how disruptive forces in the space industry will impact other industries and how this translates to investment opportunities.

Moderator, Myles Walton, CFA, managing director and senior analyst at UBS guided the panel discussion utilizing his wealth of experience as an aerospace and defense analyst and work with defense policy and weapons systems. Panelists at the event included:

  • Steven Jorgenson, co-general partner of Starbridge Venture Capital and founding partner of Space Finance group, Quantum Space Products, Space Angels Network and Integrated Space Analytics
  • Mark (M.E.) LaPenna, founder and CEI of Xenesis a pioneer in space-based optical communications technologies
  • Richard Godwin, serial investor and business consultant and director of cutting edge NewSpace and aerospace companies
  • Dr. Joan Johnson-Freese, U.S. Naval War College professor, Charles F. Bolden, Jr. Chair in Science, Space & Technology, former chair of the National Security Affairs Department at the Naval War College and researcher and author

Myles framed the discussion by asking panelists to comment on what they are most optimistic about space exploration space and what they felt were lessons learned. Johnson-Freese highlighted that seeing investment from the commercial side that came to fruition ten years ago is encouraging. This is balanced with the awareness that space projects take a long time and subsequently have a longer investment horizon. Most technology is dual-use for civil and military and because of this geopolitics come into play. Jorgenson is encouraged by the investing opportunities he sees and that companies in this industry are profitable sooner than expected. He asked us to focus on how these companies impact other industries in the economy. LaPenna honed in on data science commenting that long-term there are many ideas that are yet to be recognized or developed. Investors should not follow the herd and look for diamonds in the rough.

Shifting to lessons learned, Jorgenson spoke of previous business models that were developed by engineers and not by business-savvy managers. Business-savvy managers have come in and the management and execution risk has become better helping to define client demand with a path to revenue. Having a mix of government and commercial investors has been key. Johnson-Freese agreed that business-savvy managers have added value and that the US government recognizing innovation in commercial firms is also a big step. Godwin reflected that the work-life balance of the highly driven and intelligent employees in these firms was not sustainable. LaPenna provided a perspective that some approaches may not be realistic and there is no cookie cutter formula for determining an effective business model. For example, space entrepreneur Elon Musk wants to finance privately but his satellite project is estimated to take 15 years to obtain a mass of 750 million users.

There is significant momentum behind non-governmental stimulation for the space industry. But, is this good or bad? All panelists largely saw this as a positive boost to the space industry. However, with unique opportunities come unique challenges. A key threat is space debris. As satellites are increasingly used, who owns the natural debris found in space and more importantly who is responsible if a satellite is damaged? Godwin pointed out that no one is solving this obvious insurance problem. The insurance industry needs involvement and issues caused by debris need prioritization and resolution. Johnson-Freese added that space law is evolving, and another unique issue is forming laws around how to bring back things from space. In examining challenges, a big question is if global connectivity is demanded by space applications. Steven Jorgensen commented that solving spectrum and bandwidth issues is crucial and optical may provide faster connectivity compared to other technologies. Of options available, optical may also be a cost-effective solution.

What does the future look like for governmental space programs and what should investors expect? Part of the answer lies in American culture. NASA is culture and Americans are proud of the space program but are not as keen on funding it with tax dollars because they do not see it as a priority. Space is taught as a history lesson, but the American public is less interested in the underlying mechanics. It is also cheaper to continue using old technology versus testing new technology. New programs are announced but do not come to fruition due to costs and the inability to gain traction. Programs that do go forward have protracted development cycles opposite of how American culture focuses on quick turnaround. This causes political and technical risk. The original space race originated from political tension. Panelists pointed out that if China lands a man on the moon, the US could have increased enthusiasm for space programs.

A theme throughout the program was the role of private investors versus the government for the previously mentioned dual use technology typically used by the defense sector and how this will play out in the future. LaPenna thinks private investment is vital and reminded us that if you look back in the airline industry, many airlines were spurred by private investments from millionaires. He believes if you don’t dream big, you don’t get returns. Richard Godwin believes that it all comes down to survival and that one needs to understand the market from a technical and customer perspective. Godwin also suggested that investors should consider that many of the firms will not likely get to an initial public offering (IPO) stage and will be acquired by the government. Johnson-Freese shared an observation about barriers for commercial firms investing in space. A significant roadblock that hinders commercial firms is working through government requirements such as contracts, security clearances and paperwork. This has impacted product development adversely. On the other hand, venture capitalist firms have been able to make inroads and now have calls with the US Air Force to learn firsthand about requirements. The Air Force in turn can fund projects quickly and is working closely with private industry.

As investors, what should we take away about space investing?

  1. Few funds focus on this small sector where markets are somewhat limited.
  2. There are technological and business challenges such as global connectivity and space law that need to be solved creating investor opportunity.
  3. Private and commercial investment is growing but investment models are in their infancy with large investors filling roles that the government can’t.
  4. Projects and products have protracted multi-year time horizons.
  5. As this sector continues to evolve, there are many needs and products yet to be identified.
  6. The government is working more closely with entrepreneurs and the private sector than in the past.
  7. A catalyst such as another world power reaching a milestone could place an increased emphasis on space investing.

The space industry has an exciting and uncharted future. Buckle up and get ready for a zero-gravity experience.

Distinguished Speaker Series: David Booth, Dimensional Fund Advisors

In September of 1969, an MBA student took a course that would result in positively affecting the lives of countless people, a couple of universities, and how much of the investment industry would learn to view the world.

It started with two individuals, the University of Chicago professor Eugene Fama and student David Booth. The seed of one idea blossomed into a fifty-year friendship, a history of applying academic research to practical investing and formation of a multi-national investment firm of over 1,400 employees managing $586 billion.

Along the way, after David (student) had learned finance from Gene (professor), the circle was completed as Professor Fama likes to say he learned business from Booth.

It is the only time the professor had been asked to join a student’s business. It was a natural in this case, as the firm, Dimensional Fund Advisors (“DFA” or “Dimensional”) shared the same beliefs having been spawned by ideas Booth picked up in Professor Fama’s course.

Along the way, it should be mentioned that the intersecting worlds of academics, athletics and the arts have also benefited. The University of Chicago named its Booth School of Business in the MBA student’s honor. The University of Kansas named its David Booth Kansas Memorial Stadium in honor of its former undergraduate student (note, Booth has also funded the Booth Family Hall of Athletics in Allen Fieldhouse at KU while donating James Naismith’s original 13 rules of basketball). The Museum of Modern Art has benefited in naming the David Booth Conservation Center and Department in the same man’s honor. Another benefactor has been Georgetown University which named its Booth Family Center for Special Collections within its Lauinger Library. 

It is this story that was told through the voice of the student in the forum of the August Distinguished Speaker Series luncheon on August 14th at the Standard Club. David Booth himself provided the history of Dimensional’s roots, how its one philosophy initiated 50 years earlier, how the firm takes academic ideas and implements them into real world solutions for clients, as well as DFA’s 38-year track record of delivering outperformance versus their benchmarks.

The discussion began with a short video touting the highlights from Mr. Booth’s career which is synonymous with the formation of Dimensional. His friendship with Professor Fama is central to the story. The impact DFA had on the investing universe is also notable, with accomplishments including being pioneers in treating small cap stocks as an asset class and finding a niche between active and passive investing. Dimensional has been styled as “the original factor investors”.

The bulk of the program consisted of an interview/fireside chat with current chair of the CFA Society Chicago’s Board of Directors, Tom Digenan, CFA.

Once again, a chronicle of Mr. Booth’s 50 years in the industry was recounted: how he has inspired people, his mentors (again – Fama was both mentor and a mentee), use of academics, the very large weight put on implementation, and the tension between models and reality in conducting research. 

The importance of TRUST could not be emphasized enough. Especially as it pertained to client relations and the ability to successfully navigate the ups and downs of markets.

Questions were asked about Booth’s thoughts about the significant reduction in the number of publicly traded stocks, his bias toward either active or passive, how DFA utilizes fundamental research, how his firm’s definition of value may have changed over time, and about any change in their thinking now that a new phenomenon of negative interest rates has emerged. His answers to all questions revolved around a single core philosophy that markets are efficient and over long haul there are some simple things an investor can do that will provide a very good experience long term without trying to outguess the market.

Mental Skills: Get Your Head in the Game

How to control and increase one’s mental skills was the topic that drew a capacity crowd for the latest installment of CFA Society Chicago’s Vault Series on August 20. The featured speaker was Jim Gary, a Licensed Clinical Professional Counselor with 52 years’ experience in the mental health field. In 1999, Gary started a program to help high school athletes adapt behavioral techniques to enhance their confidence and performance. One of his students was Tom Kulentes, who found the program so rewarding it led him to a career as a high school psychology teacher and, eventually principal. He also joined Gary as a partner in his counselling business. Gary’s success with student athletes received wide media attention, to the point that the Chicago Blackhawks commissioned him to work with their players and staff. He was the first mental health therapist on the staff of an NHL team, so he developed the completely new role on his own. Gary had the honor of working with the teams that won three Stanley Cup Championships (earning him a ring for each one).

Gray began his presentation with a demonstration of a simple visualization exercise. He had the audience stand up and twist their upper bodies as far to the side as they could without moving below the waist. Then he asked them to close their eyes; draw, hold and release a deep breath; and visualize repeating the exercise while trying to turn further. Then they repeated the movement with closed eyes.  Most in the room were able to turn further than they had the first time. The effectiveness of the example was evident to everyone. Gray called visualization–when the mind directs the action of the body, a simple and effective tool that everyone can use to increase their effectiveness and performance in many ways (but that few do). When we train our minds to send a positive message to the body, we will get a positive result, although Gary also demonstrated that negative messages create a correspondingly opposite effect. Visualization has even been shown to be effective in medicine. With the right coaching and a strong signal, the body can respond in a way that helps a patient recover.

Gary next introduced his partner, Tom Kulentes. Now a high school principal, Kulentes experienced such a positive impact from Gary’s counselling when he was a high school wrestler that he has applied it in his professional and personal life ever since, eventually joining him as a business partner. Kulentes approaches his role as a school administrator by assuming his students begin with an unknown, but unlimited capability–or talent–to learn and improve themselves. Such talent can’t be measured, but it can be increased with improved mental skills. These skills can be taught and enhanced with mental exercises and are one of the best predictors of performance.

Gary and Kulentes used their work with the Chicago Blackhawks hockey team to illustrate the application of mental skills counselling. Like all teams in the National Hockey League, the Blackhawks operate at the highest level of competition in their field. They employ the best athletes, selected from around the world, guided by top coaches, trainers, and counsellors focusing on attaining peak performance of both body and mind through deliberate, intense training and practice. The level of competition creates intense pressure on all participants but especially the players. They need to perform at peak levels consistently while managing the pressure of travel, risk of injury, intense media coverage, contract negotiations, and fan expectations, not to mention family obligations.

Kulentes likened the competitive, pressure-packed environment of the professional hockey player to that of investment managers. The environment creates stress which he defined as the body’s internal response to external pressure. He diagrammed stress graphically under a bell curve. A state of stress occupied the center, tallest part of the curve where the subject should feel energized and focused, where performance peaks because work seems to be easy. By contrast, in the left tail, the subject might feel bored or detached from performance which can improve as he moves to the right on the stress spectrum and up the curve. Past the sweet point in the middle of the curve, stress increases greatly and becomes distress characterized by increasing fatigue, burn-out, poor health, and culminating in a breakdown. Successful performance requires knowing oneself well enough to stay in the mid-range of the spectrum and at the peak level under the curve. Kulentes emphasized this by quoting a proverb: “Mastering others is strength, but mastering ourselves is power.”

Kulentes continued by explaining the concept of a growth mindset versus a fixed mindset, as defined by the psychologist Carol Dweck. Everyone possesses elements of both, with one usually dominant. People with a dominant fixed mindset perceive their talent, or ability, as fixed, or limited to certain areas where they feel more of an innate aptitude. Growth mindset people perceive ability as something that can be developed and increased over time with effort. They see challenges as opportunities to improve while the fixed mindset person sees them as obstacles, or risks to avoid. The growth mindset person focuses on process while the fixed mindset person focuses on outcomes. People perceived as great achievers (even over-achievers) all demonstrate a growth mindset. He presented examples such as Mozart and Einstein, along with a number of greats from the world of sports.

The attribute that most sets growth mind set people apart is “grit” which Kulentes defined as:

  • Applying sustained effort strenuously over time,
  • Enduring temporary setbacks, obstacles, and failures, and
  • Persevering until the desired goal is achieved.

People exhibiting this sort of grit will enjoy greater success than they otherwise would.  Kulentes described success as the visible part of an iceberg, lying above the surface. It’s small compared to what’s below the surface which represents the important features on which success depends such as dedication, hard work, and diligence.

Gary returned to the lectern to complete the presentation by introducing one more concept: that of the Self Talk.  This he described as a brief statement affirming one’s commitment to taking control of how the mind controls the body. As examples he provided:

  • “I will take control of the messages I give myself.”
  • “Today I will recognize negative thoughts and replace them with positive thoughts.”
  • “Don’t let the pressure exceed the pleasure.” (From Cubs manager Joe Maddon.)

EQ vs IQ

Ask yourself – Am I intelligent? Yes. No. When I get enough sleep. All of these? Ask yourself again, am I emotionally intelligent? In general people respond in the positive to both of these questions – ‘of course I am intelligent’ (think about overconfidence). While basic intelligence may be more measurable, emotional intelligence is more imprecise. After all what does it mean to be emotionally intelligent?

On July 30th, CFA Society Chicago’s Professional Development Advisory Group invited Lee H. Eisenstaedt of the Leading With Courage® Academy to guide a sold out audience through what emotional intelligence is, how to improve it, and how to apply emotional intelligence to be a better leader.

Eisenstaedt focuses on helping individuals and teams realize peace of mind and confidence from being more effective leaders who are able to make a bigger impact and create higher-performing organizations. He uses workshops, assessments, and executive coaching offered through the Leading with Courage® Academy which is based on his Amazon best-seller Being A Leader With Courage:  How To Succeed In Your C-Level Position In 18 Months Or Less. He is also the co-author of the book Wallet Share: Grow Your Practice Without Adding Clients, and is a frequent speaker at national and regional conferences on the topics of leadership and client loyalty.

Eisenstaedt began by providing three takeaways of the presentation. They were:

  • Authority, position and title do not equal leadership
    • Leadership is about what you do, not where you’re seated
    • Authority can compel others to take action, but it does little to inspire belief
  • Leadership is about relationships and influence
    • Leadership happens when your influence causes people to work towards a shared vision
    • Influence and significance come from caring about and growing others
    • Leadership is about inspiring / motivating ourselves and others to create high-performing teams and engaged organizations
  • Being self-aware is a never-ending journey
    • Have the courage to seek feedback
    • Self-awareness keeps you relevant

Eisenstaedt explained that emotional intelligence is the ability to, Perceive, Understand, Express, Reason with, and Manage emotions within oneself and others. In a work setting, emotional intelligence is about how intelligently you use emotions to get positive results. Good to know but how is emotional intelligence important in the workplace? Eisenstaedt provided the following data:

  • 90% of what moves people up the ladder when IQ and technical skills are similar is emotional intelligence – Harvard Business Review
  • The World Economic Forum predicts emotional intelligence will be one of the top 10 employment skills of the immediate future
  • Skills like persuasion, social understanding, and empathy are going to become differentiators as artificial intelligence and machine learning take over other tasks – Harvard Business Review
  • TalentSmart found that 90% of top performers are high in emotional intelligence while just 20% of the bottom performers are high in it.

Eisenstaedt asked the audience to participate in an interactive phone app-based exercise. The audience was instructed to think about the best and worst boss they had worked for, rate them based on how those bosses made you feel, along with three words describing them. Once completed, Eisenstaedt put the results into a real-time word-cloud. Popular words describing best bosses included supportive, inclusive, and listener, while the adjectives describing the worst bosses were distant, self-serving and aloof.

Eisenstaedt provided a model of emotional intelligence applied to leadership qualities. There are six competencies that emotionally intelligent leaders exhibit.

  • Inspiring Performance: Facilitating high performance in others through problem solving, promoting, recognizing and supporting others’ work. Leaders that exhibit a more inspiring style often empower others to perform above and beyond what is expected of them.
  • Self-Management: Managing one’s own mood, emotions, time and behavior, and continuously improving oneself. Leaders high in self-management are often described as resilient rather than it’s opposite of being temperamental. Self-Management is important in leadership because a leader’s mood can be infectious and can therefore be a powerful force in the workplace.
  • Emotional Reasoning: Using emotional information from yourself and others and combining it with other facts and information when decision-making. Leaders high in this skill make expansive decisions whereas leaders low in the skill make more limited decisions based on facts and technical data only. Emotional reasoning is important in leadership because feelings and emotions contain important information.
  • Authenticity: Openly and effectively expressing oneself, honouring commitments and encouraging this behavior in others. Leaders low in this skill might be described as untrustworthy. Authenticity is important in leadership because it helps leaders create understanding, openness and feelings of trust in others.
  • Awareness of Others: Noticing and acknowledging others, ensuring others feel valued and adjusting your leadership style to best fit with others. Leaders high in this skill are said to be empathetic rather than insensitive. Awareness of others is important because leadership is fundamentally about facilitating performance and the way others feel is directly linked to the way they perform.
  • Present/Self-aware: Being aware of the behavior you demonstrate, your strengths and limitations, and the impact you have on others. This trait is important because a leader’s behavior can positively or negatively impact the performance and engagement of others. The opposite of self-awareness is to be disconnected.

Eisenstaedt returned to the best boss / worst boss exercise explaining the point of this was to confirm that better bosses exhibited high emotional intelligence, while the poorly rated bosses exhibited low emotional intelligence. Most of the words chosen by the audience could be directly related to the six competencies listed above. Eisenstaedt also pointed out that the way a boss or colleague makes you feel has a tremendous impact on your productivity.

Eisenstaedt shifted to explain basic neuroscience behind emotional intelligence and engaging with others. There is a base reptilian brain – this keeps you alive, controlling breathing, heart beating, saving you from threats. These include social oriented threats (loss of control over situations, lack of certainty in your daily life, etc.). While other parts of the brain control higher functions, the reptilian brain’s main function is to minimize danger or maximize rewards.

There are triggers that our reptilian brain reacts to. Feelings of trust, certainty, approval, sense of belonging, and fairness are rewarded in the brain with Oxytocin (a hormone associated with boosting trust and empathy and reducing anxiety and stress). On the negative side diminished approval or status, fear of being conned or tricked, lack of security, loss of control, unfairness, feelings of danger all cause the brain to release Cortisol (a hormone released by the body in stressful situations). Eisenstaedt gave suggestions on how to avoid triggers that lead to stressful situations. He used the SCARF method to identify and reduce those situations of stress.

  • Status: Represents your importance relative to others. An increase in status generates a larger neural response than money does.
  • Certainty: Humans are certainty seeking machines where any ambiguity triggers a threat response.
  • Autonomy: When we experience stressors the threat response is dramatically higher if we feel we have no control. Work on providing a feeling of choice, of control, of autonomy in every situation – try to offer alternatives and some sense of choice.
  • Relatedness: New or different people can trigger a threat response. Build trust and a sense of what we have in common by bringing people together socially, in teams, with shared goals.
  • Fairness: Unfair interactions or systems generate a threat response. Be more than fair and be generous with all, and in so doing so all must feel they are being treated fairly.

Eisenstaedt wrapped up with a suggestion to evaluate all your relationships (in particular the ones where tension exists). Use SCARF to help identify problem areas. Consider what those problems are in terms of SCARF and seek out ways to address and improve them.

ESG: Growth of Alternative Energy – Investment Opportunities and Returns

On August 8th CFA Society Chicago hosted an ESG event focusing on alternative energy. This event was structured with a featured keynote speaker, followed by a moderated Q&A with a panel of four alternative energy asset investors.

The keynote speaker was journalist Amy Harder of Axios. Based out of Washington, D.C., Harder covers national energy and climate change issues in her regular column, “Harder Line,” as well as reporting on trends and scoops. She is adept at discussing complex energy and climate issues in ways that everyone can understand. She is the inaugural journalism fellow for the University of Chicago’s Energy Policy Institute. Before joining Axios, she covered energy and climate change at the Wall Street Journal, and before that, the National Journal.

Amy Harder with Axios delivers opening remarks at CFA Society Chicago’s ESG: Alternative Energy event on August 8, 2019.

The panel consisted of moderator Martha Goodell and panelists Susan Nickey, Clive Christison, and Ammad Faisal, CFA.

  • Goodell is a co-founder and managing partner at Enigami Partners, LLC in Chicago, which supports institutional clients with all aspects of the investment process supporting private structured finance. Enigami’s clients are investing in energy technologies, projects and infrastructure.
  • Nickey is a managing director at Hannon Armstrong, a leading capital provider for sustainable infrastructure markets that address climate change. She was previously the founder and CEO of Threshold Power.
  • Christison is the senior vice president of pipelines, supply, optimization and specialties for Fuels North America; he is responsible for BP’s commercial, supply and optimization activities in the Americas. He is based in Chicago.
  • Faisal is managing director and co-head of the Chicago office at Marathon Capital. His firm as an investment bank in the energy and power sectors, and he focuses on mergers and acquisitions, debt, equity and tax equity capital raise transactions.

Harder led off the event with some remarks about the state of the energy industry, energy infrastructure and how it relates to regulation on national and international levels. She opened with a note about how the phrase “alternative energy,” as a reference to energy sources that aren’t fossil fuels, marginalizes what are already very viable sources of energy.

In 1987, fossil fuels made up of 81% of energy sources. In 2017, it was still 81%. There was relatively little fluctuation over that 30-year span. In addition, Harder made the point that hydroelectric technology is 150 years old and is the primary clean energy source in the world currently. However, hydro is in decline, while wind and solar are in ascendency. Wind has recently passed hydro as the main source of clean energy in the United States.

Harder explained that it is unlikely that all our power will come from wind or solar by 2050 – or ever. The main reason is the lack of suitable storage technology. Battery technology is not up to the task of storing energy in the amounts that can accommodate consistent and steady power supplies at this point. Wind and solar costs have dropped considerably, but that drop has been matched by a drop in prices for wind and solar power. This has made investment returns on wind and solar developments worse, which has slowed down investment in clean energy projects.

Additionally, batteries themselves are more difficult to develop because investing in battery technology is tricky. The availability and costs of the metals involved in producing the batteries could make them cost prohibitive. As a result, natural gas will likely be a part of our energy source mix for the foreseeable future.  

In Australia, which has a highly developed clean energy infrastructure, one answer to the storage issue is the use of pumped hydroelectricity. Water is pumped to create electricity on demand, which effectively stores the electricity. There are some issues with pumped hydro, though, including having to dam any river used to create the electricity.

Harder then began to discuss carbon capture. Carbon capture is the process of retrieving greenhouse gases from the atmosphere. This is a technology that is starting to gain real traction in the investment community and has great promise to help slow down global warming.

In response to some of the challenges we face, many large-scale investors, such as the Government Pension Fund of Norway (their sovereign wealth fund) has divested its investments in companies that specialize in oil exploration and production. The belief among many in the energy community is that over time, the oil exploration industry will consolidate like a game of musical chairs. There will be fewer and fewer “chairs” over time as governments begin to enforce higher levels of regulation. This move by the Norway sovereign wealth fund is indicative that this process may have begun. Europe has been the leader in this process so far.

 As for the United States, President Trump’s policies are not as opposed to clean energy as his rhetoric has been. While he has publicly shown strong support for conventional energy sources, there have not been as many policy changes as his rhetoric might indicate. Still, the Green New Deal is extremely unlikely without a Democrat president, Democrat majority Senate and Democrat majority House, and on top of that, some cooperation from Republicans in Congress. Climate change is starting to be more of a political liability for Republicans, according to Harder.

A question from an audience member was for Harder’s opinion on carbon credits as an effective policy. Her answer was that there are really three options for ways to manage carbon emissions – innovation to new technologies, carbon tax, or a cap and trade regime. Cap and trade is politically unpopular because of the “energy tax” label slapped on it during previous debates, but would probably be very effective. Renewable energy mandates would probably not be as useful for businesses, but they are politically popular.

Harder signed off, and the panel was introduced.

L to R: Martha Goodell, Susan Nickey, Clive Christison and Ammad Faisal, CFA

Goodell began by asking each panelist about what specifically they do in the energy field. Nickey’s firm, Hannon Armstrong, invests in different types of projects that either make the energy grid more efficient, such has highly efficient light bulbs, or in projects that actually generate energy. Christison works for BP and actually manages energy projects for BP, including identifying potential projects. Faisal is in the business of finding capital for clean energy projects with Marathon Capital.

Goodell asked Christison how BP and other corporations make decisions about investing in clean energy projects. Christison said it depends on the technology. BP, for example, has a group that evaluates projects that deal in emerging technologies. Most corporations have investment return hurdle rates that must be met; conventional energy projects are certainly subject to these hurdles, but these emerging technology projects don’t usually pass those internal hurdles. This requires a different type of analysis to make an investment decision.

Goodell followed that question with a question about if different renewable technologies might cannibalize each other, making those investment decisions more difficult. Christison replied that it was not as concerning because the focus for BP is on increasing its exposure to technologies and emphasizing a less conventional energy mix. In the transport field, it is likely that the energy mix will still be at 80% conventional by the year 2040, but renewables will increase in other sectors. The number of vehicles in the world is likely to increase rapidly between now and 2040, so there are some time frame challenges that make it a better solution to build out the various technologies rather than trying to pick a winner. All four panelists affirmed that wind and solar technologies are the unquestioned leaders in the clean energy space.

Goodell asked Nickey about the green bond market and its place in her firm’s investment strategy. Nickey replied that the market for green bonds is still very small, at roughly $100M in annual issues versus the global bond market of around $12T. It’s a part of their overall investment purview and a space where there is room to grow.

Goodell asked about the global leaders in renewable technologies. Christison answered that China was the clear leader in electric vehicles. The US is progressive on renewable gas, which is supported by credits. Europe is strongest in social and political awareness of climate change and backs it up with policy. Spain, for example, last year wanted 100% of its electricity from renewable sources but had to default to gas power during times where the wind wasn’t blowing sufficiently. Southeast Asia is the leader in the development of biofuels. Christison gave the example that algae-based biodiesel is an emphasis in Southeast Asia.

Goodell asked Faisal about the level of deal flow now as opposed to previous years. Faisal answered that deal flow is quite a bit stronger, especially in the wind and solar spaces. He also mentioned that European companies have been quick to step into deals outside of Europe, taking advantage of slower movement from other global players. An example was the growing area of leases on existing offshore windfarms, which are quickly being acquired by European companies and investors.

Vault Series: CFRA

On July 17th CFA Society Chicago gathered in the Vault Room at 33 North LaSalle to hear Sam Stovall of CFRA give his assessment of the current equity market and what can be expected for the second half of 2019. Stovall is chief investment strategist of US Equity Strategies of CFRA (Center for Financial Research and Analysis) and chairman of the S&P Investment Policy Committee where he focuses on market history, valuation and industry momentum strategies.  He is the author of the Standard & Poor’s Guide to Sector Investing and The Seven Rules of Wall Street.   

Stovall shared hardcopies of slides to illustrate his presentation titled, “Low Rates, High Hopes” which was produced by the research team at CFRA. This analysis of market momentum described what occurred in the first half of 2019, and what that might portend for the second half of the year, produced some fascinating results. Stovall also spoke to what affect fed rate cuts might have on the equity market going forward.

Stovall began his presentation by pointing out that the first half of 2019 was very good to equity investors. The realized gain in the S&P 500 index in the first half of 2019 was 17.3%, itself a strong signal (80% probability) that the second half will also lead to significant gains.  Several milestones were also achieved by the first half bull market: the DJIA moved past 27,000, and the NASDAQ past 8,000. In the case of the DJIA one could expect a 77% probability of an average 3.6% rise in the index in the 60 days following a 1,000-point milestone.

The bond market rally of 2019 has also lent its support to equities. The dividend yield on equities currently surpasses the yield on the 10-year bond. History shows that an average upward 12-month move by the S&P 500 of 18% can be expected when this occurs. When the 10-year treasury exceeds the dividend yield by only 100 basis points, one can still expect a 12-month upward average move of 11%.

One of the best momentum indicators is the S&P 500 relative strength as indicated by its 200 day moving average. Stovall illustrated that the S&P 500 still has room to run by showing a graph of the moving average beginning in December 2007 (prior to the recession) up to July 2019. The moving average indicated that the end of December 2018 was the best S&P 500 buying opportunity since December of 2008. The S&P 500 index currently trades at less than one standard deviation above its moving average, which indicates to him that the market is still less than fully valued.

Not all the available data point to equity market gains. We are currently in the beginning of an earnings recession. Second and third quarter estimates are now in negative territory. History shows that the probability that the earnings recession could morph into an economic recession is relatively high at 75%. Stovall stated that his team does not expect that this trough in earnings will lead to recession; however, history is not on his side.

Equity market volatility increases in the last half of the year following strong gains in the first half. A quick look at 50-day moving averages of the S&P 1500 Sub-Industries shows an over-bought condition that Stovall states might indicate that opportunities to buy might present themselves later in the year. All major global markets are expected to experience slower growth in real GDP compared to what was experienced in 2018, another factor that may weight on equities. Also, Stovall noted that every Republican President since 1901 has had a recession in his first term.

The attendees were asked if they expected a rate-cut from the Federal Reserve in July. A large majority indicated that they expected the Fed to cut at least 25 basis points. History shows that following Fed rate cuts the average 12-month S&P gain is 14.1%. However, the more recent Fed rate cuts in 2001 and 2007 were followed by large losses. Stovall thinks that the expected Fed rate cut may be premature and produced a graph that superimposed rate cut cycles since 1973 against the differential between the Fed Funds rate and the Core PCE. The current differential between these two indices is usually greater than what we see now before a rate cut cycle is initiated.

Stovall admitted that he was an “emotional” investor. He stated that it was important for emotional investors to have rules-based investment guidelines. He spoke briefly to two strategies he called “Quality” and “Seasonal Rotation”.  Of Seasonal Rotation he spoke of the sell in May and go away strategy. Since World War II the average S&P six-month (May-October) upward price change has been 1.4% (lowest of any 6-month period). He married this with certain sectors that perform well at different times of year. As an example, consumer staples and health care outperform during this six-month period of relatively low returns. With respect to “Quality”, Mr. Stovall illustrated that investment in Dividend Aristocrats lessen risk   A “Dividend Aristocrat” is an S&P 500 stock that has increased its dividend payout for at least 25 consecutive years. This strategy directs investment to these stocks which are lower beta names, limiting risk.

To summarize his presentation Stovall left us with some key points:

  • After a strong first half and achievement of millennium milestones the market remains investable and further gains can be realized
  • Despite the earnings recession, no bear market is on the horizon
  • The second half of 2019 will have more volatility than the first half
  • His S&P 500 price target for year end is 3,100
  • The Federal Reserve is accommodative, but may surprise investors in a negative way in the short term.

It is interesting to note that many pages of Stovall’s presentation contained a disclaimer at the bottom: “Past performance is no guarantee of future results”. Stovall has demonstrated that   market history and momentum can be valuable predictors of market moves in the near future.  However, ignore the disclaimer at your own risk.

Distinguished Speaker Series: Michael O’Grady, Northern Trust

On June 13th local investment professionals gathered at the Chicago Club to hear a “fireside chat” with Michael O’Grady, chairman and CEO of Northern Trust. Marie Winters CFA, past chair of the CFA Society Chicago served as host and interviewer. To begin, O’Grady outlined Northern Trust’s core values that he said were the prime reasons the firm is about to celebrate 130 years of success, and why it remains independent at a time of rapid consolidation in financial services. These values are: service, expertise, and integrity. Northern Trust has focused on these since its inception, with the interpretation, or application, of them evolving to fit the times.  O’Grady expanded as follows:

  • Service applies not just to clients, but also to employees (or partners as Northern refers to them internally), and the community. A commitment of service to these constituents has always driven Northern‘s strategy. While the firm is known publicly for its key products (such as wealth management and asset servicing) it sees itself as a service organization.
  • Expertise is a point of pride for Northern Trust. It employs over 300 charterholders (the most of any firm based in Chicago) but the expertise the firm embraces extends beyond investment management to include other functional areas such as technology, and banking.
  • Integrity, put simply, means always doing the right thing, no matter how difficult. Again, the firm applies this broadly to relationships with partners and the community as well as clients.

Winters’s first question had to do with strategic changes that O’Grady had made since becoming CEO at the end of 2018 (or that he had planned for the near future). He did not answer specifically, but instead listed three drivers of success that he intends to emphasize: 

  1. Service excellence, a combination of his first two core values, which requires understanding the constant change in the business.
  2. Productivity, an absolutely critical need in a time of low revenue growth. Productivity improvements have been a focus at Northern for several years in a program called “Value for Spend”, which seeks to get more out of each dollar of expense.
  3. Investing for growth–determining where the firm should invest now to generate growth in the future.  Again, this reflects the recent history of slower revenue growth. 

Responding to a question about how Northern Trust is addressing the secular shift from active to passive management, O’Grady noted that Northern provides products that follow both strategies. The focus on efficiency is his key to success within passive products because of the low fee levels. Within active strategies, the focus is on leveraging Northern Trust’s expertise in factor-based analysis. Both of these product lines appear in their lineup of multi-asset class solutions.

When asked about investing for ESG (Environmental, Social, and Governance) factors, O’Grady said Northern Trust sees a clear and growing interest from clients. Designing and building such products requires a vast amount of new information and we are only in the early days of reporting that. Gathering accurate information consistently, and analyzing it thoroughly, will be key to success in ESG investing. This is made challenging by the changing nature of our economy.  The number of publicly-traded companies is shrinking, in favor of private companies. Obviously, public companies are more likely to report relevant data pertaining to ESG factors (and in a more consistent manner) than are private companies. So, even for the private equity investor, following ESG strategies is a challenge.

When asked about the importance of technology and digital innovation, O’Grady turned to data security. At front of mind for him was protecting clients’ private information. Technological innovation changes our world faster and faster (blockchain and cloud computing were two drivers of change he mentioned). With this change, clients demand more information, delivered more quickly, but the more we rely on technology to satisfy that demand, the greater the exposure to cybersecurity threats. Ironically, technology will have to be the principal tool in protecting against this risk. O’Grady then made an observation about technological innovation that illustrated one big way it has changed our world. He turned around the saying that “necessity is the mother of invention” to innovation being the mother of necessity. So, not only does technology allow us to do more with less, it also allows us to do things we never thought possible, never knew we could do, and even never knew we needed to do. This gets to the heart of the fears that technology destroys job opportunities. Rather, it creates more than it destroys.

The final area that Winters asked about was how Northern Trust is addressing diversity and inclusion. O’Grady said he’s proud of what Northern Trust has done so far, while acknowledging that the process continues. He specifically noted success in improving diversity metrics in hiring, especially for entry-level jobs, but sees more improvement needed further along the career path. That improvement requires new information that will inform the company on the causes of this shortcoming, and define the corrective actions. So far, they have learned that male managers tend to change roles more often early in their careers, giving the appearance of broader experience when they are considered for promotions. By measuring this and reporting it to managers Northern Trust can hold them accountable for removing any gender-based biases. Further, he noted the firm needs to be more active in assuring that development programs are open to women and people of color and the firm’s culture, which has served it so well for so long, may also have served as an obstacle to advancement. It must evolve to embrace a new commitment to improving diversity.

Diversity improvement was the subject of the first question from the audience about the differences in the various countries where Northern Trust has a significant number of employees. O’Grady acknowledged that policies and actions need to be tailored to the customs, regulations, and existing circumstances in each country. Gender equity is easier to address with consistent policies and programs around the world. However, ethnic diversity requires more customized solutions.

When asked how Northern Trust “walked the talk” on integrity. O’Grady listed three steps: 1) he repeated his rule of always doing the right thing; 2) being transparent, both internally and externally, so your stakeholders understand what you’re saying and doing, and can judge you correctly; and 3) leading by example because telling people how to behave is ineffective. They need to embrace the rules or customs.

When asked what companies O’Grady considers to be his most formidable competitors, he mentioned a few well-known financial services providers but his general comment was more insightful: they need to be mindful of the firms that are excelling at the things Northern Trust also needs to do well. The final audience question asked about Northern Trust’s strategy for growth. O’Grady summarized the firm’s revenue stream as about two-thirds from fees directly connected to the value of the assets they manage or service. They have no control over the value of those assets. The other one-third of revenue comes from earnings on the balance sheet, which are highly correlated to interest rates. Again, they have no control over the level or direction of change in interest rates.  So, they focus on the growth of new business because it’s the factor affecting profit growth that they have the most control over. Secondary factors include productivity improvements (that they see as an offset to inflation), and prudent investments in new businesses or technology.

Impact Investing: A New Investing Paradigm

A large group of CFA charterholders and other interested investment professionals gathered at the Palmer House Hotel to hear the latest thoughts and techniques in Impact Investing from a distinguished panel on June 5. The moderator, Priya Parrish, is a leading proponent of impact investing in the Chicago community of investment managers and managing partner at Impact Engine, a venture capital and private equity manager with a focus on investments that generate positive outcomes in education, health, economic empowerment, and environmental sustainability. Prior to the event Parrish joined us for a quick podcast which can be found on the CFA Society Chicago website and SoundCloud. Her panelists at the event included:

  • Susan Chung CFA, Managing Director of Investment Management at Wespath Institutional Investments, the investment arm serving the United Methodist Church, and other faith-based investors.
  • Andrew Lee, Managing Director and Head of Sustainable and Impact Investing for UBS Global Wealth Management
  • Charles Coustain, Portfolio Manager of Impact Investments at the MacArthur Foundation

Parrish kicked-off the program with an introduction describing the development of impact investing across nearly fifty years of history. The first generation was Socially-Responsible Investing (SRI) dating as far back as the 1970s. Its primary objective was aligning investments with the owner organization’s mission or values. Popular originally with religious organizations, this version relied primarily on negative or positive screening to either exclude companies involved in businesses that were objectionable to the investor (e.g., alcohol, tobacco, or gambling) or to include firms pursuing something the investor sought to encourage. Investment returns often took a back seat to mission alignment. SRI evolved to incorporate consideration of environmental, sustainability, and governance (ESG) factors in an attempt to improve risk-adjusted performance. The reasoning being that companies that excelled on ESG factors were more likely to out-perform lower scoring peers. Impact investing is the latest generation of the model.  It seeks investments that not only generate strong financial returns, but also contribute to positive changes on social matters. Parrish provided a list of seventeen such social matters with education, health care, economic empowerment, and the environment, being the most important ones to Impact Engine.

Parrish noted that, while many people are aware of the social ills often blamed on corporations, the profit motive also gives corporations the power to change society for the better. They only need to recognize this and make it their intention to improve society while pursuing their profit-generating goal.  The element of intentionality is what defines impact investing. The challenge for the impact investor is to identify, select, and manage those firms that intend to make a positive social impact in their businesses, and do so successfully. The audience heard the panelists refer to this element of intentionality repeatedly throughout the event.

Before bringing the panel on stage, Parrish presented a graphic depiction of the spectrum of impact investments. Its vertical axis showed modest return expectations with market return at the top and declining down through return of capital to complete loss. Across the horizontal access ran the approach to impact, beginning with None, and including stages such as Passive, Intentional, and Evidence-based.  The body of the matrix listed the investment products and strategies used to apply the approach toward achieving the return goal.

Parrish then invited the panelists up on stage and asked each to make a brief statement about the involvement of their firms with impact investing. Susan Chung pointed out that Wespath is part of a religious organization and invests for both the church as well as for pension plans for church employees.  The former is primarily done in an SRI style (meaning exclusionary) because they are less concerned with the returns than avoiding investments that conflict with the organization’s values. The qualified funds are more return-seeking so they have adopted impact investing. Engagement with corporate management is their primary tool for effecting change. They sometimes partner with other investors with a like mind to increase their leverage.

Andrew Lee of UBS Wealth Management said the firm sees impact investing as a major trend with a lasting impact so they have embraced it very broadly.  This is driven both internally, by the Wealth Management CIO who is committed to the style, and externally by clients.

The MacArthur Foundation, being a philanthropic organization, takes a different approach. Its primary purpose is effecting positive social change to begin with, and it pursues that objective with direct grants to institutions working in its areas of choice. These aren’t intended to generate a financial return, however as far back as 1983, the foundation began investing in public banks that address special social needs (such as affordable housing) that were underserved by the market. Their involvement was trailblazing in that it encouraged regular, for-profit, banks to invest in the same manner to the point that they now provide more funding than philanthropic organizations. MacArthur’s impact investing has grown to encompass a separate carve out of the foundation’s endowment that seeks return-generating impact investments that further the goals of its grant program.

As to how to select managers who best align with the investor’s goals, both Chung and Lee stressed the need for vigorous research to understand a manager’s process and determine how committed they are to impact investing. Wespath uses a detailed assessment survey to help with this.

Chung outlined how Wespath found a way to incorporate impact investing into passive strategies. By partnering with Blackrock, they were able to access data to score companies on ESG factors. Searching for indicators of either positive or negative correlation to performance, they identified factors used to make slight adjustments to the index components and thereby, drive alpha. As an example, Chung said they discovered that the rate of decline in carbon emissions was a better performance indicator than the gross amount of emissions. So, firms demonstrating the greatest decline, even if from a high base amount, out-performed firms showing lesser declines (or increases) even if from a very low base. The resulting strategy is very neutral on sector and industry metrics, while benefiting from relatively small mis-weights in the individual stock positions. Indexing purists would consider this to be enhanced indexing (if not a quantitative active strategy) rather than true indexing.

All three panelists stressed the importance of collaboration with other firms interested in impact investing to stretch their resources and increase their leverage with managements. This is especially important in the governance area where engagement with company management has proven to be an especially effective way to effect change. Wespath joins with other investors (or asset managers) when they engage with firms to discuss corporate governance. 

Lee added that UBS has determined that engagement with management is the best way to bring about change—far more so than simply voting proxies against management recommendations. This is especially true in the public equity markets. The firm sets an engagement goal at the outset when making a new investment.  

MacArthur collaborated with the Chicago Community Trust (CCT) and Calvert Research and Management to increase the scale and focus of its impact investing. The CCT brought a local focus to the investing to assure that funds were invested where the investors intended them to be.  MacArthur brought its institutional funds and Calvert added funds raised from their individual investors interested in the strategy. 

The Q&A session that followed the discussion lasted for half an hour, indicating the high level of interest from the audience. The first question asked the panelists to identify some impact investments that had not worked out as expected. Chung listed emerging market infrastructure, solar power following the removal of government subsidies, and wind farms in the North Sea. Coustan added for-profit education as an example. Lee noted that sometimes an underperforming investment needs to be reassessed to see if the investor can help the organization improve. The panel was in agreement that impact investing was more difficult to apply to fixed income. Chung advised that fixed income managers should borrow the scoring methodologies used on the equity side.  Lee added that UBS has substituted bonds from supranational financial companies such as the World Bank and UN-sponsored development banks in place of sovereign debt in the high-quality portion of fixed income portfolios. Coustan said MacArthur primarily utilizes private debt vehicles for impact investing because of the flexibility in structure and use of the funds. In these cases, however, their return objective is only to preserve capital.

Big Data, Machine Learning & AI

Cathy O’Neil: Founder of ORCAA and
Author of Weapons of Math Destruction: How Big Data Increases Inequality and Threatens Democracy

Big Data, artificial intelligence (AI) and machine learning are becoming some of the hottest topics in finance. A packed room of CFA charterholders gathered to hear a presentation by Weapons of Math Destruction author Cathy O’Neil and a panel discussion on that topic in early May.

O’Neil began her discussion with Google’s autocomplete predictive search that can occasionally feature unreliable or conspiracy-laden results. She said that Google shouldn’t be able to have it both ways, making money off users’ trust yet saying that bogus search results aren’t their fault.

According to O’Neil, AI is not a model for truth. Artificial intelligence technology could be characterized as a series of opinions fed into an algorithm. The authors behind the algorithm will tell you to “trust the math”, but should we be that trusting when companies are incentivized not by truth but by profit?

AI amounts to making a prediction. There are two parts to an artificial intelligence prediction: the historical data, which contains a possible pattern, and the algorithm’s definition of success (such as a quant generating profit at a certain volatility level). Even mundane things such as determining what to cook for dinner could be characterized as an algorithm.

Our lives are increasingly touched by algorithms, in areas such as banking and credit, policing, jobs and even matchmaking. Sometimes the algorithms are incredibly helpful, but sometimes they can cause a great deal of harm. When a company runs an algorithm on you, you should trust that it will optimize the result to the company’s definition of success, not necessarily what is best for you. O’Neil said that many of today’s algorithms can be characterized as WMDs (Widespread, Mysterious and Destructive). And algorithms do make mistakes, but those mistakes aren’t typically publicized because the algorithms are usually secret intellectual property.

O’Neil told a story about a teacher who was fired because her students received poor test scores. This happened even though the administration didn’t have access to the actual score which was generated in a black box that no one outside of the firm had access to. Finally, access to the scores was provided. Upon reviewing them, the teacher scores looked essentially like completely random numbers with little predictive power from year to year. Some teachers have sued for wrongful termination and have won their cases.

Another example O’Neil gave of an algorithm causing harm was the case of Kyle Beam, who didn’t get a Kroger job because of a personality test result. The test resulted in a “red light” outcome where Kyle was not offered an interview. He complained to his father about the process, who is an attorney, and his father determined that the test violated the Americans With Disabilities act, as it is unlawful for a company to require a health exam as part of a job screening.

One of the main problems with algorithms today is that they tend to look for an initial condition that led to success in the past. Amazon developed a hiring algorithm (that wasn’t ultimately used) that aimed to determine which characteristics of certain hires led to success in the job. The algorithm proxied job success with metrics such as salary raises, promotions and workers who stayed more than four years. Upon scanning the data, the algorithm found that initial conditions such as being named “Jared” and using the word “execute” more frequently on resumes tended to lead to success. Unfortunately, it was also determined that male candidates tended to use the word “execute” more frequently than women, so some of the characteristics the algorithm was searching for were proxies for gender.

Couldn’t there be a market-based solution to all the defects inherent in algorithmic decision-making? According to O’Neil, expecting companies to self-police their own algorithms might be somewhat unlikely. This is because algorithms that maximize profits without any constraint on fairness are more profitable than algorithms with fairness constraints. This dilemma can be seen with Facebook. Facebook has a higher level of engagement and a more lucrative advertising business when its users are arguing about fake news and conspiracies.  Most companies facing demanding shareholders would be reluctant to agree to lower profitability in order to ensure fair algorithms. Because of this issue and others outlined above, O’Neil believes that regulation is needed.

Currently the legality and ethics around employers sourcing alternative data such as health information in order to make hiring decisions is murky. “What’s stopping Walmart from buying data to see who is sick or healthy [in order to make decisions on employment],” O’Neil asked.

O’Neil laid out three principles for responsible algorithm usage:

1) First do no harm

2) Give users the ability to understand scores and decisions

3) Create an FDA-like organization that is tasked with assessing and approving algorithms with a high level of importance

L to R:
Metin Akyol, Ph.D., CFA (Zacks Investment Management) Kevin Franklin (BlackRock),
Sam Shapiro (Goldman Sachs Asset Management), Cathy O’Neil (ORCAA)

During the panel discussion, speakers talked about how machine learning and AI are used in their portfolio management process, particularly parsing through large data sets. They talked about how it is more challenging to hold risk models to the same standard as trading models because risk cannot be directly measured, and the success of a trading model can easily be evaluated by the P&L generated. Are machine learning and Big Data a flash in the pan, or are they here to stay? The CFA Institute believes that it’s the latter, and have added the topics to the 2019 CFA curriculum.