Opportunities in Hedge Funds in 2019

A distinguished panel gathered on October 10, 2019 at the Standard Club to discuss the current environment for hedge fund investments. Kenneth Heinz, president of Hedge Fund Research, Inc. served as the moderator.

The panelists included:

  • Kevin Doonan, Executive Director, Hedge Fund Strategies, GCM Grosvenor
  • Joseph Scoby – Head of Systematic Investing, Magnetar Capital
  • Tristan L. Thomas, CFA – Director of Portfolio Strategy, 50 South Capital

HFR’s Ken Heinz began with some opening remarks, which he dubbed “Whistling Past the Graveyard”. After a rough couple of years, investing in hedge funds in the next 2-3 years will be better, he said. One reason is that hedge funds are currently preparing for macro risks for which many mainstream investors might not be ready. A couple warning signs Heinz noted include a recent huge jump in overnight repo rates, and negative interest rates on a wide swath of global debt. Also, IPO markets are showing weakness, with the large We Work IPO having been pulled recently at the last minute. Impeachment proceedings and a possible Warren presidency (with her populist, anti-corporate message) also suggest more risk on the horizon.

Tristan Thomas started by talking about bond returns. A return of about 8% YTD for the Barclays Aggregate index indicates that a lot of bond returns have been pulled forward. That leaves little return potential ahead for bond investors unless yields go negative. The minuscule amount of yield available leaves bond investors in a quandary. They still need income and cash flow, but aren’t entirely comfortable taking on more risk. With that backdrop, hedge funds can play a role in the portfolio. One symptom of this trend, Thomas noted, is that he has recently been talking more to clients’ fixed income departments, who need help generating yield, instead of the alternative groups he typically speaks with. Another challenge is that the costs of running a hedge fund have gone up.

Heinz asked the panel if they are seeing reduced liquidity in the market. Thomas answered yes. Doonan added that markets are now faster to gap down because of weaker hands and banks are less involved than before. Some securities have better liquidity than before, particularly securities held inside ETFs, but securities outside of ETFs have fared worse with respect to liquidity.

The conversation then shifted to ESG, a fast-growing area of investing that the hedge fund world has been slow to embrace. Thomas opined that the ESG trend is real and here to stay and represents a big opportunity for hedge fund managers to win additional mandates. One challenge managers face is defining exactly what ESG is. Investors each have their own answer on what ESG constitutes, and managers need to be flexible and offer customization in order to capitalize on the opportunity. As for returns, Heinz asked the panel if ESG has an impact. Thomas said that there isn’t quite enough data in the hedge fund space to definitively answer that question. Doonan also said that he believes the implications of focusing on ESG will be huge and may have an even bigger environmental impact than government policy.

The group spoke at length about the growing influence of tech on their investment process. Scoby said that at Magnetar, they often debate whether they are a technology firm or an investment firm (Answer: they aren’t mutually exclusive, so both). To remain competitive, firms must constantly appraise external technology to ensure they are using the best tools available. Doonan said that many asset owners and funds-of-funds use advanced analytical tools to decompose returns to ensure that they aren’t overpaying for beta. Regarding some other more nascent technologies such as blockchain, Doonan said that they have generally stayed away.

Heinz asked how the panel’s investment processes have changed over the past five years. Doonan said that the average hedge fund has not delivered enough return to justify its fee, which has made focusing on specialization and co-investment recurring themes. As far as identifying an attractive strategy for the current market (or alternatively, which should be avoided), Thomas said that in a perfect world, it would be macro, but there are few good macro managers out there. He likes credit-oriented managers and strategies with short books that are delivering alpha. He sees relative value strategies as less interesting right now. Doonan said that his firm generally tries to avoid generalist managers in favor of more niche, specialist strategies, while rates trading strategies look problematic to him.

A lot of the appeal of hedge funds comes when equity markets are challenged, so if the equity beta continues to deliver returns around 10% with lower than norm volatility, hedge funds will be somewhat unattractive. It is very hard to find true alpha, and also difficult to separate skill and luck, which makes advanced analytical tools, careful due diligence, and experienced managers with niche strategies all the more attractive in today’s low rate world.

Distinguished Speaker Series: David Herro, CFA, Harris Associates

Trust and effective communication provide investment teams with the ability to stick with a sound investment philosophy and process during periods when the approach is out of favor with the market. Oakmark’s focus on developing an intrinsic value for companies provides a foundation for portfolio management decisions. He believes that this foundation drives the long-term successful investment returns that the firm has earned for clients.

David Herro, CFA, partner, portfolio manager and chief investment officer of International Equity at Harris Associates, addressed 200 guests at the University Club on Tuesday, October 8th for the sold-out Distinguished Speaker Series luncheon. Herro emphasized the importance of our fiduciary duty, a sound investment philosophy, the difference between a business’s value and its stock price, the opportunities that macro events can create and the importance of managing emotions. These five themes have been central to his long-term success managing the Oakmark International Equity mutual fund.

Herro measures the attractiveness of a business based on the present value of expected free cash flow. Prices below this value create buying opportunities, and above a reason to sell or not buy. He uses a normalization process to determine the required discount rate, instead of using today’s very low rates. The discount rate also varies for countries and companies based on risk assessments. During his presentation, he illustrated times when one of his holdings, Glencore PLC’s stock price movied far from his computation of intrinsic value. He noted that price often responds to current information versus the long-term business value. This volatility provides opportunities for investors. He guides clients to think and act like investors, not traders.

Herro provided several examples of when macro events moved security prices far from intrinsic value. During the European sovereign-debt crisis investors could purchase Italian government bonds with yields near 8.0% that are less than 1% today. Additionally, yields on Greek government bonds moved above 30% in 2012 and are now lower than US Treasury yields. He notes that despite these movements in price, intrinsic values have not changed by these large magnitudes.

Managing emotions requires a strong foundation. The faith to maintain a set of beliefs during the great financials crisis eventually rewarded investors. In contract, a focus on stock price movement created severe anxiety that lead to many poor decisions.

Herro compared today’s difference between the performance of growth and value styles as comparable to the 1995 to 2000 timeframe. He acknowledges that identifying a change in this relative performance is extremely difficult due to a large number of variables with unstable coefficients. However, he believes that the magnitude of the differences strongly favors the value style currently.

Herro noted that we should never forget that our purpose is to earn returns for our clients. Key ingredients to success include a sound approach, acting like an investor vs. a trader, exploiting opportunities created by macro events and managing emotions. These thoughts have served him well and he believes that they will continue to serve our industry well.

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!

Distinguished Speaker Series: Rob Brown, CEO, Lincoln International

Current drivers of the global M&A market and perspectives on how it may evolve going forward

On September 10th the Distinguished Speaker Series Advisory Group hosted Rob Brown to provide his insight on the M&A market over lunch at the Metropolitan Club. Brown is the CEO of Lincoln International. His firm serves private equity firms, corporations and private businesses around the world, providing advice when selling or buying a business, securing financing solutions, valuing an organization or portfolio, or navigating special situations. Brown has nearly 30 years of experience advising leading private equity groups, privately owned businesses and large public companies on divestitures, acquisitions and other strategic initiatives.

Brown is a recognized advisor and thought leader in the investment banking industry. He is a frequent guest on WBBM’s Noon Business Hour in Chicago, and a speaker and author on mergers and acquisitions-related topics. Brown sits on the board of UNICEF USA and the Dean’s Business Council for the Gies School of Business at the University of Illinois. He is also President of the Board of Regents at Saint Ignatius College Prep in Chicago.

Brown started with an outlook on the M&A market. Global M&A activity has increased year to date in 2019 compared to the same period in 2018. There have been around 230 M&A deals this year verse 200 in 2018. The P/E market has been robust as well. Following several years of growth with an all-time high in 2018, inflows have returned to more moderate levels. Activity in 2019 could be characterized by established P/E platforms getting larger, with new funds facing a more challenging fundraising environment. Despite the fundraising slowdown, a thinner slate of opportunities for capital deployment has mitigated the impact to capital supply, leaving significant dry powder available in private debt funds.

On the lending front, bankers are still providing funds while defaults, the bellwether of a slowing economy, have not increased in a material way. Overall, the continued trade/tariff uncertainty, slowing global growth, Brexit concerns, and mixed signals from key economic indicators about the likelihood and timing of a recession have given lenders a pessimistic view of the market. They are lending but looking for a reason not to!

Brown advised that valuations of businesses have grown to historic highs. This is due to several factors, the most significant being the tax cuts passed in 2017 (reduction of the U.S. corporate tax rate has made the United States a more attractive jurisdiction for inbound M&A activity and has likely increased the value of U.S. domiciled businesses), and the large sums of P/E money raised over the past several years looking to be invested.

Additionally, there is nothing on the horizon which makes Brown think these valuations would change in the next 3-6 months. Overall deal activity is great with high valuations being the norm. Brown advised that now is an excellent time to consider selling a privately held business. The M/A market could be close to its top as the number of private sellers entering the market is high. These entities are usually late to the market.

Brown noted that although the market is richly priced, a recession would not necessarily bring down M&A prices. It is more likely that M&A activity would cease, but as soon as there is an upturn in the market deals would flow again.

Browns kept his prepared remarks relatively short in order to answer audience questions.

Q: Should a recession occur would capital be available, or would the market dry up?

A: M&A firms have committed capital on their books. This capital would not be put into M&A deals, but left as idle, short term investments. The M&A firm will sit on these funds making a nominal rate and wait until the market breaks upward.

Q: How much of the high multiple business valuation is due to any cyclical effects?

A: Modeling of returns has dropped over the past several years. P/E should float based on a measure of public equity plus a spread. As the prices in the public equity market have risen, so to have the multiples for the M&A market.

Q: Is there pressure on the 2 and 20% fee schedule?

A: In 2009 when the market was in disarray the outlook was for a 30% reduction in P/E firms. This outlook turned out to be completely wrong. The overall amount of P/E firms is now greater than in 2009, and with the constant search for returns that will beat the market, the current fee structure is unlikely to change.

Q: What effect will negative interest rates have on the M&A market?

A: Low or negative rates have not affected the cost of capital. Capital has been cheap for an extended period.  Any nominal change in interest rates will have little to no impact.  What is more important is the availability of capital. It is the extension of investors risk appetite that is the greater concern. Investors are stretching beyond their comfort zone, getting riskier with their investments.

Q: What is the state of European M&A?

A: The trade war with China has caused a number of unintended consequences, one of which is that China has refocused its M&A activity away from the U.S. to Europe and Germany in particular. Lincoln’s office in Germany will set an M&A record in deals for 2019.

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: Vivien Azer, Cowen & Co.

Cowen’s Views on Cannabis

On July 9, Vivien Azer, the analyst responsible for covering cannabis at Cowen & Co., presented her views at CFA Society Chicago’s Distinguished Speaker Series luncheon at the University Club. Cannabis/Hemp/CBD is an “emerging” sector within the U.S. and Canadian stock markets as legalization of the formerly stigmatized substances has begun to change.

Azer concluded that the “relative size of mature Consumer Products Group (CPG) categories reflects a long runway for growth in cannabis”. The global size of the alcoholic beverage market is $1.3 trillion, the NARTD (non-alcoholic ready-to-drink) market is $1.2 trillion in size with traditional tobacco being $800 billion, while the currently “illicit” cannabis market is estimated at $150 – $200 billion in size.

Azer started coverage at Cowen & Co. in September of 2016 and the two questions she asked before starting to examine the sector were: 1) Can Cowen make investors’ money covering cannabis; and, 2) Can Cowen make companies money (presumably bringing private companies public) covering the sector?

The Disruptees:

Within the Consumer Products Group (CPG), there are 4 distinct verticals:

  • Adult Use which includes breweries like BUD, Heineken and Molson (TAP)
  • Beauty & Nutraceuticals which encompasses Coca-Cola (KO), Pepsi (PEP) and cosmetic companies like Estee Lauder (EL)
  • OTC Pain / Sleep, which is primarily Johnson & Johnson (JNJ) and Procter & Gamble (PG)
  • Traditional pharmaceuticals like Merck (MRK), Eli Lilly (LLY), and AstraZeneca (AZN)

Azer noted that both Constellation Brands and BUD had either made investments in the cannabis space already or were interested since the traditional breweries and alcoholic brands were likely to be disrupted from cannabis as consumers see it as a psychoactive substitute.

Don’t forget Canada (The Great White North, eh?)

Azer and Cowen believe that cannabis represents a $12 billion market opportunity in Canada by 2025 with retail accounting for the bulk of the sales. One slide showed the monthly progression of Canadian retail sales in cannabis from October 2018 to March 2019 which cumulatively represented $300 mm (CAD) in retail sales. Cowen seems to see Canada as an early leading indicator of U.S. retail sales since Canada seems so far ahead of the U.S. in terms of its retail rollout. The early retail sales adopters in terms of Canadian provinces are Alberta, Ontario, Quebec and Nova Scotia with each having 24%, 23%, 13% and 8% respectively of Canadian cannabis sales. Alberta has 13% of Canada’s population but 24% of Canada’s total cannabis sales given early bricks-and-mortar adoption.

United States:  

At the time of the lunch, 11 states and District of Columbus had legalized cannabis for adult use. Colorado was the earliest adopter in terms of retail sales but their sales slowed when California and Nevada legalized adult use of cannabis. Cowen estimates that 80% of the $50 billion cannabis market in the U.S. is currently “illicit”.  By Q1 ’19, five states had generated roughly $5 billion in cannabis revenue and those were Colorado, Washington, Oregon, Nevada and California. Cannabis use has clearly come at the expense of alcohol.

Here are the numbers Cowen published as market sizes for various aspects of the cannabis market:

  • THC is an $80 billion opportunity by 2030
  • CBD is a $16 billion revenue opportunity in the U.S. by 2025

Vivien Azer of Cowen did a great job outlining market opportunities and the “macro” of the cannabis/THC/ Hemp/CBD markets. Canada is an interesting comparison since it appears to be out in front of the retail rollout experience. During Q&A, Azer touched on the SAFE Banking Act which will insure access to financial services for cannabis-related businesses. Since the lunch, the House has passed the SAFE Banking Act, but it still hasn’t been passed in the Senate, although passage is ultimately expected.

If you were unable to attend this event but want to learn more about the cannabis industry and where it’s headed, be sure to join us at our next cannabis event hosted by our Education Advisory Group at the beginning of 2020. Information available on the CFA Society Chicago website soon!

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.