CFA Society Chicago Book Club:

GDP: A Brief but Affectionate History by Diane Coyle

Don’t confuse familiarity with understanding. That’s perhaps the biggest takeaway from Diane Coyle’s short and highly readable GDP: A Brief but Affectionate History. The official guidance for calculating GDP, the System of National Accounts (SNA), published by the United Nations runs 722 pages. That combined with the difficulties of executing the actual calculation makes one wonder how many people, even ostensible experts, really understand the quarterly numbers. In addition to the intricacies of defining and calculating GDP, Ms. Coyle takes the reader through the short yet turbulent history of the metric, its uses and mis-uses, and several possible improvements and alternatives. The CFA Society Chicago Book Club members who met to discuss the book at their March 2019 meeting agreed that the book left the reader with more questions than answers, which is perhaps one of the marks of a good book.

As for GDP’s short yet turbulent history, Ms. Coyle traces the origins of the modern metric to Colin Clark and his pioneering work at the United Kingdom’s National Economic Advisory Council, an organization based on the then-novel concept of providing economic advice to governments to combat problems, the most notable problem at that time being the Great Depression. On the other side of the pond, the famed U.S. economist Simon Kuznets applied Clark’s concepts to the U.S. economy at the National Bureau of Economic Research, work for which he was later awarded the Nobel Memorial Prize in Economic Science. From the very beginning, Kuznets grappled with using the metric to read into welfare, well-being, or happiness, a theme that’s repeated throughout the book and a problem that persists to this day. 

Spawned in depression, the concept of national accounting gained maturity in war. The Allies’ efforts to defeat the Axis powers required a complete mobilization of their nations’ resources, so it’s no surprise that understanding what those nations’ resources were was vital to that effort.  During that time economists started meaningfully incorporating government spending into GDP calculations for the first time. The reasons for neglecting it previously were numerous.  For one, as is easy to forget with our current bloated governments, government spending prior to the war was miniscule in comparison to aggregate economic output. A second reason for incorporating government spending was a matter of mathematical necessity. Without taking into account government spending, national income would fall short of the market value of goods and services produced. Kuznets again warned that incorporating government spending into GDP “’tautologically ensured that fiscal spending would increase measured economic growth regardless of whether it actually benefited individuals’ economic welfare.’”

Fast forward nearly a century later, and that recurring theme of reading too deeply into GDP notions of happiness or welfare is no less tractable. Efforts to combat that shortcoming include the Human Development Index (HDI), the Index of Sustainable Economic Welfare (ISEW), the Measure of Economic Welfare (HEW), and several others. Those indices try to account for, among other things, leisure time, environmental degradation, crime, the negative impacts of defense spending, and several others. The most compelling response to attempts to read welfare and happiness into GDP might come from Clayton Christensen’s How Will You Measure Your Life.  In that classic book he discusses “motivators” and “hygiene factors” in the context of one’s personal life. Motivators are, like the name suggests, factors that compel people to go above and beyond the call of duty and can include the sense of duty or purpose that comes from curing disease, educating people, or defending the innocent in the military or as first responders. Hygiene factors, like salary, are necessary but not sufficient conditions for happiness. Below a certain level, people are unable to meet basic human needs and their happiness is adversely affected.  After a certain level income level ($75,000, according to a study by Angus Deaton and Daniel Kahneman), there’s little relationship between income and happiness.  Perhaps the same can be said of GDP. Below a certain level of economic output, a country likely will be unable to meet the basic needs of its people, such as nutrition, sanitation, and vaccinations. After a certain point, GDP and happiness likely has a more tenuous relationship. It might even be a negative relationship. Anecdotally, demand for mental health counselling seems to rise with income.

Perhaps people wish too much of one metric. Not only can GDP not explain human happiness and prosperity, but it’s very hard to make it account for economic output. How should GDP account for nominally free services like search engines, Wikipedia, or open-source software? How should GDP account for unpaid labor such as the cleaning and child care services performed by stay-at-home spouses (mostly women), a perennial bugbear among feminists?  Perhaps most consequentially, how should GDP account for the changing variety and quality of goods over time? To account for the change in quality, Ms. Coyle discusses hedonic price measures.  Instead of just looking at the price of a good over time, hedonic price measures regress the price of a good on measures of quality, such as screen size and screen resolution in the case of televisions and computer monitors. The consequences of hedonic price measures for health care and education, two of the goods with the highest inflation rates, could be striking.  The cost of health care has increased markedly in this author’s lifetime, but so have the availability and efficacy of several treatments. Education, unfortunately, has probably suffered the opposite fate. Despite the rising cost of higher education, there’s little evidence that the average graduate has gotten smarter based on measures of verbal and quantitative competency.

Those are just a few of the questions raised in a remarkably short book, only 145 pages. Although those questions deserve careful thought, one should only undertake such contemplation with Ms. Coyle’s warning about GDP: “the ‘object’ being measured is only an idea, not something with an independent existence waiting to be discovered and counted.” With all the variation in definition and measurement, one is unlikely to come to stable and satisfactory conclusions about GDP, but knowing that before contemplating GDP is perhaps the greatest lesson from an excellent book with several such lessons.

Curling at Kaiser Tiger

On a frosty evening where temperatures hovered just above ten degrees, CFA Society Chicago hosted an evening of curling and drinks at Kaiser Tiger, a bar with a large beer garden on Randolph Street. Curling, with origins dating back to 16th century Scotland, involves sliding a smooth stone across a sheet of ice, with the goal of centering the stone in the middle of a target (typically 146-150 feet away, the rink at Kaiser was a bit smaller though). It was added to the Olympics in 1924 as a “demonstration sport”, and was officially added in 1998. Curling is most popular in Canada, but many countries across the globe field teams in the world championships and Olympics, including Finland and Scandinavian nations, the UK and Japan.

This was our first curling occasion as a Society, and it was a packed event, with networking taking place in Kaiser Tiger’s large West Room and participants bearing the cold and taking turns hurling stones outdoors in the ice curling rinks in the beer garden. If you missed the event, you can get a group of friends together rent a lane for $40 per half hour here – Kaiser Tiger Curling. Aside from the networking, attendees were treated to a fantastic menu of craft beers, wine and appetizers. Despite the chilly temperatures, fun was had by all, and curling very well may turn into an annual CFA Society Chicago winter tradition!

Portfolio Construction and Allocation in this ever changing market

On Feb 20th at the UBS Tower, CFA Society Chicago’s Education Advisory Group offered a panel discussion highlighting the issues and opportunities of allocating assets for various types of portfolios. A full room of about 100 financial professionals were privileged to hear from an experienced, diverse group of fund managers and advisors.

Opening speaker Tim Barron, CAIA, CIO of Segal Marco Consulting, prepped the feature event with his entertaining yet practical list of eight things to be aware of and thinking about when structuring portfolios. His list consisted of relating several quips from the likes of Yogi Berra, Mike Tyson, Harvey Pinnick, Wayne Gretzky and Bobby Unser into practical guidance for professional investment of assets. Lessons learned included; understanding the purpose for the portfolio, having a plan in place in the event of market turmoil, not having a false sense of security in making predictions while understanding one’s skillsets, and not being afraid to stand apart from the herd while putting in the hard work necessary for being in a position to win.

A brief Q&A ensued before giving way to moderator Chris Caparelli, CFA, at Marquette Associates and the panel of (1) Patricia Halper, CFA, CIO at Chicago Equity Partners, (2) Josh Lohmeier, CFA, Head of Investment Grade Credit and AIA Investment Officer, Aviva Investors, (3) Ellen Ellison, CFA, Chief Investment Officer, University of Illinois Foundation, and (4) Kevin Zagortz, FSA, US Head of Portfolio Management (OCIO) at Aon.

Caparelli’s first question for the panel was to provide a high-level description of their approach to asset allocation. Kevin spoke first from his background with qualified corporate defined benefit and 401(k) plans. His first objective is to be mindful of mitigating risk before evaluating a multitude of asset classes in priming the portfolio for growth was a common theme across the panel.

Ellison’s perspective is of a large foundation with a very long-term investing horizon, minimal concern for liquidity and growth sourced from a global rolling portfolio approach. The foundation’s clients consist of a large base of living alumni, trustees and committees, with a strong focus on governance and fiduciary risk. The only thing worse than not having a plan is changing the plan over the course so being mindful of the human element is important.

In contrast, Lohmeier has a relatively narrow focus of investment grade credit and is most concerned about target benchmarks and how to manage to against that performance. Common issues to be aware of include behavioral biases, herd mentality, tail risk and downside protection especially in environments of severe stress.

Halper stressed the importance of knowing your place. If your client is relying on investment exposure to a specific asset class then it is imperative to not stray from that mandate. In other words, only perform asset allocation within the bounds that you engaged for.

The remainder of the discussion involved the panelists providing perspective on a variety of topics such as their use of alternatives, adaptation to the market environment, and being tactical  via factor investing. Context is important once again as each strategy depends on the purpose and objective for that client. 

After taking formal questions, the panelists generously made themselves available after for further inquiries.

In summary, this was a fast paced and informative exposure to the topic of portfolio construction. Caparelli was effective in moderating the discussion and the diversity of viewpoints represented on the panel was of tremendous value.

CFA Society Chicago Book Club:

Bad Blood: Secrets and Lies in a Silicon Valley Startup by John Carreyrou

Silicon Valley and venture capital (VC) in the technology sector always offended this Midwesterner’s conservative sensibilities.  Having come of age during the dotcom boom, I’m skeptical every time a technological shiny thing catches the public’s attention, which seems to happen with alarming frequency given the regularity of fads and corresponding losses to come out of the sector.  John Carreyrou’s masterfully written Bad Blood confirmed my biases.  In addition, he weaved together a highly readable tragedy involving a deceptive and manipulative villain in the form of Theranos’s founder and CEO Elizabeth Holmes; a board that emphasized prestige of its directors to the near complete exclusion of any relevant industry expertise or meaningful control; a media and public blinded by the desire to see women entrepreneurs and women in Science, Engineering, and Technology (STEM) fields; and a group of similarly gullible investors that included Walgreens, Safeway, and several of the Valley’s most prestigious VC firms.

My sentiments during the majority of the book were similar to that of a cynic observing drug dealers fighting over territory: there were no innocent bystanders and the only people who got hurt deserved it.  Unfortunately, though, there were innocent bystanders.  The first casualty is the realities of success succumbing to the Horatio Alger-type myth of the college dropout cum tech entrepreneur.  Elizabeth Holmes, whose family tree includes the founders of Fleischmann Yeast and the Cincinnati Medical School, used her family connections for her initial funding.  Although America is still the land of opportunity, it’ll always be easier to score runs when one is born on third base.  The second casualty is the line workers and main street investors in Safeway and Walgreens who suffered the consequences of poor decisions to partner with Theranos that they had no control over.  Last and most importantly, Theranos made defective medical equipment that hurt the people upon whom it was used without their informed consent—a tenant of ethical medical practice.

First, the villain of our story, Ms. Holmes.  Mr. Carreyrou paints a portrait of unbridled ambition starting from a very young age.  Despite her shortcomings, no one should doubt Ms. Holmes’s  drive.  From a very young age she declared her ambition to be a billionaire and worked tirelessly starting in early high school, studying hard, sleeping little, and earning straight As, a pattern that continued through her brief stint at Stanford and throughout her tenure at the helm of Theranos.  Ms. Holmes seemed determined to emulate Steve Jobs’s path, a point emphasized in the chapter “Apple Envy,” noting Ms. Holmes’s wardrobe, modeled after the Mr. Jobs’s signature black turtleneck, her desire to make “the iPod of healthcare,” and her hiring of TBWA/Chiat/Day, the same advertising agency responsible for the Apple Macintosh’s “Think Different” campaign.  Her infatuation went so far that while reading Walter Isaacson’s biography Steve Jobs, colleagues were able to guess which chapter she was on based on her attempts to emulate Mr. Jobs at different stages of his career.

There are at least two lessons from the Jobs story that Ms. Holmes would have benefited from learning.  First, CEO of Apple was not Mr. Jobs’s first role.  By the time he led Apple, he had served in other roles at Apple, Atari, and Pixar, as well as having founded NeXT, Inc.  Ms. Holmes shortcomings as a manager were apparent throughout the book and she most likely would’ve benefited from the humility and experience gained from working outside the C-suite.  Throughout the book Ms. Holmes comes across as a tyrant who managed through intimidation and ruthlessly eliminated any employee who tried to attenuate Ms. Holmes unrealistic expectations or call attention to her fraudulent business practices.  The second lesson is that Apple isn’t a technology company, a point often made by Rupal Bhansali of Ariel Investments.  Apple didn’t invent the integrated circuit chip or the MP3 format.  It achieved its success through innovative design, novel strategy, and superior marketing—not through any technological breakthrough.  Even Apple’s most distinctive feature, its operating system, was modeled after Xerox’s operating system (Bill Gates benefited from third-mover advantage when he then applied the model to IBM-compatible machines).  Ms. Holmes probably would’ve benefited from staying in school and acquiring the expertise necessary to achieve medical breakthroughs or at least listening to the experts who advised her to develop a minimally viable product instead of swinging for the fence with what was and still is a fictitious miracle machine that fits in a shoe box and can run hundreds of medical diagnostic tests with only a drop of blood.

A second theme in the tragedy involves Theranos’s ineffectual show pony board of directors.  Long on prestige and short on oversight and expertise, the list of directors included then General and future Secretary of Defense James Mattis, a Navy Admiral, and not one but two former Secretaries of State, George Shultz and Henry Kissinger.  Not only did their decades of experience in war and diplomacy, while laudable, have almost nothing to do with blood testing, their collective influence was negligible.  Mr. Carreyrou notes in the Epilogue that Ms. Holmes forced through a resolution giving her 100 votes per share, effectively 99.7 of the votes.  He quotes Secretary Shultz as saying, “’We never took any votes at Theranos.  It was pointless.  Elizabeth was going to decide whatever she decided.’”  Ms. Holmes contempt for corporate governance and board oversight came through in another story.  An interviewee asked Ms. Holmes about the board’s role, to which she shot back, “’The board is just a placeholder…I make all the decisions here.’”  The board failed to notice or act on, among other things, that Ms. Holmes appointed her boyfriend, a similarly flawed individual, as number two at the company.  In perhaps the only time the board came close to taking decisive action, four members of the board met to discuss Ms. Holmes’s financial projections that “weren’t grounded in reality” and were “impossible to reconcile with the unfinished state of the product.”  Having resolved to replace Ms. Holmes, the directors confronted Ms. Holmes.  Then in a two-hour bravura performance of deception and charm, a recurring theme throughout the book, Ms. Holmes convinced the directors that she should remain as CEO.  Mr. Carreyrou raises the question of potential sociopathy but defers to the psychologists for the final answer.  Regardless of the clinical diagnosis, there’s little question that Ms. Holmes was a master manipulator. The last theme that this author will address—also the most important and the one most overlooked in this debacle—was how Theranos flaunted regulation and used faulty equipment on patients without their informed consent.  Since the Nazi experiments on prisoners in during World War II, informed consent has been a core tenant of ethical medical practice.  Right now all over the U.S., researchers are pleading their case before human subjects review committees in order to get approval to use human subjects for experiments as mundane as surveying consumer preferences, yet Theranos was able to use untested and faulty equipment to conduct tests on medical patients, many with terminal conditions.  That last fact receives far too little attention.  What happened at Theranos wasn’t a tragedy—it was a crime.  The culprits should be held to account.