Oak Brook Progressive Networking Dinner

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On May 23rd, CFA Society Chicago held a progressive networking dinner at Maggiano’s Little Italy in Oak Brook.

A progressive networking dinner allows participants to meet people in a casual environment over good food and drinks. Dinner is split into three rounds; salad/appetizer, main course, and desert. Each participant is assigned a specific table for each round / course. Then over that course, each person has the opportunity to provide an introduction and background to their table mates. After each course the participants reassemble at different tables and sit with a new group. The setup allowed me to meet 15 people during the event.

Conversation at the various tables went quickly from introductions to a wide variety of topics. I shared my first course with a quant from a prop trading firm, a member of an independent financial advisory firm, and a credit underwriter. Conversation ranged from the potential effects of the Department of Labor’s Fiduciary Rule, while another table mate explained how and where to attract funds for a hedge fund that he was starting.

My second and third courses allowed me to meet a new set of individuals including an ETF portfolio manager, wealth manager, institutional asset allocation manager, and financial consultant. These conversations also went in a variety of directions; the nature and constraints that must be followed to build and run a completion fund, the rationale behind currency hedging global trading in the current market, and the Bears trade for the second pick in the recent draft. Consensus on the trade was that it was rich.

My straw poll as to the effectiveness of the event was overwhelmingly positive. The participants I spoke with appreciated the setting, which allowed for more in depth conversation, as well as discussions that involved all of their tablemates.

This event was one of several CFA Society Chicago events that are held in the suburbs each year. The central Oak Brook location allowed 25 people to attend from a variety of suburban locations.

Distinguished Speaker Series: Will McLean, CFA, Northwestern University

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The Endowment Model in a Low Return World

On January 24th the Distinguished Speaker Series held its first luncheon of the year welcoming one of our own, Will McLean, CFA. Mr. McLean is Vice President and Chief Investment Officer at Northwestern University, and is responsible for managing the University’s $9.7 billion endowment portfolio. Mr. McLean gave an engaging presentation to a sold out crowd over lunch at the W City Center.

Mr. McLean’s presentation centered on the challenges endowments face given the low expected return environment. McLean explained that Northwestern University follows the Yale Model of endowment investing. The Yale Model is an investment philosophy developed by David Swensen, the Yale University Chief Investment Officer. This model deviates from the traditional asset classes (stocks, bonds, and cash) and uses modern portfolio theory to invest in alternative and non-liquid assets in the form of private equity and hedge funds.

Mr. McLean laid out five principles used to manage the University’s portfolio:

  1. Diversification – this concept is straightforward. As a portfolio becomes more diversified there is typically less correlation, and the risk of the portfolio is reduced. McLean advised issues could arise if a portfolio becomes overly diversified. Excessive diversification spreads capital thinly and causes an excellent investment to impart a marginal influence on the total value of the portfolio. Over diversification could also cause investment standards to be lowered – when anything can be added to the portfolio, standards are more likely to loosened.
  2. Equity oriented portfolios need to provide a higher than average return. Given the makeup of the portfolio and the annual needs of the University, the expected return of the portfolio is in the 7-8% range.
  3. Take advantage of the illiquidity premium. The time horizon of the University’s portfolio is near perpetuity. Therefore, it is reasonable to invest in illiquid / inefficient markets.
  4. Use active managers – invest in stock pickers in the right markets. Northwestern’s investment management team and board of trustees believe active management adds value, and more uncertainty should be good for active management. Different asset classes offer different dispersions. It makes little sense to invest in the large cap equity space when the difference between the top and bottom quartile manager is not significant. Seek out alternative asset classes with bigger dispersions of returns.
  5. Ensure that your manager’s interests aligned with your own. When engaging in manager selection find out who owns the investment management firm that is under consideration. What is the owner’s motivation? McLean advised that it had been his experience that when a manager takes their firm public with an IPO, the manager’s performance underperforms. Their motivation changes from client enrichment to self-enrichment.

Due diligence should also take into account other aspects besides the manager’s performance record. Consider the internal split of management fees; do they flow to a select few individuals? How much career advancement is available to junior employees at the investment firm?  Are employees likely to be nurtured and grow or leave the firm? Negative answers to any of these questions the long-term viability of the manager to produce alpha.

DSC_3299Once his prepared remarks were concluded, Mr. McLean took a number of questions from the audience.

How do you manage board expectations of returns?

Many board members are former money managers, thus they are well versed in the risk vs. return dynamic, and they have rational market expectations.

How do you manage spending over bad returns?

There is a spending policy, which is a board level decision. The portion of the University budget funded by the endowment does not vary much from year to year.

Does Northwestern University take a view on asset allocation?

The University does not believe in market timing or tactical investing.

What is the thought process of the allocating AUM to the hedge fund asset class?

The University’s current allocation is for a 20% weighting to hedge funds. In general, 1/3 goes to long/short, and 2/3 goes to uncorrelated macro and market neutral strategies. Overall Northwestern University views hedge funds as an uncorrelated piece of the portfolio.

How does one incorporate human phycology / behavior into choosing an investment manager?

The University has a standardized approach for manager selection. Behavioral patterns at the manager firm are collected and evaluated. The manager selection team has been trained (by outside sources) to ask the right questions during the interview process, and to evaluate the manager’s non-verbal answers. Current and former employees are also interviewed for their points of view. Overall, you must train yourself to consider the all aspects of the manager’s answers and behavior.

Distinguished Speaker Series: Dr. David Kelly, CFA, J.P. Morgan Global Investment Management

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Dr. David, Kelly, CFA

Dr. David Kelly, CFA, the Chief Global strategist for J.P. Morgan Global Investment Management, provided his thoughts and views on investing in the current low/no rate environment.

Starting with a review of the U.S. economy Kelly noted that real GDP has grown just over 2% on average over the past five years. Under normal circumstances this level of growth is considered anemic, but the current slow and steady expansion is acceptable from Kelly’s point of view. Consumers are benefiting from low mortgages and gas prices, overall demand is growing, and banks are issuing more credit. Kelly considers this economy analogous to a healthy tortoise – it does not move swiftly, but it is steady. It is unrealistic for the U.S. economy to grow at historical levels (+3%) given the low unemployment rate, which from Kelly’s point of view is the biggest impediment to continued growth of the economy. Kelly believes that the sliding unemployment and labor participation rates are due to the aging population. Baby boomers comprise a large segment of the working population, the oldest of which became eligible for retirement in 2011. Boomers will of course will continue to retire, constraining the labor market, and helping the unemployment and participation rates to fall further. To combat the coming labor shortage Kelly suggested comprehensive immigration reform, bringing more people (workers) in to the U.S.  If immigration reform is not successful the unemployment rate could fall into the 3% range, constricting the economy to a growth rate under 2%.

Kelly believes that the Federal Reserve needs to raise rates in September. If this window were missed then the Fed would likely have to wait until December to not affect the November election. Further delays in raising the Fed Funds rate will make raising rates harder to do in the future – the Fed will be provided with more reasons for not raising rates, which will further undermine its credibility.

dsc_3084As of April 2016, 35% of all developed world government bonds had a yield below zero. Low global rates have helped lower U.S. interest rates. Global bond buyers looking for better yields have moved to U.S. denominated securities driving down domestic yields. However, Kelly suggested that rising rates in the U.S. could act a balloon to world bond rates. Given the current and projected fixed income market, Kelly suggested underweighting domestic and global fixed income until real rates reach a normalized range.

Turning to the equity markets Kelly believes the current equity market is still relatively cheap. Do to the expected rising rate environment the financial sector should be overweighed while the utility sector is expected to underperform. However, there is more upside outside of the U.S. equity market in Europe and the emerging market space.  These areas should outperform in the medium term based on stronger relative earnings. The current forward P/E of the S&P 500 is around 17x earnings, over the long-term average of 16x, while the MSCI EAFE forward P/E is at its long-term average.

Kelly took questions at the end of the presentation from several members from the audience. One individual asked “How best should a government sustain a countries economic growth?” Kelly’s answer was a bit surprising in that he focused on income inequality – the more there is, the less sustainable economic growth becomes. Kelly noted that most problems that create income inequality start with single parent families (SPF). In the 1980’s, 18% of households were SPF. As of this past year the SPF households number 42%, which from any number of perspectives is an alarming statistic.

CFA Society Chicago Euchre Tournament

20160303_180851_resizedOn March 3, more than 40 investment professionals joined CFA Society Chicago at Exchequer Restaurant and Pub for its first card tournament.

The evening brought out a diverse group including:

  • Over confident card players (after all, over confidence is a trademark of our profession isn’t it?).
  • Novices wanting to learn a new game while networking with peers.
  • Deal stealers? Yes, that’s part of the game.
  • Deck stackers? Probably were, but none were caught.

DSC_2623Throw in an open bar along with pizza and chicken wings (included in the price of admission) and what do you get? The CFA Chicago’s first Euchre tournament.

What exactly is Euchre? Euchre is a trick-taking card game most commonly played with four people in two partnerships with a deck of 24 standard playing cards. Euchre appears to have been introduced into the United States by the early German settlers in the Midwest. DSC_2621It has been more recently theorized that the game and its name derives from an eighteenth-century Alsatian card game named Juckerspiel. (From Wikipedia).

Euchre retains a strong following in some parts of the Midwest; especially in  Indiana, Iowa, Illinois, Ohio, Michigan, and Wisconsin. A survey of several players confirmed where they learned the game – typically from parents or relatives, or in college.

There were 19 teams that took part in a single elimination style tournament. The winners of the tournament were Hans Stege and Ankit Bhutada!DSC_2630

Looking to play? You can find bar sponsored leagues especially in the northern suburbs. Several players mentioned that they would partake in a periodic (semi-annual) Euchre tournament, so stay tuned for future tournaments.

Distinguished Speakers Series: Jason DeSena Trennert

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Jason Trennert – Strategas Research Partners LLC

Jason DeSena Trennert provided his thoughts, observations, and market predictions for 2016 to a sold out audience at the Standard Club on January 13th.

Trennert first addressed the drop in the market that coincided with the start of the year. He noted that historically the first weeks of January are generally a poor predictor of total year performance. He then addressed recent market commentary suggesting the United States is headed for a recession. There are three things that can create or cause a recession:

  • Inflation
  • Policy errors (think of the Japanese government raising taxes in 1988)
  • Exogenous events (oil embargo)

While not agreeing with current fiscal/monetary policy, Trennert did not consider the current policies so bad that they would push the country into recession, and with a current inflation rate around 5%, he found no reasonable catalyst for a 2016 recession. Trennert asked rhetorically why do people feel lousy and think the outlook in the near term is for a recession when we have; a continuing fall in unemployment, wage growth acceleration, and lower oil prices? The short answer is the 24 hour news cycle that focuses on the negative and unlikely (such as 2016 recession) instead of the longer-term view of expected growth.

Expanding his point of view on monetary and fiscal policy, Trennert pointed out an inefficient policy mix. Over the past eight years the Fed has used an easy monetary policy, while fiscal policy has been that of tight regulation brought on in large part by Dodd/Frank legislation. This combination has favored financial risk taking over economic risk taking or capital investment. In this period companies have received more credit for uses of cash that were more accretive (share repurchases and M&A) than they have for long-term investments like capex. Frequently changing government policies make long-term planning difficult.

Trennert 1Trennert also provided his thoughts on why the stock market will likely go up in the next few years. The number of companies listed on U.S exchanges has fallen from over 8,800 in 1997 to 5,300 in 2015. Simple supply and demand could provide the continuation of the rally of high-quality stocks. Today there are simply fewer stocks being chased by more dollars. Why aren’t more companies going public? Regulatory costs of being a public company along with the growth of the private equity industry could account for the relatively small number of companies deciding to go public.

The audience was given the opportunity to ask several, wide-ranging questions including; what is the best catalyst for continued growth? Trennert – Tax reform (an overall reduction in the tax code) would provide the biggest, most effective impact to growth in the economy. Tax code simplification would provide companies certainty with regard to long term investments which would help spur economic growth.

Distinguished Speaker Series: Dmitry Balyasny

Dmitry Balyasny, Managing Partner and Chief Investment Officer, provided an outline of his firm, Balyasny Asset Management (BAM), as well as thoughts on how a well-functioning hedge fund should be structured at a luncheon presentation hosted by CFA Society Chicago on September 10th, 2015.

Balyasny provided a summary of how he got his start in the business; beginning with trading short-term equity and futures, and later in a fund of funds analyst role. After a number of years of trading and fundamental analysis under his belt, Balyasny set up BAM in 2001. He happily advised BAM Atlas Global fund has never had a negative return since its inception (2002) and also noted that Atlas Global has a correlation with the S&P 500 since inception of .04.

Balyasny provided several tips on what it takes to build a good hedge fund complex, from returns to the overall culture, and include the following:

  1. Ensure that you have a low correlation index – Balyasny Dmitry headshot with tie 1consistently looks for uncorrelated managers; people that are doing different things (that add Sharpe).
  1. Promote a collaborative, partnership culture, and attract and retain talent through a culture of excellence.

According to Balyasny a good hedge fund is small to medium in size and has robust risk management separate from portfolio management, emphasizing sector specialization, and dynamic capital allocation.

How does BAM produce for their clients? Their source of alpha is primarily drawn from ideas – bottom up bets (big bets do not work). BAM generates alpha primarily from ideas, 87%, while sizing of the bet only accounts for 13% of alpha. Thus it is critical to have numerous good ideas.

Balyasny also noted that since the market is mostly efficient, alpha is typically acquired over a short period of time. Approximately 70% of BAM’s alpha is generated within four months of purchase; 44% in less than one month, and 26% in one to three months. Thus BAM turns over their portfolios frequently in an effort to generate alpha. The BAM model focuses on the short-term as they believe it is difficult to look out years into the future and have expectations hold.

Balyasny finished the discussion by answering several questions including an interesting question regarding fee compression in the hedge fund market. Balyasny thought it strange that nearly all hedge fund products are priced the same, the 2 and 20 model. “Either they are too expensive, they are not providing alpha, or they are too cheap.” Balyasny noted that BAM’s pricing structure pushes past the 2 and 20 to a higher level because of their delivery of alpha and in an effort to remain small.

Hey! They’re Raising the Price of the Free Lunch

On May 21st, Tad Rivelle gave a presentation over lunch at the Chicago Club.  The subject “Hey! They’re Raising the Price of the Free Lunch” revolved around on how interest rate increases and deleveraging will affect the economy, capital markets, and the investor class.

Mr. Rivelle is the Chief Investment Officer, Fixed Income for the TCW and MetWest Fund brands.

Tad started his discussion noting that too much thought and weight are given to next word or phrase that is added or eliminated from Fed pronouncements and minutes.  Instead, more time and thought should be applied to considering the overall policy and climate that it is applied in. The stage and length of the business and market cycle are also of great importance; “Identify those variables that drive the cycle, as opposed to those variables that are driven by the cycle.”

Tad described a traditional cycle in which business overproduction leads to layoffs and excessive growth rates push inflation higher.  Historically central banks have then stepped in to lessen the effect of the cycle by using monetary policy to slow the economy.  Tad suggested that this cycle is different as the inventory cycle has largely been eliminated with more efficient supply chain management and the current cycle has been fueled with cheap credit and quantitative easing (QE) programs.  These include several rounds of QE initiated by our own central bank, Abenomics in Japan, and now the ECB’s version of QE in Europe.  What then will kill the current cycle?  Expanding credit past reasonable levels and the resulting debt service hitting a tipping point (usually unseen) will push the current cycle to recession.

One of the problems with all of the recent QE programs is that they are designed to only “fix” one problem, while the capital markets commonly believe that these programs can remedy an assortment of problems; stagnant wages, slow growth, inflation/deflation, and suppress volatility.  At its core, a QE program is a credit centric growth model structured to enhance near-term growth at a cost of building up a stock of bad loans and malinvestments (badly allocated business investments, due to artificially low cost of credit and an unsustainable increase in the money supply).  These bad loans will end a cycle and the central bank, using the tools at hand, will not be able to stave off a market correction.  In simple terms QE was designed to promote cheap credit and the efficient allocation of resources.  Substantially QE has changed the allocation of loanable funds.  Cheap capital has been pushed to unproductive endeavors while capital is rationed to more productive business oriented endeavors.

The current QE program in Europe is one that promotes inflation and a weaker currency.  The ECB will likely succeed by “importing” growth and economic activity.  A tangent result will be that as Europe imports growth, they will also “export” deflation to the U.S.

While the intent of QE programs has merit, their effects have been and will continue to be problematic.  In the United States, GDP and inflation were both supposed to rise – they haven’t.  In Europe and Japan growth prospects are stagnant to recessionary.  Mexico and Canada (our largest trading partners) are in an economic slowdown.  There is a recession in Brazil, depression in Russia.  China’s growth is at a 25-year low, and global disinflation has continued unabated.

Tad provided some conclusions; he expects a flattening yield curve, which foreshadows an economic slowdown.  The Fed, with its expanded balance sheet, will not be able to maneuver in an economic decline.  If the Fed carries out on its promise to renormalize or raise rates, then risk assets will suffer and marginal borrowers will be crowded out by higher rates.

So then how should one position themselves in the market?  Tad recommended playing defense with risk assets, under weighting airline, bank, and utility debt, and strong underweight high yield and bank loans.  Overweight; non-agency MBS (ongoing de-leveraging of senior tranches limits downside risk), CMBS / ABS (the capital structure of CMBS are reasonably valued).

Tad concluded the presentation by taking questions.  One member of the audience asked Tad to comment on the muni bond market and in particular his view of the Illinois and California public debt problem.  Tad’s answer was brief, but perhaps a relief to an audience of Illinois residents as he saw no obvious catalyst to bring the current public debt problem to a head.

Distinguished Speakers Series: Barry Sternlicht

Distinguished Speakers Series: Barry Sternlicht

Distinguished Speakers Series: Barry Sternlicht

Barry Sternlicht was the featured guest at the Distinguished Speakers Series held on Nov. 21 at the Standard Club.  Sternlicht is the Chairman & Chief Executive Officer of Starwood Capital Group, a private investment firm he formed in 1991 focusing on global real estate, hotel management, oil and gas, energy infrastructure, and securities trading.

Using an inordinate number of slides Sternlicht gave a sweeping account of just about everything that related to the global economy.  His remarks covered a range of investment topics including; the domestic housing market, New York City property prices, currencies, quantitative easing, oil prices, global real estate valuations, and the 2015 outlook for the U.S. and global markets.

A subset of Sternlicht’s presentation comments included:

  • The top 1% are getting richer in all markets. This subgroup of the investing population is no longer willing to solely invest in domestic or global markets.  Instead, these investors are now buying up real assets in prime locations – South Americans investing in Miami, Asians investing in New York, Russians investing in London, etc.  These global buyers are pushing higher purchase prices in these ‘world class’ cities.  As a result, buyers looking for reasonably priced real estate will have to look to ‘second tier’ cities.
  • The U.S. government deficit will continue to grow despite the spending bill passed at the start of 2014. Entitlements – Medicare, Medicaid, and Social Security will increase the deficit dramatically over the next decade.  To combat this the retirement age will be raised, and benefits will be reduced.
  • The movement of populations from high tax states to low tax states will accelerate as more baby boomers retire. This will drive real estate growth in those low tax states and provide for slow or even negative growth in high tax states.
  • Growth in retail rents is and will continue to be bifurcated. Luxury retail malls will continue to outperform in terms of high occupancy rates, and growth in rents.  Properties that are not at the A level will likely exhibit slow or flat growth in rents.
  • The Euro zone and Japan will institute their own form of quantitative easing. This will cause the dollar to rise against the Euro and Yen.  The U.S. has promoted a weaker currency over the past several years with lower interest rates and growth in the money supply.  The stagnating economies in Europe and Japan will push policy makers to weaken their own currencies in an attempt to reflate their respective economies with increased exports.  Even so, a greater currency war will be fought over the next several years with many nations fighting to have a weaker currency.
  • The Federal Reserve will keep interest rates lower for a longer period due to a lack of any inflation on the horizon and lower energy prices. In addition U.S. yields are higher than in Europe and Japan, which will cause flows into the U.S. market, keeping the long end of the curve depressed.

Sternlicht ended his presentation by taking questions from the audience and sharing details of his latest hotel and apartment project – the ultra-luxury Baccarat Hotels and Resorts development in midtown Manhattan.  This development underscored several of the points Sternlicht made earlier – premium properties commanding outsized rents, and investing in world-class cities for outsized returns.