Starting Your Own RIA Firm (Part 2): Tips for Marketing and Business Development

Many talented professionals some day dream of having their own business. In the financial industry this usually means being the trusted advisor and investor on behalf of individuals and institutions. On October 4, CFA Society Chicago and its Professional Development Advisory Group assembled a panel to discuss the challenges of building an RIA business for the second part of the Starting Your Own RIA Firm series. The process of business development, brand development and marketing were addressed by the panel.

  • Jennifer Aronson, CFA: Aronson, moderator of the panel, is managing partner with Mosaic Fi, LLC. In that role, she works with family offices and high net-worth individuals. Prior to founding Mosaic, Aronson had over 20 years of experience with Northern Trust and Brinson Partners. She is currently serving on the Board of Directors for CFA Society Chicago for a three year term (2017-2020) and is a member of the CFA Women’s Network Advisory Group.
  • Scott Bosworth, CFA: Bosworth is vice president and regional manager in the Strategic Relationships group of Financial Advisor Services. He is responsible for sales, leadership and management of some of Dimensional’s larger advisory relationships.
  • Andy Kindler: Kindler is managing partner at Xcellero Leadership. Xcellero is focused on facilitating solutions for developing individuals, teams and organizations to spur growth. Kindler has a wealth of experience from different industries both on the corporate side and consulting.
  • Laura Sage: Sage is director of marketing and investor communications at Castle Creek Arbitrage, a relative value hedge fund. Prior to joining Castle Creek, Sage was an independent equity options trader.
  • Mark Toledo, CFA: Toledo has over 40 years of experience providing investment advice to individual and institutional investors. He began his career at Aetna Capital Management and after leaving Mesirow Financial in 2003, he founded Total Portfolio Management, LLC, his own RIA firm. In 2013 he merged his business with Chicago Partners Wealth Advisors.

 

Aronson began the discussion by asking the panel to address the critical tasks of marketing and business development for newly formed RIA firms.

Marketing and Business Development

The panelists agreed that as in any business, a business plan must be created, and that plan must include a path to an effective marketing strategy. The leader of the new advisory firm should spell out his role and have goals. A statement of investment philosophy is critical to the process. Advisors should focus on why they want to do this, what is their passion? You need to stick to your expertise and not try to be everything to anybody. It is important to be true to yourself and be able to tell your story. New RIA’s should attempt to have client meetings scheduled weekly and if you believe a prospective client’s needs are outside of your expertise, refer them to someone else. Client referrals will be critical to your success; often you will get a referral back. It would be useful for a new RIA to have a five-year plan where years one and two would be devoted to getting your story out; you will probably need to pay bills from some other source. Years three through five is when you can expect your business to ramp up.

Targeting Institutional Clients

The universe of potential institutional clients is much smaller. Sage was the panelist with the most experience in this arena. Most pension funds and sovereign wealth funds employ consultants. You will market to the consultant, not the fund directly. There are proprietary databases that contain information on these funds which can be accessed for a fee. There are other platforms similar to “speed dating”, which can gain you some introductions.

Methods to grow the business

  • Social Media: The use of social media is a critical skill to garner and keep clients. Retirees are ubiquitous on social media sites. LinkedIn is a site that can be helpful. Congratulate clients and potential clients on life-events they post online. Follow their work and offer assistance if there are sudden interruptions in their careers. They will remember you for it. A clear and concise website for your business is a must.
  • Referrals: Referrals are the way in which you will grow your business. A vast majority of clients would be happy to give you a referral, however not enough RIA’s ask for this. It is wise to spend time teaching your clients how to sell you. Don’t be shy about asking your client for a referral, however, you never want to put your client on the “spot”, be clear as to why you are asking for this.
  • Public Speaking: The panelists encouraged prospective RIA’s to burnish their public speaking skills. When you present yourself to other people, either publically of privately, be passionate about your expertise. It is important that you are able to communicate your conviction. You may suffer some setbacks, but show no fear in your demeanor. If you are able to keep your level of enthusiasm high, people will want to be part of your success. Clients are more motivated to put their trust in someone who can communicate vision and strategy with confidence.

There was a brief question and answer session with the audience at the end of program. There were inquiries on how to “close”, whether to remain independent or affiliate with an institution, and what functions to outsource. The panelists termed “closing” as the natural outcome of a positive meeting, once again there should be no fear in the “ask.” Typically affiliating with an institution is something that is done after establishing your business. Outsourcing functions can be expensive, but pay dividends down the road. You must look at your skill set to determine if some functions are better left to others.

 

Water’s Impact on Investing

On September 26th, CFA Society Chicago hosted a panel discussion in the Vault Room at 33 North LaSalle on the implications of the worldwide scarcity of potable water. The panel was focused on how this water scarcity may affect future investing. The lack of usable water is an “obvious” danger that does not garner a lot of attention at the moment.

The moderator and three panelists brought their perspectives to this worsening condition.

Michelle Wucker: Wucker, moderator of the panel, is a Guggenheim Fellow and founder of Gray Rhino & Company. A Gray Rhino as defined by Ms. Wucker is an obvious danger that many people ignore. Her expertise is in strategy, public policy and crisis management. She is the author of the book “The Gray Rhino:  How to Recognize and Act on the Obvious Danger We Ignore”.

Dr. Dinah Koehler: Koehler has primary responsibility for the overall product positioning and development of Sustainable Equity Strategies and ESG database development at UBS Asset Management. She is a recognized researcher on corporate sustainability.

Dr. Bruce Gockerman: Gockerman specializes in the use of cross disciplinary analytics to understand and address complex issues and environments. In addition to his consulting work, he is a faculty member at Illinois Tech Stuart School of Business.

Lauren Smart: Smart is Global Head Financial Institutions Business with Trucost. She is an expert in sustainable finance and has advised money managers on how to integrate climate change into investment decision making.

Wucker began the panel discussion by stating that the demand for portable water is forecast to continue to outstrip supply. Current thinking is that 1. By 2030 demand will be 40% more than supply, 2. By 2050 global GDP may be reduced by 6% due to this shortage and 3. 43% of corporate CEO’s believe that their businesses will be impacted by this looming shortage.

The first panelist to speak was Koehler who presented four slides that geographically mapped out an investment opportunity set based on global water risk. The slides included:

  • Global Water Risk Map
  • Investment Challenges
  • Negative Impacts of Investment
  • Opportunities for Impact by Geography.

The slides illustrated that the greatest investment opportunities are located in densely populated areas with scarce water resources.

In response to a question from the moderator, Koehler stated that at the moment, most financing for water investment is coming from the World Bank. She expects the private sector to be taking a bigger role.

Gockerman, the second panelist, stressed six points that he believed has worsened the supply/demand equation.

  1. Governance is very weak (mainly local)
  2. Pricing does not include the cost of water (infrastructure only).
  3. Under investment has led to a deteriorating infrastructure.
  4. Needed capital must be focused on the “resilience” of any infrastructure.
  5. Investing impacts must include addressing increasing risk.
  6. Resulting opportunities

Gockerman pointed to the recent hurricane flooding in Houston as illustrating a lack of resilient infrastructure. Investments need to be made into better pumps, advanced technology and better designed large scale projects. He suggested that perhaps a “Marshall Plan” that included public/private partnerships may be a solution.

In response to a question by the moderator, Gockerman stated that current federal policy is mainly derived from the Clean Water Act enacted in the early 70’s. He reiterated that there is a need for the entire system to be rebuilt and expanded.

Smart was the third panelist to speak. She focused on the impact of dwindling water resources on agriculture and energy. Water stress with respect to crop production was illustrated on a slide she presented. The ratio of water withdrawal to supply can exceed 80% in areas where critical crops such as wheat and corn are grown.

In another slide, Smart illustrated that the price of water in most countries does not reflect actual supply or cost. Cities in arid countries like Cairo and Jeddah have much lower prices for water than cities like Copenhagen or Atlanta. These prices do not reflect true cost, are heavily subsidized and cannot be sustained.

After the presentation, there was a question and answer session. Some of the questions revolved around how regional or national solutions may help. Would a regional grid like an electric utility be workable? This is probably not doable since water resources are divided up into different aquifers across the US. Gockerman stated the Great Lakes aquifer region would resist water being diverted out of its aquifer to other states. The panel seemed to agree that Water Bonds might be a good solution and could be funded by pension funds and foundations. Finally the panel was unanimous in stating that de-salinization was not the answer to any shortage as it is currently prohibitively expensive and energy intensive.

Vault Series: Doug Ramsey, CFA, CMT, The Leuthold Group, LLC

Playing the Market Melt-Up

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The CFA Society Chicago gathered in the Vault Room at 33 North LaSalle to hear Doug Ramsey, CFA of Leuthold Weeden Capital Management discuss the likely future direction of the equity market. Ramsey is the CIO of The Leuthold Group and co-portfolio manager of the Leuthold Core Investment Fund and Leuthold Global Fund. .

Ramsey is both a CFA charterholder and a Chartered Market Technician (“CMT”). Holders of the CMT have demonstrated expertise in the theory, practice and application of technical analysis. He maintains Leuthold’s proprietary Major Trend Index, a multi-factor model that utilizes mainly technical data. The model contains a long history of market data going back to 1930. The data and subsequent market behavior discussed in the Vault Room included data up to May 12th of this year.

The Major Trend Index is comprised of 130 indicators that roll-up into 5 categories. The categories are comprised of quantitative and qualitative factors that influence the direction of markets. A plus and minus figure is computed for each category and a ratio that includes all the data is computed. The Major Trend Index yielded a ratio of 1.14 as of May 12th,  a ratio over 1.00 is considered bullish.

The age of the current bull equity market has many speculating that the bull market is nearing an end. Ramsey spoke at length as to how his model can be used to forecast a market top. The Major Trend Index concludes that the current bull market has more room to run. He believes that the equity market sell-off in early 2016 has set the stage for another leg-up in the current bull market.

The model used by Ramsey uses seven (7) stock market indices to monitor the health of the equity market.  They are as follows:

  • Dow 65 Composite
  • Dow Transports
  • Dow Utilities
  • Russell 2000
  • S&P 500 Financials
  • S&P 500 Cyclicals
  • NYSE Advance/Decline Line

Negative performance in at least 5 of these 7 categories has foretold a market top. Ramsey characterizes a market top as a “lonely” one. The bull market is propelled at its end by only one or two sectors before a bear market begins.

DSC_3744Ramsey then spoke at some length about the market sell-off that occurred at the beginning of 2016 and its effect on the current bull market. In May of 2015 six (6) of the seven (7) categories were in negative territory which is a strong indication of a market top. The equity market was essentially flat in 2015 and the beginning of 2016 a market correction occurred. A bear market did not occur as the index only fell 14%, by definition a bear market does not begin before a 20% sell-off.

The fact that a bear market did not occur after the 2015 signal does not necessarily negate the usefulness of the model. The year 2015 coincided with a trough in corporate earnings and the market reflected that. Ramsey believes that the 14% pullback that occurred in early 2016 has given new life to the current bull market which in his opinion does not look to have reached its top.

Following his presentation Ramsey spoke with a group of attendees on a number of topics including:

  • Momentum investing works, investing in sectors or companies that have already experienced price appreciation can still yield profit.
  • Tech valuations are not in bubble territory. Several slides in his presentation illustrated the strong earnings that are now being realized by tech companies.
  • You can make an argument that low volatility (higher dividend)  stocks may have reached bubble territory since investors appear to be drawn to these.

Distinguished Speaker Series: Richard Driehaus, Driehaus Capital Management LLC

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The Distinguished Speaker Series hosted Richard H. Driehaus at the Metropolitan Club Oak Room on March 1st, 2017. Mr. Driehaus is founder, chief investment officer and chairman of Driehaus Capital Management LLC. In 2000 he was named to Barron’s “All-Century” team whose players were deemed the most influential in the mutual fund industry over the past 100 years. Mr. Driehaus aim was to divide his presentation into three sections: Early Years, Investing, and Industry Trends.

DSC_3548He began his presentation by referencing the difficulties his father had in developing a residential lot his family owned. Although his father had a steady paycheck as a mechanical engineer, he was not able to afford his goal of developing the land for his expanding family. Mr. Driehaus at that point began thinking about how he would make sure to achieve his goals.

When he was 13, Mr. Driehaus spotted the NYSE quotes in a local newspaper. DSC_3533When informed about what the NYSE quotes meant, he became fascinated and soon found that his calling was the investment industry.

Mr. Driehaus argues that the principals of Taoism are applicable to the stock market. Taoism stresses living in harmony with the universal laws of nature. Nature has given man both a creative and analytic side to his brain. You must be able to use both sides of your brain to understand the market.

Mr. Driehaus shared the following market insights:

  • Stock price will almost always never equal a company’s intrinsic value. The valuation process is flawed.
  • It is better to concentrate in sectors as certain sectors will have better outlooks than the market as a whole.
  • More money is made by buying high and selling higher (positive relative strength).
  • Hit home runs, not singles and avoid striking out (cut your losses).
  • High turnover reduces risk; take a series of small losses but not a big loss.
  • Standard deviation is a poor measure of investment risk.
  • The greatest long term risk is not having enough exposure to risk.

Mr. Driehaus emphasized that continuous observation is needed for investment analysis.  Knowledge gained must then be applied in the context of a rapidly changing environment. You must maintain belief in your core principles for the long-term to succeed.

DSC_3541Mr. Driehaus had the following observations of the industry and current equity market:

  • A 60/40 equity/bond allocation will not be aggressive enough for retirees due to longer life spans.
  • As inflation becomes hotter bonds will be less attractive than stocks.
  • Active managers have been losing assets due to the lower fees associated with indexing.
  • Meaningful alpha generation is not easy in this environment but still doable.
  • Active management will outperform when interest rates normalize as equity dispersion will be greater.
  • Expect a greater shift to international equities.

Following his presentation Mr. Driehaus fielded questions on a number of topics:

  • Investing in growth stocks allowed him to prove himself more quickly.
  • Hedge funds are paralyzed because they want safety; they are not taking on enough risk to differentiate themselves.
  • Look closely at volume when you’re thinking about selling one of your winners.
  • His philanthropy emphasizes that architecture is very important. Big box retail has killed a number of small communities and failed to protect the “sense of place”.

Starting Your Own RIA Firm

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Many talented professionals some day dream of having their own business. In the financial industry this usually means being the trusted advisor and investor on behalf of individuals and small businesses. The CFA Society Chicago and its Professional Development Advisory Group assembled a panel to offer insights for people who are considering exploring this possibility.  This panel of experts was composed of the following RIA professionals:

Jenifer Aronson, CFA – Ms. Aronson, moderator of the panel, is managing partner with Mosaic Fi, LLC. Ms. Aronson is a member of the Steering Committee for the CFA Women’s Advisory Group. She works with family offices and high net-worth individuals. Prior to Mosaic, Ms. Aronson has over 20 years of experience with Northern Trust and Brinson Partners.

Chris Abraham, CFA – Mr. Abraham is founder of CVA Investment Management. Prior to founding CVA, he held positions at Nuveen Investments, Anderson Tax, Mercer Investment Consulting, Intel Corporation, and Ariel Investments. Mr. Abraham left Ariel to found his own investment firm.

Gautam Dhingra, CFA – Mr. Dhingra founded High Pointe Capital Management. Prior to founding High Pointe he spent most of his career at Hewitt Associates. Mr. Dhingra has served as a Lecturer of Finance at Northwestern, Chairman of CFA Society Chicago, and on the Board of Regents for CFA Institute. Mr. Dhingra left Hewitt to found High Pointe.

Robert Finley, CFA, CFP – Mr. Finley is Principal of Virtue Asset Management. Prior to founding Virtue, he held positions in wealth management at LaSalle Bank and at TIAA-CREF’s Trust Department. Mr. Finley founded Virtue after leaving TIAA-CREF.

GJ King – Mr. King is President of RIA in a Box. Prior to RIA in a Box, Mr. King held positions at Goldman Sachs serving as an advisor to high net worth entrepreneurs, families, and foundations. RIA in a Box currently assists nearly 1,500 RIA’s in helping to overcome the compliance challenges of having your own RIA firm.

Ms. Aronson began the discussion by asking a series of questions of the panel members. Below is a list of those questions and the responses of the panel.

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Why did you start and what was your biggest concern about starting?

The panelists were certain that they could provide a better investing experience for their clients. The people they were recommending on behalf of their employers appeared to add little value. Their corporate jobs were becoming more demanding, but their salaries were not reflecting the added responsibilities. They expressed a fascination with the markets and a drive to obtain upper quartile performance for clients who would put their trust in them.

Their biggest concerns revolved around their families and the fact that they would not have a reliable paycheck for some time.

How did you develop your firm?

Panelists talked about a wide range of service providers that can be utilized. Interviewing managers and hiring the right legal help is critical. It is important to determine what fee structure will be needed given your costs. If you need a Bloomberg machine, that is a significant cost.  You can find firms that can provide all the services you need, or you can parcel it out.

What is a day in the life like?

The panelists stressed that there are two separate but critical roles, marketing and investing.  People with investing talent tend to spend too much time in that role. More time is needed in marketing which means finding potential clients amenable to your sales pitch. You must be able to separate cold leads from warm leads. Traveling is also essential to meet clients and evaluate companies you are thinking of investing in.

What questions should people ask themselves before starting an RIA?

Do you want to be an entrepreneur? You must be motivated to sell and be willing to hustle to accumulate assets. Has your family bought in? The few years will be difficult; can you handle the ups and downs? There is a leap of faith to leave an established firm.

What would you do different?

Look for partners, mentors and advisors, don’t be afraid to engage others. A trusted partner to share the burden would be a valuable asset. Don’t be afraid of compliance, but keep it lean. The client is trying to evaluate if he can trust you, you must be able to show responsible reporting and compliance.

What was your biggest surprise?

Institutions can be more short-sighted than individuals. Retail clients will be more loyal. The ups and downs were tougher than the panelists first thought they would be. People will be more helpful than you think. You must be disciplined in spotting bad deals and being able to say no.

How did you build your book?

The panelists stressed that you must be adept at marketing, or find someone who is. Friends, family, ex-colleagues, and people you have had relationships with over the past five years are potential clients. Walk-ins must be able to find you. How do you differentiate yourself from your competitors? If you have an edge in substance and style they will remember you. Can you get to the point where you can withstand a 50% hit in a bear market?

Current Market & Regulatory Environment

GJ King of RIA in a Box pointed to three regulations that directly impact this industry and that may see significant modification in the near future.

  1. DOL Fiduciary Rule. This rule will require that most advisors must be in a fiduciary role for their client. If implemented this should have little effect on RIA’s, but may be more disruptive to broker/dealers. This rule is facing delay and possible modification.
  2. Repeal of Dodd Frank. Modification may include that funds that previously were required to register with the SEC may be relieved of this burden.
  3. A new Form ADV will be required by October 1st. RIA’s will be required to reveal more about their company.

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Mr. King also spoke briefly about the need for a chief compliance officer (CCO) for every RIA firm. Typically the CCO is also the principal of the company. Companies with over $500 million in assets under management are required to have a full time CCO.

There was a brief Q&A session following the panel’s presentations that touched on the following topics:

  • CFAs are exempt from passing the Series 65 exam in Illinois.
  • Liability insurance is relatively cheap and does make sense.
  • Disgruntled clients can be avoided by doing quality control on prospective clients. Agree up front on what is expected of you.
  • Robo Advisors have not been disruptive to this industry. They have affected the brokerage industry.
  • Although the target market may be 60 years of age or above who have the most accumulated assets who are 60 years of age and above, do not leave their children out of the discussion as they are future clients.

Preserving Alpha through Successful Execution

Alpha is the ability to generate superior risk-adjusted returns compared to the return of an appropriate index. The purpose of most equity trades for managed portfolios is to hopefully create alpha for that portfolio. The hidden costs of not obtaining the best execution can destroy that alpha.

How does the trader know his trade is being treated fairly with respect to other trades being placed at the same time? Is the trade being shown to the right people? The SEC website lists 20 exchanges approved for securities trading. What drives the decision by a trader to use one exchange over another?

CFA Society Chicago’s Education Advisory Group hosted a panel discussion on insights on market structure in the equity market and how this structure affects equity trading today. The moderator was Michael Thompson, CFA. The panelists were Haim Bodek, Nanette Buziak and Larry Harris, CFA. Their backgrounds are as follows:

Michael Thompson, CFA – Mr. Thompson is a Partner and Head of Domestic Equity and Derivatives Trading for William Blair Investment Management. Mr. Thompson began his career in the late 1980s as a securities trader associate with Principal Financial.

dsc_3238Haim Bodek – Mr. Bodek is a Managing Principal of Decimus Capital Markets, LLC a tactical co nsulting and strategic advisory firm focused on high frequency trading (“HFT”) and U.S. equities market structure. Mr. Bodek is the author of two books on market structure and is known as a whistleblower that brought attention to the questionable practices of HFT.

Nanette Buziak – Ms. Buziak is Head of Equity Trading at Voya Investment Management. Ms. Buziak manages a team of equity traders and is responsible for all facets of equity trading and related operations at Voya.

Larry Harris, Ph.D., CFA – Dr. Harris holds the Fred V. Keenan Chair in Finance at the USC Marshall School of Business.  Dr. Harris addresses regulatory and practitioner issues in trading and investment management in his research and consulting.

Mr. Thompson began the panel discussion by briefly speaking about his background and introducing each panelist. Mr. Thompson provided a brief history of the changes in equity trading since the late 1980s. When Mr. Thompson began his career, there were only two exchanges and orders were brought to brokers who announced the bid or offer on the floor of the exchange. There were only two recognized equity markets, the NASDAQ and the New York Stock Exchange. By his estimate there are now 13 well known exchanges and 40 dark pools that can trade, with all trades done electronically. Each panelist made a brief presentation which is summarized below:

Dr. Larry Harris

  • The need for speed critical, you need to be the first in line for execution or the first to cancel if you don’t want to get hit.
  • A buyer grants a “put” option to the market and the market will move away from a buyer over time.
  • Brokers can hide orders or search for hidden orders. Dark pools will not show orders.
  • Limit trades often come with price discretion. Someone with a limit order of 23 might accept a price of 21; however this fact is not shared with everyone.
  • “Maker-taker” fee structures have become more common. The broker will typically extract a fee from the taker and rebate part of that fee in the form a liquidity rebate to the maker.

Haim Bodek

  • There are basically two worlds in equity trading, HFT and non-HFT. Firms that specialize in HFT exploit the structure of the market to take advantage.
  • HFT is not really a quant strategy.
  • The two biggest HFT firms paid substantial fines to the SEC in 2012 due to the work of Mr. Bodek in exposing the unfair advantage of firms using HFT when competing with traders not using HFT.
  • HFT comprises around 40% of equity volume and is still legal to use as long as those firms use proper disclosure.

Nanette Buziak.

  • Her team is composed of traders, analysts and portfolio managers who are all cognizant of trading costs. The team strives to limit the implicit costs of trading.
  • The average print size of an equity trade is around 217 shares; her typical trades at Voya are in the millions of shares.
  • Need to assess what venue is appropriate for what trade. Does the name trade in dark pools?
  • HFT is not an issue as long as she feels her positions are not compromised. Some venues can be more toxic than others.
  • Liquidity appears to be coming out of the market at this time since the dwindling amount of IPO’s are not able to replace firms lost to M&A.

There was a brief Q&A session following the panel’s presentations that touched on the following topics:

  • There was some frustration expressed on how slowly the SEC responds to complaints. Since the SEC must follow due process, it is up to institutions to do their own due diligences on these venues and brokers.
  • Firms that do large equity buybacks in many cases use minority brokers.
  • In assessing what algorithm to use when trading it’s important not to use those that are repeatable and can be used against you.
  • Voya’s portfolio managers know what names are not liquid and they will not build a large position in a thinly traded stock.

In response to where they see the market in 5 years, most participants felt there would be little change in that time. With the new administration, Dodd-Frank might be in jeopardy

Distinguished Speaker Series: Jeffrey W. Ubben, ValueAct Capital

Come so far…now the slog

dsc_3125CFA Society Chicago’s Distinguished Speaker Series hosted Jeffrey W. Ubben at the University Club. Mr. Ubben is Founder, Chief Executive Officer and Chief Investment Officer at ValueAct Capital. Prior to founding ValueAct, Mr. Ubben was a portfolio manager at Fidelity and a managing partner at Blum Capital. ValueAct is a hedge fund that invests in companies in fundamentally “good” businesses that are available at depressed valuations. The company typically manages 10-18 investments with total assets over $11 billion.

Although Mr. Ubben’ s hedge fund is located in San Francisco, he spent part of his life in the Chicago area and is a graduate of the Kellogg School MBA program at Northwestern University. His appearance at the University Club was in part a homecoming; his parents were in attendance.

Mr. Ubben began his presentation with three charts that chronicled the history of the debt and equity markets beginning in the late 1970’s to its current state. They were as follows:

  • “Corporate Equities to GDP”
  • “Governance Timeline”
  • “US Total Credit Market Debt as % of GDP”

The corporate equities and credit market charts illustrated the rapid growth of the equity and debt markets in comparison to GDP. Mr. Ubben blames “fed-induced financial engineering” for the outsize growth of debt.  Historically low interest rates have fanned these flames as companies have gotten a free pass to increase leverage. He lamented the thinking that stocks are the new bonds and feels that stocks are currently priced nearly to perfection. The “Governance Timeline” showed a history of shareholder activism beginning with hostile LBO’s in the late 1970’s to current attempts by shareholders to change the composition of target companies Board of Directors.

Mr. Ubben stated that value investors like him are attracted to what he termed “pain” experienced by many corporations. This “pain” eventually incents corporations to make decisions that will benefit shareholders. His examples of “no pain” were corporate deal making and lavish pay to CEO’s like Google’s Eric Schmidt.

Mr. Ubben briefly discussed three investments recently made by ValueAct in companies currently experiencing “pain”. These were positions in Rolls Royce, Morgan Stanley and Baker Hughes. In each case Mr. Ubben state briefly what attracted ValueAct and what changes were being made to secure a brighter future for each company. Perhaps this was the “slog” he alluded to in the title of his presentation.

The role ValueAct had in the removal of Steve Ballmer from Microsoft was also discussed. Mr. Ubben stated that he merely encouraged management to listen to its major shareholders opinion of Ballmer’s performance. In contrast, Mr. Ubben made mention of Jeffrey Immelt’s action in selling GE Capital’s multibillion dollar portfolio of real estate assets. GE’s share price has since improved markedly.

There was a lively question and answer session following the presentation. Mr. Ubben was questioned further about ValueAct’s investments. These included questions concerning Morgan Stanley, Valeant Pharmaceutical, Trinity Industries and Alliance Data.

ValueAct’s investment in Valeant Pharmaceuticals was one of which Mr. Ubben spoke at some length. He was quick to admit that this was an investment where ValueAct had taken its eye off the ball. They were instrumental in the CEO change that occurred in 2008 which brought in Michael Pearson. However, Pearson became very aggressive and this led to bad decision making.

Mr. Ubben reiterated his advice to go where there is dis-investment as this is a place where there are lower costs and lower volatility. It is important to measure the quality of any business versus its valuation. Despite many stocks and industries being priced to perfection, there are still parts of the market where opportunities can be found.

 

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Distinguished Speaker Series: Liz Ann Sonders, Charles Schwab & Co, Inc

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The Distinguished Speaker Series recently welcomed Liz Ann Sonders at the Metropolitan Club in the Willis Tower.  Ms. Sonders is currently Chair of the Investment Committee at Windhaven Management Inc., and is Senior Vice President and Chief Investment Strategist of Charles Schwab & Co, Inc.  Her responsibilities at Schwab include market analysis and interpreting economic trends for Schwab clients as they pertain to the equity market.

It is Ms. Sonders view that the following factors mostly favor this “unique” bull market:

  • Central bank policies have diverged with Japan and ECB leading the way in providing any perceived need for liquidity. The US central bank is not going down this path, but rather is looking for opportunities to tighten liquidity.
  • Due to the continued outperformance of the US economy, global economic indicators remain slightly positive. The level of pessimism remains high.
  • A generational shift toward higher savings as driven by the “great recession of 2007-2008” has muted the recovery.
  • The 5-year normalized P/E ratio reveals that the equity market’s value is only slightly above average. This metric is her preferred method of determining the richness of the equity market.
  • Corporate earnings hit a trough in the first quarter, but will recover for the remainder of the year.
  • Leading economic indicators do not lead to the conclusion that a recession looms in the near future.

Ms. Sonders claims the twitter hashtag #NoRecession as her idea; however it is far from “trending” and she does not expect that it will.  The level of pessimism concerning the future of the equity market can be compared to sentiment following the crash of 1987.  This is reflected in equity fund flows that remain negative for equities, making the market mostly reliant on corporate buybacks.

Inflation is something that might derail the bull, and per Ms. Sonders it should be on investors’ radar.  Commodity and wage pressure have not forced the Fed’s hand, however they are keen on attempting to normalize rates.  The velocity of money is most important and that has been slow to increase.  Ms. Sonders postulates that the Fed is driven more by the currency markets and the strength of the dollar may be more of an influence of the direction of the Fed.

Ms. Sonders also touched on the high amount of government debt now held by the US and how she thinks that is affecting the economy.  She stressed that high debt levels have led to low US growth and made the economy prone to mid-cycle slowdowns.  However, it has also served to dampen economic cycles on both the upside and the downside.

In her opening remarks Ms. Sonders referred to Martin Zweig and Sir John Templeton who helped shape her thoughts as an investor.  Sir John Templeton stated that bull markets mature on optimism and die on euphoria.  It appears that we have yet to reach the “optimism” stage.  Bull markets have never been killed by longevity.

In the Q&A session following the presentation Ms. Sonders commented on the following:

  • Gold is less an inflation hedge and is now being used more as an alternate currency. Some sovereign debt now has negative carry similar to gold.
  • Active strategies now have an advantage over passive investment strategies; there will be no reversion to a “nifty 50” as seen in the 1970’s.
  • Increased wages have implications for inflation; a September rate hike is not unrealistic.

CFA Society Chicago Company Presentation: AstraZeneca

DSC_2846The prospect of curing or even “containing” cancer has proven to be an elusive goal. One company that has recently joined the battle against this disease is AstraZeneca, a UK based Biopharmaceutical Company. On June 6th, CFA Society Chicago hosted a presentation by AstraZeneca given by Luke Miels, Executive Vice President Global Products and Portfolio Strategy. Mr. Miels outlined AstraZeneca’s going forward strategy and its plans to return to growth in 2017.

After a brief review of the company’s most recent acquisitions, Mr. Miels illustrated that an increase in research has yielded an increasing number of high-impact publications and Phase III trials of prospective breakthrough drugs. This increase in research and development has set the table for an acceleration of growth that is forecast to occur in 2017.

AstraZeneca will focus on three main therapy areas: Respiratory, Inflammation & Autoimmunity, Cardiovascular & Metabolic disease, and Oncology. There are currently 10 AstraZeneca drugs in late-stage development targeted to treat these diseases. The drugs he highlighted did not exist five years ago. Mr. Miels went on to describe five growth platforms that will support the three main therapy areas. These platforms currently represent 56% of AstraZeneca’s business.

For each of the three main therapy areas, Mr. Miels listed the existing or late-stage trial treatments, the evolution of the treatments and the areas for which the treatments are most profitable. It appears that AstraZeneca is having its greatest success in emerging markets and the EU. It has developed successful treatments for severe asthma and COPD (Beralizumab), a super-aspirin (Brilintal/Brilique) and a treatment for diabetes (Faxiga).

AstraZeneca is a relative newcomer to Oncology. There are new treatments in development for ovarian cancer (Lynparza) and lung cancer (Tagrisso). AstraZeneca intends to focus on tumor resistance, DNA damage response, Immuno-oncology and antibody conjugates in its fight against this terrible disease. The ovarian cancer and lung cancer treatments appear to be more effective for patients with DNA mutations that make them susceptible to these cancers.  Research is ongoing by multiple drug companies on what treatments might make the immune system be able to recognize and fight an invading cancer.

There were several questions posed to Mr. Miels following his presentation. They focused on patent expiration and generic drugs. One question focused on the manufacture of a drug after patent expiration. Mr. Miels stated that it still was cheaper for the company with the patent to manufacture the now generic drug; however there is little incentive for the company to do so.  Another question concerned the efficacy of a biologic generic drug.  Mr. Miels stated that generics of chemical drugs are exact copies, however due to the nature of its manufacturing; biologic drugs are never exact copies.

CFA Society Chicago Book Club:

While America Aged: How Pension Debts Ruined General Motors, Stopped the NYC Subways, Bankrupted San Diego, and Looms as the Next Financial Crisis by Roger Lowenstein

While America AgedThe specter of unfunded pension liabilities haunts many of our major cities and a large number of public companies. This is especially true in the city of Chicago as public unions continue to threaten to strike over benefits and unfunded pension liabilities. We discussed Roger Lowenstein’s book about this topic at a well-attended CFA Society Chicago Book Club meeting held in April. The book attempts to answer why the private pension system as conceived in the United States has failed.

Mr. Lowenstein divides his book into three parts. Each part addresses the pension crisis from the perspective of; a public company (General Motors), public service workers in New York, and the public service worker pension plan for the city of San Diego.

Part One: Who Owns General Motors?

The question asks whether it is the shareholders or workers who own a publicly traded company.  GM was one of the most successful companies in the world, however due to labor union gains at the bargaining table, its future cash flow would not accrue to its shareholders, but rather to its pension obligations.

This part of the book revolves around Walter Reuther and the UAW. Mr. Reuther became the visionary leader of the UAW in the 1930’s. In 1950 Mr. Reuther crafted what Fortune Magazine dubbed the “Treaty of Detroit”. It was a 5-year agreement which committed GM to guarantee a pension, wage increases with a cost of living formula and hospital and medical insurance at half cost. It was the inability to fund these ever-growing commitments which eventually led to the downfall of GM.

Part Two: The Public Freight

Pension plans for city workers help to guarantee a stable work force; a highly desirable trait for teachers, firemen and transportation workers. Reliable bus and train service is critical for the economy of a city. The second part of the book examines the history of wages and pensions for the public workers of New York City.

The most effective union leader was Michael Quill, an Irish immigrant who was a member of the IRA and fought in the rebellion against the British. In the 1930’s, the Transit Workers Union (“TWU”) was led by a coalition of Communists and former IRA activists. In 1937, Mr. Quill became President of the TWU. A 13-day strike in 1965 permanently changed the dynamic between the unions and the city. New Yorkers endured the worst traffic-jams in its history during this strike. The state government reacted by passing stricter laws prohibiting strikes by public workers. These laws were ignored as union leaders happily went to jail. The citizens of any municipality are captive customers and are unable to shop elsewhere for subway service or police protection.

Part Three: Debacle in San Diego

The risk that the government will put the expense of a pension plan onto future generations is illustrated by the city of San Diego. By the summer of 2005, the municipal pension fund in San Diego, the San Diego City Employees Retirement System (“SDCERS”) was underfunded by $1.7 billion. How it got that way is addressed in the third part of this book.

In 2005 the national press referred to San Diego as “Enron-by-the-Sea”. The cause of the underfunding was the extreme reluctance of local politicians to raise money by increasing taxes. The political climate in the city was very conservative with a mistrust of any tax. The city covered its cash shortfalls by continuing to avoid making the required pension contributions.

Labor unions in the city began to contribute heavily to political campaigns; this was more effective in San Diego which had a weak form of city government where a relatively small amount of votes could sway elections. In the end, public employee unions had political clout on par with business interests. City managers became more adept at structuring solutions which circumvented state laws regarding the required funding of SDCERS.

Conclusion: The Way Out?

The author has a few suggestions as to how to mitigate some of the risks endemic to these pension and health care schemes. However, most participants at the Book Club thought they were rather weak. The author is of the opinion that the 401K is not an adequate substitution for a pension and advocates a “national” 401K offering matching credits to lower wage earners. He also suggests that 401K providers be required to offer an annuity as a default option. The author ends the book with a plea to strengthen social security by raising taxes, an unpopular but perhaps necessary measure.

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