Fintech Part 1: Blockchains – Disruptor, Panacea, and Reality

CFA Society Chicago hosted Blockchains – Disruptor, Panacea, and Reality, the first fintech event of a three-part series, focusing on blockchain technology and its applications. The event was held at The Chicago Club on January 17, 2018, attracting a sold-out crowd of over 200 people. The afternoon started with a keynote address and was followed by a panel discussion with industry members working in the crypto space. Those in attendance participated in Q&A session at the end of the event.

Keynote Address

Wulf Kaal, the event’s keynote speaker and moderator, is director of the University Of St. Thomas Private Investment Fund Institute, a tenured associate professor of law at UST School of Law, a leading expert on hedge fund regulation in US and EU, and an industry expert in the cryptocurrency space. He initiated the event by gauging the audience knowledge and involvement within the crypto space, introduced blockchain technology and outlined the following event agenda:

  • Blockchain Technology
  • Smart Contracts
  • ICO Market – Best fundraising for start-ups
  • Case Study – Blockchain in Loan Industry
  • Panel Discussion
  • Q&A session

Kaal then continued to highlight the magnitude of growth possibilities within the crypto space. He displayed past year price data for Ethereum and Bitcoin (two of the most famous cryptocurrencies) and emphasized the fact that what has been seen to date can be thought of as linear growth and that exponental growth is expected by the industry. He also shared four years of ICO related market data showing a total fund raising of $6.4bn to date.

Kaal discussed how some market participants regard the rise of blockchain as a bubble; some audience participants share the same view. He went on to educate the audience with the crypto space, blockchain technology and its application beyond the talk-of-the-town cryptocurrencies like Bitcoin and Ethereum.

He described the core characteristics of people believing in the crypto space. The following key characteristics describe a “Crypto Purist”, such as himself:

  • Believes in crypto space
  • Believes in decentralization
  • Believes in a New Economy – a new way of thinking

Moving on, Kaal educated the audience on blockchain technology stating that it is similar to “having an internet” like event. With “Code being the Law”, blockchain technology is self-executing. It is a decentralized public ledger where each block (or node) in the chain can be thought of as a sheet with the footprint of a previous page along with its information. Blockchain could be referred to as a peer-to-peer (P2P) network based upon “Trust” and “Disintermediation” with a copy of the ledger stored in different computers all over the world. The result would be a transparent decentralized economy. Constant additions to the blocks in the chain would require higher computing power to modify past blocks/nodes making it difficult or next to impossible to cheat/hack this system. Lacking scalability in applications at the moment, Kaal believes that whoever can figure out a way to apply blockchain technology to enterprise facing solutions will be the next “Google” of today.

By not being physical in nature and anonymous over VPNs (Virtual Private Networks), the use of blockchain ledger faces issues concerning lack of legal remedies and/or recourse in contrast to what we have today with internet related solutions. However, legal groundwork is being carried out to deal with such issues.

Continuing the discussion on law and blockchain, Kaal geared the discussion towards Smart Contracts which are self-regulating and self-executing contractual obligations. These contracts are inexpensive, automated by code, take only minutes to execute and have automatic remittance versus 1-3 days for traditional contract execution at a comparatively higher price with manual remittance. This reduces the need for lawyers due to the nature of the contract. When a smart contract is coded, it will end with an execution and cannot be stopped by either party. However, this could lead to some issues where unexpected circumstances occur in normal business transactions requiring flexibility from parties to the transaction. Kaal also briefly touched upon the different use cases of smart contracts with varying level of complexities. The industry expects banks to spend heavily in blockchain based solutions in the coming years. He predicted that settlements may very well happen one day using this technology platform.

Kaal then steered the focus towards the funding landscape within the crypto world. He discussed venture capital interest funding blockchain based start-ups in various industries ranging widely from Finance, Government, Consumer and Media. Next, he touched upon ICOs (Initial Coin Offerings) and how they stack up against traditional Venture Capital and crowdfunding sources in characteristics for start-up funding. Kaal shared market data on how since September 2016, Ethereum was the most popular blockchain for ICOs’ assets globally. The US leads the industry with the highest number of crypto start-ups globally followed by Europe and Asia. Russia on the other hand is leading in government support for the overall technology platform with state funded academy formation and by creating a more favorable regulatory environment than the US.

Proceeding to the next agenda item for the evening, the Kaal discussed a blockchain case study of a Loan Securitization. He compared the blockchain process to the existing loan securitization process and identified the following key benefits of the former:

  • Lower costs
  • Increased Safety
  • Faster Payment Streams
  • Rise in trading volume

Panel Discussion

The second half of the evening featured a panel discussion moderated by Wulf Kaal with speakers Colleen Sullivan, Zabrina Smith and Biju Kulathakal. Each of the panelists introduced themselves and discussed how they engage with the crypto space for their clients.

Colleen Sullivan is co-founder and managing member of Sullivan Wolf Kailus LLC, a boutique law firm based in Chicago that specializes in hedge fund, private equity, venture capital, digital assets and other alternative investment products. She discussed blockchain from a legal standpoint clarifying that ground reality for the regulatory environment is very different than what has been observed in the media. She recalled being present in South Korea when a reported surprise government “crackdown” on the crypto exchanges was merely an examination by Korean tax authorities on the tax implications of the crypto exchanges. She noted that governments are looking to exchanges to self-regulate in these unchartered territories.

Furthermore, Sullivan discussed various cases she has been working on for legal solutions around asset servicing, asset management and wealth management. Her firm has been leveraging blockchain technology for asset safety of their clients, efficient transactional authority and transparency, proof of value assessments, etc.

Next, Zabrina Smith, vice president within Northern Trust’s Market Advocacy & Innovation Research (MA&IP) team, introduced herself and described how she was working on researching ways to incorporate block chain technology to add value for global clients. Her team has been working with use cases around contracts, wealth management and other creative uses within the organization to add value and/or improve existing customer solutions. Northern Trust has been proactive in trying to apply the technology and has been working in the space as a pioneer to bring better solutions to its customers.

Finally the last panelist, Biju Kulathakal, founder of Halo Investing – first independent multi-issuer technology platform, introduced himself and described how his organization utilizes the blockchain technology for structured loans with options contracts. Halo Investing packages products from sellers like JP Morgan, Credit Suisse, and Goldman Sachs, and sells it to advisors like Schwab and others.

He presented an example of a typical transaction based on blockchain to illustrate the potential benefits like less documentation, quicker execution, lower costs and flexible issuance sizes when compared to traditional structured notes.

Q&A Session

The session continued with questions from audience noted below:

Implications/application of blockchain for lending securities?
Blockchain can leverage various functions including the following aspects of securities lending:
• Digital Identity; and/or
• Settlements (similar to implementation by Australian Stock Exchange)

Implications of blockchain for auditors?
Blockchain could be applied to automate life cycle processes reducing overall audit times and increasing efficiency for the whole process.

Benefits of leveraging blockchain technology to CDS contracts?
Blockchain based CDS contracts would be expected to be of a lower cost as no counterparty would be maintaining a ledger.

Implications of blockchain on access to asset classes?
By being able to sell part of assets, blockchain implementation would lead to increased access to assets which would otherwise be known as ‘Exotics’.

Implications for Visa systems?
Viewing Visa as a huge notary, blockchain could result in reduced visa costs.

Where blockchain would not be a viable technology?
Blockchain would not be viable where actual enforcement is required, for example policing etc.

Distinguished Speaker Series: Brian Singer, CFA, William Blair

CFA Society Chicago hosted Brain Singer, CFA, on July 19, 2017 at The Standard Club to present on the topic – Riding the Waves: Dynamic Asset Allocation (DAA) and Evolution of Top-Down Investing.

Singer is the head of the Dynamic Allocation Strategies team and a portfolio manager at William Blair where he shares responsibility for strategy setting and portfolio construction across all DAS portfolios. He serves on the endowment investment committee for Exeter College at Oxford University and on Rehabilitation Institute of Chicago Foundation’s board. He is also the chairman of the “Free to Choose Network.”

In 2015, Singer received CFA Institute’s Distinguished Service Award and has formerly served as a board member and chair of the CFA Institute board of governors. He has written extensively on global portfolio, currency, and performance issues. In 2015, he was also inducted into the Performance and Risk Management Hall of Fame by The Spaulding Group.

While the hot debate of traditional active vs. passive consumes most talks in the investment industry, Singer focused on the other leg of liquid investment strategies, Liquid Alternative Investing. He focused his presentation on the following four broad strategies:

  • Risk Parity;
  • Smart Beta;
  • Risk Premia; and
  • Active currency.

Quest for a superior investment strategy has given birth to many new ideas and terms that have changed the investment landscape as it was known two decades ago. After the advent of efficient market hypothesis and rise of CAPM, we now live in the world of smart beta and where CAPM is seen as dead by many. However, Singer believes CAPM is not all that dead. He advised to consider long-term horizons rather than the short-term when evaluating the relevance of CAPM as his initial remarks. He expressed how Modern Portfolio Theory post financial crisis has been seen as wounded where risks are known to be non-static and non-symmetric and that tail size does matter. He recommends focusing on the Macro investing models with dynamic allocation strategies for dealing with systematic risks in line with return expectations.

He re-iterated validity of CAPM while discussing risk parity strategies from a passive (35% Global Equity – 65% Global Fixed Income) and an active (traditional asset allocation) standpoint.

He also presented how the understanding of betas and alpha in the pre and post CAPM world has changed. In the advent of Smart Beta – Systematized Alpha, he cautioned against considering it as a free lunch and discussed smart beta strategies. He noted that such strategies aim at exploiting “Persistent” systematic risks following an auto-pilot strategy. He also cautioned against them as being static in nature relying on back tested rule sets. Further along in the presentation, he explained how such narrow rule sets can bring about volatility and fragility in the investment process and later provided recommendations to overcome such issues.

While discussing the risk premia strategy, Singer stressed on macro diversification based on fundamentals with a long term focus. For the short term, he advised to utilize unique rule set disciplines to navigate a dynamic path and ignore the media ripples which tend to make investment management process more fragile. He explained differing strategies using an example of a village at the foot of a mountain facing the risk of an avalanche taking extreme actions such as complete evacuation of the area vs. building fences to contain the snow to tackle the risk. He discussed different strategies to cope with risks faced in the investment world based on narrow vs. broad rule sets and impact of such rule sets on the overall investment process and asset allocation.

The speaker also spent a fair amount of time to share the active currency investment strategy. Despite not being an asset class, Singer explained that active currency investment is an effective alternative investment strategy as correlation of passive and active currency with assets is very low. He noted that currencies tend to converge to equilibrium prices (using PPP and IRP) faster (average of ~4-5 years) compared to assets (average of ~8-10 years). He presented varying half-life of currencies and asset classes along with correlation of USD index with monthly MSCI returns being as low as 30%.

He shared his Antifragile Investment Process methodology consisting of identifying and assessing opportunities of value to price discrepancies and designing portfolios with integrated risk exposures. He noted that such investment processes are dynamic, imperfect, progressive and make use of evolving tool set stating it to be analogous to growth of a living organism.

Singer also shared the idea of forming an Antifragile Investment Team for which “cognitive diversity” is key as he believes such team resources back multiple ideas using “wisdom-of-crowd framework” for survival. Such teams work continually to Research, Implement, Perform and Review numerous ideas as opposed to fragile teams which resources back few ideas that cannot afford dismissal.

He concluded by making a recommendation to identify market inefficiencies as dynamic investment opportunities stating: “There needs to be a level of market inefficiency to have market efficiency”. He again stressed on following wider rule sets for asset allocation decisions for a less fragile investment process.

At the end of the presentation he commented on the following questions from the audience:

Big Geo-Political risks to consider

  1. Domestic to US – Impact of proposed regulatory changes to Volcker Rule which may cause tail risk.
  2. International – Follow European Union market especially outcomes of the Italian Election and monitor the risk of national banks going bankrupt.

How to tackle Behavioral Risk?

  1. Incorporate it in Risk Premium.
  2. Since behaviors cannot be predicted, focus on identifying significant behavioral shifts – both frequency and magnitude of signature behavioral shifts.

Near term opportunities in Active Currency

  1. Short on Developed market currencies including USD (currently expensive).
  2. Long on Emerging market currencies.

CFA Society Chicago Candidate Mix & Mingle

stress-391659_1920With every passing day the CFA exam gets near and candidate stress levels rise. What could help? A free event with an open bar, appetizers and pizza! CFA Society Chicago organized an event on March 29th at Hotel Allegro where candidates poured in to relax and network with their peers. They discussed what was and what was not working for them (in hopes to hear similar stories for affirmation that they are not alone!).

Kaplan Schweser, co-host of the event, sponsored a raffle prize of their Review Workshop to a candidate which was awarded to Kevin Anderson. Bijesh Toila, Lecturer at Kaplan Schweser, was sharing his wisdom helping out candidates with any concerns they had and getting feedback on study materials. He views his organization’s partnership with CFA Society Chicago to be a success and looks forward to strengthening it. The Society’s organizing committee members and executives joined the event for moral support of candidates.

We wish all the candidates best of luck on their upcoming exam and wish them success on the path to obtaining their charter!