Industry Roundtables

On September 12th, CFA Society Chicago hosted its Industry Roundtables event at The Chicago Club. There were ten tables that focused on different sectors of the investment industry and participants chose three topics they wanted to learn more about. Each round lasted 30 minutes and gave attendees the opportunity to engage in face-to-face interaction with colleagues in a small group setting. Here’s a recap  by Richard Schiller, CFA, Rida Iqbal, and Susan Zeeb of some of the featured tables!

Equity Research: RJ Bukovac, CFA, CPA – Partner & Equity Research Analyst, William Blair

Bukovac is a partner and equity research analyst at William Blair focusing on Large and Mid-Cap US consumer companies. His team focuses on tech companies like Amazon, Tesla, Facebook, Netflix etc. They focus on market share value add against alternatives. Bukovac highlighted some of the qualities that are required for this nature of work:

  • Knowledgeable – Understand Accounting & Finance;
  • Inquisitive – to add value on top of management forecast;
  • Risk-taker – Willing to take a risk and bet on the company’s performance;
  • Convincing – Ability to sell it to clients to take investment actions.

He briefly discussed Netflix valuations in response to table participant inquiries which enabled him to demonstrate the everyday work challenges.

 

Fintech: Jim Daley, CEBS, CFA, CFP® – Project Manager, Morningstar

Fintech is one of the most popular discussions in the industry but also a very broad one that further understanding by the market participants. Jim Daley, CFA, shared his experience working for the Retirement Planning team at Morningstar. He was associated with Ibbotson Associates and continued to work with Morningstar as a project manager after Morningstar’s acquisition of Ibbotson Associates.

Daley introduced the table participants on basic branches of Fintech: Block Chain; AI Lending; and Machine Learning. He emphasized on the efforts in this area and that CFA Society Chicago is planning a series of events on the topic and how this is becoming a part of the CFA curriculum.

Daley is engaged in the retirement planning platform which is based on robo-advisor model which serves retirement planning (401K plans) by automating the investment strategies for discretionary plans like savings plan allocation of funds, quarterly rebalancing etc. This platform is capable of deploying both active and passive investment strategies. He explained how the traditional process of investment strategies has eliminated a sizeable amount of human interaction which now is only needed to review fund portfolios. Although Morningstar is currently offering a very limited Fintech related service, this current robo-advisor model could be replicated and expanded to Morningstar IRA planning accounts and retail. Fintech appeals to an age group of 30+ with some accumulated assets but the scope is growing constantly as people develop a greater understanding of how Fintech can serve the markets. Daley noted that Programming/Developing Languages, Statistics and Product Management skills are highly sought for in this area of industry and people with Engineering backgrounds and knowledge of C++, R, Python may do well in this field.

 

Fixed Income – Research: Rick Tauber, CFA, CPA – Senior Vice President, Morningstar

Tauber described his experience for the group which included roles as general credit analyst, high yield analyst, bank loan analyst, private placement analyst, and corporate bond analyst.  He explained how his role at Morningstar evolved from credit research to the corporate bond rating agency at the firm where he also covers industrials and manages the corporate team.

Tauber explained the different dynamics between buy side research, sell side research and agency research. Fixed income research on the buy side is usually team focused and the client is the portfolio manager/trader. Sell side fixed Income research is marketing and publishing oriented, with the client being buy side bond investors. Agency research is highly regulated with no conflict of interest as ratings are unsolicited, uses a committee process and is focused on the filing documents. Tauber explained the different research techniques between hedge funds and long-term investors, where hedge funds would be potentially looking for short-term volatility trades such as capital structure arbitrage trades or bond issue covenant violation trades. Long-term bond investors would focus more on long term fundamentals of the bond issuer and where the bond could potentially move if it was upgraded, for example.

He was asked if quantitative analysis methods were used in his position and he noted that Morningstar’s corporate credit uses four pillars to evaluate credits including business risk (which includes Morningstar’s Economic Moat analysis), a cash flow cushion, a solvency score, and distance to default. Tauber noted that the analysts conduct due diligence interviews with companies that issue bonds.

 

Investment Consulting: Chris Caparelli, CFA – Vice President, Marquette Associates

Caparelli has 9 years of investment consulting experience serving primary consultant on several client relationships. His company is mid-sized with 50bn in AUM with 80% clients in the Midwest and competes with companies like Mercer, Aon etc. He discussed the structure of his organization with distinguished fee structures as being contract based retainer fee as against the popular performance based fee.

He pointed out that apart from research and analytical skills, sales and marketing skills are effective in dealing with clients and more of a consultant’s time is spent on such activities as the individual progresses. He discussed his day to day activities including quarterly client meetings, manager selection process etc. He advised the table participants to read extensively and to focus on behavioral finance for self-correction and client correction/dealing to be successful in this field.

 

Manager Due Diligence: Daniel Harris, CFA – Principal, Borealis Strategic Capital Partners, LLC

Harris reviewed his background in the investment consulting, fund of funds, and manager due diligence segments. His current firm is focused on providing seed capital to top tier, early stage investment talent in return for direct economic participation in their growth and success. Harris led a discussion of the hedge fund industry and manager due diligence. He noted that manager due diligence includes reference checks of managers/teams, a thorough track record analysis, and several interviews with managers/teams. It is very important to have an aligned fee structure at the outset and that managers should know their operational level or break even AUM (assets under management). He also noted that it is somewhat more difficult to evaluate quantitative managers but he would focus on their R&D efforts, or what the next alpha signal will be, for example. There are typically several warning signs that put managers on watch lists, including team turnover, AUM size (too big for the strategy), distrust issues, and knowing the reason that managers have sold their business, either to cash out or to get working capital to growth the business.

Harris said that 3 year performance track records are very important and are typical minimums for foundations and endowments for example. Patience is also required. His firm will help hire a CFO and investor relations person if necessary. A manager should also typically have personal money invested in the strategy and/or a large percentage of his net worth in the business, which speaks volumes in terms of alignment incentives. Harris noted that one skill required in manager due diligence is diligent note taking; logging all notes and discussions with individuals and in background interviews. Manager due diligence also includes networking within the industry.

 

Real Estate:  Jimmy Georgantas, CFA, CPA – Assistant Vice President, Asset Management, Boyd Watterson

Boyd Watterson is an asset management firm with a real estate portfolio invested primarily in office assets with over $2.0B in total assets. Boyd operates through three funds with the largest holding $1.5B, or 75% of total real estate assets under management. After a round of introductions, our roundtable discussion started with disruptions that we’re seeing in the real estate market. What many think of as a stable, low volatility, technology-light asset class, real estate is actually being massively impacted by technology. Companies offering shared office space such as WeWork, TechSpace, and Regus are taking large blocks of space in the office sector and then releasing space to smaller users for space ranging from as large as 1kSF to single offices and even just a membership plan offering access to a shared workspace. This dramatic change in the demand profile begs the question what the future of office leases will look like and further what will the tenants demand of their workspaces? What we have seen is that leases rates are getting shorter on average and as a result we’ve seen far less build-to-suit requirements.

The conversation shifted to a very topical retail sector and more specifically shopping malls which have been severely impacted as a result of ~15% annual growth in e-commerce sales. We delved deeper into the what is negatively impacted the sector and we concluded that market sentiment is overly bearish while the majority or retail real estate is experiencing steady occupancy with increasing rents particularly in well located areas. It is also important to realize that not all retail real estate is created equal. Grocery supported retail is still performing phenomenally well while the suburban big box malls in the tertiary markets are struggling. Smaller strip centers in well located areas remain fundamentally sound with the colloquial saying “you can’t get a haircut online”.

Finally, we wrapped up our conversation briefly talking about the commercial mortgage backed securities market (CMBS). This is particularly topical in today’s environment because these securities are typically written with a 10-year term and if you remember the peak of the market before the Great Recession was back almost 10 years ago (2007). Several of the CMBS’s that were issued in 2007 are looking to refinance with their debt coming due in 2017. So far with credit spreads near lows and increasingly low interest rates versus what the market offered in 2007, debtors are able to refinance these loans without much market interruption. To conclude, we can all agree that real estate is relatively illiquid asset class which makes the business a very personal business. Relationships with key leasing and investment sales brokers along with the tenant representatives can be the difference in finding success in this growingly complex marketplace.

 

Wealth Management: Brad Summers, CFA, CPWA, CRPC, Financial Advisor, Wells Fargo

Summers reviewed his background in the investment banking and capital markets before he eventually moved into wealth management. Summers noted several takeaways with regards to why one may consider a career in wealth management including 1) your client base is your own and will generally follow you to another firm if you make a switch, 2) there is flexibility on how to build your client base, 3) there is flexibility on what you do for clients in terms of investing strategies, 4) your career path is as long as you want to keep working with your clients. Summers stated that there are a variety of firms in the wealth management business and fee structures vary as well. A large reputable shop would provide compliance monitoring while a smaller registered investment advisor you may have to perform that role as well. There are also different tasks involved in wealth management including marketing and seeking out new clients to build your base, relationship building with existing clients so they are satisfied and would potentially give you referrals, and staying up to date on industry trends and continuing education. Estate planning is not typically covered in CFA exams but is covered in the CFP, so that would be one area where you would need to learn. There are also additional designations such as CRPC (Chartered Retirement Planning Counselor) and CPWA (Certified Private Wealth Advisor) that can help you differentiate yourself as well. There is no typical day in the job as the diversity of tasks is large but once you are established you will likely spend the majority of your time focused on what you like to do the most.  Summers noted that the career path requires very hard work for up to five years until you have built up a big enough book of business to be stable. If possible, starting your career with a private bank or wealth management firm or working with another advisor would give you good exposure to the holistic client management model.

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.

Networking with Leadership

CFA Society Chicago gathered on September 27 for the annual Networking with Leadership reception at the Hard Rock Hotel on Michigan Avenue. With no formal presentation or agenda, the members-only event provided a full two hours for networking, making new acquaintances, and renewing old ones. The venue at the Hard Rock included both indoor and outdoor space. A balcony directly off the reception room provided a view of the Michigan Avenue scene below, and was a welcome feature given the unusual warmth for late September. Judging from the nearly sold out attendance of more than 100, our membership values this opportunity for face to face conversations with board members about society business, financial markets, careers, or any topic that comes to mind. Anyone who missed it should make a point to attend next year.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

How CFA Charterholders Can Become Investment-Grade Writers

CFA charterholders are by de facto investment writers; Writing is the primary way of communicating investment ideas and we are judged by the quality of our ideas in written format. Bad writing can be a major career risk and it is a skill that we should focus on. There are a few reasons why we financial types typically resist improving our writing skills. One, we say “I’m a numbers person, not a words person.” While you may be a numbers person, you live in a world where you need to be able to be both types of people. Two, you feel that writing is an innate skill and you don’t have it. This is not true, if you focus on writing and practice it, you can become a better writer.

On August 15th, CFA Society Chicago welcomed Scott Wentworth, founder of Wentworth Financial Communications, to help attendees learn how portfolio managers, analysts, and other investment professionals can enhance the returns of their writing efforts by following a disciplined, repeatable process.  Wentworth explained six keys to improving your writing.

  • Trust the Process
  • Tell your Alpha story
  • Don’t bury the Lead
  • Overcome the Curse of Knowledge
  • Attack the Misconceptions
  • Narrow the Scope

Mr. Wentworth noted that in the same way you have an investment process; you also need a process for writing. There are several steps to the writing process including brainstorming, researching, making an outline, writing, and editing. When brainstorming, putting ideas down on paper will help you start identifying themes. When researching, gather your inputs and narrow the focus of the article. Be sure to make an outline, which will help organize the ideas, identify headlines and sub-themes, and will create the roadmap for the article. For the actual writing portion, he suggested getting “chunky” and setting aside blocks of time to write. Writing takes a lot of concentration and you should eliminate as many distractions as possible. Find a different location or empty office, and then just pull the trigger and do it!  The last process of writing is editing. You should first take a mental break and then come back and read your piece out loud. Also have a friend or co-worker edit the article, as it is hard to edit your own work.

When you tell your Alpha story, you need to focus on a compelling way to articulate your thesis, explaining why it exists and telling where it came from in a qualitative manner. You can be more creative in this step. Story telling should incorporate anecdotes, examples, and analogies that help the reader visualize what you are writing about.

The headline is valuable real estate in your article, so don’t bury the lead. You need to be able to capture the reader’s attention span so that they read the article and don’t just skim it. You should write like a journalist: give the conclusion at the beginning and then back it up with your facts and insights.

To overcome the curse of knowledge, put yourself in the reader’s shoes.  Avoid writing over their heads and say things clearly and plainly; be sure to avoid jargon. When you make a complicated topic accessible, you appear smarter to your audience. Be sure to spell out your line of reasoning and take them through your thesis step by step.

When attacking the misconceptions you should be aware of what the audience knows. Then focus on completing their level of knowledge by addressing the myths and facts. It will also allow you to make the topic relevant to your audience. This also saves time and will keep your article focused and shorter in length.

To narrow the scope of an article, it is better to go deep into the subject to showcase your expertise. If the scope is too broad, your article will be too big and too long. Smaller pieces allow more specific insights and avoid high level general insights.

In review, the six keys to improving your writing are trust the process, tell your Alpha story, don’t bury the lead, overcome the curse of knowledge, attack the misconceptions, and narrow the scope.  If you are able to follow these key items, you will be able to produce good writing and improve your writing skills and communication with your clients.

Vault Series: Gautam Dhingra, CFA, High Pointe Capital Management, LLC

On September 7th, the CFA Society Chicago welcomed Gautam Dhingra, CFA, the CEO and a portfolio manager at High Pointe Capital Management, LLC to discuss incorporating intangible assets and ESG factors into stock selection.

 

According to Mr. Dhingra, there are multiple examples of intangible assets; patents in the case of Qualcomm, brands like Pepsi and Apple, difficult to replicate assets like Union Pacific railroad, or sanctioned oligopolies like Moody’s, to name a few. When looking to use these intangible assets one should look beyond accounting data and focus on ‘what really matters’, or historical financials versus future economic profits. Much of the value derived from intangible assets, like the ones mentioned, cannot be found on a balance sheet, rather derived through future pricing power or lack of competition, for example. In the growing information based economy, traditional accounting won’t be as useful going forward and stock selection models must be adapted to incorporate intangible assets to find an edge and outperform. An increasing proportion of companies’ values are being derived by intangible assets, which poses a question; should one view Procter and Gamble and Qualcomm as peers, both benefiting substantially from intangible assets?  The answer is yes.

 

The speaker discussed another form of intangibles, Environment, Social, and Corporate Governance (ESG), which can be described as putting your money to work into companies that follow good practices, e.g. treat their employees and other stakeholders well. With employee satisfaction having shown a strong correlation to stock performance by one study, some 3.5% per year above its benchmark, adjusted for characteristics, which found that it could be a leading indicator to predicting earnings surprises.

 

High Pointe conducts its research into ESG and other intangible factors and inputs it into its model that combines ‘franchise quality’ and ‘expected growth’ in an effort to find great stocks. The company seeks to find a business’s ‘franchise quality’ by ranking stocks on a variety of factors, including ‘how good is the business’ (using barriers to entry, degree of competition, pricing power vs. customers, pricing power vs. suppliers, and suitability of advantage) and ‘how well is this being managed,’ which includes management, employees, and governance.

 

Distinguished Speaker Series: Mario Gabelli, CFA, GAMCO Investors Inc.

Well known value investor Mario Gabelli, CFA, chairman and chief executive officer of GAMCO Investors Inc. and LICT Corp., addressed a capacity audience of CFA Society Chicago members and their guests at the Standard Club on September 14th. In a wide-ranging presentation, Gabelli drew on his four decades as a money manager to offer his insight and wisdom on the current state of the economy and investment markets. He began by extoling the virtues of a CFA Charter, pointing out that only through the detailed analysis of a charterholder could one understand a business well enough to see how it fits into the economy and how to value it correctly. He encouraged everyone to “keep doing what you are doing” to help our country and make capital markets work even better.

Gabelli touched briefly on two topics he believes need regulatory change. The first was ETFs and the advantage they have over mutual funds because of their tax-efficiency.

He strongly advocated for leveling the playing field with an end to the requirement that mutual funds distribute realized capital gains annually, thereby creating a taxable liability for investors even though they have made no transaction. Every other type of investment requires a sale to generate a capital gain, and mutual fund shares ought to be treated the same.

Second, on tax reform, he said Congress needs to cut the corporate income tax rate to make American firms more competitive with foreign ones.  The protracted debate is only serving to delay new investment that our economy badly needs.

Without going into great detail, Gabelli listed several sectors that he thinks currently offer attractive investment opportunities, including:

  • Infrastructure: Although this is on the top of many favored lists, he pointed out that the American Society of Civil Engineers rates infrastructure in the U. S. as D+, which will require new investment regardless of the political environment.
  • Health and Wellness: Drawing on the trend of an aging population, he recommended investments in vision and hearing care, joint replacement, and obesity treatment.
  • Live entertainment: Gabelli described this as being immune to competition from Amazon (or, more generally, the internet). Noting the high valuations put on sports teams in private transactions, he has calculated that a sum-of-the-parts analysis on Madison Square Garden Entertainment yields a value of zero for the New York Knicks.
  • Equipment rental: A secondary play on infrastructure, but one that he expects to do well even without that tailwind.

Distinguished Speaker Series: Jean-Marie Eveillard, First Eagle Funds

Value investing makes sense; it works over time, so how come there are so few of us?

On August 9th, CFA Society Chicago welcomed Jean-Marie Eveillard, senior investment adviser to First Eagle Funds, at the Chicago Club. The famed investor behind $110 billion First Eagle Investment Management has long believed that value investing can be a lonely place.

The septuagenarian still follows the advice of Warren Buffet and his predecessor Benjamin Graham. “The best book on investing ever written is [Ben Graham’s book] Intelligent Investor,” he said. Despite the sustained popularity of those pioneers today, pure value investing is becoming increasingly rare, Eveillard said.

Value investors must shun the wisdom of the crowds, and more importantly, they must be right. Sometimes value investing is fashionable, oftentimes it is not. Eveillard estimates that only 5% of the investment industry practices value investing. The limited embrace of a value tilt is partially due to the career risk portfolio managers face when choosing out-of-favor stocks. Sometimes investing in these stocks may take years for an investment thesis to play out, and asset owners are frequently less patient. The fear of losing a job causes herding into more socially acceptable stocks, and this dynamic makes it very hard for an investor to commit to value. This often tilts mutual funds towards becoming “closet indexers”, said Eveillard.

Eveillard discussed how he uses both qualitative and quantitative in his process. As a value investor, he marches to the beat of his own drum, eschewing the tactics used by marketing-focused money managers.

Jean-Marie Eveillard, First Eagle Funds

“I never spent a penny on advertising,” said Eveillard, contrasting his near singular approach to investing to more commercially-minded mutual fund companies. In his talk, which connected his years working in the industry with the thinkers that most influenced him, one area mentioned was the Austrian school of economics, particularly its 1974 Nobel Prize winner Von Hayek. Margin of safety was also mentioned, with Eveillard saying that it was the secret of strong investors.

Interestingly, Eveillard reckoned that a great deal of his success as a portfolio manager didn’t come from the stocks he picked; it came from what he didn’t own. Eveillard cited a number of examples such as Japanese stocks in the late 1980s, tech stocks in the late 90s, both of which he avoided. Eveillard was asked if he thought there is currently a bubble reminiscent of the late 1990s in today’s tech stocks, and Eveillard opined that today isn’t as bad as the dotcom bust era defined by the epic failures of Webvan and Pets.com.

Covering his use of qualitative data, Eveillard told a story about Enron, saying that he asked a research analyst on his team to look into the firm for a possible investment. The analyst found Enron’s statement footnotes incomprehensible, to which Eveillard responded that if that was the case, they’d move onto something else and wouldn’t invest.

Eveillard noted that so many of the numbers you see in accounting estimates are estimates. He said that in the late 1990s, he would often spot crafty CFOs who would observe the letter of the regulation, but not necessarily the spirit. In some ways, Eveillard said, accounting is more a reflection of a cultural mindset, with more conservative, risk-averse cultures taking earnings provisions on potentially low risk items. A good international investor needs to be mindful of the cultural differences in preparing accounting statements.

On the Efficient Market Hypothesis, Eveillard said that “it denies human nature.” He’d often debate the EMH with his academic friends and they would say that although they might agree, they needed to find a new theory before abandoning an old theory.

He mentioned the topic of moat, a means of ensuring that a company has a long run sustainable advantage. One reason that Warren Buffet rarely sells stocks is because it is hard to find companies with sustainable advantages, and once one is identified, an investor simply needs to be patient.

Given the strong outperformance of growth vs value stocks in the US over the past decade and the dearth of dedicated value investors, a change in investor mindset might be needed before value investing returns to vogue. But patient investors such as Jean-Marie Eveillard will be willing to wait it out.

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.

The Active vs. Passive Debate

 

 

 

 

 

 

 

 

 

 

 

 

On Tuesday, June 13, approximately 400 people gathered at the Standard Club to attend CFA Society Chicago’s forum on trends, insights and case studies about active vs. passive investment strategies. An additional 200 joined the event via webcast. All of the participants agreed that the terms active and passive represent a spectrum. Nat Kellog, CFA, director of research at Marquette Associates, moderated the first debate.

 TRENDS & INSIGHTS

Joel Dickson, Ph.D., global head of investment research and development with Vanguard, began the conversation by stating Vanguard’s objective to generate market performance at the lowest cost. He noted that if one group has a persistent information advantage than another must be disadvantaged because the aggregate investment results represent a zero sum game. The discussion then focused on whether or not empirical data suggests that the winners can be identified in advance.

Brett Hammond, research leader at the Capital Group stated the firm’s strategy of increasing the number of analyst visits with company management to make superior qualitative decisions about business strategy and execution. Hammond estimated that 1,600 domestic mutual funds employ a factor based approach to quantitatively structuring portfolios. He notes that these strategies represent a form of active management. He also believes that they create opportunities for investment management firms with a long term perspective and superior fundamental analysis.

Aye Soe, CFA, managing director, Global Research & Design at S&P Dow Jones Indices, noted that Paul Samuelson’s 1974 article Challenge to Judgement, promoted the idea of a portfolio that tracks the S&P 500.

Since then, indexes and index funds have evolved to tilt toward factors in an attempt to enhance returns. This evolution moves the objective from market returns to alpha, which is the goal of active management. Soe suggested that the nature of the bond market and bench mark indexes provide more opportunity for deviations (i.e. exclude Treasury bonds) from the market to enhance returns.

The conversation addressed the impact of the rise of index funds on the price discovery role of the securities markets. The Bernstein article- Why Passive Investing is Worse than Marxism may overstate the impact. Although index funds now own approximately 25% of US equity capitalization, they only represent about 5% of trading.

KEYNOTE INTERVIEW

Bob Litterman then interviewed Eugene F. Fama, 2013 Nobel laureate in economic sciences and Robert R. McCormick Distinguished Service Professor of Finance at the University of Chicago Booth School of Business, to learn about the evolution of his thoughts over the past 50 years. Dr. Fama drew a distinction between active and passive approaches to factor tilts in portfolios. An attempt to time factor premiums or add an additional level of analysis produces an active approach.

Fama acknowledged the impact of micro-cap stocks noted in a May 2017 paper titled Replicating Anomalies. This paper concludes that the excess returns identified for most factor based strategies disappears when you adjust for the outsized impact of extremely small companies. Fama emphasized the need to adjust for this impact, a sound basis in financial economics and persistency in the results across markets and time. He noted the robustness of the value factor and the more limited effect of the size factor on portfolio returns. Momentum represents a factor that is evident in the data, but hard to exploit because of the extreme overweight required in illiquid, micro-cap stocks. Fama noted that momentum represents “the biggest embarrassment to the efficient market hypothesis” because it does not fit well into financial theory.

One trend identified over the past 50 years is the growth in the study of financial economics. In the 1960s, MIT and the University of Chicago dominated this area of study. Now, every major university devotes resources to data analysis for market anomalies.

Firms like Dimensional Fund Advisors and Vanguard devote substantial resources to fulfill their corporate governance responsibilities as shareholders. The firms also employ sophisticated trading strategies to obtain best execution. Fama noted that active managers who add value deserve to earn a return on their human capital. As a result, the excess return generally flows to the manager, not the investor in the fund.

The conversation concluded with comments about the future direction of the investment advisory industry. The movement from investment managers to financial advisors to wealth management may move the compensation model from a percentage of assets under management to an hourly or fee for service basis. The growth of “robo advisors” may create another tool for wealth managers to serve clients, versus a replacement for the advisor. The role of the advisor may shift toward a focus on the distribution of possible outcomes and the incorporation of uncertainty in financial plans.

CASE STUDIES

Lisa Haag, CFA, director of investment strategy with The Boeing Company, presented the case for active management of defined benefit and defined contribution retirement plan assets. The Boeing Company’s defined benefit plan has 25% of its assets invested in publicly traded equities with only 5% employing passive strategies. The remainder of the plan’s assets is invested in long duration bonds and alternative investments.

Jason Laurie, CFA, of Altair works with near 300 high net worth family groups. Passive strategies represent 10% to 15% of assets. Laurie noted the firm’s size provides them with the opportunity to negotiate low fees for clients. He emphasized the importance of patience with active managers by noting that over 90% of top managers periodically experience one to three years of sub-par performance.

Marc Levinson, chair of the Illinois State Board of Investments, outlined the transition from active management toward passive management of the State’s pension assets since September 2015. The $4 billion of defined contribution assets moved from 75% active to all passive. The $17 billion defined benefit assets moved to 70% passive. The state moved from near 100 managers to less than 20. Levinson lead the Board from the political nature of “who are you going to replace my guy with” to a market approach that did not require hiring a manager with a sponsor.

In conclusion, two of the three entities continue a commitment to selecting managers who can beat the market after fees. In contrast, two of the first three panelists and Fama presented a case that the financial markets efficient from a beat the market after fees perspective. The debate goes on.