Distinguished Speaker Series: Michael O’Grady, Northern Trust

On June 13th local investment professionals gathered at the Chicago Club to hear a “fireside chat” with Michael O’Grady, chairman and CEO of Northern Trust. Marie Winters CFA, past chair of the CFA Society Chicago served as host and interviewer. To begin, O’Grady outlined Northern Trust’s core values that he said were the prime reasons the firm is about to celebrate 130 years of success, and why it remains independent at a time of rapid consolidation in financial services. These values are: service, expertise, and integrity. Northern Trust has focused on these since its inception, with the interpretation, or application, of them evolving to fit the times.  O’Grady expanded as follows:

  • Service applies not just to clients, but also to employees (or partners as Northern refers to them internally), and the community. A commitment of service to these constituents has always driven Northern‘s strategy. While the firm is known publicly for its key products (such as wealth management and asset servicing) it sees itself as a service organization.
  • Expertise is a point of pride for Northern Trust. It employs over 300 charterholders (the most of any firm based in Chicago) but the expertise the firm embraces extends beyond investment management to include other functional areas such as technology, and banking.
  • Integrity, put simply, means always doing the right thing, no matter how difficult. Again, the firm applies this broadly to relationships with partners and the community as well as clients.

Winters’s first question had to do with strategic changes that O’Grady had made since becoming CEO at the end of 2018 (or that he had planned for the near future). He did not answer specifically, but instead listed three drivers of success that he intends to emphasize: 

  1. Service excellence, a combination of his first two core values, which requires understanding the constant change in the business.
  2. Productivity, an absolutely critical need in a time of low revenue growth. Productivity improvements have been a focus at Northern for several years in a program called “Value for Spend”, which seeks to get more out of each dollar of expense.
  3. Investing for growth–determining where the firm should invest now to generate growth in the future.  Again, this reflects the recent history of slower revenue growth. 

Responding to a question about how Northern Trust is addressing the secular shift from active to passive management, O’Grady noted that Northern provides products that follow both strategies. The focus on efficiency is his key to success within passive products because of the low fee levels. Within active strategies, the focus is on leveraging Northern Trust’s expertise in factor-based analysis. Both of these product lines appear in their lineup of multi-asset class solutions.

When asked about investing for ESG (Environmental, Social, and Governance) factors, O’Grady said Northern Trust sees a clear and growing interest from clients. Designing and building such products requires a vast amount of new information and we are only in the early days of reporting that. Gathering accurate information consistently, and analyzing it thoroughly, will be key to success in ESG investing. This is made challenging by the changing nature of our economy.  The number of publicly-traded companies is shrinking, in favor of private companies. Obviously, public companies are more likely to report relevant data pertaining to ESG factors (and in a more consistent manner) than are private companies. So, even for the private equity investor, following ESG strategies is a challenge.

When asked about the importance of technology and digital innovation, O’Grady turned to data security. At front of mind for him was protecting clients’ private information. Technological innovation changes our world faster and faster (blockchain and cloud computing were two drivers of change he mentioned). With this change, clients demand more information, delivered more quickly, but the more we rely on technology to satisfy that demand, the greater the exposure to cybersecurity threats. Ironically, technology will have to be the principal tool in protecting against this risk. O’Grady then made an observation about technological innovation that illustrated one big way it has changed our world. He turned around the saying that “necessity is the mother of invention” to innovation being the mother of necessity. So, not only does technology allow us to do more with less, it also allows us to do things we never thought possible, never knew we could do, and even never knew we needed to do. This gets to the heart of the fears that technology destroys job opportunities. Rather, it creates more than it destroys.

The final area that Winters asked about was how Northern Trust is addressing diversity and inclusion. O’Grady said he’s proud of what Northern Trust has done so far, while acknowledging that the process continues. He specifically noted success in improving diversity metrics in hiring, especially for entry-level jobs, but sees more improvement needed further along the career path. That improvement requires new information that will inform the company on the causes of this shortcoming, and define the corrective actions. So far, they have learned that male managers tend to change roles more often early in their careers, giving the appearance of broader experience when they are considered for promotions. By measuring this and reporting it to managers Northern Trust can hold them accountable for removing any gender-based biases. Further, he noted the firm needs to be more active in assuring that development programs are open to women and people of color and the firm’s culture, which has served it so well for so long, may also have served as an obstacle to advancement. It must evolve to embrace a new commitment to improving diversity.

Diversity improvement was the subject of the first question from the audience about the differences in the various countries where Northern Trust has a significant number of employees. O’Grady acknowledged that policies and actions need to be tailored to the customs, regulations, and existing circumstances in each country. Gender equity is easier to address with consistent policies and programs around the world. However, ethnic diversity requires more customized solutions.

When asked how Northern Trust “walked the talk” on integrity. O’Grady listed three steps: 1) he repeated his rule of always doing the right thing; 2) being transparent, both internally and externally, so your stakeholders understand what you’re saying and doing, and can judge you correctly; and 3) leading by example because telling people how to behave is ineffective. They need to embrace the rules or customs.

When asked what companies O’Grady considers to be his most formidable competitors, he mentioned a few well-known financial services providers but his general comment was more insightful: they need to be mindful of the firms that are excelling at the things Northern Trust also needs to do well. The final audience question asked about Northern Trust’s strategy for growth. O’Grady summarized the firm’s revenue stream as about two-thirds from fees directly connected to the value of the assets they manage or service. They have no control over the value of those assets. The other one-third of revenue comes from earnings on the balance sheet, which are highly correlated to interest rates. Again, they have no control over the level or direction of change in interest rates.  So, they focus on the growth of new business because it’s the factor affecting profit growth that they have the most control over. Secondary factors include productivity improvements (that they see as an offset to inflation), and prudent investments in new businesses or technology.

Impact Investing: A New Investing Paradigm

A large group of CFA charterholders and other interested investment professionals gathered at the Palmer House Hotel to hear the latest thoughts and techniques in Impact Investing from a distinguished panel on June 5. The moderator, Priya Parrish, is a leading proponent of impact investing in the Chicago community of investment managers and managing partner at Impact Engine, a venture capital and private equity manager with a focus on investments that generate positive outcomes in education, health, economic empowerment, and environmental sustainability. Prior to the event Parrish joined us for a quick podcast which can be found on the CFA Society Chicago website and SoundCloud. Her panelists at the event included:

  • Susan Chung CFA, Managing Director of Investment Management at Wespath Institutional Investments, the investment arm serving the United Methodist Church, and other faith-based investors.
  • Andrew Lee, Managing Director and Head of Sustainable and Impact Investing for UBS Global Wealth Management
  • Charles Coustain, Portfolio Manager of Impact Investments at the MacArthur Foundation

Parrish kicked-off the program with an introduction describing the development of impact investing across nearly fifty years of history. The first generation was Socially-Responsible Investing (SRI) dating as far back as the 1970s. Its primary objective was aligning investments with the owner organization’s mission or values. Popular originally with religious organizations, this version relied primarily on negative or positive screening to either exclude companies involved in businesses that were objectionable to the investor (e.g., alcohol, tobacco, or gambling) or to include firms pursuing something the investor sought to encourage. Investment returns often took a back seat to mission alignment. SRI evolved to incorporate consideration of environmental, sustainability, and governance (ESG) factors in an attempt to improve risk-adjusted performance. The reasoning being that companies that excelled on ESG factors were more likely to out-perform lower scoring peers. Impact investing is the latest generation of the model.  It seeks investments that not only generate strong financial returns, but also contribute to positive changes on social matters. Parrish provided a list of seventeen such social matters with education, health care, economic empowerment, and the environment, being the most important ones to Impact Engine.

Parrish noted that, while many people are aware of the social ills often blamed on corporations, the profit motive also gives corporations the power to change society for the better. They only need to recognize this and make it their intention to improve society while pursuing their profit-generating goal.  The element of intentionality is what defines impact investing. The challenge for the impact investor is to identify, select, and manage those firms that intend to make a positive social impact in their businesses, and do so successfully. The audience heard the panelists refer to this element of intentionality repeatedly throughout the event.

Before bringing the panel on stage, Parrish presented a graphic depiction of the spectrum of impact investments. Its vertical axis showed modest return expectations with market return at the top and declining down through return of capital to complete loss. Across the horizontal access ran the approach to impact, beginning with None, and including stages such as Passive, Intentional, and Evidence-based.  The body of the matrix listed the investment products and strategies used to apply the approach toward achieving the return goal.

Parrish then invited the panelists up on stage and asked each to make a brief statement about the involvement of their firms with impact investing. Susan Chung pointed out that Wespath is part of a religious organization and invests for both the church as well as for pension plans for church employees.  The former is primarily done in an SRI style (meaning exclusionary) because they are less concerned with the returns than avoiding investments that conflict with the organization’s values. The qualified funds are more return-seeking so they have adopted impact investing. Engagement with corporate management is their primary tool for effecting change. They sometimes partner with other investors with a like mind to increase their leverage.

Andrew Lee of UBS Wealth Management said the firm sees impact investing as a major trend with a lasting impact so they have embraced it very broadly.  This is driven both internally, by the Wealth Management CIO who is committed to the style, and externally by clients.

The MacArthur Foundation, being a philanthropic organization, takes a different approach. Its primary purpose is effecting positive social change to begin with, and it pursues that objective with direct grants to institutions working in its areas of choice. These aren’t intended to generate a financial return, however as far back as 1983, the foundation began investing in public banks that address special social needs (such as affordable housing) that were underserved by the market. Their involvement was trailblazing in that it encouraged regular, for-profit, banks to invest in the same manner to the point that they now provide more funding than philanthropic organizations. MacArthur’s impact investing has grown to encompass a separate carve out of the foundation’s endowment that seeks return-generating impact investments that further the goals of its grant program.

As to how to select managers who best align with the investor’s goals, both Chung and Lee stressed the need for vigorous research to understand a manager’s process and determine how committed they are to impact investing. Wespath uses a detailed assessment survey to help with this.

Chung outlined how Wespath found a way to incorporate impact investing into passive strategies. By partnering with Blackrock, they were able to access data to score companies on ESG factors. Searching for indicators of either positive or negative correlation to performance, they identified factors used to make slight adjustments to the index components and thereby, drive alpha. As an example, Chung said they discovered that the rate of decline in carbon emissions was a better performance indicator than the gross amount of emissions. So, firms demonstrating the greatest decline, even if from a high base amount, out-performed firms showing lesser declines (or increases) even if from a very low base. The resulting strategy is very neutral on sector and industry metrics, while benefiting from relatively small mis-weights in the individual stock positions. Indexing purists would consider this to be enhanced indexing (if not a quantitative active strategy) rather than true indexing.

All three panelists stressed the importance of collaboration with other firms interested in impact investing to stretch their resources and increase their leverage with managements. This is especially important in the governance area where engagement with company management has proven to be an especially effective way to effect change. Wespath joins with other investors (or asset managers) when they engage with firms to discuss corporate governance. 

Lee added that UBS has determined that engagement with management is the best way to bring about change—far more so than simply voting proxies against management recommendations. This is especially true in the public equity markets. The firm sets an engagement goal at the outset when making a new investment.  

MacArthur collaborated with the Chicago Community Trust (CCT) and Calvert Research and Management to increase the scale and focus of its impact investing. The CCT brought a local focus to the investing to assure that funds were invested where the investors intended them to be.  MacArthur brought its institutional funds and Calvert added funds raised from their individual investors interested in the strategy. 

The Q&A session that followed the discussion lasted for half an hour, indicating the high level of interest from the audience. The first question asked the panelists to identify some impact investments that had not worked out as expected. Chung listed emerging market infrastructure, solar power following the removal of government subsidies, and wind farms in the North Sea. Coustan added for-profit education as an example. Lee noted that sometimes an underperforming investment needs to be reassessed to see if the investor can help the organization improve. The panel was in agreement that impact investing was more difficult to apply to fixed income. Chung advised that fixed income managers should borrow the scoring methodologies used on the equity side.  Lee added that UBS has substituted bonds from supranational financial companies such as the World Bank and UN-sponsored development banks in place of sovereign debt in the high-quality portion of fixed income portfolios. Coustan said MacArthur primarily utilizes private debt vehicles for impact investing because of the flexibility in structure and use of the funds. In these cases, however, their return objective is only to preserve capital.

Big Data, Machine Learning & AI

Cathy O’Neil: Founder of ORCAA and
Author of Weapons of Math Destruction: How Big Data Increases Inequality and Threatens Democracy

Big Data, artificial intelligence (AI) and machine learning are becoming some of the hottest topics in finance. A packed room of CFA charterholders gathered to hear a presentation by Weapons of Math Destruction author Cathy O’Neil and a panel discussion on that topic in early May.

O’Neil began her discussion with Google’s autocomplete predictive search that can occasionally feature unreliable or conspiracy-laden results. She said that Google shouldn’t be able to have it both ways, making money off users’ trust yet saying that bogus search results aren’t their fault.

According to O’Neil, AI is not a model for truth. Artificial intelligence technology could be characterized as a series of opinions fed into an algorithm. The authors behind the algorithm will tell you to “trust the math”, but should we be that trusting when companies are incentivized not by truth but by profit?

AI amounts to making a prediction. There are two parts to an artificial intelligence prediction: the historical data, which contains a possible pattern, and the algorithm’s definition of success (such as a quant generating profit at a certain volatility level). Even mundane things such as determining what to cook for dinner could be characterized as an algorithm.

Our lives are increasingly touched by algorithms, in areas such as banking and credit, policing, jobs and even matchmaking. Sometimes the algorithms are incredibly helpful, but sometimes they can cause a great deal of harm. When a company runs an algorithm on you, you should trust that it will optimize the result to the company’s definition of success, not necessarily what is best for you. O’Neil said that many of today’s algorithms can be characterized as WMDs (Widespread, Mysterious and Destructive). And algorithms do make mistakes, but those mistakes aren’t typically publicized because the algorithms are usually secret intellectual property.

O’Neil told a story about a teacher who was fired because her students received poor test scores. This happened even though the administration didn’t have access to the actual score which was generated in a black box that no one outside of the firm had access to. Finally, access to the scores was provided. Upon reviewing them, the teacher scores looked essentially like completely random numbers with little predictive power from year to year. Some teachers have sued for wrongful termination and have won their cases.

Another example O’Neil gave of an algorithm causing harm was the case of Kyle Beam, who didn’t get a Kroger job because of a personality test result. The test resulted in a “red light” outcome where Kyle was not offered an interview. He complained to his father about the process, who is an attorney, and his father determined that the test violated the Americans With Disabilities act, as it is unlawful for a company to require a health exam as part of a job screening.

One of the main problems with algorithms today is that they tend to look for an initial condition that led to success in the past. Amazon developed a hiring algorithm (that wasn’t ultimately used) that aimed to determine which characteristics of certain hires led to success in the job. The algorithm proxied job success with metrics such as salary raises, promotions and workers who stayed more than four years. Upon scanning the data, the algorithm found that initial conditions such as being named “Jared” and using the word “execute” more frequently on resumes tended to lead to success. Unfortunately, it was also determined that male candidates tended to use the word “execute” more frequently than women, so some of the characteristics the algorithm was searching for were proxies for gender.

Couldn’t there be a market-based solution to all the defects inherent in algorithmic decision-making? According to O’Neil, expecting companies to self-police their own algorithms might be somewhat unlikely. This is because algorithms that maximize profits without any constraint on fairness are more profitable than algorithms with fairness constraints. This dilemma can be seen with Facebook. Facebook has a higher level of engagement and a more lucrative advertising business when its users are arguing about fake news and conspiracies.  Most companies facing demanding shareholders would be reluctant to agree to lower profitability in order to ensure fair algorithms. Because of this issue and others outlined above, O’Neil believes that regulation is needed.

Currently the legality and ethics around employers sourcing alternative data such as health information in order to make hiring decisions is murky. “What’s stopping Walmart from buying data to see who is sick or healthy [in order to make decisions on employment],” O’Neil asked.

O’Neil laid out three principles for responsible algorithm usage:

1) First do no harm

2) Give users the ability to understand scores and decisions

3) Create an FDA-like organization that is tasked with assessing and approving algorithms with a high level of importance

L to R:
Metin Akyol, Ph.D., CFA (Zacks Investment Management) Kevin Franklin (BlackRock),
Sam Shapiro (Goldman Sachs Asset Management), Cathy O’Neil (ORCAA)

During the panel discussion, speakers talked about how machine learning and AI are used in their portfolio management process, particularly parsing through large data sets. They talked about how it is more challenging to hold risk models to the same standard as trading models because risk cannot be directly measured, and the success of a trading model can easily be evaluated by the P&L generated. Are machine learning and Big Data a flash in the pan, or are they here to stay? The CFA Institute believes that it’s the latter, and have added the topics to the 2019 CFA curriculum.

Annual Business Meeting 2019

CFA Society Chicago held its Annual Business Meeting on June 20th at Convene. The meeting was open to all CFA Society Chicago members.

After a welcoming from the Society’s CEO, Shannon Curley, CFA, the Society’s Chair, Tom Digenan, CFA, gave an overview of the successes over the past year. The Society is the sixth largest society in the world under CFA Institute and recently hit over 5,000 members.

Over the last year, the Society hosted over 130 events including the Annual Dinner featuring keynote speaker Richard Thaler with over 1,000 registered attendees. This event also welcomed our newest charterholders to the Society. The Distinguished Speaker Series Advisory Group continued to bring in leading speakers, the Professional Development Advisory Group expanded on its career development programming, the Education Advisory Group hosted a great series of panel events and recorded its first podcast, our CFA Women’s Network

Kristan Rowland, CFA, the secretary treasurer of CFA Society Chicago, shared the financial position of the Society over the prior fiscal year before Dan Kastholm, CFA, vice chair of the Society, provided remarks on the future direction of the Society. The event concluded with questions from members along with a post-event networking hour.

CFA Society Chicago would like to thank all of its board members, advisory group co-chairs and volunteers as the Society would not be where it is today without the time and effort these individuals dedicate to the Society.

CFA Society Chicago Executive Committee 2019 – 2020
(Starting September 1, 2019)

Chair: Dan Kastholm, CFA
Vice Chair: Kristan Rowland, CFA
Secretary/Treasurer: Garrett Glawe, CFA 
Immediate Past Chair: Thomas Digenan, CFA
CEO: Shannon Curley, CFA

CFA Society Chicago Directors 2019 – 2020
(Starting September 1, 2019)

New three-year terms ending  August 31
Class C Michael Miranda, CFA (2022)
Class C Alan Papier, CFA (2022)
Class C Sunitha Thomas, CFA (2022)

New one-year term ending August 31:
Class E William Fitzpatrick, CFA (2020)
Class E Linda Ruegsegger, CFA (2020)
Class E Mark Toledo, CFA (2020)
Class E James Schroeder (2020)

Directors continuing in their respective terms ending August 31:
Class A: Jenifer Aronson, CFA (2020)
Class A: Cosmin Lucaci, CFA (2020)
Class A: Tanya Williams, CFA (2020)

Class B: Michael Holt, CFA (2021)
Class B: Dhvani Shah, CFA (2021)
Class B: David Smith, CFA (2021)

Wine Tasting: Emerging Market Wines

The marvelous thing about tasting wine is that two people can split a bottle and experience something completely different, yet both opinions, shaped by each individual’s personal experiences, can still be valid.

On April 30th, CFA Society Chicago took in an educational wine tasting class presented by 40-under-40 Tastemaker Derrick Westbrook. After a stint as beverage director at Michelin-starred Elizabeth, Westbrook took his knowledge to Madison Vine Wines (now 1340 Beer Wine Spirits), a shop near the near West Side, where he recently became a partner.

Westbrook aimed to do a few things during his talk: make wine approachable and fun, introduce charterholders to some lesser-known wine regions, and equip tasters with a few tools that would increase overall enjoyment. We started our session by each naming a varietal. As we rattled off terms such as Malbec, Cabernet Sauvignon and Pinot Grigio, Westbrook explained that sommeliers such as himself tend to think of wines in terms of region, not grapes, as to limit the massive universe of wine types down to a manageable set. The regions will inform you of the types of grapes used and the varietals. For example, Burgundy in France features wines made from Pinot Noir and Chardonnay grapes as well as lesser known varieties such as Gamay.

According to Westbrook, “Is it yummy?” is the first question one should always ask after tasting wine. Drinking tasty wine that you like is the point and everything else is secondary. But before tasting a wine, it’s a good idea to both smell and look at the wine. The taste and color will inform how you expect a wine to taste. You should begin by raising your glass (holding it by the stem as not to raise the temperature) and looking at the color. Is it light, dark or medium? Darker wines will tend to be made from grapes with thicker skins. Then you ought to sniff it, with the goal of seeing if the wine smells ripe or tart. Warmer regions will tend to correlate to riper grapes, and colder growing regions will often see their grapes a bit more tart in flavor. Wines that are sweeter or less acidic are usually made with riper grapes in warmer growing regions.

We tasted some wines that are a little less known than California or French wines, and Westbrook said that savvy consumers can often get a good deal by buying from these lesser known areas. One wine we tasted was from Armenia. Westbook asked us to smell the wine in a glass and determine if it was more ripe or more tart. We thought it had a bit more of a tart odor, but when we drank it, we found that the alcohol feel (the burning sensation when it goes down your throat) indicated that the alcohol content was on the high side. This was a bit of a surprise given that the tart smell would typically be associated with less alcohol than a riper grape. Westbrook explained that the grapes were grown in Armenia in a mountainous region, so the terroir (the geographical characteristics where the grapes were grown, generally everything that the wine grower can’t control) includes very cold periods as well as a very warm summer, which can lead to higher alcohol content, yet with more tart flavor profile. Our crash course was a hit and well-attended, and those who couldn’t make it can sign up for classes on the 1340 Beer Wine Spirits’ website at https://www.1340bws.com/wine-class.

Storytelling: A Critical Brand Building Skill for Leaders

CFA Society Chicago hosted a storytelling event on May 14th at the Global Conference Center. The purpose of this program was to help society members claim their value using stories as a tool to highlight leadership and communication skills. Storytelling is a big part of personal branding. So, how can it help us and how do we tell a good story while remaining authentic? Daniella Levitt, president of Ovation Global Strategies and Executive Director of Leading Women Executives, engaged our right side of the brain and helped us become more comfortable talking about ourselves and the unique value proposition we bring to the table.

Storytelling shapes how others see us and embodies what we have learned about ourselves as leaders, but telling your own story can be uncomfortable. However, learning and practicing this does reap benefits because stories are 22x more effective than just rattling off a list of accomplishments. A story is a tool of authentic leadership. We started by creating the framework for our leadership stories and exploring the idea of leaders as teachers with a unique teachable point of view (TPOV). 

A TPOV includes the following attributes:

  1. In context of your role as a leader in your organization
  2. In context of your leadership identity.
  3. A direct tie-in with your leadership story and your persona brand.

Elements of this also include ideas, values, emotional energy and edge.  It should reflect how we take risks and make decisions. 

To create our TPOVs, we can create a chart mapping our leadership story placing events on the Y-axis and time on the X-axis. Organizing high events in our lives and careers above a horizontal dotted line and low events below will help uncover insights from our leadership stories. We will be able to answer questions such as: Am I a risk taker? Did my low points bring clarity and help facilitate change? These discoveries will become our TPOV.   

Levitt emphasized that developing this is an iterative process requiring reflection and feedback.  We should also develop a plan that encompasses the most important milestones we can think of and identify a small group of people who can help us move forward with the most critical aspects of our plans. 

We worked in groups at our tables on illustrating our own TPOV and the stories that would bring them to life. Levitt recommended we meet our fellow attendees again for coffee to practice and communicate our next iteration.

Levitt closed the event by providing a checklist for a good story:

  1. Know your theme and punchline.
  2. Draw from what you know.
  3. Simplicity works best.
  4. Adjust chronology as required.
  5. Make your audience care.
  6. Be passionate and value a dash of mystery, unpredictability and drama.

Hopefully with a TPOV and personal story, we will all feel better prepared the next time someone says “Tell me a little bit about yourself”. 

Distinguished Speaker Series: Charles K. Bobrinskoy, Ariel Investments

Some investors have great analytical skills in assessing current and potential future investments, but the best investors also possess an uncanny ability to both recognize and combat their own behavioral tendencies when making investment decisions. This was the topic of Charles “Charlie” Bobrinskoy’s presentation to a packed room of eager members of CFA Society Chicago and local investment professionals at the Society’s Distinguished Speaker Series luncheon held on May 15, 2019. The program titled, “Combating Unhealthy Behavioral Tendencies in an Investment Firm” discussed how Bobrinskoy’s firm Ariel Investments has adjusted its investment process to incorporate the latest academic findings in the field of Behavioral Economics, and how these process improvements have helped Ariel’s flagship Mutual Fund, The Ariel Fund, become number #1 in its mid-cap value category over the last 10 years.

As way of background, Charles Bobrinskoy is the vice chairman and head of Investment Group for Ariel Investments. Headquartered in Chicago, the firm offers six mutual funds for individual investors and defined contribution plans as well as separately managed accounts for institutions and high net worth individuals. He manages their focused value strategy—an all-cap, concentrated portfolio of U.S. stocks. Bobrinskoy also spearheads Ariel’s thought leadership efforts and takes an active role in representing Ariel’s investment strategies with prospective investors, clients and major media. Additionally, he is a member of the Ariel Investments board of directors. Bobrinskoy is frequently quoted in various news publications such as The Wall Street Journal, Barron’s, Money and USA Today, is a regular contributor to CNBC, and is frequently a guest on Bloomberg Radio.

Many in the room with a CFA curriculum under their belts were familiar with the inherent behavioral biases in our decision making, but Brobinskoy started off by suggesting that he not only was going to share with us the most influential biases, but more importantly, he was going to teach us how to combat them.  Some economists believe that no matter how much we recognize behavioral biases, we are helpless in trying to combat them.  Bobrinskoy and Ariel Investments don’t believe this, and they have purposefully instituted structural processes to combat each bias.

Before jumping into each bias, there are four common observations in the markets that defy efficient markets. The existence of behavioral finance is why each of these market anomalies exist.

  • Stocks beat bonds over the long term.
  • Until the last 10 years, value has consistently outperformed growth.
  • Small caps outperform large caps.
  • And finally, there is momentum in every asset class.

Here is what we learned by bias, in no particular order.

  • Confirmation bias. The tendency to seek data that is compatible with beliefs currently held and to reject conflicting data. Unfortunately, the smarter you are, the more susceptible you are to confirmation bias. A common example is people watch Fox News if they are a Republican and MSNBC if they are a Democrat.

Ways to combat: Appoint a fellow research analyst to play Devil’s Advocate. Challenging another analyst’s assumptions is inherently difficult because it creates conflict. Official appointment of a devil’s advocate actually removes the conflict inherent in challenging someone else’s assumptions because it is his/her job to contradict initial assumptions.

  • Overconfidence bias. The tendency to overestimate what one knows and underestimate the uncertainties of the future.

Ways to combat: Place probabilities on outcomes, and ask for feedback on those probabilities. Ask questions to narrow down the range on probabilities.

  • Anchoring on prior estimates. The tendency to adjust prior estimates insufficiently when presented with new information.   This is why momentum exists in the markets. 

Ways to combat: You need a culture that does not penalize analysts for revisions. Encourage analysts to change their views based on new information that is learned in the market.

  • Loss Aversion. The tendency to overweight losses relative to gains.  This is why there an equity premium.  Investors are willing to accept a certain $5 gain, versus an expected return of $10.

Ways to combat: Ignore your costs basis. Examine each investment decision as if you didn’t own the stock.  Ask yourself, “Would you buy it again today?”

  • Endowment Effect. The tendency to overvalue that which one owns versus that which one doesn’t own.  

Ways to combat: Keep a watch list of what you don’t own that is comparable to what you do own. Look at the data as if you didn’t have any portfolio positions in play and ask, “If I had fresh capital, what would I own today?”

  • Reliance on Intuition over Data. The tendency to think one’s gut instinct is superior to data and to overestimate the significance of very small samples. Model based decisions are always better than guy instinct.

Ways to combat: Always trust the data over intuition. Ask yourself if a decision is data based or on gut instinct. 

  • Vividness/Recency effect. The tendency to measure frequency by one’s ability to think of example which in turn produces a tendency to overweight recent examples.

Ways to combat: Be required to have several examples to prove your point.

For further reading, Brobinskoy suggested three books:

  • Thinking in Bets by Annie Duke.
  • Thinking Fast and Slow by Daniel Kahneman
  • Misbehaving: The Making of Behavioral Economics by Richard Thaler

Last but not least, if you’re a Republican, challenge yourself to watch MSNBC.  If you’re a Democrat, challenge yourself to watch Fox News!

Karyl Innis: Building a Distinguished Career through Personal Branding

The CFA Society Chicago Women’s Network hosted the third event of its four-part Alan Meder Empowerment Series on March 15th at The University Club. The series is intended to support career development and the advancement of women in the investment management profession. This event also attracted a number of men who were interested in the universal topic of Personal Branding.

In today’s workplace how you articulate your value proposition to the organization can make or break your career possibilities. Advocating for yourself, articulating your value and utilizing your branding statement as a part of your personal development strategy are all crucial to long term career success.  Your future at work is tied to who you think you are, as well as who your customers, clients, partners and prospects think you are.

This interactive session was led by Karyl Innis who knows why successful people succeed and, when they don’t, how to help them. She is a career expert, CEO and founder of The Innis Company, a global career management firm, and one of the most successful woman-owned businesses in the country.

Innis took the podium and quickly asked the audience “What do you think of me?” Write down one word that answers that question.  She then asked us to contemplate “what does that word mean to you?” and “what about me made you think that?” She then noted that we’d return to this topic later.

Innis went on to share that how you talk about yourself and how you let others talk about you is a career accelerator or killer! She next asked “how many of you have a brand?” By show of hands, about half the room indicated they have a brand and the other half felt that they didn’t.

Lesson #1: Everyone has a personal brand!  You may or may not know what it is; you may think you know, or you may think it is one thing while others think it’s something else.  You may like the brand people bandy about when they speak of you, or you may want to change it.  Why does personal brand matter?  Because people make decisions based on what they think they know about you. The more you/others hear what your “brand” is, the more it becomes truth and reality. Your brand is other people’s perception of you – rightly or wrongly.  That’s why it’s so important for you to be in charge of your narrative!

Take Oprah for example, she has a personal brand.  She has a lot of other stuff too – television networks, property, copyrights, licenses, and that very valuable personal brand of hers.  Some say the value of that personal brand is worth a tidy 2.4 billion dollars. So what do you get for that $2.4 billion?  Nothing – her brand belongs to her and your brand belongs to you. Oprah’s brand solidifies her reputation, transmits what matters to her, and creates future opportunities for her. Her brand does that for her and your brand can do that for you!

Lesson #2: Brand messaging and brand are different. Brand messaging = Look, Act, Sound, Say. Your brand is how people think and feel about you – it’s a combination of a thought and a feeling. Brand is the place YOU occupy in the decision maker’s mind relative to all others. It’s similar to the place a product occupies in your mind. 

Consider three pairs of leopard shoes: one from Target; one from Nine West; one from Jimmy Choo.  You have a different perception of each shoe based on various factors such as durability, price, styling, etc. Based on these factors you position and differentiate the shoes in your mind and have reasoning for why you would choose one over the other. There is a premium brand, a middle of the road brand, and a low-end brand.   This same positioning and differentiating translates to human capital hiring – are you worth the money? You want to be the premium brand!

Lesson #3: We tend to position ourselves as average. We talk about ourselves with average words, yet we want more pay and more responsibility! We should be using premium words to describe ourselves and our capabilities.  There are A, B, and C levels of words to describe your brand. People frequently use “competent” to describe themselves, when in fact this is a C-level adjective with broad interpretation (having the necessary ability, knowledge, or skill to do something successfully – capable, able, adept, qualified). The elevated or “A” version of this adjective is expert or executive.  Use A-level words to describe yourself and your competencies. How valuable is your personal brand? The more premium you are, the more you can command!

Start creating your brand by selecting three premium words which convey what you want your leader, hiring manager, or others to think of you. 

“A” Words                                                           “C” Words

Expert                                                                   Competent

Authority                                                             Skilled

Strategist                                                             Doer

Master                                                                 Reliable

Visionary                                                             Action-Oriented

Talent Scout

Champion

Guru

Futurist

Leader

Brand makes a difference – you will be hired for what you know and how you’ve applied it:

  • Oil and gas banker – an executive that fixes broken businesses
  • Client service advocate (voice of the client) – leader for everyone
  • Hard worker – powerful leader of people and teams

Lesson #4: Have what it takes to create an initial impression. Brand also has to do with how you look and how you deliver your message.  Initial impressions are key and based on the following: 55% visual; 38% vocal; 7% verbal (this goes up to 22% if you’re talking on a continuum). Everything from the tilt of your head, shoulder positioning, hand and leg placement, clothing, and smile factor in to how you are perceived by others. 

This takes us back to the start of Innis’ presentation when she asked the audience to write down one word describing her, before she had even delved into her presentation. This word was our first impression of her. Since she had barely spoken people’s perceptions of her were largely visual, as findings show.

Creating Your Personal Brand

Like those of us in the audience, you may be wondering how get an accurate assessment of your current brand. Innis suggests gathering performance reviews, email compliments, bio’s, casual notes, etc.  Additionally, interview at least five people, asking them all the same questions, clarifying with them what you thought they were telling you and recording their answers. The takeaways from these various sources will help you gain insight into others’ perceptions of your brand.

In the world of work, you will be talked about. People will describe you as they introduce, evaluate and sponsor you by using a succinct description attached to your name. It’s important that you control the brand attached to you and that it be one that accelerates your career and not one that stalls it. It takes about 18 months for a rebrand to take root, so write yours today!  If you desire Karyl’s help in crafting your brand, she can be reached at info@inniscompany.com

To learn more about career development and advancement, read about the previous events of the series – “Taking Control of Your Career” and “Tips and Tricks for Negotiating for Yourself” on the CFA Society Chicago blog.

Distinguished Speaker Series: Sheila Penrose, Jones Lang LaSalle

On April 9th, CFA Society Chicago’s Distinguished Speaker Series Advisory Group welcomed Sheila Penrose at The Metropolitan. Penrose is Non-Executive Lead Independent Chairman of the Board at Jones Lang LaSalle, a global real estate services company, and also serves on the Board of Directors for McDonald’s. Penrose retired from Northern Trust in 2000. In her 23 years at Northern Trust, she served as President of Corporate and Institutional Services and as a member of the Management Committee, where she was the first woman to serve. Subsequently, she served as an Executive Advisor to The Boston Consulting Group from 2001 to 2007. She has been on the boards of Entrust Datacard Group, eFunds Corporation, and Nalco Chemical Corp. She has also served on the advisory board of the Gender Parity initiative of the World Economic Forum, the board of the Chicago Council on Global Affairs, and as a founding member of the US 30% Club, a group whose initiative is to achieve female representation of at least 30% on corporate boards.

After detailing some of her credentials and experience, Penrose highlighted three topics she wanted to explore:

  1. What issues are boards of directors discussing the most?
  2. How are boards of directors handling the evolution of the business environment?
  3. How do a group of highly ambitious, competitive and capable people, all of whom are used to leading others, form a functioning team that can effectively oversee a company?

She emphasized that in each topic, boards are fiduciaries for both shareholders and stakeholders, and need to understand how to balance the needs of both groups. She also emphasized that individual board members should be listening and learning all the time, while contributing and remaining objective.

Penrose expounded upon the recent transformation of the business environment as it relates to the board of directors.  Recently, boards have become less dominated by the executive. The CEO/Chairman dual role that was so common in previous years is now no longer as accepted as it once was. This was spurred by Sarbanes-Oxley, but also investors and employees who now have more of a voice shareholder activism has increased. Digital disruption has also been a major category for boards to tackle, and relatedly, managing corporate reputation in an age of social media, where all voices have access to the public. Diversity on boards, and not just different kinds of people, but different viewpoints, has also been an important topic. Boards have been seeking to find people who have different types of experience and different types of expertise, as opposed to finding a group of CEOs for the board. Boards need to develop consensus, not groupthink. She brought up the dilemma of cybersecurity. Boards must wrestle with the questions of how much cybersecurity is enough and how quickly the company can react in the event of a breach. Boards must also consider the impact of global events, as almost all large corporations are now global in reach. Lastly, and importantly, she discussed the issue of talent and corporate culture. Boards must grapple with the future of work and the changes in expectations of their employees. Companies assume they will be able to find the skills they need in the labor market, but they are not doing much to develop those skills in employees and not moving quickly enough to develop people whose jobs might be redundant in the future.

Boards also have to understand how best to find directors. With the changing business environment, new skills are often necessary, and boards have begun looking for people who have those skills, such as digital experience, to help them stay current.

The composition of the board, its dynamic, and its leadership are all critically important. The board should be “collegial but not clubby”, and board decisions should be made in the room, not in private meetings.  Board members should maintain a healthy balance of both listening and contributing.

Individual board members should have what Penrose called “The Four Cs.”

  • Curiosity
  • Conviction
  • Courage
  • Compassion

During the Q&A portion of the event, Penrose described how she believes someone can become a member of a board of directors. She said the individual must have a good reason for why they want to join a board, should be strongly curious and constantly learning, should have experience trying to manage a business on some level, and should be wary of joining a board too quickly. Joining a board too quickly usually means that board is likely of lower quality, and the first board you join dictates one’s future opportunities.

The Equity Risk Premium: Applications for Investment Decision-Making

Professor Aswath Damodaran’s opening remarks at CFA Society Chicago’s Equity Risk Premium event on April 2, 2019 at the W Chicago City Center.

Aswath Damodaran, Kerschner Family Chair in Finance Education and a Professor of Finance at New York University Stern School of Business, is well known for his books and articles in the fields of valuation, corporate finance, and investment management, philosophies, and strategies. On April 2, he treated the CFA Society Chicago to a tour de force through the foundations of risk premia, the macroeconomic determinants of equity risk, and how the risk premium can me misused.

Damodaran’s talk was followed by a panel which included himself, Michele Gambera, co-head of Strategic Asset Allocation Modeling at UBS Asset Management, and Bryant Matthews, global director research at HOLT. The panel discussion was moderated by Patricia Halper, CFA, co-chief investment officer at Chicago Equity Partners.

Damodaran pointed out that while the risk-premium is referred to as one number, it contains several various risk factors, such as political and economic risks, information opacity, and liquidity risks. Despite the underlying complexity, a common way to derive the risk premium is from the average volatility of some historical period. This, Damodaran warns, is a dangerous approach. By using historical data you can derive any risk premium you want by using the time horizon of your choosing. When you look at historical averages, you are also searching for a number that nobody has ever experienced. And even if they did, you should not believe that history will simply repeat itself. And even if history did repeat itself, you are still estimating a number with large error margins. In the end, the exercise is just not useful.

Damodaran has done a lot of work determining equity risk premia for different countries and makes his data available on his homepage. His approach is to derive an implied risk premium based on consensus forecasts of earnings and adding country risk premia for different countries. He cautions that there is no pure national premium thanks to our integrated world. Much of S&P earnings, for instance, are derived from abroad, and this must be taken into account.

For a person who has devoted so much time to estimating risk premia, it may come as a surprise that Damodaran thinks people should spend less time on it. His approach is that once you observe the market-implied risk premium, you should use this in your valuation model and devote your attention to estimating cash-flows. Right now, too many people are wasting too much time on valuing companies through finding the perfect risk-premia when cash-flows are ultimately going to determine whether they will get valuations right. Academic finance is another culprit here, which spends too much research time on discount rates.

Ask yourself this, are you working on your model’s risk premia because that is where you have superior knowledge, or because it is your comfort zone?

Damodaran is also critical of the use of the price-to-earnings ratio to assess valuation, since it looks at earnings only for the current period. In the US market the ratio may look high, but the pictures very different for current implied risk premia. Since 2008, risk-free rates have come down while expected stock returns have remained roughly the same. This actually implies a higher risk premium.

 Michele Gambera shares Damodaran’s criticism of historically derived risk premia. He also pointed out that while the risk premium fluctuates a lot, we pretend in our models that it is constant. In effect, Gambera stressed, we are estimating a random-walk variable. A better approach for your valuations is to use a forward-looking covariance matrix with various factor loadings.

Should we therefore throw the historical data out the window? When asked the question, Bryant Matthews of HOLT pointed out that historical data are not all useless in a world where variables tend to mean-revert. But you may need to wait a long time for it to happen.

Is there a small-cap premium? Damodaran pointed out that if you estimate the historical premium since 1981, it is negative, which is clearly fictional. However, Matthews estimated a small cap premium of 0.6%, albeit with a standard error that makes it statistically zero. By slicing the equity market in other ways, he estimates that value stocks tend to have a 3.5% equity premium over growth stocks, while Fama and French’s quality stocks-factor enjoys a 2.1% premium over non-quality stocks.

Matthews has also calculated market implied risk premia for over 70 countries, and found it rising in the US from 0% in 2000 to 4% today. Such estimates, he pointed out, are often counterintuitive for clients. Surely, equities were riskier in 2000 when valuations were high. But precisely because valuations were so high, the implied risk premium, which was part of the discount rate, was low.

Can we make money by investing in high-risk premium stocks? After all, theory tells us returns are the reward for taking risk. Yet as Gambera pointed out, high-volatility stocks tend to be favored by investors in part as a way to leverage up according to the CAPM-models, as is done for instance in risk-parity models. At the same time, pointed out Matthews, low-volatility stocks are generally also high-quality stocks and therefore tend to have high return, despite their historically low risk.

Matthews argued that while profits are high for the US market as a whole, this really applies to only 100 companies. This concentration, he suggested, is due to lax regulations. Damodaran, however, suggested that antitrust measures cannot be relied on to change this fact. They may have been politically attractive in the time of Standard Oil, when that company’s dominated position allowed it to raise prices. The dominant firms of today are offering consumers very low prices. Break them apart and any politician will be met with discontent from voters.

Let us end with some historical perspective from Michele Gambera. Much of the early work on risk premia was made at a time of a very different market structure of industrialized countries. Steel and railroads ruled the day and many of today’s giants were not listed. The likes of Alphabet and Facebook pose new challenges in estimating risk premia. This suggests that now more than ever historical data will be misleading in estimating the risk premium, a modest number that means so much.