On a frosty evening where temperatures hovered just above
ten degrees, CFA Society Chicago hosted an evening of curling and drinks at
Kaiser Tiger, a bar with a large beer garden on Randolph Street. Curling, with origins
dating back to 16th century Scotland, involves sliding a smooth
stone across a sheet of ice, with the goal of centering the stone in the middle
of a target (typically 146-150 feet away, the rink at Kaiser was a bit smaller
though). It was added to the Olympics in 1924 as a “demonstration sport”, and was
officially added in 1998. Curling is most popular in Canada, but many countries
across the globe field teams in the world championships and Olympics, including
Finland and Scandinavian nations, the UK and Japan.
This was our first curling occasion as a Society, and it was a packed event, with networking taking place in Kaiser Tiger’s large West Room and participants bearing the cold and taking turns hurling stones outdoors in the ice curling rinks in the beer garden. If you missed the event, you can get a group of friends together rent a lane for $40 per half hour here – Kaiser Tiger Curling. Aside from the networking, attendees were treated to a fantastic menu of craft beers, wine and appetizers. Despite the chilly temperatures, fun was had by all, and curling very well may turn into an annual CFA Society Chicago winter tradition!
On Feb 20th at the UBS Tower, CFA Society Chicago’s Education Advisory Group offered a panel discussion highlighting the issues and opportunities of allocating assets for various types of portfolios. A full room of about 100 financial professionals were privileged to hear from an experienced, diverse group of fund managers and advisors.
Opening speaker Tim Barron, CAIA, CIO of Segal Marco Consulting, prepped the feature event with his entertaining yet practical list of eight things to be aware of and thinking about when structuring portfolios. His list consisted of relating several quips from the likes of Yogi Berra, Mike Tyson, Harvey Pinnick, Wayne Gretzky and Bobby Unser into practical guidance for professional investment of assets. Lessons learned included; understanding the purpose for the portfolio, having a plan in place in the event of market turmoil, not having a false sense of security in making predictions while understanding one’s skillsets, and not being afraid to stand apart from the herd while putting in the hard work necessary for being in a position to win.
brief Q&A ensued before giving way to moderator Chris Caparelli, CFA, at
Marquette Associates and the panel of (1) Patricia Halper, CFA, CIO at Chicago
Equity Partners, (2) Josh Lohmeier, CFA, Head of Investment Grade Credit and
AIA Investment Officer, Aviva Investors, (3) Ellen Ellison, CFA, Chief
Investment Officer, University of Illinois Foundation, and (4) Kevin Zagortz,
FSA, US Head of Portfolio Management (OCIO) at Aon.
Caparelli’s first question for the panel was to provide a high-level description of their approach to asset allocation. Kevin spoke first from his background with qualified corporate defined benefit and 401(k) plans. His first objective is to be mindful of mitigating risk before evaluating a multitude of asset classes in priming the portfolio for growth was a common theme across the panel.
Ellison’s perspective is of a large foundation with a very long-term investing horizon, minimal concern for liquidity and growth sourced from a global rolling portfolio approach. The foundation’s clients consist of a large base of living alumni, trustees and committees, with a strong focus on governance and fiduciary risk. The only thing worse than not having a plan is changing the plan over the course so being mindful of the human element is important.
In contrast, Lohmeier has a relatively narrow focus of investment grade credit and is most concerned about target benchmarks and how to manage to against that performance. Common issues to be aware of include behavioral biases, herd mentality, tail risk and downside protection especially in environments of severe stress.
Halper stressed the importance of knowing your place. If your client is relying on investment exposure to a specific asset class then it is imperative to not stray from that mandate. In other words, only perform asset allocation within the bounds that you engaged for.
The remainder of the discussion involved the panelists providing perspective on a variety of topics such as their use of alternatives, adaptation to the market environment, and being tactical via factor investing. Context is important once again as each strategy depends on the purpose and objective for that client.
taking formal questions, the panelists generously made themselves available
after for further inquiries.
summary, this was a fast paced and informative exposure to the topic of
portfolio construction. Caparelli was effective in moderating the discussion
and the diversity of viewpoints represented on the panel was of tremendous
Silicon Valley and venture capital (VC) in the technology sector always offended this Midwesterner’s conservative sensibilities. Having come of age during the dotcom boom, I’m skeptical every time a technological shiny thing catches the public’s attention, which seems to happen with alarming frequency given the regularity of fads and corresponding losses to come out of the sector. John Carreyrou’s masterfully written Bad Blood confirmed my biases. In addition, he weaved together a highly readable tragedy involving a deceptive and manipulative villain in the form of Theranos’s founder and CEO Elizabeth Holmes; a board that emphasized prestige of its directors to the near complete exclusion of any relevant industry expertise or meaningful control; a media and public blinded by the desire to see women entrepreneurs and women in Science, Engineering, and Technology (STEM) fields; and a group of similarly gullible investors that included Walgreens, Safeway, and several of the Valley’s most prestigious VC firms.
My sentiments during the majority of the book were similar
to that of a cynic observing drug dealers fighting over territory: there were
no innocent bystanders and the only people who got hurt deserved it. Unfortunately, though, there were innocent
bystanders. The first casualty is the
realities of success succumbing to the Horatio Alger-type myth of the college
dropout cum tech entrepreneur. Elizabeth
Holmes, whose family tree includes the founders of Fleischmann Yeast and the
Cincinnati Medical School, used her family connections for her initial
funding. Although America is still the
land of opportunity, it’ll always be easier to score runs when one is born on
third base. The second casualty is the
line workers and main street investors in Safeway and Walgreens who suffered
the consequences of poor decisions to partner with Theranos that they had no
control over. Last and most importantly,
Theranos made defective medical equipment that hurt the people upon whom it was
used without their informed consent—a tenant of ethical medical practice.
First, the villain of our story, Ms. Holmes. Mr. Carreyrou paints a portrait of unbridled
ambition starting from a very young age.
Despite her shortcomings, no one should doubt Ms. Holmes’s drive.
From a very young age she declared her ambition to be a billionaire and
worked tirelessly starting in early high school, studying hard, sleeping
little, and earning straight As, a pattern that continued through her brief
stint at Stanford and throughout her tenure at the helm of Theranos. Ms. Holmes seemed determined to emulate Steve
Jobs’s path, a point emphasized in the chapter “Apple Envy,” noting Ms. Holmes’s
wardrobe, modeled after the Mr. Jobs’s signature black turtleneck, her desire
to make “the iPod of healthcare,” and her hiring of TBWA/Chiat/Day, the same
advertising agency responsible for the Apple Macintosh’s “Think Different”
campaign. Her infatuation went so far
that while reading Walter Isaacson’s biography Steve Jobs, colleagues
were able to guess which chapter she was on based on her attempts to emulate Mr.
Jobs at different stages of his career.
There are at least two lessons from the Jobs story that Ms.
Holmes would have benefited from learning.
First, CEO of Apple was not Mr. Jobs’s first role. By the time he led Apple, he had served in
other roles at Apple, Atari, and Pixar, as well as having founded NeXT,
Inc. Ms. Holmes shortcomings as a
manager were apparent throughout the book and she most likely would’ve
benefited from the humility and experience gained from working outside the
C-suite. Throughout the book Ms. Holmes
comes across as a tyrant who managed through intimidation and ruthlessly
eliminated any employee who tried to attenuate Ms. Holmes unrealistic
expectations or call attention to her fraudulent business practices. The second lesson is that Apple isn’t a technology company, a point
often made by Rupal Bhansali of Ariel Investments. Apple didn’t invent the integrated circuit
chip or the MP3 format. It achieved its
success through innovative design, novel strategy, and superior marketing—not
through any technological breakthrough.
Even Apple’s most distinctive feature, its operating system, was modeled
after Xerox’s operating system (Bill Gates benefited from third-mover advantage
when he then applied the model to IBM-compatible machines). Ms. Holmes probably would’ve benefited from
staying in school and acquiring the expertise necessary to achieve medical
breakthroughs or at least listening to the experts who advised her to develop a
minimally viable product instead of swinging for the fence with what was and
still is a fictitious miracle machine that fits in a shoe box and can run
hundreds of medical diagnostic tests with only a drop of blood.
A second theme in the tragedy involves Theranos’s
ineffectual show pony board of directors.
Long on prestige and short on oversight and expertise, the list of
directors included then General and future Secretary of Defense James Mattis, a
Navy Admiral, and not one but two former Secretaries of State, George Shultz
and Henry Kissinger. Not only did their
decades of experience in war and diplomacy, while laudable, have almost nothing
to do with blood testing, their collective influence was negligible. Mr. Carreyrou notes in the Epilogue that Ms.
Holmes forced through a resolution giving her 100 votes per share, effectively
99.7 of the votes. He quotes Secretary
Shultz as saying, “’We never took any votes at Theranos. It was pointless. Elizabeth was going to decide whatever she
decided.’” Ms. Holmes contempt for
corporate governance and board oversight came through in another story. An interviewee asked Ms. Holmes about the
board’s role, to which she shot back, “’The board is just a placeholder…I make
all the decisions here.’” The board
failed to notice or act on, among other things, that Ms. Holmes appointed her
boyfriend, a similarly flawed individual, as number two at the company. In perhaps the only time the board came close
to taking decisive action, four members of the board met to discuss Ms. Holmes’s
financial projections that “weren’t grounded in reality” and were “impossible
to reconcile with the unfinished state of the product.” Having resolved to replace Ms. Holmes, the
directors confronted Ms. Holmes. Then in
a two-hour bravura performance of deception and charm, a recurring theme
throughout the book, Ms. Holmes convinced the directors that she should remain
as CEO. Mr. Carreyrou raises the
question of potential sociopathy but defers to the psychologists for the final
answer. Regardless of the clinical
diagnosis, there’s little question that Ms. Holmes was a master manipulator.
The last theme that this author will
address—also the most important and the one most overlooked in this debacle—was
how Theranos flaunted regulation and used faulty equipment on patients without
their informed consent. Since the Nazi
experiments on prisoners in during World War II, informed consent has been a
core tenant of ethical medical practice.
Right now all over the U.S., researchers are pleading their case before
human subjects review committees in order to get approval to use human subjects
for experiments as mundane as surveying consumer preferences, yet Theranos was
able to use untested and faulty equipment to conduct tests on medical patients,
many with terminal conditions. That last
fact receives far too little attention.
What happened at Theranos wasn’t a tragedy—it was a crime. The culprits should be held to account.
On March 6th, thirty-two members of CFA Society Chicago gathered
at Lloyd’s to enjoy a progressive networking luncheon. Participants were seated
at six tables which they moved between for each course. This progressive style
allows attendees to meet 15-18 different people and is an immediate icebreaker
for those who are uncomfortable networking generally or through individual
conversations. During each of the three rounds, participants shared a personal introduction
and any other information they desire whether it be a question on an industry topic
or that they’re seeking employment, these exchanges form the basis of great
Attendees represented a cross section of firms, organizations
and universities including: Well Fargo, Societe Generale, Dearborn Partners,
Merrill Lynch, Ernst & Young, Byline Bank, Chicago Booth School of Business
and DePaul University. The individuals’ roles were equally diverse and encompassed
an MBA student, a professor, several wealth management advisors, a tax specialist,
a director of corporate development and financial planning analysis, as well as
the founder & CEO of a buy-side fund administration company.
Whether you’re looking to expand your network, gain business,
find employment, or share industry insights, these progressive networking
events provide a terrific forum for developing, building and maintaining
relationships. The goal of any successful networking event is walking away with
new connections and that objective was definitely met, including for those who
are a bit more apprehensive about working their way through a room to meet new
people. I definitely encourage you to take advantage of these events.
On Demographics, Growth, and Investing: When the structural collides with the cyclical
Francis Rybinski CFA, treated CFA Society Chicago to his
analysis of the current global demographic situation and its implications at
the latest Vault Series lecture on March 12.
Rybinski is the chief macro strategist at Aegon Asset Management,
responsible for guiding the firm’s global macroeconomic view pertaining to
tactical and strategic asset allocation. His presentation included a wealth of
statistics that highlighted the weak rates of growth of both population and
productivity in developed economies around the world and how that situation
limits investment managers.
Rybinski began with some observations on the trend in GDP
growth in the U.S.:
Actual GDP growth has declined erratically from about 4% in the early post-World War II period, to 3% late in the last century, to just 2% since the last financial crisis. Growth above 2% in very recent quarters has not persisted long enough to define a change in trend. (Slide 4)
Accompanying this change has been a decline in the volatility of the growth rate, both absolutely and relative to potential growth.
While growth has been slowing, the business cycle has been lengthening. The economy seems to be stretching out expansions by pacing itself at a slower rate of growth.
The two driving factors behind GDP growth are the rates of growth in the labor force, and in productivity. Both have been anemic with little expectation of a move to the upside. The Congressional Budget Office projects near term potential GDP growth at less than 2%, incorporating 0.5% growth of the labor force and 1.4% productivity growth. Rybinski argued that even if the labor force were to grow at 1.4% (the average since 1950) potential GDP would not reach 3%, and would trend downward after 2020. Even boosting productivity to 2% gets GDP growth only to 2.5%. While President Trump claims his policies will increase productivity well beyond its recent trend, Rybinski is skeptical. He listed several forces most likely to boost productivity significantly including autonomous vehicles, robotics, 3D printing, genomics, and generally the internet of things. He doubted any of these could be as transformative as the forces that drove productivity higher in the 20th century such as the expansion of the electric power grid, telecommunications, and the development of computers. Maintaining a persistent 3% growth in GDP would take 2% productivity growth—a level last experienced in the 1990’s tech boom–and 1% labor force growth–which would be dependent on increased immigration.
Rybinski applied the term “demographic drag” to the situation he had described. Noting that it exists throughout developed economies, he concluded that “It’s a small(er) world after all”. (Or at least a slower growing world.) This situation, he thought, was at the root of many current global movements such as the new nationalism, anti-immigration stands, and the Brexit vote. The demographic situation also has implications for retirement investing and the social safety net. Lower prospective investment returns will require even higher amounts of savings to fund retirement, and/or an increased burden on government retirement plans.
Rybinski went on to present more demographic data to support
In the 1970’s, a demographic tailwind driven by the maturing of the baby-boom generation and the flood of women entering the work force, provided a big boost to GDP growth in the U.S. This has now become a tailwind as the baby-boomers reach retirement age and the increase in women in the work force has leveled off. This leaves only productivity to boost GDP growth.
The fertility rate in the U.S. declined by about 50% from 1960-75 and has been under the replacement rate of 2.1 births per woman for a decade. Similar trends appear around the world in countries across the income spectrum.
The share of the U.S. population over age 55 is about 27% and continues to rise. The share in the prime working years has been trending down for over twenty years and is now under 50%. The share ages 16-24 is not growing, but is stagnant at about 15%.
The old age dependency ratio (ratio of people ages 20-64 vs. those older) has received a lot of attention because of its dramatic down trend. Rybinski showed that, when adjusted for the increase in the labor force participation rate since 1948, the decline is not as significant, but the trend is still negative. This is a common feature across developed economies.
Currently, immigration accounts for just over 40% of U.S. population growth and it is rising. Native births account for the other 60%, but the share is declining. Within ten years, these factors will be about equal and by 2045, immigration could provide more than 70% of population growth.
Average life expectancy continues to increase and has reached 72 years globally (80 years in high income countries).
Increasing life expectancies and earlier retirements mean more time is spent in retirement. In 2010 it reached 13 years in the U.S. and 18 years in Germany. Even China has advanced to eight years from just two in 1990. This adds stress to retirement plans—an inauspicious factor in the U.S. where over 95% of public pension plans were underfunded to a cumulative total of $1.1 trillion by 2017.
Rybinski had one positive observation regarding inflation, based on the correlation between inflation and the dependency ratio. His data shows that countries with a worsening ratio (primarily the U.S., the E.U. and Japan) have experienced low rates of inflation (under 2%) for the past five years. Countries with higher inflation (such as India, Brazil, Turkey, and South Africa) have improving dependency ratios. Not only has inflation been low in developed economies, but it has also been less volatile. These two trends have put downward pressure on the term premia of sovereign debt. In fact, the term premium on the 10-year U.S. Treasury note is negative, and Aegon expects it to remain so, with the extremely low yields on German Bunds an important reason.
With the Federal Reserve taking a less aggressive position on
raising interest rates and inflation expectations anchored, Aegon expects rates
on treasury debt to remain at their historically low levels.
From his analysis Rybinski provided two implications for
As inflation has declined secularly in the past forty years, the correlation of returns on treasuries vs. equities has fallen from strongly positive, to slightly negative. Thus, treasury debt has been a good hedge against equity markets. With Aegon’s forecast for low inflation to hold treasury yields lower for longer, he expects this hedge relationship to continue.
Low growth of global GDP, and the worsening demographic situation, will place a premium on growth investments. Searching these out will be the primary challenge for investment managers in the foreseeable future. This would typically suggest emerging or frontier markets, but they present increased risks. Many are not easy places to conduct business. Managers will need to be highly selective on choosing which countries to invest in, and will also need to search for pockets of growth hidden in selected industries or companies within developed markets.
Supplement: Post-Event Q&A by Brian Gilmartin, CFA
The overall theme of the presentation was that as the US
population has aged, from the 1960’s “baby boom” being in full swing to the
Generation X, Y and Z’s, of today, US GDP trend growth has slowed, and the
aging of the US population is presenting challenges for everything from retired
workers outliving their savings to putting pressure on public and private
pension fund plans.
In other words, the “demographic tailwind” has become a
“demographic headwind” (per two slides within the presentation) for the USA,
much like it has become in Japan.
“Trend” growth for the US economy was 6% in the 1960’s,
slowing to 4% in the 1980’s and 1990’s and is now just 2.5% today. (My thought
on this was that, the US economy – in terms of real GDP was also much lower in
the 1960’s, just under $1 trillion in each of the 4 quarters in 1966 per the
FRED database, to over $20 trillion by Q4 ’18. The logic being growth looks
faster with a smaller denominator.)
Frank Rybinski noted the decline in global fertility as well
as the increasing life expectancy and slowing population growth rates has
resulted in a “global silver” economy as the number of countries with more 65+
adults than kids under the age of 15 has expanded from 30 in 2015 to a
projection of over 60 by 2035.
From an investing perspective, the presentation noted that
the older a society becomes, the slower the change in the CPI, and in the
Q&A following the presentation, Frank was asked if this changes the role of
the Fed as America ages. Frank Rybinski noted that finding the “optimal policy”
for the Fed today is more challenging given demographics, since the “old rules”
(and Frank Rybinski” specifically cited the Taylor Rule) may have diminished
influence in the future.
From an asset allocation perspective, looking strictly at
demographics, the Frontier and Emerging Markets are better longer-term equity
investments given that GDP growth and productivity improvements are still to be
seen by many of these economies while Japan and old world Europe and other
mature countries (and even the US to some degree) are at the opposite end of
the spectrum and bond market investments and US Treasuries should be held in
portfolios, with Aegon calling Treasuries a “viable portfolio hedge” as
structurally slower growth and low inflation keep inflation contained.
Sub-Saharan Africa, Frontier Markets and Emerging Markets
should be held as equity investments given the longer-term GDP growth
potential, while Treasuries and fixed-income should be held for clients in
On February 6th Mellody
Hobson was the featured guest at CFA Society Chicago’s Power Breakfast series
held at The Standard Club hosted by the
CFA Women’s Network. Hobson, president of Ariel
Investments, is responsible for
managing Ariel’s business operations, development, and strategic
event was a conversational interview and moderated by Linda Ruegsegger, CFA. Ruegsegger started by asking Hobson what she sees as
current risks and challenges in the investment industry. Hobson answered by
stating that most risks should be considered as opportunities to be exploited
whether they are new/emerging or persistent risks. The proper frame of
reference is key to this here. Hobson used a hot topic as an example; the
movement from active to passive management, or the growth of the ETF market. The
growth of the ETF/passive market has come primarily at the expense of active
management. With wide availability, it can be an easy choice to go the passive
route. While ETFs are not inherently bad or wrong to own, they will only
provide an average return – beta. Since the average market return is the best
one can earn, eventually investors will realize that obtaining alpha is a
valued outcome, and they will understand that it is worthwhile to pay for an
active return. Since an ETF portfolio can only offer the market return,
reversion to the mean should favor the active manager.
Hobson brought up a related
topic – fee compression and how different ages of investors evaluate the cost
of investing. The latest generation of investors have been able to invest their
entire (short) life with investments that are effectively free. There are any
number of Vanguard, Fidelity, and Schwab products that are no cost or near zero
cost options. There is no turning back from these products – they are becoming
the default option for the market investor. How then does an active manager
compete against these companies/products? These companies have scale, which
cannot be easily duplicated, thus midsized companies could be squeezed out of
the market leaving a barbell-type investment manager landscape with large, mega
cap providers on one side, and smaller niche-oriented managers on the other. However,
it is the smaller provider that can use their size to be nimble and capitalize
on customization and client service.
Hobson noted another result of
the increased use of passive investments. It is getting more difficult for a
401K plan to provide a combined suite of active and passive investment options.
Active portfolios are being squeezed out due to their perceived expensiveness. She
told the audience of a conversation she had with a trustee of a 401K plan
noting the trustee would no longer consider including active strategies because
of the price difference from passive strategies.
Ruegsegger brought up the
great recession and asked how Ariel Investments made it through 2008-2009.
Ariel underperformed in a material way during this period. According to Hobson
this was the first time this happened. AUM fell due to market declines and significant
client defections. Hobson developed a mentality of ‘just getting through’ to the
next week, next the month, next the quarter and urged her staff to do the same.
There was no payoff at the end of these periods in terms of gift cards, cake, or
parties. The payoff was the opportunity to come back to the job of managing
money for clients and hope that the next period would be better than the last. With
this mindset came more focus from the staff, brutal self-evaluation, and
admitting mistakes that were made. Hobson also developed what she called a
depression baby mentality – scrutinizing all expenses, making due with what you
have, a needs-only mentality. This mentality served Ariel well during that
period. It is important to be able to hold this mentality not just in stressful
times, but also in better times as good times will ebb and flow.
During the downturn Hobson
also met with all Ariel investors – these were hard discussions as many
long-term clients withdrew their assets. For the clients that remained, positive
performance was not promised, but she told her clients she would not bet
against Ariel. Patience was the key – after 2008-09 the Ariel midcap blend was
ranked number one in the Morningstar Mid-Cap Blend category out of 311 funds
that were in existence over the 60-month period ended March 31, 2014.
Ruegsegger deftly segwayed by
asking if patience is ok when bringing diversity to the investment industry. Hobson
answered with a resounding “No!” Lack of diversity is corporate suicide, she
opined. Hobson mentioned a book by Scott Page, The Diversity Bonus: How Great Teams Pay Off in the Knowledge Economy.
The theme of the book is that diversity will always trump intellect. Hobson
recommended the book and gave an example from it about how the small pox
vaccine was discovered. Although there were teams of doctors researching for a
cure, the idea that led to the vaccine was not found by a team of (like-minded)
doctors, but buy a dairy farmer – from a person with a different (diverse)
point of view than the teams of researchers.
Most companies do not
formally address lack of diversity, and while it is great to aspire to having a
diverse workplace, a process must be in place to build and maintain a diverse
team. First, there needs to incentives in place to promote diversity. Incentivizing
behavior will get the desired behavior. Second, have a process in place to
source different pools of people. One must look for talent in a number of pools
– the source of talent must be diverse. Firms
must realize and accept that one person of color, creed, ethnicity does not
make a diverse workplace. More than one of X, Y or Z is needed. Third is having
a mindset of diversity. Building a team is not a choice of taking the best
person or the diverse person. This is the wrong perception. To find and build a
diverse team move away from looking for a skill or credential. Instead look for
intellect and be willing to train. Most people have biases, but they usually do
not realize this fact. Teach yourself and your team to identify bias. Hobson
believes diversity at Ariel is what makes the firm special, it is a competitive
At the conclusion of the
discussion, Hobson took questions from the audience. Several of the audience
members asked questions directly related to her comments on diversity –
Q – Should legislation be
used to improve diversity of corporate boards?
Hobson made some
observations; 25% of public companies domiciled in California do not have any women
on their board, and white adult men constitute 30% of population, but 70% of
corporate board seats. It is painfully obvious that corporate boards need to be
more diversified. However, while mandates for diversity forces us to look at
the facts, the U.S. as a country does not handle these mandates well.
Q – When looking to fill a
position should one find the right intellect or the person that adds to a more
Hobson stated that when given
the question of ‘should I hire the best person or the diverse person’ the answer
should be yes. One must understand that it is not a choice of hiring one or the
other. Circumstances will dictate the best person for the job provided that
diversity is valued at the workplace. That someone does not have the correct
skill set is not an acceptable excuse for hiring in a diverse manner. Any
person can be trained to on aspects of the job that they may not have
previously encountered. It is worth the investment to train in order to obtain
a well-rounded, diverse workplace.
Howard Marks, CFA, is co-chairman of Oaktree Capital, where he contributes his experience to big-picture decisions relating to investments and corporate direction. He shared his insights on investing and managing the business cycle for the CFA Society Chicago community on February 22, 2019. His presentation, entitled “Investing in a Low-Return World,” touched on some of the big questions investors are asking themselves today: Should we lower our return expectations? And if so, how do we make money in a low-return world?
Marks describes today’s environment as a “low-return,
high-risk world.” Prospective returns and safety are hard to come by in the
current over-optimistic climate where people have great trust in the future. Combined
with higher risk-aversion, such sentiments lead to asset price appreciation, which
means lower future returns, without any lower risk.
Let us follow Marks back to basics to consider what lower
returns actually mean. Consider the CAPM model, which shows the trade-off
between risk and return. As central banks have lowered interest rate, this line
has shifted down. For the same level of risk, you now have lower returns,
whether you are investing in T-bills or equity. The CAPM model hints at two
reasons why taking more risk is no surefire way to higher returns. For one, the
downward shift in the CAPM-line means that returns are lower even for such
risky ventures like private equity. Secondly, and more fundamentally, the CAPM
does not ensure higher return for riskier assets. As Marks explains, if higher
returns were guaranteed for these assets, they would not be risky. For risky
assets, therefore, while required returns appear to be higher, there is a wide
range of possible outcomes that offer no safe way to high returns.
In Marks’ view, the seven worst words are ”too much money
chasing too few deals.” This is what we are seeing today, with returns lower
across the board. As Marks clarifies in a memo,
“too much money” does not mean investors have more money on their hands to
invest, but that they are moving resources out of cash, where returns are low, to
seek more risky opportunities, and as such, push down required returns on
What, then, is an asset manager to do in this environment? You
cannot both position yourself correctly in a heated bull market and be
positioned for reversal at the same time. Counting on historical returns being
the same in the future is foolish but settling for today’s low returns
contradicts the business plan of most organizations. You may not survive in the
business if you go all into cash and wait for a better environment.
As an asset manager, argues Marks, you have two jobs, that
of asset selection and cycle positioning. You cannot give up on timing when to
be aggressive because then you cannot ever be defensive. Cycle positioning does
not mean forecasting economic growth for the next year. Marks makes very clear
that he does not believe in forecasting. Instead, you need to understand where you
are in the relevant cycles, such as the business cycle, credit cycle, and the
market psychology cycle. Knowing where you are gets the odds on your side. It
does not mean you can predict what will happen tomorrow but it should tell you
whether to be more aggressive or more cautious. Marks explains that there are
times for aggressiveness and times for caution:
When prices are low, pessimism is widespread and
investors flee from risk, it is time to be aggressive.
When valuations are high, enthusiasm is rampant
and investors are risk-tolerant, it is time for caution.
It seems Oaktree’s view is that the current environment is a
mixed bag. For the past three years, their mantra has been “move forward but
with caution.” This, as Marks explains, means being fully invested while biasing
the portfolio towards defense rather than offence.
In addition to getting the cycles on your side, explains
Marks, there are opportunities for alpha also in the current environment.
Despite low returns overall, there are mispricings to exploit. You do have more
and less efficient markets, and with the right set of skills, you can identify
them. This is harder than it used to be, when there were more structural and
persistent inefficiencies to exploit. Nowadays, most inefficiencies are
cyclical, and emerge only once in a while.
In inefficient markets, some investors will earn positive
alpha, and some negative alpha, so you should enter these markets only if you
think you can be on the right side of the trades. You can do this only if you
dare to be a contrarian. Going this rout is risky and costly but it is the
right way to invest if you have the skills to do it.
For additional reading, see Howard Mark’s memo “Risk and Return Today.” You can find all his memos while at Oaktree here. You can also view the CFA Society Chicago luncheon presentation below.
On January 16, 2019, a profound reflection on economic
policy, politics’ influence on it, and the US economic outlook took place at
the Standard Club in Chicago. The discussion was moderated by CFA Society
Chicago’s very own Lotta Moberg, CFA,—with William Blair’s Dynamic Allocation
Strategies team—and featured David Lafferty, senior vice president and chief market
strategist at Natixis Investment Managers; Nicholas Sargen, chief investment officer
for the Western & Southern Financial Group and chief economist of its
affiliate, Fort Washington Investment Advisors Inc.; and Jas Thandi, associate partner
of Aon Hewitt’s Global Asset Allocation Team. The discussion began with setting
up the big picture of the world economy with the US as the focus and then
progressed to cover the panelists’ outlook on how central bank policies and
deregulation will play out in the US. Finally, the panelists shared their
perspectives on the future of globalization before offering some concluding
remarks. After the panel discussion was completed, Moberg opened the panel to
Sargen kicked off the discussion by encouraging the
attendees to “not focus on the tweets”—referring to the President’s activity on
Twitter—or even the Federal Reserve. Instead, he encouraged people to focus on
economic policy. He walked through the story of Trump’s economic policy since
he took office citing the corporate tax cuts and deregulation in 2017. Sargen
explained his view that these policies carried the markets through 2017 and by
2018 most of this positive news was already priced in to the market. The
realization that these policies were already priced in combined with the new
developments in the China Trade War led to 2018 falling flat by the end of the
year. He closed his opening remarks citing political gridlock in America and a
global economic slowdown as the continuing risks for markets. Lafferty
continued the conversation agreeing with Sargen on all counts and expanding
with his views on the global economic slowdown. He laid out a view of global deceleration
across all major asset classes stating that some of the pessimism is already
priced in. Lafferty even conjectured that he believed most broad asset classes
were not far from fair value. However, none of these broad asset classes are
currently priced for recession. Thandi rounded out the opening remarks by
emphasizing politics’ growing role in markets and bringing focus back to the
U.S.-China trade war and its implications on global assets—especially in
Europe. He expounded on his European focus by pointing to the ECB and the need
for investors to be wary of their policy actions as well. He wrapped up the
opening remarks by touching on the increase in supply of treasuries due to the
runoff of the Federal reserve balance sheet and the impact we should expect to
be seen in the credit markets. This final point set up Moberg’s next point of
discussion: how will the U.S. markets react to recent U.S. government and FED
Thandi picked up by stating his belief that the U.S. economy
would experience a soft landing due to some growth from the tax stimulus.
However, he has been surprised by the way capital expenditures by corporations
has “fallen off a cliff.” Lafferty followed Thandi’s comments regarding low
capital expenditures by explaining that the execution of economic policy can
have an outsized impact. Lafferty explained to attendees that the corporate tax
cuts should have incentivized companies to spend more on capital expenditures,
however, due to recent protectionist rhetoric from the President many companies
became cautious to make capital expenditures due to political uncertainty.
Lafferty also stated that the current political gridlock in the U.S. government
could be dangerous for markets should any major problems arise. Despite these
warnings, Lafferty too expressed some optimism stating his belief that we are
merely experiencing a slowdown. However, he cautioned that Federal Reserve
adjustments could have already killed the expansion. Sargen agreed with
Lafferty regarding Fed policy and shared his view that the Fed’s communication
regarding policy has been poor. He also revisited Thandi’s point of the tax cut
stating his belief that the resulting stimulus would run its course by mid-2019.
However, Sargen also supported the view of a soft landing stating that the U.S.
would not experience a recession this year—but a recession beyond that short
horizon is likely.
The next topic for the panel was deregulation in the US.
Before this topic was kicked off Lafferty offered thoughts by first stating
that there has been a surprising focus on regulating new forms of systemic risk
and investor protection. He cited the growth of the ETF market as a point of
concern for regulators. After making this point he explained that deregulation
has been positive for smaller shops as it has eased their regulatory burden.
Sargen expounded on this point by saying that executives overwhelmingly prefer
less regulation—no matter the size of the company. He pointed to the current
political landscape saying it is no longer as supportive of deregulation due to
the democratic party’s representation in the House of Representatives. Thandi
offered the final thoughts on this topic by stating that deregulation has only
had a small impact. He explained that there were short term gains from
deregulation but they were muted due to tariffs resulting from the U.S.-China
After the deep dive into recent developments in the US the
panel transitioned to discuss the future of globalization, both in the US and
across the globe. Thandi started off by discussing the recent protectionist
rhetoric not only in the U.S. but across the globe citing Brexit as a major
example. He explained that such policies will lead to consolidation in equities
as large companies seek growth through acquisition instead of organically.
Ultimately, Thandi believes these policies will lead to a lower growth
environment. Lafferty agreed that protectionist policies appear to be growing
in developed markets and will lead to a lower growth environment. Further, this
lower growth environment will lead to stunted performance in passive investment
strategies. He also expects these protectionist policies to cause more
volatility in markets. Lafferty’s final point on the matter was that with the
combination of low growth and higher volatility investors will allocate more
capital to active investment strategies.
Finally, the panelists concluded the evening with their
The trade war is not about prices but about
national policy, specifically the U.S. is targeting the “Made in China 2025”
Regarding monetary policy, backtracking on
Quantitative Tightening is actually bad for equities because it signals the Federal
Reserve doesn’t have faith in markets’ strength.
The dollar will be stable or bearish in 2019.
Reforms and policy decisions in Europe will be
more influential than the media is portraying.
Assuming a soft landing for the U.S., emerging
markets already had their correction and are due for a rebound.
Alternatives such as private equity are an
Passive investment strategies generally
outperform hedge funds in the long run.
After the discussion was concluded Moberg opened the panel
Does it matter who
Trump’s Economic Advisor is?
diversification out of date?
Thandi: No, however correlations have
lowered with globalization. Currency risk still plays a big role.
Lafferty: No, however Emerging Markets are
no longer as attractive in the long run because growth has slowed. Low
correlations have become much rarer due to an interconnected global economy.
Sargen: No, but benefits of international
diversification are not as attractive. Additionally, investors should be wary of
diversification into bonds as the Federal Deficit continues to grow.
What is the big thing
the general consensus is missing?
Lafferty: Bubbles in the capital markets.
Sargen: Global leaders are running out of
policy ammunition to deal with crises.
What will volatility
be in the next 6 months?
Lafferty: Low 20s as opposed to low teens
(referring to the VIX Index level).
Chicago held its annual celebration for new members and volunteers on Thursday,
January 17, 2019. The venue was a new one the Society, hosting the event at River
Roast on LaSalle Street just north of the river. Attendees enjoyed a spacious,
private setting away from the public area of the restaurant. The setting
provided an excellent opportunity for new members to build their professional
networks, and for everyone to reconnect with friends and colleagues.
CEO of the
Society, Shannon Curley, CFA, led off the official portion of the event by
welcoming everyone, and introducing members of CFA Society Chicago’s Board of Directors
and co-chairs of advisory groups who were present. He added a special welcome
to new members, encouraging them to take advantage of the event to speak with
members of the various advisory groups represented, and consider volunteering
their time by joining one. Finally, Shannon gave a well-deserved thank you to
society staff for planning this (and every) event.
Shannon then announced the list of volunteers recognized for their outstanding contributions during 2018 to each advisory group:
Annual Dinner – Cara Esser, CFA
Professional Development – Kevin Ross, CFA
Communications – Lisa Davenport, CFA
Education Seminars – Matthew Morris, CFA
Distinguished Speakers Series – Arthur Olunwa, CFA
Membership Engagement – Deb Koch, CFA
Social Events – Jenny McNicholas
CFA Women’s Network – Bhavna Khurana, CFA
Shannon continued by thanking the co-chairs of the advisory groups for the extensive time and energy they put into making the events the society offers so valuable to our membership. All recognized volunteers received a gift from the Society in appreciation of their service. The final piece of official business was the drawing of raffle prizes (to some the highlight of the event). This year, everyone could choose to enter their choice of two drawings for overnight stays for two at the Standard Cub or Hyatt Regency. Congratulations to Ben Huddleston, CFA, and Pranay Subedi, CFA, winners of the raffle! With the official business completed, the socializing continued for the remainder of the event.
How should one define networking? It could be described as simply
an exchange of information and services. But, according to Sameer Somal, a
better definition that could lead to a very successful career could be “finding
ways to give to others”.
“You have one of the
very best societies,” Sameer said, mentioning the many high quality events put
on by CFA Society Chicago. He couldn’t resist a gentle dig on the Chicago
Bears, fans of which had recently witnessed a double doink missed field goal that
led to a playoff loss against his favorite team the Eagles.
His Blue Ocean Global Technology provides digital reputation
management, which Somal described as building, maintaining and repairing
reputations. He’s an expert who has testified on internet defamation cases in
court and says that the digital identity we all have will be one of the most
valuable commodities of the future, which makes reputation management important
not just for companies but for individuals as well.
His message has much in common with How to Win Friends and Influence People by Dale Carnegie, which
Somal said was “the bible of the subject”. According to the Carnegie Institute,
as much as 85% of an individual’s success can come from ability to communicate,
with only a small fraction determined by analytical skill.
One thing that Somal hears a lot from investment managers is
“our business comes from word of mouth”. He said that might be true a decade
ago, but now young generations (children of a client, etc.) will immediately
look up a firm on the internet, and you need to manage your presence online.
His highly interactive presentation was sprinkled with
giveaways to encourage participation, with Somal handing out a tin of
Butterfields Peach Buds (“This is the finest candy that I send out all over the
world”) to Austin Galm for being the first to answer a question.
Networking is really just the beginning step, as
relationships are built over a period of time, and according to Somal, “the
fortune is in the follow up”. Somal said that following up after meeting is the
biggest part of networking that is often overlooked, and he asked the audience
“Why would you even go to a networking event if you’re not going to follow up
with the people you meet there?” And while the internet is an indispensable
part of networking, Somal said that it is best to “use the internet to get off
the internet”, and connect with people in person.
Somal confronted some myths he frequently hears about
networking, such as it is only for salespeople and it isn’t as effective as
people think. He told a story about how he was able to connect with a number of
influential people using respectful and thoughtful language, often in
handwritten notes. It’s also important to decide what kind of networker you
want to be, Somal said. For some, it means making one important connection at
an event. Somal described himself as a “speed networker”, and he tries to have
memorable interactions and make as many connections as possible while at an
He also has a process that he follows for staying in touch
with someone new, which he does within the first 6 months of meeting. When
interacting with someone for the first time, it’s best to avoid the question
“What do you do?”, because the answer can define a person. Better questions are
open-ended, and could be something like “Tell me about your role at your firm”.
Not everyone is as altruistic as Somal when it comes to
seeing networking as a way to enrich others. He is always on the lookout for
what he terms “givers and takers”, and will quickly determine which side a new
contact is on.
He covered topics such as body language, ways to introduce
yourself and ideas for some interesting questions to ask. Things like eye
contact, positivity, keeping your phone in your pocket and being confident will
go a long way when meeting new people. Good questions come from preparation,
and it is helpful to research who will be attending a conference in order to
think about what might be good things to ask him or her. One of Somal’s
favorite questions to ask is “What is giving you positive energy lately?” This
question tends to get a smile on people’s faces and get them to remember you in
a good way.
When reaching out to execs with mentoring and networking
requests, Somal said that it’s best not to ask for anything right away, but to
simply say that you’d like to build a relationship with them over time and earn
their trust. After you connect with someone you met at a conference, wait about
a month and then send another quick note telling them a little more about
yourself. Here are three tips Somal recommended to prepare for meeting people
at an event:
Prepare a memorable 30 second elevator pitch
Create relevant and thoughtful questions
Focus on quality, not quantity
If you read an article by someone you liked, send them a
note that says “I loved your article and would be delighted to invest in this
friendship over time”. Going along with his digital reputation mindset, Somal
will often encourage prospects and networking targets to Google him on
voicemails he leaves.
In terms of methods of following up, you can use social
media, email, text, phone or a handwritten note. Somal said that it’s important
to use all of them. Many people he speaks with, particularly younger people,
hate using the phone, yet it’s still important to have good phone skills
despite all of us being better at in-person interaction.
Somal finished his speech with a quote that summed up his
philosophy on networking: “Give without remembering and receive without