Distinguished Speaker Series: Joel Greenblatt, Gotham Asset Management

Joel Greenblatt, the legendary author, Columbia B-school professor and hedge fund manager, presented his thoughts and methodology on investing to CFA Society Chicago and local investment community on Wednesday, December 5, 2018.

The title of his presentation compared value investing to the New York Jets, i.e. unpopular and out of favor. Per Greenblatt, where we stand today on a valuation basis relative to the past 25 years is that about 25% of the S&P 500 could be considered “undervalued” versus just 7% of the Russell 2000, if we assume the S&P 500 earns its long-run average forward return of 7%. Greenblatt also thought that the S&P 500 could earn a below-average 3%-5% return for the next few years.

In a statement that was likely no surprise to anyone in attendance, Greenblatt noted that “Growth” has outperformed the market the last 5 years. Greenblatt defined for attendees what the parameters were for a value investor (with all of these definitions supported by the Russell and Morningstar definitions:

  • Low price-to-book
  • Low price-to-sales
  • Low cash-flow valuation

What Greenblatt admonishes his students to aspire to, “Do good valuation work, and the market will likely agree with it”. Greenblatt noted he just wasn’t sure when the market would agree, but in theory at some point it will.

Greenblatt put up the chart that showed the classical individual stock return versus company valuation, and to no surprise to anyone, the overvalued stocks typically had the lowest forward returns relative to the lowest valuation. He also used the examples of two lectures he gave to a group of NY doctors who only asked what he thought the market would do over the next few years, versus the Harlem high school jelly bean test, and asking the kids to guess as to the number of jelly beans in the jar. Joel Greenblatt used the story to lead listeners to the conclusion that the kids in Harlem were closer to the right answer in terms of the accurate number of jelly beans in the jar, when doing their own homework versus listening to “word-of-mouth” guesses by the class.

It was clear that Greenblatt was more impressed by the analytical rigor of the Harlem high school class than the group of doctors, but he also used the story to illustrate the power of impression and what is heard by the retail investor and how emotion and psychology play important roles in investing. Greenblatt also talked about one of first books, i.e. The Big Secret for the Small Investor and the two most important points from the book:

  • 41% of the investment managers with the best 10-year track records also spent at least 3 of those years in the bottom decile of performance rankings.
  • The “Big Secret” is really just patience. Find an investment strategy that you are comfortable with and stay with it.

Greenblatt noted that the press’s preoccupation with Tesla is the “tyranny of the anecdote” contrasting that with deep value investing strategies and how they work over long periods of time.

The Q&A session noted that – not surprisingly – Greenblatt finds more opportunities in the smaller-cap universe despite the valuation comments from above. The valuation metrics aren’t “weighted” in that price-to-sales isn’t weighted more heavily than price-to-book although from his side comments and what were more impromptu thoughts by Joel, price-to-cash-flow and cash-flow health was rather significant.

Greenblatt did note that with “international” investing, the Professor’s fund trades long-only since with international there are trading costs, different forms of regulation, liquidity and other notable differences between US and Non-US investing.


*If you missed the event the webcast of the full presentation is still available to watch on the CFA Society Chicago website.

Distinguished Speaker Series: James Grant, Grant’s Interest Rate Observer

James Grant has a resume. Navy man. Journalist. Founder and editor of Grant’s Interest Rate Observer. Author of books that range from the Great Depression, financial histories, a presidential biography, a forthcoming biography about Walter Bagehot, and appearances on numerous financial programs. Grant was the featured guest speaker at CFA Society Chicago’s Distinguished Speaker Series on November 14, 2018. Over lunch at the JW Marriot, Grant gave his views on topics ranging from interest rates to asset valuations and finished with questions from the audience.

Grant started with a U.S. economic review of the past 10 years concentrating on the progress and consequences of the monetary / fiscal policies applied over this period. Grant noted in 2007/08, the largest banks were leveraged around 29/1. The same group of banks are now levered approximately 13/1. While the risk these banks pose to the financial system has been reduced by de-levering over the past ten years, the leverage ratio of the Federal Reserve Bank has moved in an opposite direction, now standing at all-time highs. Fed policies have created a risky and perhaps fragile economic situation. Although the Fed has the ultimate backing of the U.S. government, at some point the investing public could say “enough” as ultimately the term “risk-free asset” will come into question. Grant then compared debt loads to GDP, asking rhetorically what is the level of debt that inhibits a country from issuing new debt at any price? Japan’s ratio of public debt to GDP is around 228%, Italy’s is 130%, while the U.S. stands at 105%. None of these countries currently have a problem issuing or servicing their debt. However, Grant explained that the level of debt is not the key, but how a country is viewed in the eyes of the world markets. For example, in 1978 the U.S. was in the midst of a funding crisis and the debt/GDP ratio was at only 26%. While finances and balance sheets matter, it is the cycles of interest rates that dominate a countries ability to raise debt and the world economies appetite for it. An alarming fact is the level of U.S debt issuance (in terms of percentage of GDP) is at its highest point since 1945. Grant pointed out the incongruity of the U.S. bond market activity and the overall economy. The economy by any measure has exhibited steady and reasonable growth in the past 10 years. Yet the U.S. government continues to issue more debt and increase the overall deficit in the face of increasing GDP.

Next, Grant addressed the value of risk-based assets. The past ten years of near zero term rates has created a perversely low cost of capital. By holding interest rates to artificially low levels, asset prices have inflated abnormally. Companies have exhibited a vicious cycle of issuing debt and using the proceeds to buy back their stock thereby propping up valuations. Fed policy is the main reason why there are a number of mega-sized companies that have recently gone or are about to go public. The commonality among these companies is that they typically make no money, have remarkably high valuations, and have easy access to cheap capital. Think Uber – it has never been profitable, year-over-year growth is decelerating, and it continues to lose market share. Despite this documented financial condition Uber has been recently valued at an enterprise value over $70 billion.

To underscore his points, Grant cited the works of two other authors. The first was Ed McQuarrie, Professor Emeritus at the Leavey School of Business, Santa Clara University. McQuarrie is a part-time market historian who takes particular issue with the views popularized by Jeremy Siegel of a 6-7% average return in the stock market over time. McQuarrie’s position is that for decade long periods the stock market has had negative returns and there is not necessarily a reversion to the mean. Grant strongly advised the audience to read Dr. McQuarrie’s paper Stock Market Charts You Never Saw.

When Grant finished his prepared remarks he fielded questions from the audience.

Q – Given your outlook on interest rates and asset valuations, is the pricing of private equity realistic?

A – Grant answered with a quick “No”, and pointed to a recent disagreement between Palantir Technologies and Morgan Staley which has a stake in the company. Palantir has been valued in the $30B – $40B range and is looking to launch its IPO in 2019. Morgan Stanley has lowered the valuation of the company to a fraction of its private market $30-$40B valuation. What does it say to the current state of private equity valuations if the very banks that are to take a company public cannot agree with the company on valuation?

Q – In the current market environment where would you put capital?

A – As bond yields go up (a certainty in Grants eyes), gold will also go up. When the public losses confidence in a country’s fiscal management, there will be a flight from that currency.

Q – Given the state of the U.S. finances, what is the answer – raise taxes, lower spending?

A – The first step to fixing our financial crisis is something akin to a person dependent on drugs. Admit there is a problem. Setting aside the lawmaker (or the out of power political party) that calls for fiscal responsibility, the U.S. government as a whole must tackle the problem. It is more likely that there will be monetary disorder before the problem is addressed. If this is the most likely scenario, then investors should consider gold as hedge.

Distinguished Speaker Series: Rick Waddell, Chairman of Northern Trust

Who better to teach management during a crisis than a former bank CEO who began his job in the midst of the 2008 recession? Rick Waddell has one of the most extensive resumes you’ll find in banking and dedicated his career to growing Northern Trust from a sleepy custody and wealth management firm into the technology-driven asset management and banking leader it is today. Waddell was CFA Society Chicago’s guest speaker on October 10th for its Distinguished Speaker Series luncheon.

He noted proudly that he saw many former and current Northern Trust employees in the audience. “The CFA Society is really important to us at Northern Trust,” he said. Waddell said that he was told not to make his speech a commercial for his bank, and joked that “this eliminates about 95% of my content” and made him ponder what would be a good topic for him to address, ultimately deciding on “5 Things I Learned From the Global Financial Crisis of 2008”.

In Waddell’s mind, the following five key features made the difference between success and failure during the financial crisis.

Capital matters. For any organization with a balance sheet, both the quantity and quality of its capital during ’08 were incredibly important. He noted that capital ratios had been too low in Europe, but generally were roughly OK in the US. He still sees problems with bank capital transparency in Europe today.

Liquidity matters. Again, both the quality and the amount of liquidity are important. Waddell said that he believed that the fall of Lehman Brothers was not due to lack of capital, but to lack of liquidity. The Fed was much more focused on capital during the global financial crisis than liquidity, but the latter was just as important. One of the earliest warning signs Waddell saw that all was not right in the financial world was when HSBC wrote down $11 billion worth of subprime mortgages in March of 2007. Waddell wanted to know if any part of Northern Trust had exposure to subprime lending and found that, while they didn’t make the loans themselves, they still had subprime-related instruments in some of their investment pools. Another warning sign came in August 2007 when Waddell learned that a securities lending collateral pool was facing losses when a number of banks withdrew from the niche Auction Rate Securities (ARS) market and banks holding the formerly liquid instruments suddenly faced losses.

Leadership and management during a crisis matter. Waddell said that during a tumultuous period, “the good and the not so good in all of us comes out.” With his background focused on commercial banking, he had to learn a lot of things quickly during the crisis as a new CEO leading a diversified financial firm. At the same time, Waddell had consultants and executives coming to him asking who he was going to fire in order to shed costs. Firing people immediately after the bank’s best year on record (2007) didn’t make sense to Waddell. He didn’t want to go down that route, and it turned out that staying the course and not making widespread headcount reductions was the right decision.

Culture matters. “At Northern Trust, our values are service, expertise and integrity,” said Waddell. Having that culture in place before a crisis hit was extraordinarily important. While Waddell admitted that Northern Trust has its share of problems like any firm, and its culture needs to evolve while holding employees more accountable, having a set of values that the team buys into was one of the main reasons the firm navigated the crisis so well. “Culture is more important than strategy,” Waddell said, echoing management consulting pioneer Peter Drucker. Despite the bank’s commitment to its partners and Waddell’s desire to avoid mass layoffs, its ROE fell to 8.2% in 2011, below its cost of capital, so the bank went on a mission to cut costs while still avoiding large layoffs that could have demoralized staff.

Strategy matters. Waddell said that having skin in the game was important during the recession. He found that the trend of banks securitizing assets and immediately getting them off their balance sheet led to a lack of skin in the game with financial institutions, and this made the crisis even worse.

Waddell continued on at length about his experience during the financial crisis. In 2009, large US banks were forced to accept a capital injection as part of TARP. Northern Trust was well-capitalized and didn’t need the money, but regulators hinted that they needed to comply or there could be consequences. Waddell said that the TARP program was in theory a good idea that could act as a stimulus, but the problem was that there weren’t enough borrowers demanding capital for it to have much of an impact. What was originally termed the “healthy bank program” soon became “the bailout” in the public’s eyes, which led to protest movements such as Occupy Wall Street, some of which were held immediately outside Northern Trust’s headquarters at LaSalle and Monroe. This populist take on the government bailing out fat cat bankers hurt the perception of Northern Trust, despite the firm’s insistence that it didn’t need capital and its desire to quickly repay the money. Waddell said that the terms of the loan Northern Trust was forced to take netted taxpayers a 15.5% return, and TARP overall was one of the most successful investments for taxpayers in recent history and very profitable for the government.

Blame for the crisis is difficult to assess, but Waddell said that the Fed was responsible for missing some of the warning signs, banks were also responsible to an extent for lax standards, and consumers were also responsible by borrowing far more money than they were able to repay. Waddell said that eventually there will be a recession in the US but the banking system will be in a much better position to not only withstand it, but even be a positive force for stability. One thing that remains unresolved is the issue of “too big to fail”, but bank capital and credit quality have greatly improved overall. While he noticed some clues that markets were starting to crack back in 2007, Waddell sees few red flags on the horizon today. He said that usually problems will manifest early on in the mortgage market, but that the industry appears to be functioning fairly normally now. There could be some issues with Brexit next year, and Northern Trust continues to monitor that situation closely, as well as the Chinese economy and issues around cybersecurity. In his Q&A, Waddell said that young professionals considering a career in banking will still find opportunities in the future, as the practice of safeguarding assets and allocating capital will be around for a long time. He was slightly less upbeat about the prospects for the asset management industry in light of the disruptions faced by robo advisers, low (and sometimes free, in the case of Fidelity) account fees, and the trend towards passive investing.

True to Northern Trust’s values, Waddell finished his speech by encouraging the audience to get involved in a philanthropic endeavor that aligns with their interest, saying “to much is given, much is expected”. Lastly, he noted the firm’s long history of collaborating with United Way and said that there’s still much work to be done.

Distinguished Speaker Series: James Bullard, President and CEO of the St. Louis Federal Reserve Bank

On September 12th, CFA Society Chicago welcomed James Bullard, president and CEO of the St. Louis Federal Reserve Bank. Members and guests heard Bullard’s remarks over breakfast at The University Club.

The focus of the discussion explored a possible strategy to extend the U.S. economic expansion. Bullard noted that historical signals used by monetary policy makers have broken down, specifically the empirical Phillips curve relationship. As a result Bullard suggested putting more weight on financial market signals, such as the slope of the yield curve and market -based inflation expectations. Handled properly, these signals could help the Federal Open Market Committee (FOMC) better identify the neutral policy rate and possibly extend the U.S. economic expansion.

Following are excerpts from Bullard’s presentation “What Is the Best Strategy for Extending the U.S. Economy’s Expansion?

The Disappearing Phillips Curve

Prior to 1995 inflation expectations were not well anchored. Around 1995, the U.S. inflation rate reached 2 percent, and U.S inflation expectations stabilized near that value. Bullard interpreted this as the U.S. having an implicit inflation target of 2 percent after 1995, calling it the inflation-targeting era. The FOMC named an explicit inflation target of 2 percent in January 2012, but Bullard said he believes that the Committee behaved as if it had a 2 percent target well before that date. The post 1995 period in the U.S. coincided with a global movement among central banks toward inflation targeting beginning in the early 1990s. During this period, the 2 percent inflation target became an international standard.

Once inflation expectations stabilized around this international standard, the empirical relationship between inflation and unemployment– the so called “Phillips curve”–began to disappear. Bullard provided a chart showing the slope of the Phillips curve has been drifting toward zero since the 1990’s and has been close to zero for the past several years.

Current monetary policy strategy

The conventional wisdom in current U.S. monetary policy is based on the Phillips curve and suggests that the policy rate should continue to rise in order to contain any increase in inflationary pressures. However, in the current era of inflation targeting, neither low unemployment nor faster real GDP growth gives a reliable signal of inflationary pressure because those empirical relationships have broken down. Continuing to raise the policy rate in such an environment could cause the FOMC to go too far, raising recession risk unnecessarily.

Given that, Bullard suggested using financial market signals such as the yield curve as an alternative to the Phillips curve. The slope of the yield curve is considered a good predictor of future real economic activity in the U.S. This is true both in empirical academic research and in more casual assessments. Generally speaking, financial market information suggests that current monetary policy is neutral or even somewhat restrictive today. Specifically, the yield curve is quite flat, and market based inflation expectations, adjusted to a personal consumption expenditures basis, remain somewhat below the FOMC’s 2 percent target. Financial market information also suggests the policy rate path in the June 2018 summary of Economic Projections (SEP) is too hawkish for the current macroeconomic environment.

A forward-looking strategy

More directly emphasizing financial market information naturally constitutes a forward looking monetary policy strategy. One of the great strengths of financial market information is that markets are forward looking and have taken into account all available information when determining prices. Thus, markets have made a judgment on the effects of the fiscal package in the U.S., ongoing trade discussions, developments in emerging markets, and a myriad of other factors in determining current prices.

Financial markets and the Fed

Financial markets price in future Fed policy, which creates some feedback to actual Fed policy if policymakers are taking signals from financial markets. This has to be handled carefully. Ideally, there would be a fixed point between Fed communications and market based expectations of future Fed policy, i.e., the two would be close to each other. Bullard said that generally speaking, markets have currently priced in a more dovish policy than indicated by the FOMC’s SEP – they expect the Committee to be more dovish than announced but still not enough to achieve the inflation target.

Caveats on financial market signals

Financial market information is not infallible, and markets can only do so much in attempting to predict future macroeconomic performance. The empirical evidence on yield curve inversion in the U.S. is relatively strong, and TIPS -based inflation expectations have generally been correct in predicting subdued inflationary pressures in recent years. Therefore, both policymakers and market professionals need to take these financial market signals seriously.


Bullard suggested that yield curve inversion would likely increase the vulnerability of the economy to recession. An inflation outbreak is possible but seems unlikely at this point. By closely monitoring market based inflation expectations, the FOMC can keep inflationary pressure under close surveillance. In addition, financial stability risk is generally considered moderate at this juncture. Arguably, these are being addressed through Dodd-Frank and related initiatives, including stress testing.


The current expansion dating from the 2007-2009 recession has been long and subdued on average. The slow pace of growth suggests the expansion could have much further to go. The strong performance of current labor markets could entice marginally attached workers back to work, increasing skills and enhancing resiliency before the next downturn.


Another long standing issue in macroeconomics is how to think about parameter uncertainty, or more broadly, model uncertainty. Bullard pointed to two studies: Brainard (1967) suggested that when model parameters are in doubt, policy should be more cautious than otherwise and, Hansen and Sargent (2008) suggested that, in some cases, policymakers might want to be more aggressive than otherwise. This is an unresolved issue, but how to handle parameter uncertainty has been a concern for the FOMC for years.


Bullard re-iterated his position stressing that U.S. monetary policymakers should put more weight than usual on financial market signals in the current macroeconomic environment due to the breakdown of the empirical Phillips curve. Handled properly, current financial market information can provide the basis for a better forward-looking monetary policy strategy. The flattening yield curve and subdued market-based inflation expectations suggest that the current monetary policy stance is already neutral or possibly somewhat restrictive.

Distinguished Speaker Series: Morton Schapiro, Northwestern University

How is your earnings trajectory impacted if you attend a top private versus a top public institution? How many students pay the full ticket price of tuition and what is the average tuition payment post-financial aid?  Should we be concerned about the levels of student loan debt in this country?

These questions and more were the topics of discussion at The Chicago Club where approximately 150 investment professionals gathered to hear Morton Schapiro, economist and the current president of Northwestern University, opine on the state of funding for higher education. For background, Morton Schapiro is currently the 16th president of Northwestern University for which his term began in September of 2009. He is a Professor of Economics at Northwestern and also holds appointments in the Kellogg School of Management and the School of Education and Social Policy. He previously served as the president of Williams College. Schapiro is among the nation’s leading experts on the economics of higher education, with particular expertise in the area of college financing and affordability and on trends in educational costs and student aid. He has written more than 100 articles, and he has written or edited nine books, his most recent Cents and Sensibility: What Economics Can Learn from the Humanities (Amazon). His most recent book challenges modern day economics and discusses how economics can be improved through reading great literature, and even taking a step further, how one can improve investment performance through being immersed in great literature.

The industry of higher education is a fascinating one in that it is unlike any other industry in the world. In fact, some economists do not even consider it as an industry at all, however Shapiro argues the industry can be viewed with many similarities to a traditional business sector. Dissecting the industry of higher education, nationwide there are 4,400 colleges and universities that can be bifurcated into public and private, and for-profit and non-for-profit. As for students, or “customers” of the industry, there are 17 million undergraduate students and 3 million graduate or professional students. If you were to combine all the operating budgets of these 4,400 institutions, you would reach $600 billion dollars, or roughly 3% of this country’s GDP. Now this figure may seem large to some, but what one must also take into consideration is the multiplier effect of this 3%—the present value of future cash flows from the individuals that are bestowed with a great education and their respective spending impacts on other sectors of the economy.

Let’s dig in to take a closer look at the composition of these 4,400 institutions. Of these higher level education institutions, only about 350 schools (or 8%) have any admission standards whatsoever. Said another way, 92% of these higher education institutions accept anyone who applies. On the other end of the spectrum, for every twelve students who apply at Northwestern, only one is accepted equating to a less than 8% acceptance rate. Stanford, Harvard and Yale have even lower acceptance rates closer to ~5%. The reality is, the vast majority of students at higher education institutions are enrolled at schools that take everyone who applies. Further, of the 350 schools that do have admission standards, only about the top 150 schools get much publicity with the overwhelming attention going to the top 60 accredited research universities comprised of 26 private institutions including Stanford and Northwestern, and 34 of the public institutions including University of Illinois at Urbana Champaign, Michigan and Wisconsin.

This begs the question, how important is it to go attend to one of the top 60 accredited research universities? As most financial minded people would conjure, it ultimately comes down to a simple rate of return equation. Shapiro points out that we are at record rates of return for higher level education. The New York Fed looked at the direct costs of room and board and tuition plus the opportunity costs of entering the labor force immediately after high school. It took 23 years to cover the direct and indirect costs of a college education 25 years ago. Today, it takes less than 10 years to cover the direct and indirect costs—despite the rising cost of tuition that we’ve seen over the last 10 years. The return on higher education has increased much more rapidly than the rising cost of tuition. Simply put, higher level education is more important today than ever to maximize a student’s future expected earnings potential.

Let’s bring demographics into the analysis. Statistics show if you grew up in a household in the bottom 20% income range and you earned a degree from a higher level education institution, you had a 21% chance of jumping to the top 20% of income earners in the United States. The national average of a child growing up in the bottom 20% income earning household jumping to the top quintile is ~8%, leaving the non-attending high level education student in the low-mid-single digit percent range. This means that a lower-income student has roughly a four-times better chance at making the transition to the top quintile of household earners if he/she attends a higher level education institution versus if he/she does not attend. Further, if you went to one of the accredited public universities, the chances of moving from the bottom bracket to the top actually increased to 42%, roughly eight-times a child who does not attend any college or university. Taking it one step further, if a student attends one of the top private institutions, their chances of success (measured financially) moves to over 50%. Higher education matters.

This then begs the question, “Do the benefits of this higher education outweigh the costs?” Currently there is ~$1.4 trillion dollars of student loan debt outstanding in the United States. However, less than 1% of students have loan balances over $100,000. In fact, only 60% of college graduates have student loan debt (40% graduate debt free) and the average student loan balance for those that have loans is only $30,000. If you look at the rate of return on higher level education, particularly if you are attending a top 60 school, you cover the costs of your education very quickly. One area of concern is attendance at a less accredited “for-profit” school where we find the vast majority of student loan defaults.

What scares people from pursuing higher level education most often is the quoted “sticker price”. Although the sticker price of higher level education is what garners the most attention, the majority of students do not pay the full sticker price. In fact, only 25% of students attending four-year public universities pay the full sticker price. The average sticker price for in-state tuition is $10,000.  In fact, 75% of students receive some form of financial aid lowering the average student cost of attendance to ~$4,000/year for a public university. At the top private institutions, only 15% of students pay the full sticker price. The average tuition at these higher-level educations is $35,000/year and with the help of financial aid, the average student pays only $15,000 per year.   At Northwestern, roughly 40% of students pay the full $72,000/year sticker price and the remaining 60% of students pay on average $28,000/year. With the average student paying $28,000/year, Shapiro points out it is rather deceptive to only focus on the full $72,000 sticker price.

The event wrapped up with a Q&A session, where the focus was on top public schools vs. top private schools, financial aid, online education, and best advice for future students.

  • Top private school vs. top public schools. Penn State did a study that showed if a student could graduate through Penn State in four years and you paid full sticker price at both Penn State and University of Pennsylvania, your earnings potential was not dependent on which school you attended. However, if you attend a public school, graduation rates tend to be closer to 4.5 to 5 years, whereas the private universities are closer to 4 years. Demographically, the study showed that if you are a Caucasian coming from a wealthy family, you are just as better off at a top public school as you are at a top private institution. If you are a female, it tips marginally in favor of going to the top private. If you are a minority, you are much better off at a top private institution. There is a lot of debate on why these results are the way they are.
  • Financial aid and the rise of merit-based aid. Many schools have made a move towards merit-based aid versus needs-based aid; however Northwestern has not made this transition. Shapiro’s position is needs-based aid provides more value—the merit is being accepted into one of these prestigious institutions that changes the trajectory of your future earnings stream in a dramatic way. Shapiro doesn’t believe we should discount school for students who come from well-off households.
  • Online education. Despite a rise in popularity, it is impossible to disrupt the control the top 60 institutions have on the marketplace. Technology has made all higher level education better in terms of greater efficiencies, but Shapiro doesn’t envision the online degrees disrupting the premier institutions. Generally speaking, the higher institutions do not accept credit from online institutions.
  • Best advice for future students: Apply early. Northwestern takes 50% of their students through early admission. The school wants those students who would do anything to be able to attend their university. Find a school where your child will really thrive and not find himself/herself in over his/her head and apply early.

Distinguished Speaker Series: Ari Paul, CFA, BlockTower Capital

It was an inauspicious day for a cryptocurrency discussion. With many cryptocurrencies down by over 10% on August 8th, Ari Paul, CFA, CIO of BlockTower Capital, gave CFA charterholders a crash course in blockchain technology and the various cryptocurrencies available for investors.

Paul said that surprisingly, many risk management professionals such as himself were among the biggest proponents of cryptocurrencies. Risk skills are definitely helpful for evaluating and investing in digital assets such as Bitcoin, and Paul believes that the space sits at the intersection of game theory, cryptography, computer science, economics, venture capital and public markets. He said that very few individuals have all of these skills, and that there is a big opportunity for people with just a small amount of cryptocurrency knowledge to generate large returns because most people don’t know much about the space yet. He compared investing in cryptocurrencies today to investing in stocks pre-Benjamin Graham. Although the idea of the blockchain is not exactly new (Paul pointed to patents received by IBM back in the 1970s for distributed databases), the current digital coin offerings such as Bitcoin, Litecoin and Ethereum are all under a decade old.

The big question when considering how to approach cryptocurrencies is “What are these helping and why do we need this?”

Paul said that a big part of the need stems from banking and capital markets technology being incredibly obsolete. He cited the examples of ACH bank transfers taking 4 days to process and $35 fees for international Western Union transfers being an opportunity for cryptocurrency disruption. While the internet has greatly increased the speed of messaging and email, payment transfers have not seen the same amount of development.

There are 3 main enhancements to the original ideas of distributed databases that have greatly increased the interest in digital currencies and blockchain lately:

  • Proof of work mining, which ensure skin in the game
  • Public key cryptography
  • Permissionless blockchain

A simple definition of blockchain could be a type of database that has its transaction entries linked with cryptography, the art of solving codes. Cryptocurrencies are the intrinsic, tradeable tokens of blockchain and the most commonly known version is Bitcoin, which had over $100 billion in market cap on the day of this presentation. Intrinsic tokens can be spent on monetary transmissions (Bitcoin) or on decentralized computing power (Ethereum). There are also asset backed tokens that can be created by a third party.

There are over a thousand digital coins tracked by coinmarketcap.com, but Paul said that the use cases and value propositions of most of them can be described in terms of three distinct categories:

  • A censorship-resistant store of value – “digital gold” or a “Swiss bank on a phone”
  • Utility tokens – amusement park tickets or paid API codes
  • Tokenized securities – crypto versions of traditional asset ownership interest

Paul said that the Initial Coin Offering market, or ICOs, has exploded in the past year, becoming larger than the overall seed stage VC market. “Many people, including myself, are skeptical of the ICO business model,” Paul said, saying that ICOs are like “hot potatoes” that speculators will often try to offload on unsuspecting get-rich-quick hopeful investors, saying that they can be seen as analogs to Chuck E. Cheese tokens.

In terms of how investors are accessing cryptocurrencies, Paul said that “we’re transitioning from crypto being un-investible [by most] to far easier,” mentioning Coinbase and other exchanges that have greatly risen in stature over the past couple years. While individuals have an easier time of buying digital coins such as Bitcoin, it is still difficult for institutional investors to access them because there aren’t many good custody options. Paul thinks that major custody bank State Street may be as far as three years away from launching a viable cryptocurrency custody product. There is also a high degree of risk of theft with the coins, and even a sophisticated investor such as Paul believes that his firm will ultimately lose money from a collapsed exchange, such as the hack of Mt Gox in 2014. Other factors limiting institutional participation in crypto include operational risk in handling the assets, the lack of credible managers with 2+ year track records and the absence of well-constructed, low fee passive indexes.

Despite the 2018 meltdown in cryptocurrency prices, Paul appeared sanguine about their long term prospects, noting that every 2 years or so there has been a large boom-bust cycle in the space, and that the potential for growth is still enormous. While Bitcoin is “already obsolete from a technology perspective” according to Paul, it still commands a widely-known brand name in the space and there’s still a huge amount of investment by institutions such as CBOE and Square. It’s difficult to know which cryptocurrency will win out in the future, but Paul believes that an allocation could make sense for some investors that can be patient riding the frequent ups and downs of the digital coin landscape.

Distinguished Speaker Series: Dean Harrison, Northwestern Memorial HealthCare (NMHC)

On June 14th at The Chicago Club, Dean Harrison, president and CEO of Northwestern Memorial HealthCare (NMHC) shared his story of leading a local organization from good to great. Since taking the helm in 2006, he has led a powerful transformation. Already boasting the top-rated Northwestern Memorial Hospital in Chicago, NMHC has significantly expanded its health system to include over 100 diagnostic and ambulatory sites and seven hospitals across Northern Illinois.

The full story, however, is much broader than just the growth of the hospital system. It is about doing so for the right reasons. It is about providing state of the art care to serve patients better. It is about research, a better academic health system, a relentless pursuit of better medicine. It reflects a vision of transforming healthcare, integrating the many parts of the system. It involves the creation and success of Northwestern Medicine. The full story reveals how to achieve spectacular results through properly applying strategy with financial discipline on top of solid fundamentals of the right culture, people and resources.

Northwestern Medicine (NM) reflects the shared strategic vision and collaboration of NMHC and Northwestern University Feinberg School of Medicine to develop a premier, integrated academic health system. NM employs 33,800 across the interconnected spectrum of healthcare, education and research with notable honors and accomplishments including:

  • Northwestern Memorial Hospital is currently the only Leapfrog A, CMS 4 Star, U.S. News & World Report Honor Roll Hospital and AA+ Rated Hospital in the United States.
  • Northwestern Memorial Hospital is consistently ranked 1st in Illinois with 11 of its specialties nationally ranked in 2017.
  • NM has the highest-ranked cardiology and heart surgery program in Illinois, (10 years running)
  • NM has the highest-ranked neurology and neurosurgery program in Illinois (11 years running).
  • Conducted 4,488 clinical trials and studies offering patients access to groundbreaking new treatment options
  • Treated nearly 1,000,000 unique patients in the past year and handled 4.7 million calls in the patient service center.

NM has over 20 years of AA-rated financial performance. This is most impressive considering the financial success occurred coincident to a tremendous period of expansion: the large investments in research, rapid growth of the health system, and consequent integration of diverse medical practices as well as alignment with academia. Never losing sight of its mission, none of the above would matter had NM not first and foremost maintained its ability to uphold its standard of exceptional care for patients.

As Harrison took us through the journey from good to great, it became clear that a focus on excellence resonated every step of the way. However, while the path was not necessarily straight, there was never any wavering on the criteria of patients first. How to deliver exceptional care where patients want to receive it was at the core of all of NM’s strategic priorities.

Staying true to the long-term strategy, supported by shorter term business plans responsive to the evolving market were fundamental to the journey. For example, the importance of having medical information available in all locations required installing an integrated electronic health record system. Doing so in the same year as opening a hospital was a particular challenge, but one that was not optional as it was imperative to introduce the new system quickly to satisfy the expectations of both patients and providers.

Throughout NM’s growth, applying a disciplined approach to expansion, while implementing a rigorous and consistent integration process was essential to achieving success. Of course, a large part of NM’s success comes from people, both within the organization and outside in its partnerships with donors and others in the community. NM instills a single culture across all of its locations and partnerships. They have made a large investment in people. Harrison commented how NMHC management is strengthened by frequent exposures to new roles and assignments within other parts of the organization as evidenced by an average of 14 years of service across senior leadership with an average of 3 years’ service in a current role. Developing people, the right culture, and nurturing resources are very important to the NM success journey.  Their upcoming priorities include:

  • Investing in fellowships and creating endowed professorships for the most promising physicians and scientists,
  • Establishing endowed and expendable innovation grants for breakthrough research and,
  • Funding scholarships for exceptional medical, PhD, physical therapy students, and nurses.

Philanthropy has been a key part of the good to great story. Areas in which achievement of NM’s strategic vision has been supported by donations while also giving back to the community in terms of jobs, improved care and outcomes in recent years include:

  • Louis A. Simpson and Kimberly K. Querrey Biomedical Research Center (scheduled for completion in 2019)
  • Lavin Family Pavilion, a new state-of-the-art outpatient facility on the downtown campus (2014)
  • New Prentice Women’s Hospital (2007)
  • Donations from longtime benefactors Suzanne S. and Wesley M. Dixon to support emerging clinical translation research initiatives, and the William Wirtz family supporting cancer research
  • New Northwestern Medicine Lake Forest Hospital just opened in March with new medical office facilities underway.

To bring it all together before taking questions,  Harrison showed a brief video about a patient with a successful outcome to a spinal injury that demonstrated the positive impact the integrated system is having on the community.

In conclusion, the good to great story of Northwestern Medicine is a collaboration of employees, students, physicians, scientists, and the community all the while keeping the interests of the patient front and center. Although the journey is continuous, NMHC has achieved tremendous recognition becoming both a local and national center for healthcare, research, education and community service.

Distinguished Speaker Series: Kunal Kapoor, CFA, Morningstar

Kunal Kapoor, CFA, chief executive officer of Morningstar, addressed a full house at the University Club on May 16. His address reviewing the current business lines at Morningstar can be summed up in his title–Serving Investors of the Future: Ratings, ESG, and Research Innovations. Most would know Morningstar as a leader in research on mutual funds, the firm’s original product, but Kapoor defined the firm more broadly as a data gatherer and analytics firm. It seeks to deliver innovative data and research to benefit investors by leveraging technology which Kapoor described as an “enabler”.  He provided the following key metrics for the firm:

  • 24 million participants in retirement plans that use Morningstar products or services
  • 12 million individual clients
  • 80% of financial advisors touch Morningstar in some way

Kapoor went on to describe in summary Morningstar’s newer services that many people would not associate with the name. The first was research in individual equities. This began following the tech bubble when institutional investors began to question the objectivity of research from broker-dealers. The environment presented an opportunity for independent research analysis that Morningstar capitalized on. It now employs over 300 equity analysts making it one of the largest independent research providers. Philosophically, the firm takes a very long-term approach a la Warren Buffet. They have even adopted his moat concept to identify companies with defensive characteristics, and as a determinant in Morningstar’s fair value calculation. To judge macro-market conditions, they have developed their proprietary Global Market Barometer (which currently reads as very slightly overvalued).

More recently the firm has expanded into credit research. This was also a response to market upheaval when, after the crisis in housing-related securities, investors viewed research from dealers, as well as the major ratings firms, with skepticism. Kapoor expects credit research to be a growth driver in the future.

Morningstar uses its data and analytics in equity research to provide indices as well. The Wide Moat Focus Index selects for firms with the widest moats in their universe and weights them according to the scale of undervaluation relative to fair value.

Morningstar recently purchased the remaining equity in Pitchbook, a data analytics firm focused on the private equity and venture capital markets, in which it previously had a minority interest. This is a response to the shrinking public equity market that is encouraging more investors to look to the private markets for new investment ideas. Data gathering and analysis is more difficult in this arena, but Morningstar intends to make it an area of focus.

ESG (Environmental, Social, and Governance) investing is yet another new product area for Morningstar. Kapoor noted that this is more than the SRI (socially responsible investing) of the past which sought to eliminate certain out-of–favor companies or sectors (e.g., gamboling, tobacco, or alcohol). Rather, Morningstar scores companies on various ESG-related metrics to identify those more likely to succeed because of their adherence to responsible policies regarding their impact on the environment and their communities. The market for ESG investing is estimated at $23 trillion and covering 26% of retail investments. Additionally, we are at the beginning of a huge wealth transfer from older to younger investors with more women making investment decisions. Both groups demonstrate a preference for investment products with an ESG focus. To address this opportunity, Morningstar has partnered with Sustainalytics, a leader in ESG research and ratings, to score mutual funds and ETFs.

Finally, Kapoor spoke to Morningstar’s processes by describing their Robotic Process Automation (RPA) effort which seeks to automate rote tasks as much as possible to improve the timeliness and reliability of products and services.  He believes there’s no activity that can’t be automated to some degree which offers the benefits of lower cost, increased scale, and improved compliance, all of which contribute to better outcomes for investors who use Morningstar’s products.

Distinguished Speaker Series: Jane Buchan, PAAMCO

Jane Buchan

The hedge fund industry has been assailed by the media as a costly, underperforming asset class, yet according to PAAMCO CEO Jane Buchan, that rhetoric simply isn’t true. On April 18th, the founder of the Irvine, CA-based hedge fund-of-funds presented to CFA Society Chicago to share her views on the hedge fund landscape.

Buchan is tired of hedge funds getting beat up in the press, and her talk both defended the industry and talked about new opportunities currently being developed. She said that the environment lately has been difficult for active equity managers and interest rates and volatility continue to remain stubbornly low. Some results of this backdrop include:

  1. Investors are focused on beta
  2. Perceived differentiation is low, causing allocators to emphasize fees
  3. Simplicity is key

The market climate has affected the hedge fund industry by giving rise to Alternative Risk Premia (ARP) strategies, which focus on fees and simplicity, and deals and co-investments, which can offer investors lower fees. PAAMCO has been active in developing risk premia solutions, which can be described as a means to access a hedge fund-like return at a lower cost with enhanced liquidity than typical hedge funds. Buchan cited Albourne’s research on ARP that shows $216 billion is invested in these types of strategies today. Somewhat surprisingly, 80% is managed by sell side broker / dealers and only 20% is managed by asset managers.

Despite the media’s negative coverage of the hedge fund industry, there is still a lot of capital in hedge funds at around $3.2 trillion, which has been growing at a fast pace. “It seems like hedge funds are the dog you want to kick,” said Buchan of the media’s view on them, saying she “suppose[s] somebody has to be the villain.” Buchan mentioned news such as the wager between Buffet and Tarrant on hedge funds outperforming the S&P 500. Given the lower market exposure of hedge funds, it is a tough bet for them to win, she said.

Considering the market environment we’re in, what’s an investor to do? “The only free lunch is diversification,” opined Buchan. One example of that is volatility strategies. Buchan said that they often look horrible on a standalone risk-adjusted basis, but on the portfolio level, adding volatility can offer significant benefits. “It’s hard when [investors] add hedge funds for downside protection and there’s no downside,” she said.

“Now let’s have some fun with data,” said the former Dartmouth professor. Buchan showed the audience a number of return histograms and asked them to figure out which asset class they were. One surprise was how concentrated the hedge fund returns were compared to high yield, which had larger tails. Private equity, also a top performing asset class, also had a much fatter tailed distribution of returns than hedge funds. One of the benefits of lower volatility is higher compound returns over time, Buchan said. This is something that current hedge fund investors are well aware of, she said, pointing to the previously referenced $3.2 trillion invested in the industry.

Another positive trend for the hedge fund industry can be found in corporate 10k filings. Buchan said that PAAMCO has been tracking them and has found that corporate defined benefit pensions are moving cash from private equity into more liquid, alpha strategies such as hedge funds. Like all asset classes, there will be periods where hedge funds underperform and outperform, but there is still a lot to like given their high return to risk ratios compared to other asset classes.

Lastly, Buchan encouraged attendees to support women in finance with the organizations Women Who Invest and 100 Women in Finance. Despite a number of studies showing that women can often make superior investors than men, Buchan said that some research indicates that a female hedge fund manager must outperform a male counterpart by 150-200 bps in order to achieve the same level of AUM.

Distinguished Speaker Series: Rupal Bhansali, Ariel Investments

Rupal Bhansali was the featured guest speaker at CFA Society Chicago’s March Distinguished Speaker Series luncheon held at the Chicago Club. Bhansali is chief investment officer and portfolio manager of Ariel Capital Management’s international and global equity strategies. Her presentation was called The Power of Non-Consensus Investing.

Bhansali began with two examples of non-consensus thinking: the micro-lending phenomenon that has helped eradicate poverty in places like India and the rise of Silicon Valley business model that was radically different from what was conventionally accepted. These examples highlighted that non-consensus thinking can be applied to a variety of situations and disciplines, including investment management. Also, this type of non-consensus thinking can drive alpha in investment portfolios. Considering the non-consensus aspect of your research is a great way to determine if there may be alpha.

The aim of institutional asset management is to be correct – correct in your assumptions, correct on your earnings estimates, correct with rates of growth. The problem with being correct is that it gets you to the same place as other good investors. A research analyst that is correct along with the rest of the institutional market is not necessarily rewarded. Fundamental research is about finding alpha, which in most cases is akin to proving everyone else wrong. Being correct and non-consensus provides rewards. The question then is how to be behaviorally different but remain analytically sound?

Bhansali provided an example of applying non-consensus thinking to the investment prospects of a global tire company. The consensus view of this company (and tire industry) was that tires were a conventional part of a car, low tech in terms of manufacture (it is just rubber and steel bands right?), and that the market is driven by new car sales. That view seemed reasonable, certainly a consensus view at the time. She then offered a non-consensus view. Is the manufacture of a tire a simple process that can be copied by a competitor? Turns out no, tire manufacturing is an involved process that cannot be easily reverse engineered. Do consumers consider tires interchangeable? No – they have brand affiliation. The consumer also cares about safety, fuel economy, and performance, which provides the company a value proposition. What drives this market is miles driven, not new car sales. A sector and business that was consensus branded as a low tech, interchangeable auto part, turned out to be a high tech, branded, mission critical good. If you had a non-consensus view on this market/brand, outsized returns were made.

A second example of a non-consensus investment view was provided on the mobile phone market. There was a time when BlackBerry and Nokia were market darlings. In part, these views were based on advanced technology, great user experience, superior growth, and competitive product advantage. The market took those factors to be insurmountable barriers. In fact these companies suffered from an eroding advantage where their products were surpassed by other brands. Apple seized the opportunity to displace these companies with a better product and user experience, offering the market exceptional growth of its own – for a time. Bhansali remarked that the consensus view on Apple has been positive for too long. Apple also suffers from many of the factors that doomed Blackberry and Nokia: alternative options and equivalent user experience for a cheaper price. She also noted that the iPhone is the dominate driver of revenue for Apple. If iPhone sales falter, Apple returns will suffer.

Bhansali’s last example of consensus/non-consensus thinking was particularly pertinent to the audience. Currently passive management is the go to option for investors. It is consensus – low entry cost, simple, easy, a no-brainer decision, while active management exhibits high costs, might have hidden risks, and is an active decision. Seems like there is no hope for active management given this view. Passive management and ETFs are winning and the outlook for active management is bleak. However, what would a non-consensus view of this subject consider? Although passive management is low cost, it is not low risk. Passive management has come of age in a prolonged bull market. It has not been stressed in a recessionary, or bear market. What might occur when large passive funds try to liquidate at the same time? For starters, the bid/ask spread will widen – a crowded trade is a risky trade. The scale that helps keep the cost of passive management low also exposes it to be too big to liquidate. A non-consensus view of active management might consider that the ease of ETF investing doesn’t equal being right, that real active management pays for itself when true active management is identified with active share, fundamental research, and management that has skin in the game.

The audience then offered some questions to Bhansali:

Q: If you believe that alpha is everywhere then the universe of securities is huge, how do you screen down to a manageable amount of securities?
A: Start from a rejection perspective not a selection perspective. Good securities will be the residual.

Q: In your portfolio what type of downside protection do you use or recommend?
A: I do not use derivatives as they are too short term in nature, and one must get the timing and thesis right for them to be effective. Protection can be obtained via investment ideas – using securities that have low correlation with the portfolio.

Q: What makes a great research analyst?
A: Bhansali noted that although it less common today, that being a generalist was helpful to her evolution as a research analyst. She also advised that a good analyst should follow multiple sectors, and always examine the counterfactual – understand what will cause a company to underperform as much as you understand the factors of outperformance.