New Financial Literacy Effort Launched for Minnesota Communities and Schools

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By David Slegh, CFA, CAIA

Several CFA Minnesota Society members and industry professionals recently launched a financial literacy education program called MNFEI (Minnesota Financial Empowerment Initiative) in partnership with Financial Beginnings, a non-profit organization that teaches individuals how to play an active role in their financial well-being. The group’s mission is to help those in the Minnesota community who seek to improve financial knowledge and economic security and to raise awareness of the importance of financial education for all Minnesotans. MNFEI (pronounced MIN-FAY) provides a platform for passionate volunteers to deliver no-cost, unbiased, and open-sourced financial education programs to those in Minnesota communities and schools, with a special focus on those populations in greatest need.

MNFEI programming went “live” last month with volunteers collaborating with Jeremiah Program to deliver financial empowerment training. Jeremiah Program offers community-based and residential services to children and moms across the nation. Specifically, in the St. Paul and Minneapolis area, the locations are projected to support 155 moms and children, with an average age of 26 for moms and annual income of $12,428. Importantly, these young mothers are gaining work skills which are designed to significantly increase future earning potential.  We are thrilled to support Jeremiah Program’s great mission.  Feedback from participants and volunteers has been positive and we are excited to build on this momentum moving forward.

Volunteer with MNFEI

MNFEI is currently working to expand its impact by initiating financial education programs with several non-profit organizations and schools seeking to serve diverse lower-income communities, immigrants, and underserved populations. There are several volunteer opportunities with MNFEI:

  • Volunteer as financial literacy teacher – materials and training provided
  • Help identify beneficiaries – connect us with areas in the community that could benefit from basic financial education
  • Volunteer as Firm ambassador – work in the financial industry and are interested in spreading the word or connecting MNFEI with people in your firm who have similar interests/passions? We would love to chat!
  • Volunteer on the Advisory Board – MNFEI is actively recruiting individuals who are passionate about furthering financial literacy in underserved communities

To learn more about MNFEI, including opportunities to give back to your local community through increasing basic financial literacy, visit the Financial Beginnings website or email us at info@finbegmn.org.

Contact MNFEI Advisory Board

The current MNFEI Advisory Board members would also welcome the opportunity to discuss this exciting new initiative. Contact the Advisory Board at:

Jack Hansen, CFA
jackhansenjoan@gmail.com

Stefanie Adams
stefanie.adams@peregrine.com

Mark Salter, CAE, ABC
mark.r.salter@gmail.com

David Slegh, CFA, CAIA
david.slegh@gmail.com

Erol Sonderegger, CFA
eroldsond@gmail.com

End of an Era

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By Susanna Gibbons, CFA

For decades now, we have been waiting for the end of the bull market in interest rates. Every conference, every article on higher interest rates looks on fixed income markets with scorn – “Now that interest rates are moving higher, what are you going to do with your bond allocation? Why would you even own bonds with rates at these levels?” And so now, perhaps – here we are. Maybe it’s over.

But that is not the era that I’m talking about. The Fed has backed itself into a corner, where aggressive inflation fighting appears to be its only option, and that certainly means higher short term interest rates. But much more significant than the end of the bull market in interest rates is the end of the Greenspan Put era.

The Greenspan Put, which became the Bernanke Put, and then the Powell Put in March 2020, is the policy of lowering interest rates to protect investors from the intolerable pain of falling stock prices. The policy was predicated on the wealth effect – that falling stock prices would cause people to reduce spending. If the Fed were to maintain liquidity in financial markets, they expected it would fend off anticipated weakness in the real economy, the world where people have to eat and live places and send their kids to school.  It has worked, in a way, but at the same time the Fed has created a moral hazard, where equity investors do not have to bear the full risk of their investment choices. For decades, they have been able to rely on the Fed to provide a liquidity balm whenever valuations became excessive, and fear took over.  

That era is over. Until the Fed believes that we are through the current inflation crisis, they are going to drain liquidity from the system. They are not going to be there to support equity markets. Or Bitcoin or NFTs. Or Real Estate. This is no time to buy the dip. The Fed has no capacity to rescue markets this year.  And that means that risk of owning equities is increasing, and will probably continue to do so.

As market have sold off, we have indeed seen VIX march upward. We have also seen correlations break down, as is typical during times of stress. Unfortunately for most institutional portfolios, that correlation break down includes Treasuries. If long term interest rates continue to increase for some period of time, Treasury prices will remain positively correlated with equities, just as they were in the 1970s. That does not bode well for portfolio construction. Most asset allocators have added increasing amounts of equities (both public and private – I am not willing to pretend that private equity isn’t going to get riskier too, just because we aren’t marking it to market), with some of the added risk protected by long duration Treasuries. If the riskiness of equities continues to increase, and the correlation with bonds remains positive, then the current standard portfolio structure becomes pretty perilous.

I do not think, though, that we are in for a 1970s style inflation with a Volcker-like response. How could that possibly happen? In 1975, the combined Federal and Household Debt / GDP ratio was about 75%. Today, that figure is over 200%. For inflation to really become imbedded, we have to be willing and able to borrow money at higher rates, pay the higher prices for goods, just to maintain our level of consumption. Seems more likely to me that we are just going to have to stop buying Impossible Burgers and buy cans of beans instead. That is not good news for our equity allocations. Not only will profit margins need to come down from record levels, they will probably fall below historical averages.

We probably need to settle in for the long haul. As long as the Fed is fighting inflation, equities have nowhere to go. In the absence of the Greenspan Put, portfolio returns probably won’t amount to a hill of beans.

Starting my Midwestern Goodbye

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Executive Director Mark Salter enjoying a spare cake (or two) at the 2022 Annual Dinner.

I’m sure you’ve experienced it. You’re at a gathering of some sort (a Society social [1] perhaps?) when someone announces, “Welp, I have to get going” – and they’re still talking 45 minutes later. [2]

This is my official “Welp, I have to get going.”

I’ve had the pleasure of serving as your Executive Director for the past 10 years, and it’s been the best gig I’ve ever had. But it really is time for me to get going, so I will be retiring at the end of this fiscal year (August 31).

This “welp” has been in the works for a while. I told our Board of Directors back in the summer of 2019 that I planned to retire this year. Since that time, we’ve diligently worked our way through the succession planning process, examining where we’ve been, where we want to be, and how we plan to get there. We’re now at the final step in the process – finding and onboarding our next Executive Director.

This last point is why I wanted to start saying goodbye now and shift the focus to where it needs to be – on the future. The Board has formed a search committee and posted the opening in several places (see and share our LinkedIn post). Our goal is to have the new Executive Director in place and ready to go before I walk out the door. So, please engage with your network and tell us if you know of someone who might be a good fit for this opportunity.

Plus, there’s one more thing I’m asking you to do:

Get re-engaged.

This Society has done some amazing things in our 70-year history, and there are plenty of amazing things yet to do. And that takes people like you.

We’re finally able to start meeting in person again, and we need to continue that trend. So, please participate. Register and show up. Volunteer for something. Network. Do whatever you can to re-engage with one of the most extraordinary communities on the planet, and make it even better.

Welp, that’s all for now; more to follow.

Mark Salter, CAE, ABC
Executive Director

[1] Speaking of socials, join us at our Putting Investors First event (it’s free, by the way) in Saint Paul on Thursday 4/14 and stick around for the April Society Social!

[2] The “Midwestern goodbye” is a real thing with 9 identifiable stages to this process – check it out and see how many you recognize!

Face-Off

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By Susanna Gibbons, CFA

Ah, Lake Wobegon. Where all the women are strong, all the men are good-looking, and all the children are above average. Sounds a lot like the pursuit of active management, doesn’t it? The belief that we can find investment managers that are top performers drives everything. In a 1991 article, The Arithmetic of Active Management, William Sharpe basically chides us for acting as though we can all be above average. He notes: “Properly measured, the average actively managed dollar must underperform the average passively managed dollar, net of costs. Empirical analyses that appear to refute this principle are guilty of improper measurement.” (Sharpe, 1991)

Most of the academic research on the performance of investment managers is completely consistent with this notion and demonstrates that there is very little persistence in performance over time. There is some variability in results when viewed over the short term (generally less than a year), but by and large, performance is strongly mean-reverting. (Luckoff, 2010) This should not come as a surprise to anyone in the active management world – it is extraordinarily difficult to consistently beat a benchmark, let alone remain in the top quartile or even the top half.

Using a broader range of quantitative measures for selecting asset managers does not really provide additional hope. The Sharpe ratio is among the most widely used measures, and it adjusts historical performance for the excess risk in the portfolio relative to a benchmark. Theoretically, the higher the Sharpe ratio, the more skill the manager has.

Except that the skill purportedly measured by using historical numbers does not translate into future performance. Just as prior period Alpha is not predictive, high Sharpe ratios are also not predictive of future performance. In fact, they aren’t even predictive of continued high Sharpe ratios.

Why, then, do we continue to use these frameworks as a way of identifying which managers to hire? Investment Consultants put enormous effort into managing their approved lists, conducting “searches” for new managers, and in general acting as gatekeepers for asset owners. Recommendations will not include managers without strong three-year track records at a minimum, in spite of the fact that we know these results have little bearing on expected performance going forward.

In fact, it’s even worse than that. There has been some research on the performance of emerging managers, and it consistently shows strong performance – primarily in the first two years. (Aggarwal & Jorion, 2008) (Preqin, 2013) (Liu, Ma, Shi, & Wang, 2017) According to Aggarwal, “each additional year of age decreases performance by 48 basis points, on average”. The best performance from these managers comes before consultants will recommend them. We are knowingly, willfully leaving performance on the table.

And all of this begs the question: where did the three-year track record come from in the first place? I stumbled across an article recently that suggests that, essentially, the investment business-backed into it because it needed enough data points to calculate Alpha and Sharpe Ratios. In “Are 3-Year Track Records meaningful?” Corey Hoffstein argues that in statistical analysis, 30 samples is the minimum needed to rely on a normal distribution – a requirement for meaningful Alpha and Sharpe calculations. A 3-year track record gives investors the bare minimum required for a (theoretically) meaningful calculation. (Newfound Research LLC, 2016)

The problem, though, is that monthly data should not really be annualized as most consultants do – to multiply by the square root of time. This method would be fine in the absence of serial correlation, but stock returns have a great deal of serial correlation (momentum), so the calculation actually overstates the Sharpe ratio by as much as 65%. (Lo, 2002)

Okay, so we have to have a three-year track record because that’s the minimum amount of data needed for a calculation we know will be wrong, using time series that we have determined have no ability to identify which managers are going to outperform in the future. We then take the three-year requirement and establish a barrier to keep out managers who actually do have a likelihood of outperforming. That’s our framework for identifying excellence. Yikes.

The tools that have evolved over the years to help asset owners make really complex decisions are actually working against their best interest. These tools have had a disproportionate impact on women and people of color. The barriers to starting a new investment fund are high, and the likelihood of being able to keep an emerging business going for three years if you do not already come from a position of privilege is discouragingly low. Those three years have nothing to do with manager performance; they serve only to keep “the unwanted” out of the business, and asset owners are paying the price. Dismantling any entrenched system is hard, particularly when it has been wrapped in complex formulas and years of accepted practice.

We are well past due to escape from this fanciful world, this Lake Wobegon of investing that never actually existed. However risky it feels to step into the real world, it is time.

References
Aggarwal, R., & Jorion, P. (2008). The Performance of Emerging Hedge Fund Managers (draft). Unpublished.
Hendicks, D., Patel, J., & Zeckhauser, R. (1993). Hot Hands in mutual funds: Short-run persistence of relative performance. Journal of Finance 48, 93-130.
Liu, S., Ma, J., Shi, H., & Wang, C. (2017). The Performance of Emerging Managers and Funds. Minneapolis: Carlson Finance & Consulting Lab.
Lo, A. W. (2002). The Statistics of Sharpe Ratios. Financial Analysts Journal Vol. 58, No. 4, 36-52.
Luckoff, P. (2010). Mutual Fund Performance and Performance Persistence: The Impact of Funds Flows and Manager Changes. Gabler Verlag.
Newfound Research LLC. (2016). Are 3-Year Track Records Meaningful? Boston, MA: Newfound Research LLC.
Preqin. (2013). The Performance of Emerging Manager Funds. Company Website, Hedge Fund Spotlight.
Sharpe, W. F. (1991). The Arithmetic of Active Management.


The Madding Crowds

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By Susanna Gibbons, CFA
Managing Director, David S. Kidwell Funds Enterprise
Carlson School of Management, University of Minnesota

Susanna Gibbons, CFA

One of the things we constantly remind students of as they evaluate different stocks is the need to understand what the market has priced in. It’s a ridiculous question, really. If a stock is trading at $20 a share, is it because everyone thinks it is worth $20? Or because half of the world thinks it is worth $15, and the other half $25? Or any of an infinite number of combinations? How would we even know? Equity markets in the United States are sufficiently large to balance a really wide range of views, and that is the whole point of market efficiency. This understanding has driven most investors into passive investing strategies, particularly where markets are deep and liquid. There is collective wisdom even in the madding crowds, and sophisticated investors choose not to defy it.

It is fascinating to see how quickly we abandon that discipline when it comes to thinking about the market for U.S. Treasury Bonds. Certainly, there is a great deal of market segmentation that might lead to inefficiencies, but no one really makes that argument. The discussions have, for decades, centered on “how low-interest rates are right now”. Why would anybody buy bonds when interest rates are so low?

In a recent piece published by Morgan Stanley, “A Borrower Not A Lender Be”, Andrew Sheets argues precisely that. Economists at Morgan Stanley believe that economic growth is accelerating, and this justifies borrowing at current levels, but certainly not lending. The growth opportunities cited all provide excellent support for the faster growth scenario – increased spending on combatting climate change, higher infrastructure spending, higher levels of capital investment across all sectors. But there is a flip side to each of these coins. These investments all entail significant economic transitions, and unless we consider the losses that might also result, we have no context for judging the growth.

If you believe that capital markets are efficient – and Treasury Markets in particular – then you have to consider the possibility that there are a range of negatives which the upside-only view is missing. What could detract from the economic growth driven by these opportunities?

A lot. Just a few examples:

  • The climate transition involves lots of new spending on wind and solar power, utility scale battery, and new delivery mechanisms. The faster this transition occurs, the more quickly our existing infrastructure is displaced. Stranded assets in the coal sector have already become a problem, and this will ripple through to other fossil fuels based largely on the cost of extraction. 
  • Corporate Office Parks, an innovation of the Disco era, remain largely deserted. Executives are starting to crow about how excited people are to “return to work!” (as though employees have not been working all along…) but many remain reluctant for reasons both personal and pandemic. Hybrid work looks like the direction we are headed, rendering much of our existing infrastructure obsolete – but investment in the future appears premature. We don’t really know what the hybrid model looks like, so we don’t know what type of real estate we should be investing in. Increased spending on 5G and other forms of connectivity are paired with stranded real estate investments.
  • Municipal infrastructure needs are changing. Given the increased number of drought-impacted areas, it seems likely that we will need to completely rethink our model for water and sewer management. There are a wide range of technological solutions more suited to drought prone areas, and existing systems may need to be substantially abandoned or re-tooled.
  • It seems likely that in 5-10 years, automobiles will have shifted to an all-electric fleet nationally. Think about the impact on gas stations around the country. All of this existing infrastructure will be obsolete, even as new investments in charging stations ramp up.
  • Demographics are shifting in complex ways. The baby boomers are retiring, and moving out of their income producing years into their savings-depleting years. They are dis-investing. At the same time, Millennials are delaying or rethinking child-bearing. Population growth is unlikely to support increased economic activity.

More than at any time in my career, growth opportunities are abundant but paired with equally abundant opportunities for losses. The range of potentially stranded assets is breathtaking, as we re-think fossil fuel dependence, work modality, and the very structure of our families and personal lives. Capex cycles are usually driven by replacement, expansion, and secular shift – and today, it looks like we are facing some massive secular shifts.

What are markets pricing in? To repeat, it is a ridiculous question, but it seems more ridiculous to assume markets are wrong, without considering all the possibilities being captured by current prices. I happen to think we will see extraordinary growth in some areas, balanced by stranded assets, outdated infrastructure, and climate-related property damage in others. On balance, the outlook for economic growth is both rosy and grim, and probably close to zero over the intermediate-term – which is precisely what markets are implying.

When thinking about whether or not to invest in bonds in the current market, the issue is not how low-interest rates are. The issue is entirely around what level of growth we can expect, in the aggregate, going forward. The decision to borrow or lend should be based on what level of growth we expect in the future. Unfortunately, our expectations are likely predicated on a world that no longer exists. Nominal GDP has trended lower since 1980. In the 1990s, we dreamt of the nominal growth world of 8% from the 1980s. As the new century dawned, we assumed that the 5.5% of the 1990s was the new normal. Then 4.3%. In the last decade, growth was 3.9%. We believe ourselves to be looking forward but have always assumed a return to a yesterday just out of reach. Why should we believe at this juncture that we will finally, finally, recapture the past?  

Collectively, we continue to believe in the efficiency of markets. Individually, though, we each have the hubris to believe in our own non-consensus forecasts, even as we are proven wrong time and again. Things do change. Maybe this time will be different. Yes. Maybe this time.

And so once again, Charlie Brown lines up to kick the football…

About Susanna Gibbons, CFA

Susanna has over 30 years of industry experience across multiple asset classes – equities, alternatives, and fixed income; and multiple roles – analytical, portfolio management, asset allocation, and educational. She serves on the Investment Advisory Council for the Minnesota State Board of Investments, the Editorial Board for the CFA Society of Minnesota, and as chair of the Investment Committee for the Girl Scouts River Valleys. She is currently exploring the integration of Environmental, Social, and Governance (ESG) principles into decision making, is passionate about teaching sustainable investment practices, and is a fellow within the Institute on the Environment, University of Minnesota. She earned an MBA in Finance from the NYU Stern School of Business and is a Chartered Financial Analyst.