Monthly Archives: June 2014

World’s Cup Runneth Over

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Once again, one of the world’s central bankers was in charge of the game. On Wednesday, the FOMC released its much anticipated statement, confirming as expected that the Fed would continue to taper its bond purchase program. Its 2014 growth outlook was slightly lower, but not very negative. If there was any surprise, it came during Yellen’s press conference, when she spooked a few corners of the bond market by dismissing recent inflation figures as noise. This led to a steepening of the yield curve which persisted into Thursday. It seemed to be exacerbated by the 30-year TIPS (treasury inflation protected securities) auction, which didn’t go quite as well as dealers were expecting. Nominal 30 year levels recovered sharply on Friday – but still ended the week higher by about 4 basis points. It seems that the bond market is struggling to figure out the FOMC’s next step. It may be that the FOMC is struggling to figure out its next step.

There was no uncertainty, however, on the part of credit markets, which once again took its cues from a Dovish central bank. Not worried about any increase in inflation, 10 year bank spreads rallied by 5 basis points or so, and higher vol sectors like materials have also had a good week. Utilities felt like they lagged a bit, so data all around showed support for the central bank-induced risk-on trade. The World Cup of liquidity continues to flow.

The new issue market, on the other hand, slowed down this week. Most issuers tried to get in ahead of the Fed, so Monday and Tuesday were the big days, with about 80% of the week’s volume. Total supply this week was just over $20 billion, so a pretty slow week overall. The week had more than its share of energy companies, as Cameron, ERP Operating, and Hess all brought deals to market. The interesting trade of the week was our local friend Target – the company had to widen the price from initial talk in order to get its deal done, which we haven’t seen in a while. The company brought $2 billion total, $1 billion of a 5 year at +60, and $1 billion of a 10 year at +90. These bonds ended up among the better performers on the week, so the initial guidance wasn’t that far off, but the market demanded a concession given the noise around the company’s story recently.

So in the end, we think it was a pretty solid week for credit. Should we be worried about liquidity driven bubbles? Maybe, but I think we’ll just focus on soccer for now. Gooooooooaaaaaal!

Inversion Layer

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John Boylan, CFA

The recent popularity of tax inversion strategies got me to thinking about what might be the toughest thing to do when analyzing a company. Namely determining what its optimal capital and tax structure could be. Most of the time, I tend to rely more on free cash flow analysis than trying to forecast capital structure or determine optimal tax considerations. I figure if I develop a reasonable and attainable cash flow forecast it would be easier to determine what the use of that cash might be. Even then I tended to be off in my cash use prediction because of the Curse of the Financial Analyst—we think tend to think every business decision is a financial decision. More often than not many other business and management considerations are of equal, if not higher, importance. We as analysts often forget that.

For example, why don’t more companies take advantage of tax inversion strategies? Management might feel uncomfortable having essentially two headquarters, one for executive management and one for day to day operations—some managements may feel uncomfortable managing crucial functions remotely. Some might feel that tax advantages and loopholes can shift over time for a variety of reasons, meaning a company may have to move its headquarters more than once to keep their tax saving strategy intact (e.g. Accenture moved to Ireland from Bermuda due to changes in tax considerations). Additionally some companies might see longer term opportunities for that cash that could offer a better return, even after taxes. This might include investments in research and development, marketing and distribution, new capacity, acquisitions, and the like. It also depends on where the cash resides and the opportunities, or lack thereof, there might be in that market.

Still as shareholders we often want as much cash returned to us from our investments as quickly as possible, and managements need to respect the will of its owners when it makes sense to do so over the long run. It really comes down in my view where the management and investors believe the company is in its growth cycle. If it is early on in the cycle I would rather see cash spent on growth, which also lowers a company’s tax bill without adding more managerial complexity to the organization. If the company is in a more mature industry I would rather see the company managed for cash flow and see that money returned to investors. Therefore in reality, I think that we need to take as close of a look at the personality and management style of its executive team and determine if their longer term goals match where we think the company is in its growth cycle as much as we do trying to determine what companies may be best suited for a change in capital or tax structure on a pure numbers basis.

Best Practices in Asset Manager Communications

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Tom Brakke, CFA

“The numbers speak for themselves.”

What asset manager with great numbers hasn’t wanted to toss a pitch book down on the table, utter those words, and wait for questions (only to return to the phrase over and over again in response to them)?

There are a few who have adopted that strategy (Bernard Madoff, for one, and some take-it-or-leave-it hedge fund managers), but for the most part it doesn’t fly for firms trying to win new institutional clients, even when the numbers are outstanding.

Therefore, an asset management firm must have a good communications strategy (and stick to it) if it is to succeed over time. The best practices for doing so were the topic of a recent presentation to CFA Society Minnesota by Judith McKinney and Gordon Dickinson of Callan Associates.

The presenters stressed the importance of a thorough communications strategy that is consistently applied. That’s a challenge, given that individuals have different styles and portfolio managers would prefer to be back at their desks evaluating ideas rather than answering questions about how they do what they do.

Large firms can marshal the brute force of their resources to hone such a strategy and to produce outstanding materials, but their presentations can lack the personality and display of camaraderie that are second nature for those at a small firm that are used to working closely together.

Each element of the communications chain needs attention, including requests for proposals, presentations for new business (and for review meetings), newsletters, white papers, websites, meetings with consultants, and whatever other opportunities exist to reinforce a firm’s message.

Through it all, there needs to be an ethos of quality, accuracy, integrity, and honesty. Superior materials and presentations provide a platform from which to convey the key messages that the manager wants to deliver.

The dynamics of a presentation for new business are critically important. The pitch book (whether in hard copy or on a screen) can be an effective vehicle through which the proper message is conveyed or a framework for failure, so the speakers from Callan spent a good deal of time reviewing its construction and delivery.

They said that “95% of the decks are pretty good” in following the four Ps – philosophy, people, process, and performance. A common problem is getting “bogged down in too many details” rather than concentrating on delivering a compelling narrative; they stress that “the appendix is your best friend.” Put the minutiae there.

In fact, “the best presenters don’t use the book very much.” They make eye contact, they connect with the audience, and they tell their story.

The flow of a presentation probably seems unimportant in the scheme of things, but several times the speakers from Callan talked about the quality of the transitions from one member of a presenting team to another. The little things matter, which is why practice is critical and thorough preparation often separates the managers that “show well” from those that don’t.

The most spirited interaction between members of the audience and the presenters from Callan revolved around the degree to which consulting firms are pro-cyclical in their approach to the recommendation of strategies and the selection of managers – going with recent winners rather than seeking out good managers who have been struggling. The discussion was prompted by a statement in the presentation deck that when meeting with consultants, managers should “focus on an investment product/strategy that is doing well; underperforming strategies may be non-actionable for the consultant.”

So, the numbers may not speak for themselves completely, but they speak very, very loudly. In the mutual fund world, “a five-star rating is the trigger for acceptance” (even though it is based upon past performance) and for an institutional mandate, “if you’re in the finals you don’t even have to talk about performance; you wouldn’t be there without performance.”

Therefore, the biggest hurdle to be jumped over in order to be hired is good performance. On the flip side, many good firms are fired because of a spot of poor performance. The representatives from Callan said that a big part of their job is trying to talk clients out of firing managers, but they stressed how behaviorally difficult it is for those clients – and for themselves – to go against the flow. They could cite just one situation where Callan recommended a firm that had subpar performance over the past few years but what they felt was the foundation for good performance going forward. (It turned out very well.)

The meeting featured much good information for asset managers looking to improve their communications practices – and I would not minimize the importance of the recommendations. But it is disheartening to be reminded that at its roots, this is a business of herding, and numbers, for the most part, speak louder than words, even if experience shows that they can be deceiving.

Super Mario

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Mario Draghi announced the ECB’s monetary policy actions on Thursday, June 5th, and on balance they were largely as anticipated. Without getting into too many details, the ECB launched a new series of “targeted longer-term refinancing operations”, began to set the stage for certain asset purchases, and lowered a variety of policy rates, including moving the deposit facility to -10 bps. We are not quite at QE in Europe, but they appeared to edge in that direction, and the ECB has made it clear that Deflation is a primary concern for the economy, even though it has returned to modest growth this year.

Credit markets reacted positively to this week’s data, including the ECB actions. Bank spreads seemed to be the biggest beneficiaries, with on-the-run banks tighter by 5-10 basis points. So far this month, we are seeing a complete reversal of last month, with higher rates, a steeper curve, and tighter spreads, especially on the long end. It was definitely risk-on in Europe – in addition to the ECB actions, Standard & Poor’s raised the credit ratings of a number of Spanish Banks, following a hike in Spain’s sovereign rating a week earlier. Rates in all of the peripheral countries in Europe have rallied like Luigi in a go-cart, and are trading at their lowest level in years. Spain and Italy, the two poster children for European chaos, saw rates drop by 20 basis points to 2.6% and 2.7%, respectively – just a hair above levels in the U.S.

The primary market did not wait around to see the data – as usual, the weekly calendar was front-end loaded, as few issuers wanted to take the risk of a bad outcome on the news front. Total supply was about $29 billion, which is a decent week. Large deals included Express Scripts, with $2.5 billion across three tranches, $2.4 billion of shorter paper from American Express, and $2 billion of an AT&T 30 year bond. Most deals are performing well, as most of the spread tightening this week took place on Thursday and Friday. The market is expecting more of the same next week – probably about $25 billion in supply.

There was a range of positive or at least benign data supporting credit markets this week, but we are inclined to attribute most of the rally to the ECB. At least for now, markets are expecting the announced policy measures to act like our own little Yoshi, gobbling up all the bad stuff – slow economic growth, deflation, weak banks – and turn them all into gold coins to toss back to Mario.

Personality Crisis

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Not long ago I had lunch with a friend and we discussed the Myers Briggs test (click here for a definition of the test). He mentioned to me that that he read somewhere that a majority of financial analysts were INTJ—surprisingly one of the rarest of the Myers Briggs 16 personality types (especially among women). For the record I am an INTJ. If you have never taken the test, here’s a link to a free analog version.

While psychological analysis is not the purpose of this post, there is something that has always driven me nuts about this industry. What upsets me is that there is an expectation that a stock market analyst must act a certain way to be successful. This has always surprised me. That’s likely because INTJs like me are among the most independent thinkers of the personality types in the Myers Briggs grid. This might explain why I think “Kiss Alive” is the best live album ever, but I digress…

Why do I feel this way? I am guessing it’s because that New York is the capital of our industry. Don’t get me wrong. I love New York. The Yankees and Giants are my second favorite teams (sorry Boston fans). Having said that, I believe there seems to be some expectation of a hyper aggressive personality type that might not manifest itself in people west of the Alleghenies. I realize that there has to be some degree of fighter pilot attitude amongst us as analysts, after all no one wants to look unintelligent when discussing the markets with clients. But then at the same time, I feel on occasion that we all can use a dose of Minnesota Nice. Oftentimes our worst mistakes come when we make a mistake and try to cover it up with bravado.

One of the best lessons I ever learned in this industry was in my first week on the job. One of the stocks my analyst and I were covering had an unexpected bad quarter. After doing our analysis, my analyst called up one of the biggest holders and started out the conversation with (and I am paraphrasing) “I was wrong on this stock. Here’s where I went wrong, and here’s what I think you should do now.” I was stunned by what came next. Instead of the client becoming angry he said “Thanks for the call. You are the only analyst who has called me on this name. I appreciate that.” Ever since that day I have tried to fess up to bad calls. It not always has been pleasant; and not all investors were as respectful as this one. However, I also found that rebuilding my credibility was much easier than those times I have tried to defend my decision aggressively.