Monthly Archives: October 2014

What Would Gender Balance Mean to the Finance Industry?

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Lissa Rurik, CFA, CAIA

Recently the U of MN’s Carlson School Funds Enterprise hosted a Conversation of Gender Balance in Finance. The two hour presentation hosted two speakers followed by a panel discussion with questions from the audience. The afternoon was inspired after a similar event focusing on Women in Entrepreneurship resulted in a significant increase in women contestants at the recently conducted Minnesota Cup. It is hoped that as a community we can encourage more women to consider careers in finance if we can shed some light on the topic through exploration and discussions such as this.

The Keynote speaker was Sharon McCollam, the Chief Administrative and Chief Financial Officer of Best Buy Co., Inc. Ms. McCollam sees the topic of women in leadership in finance as not only important for the growth of women in their careers, but also because such diversity is important to a company’s ultimate success, as it is valuable for different points of view in all aspects of a company’s activities.

Critically important is how women show up in the workplace. After starting out in the transportation and aviation industries, Ms. McCollam moved onto roles in consumer products, then food organizations. She spent five years outside of the U.S. running a mergers and acquisitions team, and recalled the day she was sent to Asia to negotiate a purchase transaction. Greeting the Asian businessmen at their first meeting she was asked “Why in the world did they send a woman?” Why? “Because we’re here to discuss the purchase price for your business” she responded. Then she simply moved on to the salient conversation. Women must present themselves with confidence, competence and calm.

At every level we must have a career plan. The career plan will change but we must be committed to the goal. Also, find mentors to evaluate those plans, and BE a mentor. Seek people at higher levels, not only for mentorship but also sponsorship! Do not confine yourself to other women – do not create your own glass ceiling! Think of how the next move will look on your resume.

Run into the fire – as this is where the big career moves are possible. This requires recognizing the risks. We need to lead change with courage and determination. We must be decisive and accountable. Women tend to have more difficulty with during times they aren’t popular. We must be resilient. Also leaders must have good judgment even when all the facts aren’t available. Use past experience and make the call! Men do this more easily. Wrong calls are always a part of the process but one must be courageous.

Have managerial courage, understand your personal code of ethics and be able to demonstrate good judgment. Your integrity will be challenged, and if the line gets too close that integrity will be irrecoverable. Hire great people – do not underhire, and do not be afraid to delegate. This is what allows a manager to go to the next level.

Lastly, love what you do! This is really important. Who do you work for? If your boss isn’t willing or able to help you grow, start planning the next move and adjust the career plan to change the outcome.

Next, Liz Mulligan-Ferry of Catalyst Research shared some facts to support the need for diversity and the progress that needs to be made in this area. Liz first highlighted the reasons diversity is important in the workplace: since women are responsible for 70% of purchase decisions, it makes sense for companies to reflect the marketplace; companies with women in leadership are seen as more ethical and philanthropic; diversity facilitates the ability to leverage top talent; and companies exhibiting diversity in the workplace experience increased innovation and improved financial returns. Barriers to advancement for women are encompassed in gender-based stereotypes, unconscious biases and a reliance on mentors to the exclusion of sponsors for moving ahead. Women are seen as less effective in conflict (either too timid or too abrasive, never just right). They’re viewed as competent or likable, but rarely both. And while mentors provide advice and help to navigate corporate politics, one really needs sponsors, with power and clout, to help a person fight and advance to the next level. Sponsors tend to be senior level executives where such relationships are important for facilitating the right developmental opportunities. Critical job experience includes international assignments, P&L responsibility and budget increases of 20% or more.

Strategies for Success:

  1. Learn the unwritten rules of your company (e.g., culture).
  2. Make your accomplishments known. Be visible and let people know what you can do.
  3. Build relationships. Get to know people and let them know you!
  4. Take career risks. (Interestingly, men will apply for a job when they meet about 60% of the qualifications whereas women typically wait until they meet 100%!)
  5. Ask for what you want. Be open if you don’t know what it is, but be ready to ask if you do.
  6. Get feedback for improvement (better gained from a mentor than a sponsor…)
  7. Be a catalyst!

The final segment of the afternoon entailed a panel discussion with Ms. McCollam, Matt Grimes (Wells Capital Management), Laura Moret (Chief Counsel of Piper Jaffray Asset Management), Kathy Rogers (EVP, Business Line Reporting and Planning, US Bancorp) Tammy Schuette (Corporate Controller at TCF Financial) and Mark Simenstad (VP of Fixed Income Funds at Thrivent Financial). While the panelists acknowledged that great progress has been made in this arena, Mr. Grimes and Simenstad indicated that women only account for 10 or 15% of the applicant pool in jobs where they have hired over the past several years. Additionally, women comprise only 15% of the membership of the CFA Society of Minnesota. Speculation as to the reasons for this low representation centered on women’s own misperceptions, around the hours required for the job among other issues. While questions from the audience – ranging from how to take risks to the importance of proactive negotiating, drew multiple opinions from the panel, all agreed that it is increasingly imperative for companies to find ways to be more inclusive in growing their employee bases. Demographics in the U.S. are really changing, and we need a workforce that resembles the customer base. It is a matter of community support, and it’s important for corporations to sponsor a mindset of openness and awareness as to what efforts toward diversity means. Inclusion means that people can be authentic; they can bring their whole selves to work, participate and feel good about themselves in the process.

Ordering Off-Menu

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John Boylan, CFA

I learned a lot from my first business dinner in the investment industry years ago. Number one, define your terms. Before we left our Director of Research told us we could only purchase one bottle of wine for the table. So the senior member of our team ordered a magnum. The second thing I learned is that ordering off the menu, if you know the wait staff, is a great thing to do. I had the best hash browns in my life as a result. Does investing off-menu, meaning off-index, investing offer the same tasty results?

Usually it does. Countless studies show that underfollowed and under-appreciated securities often outperform their more followed and “loved” rivals. At the same token with a nearly worldwide zero to very low interest rate policy going on as far as the eye also puts a premium on growth and/or yield—making momentum investing a viable strategy. Plus good portion of those momentum securities are in an index or an ETF because they exhibit those growth/yield characteristics—along with ample liquidity.

Therefore we can plausibly assume that as long as zero or abnormally low interest rate policy holds, and investors believe that policy will continue for the investing horizon that buying these securities on a dip is a good strategy. Indeed, the performance of momentum strategies during past few years has given credence to that notion. In addition one also can reasonably assume with the growth of index/ETF investing that as more money gravitates toward these securities, and as they grow in proportion in the index/ETF, that buying momentum stocks that are in one or both of those vehicles becomes self-perpetuating. At least as long as the investment thesis holds on those individual securities in the index/ETF—and as long as Mr. Market believes that the Fed Calvary will come to the rescue each time Mr. Market stubs his toe. Or as long as interest rates hold to a “manageable” level. How long will this continue? Your guess is as good as mine.

So where does that leave those securities that are not in an index or an ETF (or at least not in a highly liquid ETF) especially those that are not especially liquid compared to their peers at this point in time? Sometimes it feels as though that the psychological hurdle rate of those stocks has risen. Indeed, I find myself needing either some very strong and visible upcoming catalyst or some degree of beginning technical momentum to get myself interested in off-index and off-ETF names compared to a couple of years ago. This goes against my contrarian and mean-reversion heart.

Finally, I also believe that eventually the rules of supply and demand and valuation do take over and this index/ETF oriented strategy will eventually end—most likely in tears when everyone rushes for the exits at once. In the meantime will I continue to explore and add off-index/ETF names to my portfolios? Of course, as it is nearly impossible to beat the market consistently without these names, and no one wants to be a “closet indexer”. But as long as there is so much liquidity and demand towards index/ETF names the hurdle and discount rate I give to off index/ETF names will necessarily be higher than what I would normally, and would prefer to, apply.

Therefore, lets pop open a magnum and enjoy the low interest rates, liquidity and good times while it lasts.

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Easy as (Lotus) 123

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John Boylan, CFA

Not long ago I wrote about how many securities analysts including myself have a strong, almost obsessive, preference towards calculator brands. Every so often I also get asked which software I prefer to analyze securities as well. Over time my answer has changed—to a simple spreadsheet.

Before you write me off as some technology Luddite (which my children did long ago), I believe there is a great deal of value within analytical software. I personally use these tools constantly. It saves a lot of time screening securities, determining potential valuations, and figuring out statistical nuances between competing investments. Most importantly is helps investment teams speak the same valuation language—at least in the initial investment discussion.

In other words, we all have “go to” tools in our valuation toolbox, which may differ dramatically from our co-workers favorite methodologies. Therefore having analytical software can help teams start with a base scenario for a particular security in which everyone can understand and discuss. However, it is the main tool I use to determine valuation and investment value? At least for me—no.

So why do I prefer the simple spreadsheet? It goes toward the qualitative side of investing—what I consider its art. So what is art (if you ever lived in Madison, WI in the 1980’s, you know Art was a window washer)? For me personally, the art of investing means determining the right questions to ask. Spending the half day to a day or so it takes me to generate models of the various financial statements of a company helps me think deeply about what happened in the company’s past as I enter those numbers into the spreadsheet. Can I see those same numbers much more quickly with analytical software? Yes, but in a strange way I find myself glossing over them more if they are merely provided to me as opposed to trying to build a model and trying to understand why a certain number or ratio is what it is. I have more intellectual ownership of the analysis if I build a model from scratch. Additionally it is a lot easier to make notes on your model changes in the spreadsheet than in analytical software. I wish I knew how many times I created a scenario in a software program and came back to it several weeks later wondering why I used the numbers that I did.

Again, I do find those products very useful and I use them quite a bit. However, if I want to really dig down deep into a company, I find the good old fashioned spreadsheet works best for me. Plus I may not not as a big of a technology Luddite as I think, as I once knew a person who did their models using just a calculator and MSWord.

 

Twenty-Four Little Hours

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Susanna Gibbons, CFA

September was, to be blunt, a terrible month for credit. Rates were higher, spreads were wider, banks were weak, and record-setting supply weighed on the market. The Merrill Lynch U.S. Corporate master was down about 2 points, a combination of rates that were double-digit higher in the belly of the curve, and spreads which were about 10 bps wider. That may be better than small cap equities, but it was the worst month for credit all year.

What seems most interesting is that supply continued to hit the market all month long, to the tune of about $150 billion. It seems that M&A activity has been driving a lot of the issuance. That represents a change in motivation from earlier this year, when borrowers were tapping the market opportunistically. Up until now, many borrowers could pull back in the face of a less-than-rosy market, but now they no longer seem to have that flexibility.

Case in point this week was the Bayer deal. Bayer issued $7 billion in a 6 part deal, sprinkled across the curve out to 10 years. The company was financing its $14 billion acquisition of Merck’s consumer care business. Bayer already had bridge financing from a $12 billion syndicate of banks, but needed to get permanent financing in place. Given the timing, this deal looked on the cheap side, and as a result it performed well through month end.

What a difference a day makes. The Bayer deal has lagged a little bit, but the rest of the market is notably improved. Rates are better, with the 10 year below 2.5%, and spreads have improved on higher secondary volumes. Bank paper snapped back on Thursday morning, and continues to trade well. It may not be all sun and flowers, but the market feels like it has come through an autumn rainstorm. I cannot say whether it will be all rainbows before us, but I think I will enjoy the moment of romance while it lasts.

Since it rarely does.

The Pimco Soap Opera and the Challenge of Due Diligence

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Tom Brakke, CFA

The news that Bill Gross left Pimco stunned the investment world.  The man and the organization have been indelibly linked.  In fact, the man was the organization as far as most were concerned, a notion that neither Gross nor Pimco went out of their way to dispel.

This could be the start of a cautionary tale that will be played out over the next few months and years, one about the unwinding of an organization dominated by and seemingly dependent on one individual.  Of course, Pimco is more than Gross, and the professionals that remain with the firm will have a chance to prove what they can do and to rebuild the firm in a new way.

It is worth remembering that we have seen this soap opera before.  Not with the same characters or exactly the same plot, but the same conclusion:  If you choose to build an organization based upon a star, you have “key man” risk that can get triggered in short order by an organizational test of wills, the proverbial bus on the loose, or some other unforeseen factor.  If you choose to invest with such a firm, that risk comes along for the ride, and, when something happens, you don’t get a call in advance from the portfolio manager, the PR department, or your sales representative.

That said, for clients of Pimco, the immediate question is, “What do we do now?”

But, a more important question is, “How do we select managers?”  And it should be asked not just by those investors who are unwitting players in the Pimco drama, but also by those who happened to avoid that particular soap opera.

Predictably, believers in passive management have used the Pimco events to reiterate the difficulty (some would say folly) of trying to pick active managers.  The body of evidence supports their claim – and undoubtedly more and more investors will come to the conclusion that the manager selection process is stacked against them, further supporting the trend toward indexation.

For many, that would be a good decision.  Asset owners and gatekeepers (advisory firms, consultants, etc.) often have a stated belief in active management that isn’t accompanied by the proper resources or the differential analysis that would be required for success.  It doesn’t do any good to have that belief if you can’t capitalize upon it.

This is obviously an issue for most individual investors, and it’s a particular problem for advisory firms, most of whom (in my estimation) do not have sufficient in-house investment staff to devote to understanding asset management organizations.  But, as performance studies have shown, even investment consultants, funds-of-funds managers, and large asset owners (all of whom tend to have greater resources and more experience at the process) struggle to add value through manager selection.

So, the takeaway from the soap opera ought to be, “We need to determine if we can select managers well enough to make it worth our while (after hassles and expenses).”  To do that, you need to do an in-depth evaluation of the “how” of your due diligence.

Having seen selection processes from throughout the investment world, I believe that most are reactive by design.  To see why that is the case, let’s use the simple template of “the four Ps”:  philosophy, process, people, and performance.

There really is no way to understand the interplay of those four factors without doing detailed, in-person evaluations.  That knocks out most organizations, who can’t afford to do that, unless they use a third-party provider (more on that below).  And you can’t just show up (or, as is so often the case, have a relatively junior person show up).  Good due diligence requires an approach that goes beyond the conventional norm of a) hearing a manager’s presentation and b) filling out a list of due diligence questions.

Philosophy is a factor that is relatively easy to assess from a distance.  The underpinnings of a strategy, at least as it is stated, can be judged in the light of historical experience and economic circumstances.

Whether it is executed in a way that makes sense depends on the manager’s process.  But without a direct observation of it, the vision of a manager’s process in your head is the marketing version of the process rather than the process itself.  The gap between the two of them accounts for a great many allocation errors.

And then there is the assessment of the people at an organization.  Again, without being inside an organization, you don’t have much of a chance of understanding its culture.  That certainly has been proven by the Pimco episode; try to find any bad “people” grades in due diligence examinations of it in the past.  Most of the time, downgrades of a firm on this attribute come after someone leaves.  The change in judgment might be warranted, but it is reactive nonetheless.

Of course, performance is backward-looking and triggers the most powerful and destructive set of reactions.  Investors buy past winners and sell losers.  Those selecting managers talk about how everything else (especially process) is much more important than performance in their decision making, but that’s simply not true in the vast majority of cases.  I often say, “we see performance and infer process,” but really it’s broader than that:  We see performance and infer the quality of all attributes of an asset management firm.  Performance is a force field that distorts everything (approached in power only by the force field that is a star manager).

If you rely on third parties to do the due diligence on your behalf, you are not immune from these problems, you have just outsourced them (and probably don’t truly understand what has been done on your behalf).  Those you hire to do due diligence might do a better job than you would have, but that is not the proper measuring stick.

“We’ve done our due diligence.”  That phrase is heard time and again, but what does it really mean?  The challenge of due diligence is to take a process that is reactive by nature and remake it into something that is useful.  It can’t be done by following an industry standard that has been shown not to work.