Monthly Archives: March 2015

Recap of Society Luncheon – The Return of Volatility – Monetary Policy Divergence Brings the Return of a Long Forgotten Friend

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By Tom Halloin, CFA Society Minnesota Intern

Central banks are starting to diverge in their monetary policies. Marvin Loh, a Managing Director at BNY Mellon Global Markets and the firm’s senior fixed income market strategist, spoke with CFA society members about potential consequences of diverging monetary policy between central banks. Interest rates, for instance, have collapsed worldwide since the financial crisis in 2007, with some countries such as Germany realizing near-zero or negative yields on bonds out to seven years. While the Federal Reserve of the United States has stopped purchasing securities through Quantitative Easing, European and Japanese central banks continue their own quantitative easing programs in order to stimulate their economies. As a result, the best currency trade in recent months has been to buy the dollar and short the euro.

The diverging monetary policies also extend to the Federal Reserve’s decision whether to raise the Federal Funds rate. Many investors are anticipating the Federal Reserve will increase the Federal Funds rate as early as this June.  While the consensus among economists is that inflation will remain low for the foreseeable future, the Federal Reserve wants to mitigate the creation of asset bubbles as a result of a prolonged period of near-zero interest rates. There is less consensus, however, as to when the Federal Reserve will start to raise rates and how quickly rates will increase in the next two years. This lack of a consensus is an issue because markets can react violently to any slight change in monetary policy. With diverging policies between central banks internationally and diverging expectations on interest rate changes in the United States, expect volatility throughout the fixed income world in the near future.

Impact Investing Tipping Point – After a decade in the trenches, signs of progress

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Adam Seitchik, CFA

Adam Seitchik, CFA, CIO of Arjuna Capital

I went to Minneapolis this winter and something remarkable didn’t happen.

I had accepted an offer to speak at a conference on impact investing for local investment professionals. The sponsor was the CFA (Chartered Financial Analysts) Society of Minnesota. The event was sold out and the room was full despite a high temperature of 0o F on the day. We convened at the Minneapolis Club, which feels more like a place to drink brandy and clip bond coupons than discuss innovations in sustainable investing.

Just a few years ago a group of wonky CFAs like this (it takes one to know one) would mostly be asking skeptical questions about the dangers of mixing social purpose with wealth building. But somehow we seemed to have reached a tipping point and that tired old elephant was nowhere to be found in the room.

Instead, to my delight and amazement, one of the keynote presentations was from Wellington Management, a former employer of mine. Wellington is one of the largest institutional global money managers in the world, with almost $1 trillion (!) in assets under management. Their clients include pension plans, insurance companies and giant pools of state-owned assets from around the world. And at least when I was there, the client list included sultans, kings and princes.

I left the world of institutional money management over a decade ago precisely because places like Wellington were completely uninterested in, and indeed often hostile to, the idea of impact investing. Yet we heard in Minneapolis that Wellington now has a dedicated team of analysts helping portfolio managers understand the Environmental, Social and Governance (ESG) risks and opportunities that are embedded in their portfolios.

I was asked to speak because many of the investment advisors in the area are getting inquiries from their clients about socially and environmentally impactful approaches to their investments. The money managers are scrambling for solutions.

We sometimes refer to what we do at Arjuna as “total portfolio activation,” and I described how we empower client impact across asset classes. Like Wellington, we integrate ESG analysis into our equity investment strategy, but more consistently and comprehensively. As innovators focused solely on sustainable investing, we have created multiple avenues for our clients’ money to have real, tangible impact in the world. The arrows in our quiver range from shareholder engagement with publicly traded companies, to investing in a host of financially promising private enterprises with demonstrated social and environmental impact. We don’t have the conflicts of interest inherent in the big firms, whose clients often include the very companies in which they invest. We work for the enlightened shareowners of corporations, not corporate managements themselves.

When it was my turn to speak I noted how struck I was that Wellington was there in the first place. I spoke of the impact investing field in generational terms. Gen 1 were the pioneers, emanating mostly from Boston in the early 1980s, who built the foundational infrastructure measuring and monitoring corporate environmental and social performance. I am part of Gen 2. My bias as an institutional investor coming into the field of sustainable investing was that the Gen 1 firms combined an admirable idealism with a fairly rudimentary approach to investing. The niche was small and underdeveloped.

Gen 2 worked to create a performance-oriented approach to impact investing. We were learning about sustainable investing while modernizing it with state-of-the-art tools and practices. The field began to mature and to grow. Perhaps a broader perspective on investing would enhance shareholder value, not put it at greater risk.

Gen 3, which represents established institutional money managers exploring sustainable investing, was for years largely reactive and inauthentic. With strong encouragement from important, mostly European clients who were signatories to the UN Principles for Responsible Investment (www.unpri.org), the big players have been pressured over the last few years to report on their ESG investment strategies. Eventually, what gets measured gets managed, and now we are seeing some nascent attempts by mainstream managers to do this work seriously, properly and comprehensively. Mainline firms for the most part haven’t fundamentally re-engineered themselves, but for the first time I’m seeing the early shoots of something real.

What nearly brought me to tears at the Minneapolis Club on a winter’s day was imagining Gen 4: the millennials who, as study after study reveals, want meaningful work within humane organizations that positively impact our world. Unlike all those who came before them, Gen 4 investment professionals, even in places like Wellington Management, will not know of anything other than ESG-integrated investment approaches. These young men and women whom I work with and teach give me hope. Soon they will be in charge.

For baby boomers like me, they are a defense against critiques that we’re nothing but greedy, selfish narcissists. If the most important test of a generation is the quality of its offspring, then maybe we aren’t so bad after all.

3 Ideas to Implement Today from Buffet’s Annual Letter

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Adam Schwab, CFA, CFP

Warren Buffet’s annual letters are usually packed with interesting insights, but for the past couple years I had been a little underwhelmed by his thoughts. This year’s letter was the exception. As I read the letter for the second time, I realized Buffet laid out exactly how an investor should construct an investment portfolio and evaluate businesses. Although investors won’t find actual recommendations, he delivers something more valuable: a framework for selecting and analyzing businesses that any serious investor can follow. If these lessons make sense to you, you will want to read the entire letter here.

It’s ironic that the lessons seem logical and obvious as he describes them, yet 90% of investors (both individual and institutional) will completely fail at following half of his advice. We can attribute that to attention spans of zero and the general get rich quick mentality. If investors can avoid those handicaps, this year’s letter was a real goldmine for investors who are looking for a sensible way to think about investing.

Although he gives his secrets away for free every year, implementation is always the hard part! I picked out a few of the best and most practical insights that you, the investor, need to follow. By shamelessly stealing Warren’s investment principles, you will be 95% of the way to an effective investment portfolio. Now, the lessons…

One: Businesses > Treasuries

Warren wasted no time describing the tremendous outperformance of U.S. businesses over US dollar denominated bonds over the past half century. As most investors flock to “safe” U.S. treasuries, Warren’s extols the impressive track record of owning American businesses over long time periods. The common perception that stocks are risky and bonds safe is completely discredited by the long term data. Of course, this is no absolute guarantee this will repeat in the future. But consider what you would rather own for the next 30 years: a sensibly priced business that can compound value at 10-15% per year or a 30 year treasury delivering 2.7%?

Investing should be thought of as buying businesses, not trading stocks. Buffet has slowly and methodically built his portfolio of great businesses without the manic-depressive emotions that occupy most investors. Your portfolio should be structured the same way. If you have the time and aptitude to evaluate businesses, wait until they go on sale, and then start building your portfolio.

Two: What Matters Most: Durable, Competitive Advantages

Buffet highlights one the best but most forgotten elements of investing. Warren and Charlie own businesses with durable competitive advantages that can compound value over time without needing excessive capital investment. Notice how he didn’t mention fast growth, growing market share, exciting technology, or world-changing products. He distills a great business into one line.

But how quickly do most investors forget what really matters! 99% of investing conversations revolve around superficial topics that are heavy in excitement but rarely touch on the elements of investment success. Do your investments satisfy this simple test? This idea is powerful because 1) it’s free and 2) most investors won’t use it! Resist the urge to fool yourself into thinking you can ignore this advice and “beat the market”. Your portfolio will thank you.

Three: Price Matters

Although Buffet expounds on the promise of great businesses, he doesn’t pay any price for them. Even Buffet admits that at close to 2x book value, Berkshire may likely see price declines in the near future. How refreshing to have a CEO give an honest assessment of the stock price! Not many CEO’s admit their companies are priced to perfection; in fact today most CEO’s are paying egregious prices for their own stock!

Great businesses still need to be bought at sensible prices! What is sensible is debatable, but if your business evaluation skills are sufficient it’s generally achievable to be roughly right on the price. Great businesses are not on sale very often, but it certainly happens. The key is buying with deployable cash to pounce on opportunities (The 2008-2010 timeframe being the last great opportunity).

Price is an area where most investors screw up. We are hardwired to buy high and sell low, and even the best businesses make poor investments when bought at the wrong times. Activity will be skewed toward inaction 90% of the time, but the other 10% will provide incredible opportunities to pick up wonderful businesses at bargain prices.

Bonus: Charlie Munger’s Thoughts

Followers of Berkshire know the wisdom of Charlie Munger. Charlie didn’t disappoint as he gave us a few pages of insight in this year’s letter. I’ll leave you with one piece of advice that applies to both investing and life. Here Charlie describes one of the many aspects of how Warren set up his system for Berkshire Hathaway:

“His first priority would be reservation of much time for quiet reading and thinking, particularly that which might advance his determined learning, no matter how old he became…”

What great advice for investors and people in general! Notice he didn’t mention checking stock prices, scheduling meetings, or email. Great investors and great ideas are not built from at frantic pace at which the market operates. The compounding of knowledge over time will pay some large dividends if you don’t interrupt the process!

There is a treasure trove of great advice from Warren and Charlie on the Internet. Let me know and I can directly point you to the best material out there.

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Adam Schwab is a portfolio manager at Elgethun Capital Management. Prior to joining Elgethun, Adam was a portfolio manager at the South Dakota Investment Council. He managed a $250 million large-cap global equity portfolio for 5 years and a $90 million SMID portfolio for 3 years. Adam is a CFA charterholder and a CPA. He has an MBA from the University of Chicago Booth School of Business and a degree in Finance from the University of South Dakota. He currently serves as a Trustee for the University of South Dakota and also serves on the boards of the Sioux Falls City Employee’s Pension Fund and Alta Trust. Outside of work, Adam has been married to his wife Sarah for 6 years. He is active in powerlifting, competitive taekwondo, and the outdoors.

Recap of Society Luncheon – Behavioral Finance: Modern Theory and Application

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By Tom Halloin, CFA Society Minnesota Intern

Investors are increasingly turning their attention toward behavioral finance in order to find an edge in the markets. On March 4th Dr. Sergey S. Barabanov, a professor at the University of St. Thomas, spoke to CFA Society members about classic repetitive mistakes investors frequently make and ways to avoid them in the future. The data show, for instance, that investors hold on to their losing positions for far too long and sell their winning positions far too soon. This is because investors are much more likely to feel pain from losing money than they are to feel euphoria from gaining that same amount. In addition, trading frequently statistically leads to lower returns over time. Dr. Barabanov suggests examining behavioral sentiment after quantitatively screening for companies with a large, unexpected increase in earnings per share, and then using fundamental analysis to determine whether this earnings increase is sustainable. After screening using fundamental analysis, he also recommends examining market sentiment and capitalizing on earnings overreactions. One final suggestion he gave was to watch out for falling airplane parts. A person is 30 times more likely to die from a falling airplane part than to die from a shark attack. And while it is highly unlikely for either of these events to happen, the anecdote is a clever one that reminds investors to be aware of their emotions and biases when making investment decisions.