Author Archives: Tom Brakke, CFA

Judging the Research Challenge

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Tom Brakke, CFA

The Americas finals for the CFA Research Challenge were held in Seattle last week.  Out of 53 teams that presented, two advanced to the world competition that will be held in Prague later this month.  The winners were Seton Hall University and Barna Business School.

Now in its eleventh year, the Research Challenge has grown to include more than a thousand schools and five thousand student participants.  At the local level, all teams perform an analysis on a company picked by the CFA society or group of societies that are sponsoring the competition.  They prepare a written report and give an oral presentation.  Each local event yields a winning team that goes on to the regional competition.  (Our local entrant, the University of Minnesota Duluth, lost to Seton Hall in the semifinal round.)

I had the opportunity to serve as a judge for one of the semifinals this year, my first exposure to the Research Challenge.  Separate graders rate the written reports (which count for fifty percent of the final score); I was one of three judges that evaluated the content and delivery of the presentations by five teams.

It is a demanding format, for the students and the judges.  The presentations are limited to ten minutes, followed by a period for questions and answers of the same length.  That is very little time for the students to convey – and the judges to digest – an incredible amount of information.

The judges were given the names of the subject companies in advance, so that we could do some research in preparation, but we had no knowledge of a team’s thesis or recommendation until the start of their presentation.  We had a little time after each presentation to make notes and then finalized our scores (in the categories of financial analysis, valuation, presentation, Q&A, participation among the members of the team, and slides) for compilation.

I also watched the final round of one of the brackets, so between the two parts of the competition, I saw ten presentations.  I was struck by the fact that much of the feedback that I would offer students preparing for the Research Challenge is the same that I give to professionals.

The most important factor is that ten minutes is very little time to tell an effective story.  Given the depth and breadth of the work that has been put into the analysis, the tendency is to try to cram as much information as possible into that amount of time.  I’d recommend a more minimalist approach, focusing on the key issues and just a few important charts, striving to impress upon the listeners the salient aspects of the analysis.

Along with that, slides should be clean and clear.  Too much information on a slide (that goes by quickly because there are too many slides) is difficult to comprehend.  It does give the impression that a lot of work has been done, but there are other ways to do that without sacrificing comprehension.  Simpler is better in most communications settings.  Even experienced professionals have trouble processing information when it is flying by at warp speed.

Like most professional analyst reports, the student evaluations come across as entirely too precise for the real world.  Fair value estimates and/or target prices are quoted to the penny – in the slides, in the presentations, and in the responses to questions.  Each of those is better presented as a fuzzy range than a single point of reference.  The figures to the right side of a decimal point are surely superfluous in the scheme of things.

Speaking of target prices, if they are used a time frame should be attached, as well as an indication of how much of that price change is attributable to the mere passage of time.  Unfortunately, that’s often not the case, so a current fair value range is preferable (at least to me) to a target price, but students are led astray in that regard by the wide use of target prices by professionals (often mostly for marketing purposes).

At the end of a presentation, students and professionals alike like to have a slide that says, “Questions” or “Q&A.”  I think that’s a mistake.  Everyone knows it’s that time.  Instead, it’s better to leave a key concept or chart on the screen for people to ponder upon, not a slide that adds no value.

However, in most cases during the competition that question slide didn’t linger too long.  The teams usually had one student running the computer, selecting exhibits to support their responses to the questions that were asked.  The teams that clicked back and forth looking for them burned up a lot of time, but several of the teams had intricate trees of slides at the ready to support their case (sometimes close to a hundred of them).

The effectiveness of that strategy was mixed, depending on the quality of the particular slide and its pertinence to the question at hand.  Many questions should be answered directly, without referencing a slide.  Doing so is more efficient and shows a command of the material that can impress the judges even more than showing an exhibit.  But sometimes the exhibits help.  Knowing when to use them and when not to use them is an important part of becoming an effective communicator.

As is knowing when to say, “I don’t know” or “we did not look at that specific issue.”  It is hard to do that, thinking that you are admitting weakness, but honesty builds trust.  Answering a question with a tangential thread that happened to have been rehearsed but is off point is likely more damaging to your cause than supportive of it.

In a team format, you have to trust your teammates to provide a good response and not be too eager to add on additional information unless it is very important.  In some cases, it seemed like everyone added their two cents, but only some of the additional comments were necessary or helpful.  Several detracted.

In addition, it’s good to remember that a short answer is best when that is what the question calls for.

In a competition, whether it’s during the Research Challenge or between asset management firms trying to win a piece of business, there is always a question of how much you should stand out from the crowd.  Doing things like everyone else – in your analysis or your communication – is lower risk and provides a level of check-the-box comfort, but it probably lessens your chance of winning.

The presentations by students tend to have many things in common with each other, so I would suggest that teams look for opportunities to be different, picking their spots to surprise the judges with something fresh, even in little ways.

I think every presentation that I saw included a Monte Carlo analysis for the stock price of the company under review.  The number of trials performed seemed to be mentioned every time (with some teams citing an extraordinary number of trials performed, as if that conveyed more power than it really does), but not one gave the kind of context that would have made the analysis mean something more significant.  For example, by citing the key variables and the ranges for them that were used (and why), a team could provide a window into their analytical process and differentiate themselves at the same time.

To reiterate, these quibbles and concerns are just as applicable to professionals, so the students shouldn’t feel like they were particularly deficient in those areas.  But future participants might benefit from stepping apart from the norms that tend to evolve in competitions like this, and take some chances aimed at communicating a story that doesn’t look like that of past winners or other teams that they face.

I appreciated the opportunity to witness a group of impressive young people demonstrate their abilities.  There is no doubt that the Research Challenge presented them with a unique opportunity to polish their skills.  I always say that, at a high level, all investment roles can be evaluated via a simple formula:  analysis plus communication.  This competition helps students to develop each of those capabilities, which will aid them in any investment career that they might have or any other vocation that they choose to pursue.

Improving Your Investment Commentary

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Tom Brakke, CFA

It’s two weeks after the end of the quarter – do you have your commentary finished?

Many investment professionals who are responsible for writing a quarterly update for clients dread the thought each time around and drag their feet. It’s not easy to write clear and effective commentaries; often they feel formulaic, with the same structure and the same themes being used over and over.

How can you do better?

For ideas, I participated in a webinar put on by Susan Weiner, “How to Write Investment Commentary People Will Read.” Weiner is a chartered financial analyst who provides writing training and bespoke services, and who has presented at many CFA society events. (More information about her can be found on her website.)

To write commentary that is compelling for your readers, know your audience – and know that they wonder: WIIFM. That is, “What’s in it for me?” Making your ideas relevant to their personal interests is critical. “What keeps them awake at night?” asked Weiner. Start there.

A client-focused commentary includes the words “you” and “your” and a connection between the events of the quarter and their own situation, rather than a dry and distant recitation of facts.

“Say something provocative” was one of Weiner’s suggestions, although it’s not always easy to find a topic that is of great interest that hasn’t already been thoroughly covered in today’s 24/7 world of communication. For example, most of the participants felt that interest-rate risk in the bond market and the crisis in Greece were topics that would fit, but it’s not as if there’s been a shortage of coverage regarding them.

Weiner offered some ideas: look for differences of opinion (in the market or even within your firm) that can be explored, pass along ideas from materials you read that your clients likely haven’t seen, and directly address questions that you have heard from your clients about the issues of the day.

How to structure a commentary is highly dependent on where it is used. Many hedge funds, for example, produce a multi-page quarterly letter that is somewhat flexible in format. In other cases, managers only have a few brief paragraphs to get their ideas across – and they have to do so within a tightly-constrained organizational template.

No matter the palette at your disposal, it’s imperative that you structure your writing in a way that helps the reader to comprehend your ideas. Weiner suggested that you organize your thoughts before you ever start writing, and she advocated for the use of mind mapping to help you to do so. She stressed the need for strong topic sentences in each paragraph; one of the exercises in the webinar involved crossing out everything else in a piece and seeing how well the essence of it was conveyed by the topic sentences alone. Layout options can also help – bullet points, sidebars, headlines, and exhibits – if you have the flexibility to use them.

For those of us whose writing gets needlessly complex, the most important message of the webinar was, “Simplify, simplify, simplify.” Weiner urged participants to use strong verbs, to kill needless adverbs, and to be brief and precise. If you want something to be readable, use shorter words, less complex sentences, and aim for paragraphs of around 42 words and sentences of 14.

It’s better to have your writing come in at the tenth-grade level (in terms of comprehension) rather than that of a Ph.D. You might not feel as smart, but your writing will be more effective. (I took Weiner up on her suggestion to test some of my own, using the Hemingway App. It’s a good way to see whether your writing has become hard to read.)

As investment professionals, we also tend to use jargon too much. That’s how we talk amongst ourselves, and it carries over into our writing (and our presentations). Instead, Weiner said that we should follow the lead of Warren Buffett, who wants his annual reports to be in plain English, “understandable by his sisters.” In doing so, he has made them accessible to professionals in a way that others don’t.

That should be the goal. As Weiner said, focus on making your writing “compelling, clear, and concise.” If you do, it will stand out.

Standing Out in a World of Asset Management

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Tom Brakke, CFA

The CFA Institute Research Foundation Board of Trustees met in Minneapolis recently. In conjunction with the visit, CFA Society Minnesota hosted an event which featured talks by Paul Smith, the new CEO of CFA Institute, and Brian Singer, head of William Blair’s Dynamic Allocation Strategies team and a trustee of the foundation.

Smith spoke briefly about his first five months as CEO, focusing primarily on improving the value proposition that CFA Institute offers to its existing charterholders. He stressed the word “standards,” saying that the organization needs to be vigilant in protecting the standards that apply to the awarding of the CFA, CIPM, and Claritas designations. In addition, in his estimation, CFA Institute must continue to be outspoken in improving how the investment industry operates and how professionals meet the needs of their clients.

The latest event in the Distinguished Speakers Series, Singer’s presentation challenged the entrenched orthodoxy of today, which he said is due in part to the success of the CFA program. The foundation of that orthodoxy is Modern Portfolio Theory and related ideas, the assumptions of which Singer called “inherently yet quaintly stupid.”

He urged the attendees to consider the traditional notion of equilibrium versus the operation of a complex adaptive system. One is static, the other dynamic. One linear, one not. One characterized by complete information, no errors or biases, and no “endogenous novelty” – the other featuring incomplete information, plenty of errors and biases, and differentiation, selection, and amplification effects that cause distortions that aren’t immediately corrected.

When asked which they thought represented the market environment in which they work, audience members voted overwhelmingly for the latter. However, even though that is his thesis, Singer said both perspectives are important to understand if you are to be successful as a professional.

Singer disputes the notion that the fundamental value of an asset is reflected in its current price, but rather believes that fundamental value serves as a gravitational force for price over time. Therefore, he thinks that a short summary of a sound investment process involves three basic questions: Where do prices differ from fundamental value? Why do prices differ from fundamental value? How can those value/price discrepancies be captured?

While he talked about the hot topic of Greece to illustrate how his team uses game theory to assess the objectives of geopolitical (or market) players, perhaps Singer’s most interesting commentary concerned the structuring of his organization versus others.

He eschews the traditional approach, where analysts seek more and more information and then try to sell their ideas to portfolio managers, thinking that it leads to behavioral errors and a torturing of data in search of an answer. Instead, he wants his group to create “deductive frameworks” that don’t look like the decision tools that others use. For one thing, he says, in contrast to others, “We don’t need that much information.”

The key is to create a structure in which to organize information that focuses on the most important elements of a decision – and to staff the organization in a way that brings diverse points of view to the table. That means hiring individuals with different cultural, educational, and work backgrounds. Each puts forth his or her opinions privately, in advance of a discussion, so that the range of views within the group is accurately conveyed before debate is dominated by the loudest and most powerful voices.

Singer stressed the importance of being clear about the information at hand prior to making conclusions. What is fact and what is opinion? We can lose sight of the facts, because the rush to form opinions often overwhelms the process of thoughtful analysis.

In Singer’s eyes, the world of asset management as we know it has evolved on the basis of outmoded theories, no doubt reinforced by the career risk that keeps investment professionals from straying too far from the crowd and the organizational structures that haven’t really changed in decades.

It’s time, he says, to rethink your approach and “put a stake in the ground about what you believe.”

The Hazeltine Indicator

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Tom Brakke, CFA

Even before American Pharoah captured the Triple Crown, someone had looked back to see how the market had done historically in the wake of such a feat.  Bespoke Investment Group showed the performance of stocks in the years when a horse won all three races, and it wasn’t very good.  As is the case these days, the piece from Bespoke was tweeted and retweeted and pasted into blog posts and talked about by market pundits.

In a posting for Bloomberg, Barry Ritholtz warned against such dangerous connections between correlation and causation – including the most famous supposed relationship between stocks and sporting events, the Super Bowl indicator.  Nonetheless, come February, we will once again have it thrust upon us by those more interested in generating traffic than delivering enlightenment.

It’s in good fun, isn’t it?  Supposedly, but the problem extends into more serious corners of market discourse.  Anyone with a computer can plot two variables across time and, using different Y-axes, make it look like there’s something there.  In a manner of minutes the image can go viral and soon everyone is using some of their valuable time to talk about it.

Such methods are not just the province of amateurs touting their ideas online; reports and presentations prepared by professional investors often contain questionable charts and weak assertions.  The silliness of the relationships might not be as obvious as those of the Super Bowl indicator or the Triple Crown indicator (which is now destined to be tracked and reported on going forward), but the weaknesses in the logic are there just the same.

(One interesting sidebar.  Note that the Bespoke compilation did not include the results of the market in 1919, when Sir Barton won the Triple Crown.  No doubt that’s because investors are trained to think that history started in 1926, when the Ibbotson series does.)

These recent events reminded me of “the Hazeltine indicator,” which I first commented on in early 2008.  I was the historian of Hazeltine National Golf Club for many years and I wanted to write an entertaining piece for the club’s newsletter.  Hazeltine was getting ready to host the 2009 PGA Championship at a time when the first cracks of what became the world financial crisis were starting to show.  I had previously noticed that in advance of each major event at the club, there was a notable bout of economic trouble.

As you can see from the end of the newsletter story, which appears below, I gave a seven-year warning to the members to prepare for weakness this year, since Hazeltine would be hosting the Ryder Cup Matches in 2016.  If things start going haywire soon, remember:  You heard it here first.

Investment professionals are always searching for relationships in the past that they think will tell them something about the future.  A couple of years back, I hit upon one such indicator.  A sentence in a recent New Yorker article reminded me of it.

Talking about the current angst regarding the economy, it said, “It’s 1929, 1969, 1981, 1990, 1997, or 2001 all over again.”  Now think about when we have hosted men’s major championships:  1970, 1991, and 2002.  You can even throw in the Senior Open in 1983.

That’s right, each of those championships was hosted right on the heels of economic weakness.  Despite the difficulties that arose from the tight corporate and consumer spending following those slumps, Hazeltine has always managed to outperform expectations.  That is a testament to our members and other volunteers.

Right on schedule, the economy is now wobbly in front of next year’s PGA.  If you didn’t get your portfolio positioned well to take advantage of it, remember that there’s always another championship coming to Hazeltine.  Mark your calendar now to be prepared for the weakness in 2015.

An Evening with a Portfolio Manager (Thirty Years Ago)

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Tom Brakke, CFA

Those of us who are packrats (it’s harder to identify one these days, when PDFs pile up on the computer rather research reports being stacked on desks in plain sight) sometimes actually go back and look at some of what we have saved – just as we imagined that we would.

If you are of a certain age, the cache of documents might provide a certain nostalgia, some historical perspective, and quite a bit of “shoulda, woulda, coulda.” Just today, I found an interesting article on Michael Milken from a 1986 issue of Institutional Investor, a 1977 Morgan Stanley piece by Barton Biggs on the craft of asset management, a “conversation with Richard Feynman” on a range of interesting topics, and articles that had been copied on a “Xerox machine” which argued back and forth about whether active managers could beat the market (some things never change).

I also discovered a page of notes written in my own hand, from thirty years ago, with the title, “An Evening with __________.” I was pretty new to the business at that point; the small cap growth portfolio manager whose name was in the blank was on a rocket ship of performance and business success.

The night had started out in a dismal fashion. We were to be hosted by a broker at Il Mulino in New York City, one of the hottest places in town, but when we got there we found that a pipe had burst and that we would be dining elsewhere. (As we left the restaurant, we informed a man getting out of a taxi that he was out of luck. He waved us off and said, with an air about him, “I’ve got a reservation.”)

We walked down the street, found another place to eat, and had a great conversation. With a few explanations and clarifications [which are added in brackets], these are the notes I wrote down shortly thereafter about the advice that I had received:

“Work for one of the 10-15 great managers for free for 5 years.”

“Learn all you can, find yourself, fit your style to yourself.”

“Don’t let it get to your head if you do well.”

“Play the game and have fun – you gotta like it.”

“Use everyone, even contrary indicators.”

“Know human nature – not business – read Panic on Wall Street.”

“Sell when there’s a slip [by a company].”

“[Ask yourself], which small companies will get to $1 billion?”

[At this point, there were a few disparaging comments about the investment abilities of some of my co-workers, including one he called “a stopped clock”.]

“If you knew that a stock was going to go from $30 to $15, but that it was guaranteed to go to $300, you should be willing to buy it right away (and institutions won’t do so).”

“Ask questions; don’t worry [about how you’re being viewed]; one in ten will catch a management off guard.”

[Then, in my notes, there was just the name of a person; I’d love to remember what was said about him.]

“Make mistakes; see stocks go from 35 to 1.”

“Don’t kill the messenger.”

“Don’t think conventionally.”

“Buy people.”

“You need some clean-up hitters [big winners].”

“Learn the basics; adapt your style; be unique.”

All these years later, it is interesting to read the portfolio manager’s comments – and to think about them in light of the events of his career as it unfolded, and of my own.

When I encourage young analysts to study other investors and learn from them (even over dinner), I sometimes forget to tell them how personal the advice they receive will be. The notes I found matched the man I watched in subsequent years – focused on high-risk, high-return companies, entrepreneurial, outspoken by instinct, and, it should be said, lucky in a number of respects (although he took advantage of that luck when it presented itself).

His advice would be ill-fitting for so many (after all, you should “fit your style to yourself”), and parts of it match the world of 1985 better than that of 2015. But it stands up pretty well overall.

I knew I saved that sheet of paper for some reason.