Author Archives: Tom Brakke, CFA

Thought Leadership by Investment Organizations

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Tom Brakke, CFA

Over the last few years, there has been a noticeable increase in electronic communications from asset management and investment advisory firms. As clients have gotten more and more comfortable online, organizations have tried to reach them through blog postings and tweets and electronic white papers and Facebook status updates and LinkedIn Pulse dispatches and emails (lots of emails).

The activity is largely an exercise in brand awareness, filling nearly every channel with something. But what?

Some firms openly aspire to a position of “thought leadership,” although, in the minds of many, that’s an empty term these days. It’s certainly overused. A lot of companies talk about their thought leadership, there are openings posted for jobs that carry the title of “thought leader,” and there are webcasts, seminars, and conferences that use the term to describe the presenters that are being promoted.

Joel Kurtzman, who is given credit for coining the phrase, agrees that it has become “diluted, and largely meaningless.” His intent was to identify genuinely original work – the kind that leads to real breakthroughs. Instead, “thought leadership” has become a sales tool. Kurtzman says that “it can’t be real thought leadership if the only answer is ‘buy my product.’ That’s marketing.” Consequently, he doesn’t use the term any more.

Proclaiming yourself or your organization as a thought leader can run the risk of being viewed as too promotional, short on both innovative thought and actual leadership. (A recent tweet from @PlanMaestro summarized what he found when doing a search on the term: “Funny stuff since 2010.”)

Therefore, investment organizations need to think carefully about how they use the phrase in positioning themselves and their professionals. But, throwing the label aside, what should they be trying to do across all of the communication channels at their disposal these days?

They could start by considering the advice provided by Gordon Andrew in a recent newsletter on “Marketing Alternatives” from BarclayHedge: “True thought leaders seek to manage rather than to control the conversation. They determine the issues and voices worthy of attention, but do not exclusively push their own perspective. They also shine a light on the ideas of clients, prospects, referral sources and recognized authorities. By displaying the self-confidence to share the microphone, they are viewed as legitimate opinion leaders, not simply carnival barkers.”

By that standard, most investment firms fail miserably. They promote their products, they talk their portfolios, and they seem disconnected from ongoing debates about important investment issues. Their communications instead revolve around the headlines of the day and the squiggles of market activity. Plus, they provide constant predictions of this and that, most of which end up being wrong anyway. (Need we bring up the interest rate and crude oil forecasts?)

A big part of the problem is that most firms can’t ever get out of asset-gathering mode. So, blog postings leave out important issues that a balanced analysis would include, and anything that would be viewed as hurting the firm’s case never sees the light of day. A [fill in the blank] asset manager is always ready to defend [fill in the blank], despite the analytical gymnastics that might be required to make the case.

For example, as valuations have increased on stocks, there has been some “shopping” for more attractive valuation comparisons and a muddying of the terminology used; sometimes it amounts to a perversion of the historical record and outright fudging of the truth. And, earlier this year, many high yield bond managers were particularly outspoken (and one-sided) in their defense of the sector, even as other observers noted the risks of those vehicles in comparison to the apparent prospective returns.

Investment advisors face similar temptations too: Giving the whole story sometimes increases the chances that you will lose assets. In an industry that runs on assets-under-management fees, that’s a line in the sand at most firms.

So, long-term credibility is sacrificed to protect today’s business model. Is there a cost associated with that?

Look at sell-side analysts. They are very well versed in the companies and industries that they follow and can serve as great sources of information if you know how to use them. But they have long since been viewed as marketers first and foremost, extensions of the interests of their firms instead of true objective observers of a situation on behalf of their clients. (Something we were reminded of again recently.) As a group, they provide a case study of the principal-agent problem in finance, defined by information asymmetry and misaligned incentives between the parties.

Real thought leaders minimize those problems by focusing on the merits of ideas, not on the potential impact of them on their own book of business. That’s a tough standard indeed, one rarely met in the investment world.

Therefore, investment organizations usually come across as mere pushers of product, not true partners with their clients, and certainly not thought leaders. Does that matter? Time will tell, but perhaps authentic voices increasingly will be recognized and trusted in a way that conflicted ones will not be. Oddly enough, going beyond the party line today might end up being a powerful way of building a lasting brand and, yes, being seen as a thought leader rather than just another voice in the marketing din.

Two Skeptics Debate the Role of CFA Institute

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Tom Brakke, CFA

In a recent column in Chief Investment Officer (“A Skeptic’s View of Today’s Religion”), Angelo Calvello calls out CFA Institute as “the Church of the Capital Asset Pricing Model,” accusing it of perpetuating groupthink about how markets work and not having “a demonstrable positive impact on the way we invest.”

As a CFA charterholder (one old enough to have a mere four digits in his charter number), you might expect that I would bristle at the characterization. While I think the charges are too sweeping and too focused on CFA Institute alone, I agree with most of what Calvello says about the asset management industry of today.

In fact, I’ve written in a similar vein over the years. I absolutely believe that there is a “paucity of genuine innovation.” When I ask investment professionals to rate their own industry and companies (after all, they are in the business of rating other ones), invariably they assign low marks.

Like Calvello, I “have criticized asset management’s business models, culture, and compensation structures; the academy’s lack of imaginative scholarship; and asset owners’ and managers’ behavioral biases” as key factors in the promise of the investment profession not being fulfilled.

And, as for the teaching of investment notions of the day as doctrine, I gave this advice in one of my Letters to a Young Analyst (in regard to the desirability of different credentials): “If you choose to pursue an MBA or a CFA, remember that they are built upon orthodoxy, by and large, which you need to learn and attack at the same time.”

Later in that book, I added, “We need to remind ourselves that modern finance is a very young discipline. Despite that, it is common to see historical asset class returns presented in a way that presumes them to be sound estimates of the future; asset allocation and risk management techniques being made to look scientific; and securities being described, classified, and recommended using relatively few years of evidence as if they were definitive.”

There is so much that we don’t know – and, despite that, the teaching of finance in universities and by CFA Institute and other credentialing organizations is entirely too focused on answers rather than questions. It may not be surprising, then, that the same tack is usually taken when investment professionals talk to asset owners. Narrow perspectives are honed and reinforced; unfortunately, good questions tend to get in the way of pat answers.

One of the best things about the CFA exam process is the need for candidates to study a broad body of investment knowledge in order to pass the tests. However, as with other disciplines, it is easy for a test-taker to perceive that body of knowledge as fixed and foundational, even when it’s not fixed and may only be foundational for a limited period of time.

Soon enough, however, the diversity of the CFA curriculum fades away for most charterholders, at least those that find their way into asset management. Specialists rule, and the mission for most is playing the game of relative performance.

Has it worked for asset owners? Hardly.

Is CFA Institute responsible for the current state of affairs? No, although it’s complicit. In that, it has plenty of company, although it also has a lot more leverage to change the status quo than most of us.

I’m not sure how I would alter the exam process if it was mine to do, other than by stressing the transient nature of the current body of knowledge and the persistent failure of the investment industry to translate the reigning theory into successful practice. I want candidates to learn most everything that they are currently being asked to learn, just not to think of it as scripture.

And it would be nice for there to be a greater focus on the softer skills that matter just as much, from communicating effectively (yes, that means listening as well as speaking/writing), to understanding the broader context of investment decision making, to designing and managing organizations that can meet the real needs of clients. But, should the CFA curriculum be modified in some way to do that? I’m not so sure.

No doubt, we need different kinds of people in the industry, whether they are mathematicians and artists (as Ashby Monk wants to see in a new generation of asset owners) or polymaths (the subject of a previous Calvello column). Training more and more people in the same way isn’t an answer to the current shortcomings. Variant perspectives are required.

Which gets us back to CFA Institute and the tens of thousands of us that have earned our CFA charters.

The organization has always stressed the need for ethical behavior by charterholders, but, despite that emphasis and its Future of Finance initiative, it hasn’t been the force for change in industry behaviors that it should be. As I wrote in a previous posting on this site, CFA Institute “needs to engage and mobilize the large asset owners and asset managers that wield the economic power in the markets.” And change how business is done. That it apparently hasn’t done so to any degree is a greater problem right now than any tendency to cling to a particular theoretical doctrine.

In fact, charterholders are all over the map on many of the concepts that Calvello bemoans. And CFA Institute provides forums in which they are vigorously debated. While I might be an agitator and as skeptical by nature as Calvello, I’m not banned as a heretic. To the contrary, CFA Institute has invited me to share my views in various ways and I’ve had the opportunity to speak to many local CFA societies.

So, while I agree with much of what Calvello has to say, the first priority for CFA Institute should not be to rip up the current body of candidate knowledge. Instead, it should be more aggressive in trying to improve the industry. As with a portfolio manager who becomes a closet indexer to avoid career risk, professional organizations can get too focused on protecting the position they are in rather than advancing the cause.

For CFA Institute, it is time to intensify the battle. It can’t be a bystander and it can’t be thought of as merely a credentialing agency. If that’s all it does, it is providing troops for the industry, not for the profession. That’s the last thing we need.

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.

Biomimicry and the Nature of Investing

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Tom Brakke, CFA

Modern markets can seem to operate in a sphere of their own, divorced from the real economy and the real world. Plus, the process of investing has become more systematized and abstract over the last couple of decades – with the theory and jargon of the business often conveying a sense of false precision about the behavior of markets.

As a portfolio manager and former head of U.S. equity research at Fidelity, Katherine Collins felt those disconnections and yearned for a broader perspective. Her radical career shift – heading off to Harvard Divinity School – left her co-workers and others surprised. How could she leave the exciting business of investing?

As Collins told a recent meeting of CFA Society Minnesota, she never abandoned her love for investing. But she wanted to find a new context for her decision making, and her experience at divinity school, the Santa Fe Institute, and the Biomimicry Institute led her to use the lessons of nature to approach the challenges of investment analysis.

Her insights can be found in a new book, The Nature of Investing: Resilient Investment Strategies through Biomimicry, and she formed Honeybee Capital to produce research using her approach. (More information can be found in an interview with Collins in CFA Institute Magazine.)

Many of the precepts that Collins discussed involved cutting through the complexity of the investment conventions of today with simple concepts inspired by nature. She talked about the honeybees which gave her firm its name, pointing out how they cooperate to share information “openly and without spin.” When faced with a problem, they head out into the world to observe and then work together toward an optimal solution. Contrast that with many investment decision makers, laboring away alone in their offices, looking at the world through digital windows.

In fact, for people of a certain age, one of Collins’ examples was particularly apt. Back in the day when not everyone had a Quotron (the dominant electronic data platform then), they used shared terminals in common areas. That had at least two positive effects: co-workers rubbed shoulders more often and got to know each other better, strengthening the teamwork in the organization, and they shared information about their respective areas of expertise, resulting in a cross-pollination of ideas that yielded new insights. According to Collins, “the inefficiency of the Quotron was what made it so special.”

Yes, “we have become tools of our tools,” that derivation of a Thoreau quote being one of many that Collins used to show how the challenges we face aren’t exactly new (although with amped-up tools we probably have amped-up challenges). We feel like we have all of the answers at our fingertips, but only to certain questions, and probably not the key ones.

For Collins, the most important result of her inquiry into biomimicry is that it helps her to ask better questions about the investment process. She gave a number of examples of unusual adaptations among species that led her to see an investment dilemma in a new light.

The biggest issue that we confront is “risk” versus “uncertainty.” The former is bounded by the parameters of our experience, and the investment world has turned it into an apparent science. Risk equals standard deviation (although that’s a very unusual definition) and the language of risk in that sense has become universal, driving the investment framework for everyone from individuals to massive institutions. This “land of risk” is mapped and quantified – and our tools are honed to guide us within the normality that we think exists.

But the “sea of uncertainty” is something else again. It’s ironic that the financial crisis caused the risk culture to become even more entrenched; it should have exposed the shortcomings of that framework for dealing with unanticipated situations. Collins thinks that those who tread the land of risk (an overwhelming percentage of investment professionals these days) are least equipped to navigate on the sea of uncertainty. To survive in the entire range of environments, we need people that come at decisions from other directions – and ask those better questions – rather than trying to outthink and out-model everyone else.

Speaking of thinking, Collins grew up with one mantra ever-present in her life: “Think.” Her father worked for IBM, so she couldn’t get away from that famous slogan from founder Thomas Watson. But it’s easy to get lost in your own thoughts (sitting in your office with your electronic tools) or to get caught up in the conventional thinking about an investment question.

Thinking differently is essential (yet difficult), and Collins says we need better systems for approaching problems and better conversations about them. Long-term perspective is needed to succeed in a world driven by short-term performance.

That demands a reengagement with realms beyond the echo chamber of the investment business. In many ways, we have become removed from the reality of our decisions. A stock is not a blip on a screen but an economic interest in a company. As someone schooled in fundamental analysis, Collins stressed the importance of understanding the culture of a firm, and “you can’t do it in ten minutes.” You also can’t capture the world with a bunch of statistics, although they are an important part of the information mosaic (just not as important as we’ve come to believe).

Collins is an engaging speaker, sharing insights from within the investment business and from outside of it, and effectively connecting the two. You can’t help but think that you’d want her around the table the next time you had a tough issue to address – or when you needed reminding that sometimes you have to take a step out into the real world to see things in new ways.

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.