Category Archives: Hot Topic Commentary

Performance & Valuation Prime: Decision-Changing Analysis, From Arcane Accounting to Economic Reality – Event Recap

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by Robert Boucher, CFA

Valens Credit Strategist Joel Litman presented to the Society on the topic of adjusted fundamental analysis and discussed some of the unique tools Valens Credit applies in their analysis. Mr. Litman began by taking the audience through a number of examples of how, in his view, GAAP, IFRS and IAS accounting—both in design and because of management’s discretion—fall short in consistently providing measures useful for fundamental analysis.  Specifically he identified pensions, rents, R&D, acquisitions and divestures as areas an analyst should focus on and should consider analytically adjusting to arrive at adjusted cash flow and income measures. Importantly the adjustments have implications for valuation of both equity and fixed income securities, as equity analysts project growth and apply earnings multiples or discounted cash flow models; and as credit analysts focus on coverage and cash flow leverage metrics. Mr Litman also described how differences in incentive structures help to explain some of management’s accounting choices, with earnings per share incentives driving different choices than a cash flow incentive or a return on assets incentive. Unfortunately for the analyst looking for a quick fix, Mr. Litman says the only realistic approach is to roll up the sleeves and start digging.

In addition to performing the time-consuming work of digging into individual company financials, releases and other printed material, Valens also attempts to glean important nuggets from earnings calls and other recorded presentations using audio forensics tools. Mr. Litman describes Valens’ use of electro audiogram scanning technology to “listening” for cues in the tempo, timbre, tone etc, and that, for example, depending on the context, a management team signaling confidence and excitement in its cues can give Valens added confidence in growth prospects.

Mr Litman closed by framing the current credit cycle relative to historic measures through the lens of adjusted fundamentals, showing similarities to market signals from a century ago. Valens’ research suggests the U.S. is in the back half of a first stage bull cycle, with strong corporate profits, easing credit conditions around the world, credit demand that hasn’t yet moved into the important new-investment stage, and strong asset returns. On an adjusted basis, forward price-earnings multiples are still shy of prior peaks and capex is supportive of additional growth.

Joel Litman was an energetic and deeply knowledgeable speaker and, judging by the level of engagement throughout the presentation, the topic was an important one to attendees.

ESG Investing 101 – Event Recap

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Submitting by Amy L. Jensen, CFA, Investment Director, Northwest Area Foundation

On Thursday October 2nd the McKnight Foundation hosted a presentation by Mercer and Mellon Capital titled ESG Investing 101.  McKnight President Kate Wolford opened with a discussion of McKnight’s efforts to achieve greater alignment between the Foundation’s mission and values and its investments.  Laura Kunkemueller, Principal at Mercer, reviewed the vocabulary associated with ESG Investing, various methods that investors have to achieve better integration of values and asset class level opportunities and risks.  Exclusionary or negative screening has become much less of a focus, with investors showing more interest in positive screens, thematic investing, ESG integration into investment strategies as well as increased engagement.

Karen Wong, Managing Director and Head of Equity Portfolio Management at Mellon Capital, described how Mellon worked with McKnight in the creation of more carbon-efficient version of the Russell 3000 index, after the existing index was identified as the greatest carbon contributor in the portfolio. Although some advocate for divestment of companies that are owners of carbon assets, Mellon partnered with McKnight to develop a solution that reduces exposure to companies that produce more carbon per unit of sales than sector peers, minimizes tracking error to the benchmark and still allows opportunities for engagement with public companies. For more information on how McKnight is engaging companies you can go to http://blog.mcknight.org/2015/06/elizabeth-mcgeveran-fighting-climate-change-one-step-at-a-time/. The resulting Carbon Efficiency Strategy is a much more thoughtful approach than would be achieved through simple negative screening.

It was clear from the discussion that the creation of the strategy took time and required careful analysis and reflection on the Foundation’s true priorities as well as quantitative analysis of the index. McKnight’s hard work and collaboration with Mellon laid the groundwork for the creation of an investment product that is now available to other institutional investors. You can learn more about the strategy at https://www.mcm.com/web/mcm/carbon-efficiency.

Global Economic Tour & Brain Ways – Events Recap

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A Tour of the Global Economy: Outlook and Implications

presented by Garrett D’Alessandro, CFA, CAIA, AIF, Chief Executive Officer of City National Rochdale

 

–  Kelly Bretz, CFA, FSA, MAAA

With an almost completely packed room, Mr. D’Alessandro took us around the world macro-economically, and discussed key drivers for each region.  He also and touched on how the information shared impacted his firm’s strategic asset allocation.  His firm’s view is that global growth is generally alright.  This along with other factors including the shortfall in aggregate demand, China’s efforts to stimulate their economy as well as strong economic momentum in Europe and Japan, should help to keep inflation low.  Mr. D’Alessandro commented that the fundamentals of US are the best of any region, and that fears of China’s overinvestment are “over blown”.  Historical analysis suggests that the stock market should not be concerned with limited Fed rate hikes. Lastly, with possible wage inflation in the near future, he does have some concern over decreasing profits and profit margins. I found Mr. D’Alessandro’s presentation interesting and engaging, with much if not all of the information helpful as I consider current and future investment decisions.

 

– Mark Carlton, CFA, Trademark Financial Mgm’t LLC

Garrett D’Alessandro, the CEO of City National Rochdale Investment Management, gave today’s CFA Society Minnesota lunch presentation.  He went over the global economy and its implications for investment portfolios.  His thesis was that the global economic growth is okay now and will be stronger overall in 2016.  China is in nowhere near the tough shape that many people seem to believe, he argued, and the outlook for the U.S. is especially good. He came well prepared with visuals to back up his arguments, especially in the case of China.  3-4% growth is not a hard landing, he said, and the slowdown in growth is the healthy and expected result of the end of a massive infrastructure building program.  The shift is now toward the consumer, and the success of this is evidenced by 8-10% retail sales and wage growth.  Concerns over China’s banking sector are overblown, he argued, as he went into detail about their tiered real estate system.  Likewise a decline in stock prices should not be looked at as a leading economic indicator as it would be here in the United States, because the Chinese do not view their stock market the same way we do. Mr. D’Alessandro was also sanguine about the U.S. economy and market.  It is true that trend growth has slowed over the past several years, but that is due to secular factors such as productivity and demographics.  Citing Reinhart and Rogoff, he argued that debt crises always lead to an extended period of slower growth.  The U.S. consumer is in an enviable position, however, because overall employment and household net worth are at an all-time high.  None of the factors that traditionally trigger bear markets – soaring commodity prices, aggressive Fed tightening, extreme valuations, or recession conditions are present, he said.  He forecast a longer than usual business cycle. When asked about what his concerns were relative to the U.S. stock market, he conceded that rising labor costs could hurt profit margins. There were some markets he really didn’t like, however.  Europe is mired in a secular stagnation and unlike here in the U.S., employment and consumer incomes still haven’t recovered from 2008.  As such is still not a promising place to invest.  He wasn’t enthusiastic on Japan either, due to their high debt levels.

 

Brain Ways: Mental Habits to Improve Work Performance

Presented by Cindy Edwards, of Find Your Fit Career Coaching

-John O’Connor, CFA, Cherry Tree Investments

Cindy Edwards taught attendees how to improve work performance.  She gave practical tips for how to take care of your brain’s basic needs.  With its basic needs met, your brain can focus on positive outcomes and actually grow in size.  Here are some important things to incorporate into your day: focus time (make your brain do heavy lifting), meditation, down time, play time, connecting time, 6-8 hours of sleep, and healthy foods.  Fitting some parts into your work day, including play time, will increase performance.

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.”