Category Archives: Hot Topic Commentary

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.

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.

A Successful 2015 Annual Economic Dinner

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More than 500 people packed the Marriott City Center ballroom for our 2015 Economic Dinner featuring Jim Grant, founder and publisher of Grant’s Interest Rate Observer. Jim spoke with wit and insight about the causes and implications of our current zero-interest-rate environment. Zach Pandl, Portfolio Manager and Strategist at Columbia Management, moderated the Q&A session immediately afterwards.

Click here to read “Low interest rates have us in uncharted territory,” a recap of Jim’s presentation by Star Tribune columnist Lee Schafer.

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Photos Credit: Knoebel Portrait Design

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.

Trivial Pursuit.

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John Boylan, CFA

Way back when people could entertain themselves without electronic devices, we played a board game called Trivial Pursuit. The bane of my existence in that game was earning the pink entertainment chip, as for some reason I dislike watching movies and TV shows so it was a challenge for me to answer those questions. That’s where I would get absolutely smoked.

I also would get smoked when I would turn my investment theses into trivial pursuit games. All too often I spent countless hours striving for that last bit of information that would perfect my thesis and make my earnings model seemingly impenetrable—at least in my own mind. However the vast majority of investment failures that I have made and have seen others make were not when we failed to uncover that last nugget of new information, it was when the risks of an investment were well known. Our error was underestimating something already known and anticipated, and we refused to challenge our own investment thesis. Our attitude was how can our thesis be wrong when we know the company so well? Many of us have a greater fear of looking ignorant in not knowing every detail of a company when confronted than admitting the weaknesses in our thesis up front in front of our co-workers, superiors, and clients. Too much bravado can be a very bad thing.

In my view, we investors often confuse intelligence with wisdom. Intelligence is the capacity to hold and retrieve information. Wisdom is the humble application of intelligence and experience. Why is it a humble application? Because wisdom is usually imparted by Mr. Market whacking us upside the head, and us actively looking for that proverbial swinging two-by-four aimed squarely at our temple in our future analyses. Getting whomped on the noggin so many times does give you a much better idea of where your weaknesses lie and how you need to know, accept, and yes even celebrate your shortcomings.

That’s why we as investors should try to actively look for and embrace our failures whenever possible and try to find out where we went wrong and how we can improve on our processes in the future. In other words, actively confronting and embracing the lessons learned from failure as often as we can. This includes seeming investment “successes” as well. Through the years I have discovered that many times I was right for the wrong reason (aka lucky), and that by looking for failure in my analyses that are disguised as successes has been equally as helpful.

Therefore perhaps we should spend much less time on that incremental bit of information about a product in a company’s product line that might move your model by less than 5% and spend more time looking for, embracing and learning from our failures. We might not win the Trivial Pursuit game (and earn that elusive pink entertainment chip), but we may just win the investing game in the long run.