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Category Archives: Hot Topic Commentary

Twenty-Four Little Hours

3rd October, 2014 · Susanna Gibbons, CFA
Susanna Gibbons, CFA

September was, to be blunt, a terrible month for credit. Rates were higher, spreads were wider, banks were weak, and record-setting supply weighed on the market. The Merrill Lynch U.S. Corporate master was down about 2 points, a combination of rates that were double-digit higher in the belly of the curve, and spreads which were about 10 bps wider. That may be better than small cap equities, but it was the worst month for credit all year.

What seems most interesting is that supply continued to hit the market all month long, to the tune of about $150 billion. It seems that M&A activity has been driving a lot of the issuance. That represents a change in motivation from earlier this year, when borrowers were tapping the market opportunistically. Up until now, many borrowers could pull back in the face of a less-than-rosy market, but now they no longer seem to have that flexibility.

Case in point this week was the Bayer deal. Bayer issued $7 billion in a 6 part deal, sprinkled across the curve out to 10 years. The company was financing its $14 billion acquisition of Merck’s consumer care business. Bayer already had bridge financing from a $12 billion syndicate of banks, but needed to get permanent financing in place. Given the timing, this deal looked on the cheap side, and as a result it performed well through month end.

What a difference a day makes. The Bayer deal has lagged a little bit, but the rest of the market is notably improved. Rates are better, with the 10 year below 2.5%, and spreads have improved on higher secondary volumes. Bank paper snapped back on Thursday morning, and continues to trade well. It may not be all sun and flowers, but the market feels like it has come through an autumn rainstorm. I cannot say whether it will be all rainbows before us, but I think I will enjoy the moment of romance while it lasts.

Since it rarely does.

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Posted in Hot Topic Commentary, Local Charterholders, Weekly Credit Wrap | Tags: Bayer deal, credit, high rates, Weekly Credit Wrap |

The Pimco Soap Opera and the Challenge of Due Diligence

2nd October, 2014 · Tom Brakke, CFA · Leave a comment
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.

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Posted in Hot Topic Commentary, Local Charterholders | Tags: Bill Gross, Due Dilligence, PIMCO |

2014 Compensation Survey Results

18th September, 2014 · CFAMNEB · Leave a comment

2014 CFA Results Brochure

Back by Popular Demand

We’re excited to release the results of our 2014 Financial Compensation Survey, the 2nd Annual in-depth look at compensation levels in the Twin Cities and surrounding region, conducted by CFA Society Minnesota.

Click the image at right to download, at no charge, this white paper summarizing high-level survey findings in an easy-to-read format. In return for the white paper or for deeper data requests, please complete the contact form below. Your feedback is welcome and appreciated.

Thanks for your interest!

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Posted in Hot Topic Commentary, Local Charterholders | Tags: 2014 Compensation Survey, Compensation Survey |

Back to School

8th September, 2014 · Susanna Gibbons, CFA
Susanna Gibbons, CFA

After snoozing through the last few weeks of summer, it was time to get back to business, and the Corporate Bond market wasted no time in going to the head of the class. Investment Grade supply over the past week was huge, with $45 billion in new issuance (and well over $50 billion if you included all the sovereign issuers). Over 70% of the deals were in the bank and finance space. Bank of Tokyo – Mitsubishi UFJ and its partially-owned stepchild Morgan Stanley were among the two largest issuers, bringing about $3 billion, and $2.25 billion, respectively. There were also big deals out of Bank of New York, Wells Fargo, Lloyds Bank, Standard Chartered… even little Fifth Third Bank of Cincinnati did an $850 million bank note deal.

As a result of the heavy supply, the secondary market was forced to absorb a fair amount of paper, and this pushed spreads a little wider, especially in the Bank / Finance space, which saw about 3-4 basis points of widening on the week. Not a huge change, but enough to put spreads at the wide end of the very narrow, 5-10 basis points range where they’ve been stuck for most of the summer.

In all the excitement, we almost forgot JPMorgan. JPM issued $3 billion of subordinated holding company debt to start the week. This was a 10 year deal, priced at a spread of +153 (and has traded wider by a few basis points). Even though the FDIC Single Point of Entry (SPOE) rules for a bank holding company debt requirement remain under consideration, we have seen continued supply of bonds which we think might fill some gaps in this area. Depending on how the rules turn out. Which we don’t know yet. Did we miss something while on summer vacation? Banks are not usually big third quarter issuers; it is almost as though they have seen the answers to the test.

So, class, what do you think? Are bank issuers trying to fill their SPOE buckets before the rest of us even know where our new lockers are?

Good answer. Good answer. I like the way you think. I’m gonna be watching you.

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Posted in Hot Topic Commentary, Weekly Credit Wrap | Tags: back to school, Corporate Bond Market, Weekly Credit Wrap |

Biomimicry and the Nature of Investing

26th August, 2014 · Tom Brakke, CFA · Leave a comment
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.

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Posted in Hot Topic Commentary, Local Charterholders | Tags: biomimicry, katherine collins, nature of investing |
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