By Susanna Gibbons, CFA
Ah, Lake Wobegon. Where all the women are strong, all the men are good-looking, and all the children are above average. Sounds a lot like the pursuit of active management, doesn’t it? The belief that we can find investment managers that are top performers drives everything. In a 1991 article, The Arithmetic of Active Management, William Sharpe basically chides us for acting as though we can all be above average. He notes: “Properly measured, the average actively managed dollar must underperform the average passively managed dollar, net of costs. Empirical analyses that appear to refute this principle are guilty of improper measurement.” (Sharpe, 1991)
Most of the academic research on the performance of investment managers is completely consistent with this notion and demonstrates that there is very little persistence in performance over time. There is some variability in results when viewed over the short term (generally less than a year), but by and large, performance is strongly mean-reverting. (Luckoff, 2010) This should not come as a surprise to anyone in the active management world – it is extraordinarily difficult to consistently beat a benchmark, let alone remain in the top quartile or even the top half.
Using a broader range of quantitative measures for selecting asset managers does not really provide additional hope. The Sharpe ratio is among the most widely used measures, and it adjusts historical performance for the excess risk in the portfolio relative to a benchmark. Theoretically, the higher the Sharpe ratio, the more skill the manager has.
Except that the skill purportedly measured by using historical numbers does not translate into future performance. Just as prior period Alpha is not predictive, high Sharpe ratios are also not predictive of future performance. In fact, they aren’t even predictive of continued high Sharpe ratios.
Why, then, do we continue to use these frameworks as a way of identifying which managers to hire? Investment Consultants put enormous effort into managing their approved lists, conducting “searches” for new managers, and in general acting as gatekeepers for asset owners. Recommendations will not include managers without strong three-year track records at a minimum, in spite of the fact that we know these results have little bearing on expected performance going forward.
In fact, it’s even worse than that. There has been some research on the performance of emerging managers, and it consistently shows strong performance – primarily in the first two years. (Aggarwal & Jorion, 2008) (Preqin, 2013) (Liu, Ma, Shi, & Wang, 2017) According to Aggarwal, “each additional year of age decreases performance by 48 basis points, on average”. The best performance from these managers comes before consultants will recommend them. We are knowingly, willfully leaving performance on the table.
And all of this begs the question: where did the three-year track record come from in the first place? I stumbled across an article recently that suggests that, essentially, the investment business-backed into it because it needed enough data points to calculate Alpha and Sharpe Ratios. In “Are 3-Year Track Records meaningful?” Corey Hoffstein argues that in statistical analysis, 30 samples is the minimum needed to rely on a normal distribution – a requirement for meaningful Alpha and Sharpe calculations. A 3-year track record gives investors the bare minimum required for a (theoretically) meaningful calculation. (Newfound Research LLC, 2016)
The problem, though, is that monthly data should not really be annualized as most consultants do – to multiply by the square root of time. This method would be fine in the absence of serial correlation, but stock returns have a great deal of serial correlation (momentum), so the calculation actually overstates the Sharpe ratio by as much as 65%. (Lo, 2002)
Okay, so we have to have a three-year track record because that’s the minimum amount of data needed for a calculation we know will be wrong, using time series that we have determined have no ability to identify which managers are going to outperform in the future. We then take the three-year requirement and establish a barrier to keep out managers who actually do have a likelihood of outperforming. That’s our framework for identifying excellence. Yikes.
The tools that have evolved over the years to help asset owners make really complex decisions are actually working against their best interest. These tools have had a disproportionate impact on women and people of color. The barriers to starting a new investment fund are high, and the likelihood of being able to keep an emerging business going for three years if you do not already come from a position of privilege is discouragingly low. Those three years have nothing to do with manager performance; they serve only to keep “the unwanted” out of the business, and asset owners are paying the price. Dismantling any entrenched system is hard, particularly when it has been wrapped in complex formulas and years of accepted practice.
We are well past due to escape from this fanciful world, this Lake Wobegon of investing that never actually existed. However risky it feels to step into the real world, it is time.
References
Aggarwal, R., & Jorion, P. (2008). The Performance of Emerging Hedge Fund Managers (draft). Unpublished.
Hendicks, D., Patel, J., & Zeckhauser, R. (1993). Hot Hands in mutual funds: Short-run persistence of relative performance. Journal of Finance 48, 93-130.
Liu, S., Ma, J., Shi, H., & Wang, C. (2017). The Performance of Emerging Managers and Funds. Minneapolis: Carlson Finance & Consulting Lab.
Lo, A. W. (2002). The Statistics of Sharpe Ratios. Financial Analysts Journal Vol. 58, No. 4, 36-52.
Luckoff, P. (2010). Mutual Fund Performance and Performance Persistence: The Impact of Funds Flows and Manager Changes. Gabler Verlag.
Newfound Research LLC. (2016). Are 3-Year Track Records Meaningful? Boston, MA: Newfound Research LLC.
Preqin. (2013). The Performance of Emerging Manager Funds. Company Website, Hedge Fund Spotlight.
Sharpe, W. F. (1991). The Arithmetic of Active Management.
Tag Archives: CFA Society Minnesota
A Letter from Our President
Thank you, is all I can say. As we close out the 2020 fiscal year (Sept 1 – Aug 31), I do not need to rehash all of what has transpired over the past 12 months (and continues to plague us daily). However, I do need to say thank you to so many people. While most of you do not think about CFA Society Minnesota (CFAMN) on a daily basis, or even a weekly basis, the staff and volunteers at CFAMN do and continue to make this organization thrive. Like most organizations, we had to unexpectedly shift the way we operate in March 2020. While we are still working on the best way to deliver content and meaningful connections, we have made some serious progress in these endeavors.
Recently, Intellisight was switched to an entirely virtual conference, on top of transitioning to a new platform vendor. At the beginning of the shutdown, the annual Putting Investors First event was both moved to a virtual format and the discussion was changed to reflect what was happening in the world. We also had near-record attendance at the socially distanced golf outing. The staff worked hard to deliver these events, and many others, while battling the Zoom fatigue that we all have come to know so well.
I’d like to thank several individuals and groups, beginning with the staff:
Mark Salter – joined as our Executive Director in 2012 and has led the CFAMN team successfully since. We are lucky to have him guiding the organization while remaining calm and positive despite the challenges faced.
Diane Senjem – As she entered her ninth month of pregnancy, she was still hard at work preparing events and leading volunteer committees. Her ability to work ahead, gave everyone some breathing room when she went on maternity leave in April. She is now back, and we are grateful for that!
Megan Millett – The newest member of the team and likely the least well known as a result. Megan joined in a part-time capacity in 2019 and then stepped up in a big way (Intellisight 2020) as she moved to full-time earlier this year. She has delivered under pressure with grace and humor despite being the new kid on the block.
Additionally, I’d like to thank all of our volunteers. Whether you have helped at an event, contributed to the blog, served on a committee, or on the board, your contributions are critical to our success. While I won’t name all those that have contributed meaningfully, I did want to thank two individuals.
Sam Somuri, CFA, CFP, CAIA and Mark Traster, CFA both completed their terms as board members after serving eight and seven years, respectively. Thinking back to where our organization was at the time when they joined, we have made incredible strides and they were significant contributors to that success. Thank you both – although neither of you are off the hook yet entirely J
Another component of our success is the support that we receive from our sponsors. While this may not have been the year that any of us were expecting, we appreciate that you have stuck it out with us while we are doing our best to continue to deliver a positive experience for our members. Without you, we would have to cut back on many of the things that our members enjoy most. Thank you for your partnership.
To conclude, I want to thank our members. This has been a wild year and we appreciate the incredible patience that we have received from you all. We know that in many ways we weren’t able to deliver some of what you expected from us this year. We continue to try out ways to provide engaging content and offer opportunities to develop meaningful peer relationships. The latter has been particularly tricky thus far. However, on a positive note there has been a significant acceleration of our plans to offer more digital content (a special thanks to CFA Institute for providing us access to Zoom). This was the swift kick that we needed to get over a few hurdles. Thank you for bearing with us while we continue to refine this. Check out our archived webinars here.
In a year when everyday things were so hard, it feels good to think back on the positive aspects and to fully appreciate them. Be sure to check out our 2019 Annual Report to catch up on other activities. In a world of polarization and division, inclusiveness and gratitude are in short supply. Please join me in spreading the latter by thanking someone mentioned above.
Again, thank you all. We are looking forward to an even better year ahead.
Sincerely,
Chris May, CFA
Society President
PS – If you have not yet completed our short membership survey, please do. I get it, no one loves filling out surveys, but it helps inform our plans and we would greatly appreciate your feedback. Thanks!
Musings from My Laundry Room
By Susanna Gibbons, CFA
Managing Director, Carlson Funds Enterprise
Carlson School of Management, University of Minnesota
Finishing my 15th week of WFH (Work From Home), I feel an urge to reach beyond the bounds of my new home office, just to see if anyone is still out there. Friday afternoon in the laundry room is a uniquely great setting for thinking about the world in a relatively unbound way. I am not exactly unplugged, but I am somewhat insulated from the chattering of the Street, so I thought I might start chattering a bit myself.
Like many of you, I have been amazed at the resurgence of equities since March (past few days notwithstanding). The market is placing a significantly higher probability on a V-shaped recovery than I am, so I have been trying to unpack the data here and there, since I don’t really want to be right. And the retail sales number from June 16 is the perfect place to start, since it was a surprisingly strong number – up an eye-catching 17.7% compared to expectations of +8.4%. Yes, I am aware that if you are down 14.7% and then up 17.7% you are right back where you started. The number was still a really positive sign and clearly leaned in favor of a solid v-shaped recovery.
I am also aware that Autos were by far the largest part of that number, followed by Furniture. I know we don’t go out buying cars every day, or furniture, and that it was heavily promotional, but it was still a positive sign. Americans have not forgotten how to spend money! The V-shaped recovery might be within our grasp.
There is also one little tiny category that was not only up strongly in percentage terms, but actually exceeded spending from 2019: Sporting Goods, Hobby, Book, and Music Stores. This category of retail spending sounds like a boomer throwback category if there ever was one….I mean, music stores? It’s one of the few categories of retail sales that has seen virtually no growth since 2008. And yet there it was, popping up out of nowhere. Naturally, I had to talk to someone younger to figure this one out. Was everyone really buying CDs from newly re-opened record stores?
Nope. According to my sources, people-younger-than-I have realized that going to a gym for a group fitness class might not be fun for a long time. In what I am labeling the Peloton Effect, it seems they have swapped their gym memberships for Pelotons, NordicTracks, Mirrors, Bowflexes, bikes, and in what surely is an act of sheer desperation, golf clubs. I asked my source, who was recently furloughed, how it made any sense at all to purchase a $2,000 piece of equipment at this time. Apparently, this particular household had been spending $250 a month on yoga memberships, $150 a month on studio cycling, and another $50 on an ordinary gym. Those have all been canceled, and they are now left with $70 a month to finance the Peloton for the next two-plus years, and $30 a month to join their online classes –zoom-for-bikes. (They also had to get a new couch to make room for the bike, so maybe that helps explain the furniture sales numbers.) Significant monthly savings.
The important point here is that large numbers of people are shifting their behavior in dramatic ways. They are swapping monthly studio payments (bad news for commercial real estate owners) in favor of equipment ownership. To me, that minimizes to some degree the bounce we saw in retail sales. Shoppers are back, but their behavior has changed, and it would be a mistake to extrapolate sales growth right now because we are caught in the middle of this seismic shift. We are seeing this shift in other ways, too. Nobody needs nice pants anymore, we only need one nice jacket, we don’t go to the dry cleaners, we don’t get our hair cut. We do need a new router or laptop. Retail businesses may be re-opening, but many of us are re-thinking how we engage with the world, and how we allocate our resources. There is some up-front capital cost to the shift, but that short-term pop might be the front end of a long-term down-shift in overall spending.
Or not. The reason my laundry room looks so nice right now is because I could finally renovate after getting rid of the 25-year-old Heavy Bag that was part of our mid-90’s boxing-for-fitness routine. It’s been on the floor for most of its existence. I’m not going to get sucked down that hole again. Plus, it’s 12 weeks right now to get a Peloton.
A Letter from Our President
The eve of a New Year is a great time to spend with family and reflect. It is also that time of year when my wife asks about my 2020 resolutions. But, instead of making a list of future broken promises, I would rather reflect on the year gone by. When it comes to CFA Society Minnesota, I often reflect on the same question: what is the value of CFAMN to me?
If you don’t know me, you may picture the CFA Society President as a very buttoned-up, 100% professional Kool-Aid drinker who is completely sold on everything we do related to CFAMN. If you do know me, you probably laughed at that image, and instead know that I am a fellow, engaged Society member just like each of you, who has happened to get more and more involved with the organization over the years. So even as president, I need to be able to answer that CFAMN is and continues to be valuable to me (of course, if I find the answer is less-than-ideal, I am in a particularly good position to help do something about it).
There are three main things that I get out of my membership.
- Education – I had no accounting classes when I sat for the CFA exams. It was in large part CFAMN prep programs that got me through the exams. Since that time, I have attended many events and learned a ton. This year alone I improved my personal organizational habits (Managing Me event) and got a jump start on my goal to learn programming (Python event). However, education is not just the education from any single event, but also what I have learned from the people I have met since I attended my first CFAMN social at Lyon’s Pub more than ten years ago.
- Volunteering/Board Service – I have greatly enjoyed the time that I have spent as a volunteer for the Society and have found that the value I get from CFAMN has grown exponentially as I have become more involved. Whether it was helping set up at an Annual Dinner, developing the mentorship program, or helping to set the strategy for the organization, I love doing my small part to help advance our mission and get the opportunity to work with so many others who are doing the same thing.
- Flexibility to shape the organization as a member – Volunteers do a tremendous amount to shape the society into an organization to which we can be proud to belong; Society members have the ability to have significant influence well. Members often introduce us to interesting speakers and are active in providing thoughts about what is or is not beneficial to them. Without that valuable feedback, volunteers could not be nearly as responsive or effective in shaping the organization into a truly meaningful society.
However, the true value of CFAMN membership for me, and many others, is often less tangible – relationships. Not networking. Real relationship-building and CFAMN provides a forum for this to occur. The Society is comprised of a wide range of people, but we are connected in a way that many groups are not. Where else can you interact with a group of people that really get you in a way that most friends or neighbors cannot?
There is something that unites us, as a group of people that have faced the same challenges in preparing for and taking the exams and ultimately earning our CFA Charter designations. I imagine it is much the same way that a group of actuaries would feel, if actuaries had feelings. Kidding. I know an actuary and he is awesome. CFAMN acts as the clearinghouse, not for transactions, but for discussions – a place where relationships can begin.
In the future I’d like to share more about how others have benefited from the people they have met through CFAMN. For today, I’ll share a story from a friend.
“I met a person 4 years ago at a CFAMN event. Afterward, I sent them a short note and asked them a somewhat inconsequential question. They responded with a two-page email going into great detail to answer my question… Not only was I touched by the amount of care the person took to be helpful, I still have that e-mail, I still reference it. This person has had a material impact on my life because of one small thing they did.” Regarding the value of his membership he continued, “This may not do anything for most people, but I’m sure for most involved members, they have their own version of this story.”
If you have a story like this, or anything else that you would like to share about your experience as a society member, please let us know. Also, I will reiterate the call out from my last letter – please reach out if you are interested in meeting with me, or if you prefer, introduce yourself at an event. As an introvert, I am not always the best at going out of my way to meet new folks, but I would really like to meet you. Please feel free to say hello. Or maybe meeting new people should be my 2020 resolution?
All the best to you and Happy New Year!
Chris May, CFA
President, CFA Society Minnesota
University of Wisconsin-Eau Claire Financial Management Association in Minneapolis
The University of Wisconsin-Eau Claire Financial Management Association traveled to Minneapolis to visit U.S. Bank, Wells Fargo, UBS and Target on Friday, November 15. CFA Society Minnesota worked with Wells Fargo and U.S. Bank to put together an outstanding day filled with real-life experiences. We had an incredible time and look forward to this event every year. Special thank you to both of these organizations for hosting our group and for teaching us about the different career paths in the finance industry.
Wells Fargo
Wells Fargo broke the ice with a heated game of financial family feud between two groups of Eau Claire students. The family feud was geared toward topics in wealth management. After playing financial family feud, there was a panel discussion with Kashi Yoshikawa, CFA, Kevin Ario, CFA, and Tasha Alexander. Joshua Witherspoon led the panel discussion and the students were able to ask any questions they would like. The finance leaders touched on client relationships, client retention, industry certifications, specialized services, D.I.S.C. personality model, and team building. They also explained their career paths and the different roles in the industry of wealth management. Special thank you to Joshua Witherspoon, Brittany Jacks & Ploy Pattinson for organizing this visit.
Speakers:
Kevin Ario, CFA: National Investment Management and Implementation Director
Kashi Yoshikawa, CFA: Regional Investment Manager
Tasha Alexander: Senior Private Banker
U.S. Bank
U.S. Bank hosted our group in a large training room. We first heard from an HR representative, Cindy Kuehl, who went over an organization overview of the company. We also heard from six other finance employees:
Aimee Brantseg: Private Wealth Advisor
Lisa Erickson, CFA: Senior Vice President and Head, Traditional Investments Group
Preeti Higgins: Private Banker
Leisl Kistow, CFIRS: Head of Wealth Management Trust Advisory Center & SVP
Kate Lyons, CFA, CAIA: Vice President, Senior Portfolio Manager
Leslie Penrith: Vice President, Marketing
Leela Rao: Vice President, Director of Strategic Initiatives
They discussed each of their positions, what a typical day looks like for them and the challenges they face within their roles followed by a Q&A session. This was a very beneficial presentation and provided insight into the industry of wealth management. It was great to hear from all the professionals and to learn more about the different finance positions in their organization. Special thank you to Lisa Erickson and Kate Lyons for putting this visit together for us.