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: CFAMN
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!
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
A Letter from Our President
By: Chris May, CFA, President, CFA Society Minnesota
“What are you going to do as the president for CFA Society Minnesota?” – This is the question that I have received most often over the past several months as I have prepared to take on this two-year responsibility. In a way this question makes complete sense. On the other hand, it demonstrates a misunderstanding of the situation. CFA Society Minnesota has already had the benefit of having more than 60 individuals volunteer to serve as board members over the past 10 years. Additionally, for every individual board member, there are many more folks who have volunteered over the years in a multitude of other capacities. And that is just in the past ten years. Imagine all the countless people who have been involved since the society was founded in 1952. It is a result of the cumulative efforts of all of these individuals over the years that has led us to where we are today. So many incredible things have been accomplished (Intellisight Conference – eight years, Compensation Survey – six years, Mentoring Program – five years), mistakes were made, friendships were created, and fun was had.
In January 2019 the CFAMN Board of Directors ratified an updated strategic plan. This built on the plan that preceded it and was the result of work done by the entire board, support from CFA Institute (our global parent organization), and feedback from our members. I offer all this up to put today into context. When I am asked about my term as president, it is all of this effort that I think about. In short, the work has been done. The plan has been drafted. Things are underway. I feel a responsibility to see that plan executed. Our plan is simple to understand but complex to execute. We are going to focus on three things:
1) Delivering Member Value
2) Enhancing the Brand of CFAMN and the CFA Charter
3) Building and Maintaining Operational Infrastructure
There are many components to each objective that create the complexity of execution. However, it is our goal that all of our actions will support one or more of the strategic objectives.
There is another item that is important to the board that is not captured in the strategic objectives. In our Mission Statement the word ‘fellowship’ is included. Thus, we believe that it is important that CFAMN provides opportunities for our members to connect and develop relationships.
With that in mind, I recognize that I do not have a relationship with the vast majority of our members. I’d like to change that. For those still reading, please consider this your invitation to take me up on this.
I value people that are willing to challenge the status quo and try new approaches. One such person is Sam Hinkie, former GM of the Philadelphia 76ers. So my ask is this – read his resignation letter and email me your thoughts.
On the other hand, if you want to drop me a note about anything else on your mind, please feel free to do that as well. I can be reached at lyndemay6@gmail.com.
Member feedback is critical to our future success. We begin board meetings with comments from members and we would love to share your feedback. The Berkshire Hathaway letters routinely include a shameless plug for Berkshire products. In that light, I will make a similar ask. If you are interested in getting involved in the society please check out the Volunteer Board or reach out to Diane Senjem at support@cfamn.org.
Thank you to each of you. We have much to do, but without each of your, our society would not be as strong as it is today.
All the best,
Chris May, CFA
President, CFA Society Minnesota
Event Recap (part 3): Diversity & Inclusion: Bridging the Gap in the Investment Industry
By: Hilary Wiek, CFA, CAIA, Society Volunteer
In the first two segments of my reporting on the Diversity and Inclusion event of June 5, I discussed the misconceptions about the event and some of the high-level topics discussed by our esteemed speakers. In this final installment, I will outline research and resources on the topic that may 1) help convince some people that there is supportive evidence to justify diversify and inclusion efforts in the workplace and 2) provide guidance on solving some of the problems outlined previously. As a recap of the prior blog post, one broad topic area was having productive conversations about diversity and inclusion, a second was hiring a diverse workforce, and a third was retaining a diverse workforce.
Speakers at the CFA Minnesota event stated that bringing evidence-based findings to discussions about diversity and inclusion has really helped to advance the topic, in some cases converting individuals who were skeptical there even is a problem. A number of studies have found what many who have given this topic any thought would have suspected from anecdotal evidence, but having research to back up the suspicions has been powerful.
For data and evidence, the University of Chicago, in partnership with private sector support, has dedicated resources to study this topic under the moniker The Science of Diversity and Inclusion (SODI). Their website states that the initiative “brings together leading researchers and organizations to identify, accelerate, and apply new evidence-based approaches to advance diversity, inclusivity, and belonging in our places of work and learning.” Profiles of the affiliated researchers, their areas of study, and a summary of their findings can be found here.
One of the more interesting studies mentioned at the CFA event was from a team out of Columbia University (Sheen S. Levine, Evan P. Apfelbaum, Mark Bernard, Valerie L. Bartelt, Edward J. Zajac, and David Stark) about homogenous and heterogenous investment teams (called “experimental markets” in the study). A link to the work, entitled Ethnic Diversity Deflates Price Bubbles,” can be found here. From the abstract (the italics are mine at the end):
“Markets are central to modern society, so their failures can be devastating. Here, we examine a prominent failure: price bubbles. Bubbles emerge when traders err collectively in pricing, causing misfit between market prices and the true values of assets. The causes of such collective errors remain elusive. We propose that bubbles are affected by ethnic homogeneity in the market and can be thwarted by diversity. In homogenous markets, traders place undue confidence in the decisions of others. Less likely to scrutinize others’ decisions, traders are more likely to accept prices that deviate from true values. To test this, we constructed experimental markets in Southeast Asia and North America, where participants traded stocks to earn money. We randomly assigned participants to ethnically homogeneous or diverse markets. We find a marked difference: Across markets and locations, market prices fit true values 58% better in diverse markets. The effect is similar across sites, despite sizeable differences in culture and ethnic composition. Specifically, in homogenous markets, overpricing is higher as traders are more likely to accept speculative prices. Their pricing errors are more correlated than in diverse markets. In addition, when bubbles burst, homogenous markets crash more severely. The findings suggest that price bubbles arise not only from individual errors or financial conditions, but also from the social context of decision making. The evidence may inform public discussion on ethnic diversity: it may be beneficial not only for providing variety in perspectives and skills, but also because diversity facilitates friction that enhances deliberation and upends conformity.”
The CFA Institute has been spending time on diversity and inclusion as well, conducting surveys and hosting workshops with industry participants to better assess the state of diversity and inclusion in the industry, provide public data from these efforts, and come up with ideas on how to address the problems. Here is a link to the CFA Institute’s published work derived from its efforts, “Driving Change: Diversity & Inclusion in Investment Management,” which was distributed at the CFAMN event.
Once evidence has been supplied and hopefully accepted, the next question is what can be done about it? One of the resources mentioned several times at the CFA event was the book What Works, by Iris Bohnet, who is affiliated with the SODI efforts outlined above. The SODI site summarizes the book as a resource “to hand decision-makers the tools they need to move the needle in classrooms and boardrooms, in hiring and promotion, benefiting businesses, governments, and the lives of millions.” A short video summarizes Bohnet’s work here. She also authored the following articles:
- How to take the Bias Out of Interviews, Harvard Business Review
- Designing a Bias-Free Organization, Harvard Business Review
The pipeline of diverse candidates was another of the significant issues identified at the CFAMN event – even if a firm wants to hire from a diverse talent pool, there is often a dearth of qualified candidates fitting diverse profiles. Several organizations were mentioned at the event that are attempting to reach women and minorities earlier in their education to let them know a) that the investment field could be an attractive career option and b) what they need to do in order to prepare oneself for a career in the field (including education and internships).
One organization called out at the event was Girls Who Invest (GWI), which got its start in 2015. Each summer since 2016, GWI has held a four-week summer educational program for college women, after which each participant works in a six-week paid internship. The stated goal of the organization is to get 30% of the world’s investable capital managed by women by 2030. A New York Times article linked on the website states that only 7% of investment managers in the $15 trillion mutual fund industry are women. If you are looking for a way to help solve the diversity problem in our industry, GWI seeks volunteers to mentor students, speak at events, and teach courses during its college summer intensive learning program. They also seek financial partners in the investment management industry to provide mentors and host interns.
Another organization is Invest In Girls. Per the website: “Invest In Girls works with schools, community organizations, corporations and foundations to provide financial literacy programming to young girls.” This group’s programs seek to educate 10th, 11th, and 12th grade girls in workshops before they get to college, allowing them to learn about personal finance and careers in finance while there is still time to formulate a higher education plan. This organization is seeking volunteers to make short videos for its Role Model Exchange outlined here.
In 2013, financial services firms in Chicago came together with The Chicago Community Trust to form the Financial Services Pipeline Initiative. The key goals of this group are to 1) increase the representation of Latinos and African-Americans, at all levels, within the Chicago area financial services industry and 2) improve the overall cultural competency within the Chicago area financial services industry. While volunteer activities may be out of reach for the CFAMN membership, the website has interesting data and may provide ideas for how to bring some of this group’s activities back to our region.
Other resources/research not discussed at the event, but suggested by the speakers:
- Scott Page
- Ashley Goodall
- Nine Lies About Work (book abstract here)
In closing, did you know this event was planned and organized by a CFAMN volunteer? Thanks again to Amy Jensen, CFA, Investment Director at Northwest Area Foundation who put together this enriching program. Do you have a great idea to share or a project you feel passionate about? E-mail society staff and they’ll help you make it happen!