tag:srvo.org,2013:/posts Sloane Ortel 2019-10-01T00:07:21Z Sloane Ortel tag:srvo.org,2013:Post/1461414 2019-09-17T16:00:00Z 2019-10-01T00:07:21Z Free Money

I've been co-hosting the Free Money podcast for the last few months with my friend Ashby Monk. 

We do our best to deliver the Brooklyn/Bay Area consensus about institutional investing that you desperately crave in each episode.

New episodes are posted almost every week on https://sloane.substack.com/

I hope you like listening as much as we enjoy making them. 

Which is a lot.... 

tag:srvo.org,2013:Post/1361046 2019-01-07T16:44:13Z 2019-01-07T16:44:13Z Clarissa Bushman (10/3/1956 - 12/15/2018)

My mother passed away on December 15th due to complications after surgery. 

It was a shock, even in her seventh year of cohabitation with an aggressive and poorly differentiated thyroid cancer. Mother, teacher, dancer, trader, daughter, human; she was one of the great ones. 

I can't help but share this excerpt from her 40th Reunion Report which her brother Brick read at her memorial. 

I would like to change the language we use to discuss cancer.  Over and over you hear, “So-and-so lost a valiant battle with cancer after fifteen courageous years of fighting.”  This is just not fair.  You mean, not only do I have to die, but I also have to FAIL??  Sounds like piling on to me.  I would prefer something like:  Clarissa Bushman passed away from thyroid cancer on January 1st.  She had six wonderful and fulfilling years during which she was able to spend time doing the things she loved most--Children and Family, Theatre and Dance.  She was grateful to have the chance to leave the world in slow motion and was certain that she would have the chance to watch over the lives of those she has loved.”  

Get it?  I haven’t lost.  I am not fighting.  I am enjoying the time and the life I have left.  Truly--who really knows what will happen in the afterlife?  It doesn’t really matter because if the curtains close forever when the lights go out, you won’t be there to worry about it.  The only real drag about death is the dying part.  

I miss her like the dickens. 

I thought I'd upload a few of my favorite recent pictures of her here, and have pasted my remarks from her memorial last Saturday below. 

If you'd like to do something in her memory, call your mom! 

We're also raising funds to support the rare cancer research which improved and greatly extended her life through Cycle for Survival. You can support (or join) our team by clicking here

My Mom thought forty, maybe fifty people would show up at her memorial service. (Around 500 people showed up)

There are probably forty people here who are related to her by blood. So I guess we showed her. 

I know she would be surprised, touched, and perhaps a little triumphant to see all of you here today. I want to believe she’s sipping up a soup of adoration and singing along with the songs from just behind the back row. 

I do believe she heard us say we love her, and I mean that barbarically. We love her like taking off tight shoes, or like fresh sheets love shaved legs after long, hot showers. 

At one point I thought “we” was a family thing. But we who loved her are legion, and labels hardly matter. Hundreds of remembrances we've received share the sense she pulled some kind of light around with her. It seemed to strike everyone who saw it. 

That was her aura: ambrosia with dash of anarchy. 

But what’s tricky is that she always saw herself as a burden. Poorly differentiated thyroid cancer was not her primary affliction: She was a bad mom, a black sheep, and a big phony in her mind’s eye. 

Never good or smart enough, she struggled to see the love which surrounded her even as she reciprocated it. So in the early days of her illness, the big question was whether she’d take any treatment at all. She felt fine, and said so often! 

Would she see it as worthwhile to move into the parallel, volatile universe of the chronically ill for a chance at a few more years of misery? She had been an empty nester for years already.

Did we still need her? Would we miss her? 

I can’t remember how many times she asked if I would speak at her memorial service convinced I would say no. The assumption, I guess, was that my love for her would be used up by now. 

How could that be? 

There was so much more to tell her. We’d only just gotten to know each other properly, and when you lose a mother you can really talk to, the practical upshot is that you have secrets again. 

No-one can hear you in quite the same way, remembering and reminding as mothers do. No-one says “moisturize your neck!” Or can internalize your fears and somehow make them smaller. 

I turned thirty this year, which is about the average life expectancy for a transgender woman in the Americas. I expect to beat the average, but the statistic has a way of looming in the background. 

She heard me scared, thought, and set herself to learning about what I could expect in my life. She sent me articles and took me to shows: Torch Song, Kinky Boots, Angels in America. We saw the first trans actress originate a role on Broadway. 

And in September she bought me a book: To Survive on this Shore

There's an older trans woman on the cover standing in the middle of a Chicago winter looking warm. And that's the point of the book: pictures of trans elders and their stories. On the inside cover, she wrote “this is to remind you that there is life after thirty for you. I am madly in love with you. MOM.”


I know she had regrets because I found a list of them. She hadn't taken full advantage of Harvard, or structured her time dancing in NYC as she would have wished. Once, a student in a ballet class of hers offered to introduce her to someone who could have changed her life. Saying no sometimes still moved her to tears. 

Fourth and finally are the years she spent “in a bottle”, which meant slept-in Sundays and delegated diaper changes. The list ended “of greatest sorrow is the years and years I lost of the lives of my precious children.”

We could never lose her all the way. She was always a standout, beautifully different in that she pumped her own gas, which is not a metaphor. 

One of her fondest memories from her time upstate - my childhood - was speeding into our small town gas station in her little red jeep with a temporary tattoo of a tiger on her arm. She hopped out and pumped her own gas. The attendant was shocked: women just did not do that. 

Clarissa Bushman did. 

Sticking out was just her thing: she was a singing, dancing economist. Intuitive with bond math and Balanchine, she said early and often that her innate strangeness was a strength. And that’s fortunate, because she only weirdened with time. 

One specific instruction stands out: whenever the coughing fits which came standard with her laryngectomy set in, we were not to acknowledge them. Eventually we barely noticed: they were medically harmless. But it sure looked and sounded like she was choking. 

So, imagine the family out to dinner. We'd take seats and eat in the same semi-respectable way we do everything. Then it would start, and we'd hardly move an eyebrow. Her hacks and hems were an order of magnitude louder than the stage whisper she spoke in, and could go on for two or three minutes. 

The purest proof that she was magic was that this became fun. And mom, if you’re really right there behind the back row, I hope you finally know. I love you madly, and always will. 

Thank you all so much for coming. It really means the world. 

tag:srvo.org,2013:Post/1335608 2018-10-24T17:51:12Z 2018-10-24T17:57:22Z Stacey Abrams
The United States of America began as a radical experiment in democracy. 

How's that going?

Georgia's gubernatorial election offers a high definition view of the way things work today. Democrat Stacey Abrams and Republican Brian Kemp are polling inside the margin of error among likely voters. 

Does that say more about the people's split intention or the state's long history of vote-suppressing innovations?

It's worth remembering that the home of Martin Luther King also incubated the conditions he fought against. Too much is still the same today. Morehouse College's Fredrick Knight points out that black voter suppression -- sadly "a southern tradition" -- still flourishes. With regard to this particular election, he recently wrote that "from Georgia’s voter registration scandal to gerrymandered districts that dilute minority voting power, millions may be shut out of November’s midterms."

Georgia has long been a national laboratory for disenfranchisement. Gerrymandering - the practice of redrawing districts to dilute the voices of constituents - made it to the supreme court because of concerning actions taken by the state's legislature. The Atlanta Journal-Constitution has the story
[T]he state Legislature altered the boundaries of House districts in Gwinnett and Henry counties, according to a recent federal court ruling. The districts were redrawn by the Republican-controlled Legislature to exclude neighborhoods that usually voted for Democrats, which helped ensure the re-election of two Republicans: state Rep. Joyce Chandler and former state Rep. Brian Strickland, who is now a state senator
The state's election infrastructure is also subject to unintentional errors. 

It relies on unauditable machines which are at risk of being hacked. A recent ruling concluded that the state's election officials - led by Republican candidate Brian Kemp - have "buried their heads in the sand" with respect to these crucial risks. 

And it seems, to the basic needs of a free and fair election. 

For a glimpse of the way things are on the ground, consider this New York Times headline: Georgia Voting Begins Amid Accusations of Voter SuppressionHere's the lede:

MARIETTA, Ga. — Wim Laven arrived to his polling location in Atlanta’s northern suburbs this week unsure what to make of recent allegations of voter difficulties at the ballot box. Then he waited two hours in the Georgia sun; saw one person in the line treated for heat exhaustion; and watched a second collapse, receive help from paramedics, yet refuse to be taken to the hospital — so he could remain in line and cast his ballot.

Mr. Laven is now a believer.

I suggest you join Mr. Laven in believing that the Georgia Peach is at risk of rotting.  

The good news is that Stacey Abrams is magnificent. Electric enough to remind a cynic we're all made up of star stuff. Human enough to lead with empathy. 

She'll be Georgia's next governor if all the votes are counted on November 6th. I hope that happens, and not only because the candidate gives a great side hug (see below).

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Sloane Ortel
tag:srvo.org,2013:Post/1328892 2018-10-01T13:00:00Z 2018-10-04T14:52:26Z Hype is an Asset Class
The big question with cryptocurrencies is straightforward: what are you buying, exactly?

The most widely discussed approach to an answer is an ersatz equation of exchange, where the total value of all money in circulation is divided by the total number of bitcoins. This produces some funny results. My favorite was published at the height of the bubble on 25 December 2017. The author wrote: "I value 1 Bitcoin at approximately $4 million per coin. I believe this estimate to be conservative."

There are more sophisticated approaches, but I'm not sure they reach a more useful conclusion.

My preference is to value these assets in a way that's similar to accounting goodwill, which somewhat gives away that I'm not so inclined to put them in my own portfolio. 

With that said, I've learned a lot by watching the assets and their context over the last few years. I had the opportunity to present my collected thoughts in the closing keynote at CFA Society New York's 2nd Annual Blockchain Conference.

It was so much fun.

I pasted my favorite chart from the deck below, which compares the total dollar value traded on various exchanges over 30 day periods. The ones with red arrows are trading crypto, the rest are trading equities. The full video is up on CFA NY's website, and you can watch it by clicking here.

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tag:srvo.org,2013:Post/1320456 2018-09-10T20:55:29Z 2018-09-11T17:54:05Z Inside Hammond's Business Atlas of Economic Geography (1919)
It's amazing what you can learn from an out of date map.

I've rediscovered the Brooklyn Public Library, and have been exploring their stacks online. The most recent interesting acquaintance is a nearly 100 year old atlas. It's in the public domain (and you can flip through it here) but the pages have a patina I much prefer. 

Colonial possessions are the obvious difference between then and today, but it's also just amazing how little the mapmakers knew about the world they drew so precisely.
Africa has 1/3 of the world's minerals. You may have heard of a "resource curse" many of its countries have paradoxically experienced. But not much of it was on the map 100 years ago. 

The Atlas of Economic Complexity is lovely if you'd like a look at how things are now, but there's also subtle stuff inside this book that's really interesting. For instance, take a good look at this "Economic Map of North America" and get ready to compare it with the following map of Mexico. 
They're right next to each other.
North America has industrial, productive, and non-productive areas. Mexico has resources to extract. It's hard to imagine this having no effect on the reader's perception of our southern neighbor.

The world was upside down just then. World War 1 ended in November of 1918, and the Mexican Civil War was raging until 1920. So I'm hopeful this is pacifist commentary on the cost of war, but it doesn't seem likely. 

Anyway, last but not least, here's the screwiest thing I noticed: a "racial map" of Europe. 
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Sloane Ortel
tag:srvo.org,2013:Post/1319151 2018-09-06T21:11:23Z 2018-09-06T21:37:08Z Head Over Heels Into Controversy
The new musicial Head Over Heels drew some pretty strong criticism from New York Times theater critic Ben Brantley. His criticism was met with criticism, and his review has since been significantly edited. The paper issued a statement to accompany the revisions. 

Why the Sturm und Drang? A few of the sentences were a less than perfect treatment of the play's queer themes. Which are many. And Mr. Brantley does not appear to be a fan of camp in the first place. To my reading, most of the now-missing sentences objected to the play's many puns about transgender and non-binary identity as somewhat heavy handed. To me and many others  with transgender/queer identities, this is both fine and good fun. 

A long way of saying: Brantley's critique has a strain of "kids get off my lawn" to my ear. Anyway, My Mom and I went last night because it sounded very awesome to us. 

Here's the description:

HEAD OVER HEELS is the bold new musical comedy from the visionaries that rocked Broadway with Hedwig and the Angry Inch, Avenue Q and Spring Awakening. This laugh-out-loud love story is set to the music of the iconic 1980's all-female rock band The Go-Go's, including the hit songs, “We Got the Beat,” “Our Lips Are Sealed,” “Vacation,” Belinda Carlisle's “Heaven is a Place on Earth” and “Mad About You.”

I mean, come on. 

My mom — who had her hip replaced six months ago — and I were dancing in the aisles. But it's not for everyone. She put it well: "It's the gayest show I've ever seen on broadway." This is quite a statement. When she's feeling well, mom will see six shows in a week. That's a decent sample, and allows for a simple theory about the controversy: maybe it's a little too gay for Broadway, at least as policed by Mr. Brantley. 

To me and perhaps to others, this is a fundamental achievement. Almost like discovering a new element of the periodic table. The play's time on Broadway may have all the stability of unobtanium, or whatever else our best and brightest have cooked up in laboratory conditions, but it will have a certain gravity to many of us. Not least because Peppermint's broadway debut is the first time a trans woman has originated a role on Broadway.

So you should go while it's still up. Last night's show was not well enough attended. And we had a lot of fun: 

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Sloane Ortel
tag:srvo.org,2013:Post/1317747 2018-09-03T02:49:28Z 2018-09-04T02:11:57Z Charting Language Trends in Public Economics

The way we talk affects the way we think. 

Henrik Kleven put together some amazing slides about the language used in National Bureau of Economic Research papers since 1975. The whole deck is worthwhile, but here are few of my favorite slides. 

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tag:srvo.org,2013:Post/1315743 2018-08-27T22:12:26Z 2018-09-20T21:15:28Z Which Fictional Character Would Make The Best Portfolio Manager?

To me, the answer is obviously Bugs Bunny. 

I have never once seen that rabbit lose his cool, no matter the situation. His incentives - carrots - are transparent and reasonable. He wins all the time, and has 72 years of experience. What more could you want? 

Quite a spectrum, it turns out. 

I've now asked this question about forty times to groups at CFA Societies and big financial firms, and there are some really interesting patterns in the way people respond. 

Here's a chart of responses from the training program at a large global asset manager this past July: 

Whoever said Bobby Axelrod has me terrified. I'm more interested in how consistently the group picked superheroes though. 

Here's another window into the data: 
Female-coded characters barely featured. Roughly four times more essays put forward characters from the Marvel Universe. 

This response comes from a group of millennials that was diverse on any metric one might care to measure, and it shows one of the subtle ways our unconscious biases play into our professional activities. 

I would much rather have Hermione Granger as a portfolio manager than Iron Man, Spider Man, Professor X, Captain America, and the Hulk. Imagine what "administration costs" would come to after the five level a city block yet again. Expenses always make it to the end investor somehow. 

DC's Batman is often the most common response, and I hope it's because he's the first person that comes to mind for some people. I get that he's developed his capabilities through hard work and innovation, but can't see this as a healthy answer. Batman's job is to put violence on people, and Bruce Wayne is a brooding billionare that's out of touch with his emotions and his community. We're looking for the best portfolio manager, not the fictional character who most reminds us of one. 

Batman won again with a more experienced group at the CFA Society of New York recently. Here's the data from that session:
I find these answers much more satisfying despite the continued popularity of a certain caped crusader. Here's why: 

  • Only 41% could be described as a "superhero" at all. That compares with 50% from just Marvel and DC in the earlier sample. 
  • Feminine-coded characters got 20% of the mentions, up from under 9% above.
  • The characters put forward from the Game of Thrones universe (Lyanna Mormont, Samwell Tarly) were not best known for their skill at doing violence. 
  • Chihiro from Spirited Away is perfect. 

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tag:srvo.org,2013:Post/1314266 2018-08-22T17:29:59Z 2018-08-24T10:20:44Z Free Trading

JP Morgan is offering free trading to retail clients.

It's big news, and yet they're far from the first. I revisited a piece that I wrote a few years ago about it and I wouldn't change a word today. 

So here it is. Enjoy!

Free Investing is the New Free Checking

First published by CFA Institute 1 December 2014

Are you paying for checking? You totally don’t need to. Most Americans, at least, have access to a free checking account that offers many of the features we closely associate with a traditional investment account: secure storage of and access to money.

It’s not farfetched to ask the same question about an investment account and provide the same answer. Particularly for investors who own index funds (or “closet index” funds with low active shares), it’s becoming increasingly apparent that there is no need to pay significant fees for a diversified portfolio. Vanguard has long offered target date funds that combine their low-cost index offerings, but Charles Schwab’s “Intelligent” portfolios, which do not have associated fees, are a harbinger of what is to come.

I’ve already said that in the fight against algorithmic investment services, financial advisers “had better compete on something other than cost, accuracy, and speed” but haven’t yet taken that analysis further. My colleague Lauren Foster has noted that robo-advisers and financial advisers had better start getting along, but I will state that more strongly.

Charging for Non-Differentiated Investment Products Is About to Get Very Hard.

If you are selling the same thing as everyone else, and that thing is infinitely scalable at minuscule marginal cost — like many equity index funds — there is little reason for someone to pay you for it. A preponderance of services have evolved to combine various low-cost investments into “customized” investment portfolios, but those products have essentially the same characteristics. The algorithms that combine the products are as scalable as the products themselves.

This leads to a competitive dynamic that is easy to name but difficult to survive: a race to the bottom. Vanguard’s ownership framework, which is not designed to earn a profit, seems to be structured in anticipation of this competitive dynamic.

There is not going to be only one firm providing low-cost index funds, but it is difficult to imagine a true need for the hundreds of them that exist now. In 2012, Business Insider did a survey of S&P 500 index funds and found that Vanguard effectively dominated its competition. Businesses attempting to extract excess fee income from either these non-differentiated funds or the construction of a portfolio comprised of them will have a difficult time justifying their existence.

So Are Professional Investment Managers Going Away?

No way. Fortunately for investment professionals, we are not selling buggy whips. As long as there are organizations and individuals with money, there will be a market for figuring out what to do with it. That market is simply evolving, which is why Lauren’s framing of the next step for advisers as “getting on the right side” of the trend is so perceptive.

I have personally never been more bullish on the future of the investment profession, but that doesn’t mean it’s going to look the same. It’s unlikely that there will be many highly paid employees doing work that could easily be performed by algorithms in the years to come. Instead, look for small teams of investment professionals to be levered as never before by software. To me, it seems like there will still be ample room to provide products along one of three lines:

  • Personality: A more pleasant interface to money management than is otherwise available. This can take the form of a trusted adviser, but also software that integrates more thoughtfully into your daily life. I imagine that many investors would pay for value-added services, particularly for things like life coaching bundled alongside financial advice.
  • Performance: Pure alpha. Simple enough — there has always been a market for outstanding investment results and it is hard to imagine that changing. It will likely become more difficult for “closet indexers,” who are in essence pretending to provide active management, to pass by undetected, but many professional investors will probably welcome that development.
  • Permanence: Advice for the wealthy centered on specific issues relating to their legacy. This currently includes considerations like trust and estate planning, but I imagine that it will evolve to encompass a range of products that are not currently widely offered, like charitable plans that rival investment plans in sophistication, diversification, and analytic rigor.

What have I left out? Do you see a vector where financial professionals can offer value above and beyond that provided by low or no-cost indexing services? Let me know in the comments section. After all, “free checking” has been around for a while, and it would be difficult to argue that the retail banking industry has altogether gone away since then.

tag:srvo.org,2013:Post/1328873 2018-07-09T16:00:00Z 2018-10-04T13:50:49Z 13 Charts: High Yield Today

This post was written for CFA Institute and coauthored with Marty Fridson, who is one of the most perceptive analysts I have ever met. It was first published on the Enterprising Investor. 

The standard joke about high-yield bonds is that they’re not high yield any longer.

People started to tell that joke when the high-yield index fell below 10%. They’ve continued revising it as the index has moved steadily downward to its present 6%.

So let’s replace it with a much better joke: A bond manager has to appear in traffic court for a moving violation. The judge asks, “Don’t you know what ‘yield’ means?” The bond manager replies, “It’s been so long since there’s been any, I’ve forgotten.”

The judge begins to lecture him: “It’s every citizen’s duty in our society to understand the laws and obey them. It’s a sacred covenant.” The bond manager interjects, “I didn’t understand that last part.”

This joke evoked a chuckle from the audience at CFA Society New York’s 28th Annual High Yield Bond Conference. Martin Fridson, CFA, has been organizing and moderating the event for its entire history, starting back “when government bonds were yielding 9% and a respectable high yield credit could be found yielding around 14%.” Attendees have come to expect a mix of quirky humor, tactical insight, and portfolio management wisdom.

Enterprising Investor and CFA Society New York hope to transmit healthy doses of each through this experimental format.

What follows are 13 charts interspersed with related commentary from panelists throughout the event. To be clear: These quotes are from 13 and 14 June 2018 at the CFA Society of New York. In most cases, the charts and commentary were offered at different times. Participants’ remarks have been edited for clarity, and many rich veins of discussion could not be included due to length considerations.

CFA Society New York has made videos and copies of the presentations available, but the best way not to miss out next year is to attend in person. CFA Society New York puts on many insightful programs and offers many opportunities to get involved.

US Ratings Distributions

  • “The ability of companies to access the market [since the crisis] led to a large spike in B issuers. There are also a lot more rated issuers in total than 2009.” — Robert Schulz, CFA, managing director, corporate ratings, S&P Global Ratings
  • “The investment grade market has grown 40% over the last four years. The HY market has shrunk since 2015, and its overall credit quality has improved.” — Riz Hussain, director, US high-yield credit strategy, Barclays Capital
  • “Usually, things are never at the average. When defaults start spiking, they spike to double digits. A ‘non-recessionary’ average default rate for bonds is 2.3%. We don’t see anything at Fitch that leads us to believe the cycle is going to turn into a spike over the next year.” (Editor: Fitch’s work put the high-yield default rate at 1.8% in 2017.) — Sharon Bonelli, managing director, Fitch Ratings
  • “There’s no question [default rates] are very low. People talk about this as ‘We’re in the 13th inning of a credit cycle.'” — George Varughese, managing director, Alvarez & Marsal
  • “Our view is that money will be shifting from US to a more global situation over the next few years. Right now we’re getting to the unusual position where you don’t have a pickup from local EM into high yield. There’s an embedded view on the dollar, but that opportunity to swap into EM is a pretty compelling one from a total return standpoint.” — Henry Peabody, CFA, vice president, multi-sector portfolio manager, Eaton Vance Management

Higher Beta Has Generally Outperformed over the Last 12 Months

  • “Almost one third of the market was expected to default during the credit crisis because of their near-term maturities. Most companies now want to extend their runways. [They] are going out five, six, seven years. When rates start rising, you wind up getting more tenders. High-yield companies withstand rising rates better than expected because of that.” — Anne Yobage, CFA, director/co-founder, SKY Harbor Capital Management
  • “If you think about the financing cycle we’ve had this last few years, high-yield companies have built this incredible runway which means it will take some time for issuers to pay higher coupons. . . . I think the loan index coupon actually fell by 40 basis points this year. . . . [Rising interest rates] will certainly affect lower-quality issuers the most because they have more floating rate notes.” — Martha Metcalf, CFA, senior portfolio manager, Schroders Investment Management
  • “The shift we’ve seen over the past year to the Fed not giving you a get-out-of-jail-free card, the ECB not backing down as Italy gets volatility. We’re more nervous about rates than others. We don’t see a 10-year Treasury north of 5% as crazy, and people are asking if there’s value in the front end, if a 2.5% two year is sucking attention away from other credits.” — Henry Peabody, CFA
  • “If rates are going up because earnings are going up, most of the market will be just fine. From a total return basis, it gets back to bonds and what’s investable. High yield has a strong record of outperformance when interest rates are rising. Over the past 20 years, there have been 16 50 basis point hike cycles.” — Kevin Lorenz, CFA, managing director/portfolio manager, TIAA
  • “This late in the cycle, you’re really down to the relative value argument. The opportunistic buyer has definitely stepped back. Fundamentals are supportive, technicals are in balance, but valuations are stretched here.” — Martha Metcalf, CFA

The Rates Effect

  • What does a flattening yield curve mean? “The strongest relationship is between 2s10s and the 3yr forward default rate. So the oft-forecast crisis via rates is likely to happen in 2021.” — Riz Hussain
  • “Right now, we have to defend the asset category. We’re at historical tights, so a lot of clients think there’s nowhere good to go from here.” — Anne Yobage, CFA
  • “We like the B part of the market probably the most. Five to 6%, two- to five-year maturity is our sweet spot.” — Anne Yobage, CFA
  • “We’re more focused on B and CCC, but partially offset with investment-grade exposures, because we found that we could find large-cap BBB entities with higher yields than BB. Subordinated paper from [for instance] JP Morgan has more liquidity, plus a [yield] pickup. And in contrast to what we’ve said about high yield, supply in investment grade has been quite good this year.” — Martha Metcalf, CFA
  • “You don’t get paid two or three times the Treasury base rate for absolute certainty.” — Wayne Plewniak, managing director/portfolio manager, Gabelli & Company.

Correlation of Credit Assets with US Treasuries

  • “It used to be that credit had a very tight correlation with rates.” — Sam Derosa-Farag, market strategist
  • “We’re quite positive on the credit cycle. We think it still has long legs here. We are very comfortable moving down in credit quality for that reason: We think we’ve experienced much of the major headwinds already in the high-yield market. We are looking for a 5% year for both full duration and short duration products.” — Anne Yobage, CFA
  • “We are constructive on high yield overall. From a strategic vantage point, spreads are top-decile narrow, top 30% over the last 20 years. Put those two together and look at it by credit rating. If you back out credit-risk premia, historically BB has provided very strong risk-adjusted returns. We think they will continue to do so.” — Kevin Lorenz, CFA
  • “It’s hard to be enthusiastic about valuations. Leverage is extended, even though backward-looking interest coverage is solid. Technicals have been very strong. We do get the sense, at least in the near term, that foreign participation is backing away.” — Henry Peabody, CFA
  • “Maybe equity valuations are too high, and if they are, that’s going to be felt across all asset classes.” — Kevin Lorenz, CFA

High Yield New Issue Supply Constrained

  • “The average high-yield new issue is worse than average because companies come to market opportunistically.” — Martin Fridson, CFA, chief investment officer, Lehmann Livian Fridson Advisors
  • “You should be willing to move between acting as an owner and acting as a creditor if you are buying these assets.” — George Varughese
  • “We cut our forecast for new issue supply by $40B, which puts it as low as it was in 2009–10.” — Riz Hussain
  • “We tend to think there’s a pretty good correlation between volatility spikes and slowdowns in the new issuance calendar.” — Jarrod Kaplan, director, Credit Agricole Securities CIB
  • “Seventy percent or so of high-yield proceeds has been used for refinancing . . . that’s the highest since 2007.” — Riz Hussain
  • “We have the luxury of avoiding the new issue market . . . . Generally what’s new issue today is what you want to buy in one or two years. Bankers aren’t in the business of enriching investors, they work for their clients.” — Henry Peabody, CFA

Demand Outpacing Supply Has Meant

  • “Seventy-seven percent of the floating-rate loan market is considered ‘covenant lite.’ Leverage through the first lien part of the capital structure is about as high as it’s ever been. Relative to high yield, there are some concerns about credit quality. We’ve seen a 20% increase in capital structures that are loan only, and 58% of loan issuers are loans only. That means a majority of loan issuers today don’t have bonds below them.” — Riz Hussain
  • “When [abuses of covenants] happen, the company is simply doing what the documents allow them to do. And shame on us, shame on the investment community, for letting that happen.” — George Varughese
  • “The recovery experience will be much different than it’s been historically.” — Martha Metcalf, CFA
  • “Back in the mid 2000s, the structures got very esoteric. Each deal was unique. It still worked out in the end. Contrast that to today, where every deal is pretty much boilerplate. But the point that keeps getting made is that cov-lite is going to hurt.” — Kevin Lorenz, CFA
  • “You have to really trust that management teams have your interests at heart . . . ” — Anne Yobage, CFA
  •  “And they don’t.” — Kevin Lorenz, CFA

Loans vs Bonds Fair Value Index

  • “We invest across bonds and loans. In our mutual fund, loan exposure has ranged from 0 to 20%, and today it’s at 7%. Everything we buy is based on bottom-up credit views. The problem we’ve had in the loan market is one of repricing. It is just getting too rich for us.” — Kevin Lorenz, CFA
  • “You’re seeing the most late-cycle behavior in the loan market. It won’t be a catalyst for defaults but it will affect the recovery experience . . . . I heard a CLO manager say that covenants don’t pay coupon, cash flow does.” — Martha Metcalf, CFA
  • “Now is an excellent time to be in active management . . . you need to treat the market with caution and go in with a deep fundamental view.” — Henry Peabody, CFA
  • “Dispersion is sitting at the lows. Positioning suggests caution. Dealer inventories are basically flat. High-yield CDX positioning is basically flat. Mutual fund manager performance this year is really narrowly distributed.” — Riz Hussain
  • “We’ve seen deals in 2018 with a seven-plus year maturity, though still no longer than eight. For instance: Iron Mountain, Vista Energy, Telenet. There’s a continued loosening of terms. The market is getting more aggressive. The depth of the second lien loan market is increasing with large ‘bond-size’ placements readily achievable. Two to $5 billion enterprise value LBOs, where you would tend to need a junior piece to be a high-yield bond, [can now be funded with] first and second lien loans.” — Jarrod Kaplan

ETF Liquidity Enhancement in US Credit

  • “HYG and JNK have much higher flow volatility than what the price volatility would suggest. Managers have increasingly been using ETFs to take tactical views, but also to manage liquidity overall. That means you can’t look at ETF flows as additive to mutual fund flows.” — Riz Hussain
  • “ETFs are 3.4% of the US HY market. All 45 high-yield ETFs trade 15.7% of 3m average daily volume in total market. The largest premium/discount to underlying was ~.3%/-~.4% on the five most stressed days.” — Bradley Kotler, vice president, SPDR Fixed Income Group, State Street Global Advisors
  • “We see ETFs as enhancing the liquidity process. As a seller, you’re getting the greater of the liquidity in the underlying or the ETF.” — Sal Bruno, chief investment officer, IndexIQ
  • “On Columbus Day, there was $1 billion in volume for JNK even though the bond market wasn’t open.” — Bradley Kotler

Retail Downgrades

  • “We are very underweight retail. We like the telecom space a lot. Basic industries and housing are very strong areas too.” — Anne Yobage, CFA
  • “Retail bankruptcies, most of the time, end up in liquidations. Most of the lending to a retail company is typically done on an asset-based basis on inventory and receivables. Because of Amazon and many other things, brick-and-mortar business models are under attack. So when a bankruptcy happens, a secured lender is best able to get a recovery by liquidating the receivables and inventory instead of assuming the business risk. Most of the time the secured creditor wins because they have a lien to the assets. Not true in all cases: Many retail companies have emerged from bankruptcy and continued to be companies afterward.” — George Varughese
  • Retail is “the most active in terms of defaults these days, the total 12-month default rate for retail is about 9% on the high-yield side.” — Sharon Bonelli
  • “Individual sectors have been strained, but it hasn’t spilled over to the broader market.” — George Varughese

Tax Reform Credit Impact Takeaways

  • “I don’t believe we’ve taken many ratings actions based on tax reform.” — Robert Schulz, CFA
  • “About 40% of public high-yield issuers have interest coverage below 3.3x. Tax reform means that interest above 30% of EBITDA is no longer deductible. So, some portion of their interest bill will no longer be deductible. But there will be an offsetting effect in the form of a lower tax rate, which means their tax expense will also fall.” — Riz Hussain
  • “The most mentioned use of tax saving proceeds [on company earnings calls] was M&A/asset purchases.” — Riz Hussain

CCC Focus

  • “There has never been a three-year period where the high-yield market has exceeded its beginning carry. Previously, when we had sub-carry years, CCC meaningfully underperformed while BB outperformed. This year, that’s inverted and CCC has outperformed.” — Riz Hussain
  • “CCC also offers a nice premium but is the most volatile and most subject to volatility, so we are less excited about CCC given the run.” — Kevin Lorenz, CFA
  • “We want to like the CCC space but you really have to look at the companies there. We find CCC attractive as a ratings category, but don’t like the names.” — Anne Yobage, CFA
  • “From 1984 to 1999, CCC bonds were badly behaving citizens. Lots of institutional investors wanted indices that excluded CCC.” — Sam Derosa-Farag
  • “Energy rising stars (Editor’s note: that’s the opposite of a fallen angel) are particularly strong. They were 60% of rising star volume in 2017.” — Riz Hussain

BB B and CCC and Lower-Option Spreads

  • “If a company goes bust, the short-term bond and the long-term bond are both going to default. Maturity does not affect recovery in a bankruptcy. So at the extreme, people will trade a short-term bond and a long-term bond at the same dollar price.” — Martin Fridson, CFA
  • But in other circumstances: “do you get a bigger risk premium relative to treasurys in the short or the long end of the high yield market?” — Martin Fridson, CFA
  • The first two studies came to opposite conclusions:
    • Jerome Fons found wider spreads in short term bonds and narrower spreads in the longer end of the curve. (Financial Analysts Journal, 1994)
    • Helwege and Turner looked just at pairs of the same issuer (pari passu) issues of the same name and found that, pretty consistently, spread on shorter-dated maturity of same deal was wider (Journal of Finance, 1999).
  • “Our study (forthcoming in the Journal of Fixed Income) concludes that it’s not correct to say either that it’s always negative or always positive. We can reject the idea that negatively sloped curves are an illusion based on difference in credit quality among maturity baskets.” — Martin Fridson, CFA
  • “Positive spread curves indicate low concern about default risk, and are most frequent in the BB sector.” — Martin Fridson, CFA

Average Equity Commitments in LBO Transactions

  • “There’s been a transfer from high-yield bonds, which used to be the currency to finance LBOs, to leveraged loans. Clearly it could be better, but for a sponsor to put in 40% in equity is a reasonable cushion.” — George Varughese
  • “LBOs involve large-scale borrowing to fund the acquisition of the target company, with the stated intention of bringing debt down to manageable levels by the time the next recession hits. We never know when the next recession will arrive, but with each month that elapses since the last recession, we know with certainty that we’re one month closer to the next one. Logically, therefore, the multiples of debt piled on an LBO should decrease as we get closer to the next recession and there is consequently less time to bring leverage down. What we actually observe, however, is that multiples increase as the economy gets closer to the next recession. This cannot be wise corporate financial policy.” — Martin Fridson, CFA
  • “Are we late cycle? I’d put it in perspective to the three cycles the modern HY market has experienced. I’ve been a part of each of them. Each correction is cleaning up the excesses of a market cycle. Each time, that’s been LBOs. In 2007, the standard deal almost overnight became 10x leveraged. We’re not at that level yet. The Journal had an article this morning that the average deal was 6x EBITDA . . . that must be adjusted EBITDA. It’s more like 8x or 9x, and then they tell you why it’s really 6x.” — Kevin Lorenz, CFA
  • “Two to 5b enterprise value LBOs, where you would tend to need a junior piece be a high-yield bond, are getting funded with first and second lien loans. The depth of the second lien loan market is increasing with large ‘bond-size’ placements readily achievable.” — Jarrod Kaplan

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tag:srvo.org,2013:Post/1299341 2018-07-03T11:08:16Z 2018-10-04T12:17:45Z You May Beat an Algorithm Today. What about Tomorrow?

This was coauthored with the excellent Ashby Monk and originally published by CFA Institute on the Enterprising Investor

Technology will upend the way investment decisions are made.

How should investment decision makers respond?

This conversation has a tendency to assume an emotional tone even before it gets existential. For instance, you hear genuine angst over Microsoft Office’s new layout, and that’s just a redesigned application. Innovation has cumulative effects though, and after more than 50 years of Moore’s law and numerous other advances, algorithmic decision making fits too tightly into investment processes to be ignored.

That doesn’t mean it’s perfect. One purpose of this essay is to invite you into friendly competition with an algorithm designed by Ashby Monk and his colleagues at Stanford University. Their process can select managers with limited information and little time. You may be able to predict a team’s success more effectively.

Whether or not you feel like you beat the machine today, it’s worthwhile to have a plan for what happens next so that your organization can fully capitalize on its native strengths.

In our imagination, the word “algorithm” tends to evoke fast-paced and high-stakes processes.

The mundane truth is that the word refers only to a process or set of rules that describe how to accomplish a task. There is no naturally associated time horizon or risk appetite.

And that’s good, because most public pension funds, endowments, and sovereign wealth funds wouldn’t count speed or agility among their strengths.

Our goal here is to underscore that they don’t need to, and explore what a technological transformation looks like when its primary purpose is to reinforce risk-aware patience at institutions that may outlast many of their assets.

Know Who You Are

Many organizations have no formalized models or systems for characterizing data or judging data quality.

No matter. Ongoing competition among market participants to exploit new forms of information and data squarely qualifies as an arms race, definable as a situation in which parties are locked in perpetual efforts to outcompete one another without a defined endpoint. And it gets better: You can’t escape. It’s difficult enough to achieve most current risk and performance targets as things are, but alternative datasets and associated analytical techniques are already augmenting the pricing process in many markets.

Transacting in markets you don’t understand is not a recommended practice. The fear is that it may become business as usual for many investment organizations unless they develop an internal capability to assess and integrate alternative data. As we all know: Fear leads to anger and is the path to the dark side.

One manifestation of this is when entities “leap before looking” and obtain datasets without considering the actionability of what they’ve bought. This can lead to efforts that are poorly aligned with organizational capabilities or priorities and offer little long-term value. The wrong purchase can also drive pursuit of shorter payback periods to offset their costs, and so compress the time horizons of decisions made with them.

Seek Defensive, Defensible Value 

Accessing novel data should not be a goal in its own right. The idea is to manifest the best possible version of your organization.

Many large investment organizations struggle with innovation for the simple fact that they lack internal agreement about what direction they should go in. The allure of working with alternative data could make it a common point of agreement in the process of building support for new initiatives internally, and the learning from efforts to integrate it can drive significant future innovation.

The work isn’t necessarily all that different from what you do already. For instance, consider:

  • Assessing the strength of a potential general partner’s professional and social network with LinkedIn data and news reports of prior deals before committing to their fund. An allocator is likely to have little ex ante clarity about the specific start-up companies in which a venture capitalist will invest, and no control over how it does so once capital is pledged. The quality of the venture capitalist’s likely co-investors, however, may be easier to discern and serve as an indicator of the ultimate riskiness of its portfolio.
  • Conducting due diligence on candidate direct investments in leisure-related properties — say, hotels or casinos — by assembling online price and ratings histories of possible competitors — think Airbnb, TripAdvisor, or Yelp — or price-series of airfares to that locale.
  • Controlling reputational risk from investee companies by monitoring controversies about them that arise in social media posts or other localized/unconventional news outlets.

The precise tools and techniques of executing those research operations may not yet be clear, but hopefully the practice seems less like a dark art and more like defense.

There’s still a place for present value, probability, and the rest of the body of knowledge that characterizes the investment profession. Alternative data just adds new colors and textures to the mosaic of information investors have long been evaluating.

It also argues for a degree of operational openness.

Some of the most compelling implementations of alternative data strategies involve the investment organization itself. Here are a few examples:

  • Ensure your cost structure is not a simple function of market capitalization by continuously monitoring contracts with external asset managers. Fee structures based on assets under management (AUM) can creep into costs because growth in an account balance does not necessarily reflect manager skill.
  • Inventive collation and synthesis of documents like e-mails, investment memos, and contracts can uncover precious metadata with insight into communication, culture, negotiation, time allocation, benchmarking, and diligence.
  • Organizations can map their internal knowledge flows by tracking how internal users query and access documents in organizational databases. This also allows for examinations of typical approaches analysts use in problem solving. More granular visibility into these activities can expose not only areas for improvement, but also help better identify best practices.

Everyone faces technological competition.

Strategically, this means that investment organizations can invest in homegrown sources of technological leverage, and they ought to. If they don’t, the decision should come after a thorough analysis of long-term tradeoffs to the organization.

From these seats, it’s hard to imagine a winning case against it. Data is perhaps the most important input into every investment decision-making process already, and new applications for it are proliferating every day. Unforeseen (and sometimes unidentifiable) risk still hits portfolios frequently. Unrealized efficiencies abound.

You really should try to outperform the algorithm, but here is some further reading to help you seize the opportunity:

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    tag:srvo.org,2013:Post/1293031 2018-06-11T17:42:39Z 2018-10-04T13:21:35Z India: Opportunity Calling

    I published an essay called India Ascendant last week with Navneet Munot, Vikas Khemani, Sunil Singhania, and Saurabh Muhkerjea.

    These gentlemen are not that well known outside of India, but are each remarkable individuals who need no introduction there. It was my privilege to welcome each of them to the CFA Society of New York last week along with Dr. Subir Gokharn of the International Monetary Fund and Dr. Punita Komar-Sinha of Pacific Paradigm Advisors. 

    My hair was a little frizzy thanks to summer in New York, but the two panels I moderated went very well otherwise. I've embedded a few action shots below, and you can view a recording of the panel here.

    tag:srvo.org,2013:Post/1328864 2018-06-05T16:00:00Z 2018-10-04T13:41:22Z Eight Charts: India Ascendant

    This essay was written for CFA Institute in collaboration with four gentlemen who know the Indian investment landscape better than anyone: Saurabh Muhkerjea, Vikas Khemani, Sunil Singhania, and Navneet Munot. It was first published by the Enterprising Investor.

    India’s economy will experience the ordinary progress of a century over the next decade.

    That sentence is as true now as it was in 1952 when Donald B. Macurda wrote of investment opportunities in India for the CFA Institute Financial Analysts Journal.

    The appeal was humanitarian, but also prophetic.

    He wrote that the country “should logically become one of the world’s great steel centers,” and today it is. The prediction that “the Indian industrial ball will gather an accelerating momentum that could be enriching to all concerned” has also aged well.

    This is because of pro-growth policy, not political personality.

    India’s economic liberalization was really sparked during a balance of payments crisis in 1991. Ten years later, the Asian Development Bank’s chief economist observed that the need for continued work had become an item of widespread political consensus. To place the change in context, consider that the weighted average tariff on an imported product was 76% in 1990 according to the World Bank. It was 29% a decade later, and 6.2% in 2016.

    That’s more a rebirth than a liberalization.

    These compounding efforts have a straightforward result: India isn’t playing catch-up anymore. It’s the world’s seventh-largest economy, and in some ways it’s already well ahead of “developed” places.

    In early 2017, Sloane Ortel estimated that a minimum wage earner in New York City spends 1.5% to 2.5% of their discretionary income on banking fees. In India, anything above 0% is an outlier. The Pradhan Mantri Jan-Dhan Yojana (PMJDY, Scheme for People’s Wealth) provides not just free bank accounts to all citizens, but also free overdraft insurance. That makes capital formation easier, and it’s just one of a few hundred reasons why 8% GDP growth seems plausible for the next 20 years.

    So don’t be surprised if the economy starts running a little hot.

    India’s inflation rate printed below 2% in the summer of 2017, but has since risen significantly. The most recent release puts consumer prices up 4.58% from a year ago, and the year-on-year change has been well above the RBI’s target of 4% since November of last year.

    The 1 July 2017 introduction of the national Goods and Services Tax (GST) is not least among its drivers. The 18% tax it collects on services is a significant hike from the 14.5% duty that was previously imposed on 28% of the CPI basket.

    Fiscal policy is also likely to be accommodative until elections to India’s lower house of parliament, the Lok Sabha, in spring 2019. Local and national government social and infrastructure spending tends to spike in these pre-election periods.

    And of course, there are commodity prices.

    India imports 86% of its crude oil requirement: about 1.5 billion barrels each year. That means rising crude prices have nearly a one-on-one impact on India’s import bill.

    It’s less stark than it seems at first. Refined petroleum is India’s largest single export. The country sent 207 million barrels abroad in 2016, making it the world’s fifth-largest supplier behind the Netherlands and netting $29.5 billion, 9% of the country’s total export trade.

    For the Indian consumer, oil prices never fell. The government responded to the 2015 selloff by raising taxes on diesel and petrol. This increases reserves and can always be cut in the future. It’s also a footnote compared to some of the government’s other policy reforms.

    The informal sector accounts for roughly 40% of India’s 2017 output and employs almost 80% of its labor force.

    The government seems determined to get rid of it.

    India has digitized its financial plumbing, cracked down on cash, and issued a new national tax scheme largely to tamp out “black” money, or untaxed earnings on the black market. Many of these businesses are relatively low quality, and can be expected to lose share or cease operating without the ability to flout wage laws and avoid taxes.

    This is a tailwind for listed companies. Market leading franchises have long been gaining share from these informal operators. Soon they will operate in a uniform national market with much less illicit competition.

    The money habits of individual Indians are also headed for a significant change.

    About 95% of India’s wealth is invested in physical assets: 77% in real estate with the balance in durable goods (7%), and gold (11%).

    The remaining 5% is invested in financial assets. This share is already growing and looks set to go further. Households put 45% of their income into financial assets in 2012. The proportion is now around 58% and looks poised for more expanision.

    This will materially strengthen India’s capital account if it continues.

    There are risks to the rosy outlook, of course.

    A primary one is the sometimes lackluster credit discipline of Indian lenders. “India’s bad loan/twin balance-sheet problem is widely known and so far intractable,” David Keohane wrote last year.

    Historically, Indian companies have been weighed down by debt-laden balance sheets and the public sector banks that have financed them have been saddled with non-performing assets. In large part, this is because India’s bankruptcy code did not make it easy for creditors to reach economically viable arrangements. The Insolvency and Bankruptcy Code (IBC) of 2016 has materially strengthened the insolvency framework with an efficient legal structure to enforce debt service obligations.

    It’s difficult to overstate the importance of this. The Asia Securities Industry and Financial Markets Association (ASIFMA) estimated that India’s corporate bond market was worth about 15% of  GDP in 2017. That’s tripled from 5% five years earlier, but is still much lower than neighboring Malaysia, where outstanding corporate bonds were worth 40% of GDP. Deepening this market will help to finance much-needed infrastructure projects and also provide banks with a bit more breathing room.

    There are plenty of reasons to hope it works, but it may be a process. About two weeks ago, a Reuters headline blared, “India State Banks’ Bailout Stumbles as Losses Mount.” And Moody’s just cut their estimate for India’s 2018 GDP, citing a combination of higher oil prices and tighter financial conditions.

    And then there’s the same old risk: Investing is hard.

    Finding multibagger investments in India is a tricky affair because accounting quality and corporate governance standards vary wildly across companies and over 60% of the market cap of the frontline index, the NIFTY, is in highly regulated sectors like banks, telecoms, metals, power, infrastructure, and pharmaceuticals.

    However, India had 5,615 listed companies in 2017, according to the World Bank. That’s more than any other market on the planet: The United States had just 4,336. The top decile of these firms has historically delivered 10-times returns over 10-year horizons.

    That’s a 25% compound annual growth rate. Foreign investors have participated in this growth story enthusiastically, which has kept India among the most expensive emerging markets based on trailing price/earnings multiples.

    The standard question to ponder towards the conclusion of an article like this is: What inning are we in?

    In India, though, the game is cricket, not baseball. One inning can last as long as four baseball games, and there are either two or four of them. The longest game in history lasted nine days. And that’s really the point. An allocator encountering India today faces an unusual and alluring confluence of factors. The MSCI Emerging Markets Index has only an 8.5% weighting to this fast-growing, cyclically attractive, and tailwind-laden economy.

    The outlook is strong enough that we’ve gotten almost to the end before mentioning India’s outrageously favorable demographics, swift digital rebirth, and booming middle class.

    That’s because we’re not done talking yet.

    If you’ve read this far, you ought to check out the panel discussion convened by CFA Society New York one week after we published this essay. We were joined by Dr. Punita-Singh Kumar of Pacfic Paradigm Advisors and Dr. Subir Gokharn of the International Monetary Fund. You can see photos (and click through to a full video) here.

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    tag:srvo.org,2013:Post/1328863 2018-05-04T16:00:00Z 2018-10-04T13:17:35Z Billions of Reasons to Be Yourself

    Showtime’s Billions is one of the best shows on television.

    It blends excellent storytelling, great acting and writing, and a keen sense for its focal point, Axe Capital, a Connecticut hedge fund.

    We don’t often see fund management on the small screen. But Billions has also brought something else unusual: Asia Kate Dillon’s portrayal of Taylor Mason.

    Both the character and the person who plays them is non-binary, meaning they don’t identify as either male or female. What’s striking about this is not just the boundary-busting they’ve done, but also the speed with which their colleagues accept their identity, pronouns, and personhood. When Taylor comes out to their boss, the reaction is “You know, the difference in you is actually your advantage.”

    So where is the real-life Taylor? I’d wager the answer is simple: hiding in plain sight.

    There is tremendous pressure to keep what makes us different a secret in the workplace. NYU School of Law and Deloitte surveyed 3,129 professionals and found that 61% take action to cover up at least one element of their personality, whether that means straightening their hair to de-emphasize race, avoiding discussions about motherhood to appear more committed at work, or refraining from bringing a same-sex partner to a work function.

    The authors also found:

    “45 percent of straight White men — who have not been the focus of most inclusion efforts — reported covering. This finding seems particularly promising, given that a model of inclusion should, almost by definition, be one in which all individuals can see themselves.”

    It’ll take more than saying it to make it so, but it’s a start. Why does that problem seem so hard, though? Being effective takes empathy no matter who you work with. But too often human beings are met with raised eyebrows instead of open arms when they find the courage to stop covering.

    That’s too bad, and not just for the people left to go it alone. Monocultural firms can only scale so far. And when co-workers see a colleague separate from their employer because of a characteristic, the best-case scenario is that they just feel a little uneasy as a result. The worst is that such action allows bias to calcify into blindness or even bigotry.

    When I came out to my colleagues as a transgender woman in October of last year, one of the things I said was, “If you can respect me as a human, seeing me as a woman is a matter of time.”

    That time has come quickly, and my boldest hope is that it will come for you if you’d like it to. I know what it’s like to feel my dignity is contingent on keeping my immutable characteristics secret. It hurt the whole time I was trying, and I’ve never been gladder to give something up.

    Everyone ought to be so lucky no matter what they don’t feel able to say. But how to help them out? For a start, here are five great links about diversity and inclusion in investment management:

    I also think these five pieces are worth your time:

    And as is tradition, here are a few pieces that are a little more fun:

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    tag:srvo.org,2013:Post/1328859 2018-04-04T16:00:00Z 2018-10-04T13:13:05Z Bangladeshi Banks Need Bonds Back

    I wrote this post for CFA Institute with the wonderful Asif Khan, CFA, and first published it on the Enterprising Investor.

    Sustainable development is tough if your country’s capital markets are not functioning.

    And for Bangladesh, that constitutes a major setback for a nation that has made nearly unprecedented strides in development since its founding.

    Indeed, Bangladesh’s track record in raising the living standards of its citizens was dubbed a miracle by the late professor Hans Rosling. Since the nation gained independence from Pakistan in 1971, development indicators there have improved dramatically. Women have fewer children and greater individual agency. Infant mortality is way down and life expectancy way up. GDP growth in 2016 exceeded 7%.

    The two of us first met there in early 2017, and recently reconnected to discuss the stunning situation we detail here.

    Interest Ranges. 

    The story starts with a typically minor technical issue: What’s the interest rate in Bangladesh?

    In most places, fixed-income analysts can relate coupons on debt instruments to each other and infer their relative riskiness with straightforward math.

    This has never been as tidy in Dhaka, Bangladesh, as it is in New York or London, but it recently became impossible after the government stopped holding periodic bond auctions.

    This means the largest issuer in the capital markets — the government — has effectively abandoned them.

    This is more than just a petty annoyance. It makes the price of money both higher and harder to calculate. In a country where boosting entrepreneurship, building infrastructure, and creating jobs are pressing imperatives, it counts as a significant headwind at best.

    But it’s not the whole problem.

    Working Too Well

    Bangladesh’s National Savings Department (NSD) has the right idea: Make it easier for people to save by offering convenient, safe, and attractive deposits at preferential interest rates.

    The NSD was established in 1972, right after independence, in order to promote savings, help fill fiscal deficits, reduce dependence on foreign donors, and provide a safety net to women, retired officials, senior citizens, and the physically challenged.

    The savings certificates the NSD offers can be purchased from commercial banks as well as the postal service, which played a big role in financial inclusion during the early days of independence.

    People have noticed.

    Bangladeshi Debt Outsanding (Billions of Taka)

    Bangladeshi Debt Outsanding Billions of Taka

    Source: All charts derived from Bangladesh Bank data

    If the right people were accessing the program, this wouldn’t be so bad. But it’s hard to imagine that’s the case.

    Statistics on who is using these instruments are not public, but large institutions and wealthy individuals are likely buying a disproportionate share. A family of two is currently allowed to invest 16.5-million Bangladeshi taka in total, or about $199,000, in these products, and there are ways to bypass restrictions by investing under the names of other family members.

    This in a country where the per capita income in fiscal 2017 was $1,610.

    And don’t forget, these instruments are among the highest-yielding options available to savers. By definition, that makes them among the most expensive financing vehicles available to the government.

    Bangladeshi Interest Rates

    Bangladeshi Interest Rates

    Of the country’s 2017 budget deficit, about 16.6% was attributable to interest on NSD savings certificates. And unless the program is reformed, that percentage will only continue to grow. Spreads between NSD instruments and market rate alternatives are so wide that adding up the total cost is just sad.

    That money could be put to much better use elsewhere.

    But indirect costs are also part of the tragedy. This program has starved the banking sector of deposits, as demonstrated by the widening the gap between the M2 and M3 growth rates.

    Bangladesh Money Supply Growth Rates, Year-over-Year Change

    Bangladesh Money Supply Growth Rates Year-over-Year Change

    This can be changed. 

    The good news is that we know how to close the budget deficit in Bangladesh.

    The question is: Will things change?

    Eight million Bangladeshis have moved out of poverty since 2010, according to the World Bank. The savings from reform — which would be significant — could meaningfully accelerate that trend.

    Restoring health to the capital markets is required to sustain them. If NSD certificates were restricted to more reasonable investments amounts, say 10 lakh taka, or around $12,000, a number of good things would likely begin to happen.

    Among the best is that subsidies could be directed away from the wealthy and toward those who really need them.

    If you liked this post, you should subscribe to my newsletter.

    tag:srvo.org,2013:Post/1328857 2018-03-30T16:00:00Z 2018-10-04T13:04:41Z 14 Charts and No Foolin'

    I wrote this for CFA Institute and first published it on the Enterprising Investor.

    Celebrating Easter and April Fool’s Day both on the same day feels appropriate in 2018.

    Interest rates have risen again, and plenty of traders are waiting for the punchline.

    My task this weekend starts with assuring you it’s all for real. If the world feels a little crazy, it’s because you are paying attention. But stick around. We’ll try to turn it into fun.

    I found a lot of charts that I want to talk about, so let’s jump in with one that gives me very mixed feelings.

    You have to wonder: Why all the silence?

    It shouldn’t be that hard to come up with material to tweet about. Maybe he’s just being polite to his colleagues in the eurozone, who are contending with a sudden and surprising reversal in their macroeconomic fortunes.

    Importantly, the US economy isn’t just looking good by comparison. The United States is large and diverse, but growth has been a reliably urban phenomenon since the Great Recession.

    The gap between upbeat headline economic statistics and dire lived experiences is not new to the United States. It’s been a reliable feature of post-Great Recession life. And you would expect the mood as it reverses to be buoyant.

    So what’s killing the vibe?

    The unfortunate side effect of growing faster than our trading partners is that it directs their money and attention here.

    The dollar has caught a bid, and that’s just the beginning. I talked about the bond market’s “dangerous curves” last month. Perhaps I should have written about dangerous lines instead.

    The standard fear when this condition presents comes straight out of economics textbooks, where flattening yield curves are typically described as harbingers of a recession.

    Of course, that’s not automatic.

    One might see the above chart, count the red circles, and conclude that in four out of seven cases a flattening curve is a sign that the party will continue for several more years. But of course, be careful. Anything is possible.

    It does feel a bit weird, though, to hear the last few months’ trading described as a “bear market in bonds.” Thirty-year Treasuries have spent most of the month rallying and were trading at 3.01% at the close of business this Thursday. That’s 12 basis points lower than they were at the end of February.

    As it happens, the long bond opened 2017 yielding 3.04%. That was a selloff from 2016’s open of 2.98%, but it’s hardly a bloodbath.

    I don’t mean to minimize forward-looking concerns, like the increasing amount of the US federal budget going towards debt service payments.

    It’s hard not to feel that the market is evolving some very particular tastes regarding leverage.

    Look in particular at how many “investment grade” bonds, in fact, receive the lowest grade: BBB.

    Could this perhaps have something to do with the lack of “high-yield” bonds?

    The profit-free nature of recent equity issuance certainly makes it seem like capital markets are feeling promiscuous.

    And the experience of more seasoned offerings has shown that a company’s multiple can expand significantly as a reward for simply staying in place.

    Of course, that’s only true for individual equities.

    Some active managers have been experiencing the opposite, turning in significant outperformance only to be greeted by a chorus of redemptions.

    So I’d forgive you for wanting to go corporate. The market verdict seems to be that consistently manufacturing alpha isn’t worth quite as much as an ability to say “We’re Number 1” frequently and with tremendous conviction.

    I hope you found this useful. Here are a few other links you might want to peruse:

    If you liked this post, you really ought to subscribe to my newsletter.

    tag:srvo.org,2013:Post/1257210 2018-03-05T16:51:17Z 2018-09-02T22:43:59Z Weird Ideas Conference

    I’m thinking about organizing a weird ideas conference.

    Its mission would be to embolden open curiosity in the field of investment management. Ideally, a spirit of “I might be crazy, but I’ve done the work” will permeate the whole thing. Any marketing intention will be judiciously screened out, and presenters will be held to strict standards of credibility, brevity, and clarity. 

    I’ll do everything I can think of to make sure everyone present feels engaged and able to express themselves. 

    The event would most likely be held on a weekday in Bushwick, Brooklyn, cost less than $100, and take a little more than a half day. 

    Here are some subjects I’d like to discuss in particular:

    • The innate weirdness of investing.
    • Investment lessons from the crypto.
    • What is mainstream thinking, exactly?
    • Rumors, conspiracy theories, and other forces shaping geopolitics.
    • The cost of “status quo” policy in real terms.

    I hope to add to the above, but also to intersperse a series of “lightning talks” throughout the programming. These would be ten minute presentations on an intentionally wide range of topics. 

    If participating in this sounds fun to you, please fill out this brief survey

    tag:srvo.org,2013:Post/1328852 2018-02-28T17:00:00Z 2018-10-04T12:56:08Z Nine Charts: Dangerous Curves

    I wrote this for CFA Institute and first published it on the Enterprising Investor.

    The prospect of rising interest rates has been discussed for long enough that every investor on earth ought to be ready by now.

    Of course, that’s not exactly how it works.

    To many in the market, bonds play a nearly sacred role. They are volatility-dampeners in chief, tapped into a portfolio for their ability to mitigate occasional stock market jitters. Whatever else one thinks about them, their contractual interest and principal payments make them a nice asset to have around in a risk-off moment.

    At least that used to be the case.

    Last week, Michael Batnick, CFA, described the regime change we’ve been seeing so far this year:

    “in the 8 days that the S&P 500 fell at least 0.5%, bonds declined in all but 1 of those days. I would expect this number to come down as the year goes on, but finishing above 50% would not be unprecedented. In 1999, stocks fell at least 0.5% 79 times, and bonds fell 48 of those 79 days.”

    So: What’s Happening?

    There’s only one place to start: The interest rate environment has materially evolved.

    As I listened to Ben Bernanke interview Janet Yellen recently, it was hard not to see their era in sepia tones. Things have definitely changed.

    We’re worried about the economy being too good now. Not, like, ending. As was the fear for a stretch of Mr. Bernanke’s tenure.

    And that means it’s time to hike.

    The market seems to have noticed this slight difference in the tone of their successor at the US Federal Reserve, Jerome Powell.

    Did I say “market”? I meant markets.

    The outlook doesn’t seem so great for bond prices, and they haven’t looked this good as a financing alternative in more than a decade.

    If these agreeable conditions persist, one imagines that the observations offered by Martin Fridson, CFA, on forecasting fixed-income default rates will come in handy to a healthy proportion of our readers.

    Now, none of this means bonds are devoid of appeal. Some asset owners are prohibited from owning anything else. And bonds have held central roles in diversified investment portfolios since what feels like the beginning of time.

    But, to state the obvious, rising rates are a headwind for bond prices.

    And an era just ended at the Fed. We’re likely to see a few spillovers.

    If interest rates were just rising in a parallel shift, all of this would be less of an issue. 

    Stanley Kogelman discussed the consequence of a parallel rise in the yield curve with colleague Pat Light a few years ago, and offered a recipe that may still suit a material proportion of readers:

    “if you are concerned about rising rates and you aren’t convinced that you can perfectly time duration adjustments to your portfolio, you should be more comfortable sitting back and assuming that over the course of time, you’re going to get the initial yield or the initial rolling yield of the portfolio that you anticipated.”

    Maybe it’ll work out, but the curve is flattening as it rises. And as usual with this sort of thing, there’s no shortage of reasons why.

    The good news for diversified investors is that maybe the selloff is happening bullishly.

    And for those readers who, like me, happen to be based in the United States, it bears mentioning that we are fortunate to have spreads available domestically in the first place.

    And of course, the US capital markets are the world’s largest, but they’re not the only game around.

    So our Continental colleagues aren’t entirely out of luck. They can harvest a pretty significant spread by looking overseas.

    Fancy a trip to Brazil?

    Absent a trip to Latin America, there are a few other steps you can take to get ready for this environment. CFA Institute members can get a quick refresher through our one-hour module on” Yield Curve Construction, Trading Strategies, and Risk Analysis.”

    There are also some provocative observations in the CFA Digest summary of a Journal of Fixed Income paper, Profiting from Mean-Reverting Yield Curve Trading Strategies.” Here’s how Gerard Breen, CFA, described how a few different strategies performed from 1973 to 2004. The bold emphasis is mine.

    “The results suggest that for strategies pursuing mean reversion in the absolute level of yields, neither the strategy based on mean reversion of average yield levels across the curve nor that based on yield levels at individual maturity points can offer consistently superior returns. For strategies pursuing mean reversion in the slope of the yield curve, the authors find that trades involving mean reversion across the yield curve cannot offer consistently superior returns, although, conversely, those involving mean reversion between just two adjacent points on the yield curve can. For strategies pursuing mean reversion in the curvature of the yield curve, both trades involving curvature across the curve and those involving the curvature of just three adjoining points on the curve are found to offer consistently superior returns. Finally, the authors find that the most consistently profitable and statistically robust of all the strategies is that which pursues mean reversion of the slope between two adjacent points of the yield curve.

    Best of luck out there, and thank you for reading.

    If you liked this post, you should subscribe to my newsletter.

    tag:srvo.org,2013:Post/1328847 2018-02-23T17:00:00Z 2018-10-04T12:47:32Z Ski Fast, Have Fun, Don't Fall Down

    Ski racing is the kind of sport that stays with you.

    It takes the form of weaker knees and troubled joints sometimes, but something special comes from trying your best to do something very hard.

    Bill Pennington recently wrote about the culture of Norway’s ski team in The New York Times, and it got me thinking: What can you really do to help an athlete win?

    The piece’s headline — “The Ski Team That Sleeps Together Wins a Lot of Gold Medals Together” — implies a cuddle-centric strategy that fortunately is not the secret. Sharing beds is common for budget-strapped skiers, but a structure that deepens their relationships with teammates is not.

    Pennington details five rules that fit pretty well into organizations both on and off the hill. Here’s the secret sauce:

    1. No jerks.
    2. No class structure.
    3. The social fabric of the group is paramount.
    4. Talk to each other, not about each other.
    5. Friday night is taco night.

    This recipe got six of their athletes ranked in the world’s top 30 at the same time. And at some level, sign me up. I am here for taco night in a way that I can be only for my closest friends.

    But why is this such an ideal structure to grow in, and what can we learn from it that’s useful beyond entertainment?

    I was never going to carry the Olympic flag, but I did spend more than a decade as an alpine ski racer and coach. It’s a craft, much like investing, and it takes a specific atmosphere to flourish.

    I had the tremendous luck to learn under two legendary coaches: Carl Williams, who coached the Salisbury Ski Team for 45 Years, and Ron Bonneau, who took at least one of the College of Idaho’s teams to nationals every year from 1999 to 2011 and was deservedly named US Collegiate Ski and Snowboard Association (USCSA) Coach of the Year in 2016. Carl has passed away and it’s been a while since I caught up with Ron, but it’s a safe bet both would endorse the framework.

    These cultural factors are critical because ski racing is not a strictly pleasant experience. Remember: The goal of the sport is to go as fast as possible, often on the most dangerous part of the mountain. It will get icy, and then the ice will find ways to get even worse. It changes speed, catches skis, and grows ruts just to demonstrate character. As you improve, you are hitting a gate with your body at almost every turn. This leaves bruises and brittle plastic behind. When you’re done, you take off your skis, walk up the hill, and ski it again.

    And your feet are cold the whole time.

    So, in honor of the Winter Olympics and the athletes who prosper in chilly, challenging conditions, I thought I’d explore three of the big lessons I learned on the hill before launching into the usual weekend menu of links.

    1. “Bend ze Knees und ze Ankles”

    During Carl Williams’s career, the sport of skiing changed as much as anything else in the world.

    He started coaching for Salisbury in 1965, which means not only straight skis but also plenty of colleagues from abroad. Apart from the US Army’s 10th Mountain Division, there weren’t many Americans who could link turns.

    Of course, there’s a limit to how much experience you can import, and that’s how this came to be a catchphrase. I still crack up thinking of Carl describing teams of Austrians giving up on their American students after the exhortation to bend didn’t quite take. His impression of their frustration became something we repeated to each other out of intrinsic value — this was high school, after all — but the message is really important. There’s no point having the best of the best as instructors if you don’t speak the same language.

    2. Expect the Best Day Ever

    Ron Bonneau asked if I was breathing at the end of one of my first practice runs in college.

    “Oh wow, I’m not making this team” was my immediate thought. But his point was that I wasn’t going to win anything all stressed out. Racers at the peak of their capabilities still need to overcome their mood. For Ron, the secret to winning was remembering why you are competing: It’s fun.

    This is really easy to forget! Remember the bit above about bruises? The added intensity that comes with competing at the college level makes it easy to burn out.

    If you can convince yourself that the day ahead of you could be your best ever, it’s a little easier to keep moving.

    3. Ski Fast, Have Fun, Don’t Fall Down

    Carl saw plenty of disruptive innovation on the hill: plastic ski boots, breakaway gates, heel release bindings, and shaped skis. But there’s a central truth to the undertaking which never changed a bit, and so I’m pretty confident he shared the same secret recipe each successive year.

    It’s easier said than done, but that’s sort of the point. Advice always works that way. But the happy-go-lucky attitude at the center of it has helped me in situations far beyond the back bowls of Butternut Basin where we trained.

    My thanks to Carl, to Ron, to all the teammates I shared their wisdom with, and to you for indulging me. Now, as promised, here are some links that I think you’ll enjoy.

    Keep the optimistic spirit above in mind when I say: This might be the weekend when you finally “get” cryptocurrencies.

    Give these a look if that sounds fun:

    tag:srvo.org,2013:Post/1254393 2018-02-20T19:50:00Z 2018-10-04T15:21:46Z Who Owns the Assets Under Management?

    I wrote this post for CFA Institute with my friend and colleague Thomas Brigandi. It was first published on the Enterprising Investor.

    Say whatever you want about the world, but there’s never been a better time to be an end investor.

    Many things investment professionals fear — fee compression, automation, artificial intelligence (AI), and blockchain — benefit clients through higher account balances and lower fees.

    Asset owners are the largest of those clients. Though they are frequently lumped together as “institutional investors,” they can be as different from each other as any two individuals. The only characteristic they reliably share is size, which means their goals shape the market.

    But what exactly are those goals? What do these organizations want?

    Thomas Brigandi and his team of more than 400 volunteers began organizing the Asset Owner Series at CFA Society New York in 2015 with these questions at heart. Since then, they have hosted discussions among senior investors representing over $38 trillion in assets under management (AUM) or advisory (AUA). These candid, off-the-record conversations are open only to investment professionals. They will be increasingly available to CFA Institute members globally at little to no cost, but only in person.

    Institutional investors are characterized as “big fish” and “smart money,” but what else are they? Though Asset Owner Series commentary is not for attribution, the perspectives offered in these forums have removed some of the mystery surrounding these institutions, particularly the seven major types of asset owners and the motivations that are driving them.

    Here are these “big fish” in roughly descending order of their AUM:

    1. Pensions

    Pension funds are the largest asset owners, with $36.4 trillion in AUM in 2016, according to Willis Towers Watson’s “2017 Global Pension Asset Study.” They fall into four primary categories:

    • National pensions are sponsored by a federal government and can be either mandatory — all citizens must save a defined amount — or voluntary. The largest national pension plan is Japan’s Government Pension Investment Fund with around $1.3 trillion in AUM.
    • Corporate pensions are sponsored by a single employer or several related employers within a corporate group. Many are “defined-contribution” (DC) plans, which means the plan sponsor does not bear the investment risk. The largest corporate pension plans include those of IBM, AT&T, and United Technologies. Edmund A. Mennis, CFA, and Chester D. Clark’s Understanding Corporate Pension Plans offers a thorough overview.
    • Public pensions traditionally provide public employees in the United States and Canada with defined benefits after they retire. These benefits are based on a formula, not the investment returns of the beneficiary’s contributions. Mark Harrison, CFA, provided a helpful primer on the closely watched and widely emulated Canadian public pension fund model.
    • Union pensions, called Taft-Hartley plans in the United States, are operated by groups of companies together with officials of the unions that represent their workers. They are common in the building trades, trucking, retail, and mining industries. Some of the largest and most influential are the 1199SEIU Pension and Retirement Funds, Broadway League, National Railroad Retirement Investment Trust (NRRIT), and National Electrical Benefit Fund.

    Pensions tend to be conservative and often rely on liability-driven investment strategies to ensure that funds will be available to pay benefits when they are due. Some have raised concerns that these funds will not be able to fulfill their responsibilities.

    2. Insurance Company General Accounts

    Insurance companies tend to invest the premiums they are paid in order to boost their earnings. Globally, insurance company assets totaled about $23 trillion in 2015, according to the most recent insurance indicators asset data from the OECD.

    The liabilities assumed by insurers can vary considerably in their predictability and timeframe, which leads to significant divergence in how the portfolios created to offset them are managed. Differences in regulation, product mix, and competition will play a role in the ultimate composition of these portfolios, but we can lay out some high level differences.

    The three primary types of general accounts are:

    • Health: Providing health insurance creates a predictable but short-term liability with high liquidity needs. Managers of these accounts will thus keep as much as 25% of their portfolio in cash to meet these demands, and will tend to have some equity exposure to allow for long-term growth. Aetna Capital Management and CIGNA Investment Management are some of the largest organizations of this kind.
    • Life: These long-term liabilities are often offset through long-term fixed income instruments, like Treasuries and corporate bonds. Managers tend to be prohibited from holding large equity allocations, so will diversify into mortgages and other assets while holding proportionally small cash balances. New York Life Insurance and MetLife are examples of large life insurance general accounts.
    • Property and casualty: These insurers face “lumpy” liability streams that they offset by keeping as much as 10% of their assets in cash and 70% in bonds. They will typically blend equities and other assets in the balance of the portfolio to provide for some long-term growth. Among the large property and casualty insurance general accounts are Chubb and State Farm Mutual Automobile Insurance Company.

    Warren Buffett is perhaps the most widely known investor on the planet and has built his impressive track record in part by shrewdly managing the portfolios of insurance companies. John L. Maginn, CFA, explored how these entities operated in the mid-1990s in the United States.

    3. Sovereign Wealth Funds

    Sovereign wealth funds (SWFs) are state-owned investment funds whose investable asset base is derived from a country’s reserves and has been set aside for intergenerational savings, reserve management, fiscal stabilization, retirement benefits, or development. Taken together, they manage just over $7.5 trillion in assets.

    Most SWF funding comes from budget and trade surpluses or revenue generated from the exports of natural resources. They are generally not liability-driven investors, and as such, can adopt a long time horizon in their investment activities. Some funds have pursued innovative strategies to exploit the “huge advantage” their unique nature affords them, while others have fallen prey to political pressures and underperformed.

    The roughly $900-billion China Investment Corporation is one of the largest sovereign wealth funds, and also provides an interesting case study on the mechanics of operating such a fund. The fund’s chief representative, Felix P. Chee, discussed how the fund approaches portfolio construction and risk management in 2011.

    A more detailed case study can be found in Multi Asset Strategies: The Future of Investment Management, edited by my colleague. Larry Cao, CFA. The sixth chapter details the evolution of the Government of Singapore Investment Corporation. The closely watched fund does not reveal its AUM, but the US State Department estimated they were in excess of $300 billion in 2017.

    4. Investment Consultant Outsourced CIOs

    The majority of large investment consultants have outsourced CIO practices. Pensions & Investments‘ database shows total OCIO assets reached $1.69 trillion as of 31 March 2017.

    An OCIO will often manage all or a portion of the asset owner’s investment portfolio with discretion to make and monitor changes. The OCIO divisions of investment consultants differ from the core investment consulting business, which is to provide asset allocation and asset manager selection advice to asset owners. Collectively, investment consultants advise on trillions of dollars in asset owner assets under a nondiscretionary, advisory-only framework. Mercer, Russell Investments, and Aon Hewitt Investment Consultants are among the largest of these organizations.

    Hiring one of these firms can “present significant advantages for a small fund,” as they bring significant expertise in investment management and manager selection, according to Jeffrey V. Bailey, CFA, and Thomas M. Richards, CFA, in their primer for investment trustees. Though they also warn that the model comes with drawbacks, most notably that “the natural checks and balances of standard solutions” are somewhat lacking.

    5. Single Family Offices

    A single family office (SFO) is a private company that manages investments and trusts for one family. The number of family offices in the United States has grown to more than 3,000 with total AUM between $1 trillion and $1.2 trillion, according to Capgemini’s “Global State of Family Offices Report.” These organizations can cost more than $1 million a year to operate and thus are mostly used by the wealthiest of the wealthy.

    The SFO’s sole function is to centralize the management of a family fortune. SFO staff manage investments, taxes, philanthropic activities, trusts, and legal matters. SFOs are privately owned by high-net-worth families, so not much information on them is available to the public. Prominent SFOs include Willett Advisors, which invests the personal and philanthropic assets of Michael Bloomberg; the Heinz Family Office; and SAFO (Shari Arison Family Office) Investment Company.

    6. Endowments and Foundations

    Endowments and foundations (E&Fs) are large pools of money that benefit a specific charitable cause. Endowments tend to serve educational institutions while foundations write grants for a wide range of causes.

    In the United States, 805 college and university endowments and affiliated foundations collectively had over $515 billion in endowment assets, according to the 2016 NACUBO-Commonfund Study of Endowments. A further $865 billion is held by foundations, according to the Foundation Center’s database. E&Fs pay out on average 4%–5% of AUM each year to their specific cause.

    No asset owner has a longer time horizon or is able to assume greater risk. E&Fs have a perpetual life and no defined liability stream, which led to the evolution of the alternatives-heavy “Endowment Model” popularized by Yale University’s David Swensen. David Chambers and Elroy Dimson explored the origins and evolution of this model in a recent article for the CFA Institute Financial Analysts Journal®. The Bill & Melinda Gates Foundation is the world’s largest foundation, while Harvard University has the largest endowment.

    7. Multi-Family Offices

    There are an estimated 150 multi-family offices (MFOs) in the United States with about $400 to $450 billion in AUM, according to Capgemini’s “Global State of Family Offices Report.” They provide a range of services similar to an SFO, but work with more than one family group. These services are available to wealthy clients with as “little” as $20 million in investable assets.

    A MFO typically offers comprehensive investment solutions to affluent individuals and families, with some also handling other financial matters, including budgeting, insurance, wealth transfer, and tax services. Some notable MFOs are Bessemer Trust and Rockefeller & Co.

    Moving Forward

    Many aspects of the investment landscape are set to change, but these asset owners are likely to remain at the center of the market for many years to come. So if you still have questions, Owen Concannon, CFA’s exploration of the asset management industry may be the next place to look.

    There’s no substitute for primary sources, though, so we hope you’ll come meet us in person at your local CFA Society to find out why.

    If you liked this post, you should subscribe to my newsletter.

    tag:srvo.org,2013:Post/1248226 2018-02-15T22:31:52Z 2018-09-03T17:16:02Z Joshua Gotbaum
    The Hon. Joshua Gotbaum is a visiting scholar at the Brookings Institution in Economic Studies and a former director of the Pension Benefit Guaranty Corporation. That's the government-run insurer which covers private pension plans in the United States, effectively backstopping about 40 million retirees. 

    It's not unusual to see dire projections associated with the PBGC. This chart is from their most recent projections report, and shows the probability that its multi-employer program will go insolvent. Things don't look good in 15 years or so. 
    That scary tidbit is a common headline, but there's much more to the story. Josh and I spoke last week before his keynote address at the CFA Society of New York's US Retirement and Entitlement Crisis conference, and managed to cover a lot of nuance in just a few minutes.  
    tag:srvo.org,2013:Post/1235908 2018-01-22T10:54:37Z 2018-10-04T15:28:34Z Seven Reasons India is Primed for Growth

    I wrote this for CFA Institute with the peripatetic and wonderful Sameer Somal, CFA. It was first published on the Enterprising Investor.

    To many investors, India seems incredible but not necessarily investable.

    Indeed, the challenges of adapting to India as an investor go beyond not knowing what you don’t know: You won’t even be able to say most of it. Hindi and English are the most widely used languages, but the country has 22 official languages and many more are spoken, taught in schools, and printed in newspapers.

    So there is little chance you’ll be mistaken for a local, but neither would either of us.

    Sloane Ortel first visited India in 2009 and returned earlier this year for a three-month stint working out of the CFA Institute office in Mumbai. Sameer S. Somal, CFA, spends about a third of the year there. Though he is “Indian-American,” in India they just call him “American.”

    Here are seven reasons why we’re planning to keep going back.

    1. Real returns are available.

    Investors once assumed their rupees would depreciate at a nearly constant rate. Why? Because of experience: From 2006 to 2013, inflation averaged over 9%, according to the International Monetary Fund (IMF).

    A lot has changed. In the summer of 2017, the Indian CPI was rising more slowly than the United Kingdom’s.

    So investors might benefit by resetting their return expectations to the Indian context. A recent set of capital market assumptions from BlackRock forecasts nominal returns below 4% for every fixed-income asset class.

    Indian citizens have a realistic prospect of earning 5% after inflation with a simple and widely available fixed deposit.

    And Indians remain criminally under-allocated in their domestic stock market, as this spreadsheet demonstrates. Just 0.17% of all wealth held by urban households is invested in equities, compared to 4.35% in fixed deposits. Land and gold are the most widely held assets, and though investors have shifted from physical to financial assets, the rate of change has room to accelerate, especially if India’s becomes the world’s best-performing stock market.

    2. A demographic dividend is due.

    India’s youth is one of its most promising economic features: Census data indicates that about 41% of its population is under 20.

    By 2026, India is projected to have the world’s largest working-age population, and by 2030, 28% of the global workforce will live in India. India’s labor force will stay young for many decades to come. That’s an epic opportunity to create the next generation of global leaders.

    But every dividend is also a liability. India’s youth want work and meaningful careers. There just aren’t enough jobs. The OECD found more than 30% of the country’s young people are out of work and only about 5% of India’s labor force has any formal training.

    The government hopes to address this deficit through the Skill India and the Make in India initiatives, among other projects. While there are not enough jobs in India, the demographics of many developed market economies are aging. The global appetite for Indian human capital in the form of skilled actuaries, programmers, researchers, doctors and engineers from India continues to expand.

    3. The middle class is booming.

    India’s “Urban Mass” cohort, composed of 129 million people earning over $3,200 on average, will drive the country’s growth, according to a Goldman Sachs report.

    There is more room to expand: Median household income in China was around the same level in 2016. But an equivalent income in India buys quite a bit more than it does in China. Rural wages have also grown rapidly over the last decade.

    Banks want access to this growing consumer population, and there are plenty of opportunities. Morgan Stanley estimates that India’s 9% mortgage-to-GDP ratio in 2016 could rise to about 17% by 2026. Broader capital access comes with side effects: India’s property sales are expected to compound at 14% a year from 2016 to 2020 and at 18% from 2020 to 2025.

    This growth is not easy to leverage without significant adaptation, as Ortel observed earlier this year:

     “A who’s who of firms have tried and failed to expand here: Fidelity, JPMorgan, Goldman Sachs, and Nomura. The list of exits grows. The better part of wisdom as a new entrant to the market is not to discount these efforts.”

    But those who surmount the challenges of doing business here will earn the rewards. If India’s aggregate consumer spending reaches $13 trillion by 2030 as forecast, the country will be the world’s largest consumer market. The recent launch of Renault’s $4,000 Kwid is a case study in how global firms can adapt their products to local tastes.

    4. A digital revolution is brewing.

    India is now the world’s second largest internet market, with a smartphone user base of over 300 million people. The digital revolution is expected to double the country’s internet users by 2021, when an estimated 829 million Indians — or 59% of the total population — will be online, up from 373 million, or 28% of the population, in 2016.

    A massive national fiber-optic network is being built to power this growth. Much of that network will be constructed in villages and public spaces, with free WiFi coming to 1,050 villages as well as many railway stations. This will continue to cross-pollinate other verticals, including eCommerce. Flipkart, India’s domestic competition for Amazon, already employs 30,000 people.

    There are already more broadband users in India than there are people in the United States. India also has more Facebook users than any other country, having surpassed the United States this year. Mobile video IP traffic will accelerate from 57% of usage in 2016 to 76% in 2021, when India will be consuming 84 billion internet video minutes per month.

    The digital revolution will improve the delivery of government services. There is a thoughtful argument that criminal and political systems are vertically integrated in India, and so leveraging technology to eliminate intermediaries is about more than just efficiency. The ease of doing business index is already jumping as a result.

    5. The India Stack is growing.

    The India Stack is as exciting as it is terrifying. What is it? A national biometric identity database with 1.2 billion entries that link to medical records, bank accounts, government services, and more. It is an open invitation for app developers to build on a subcontinental scale.

    It begins with Aadhaar, which means “foundation” in English. This is the national biometric database that started in 2008 and now covers around 82% of Indians.

    The system is far from perfect: The Hindu god Hanuman received an Aadhaar card in 2014, so there are concerns about data quality as well as security and privacy issues. There have already been significant leaks, and Jayanth Varma compares its transaction authorization to “signing a blank piece of paper.”

    But there’s a reason Wharton’s fintech group calls it “the bedrock of a digital India.”

    A significant plank of the India Stack, the Unified Payments Interface, will allow Indians to move money freely without negotiating various “walled garden” e-wallet networks. More and more people are opting in.

    In a country with hundreds of spoken languages and widely varying educational levels, something along the lines of India Stack is the only way for digital payments to take hold.

    6. India’s fintech opportunity is here.

    Fintech partnerships in India are an area of extraordinary potential.

    According to PwC and Startupbootcamp, 95% of incumbent financial services firms in India are interested in fintech partnerships.

    Payments stand out as a hotbed of activity and innovation. The Unified Payments Interface is a case in point: Its monthly transactions rose to almost 77 million in October. It’s not a coincidence that PayTm, a payments company, recently attracted the largest funding round by a single investor in an Indian start-up.

    Peer-to-peer lending (P2P) is also a hot area. The Reserve Bank of India has just announced regulations for the sector to help move it out of the shadows and into the mainstream. But the next wave of financial services innovation is coming from unexpected places. Apps that provide telematics are helping to understand driving behavior and underwrite risk in motor insurance, and e-commerce marketplaces like Flipkart are launching financial services offerings.

    This is just the tip of the iceberg. According to a report by Tracxn, there were 750 registered fintech companies in India in 2015, of which 174 launched that year alone. The opportunities for growth are vast: Even after demonetization, 95% of financial transactions in India involve cash. Fintech can provide India’s high-earning youth with investor education and direct access to the tools to help them make the most informed decisions. And as access to broadband and smartphones increases, these firms could offer inclusive financial services to the whole country.

    7. Institutions are strengthening.

    There are many forms of infrastructure. The traditional kind — bridges, roads, and ports — is still much needed in India. But the intellectual and relational infrastructure necessary for development is growing ever more robust. A few years ago, Ortel spoke with author Anita Raghavan about the breadth of the Indian diaspora, which is the world’s largest.

    Those are familial and geopolitical ties, but India is making remarkable strides on other fronts. Last year, U.K. Sinha, the chair of the Securities and Exchange Board of India, said that minority shareholders have better rights in India than they do in the United States. While saying it doesn’t make it so, India’s soft infrastructure has made great strides.

    A whopping 70% of the Indian population pays out of their own pocket for medical expenses. This typically strengthens the financial mechanism of the insurance sector. In the United States, the out-of-pocket expenditure is much lower, around 10% to 12%.

    Hard infrastructure has made advances as well. India’s rail network moves 23 million people every day, and will soon feature solar-powered coaches. This is progress, but more rails and roads will be needed to close India’s output gap.

    Growth comes next.

    The domestic investment industry is a hub for business process outsourcing, but banks are shipping highly skilled work to India to support a variety of global businesses. For example, Goldman Sachs spent $30 million to establish a center in Bangalore back in 2004. Now it is building a $200-million campus there with enough space to accommodate 9,000 people, more than a quarter of its 34,000 global staff.

    But India is still a tiny position in the global market portfolio. At 8.64% of the MSCI emerging markets index, India is weighted less than Taiwan (11.42%) and South Korea (15.63%). Increased attention should change that.

    All we can say for sure is that we’ll keep going back. The next decade of growth in India will bring millions out of poverty, into the formal economy, and toward better lives. It will be remarkable to watch and rewarding to participate in.

    Perhaps we’ll see you over there?

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    tag:srvo.org,2013:Post/1328846 2018-01-18T17:00:00Z 2018-10-04T12:44:17Z How to See the Hidden Risks of ETFs

    I wrote this with my CFA Institute colleagues Paul Kovarsky, CFA, and Antonella Puca, CFA, CIPM, CPA. It was first published on the Enterprising Investor.

    Exchange-traded funds (ETFs) attracted more flows than “any structure ever” in 2017, according to Bloomberg’s Eric Balchunas.

    Is that bad? Steven Bregman, CFA, of Horizon Kinetics says the herd behavior ETFs inspire will be the “Delivery Agent of the Great Bubble.” Mohamed El-Erian believes that the instruments “over-promote” the liquidity of their underlying securities, which is in line with findings from BlackRock in 2015 that fixed-income ETFs trade much more often than the bonds that comprise them.

    Such sins, both real and imagined, mean ETFs are now described as “weapons of mass destruction” with disconcerting regularity. Mark Weidman, the global head of iShares, has said “ETF apocalypse concerns are way overdone” at least once. And yet the murmurs continue.

    There is no doubt ETFs are weird, but managing the risks they pose on behalf of clients doesn’t require a high-definition vision of the future. It just takes a simple question:

    What can’t the client see?

    ETFs are a great way to fulfill client objectives, but they also create a handful of opportunities to miss the mark. So advisers need to be vigilant.

    A primary risk is that the fund will fail to appropriately track its benchmark. This can happen because of market conditions, despite the best intentions of the fund sponsors. So rather than adopting a “set it and forget it” mindset, advisers need to be diligent and monitor the ETFs in which they invest.

    A straightforward example of this comes from the world of high-yield ETFs. Lisa Abramowicz noted this summer that the SPDR Bloomberg Barclays High Yield Bond ETF, trading under the ticker JNK, underperformed its benchmark by an average of 1.69% for the three years preceding her 18 August 2017 column. Rival fund BlackRock’s iShares iBoxx USD High Yield Corporate Bond ETF (HYG)’s three-year average underperformance of 0.79% seems like alpha by comparison.

    It’s understandable that there would be a difference between the performance of an index and the vehicles designed to track it. Even when their objective is just to replicate an index, investment vehicles come with costs that are not always explicit. A 2013 exploration of these issues from Morningstar found that funds generally did a good job limiting tracking error, but also pointed to interesting issues. The weekly error for ETFs tracking the MSCI Emerging Markets Index, for instance, ranged from 0.04% to 1.5%.

    A Defining Challenge

    If the performance of ETFs that track specific indices can be that variable, what about the funds with more idiosyncratic objectives?

    Take the iShares MSCI BRIC ETF (BKF) and the Guggenheim BRIC ETF (EEB) as cases in point. Both seek to provide diversified exposure to Brazil, Russia, India, and China, but how much of each? The iShares offering had 61.5% invested in China and 7% in Russia at the time of this writing, while Guggenheim’s fund had 20.2% in China, 13.9% in Hong Kong, and 18.1% in Russia.

    You would think targeting just four countries would make the innate challenge of defining emerging markets simpler, but that’s just not the case. Fund structures can only mask the intrinsic complexity of markets, not eliminate it.

    A vignette about ExxonMobil that Bregman offered to Grant’s Interest Rate Observer illustrates this well:

    “Aside from being 25% of the iShares U.S. Energy ETF, 22% of the Vanguard Energy ETF, and so forth, Exxon is simultaneously a Dividend Growth stock and a Deep Value stock. It is in the USA Quality Factor ETF and in the Weak Dollar U.S. Equity ETF. Get this: It’s both a Momentum Tilt stock and a Low Volatility stock. It sounds like a vaudeville act.”

    It may be the case that 138 years after John D. Rockefeller et al. formed the Standard Oil Company of Ohio, the shares of its corporate successor are indeed a tidy fit for such a broad diversity of investment objectives. But if that’s true, it also means that the risk of confusing activity and progress in managing ETF portfolios is real.

    Ask the Right Questions

    Determined curiosity is the primary asset you have to address these risks. A Comprehensive Guide to Exchange-Traded Funds (ETFs) is likely to be helpful, but there is no substitute for your own analysis.

    So ask questions. How liquid is this fund compared to the securities that compose it? Does it trade at a premium or a discount to its net asset value? Is there leverage built into the structure, and if so, is that leverage constant or variable? How closely does it track its benchmark?

    But don’t forget the most important question: Does this asset fulfill a useful purpose in this portfolio? The recent wave of ETF offerings comes with a substantial risk of distraction: Diligencing structures are not necessarily indicative of progress towards fulfilling an investment objective.

    It is critical to advance the state of practice in this area, and that’s why we will be joining industry leaders at the Inside ETFs Conference next week to listen, learn, and teach. What’s clear already is that most practitioners have plenty to learn about the structures that will likely continue to grow in prominence for the rest of our careers.

    As cutting edge becomes commonplace, we’re hopeful that discussion will turn away from apocalyptic predictions and towards the mechanics of diligence.

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    tag:srvo.org,2013:Post/1217170 2017-12-15T15:00:48Z 2018-09-03T17:22:20Z 4 Charts: Global Currency Crisis Count and Implications for Crypto

    What's a currency crisis? The most straightforward definition I can find is this: if a currency's nominal exchange rate depreciates by 10% or more in one year and then 25% or more in the following year, it's a currency crisis. 

    This definition originated (as far as I can tell) from a 1996 paper by Jeffrey Frankel and Andrew Rose, and has also been used in NBER materials. The numbers appear to have been picked somewhat out of thin air, but it's a useful rule of thumb.

    The recent run up in cryptocurrency prices has led me to wonder how many people have had their lives shaped by these sorts of events. If I'd lived through one, I think I'd be more likely to see the volatility, opacity, and other risks associated with crypto-assets as acceptable. They might even seem typical of currency in general.

    The links above list a number of crises, but are only updated through 2007. I pulled Nominal Effective Exchange Rate (NEER) data for 112 countries from the World Bank's Global Economic Monitor to do a quick-and-dirty update. Only 85 countries had data available in 1988, but by 1995 all 112 were included. 

    Here's the number of countries in crisis each year. 

    Here's the spreadsheet with the data

    Using this sort of rule is imperfect, since depreciations need to align with the 12 month calendar in order to register. For instance, Indonesia's 69% depreciation in 1998 doesn't count because it happened fast. 

    But with that said, roughly 1.3 billion people live in countries that have experienced this sort of currency crisis in my lifetime, many of them more than once. Here's a table of all of the countries that have. 

    It would be difficult to establish a hard link between these events and openness to crypto-assets, because they have occurred much less frequently in recent years. That comes across in the first chart, but here is the YoY change in all of the currencies in the dataset. It's amazing how much things have calmed down. 

    The contemporary picture is only placid compared to the chaos that surrounded the fall of the Berlin Wall, though. Since 2010, the percentage of countries in the sample that have experienced 10% or greater YoY depreciation has been rising steadily.

    There isn't a clear link between this currency volatility and demand for crypto, but I think it's helpful to understand the dispersion of human experiences with currency. Most of the world's capital is concentrated in countries that have been insulated from these sorts of wild price swings, and perhaps as a result investors forget how frequent they are. 

    Most of the bullish outlooks I've seen for crypto-assets are predicated on eventually capturing a material proportion of global market share. That seems moderately more plausible (though in no way preordained) after this exploration. And certainly it's easier to see why there might be innate global demand for a new kind of money. 

    tag:srvo.org,2013:Post/1212368 2017-12-06T21:18:55Z 2018-09-02T21:08:40Z Pioneering in Wall Street: How Women Came and Stayed and Conquered (1927)

    I spotted a remarkable artifact this weekend while vintage shopping: a 1927 copy of Century magazine with an essay by Eugenia Wallace entitled Pioneering in Wall StreetHow Women Came and Stayed and Conquered.

    Her legacy is essentially un-googleable, but the perspective Wallace shares is stunning for both its optimism and the candor with which she recounts the entry of women into the investment business. All I know about her at the moment is what's said in the magazine: 

    Eugenia Wallace came from the south to grow up around Columbia University, where she both studied and taught. In the pre-feminist day she braved the pits of Wall Street, as she describes in her article, and later became one of the leaders in the street's "woman movement." After the war Miss Wallace was vice-president of the committee that organized the National Federation of Business and Professional Women's Clubs, and served on the boards of many business, vocational, employment and other committees. In her leisure moments Miss Wallace delivers an occasional lecture, writes a short story, a magazine article or publishes a book. 

    I haven't been able to find any of her other writings, but am looking for them and expect to write a longer piece soon. Century was at one point the most popular magazine in the country, so this was an early mainstream moment. Here is the cover: 

    And here is the article she wrote: 

    tag:srvo.org,2013:Post/1209304 2017-11-28T19:06:00Z 2018-09-22T22:34:06Z Active vs. Passive vs. Amazon et al.

    The power of individual companies barely features in discussions of active versus passive investing.

    It ought to. The increasing returns to scale that certain companies benefit from has built more than just great investment returns. Technology-enabled “platforms” are omnipresent in our lives, with implications for everyone from parents and policymakers to C-suite executives. As these firms compound in power without much apparent profit, one can’t help but see them in their own category.

    Examining Amazon helps to better understand this phenomenon. Sentieo shows 770 mentions of Amazon in SEC filings from 439 different companies in just the last three months, more than the president of the United States. Alex Lykken, writing for PitchBook, notes that Amazon competes directly with companies ranging from Ticketmaster to Banana Republic to IBM.

    Lina M. Khan observes that Amazon’s influence is not easy to calculate “if we measure competition primarily through price and output,” the traditional way regulators have evaluated monopoly. Her 24,000-word essay was published before the company bought Whole Foods, and before CVS initiated a $66-billion buyout of Aetna that has been seen as “defense against Amazon’s potential entry into the pharmacy space.

    What’s confounding is that bullish investors are the quickest to use “the M word.” Chamath Palihapitiya began his pitch at the 2016 Sohn Investment Conference with “We believe there is a multi-trillion dollar monopoly hiding in plain sight.”

    A further wrinkle: The only chart in Khan’s essay has been widely cited by investors shorting Amazon:

    Amazon’s Annual Revenue and Net Income

    Amazons Annual Revenue and Net Income

    David Einhorn, for example, initiated his short position in 2014, noting that “Now growth is slowing, but rather than unleashing higher profits, the slower growth is leading to even greater losses.”

    It hasn’t mattered. This stubbornly low-profit company has outperformed the S&P 500 by double digits or better in six out of the last 10 years.

    Primitive Competition

    There’s nothing wrong with competing and winning, but a track record of victory implies casualties. These are not hard to find. Bespoke Investment Group publishes The Bespoke “Death by Amazon” Indices, and investment firm adventur.es recently published Gorilla Mode: What Amazon Means for the Rest of Us.

    In 2016, Ben Thompson wrote “The Amazon Tax,” which offers a compelling exploration of the company’s growth. Amazon took an early decision to concentrate on building “primitives” — the most basic elements of services — that the company could use and also sell to outside developers. The approach with each primitive, per Thompson, is to “get out of the way, and take a nice skim off the top.”

    There’s no question that this approach is one of the most important of the modern era. Amazon is a beautiful executor with an unbelievable economic engine and unusual investment opportunities. These investments pay off. As Justin Fox noted in Harvard Business Review, the company generates cash remarkably well.

    So where are the profits? The company’s $4.1 billion in operating income during 2016 is a drop in the S&P 500’s trillion, according to Edward Yardeni and Debbie Johnson in their report, “Stock Market Briefing: NIPA vs. S&P 500 Profit.” (See Figure 16).

    Monopoly Money

    The 10 most profitable firms in the Fortune 500 made $226 billion in 2015, and Amazon still isn’t one of them.

    It’s worth wondering why. When McKinsey & Company released an analysis of the global profit pool in 2015, they highlighted a trend that would seem to play directly in Amazon’s favor:

    “Sectors such as finance, information technology, media, and pharmaceuticals — which have the highest margins — are developing a winner-take-all dynamic, with a wide gap between the most profitable companies and everyone else.”

    That same report included a remarkable finding: The top 10% of firms account for 80% of all profits. This leaves us with two seemingly conflicting truths: Winners win bigger than ever, but one of the world’s biggest winners is not making much in the way of profits.

    How’s that for a brain twister?

    Making sense of the company’s soaring stock price and still-forthcoming profits is becoming a cottage industry. Aswath Damodaran writes in “Loss Leader or Value Creator? Deconstructing Amazon Prime“:

    “I have long described Amazon as a Field of Dreams company, one that goes for higher revenues first and then thinks about ways of converting those revenues into profits; if you build it, they will come. In coining this description, I am not being derisive but arguing that the market’s willingness to be patient with the company is largely a result of the consistency with [which] Jeff Bezos has told the same story for the company, since 1997, and acted in accordance with it.”

    Amazon is an example of a long time frame functioning as a latent currency for investors. It’s the “dark matter” that helps rapid growth and unrelated profits make sense. The central presence of the company’s founder helps us to have faith that a vision — not just millions of packages — will be delivered.

    But now imagine Amazon is just a singularly successful operator in an entirely new market context. Remember: If the “world is flat,” it’s flat for everyone. Amazon may just be the focus because we pay extra attention to companies that come early in the alphabet.

    Joseph Stiglitz won the Nobel Prize in economics for advancing models that accounted for asymmetries in information. In “America Has a Monopoly Problem — and It’s Huge,” he recommends considering a breadth of issues that can come from increasing concentration in market power.

    No Easy Answers

    It might be that the lens of competition and antitrust simply provides a window into a set of challenges that are best addressed elsewhere. Carl Shapiro traces the problem elegantly in a forthcoming paper for the International Journal of Industrial Organization. His discussion with Walter Frick of the Harvard Business Review ends with the opinion: “when people express general concerns about the power of the large tech firms and look to regulation to check that power, I’m more skeptical.”

    There seems to be a consensus that the analytical norms of antitrust regulation that focus mostly on short-term price effects should be revisited, but there is no evidence that such work can invert the anticompetitive nature of these newer firms.

    Damodaran revisited his thoughts on Amazon and other large tech companies in a lecture at the CFA Institute Conference: Equity Research and Valuation 2017. When the subject of monopoly came up, he said, “These models have an in-built structure where they are going to tip into winner-take-all areas. The cost of adding a new user gets smaller and smaller the bigger you get. [This starts] creating a competitive advantage that gets harder and harder to bridge.”

    It’s not unusual for a few stocks to drive broader market performance in a given year, but we would be foolish to ignore that it has been the same several stocks quite frequently in recent years. Facebook, Apple, Amazon, Netflix, and Google are responsible for roughly 20% of the S&P 500’s performance this year, and generated more than the entire return of the index in 2015. Is it healthy that including or excluding monopoly firms explains so much performance?

    It’s true regardless.

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    This was first published by CFA Institute.

    tag:srvo.org,2013:Post/1205520 2017-11-15T23:00:00Z 2018-09-03T19:22:12Z Looking Forward After Years at the Vanguard

    This interview was first published on the CFA Institute website.

    John C. Bogle ("Jack") is probably the most influential investor of all time. I was lucky to interview him at the CFA Institute Annual conference, and even luckier to get his autograph on a copy of an article (Michael Porter's What is Strategy?) with the diagram below inside. 

    And here is the interview:

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    tag:srvo.org,2013:Post/1328843 2017-11-10T17:00:00Z 2018-10-04T12:36:30Z Study the Exceptions

    Warning: This essay features a discussion of French literary theory.

    I know, bear with me. The good news: It’s pretty funny. And if you’re looking for a new and productive window on some of the unexpected developments in 2017, each of the linked stories will give you a view of something interesting and amusing.

    ‘Pataphysics — spelled with an apostrophe to avoid the obvious pun — is hard to define. That’s the point. It’s been described as the science of imaginary solutions, of the particular, and of the laws governing exceptions.

    It was put forward by Alfred Jarry, who suggested it established the “superiority of virtuality” over the concrete. Not accepting conventional wisdom at face value is right in the center of the ‘pataphysical tradition. Dr. Faustroll, one of Jarry’s characters, explains:

    “Contemporary science is founded upon the principle of induction: most people have seen a certain phenomenon precede or follow some other phenomenon most often, and conclude therefrom that it will ever be thus. Apart from other considerations, this is true only in the majority of cases, depends on the point of view, and is codified only for convenience — if that!”

    The ‘pataphysical prescription is to appreciate the subtle, irreproducible, and obscure. Massachusetts Institute of Technology (MIT)’s Archive of Useless Research is an interesting example of the value that can come from such an exercise.

    In a 1989 interview with UPI, the archivist Helen Samuels explained that the university keeps it because “We’re an institution that looks at the evolution of scientific research . . . It’s very easy to document our Nobel Prize winners and advances in mainstream science, but it’s also useful to document the craziness, the fringe, or you don’t get a full picture of what’s going on.”

    But it’s not enough to go off the beaten path. To a ‘pataphysician, it’s also critical to think about the nature of paths themselves.

    This is because the delivery of information changes both its nature and our relationship to it. In his essay “‘Pataphysics of Year 2000,” Jean Baudrillard writes, “Where should one stop the perfecting of the stereo? Its bounds or limits are constantly pushed back or forced to retreat in the face of technical obsessions. Where should information stop?”

    When I talk to investment professionals, perhaps the most common observation they offer is that there is too much disconnected information. The real-time trap — where we are bombarded with updates yet learn nothing — should be familiar to all of us. Baudrillard described it and the resulting alienation of societies from their own history at the dawn of the millennium.

    But what does this mean for our work?

    Investment managers are intimately concerned with seeing the truth of the organizations that they invest in and how they relate to society. As Damian P. O’Doherty of the University of Manchester wrote nearly a decade ago:

    We are beginning to see then that, on the one hand, we are confronted with practitioners of Theory, inheriting the traditions of sober, scientific method, but producing, nonetheless, strange and often startling, internally inconsistent findings; on the other, all pretence at participating in a disciplinary project that proceeds by linear, incremental steps of iteration and addition has been abandoned.

    Seemingly unconcerned with collective synthesis or contributing to any shared, iterative construction of a common understanding of organization that would enable communication, debate and compromise, recent developments simply prefer to promote idiosyncrasy, difference and shock.”

    He concludes by asserting that ‘pataphysics offers a solution to this issue by prompting us to see the absurdities that surround us for exactly what they are: exceptional.

    The spreadsheets and databases we employ as investment professionals often purport to describe “the universe” without irony. There are good reasons for this, but as we go into the weekend and towards the end of the year, we’d be well served by remembering that these universes are systems of exceptions.

    Here are a few related readings you might find interesting:

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    tag:srvo.org,2013:Post/1205513 2017-10-25T16:00:00Z 2018-10-04T12:29:06Z A Trillion Dollar Hedge against the US Retirement Crisis

    I wrote this for CFA Institute and first published it on the Enterprising Investor

    Most proposed solutions to the US retirement crisis boil down to a simple maxim: Spend less, save more.

    That makes sense. “Enough money” is an important component of building a retirement system that works. Fiduciary oversight and high returns won’t do much for an underfunded system, so it’s easy to see why discussions about reform quickly land on a simple question: Where to send the bill?

    There are more productive places to take the conversation.

    Back in 2010, inspired by a Wall Street Journal article, an online commenter known as “Beowulf” observed that the US Treasury theoretically has the power to mint a trillion-dollar coin. Beowulf’s coin idea gained further currency amid the debt ceiling debates of 2011 and 2013. The Obama administration, coin proponents said, could forego negotiations with the US Congress by just minting a trillion-dollar platinum coin and paying off the debt.

    Platforms as wide-ranging as The New York Times, the American Enterprise Institute, and MSNBC discussed the proposal. A former director of the US Mint even said that minting the coin was not only legal but (at the time) expedient.

    My contention is that this “silly but totally legitimate” loophole could be used to endow a US sovereign wealth fund.

    Just in Time

    The US Government Accountability Office released a 173-page survey of our fast-approaching retirement crisis a few days ago.

    Things are bad. The growing striation in US incomes contributes to a significant and widening disparity in retirement savings. Fidelity suggests that savers should seek to have 10-times their income stashed away by age 67.

    Only the highest quintile of earners has anything near that.

    Retirement Savings by Cohort

    These private savings are a crucial buffer for retirees. The absolute maximum Social Security benefit a person retiring in 2018 can receive is $44,376. But that is still just 43% of the lowest base salary the person receiving such benefits would have earned prior to retirement. And most people are not so fortunate: The average Social Security benefit is closer to $16,000 a year and about three of five Social Security recipients rely on the program for at least half of their total income.

    Moreover, accelerating changes to the US demographic structure will make Social Security’s income-based funding model less and less sustainable. By 2035, just 2.2 workers will be supporting each Social Security beneficiary, according to estimates, compared to 2.8 workers today.

    And those figures assume that demographics aside, the nature of work won’t be much different in 2035 than it is today. But as Y Combinator president Sam Altman noted, artificial intelligence (AI) is developing rapidly with potential ramifications for workers. In particular, Altman referenced an OpenAI bot that recently defeated some of the top human Dota 2 players. Soon after the bot’s victories, a new version was created that exceeded the capabilities of the undefeated one. According to recent estimates, AI could outmatch humans at translation by 2024, and earlier this month, Google unveiled headphones that it claims can translate 40 languages almost in real time.

    The technological shifts don’t need to be all that significant to significantly impair people’s ability to earn a living.

    Cash Flows

    As progress in AI marches onward and reshapes the nature of work, the elderly will continue to depend on a retirement system that requires many incomes to function.

    Even without the forthcoming transformation of the workforce, the funding picture for Social Security doesn’t look great.

    Screen Shot 2017-10-22 at 10724 PM

    What happens if fewer people are working by 2025? What if, as PwC estimates, “fewer” translates to the elimination of 38% of US jobs by the 2030s? Peter Norvig, Google’s director of research, “certainly see[s] that there will be disruptions in employment.” Treasury Secretary Steven Mnuchin is not so worried, and I hope he is correct.

    If he’s not, a cash flow of “just” negative $174 billion in 2025 will seem fairy-tale optimistic.

    Learn from the Guardians

    Other countries have felt these headwinds and done something about them.

    New Zealand is a case in point, as I learned at CFA Society New York‘s 3rd Annual Sovereign Wealth Fund conference. (These forums are strictly Chatham House Rules, but I can still tell you what I googled afterward.)

    The New Zealand Parliament recognized the mounting challenges the country’s demographic trends posed and in 2001 endowed a sovereign wealth fund to counteract them. The government will begin to withdraw money in 2035–2036, but the fund is expected to continue growing until 2073.

    It has already served its purpose quite well.

    Screen Shot 2017-10-22 at 21505 PM

    A strong internal culture of alignment with beneficiaries — employees refer to themselves as “guardians” — has propelled this growth. So too has a remarkable governance structure and the innate advantages that sovereign wealth funds enjoy. These kinds of investing entities can be remarkably pro-social. They don’t just provide a direct link between market progress and social welfare, they also build, buy, and operate infrastructure; stabilize currencies; and prove up new asset classes.

    Imagine how much economic anxiety in the United States could be soothed by such a mechanism.

    Matthew O’Brien wrote in 2013, at the height of the debt ceiling debate, that the trillion-dollar coin “might just be the crazy solution Washington deserves and needs.” Today, if properly governed and given time to mature — a 30-year plus horizon would be ideal — a sovereign wealth fund bankrolled by that trillion-dollar coin might just be crazy enough to cushion the approaching impact of the US retirement crisis.

    At the very least, it would give Americans a tangible reason to worry less about how they will afford to eat in their old age.

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    tag:srvo.org,2013:Post/1197460 2017-10-11T00:55:59Z 2017-11-15T16:52:00Z Out
    Coming out of the closet sounds simple: 
    1. Open the door. 
    2. Exit the closet.
    3. Close the door behind you (optional).

    There is a bit more to it than that. 

    I was genuinely surprised at how many times I wound up coming out. I told my family I was transitioning in October of last year, started hormones in December, and updated my Facebook profile in January, but continued to present male professionally until the end of September 2017. I came out hundreds of times in the intervening period, and I have been lucky not to lose a friend or (to my knowledge) alienate a colleague in the process.   

    When I posted my personal update on Sunday, that finally finished. I had sent a letter on the previous Friday to my colleagues at CFA Institute and was ready to make who I am all the way google-able.

    So I did. 

    People from all over the world have since written to express congratulations and support through social media and email. This torrent of affirmations coupled with the trickle of smaller ones i'd gotten in the prior months to entirely change my life. 

    Buttoned-down, serious people have not hesitated to accept me. Some even went so far as to say "why would this change anything?"

    Not everyone is met with so much positivity, and there is no question that I am lucky. But I think you should know how far this was from my expectations. In the echo chamber of the closet, I convinced myself that I would be forced to make a living as a sex worker if I opened the door. 

    I never talked about it, and so I never examined that absurd idea. It started to seem non-negotiable, like death or taxes. 

    We are capable of believing anything with our eyes closed to contradictory evidence. 

    National Coming Out Day will be celebrated on October 11th 2017 for the 29th time. I am glad to share that the people who surround me have exceeded my wildest expectations, and my hope is that others who have edited their own dreams out of reality will give their surroundings a chance. 

    I know it can be hard to find the words, and so I've reproduced the letter I sent on Friday below. 

    I wish you all the best as you move forward on your own journey. 


    I would like to share a personal detail with you: I am a transgender woman. 

    This tends to come as a surprise, but that’s the nature of secrets. This is the only good one I had. I am thrilled to share it with you as a mundane fact. I’ll just ask one favor: please keep this to yourself until you see a more formal announcement in the next few weeks. This letter is just going to the people I've had closer contact with over the years. 

    Some of you have known this was coming for months, and your support has been a remarkable source of strength and wisdom. For most of my life, I had assumed that I would have to leave any professional ambitions behind if I stepped out of the closet. I am overjoyed to learn that won’t be necessary, and indebted to you all for building a workplace that slowly chipped away at my own self-limiting assumptions. 

    Of course, “colleague” does not have a gender, and so in a way I am announcing nothing has changed. I understand if you don’t quite see that yet, or if you are unsure about how to refer to me. The last bit is not complicated: I am a woman, which means I am “she” and the things I possess are “hers.” 

    I’ll also be changing my name. Pleased to meet you: I’m Sloane Ortel. 

    I understand many of you have known me for a while, and are not used to referring to me that way. It’s important you know I will always trust the intention in our interactions, and also that it’s very easy for me to separate an error from a slight. If you can respect me as a human, seeing me as a woman is a matter of time. 

    I trust you will get there, but I also know that you may not know very much about trans issues or the broader ”queer” community. Clicking through a few of these comics might be a fun way to fill that gap if you’d like to. CFA Institute has also been predictably, wonderfully diligent in ensuring this doesn’t catch anyone off guard, and you can expect to hear from people who know more than I do in the coming months. 

    I am happy to discuss the details of my own situation with you at an appropriate time, but the bigger hope is that you will see it as a reminder everyone has their struggles. 

    Hiding my own has meant near-constant multitasking. 

    I will discontinue it with pleasure, and look forward to putting my added capacity toward the work we’ll do together. Specific thanks are due to dozens of you, and you know who you are. Acceptance is due to everyone, and our privilege is to work so they get it.  

    With admiration, excitement, and serenity —  

    Will Sloane

    Sloane Ortel 
    Direct: (Phone number redacted)
    Twitter: @sloaneortel
    Writing: Enterprising Investor