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How Finance Can Build a Better World

By Will Ortel

To think about how financial professionals can change the world, think first about how far we’ve come.

I’m fond of reminding readers that it was once a fringe idea to examine accounting information and derive something of value for the investment decision-making process.

We didn’t arrive at modern best practices because a factor model fell out of a tree onto the head of a sleeping investor. The profession of investment management has developed over time through an iterative process where people tried different things, many of which were once considered too far from the mainstream to be taken seriously.

What’s weird today that will seem obvious tomorrow? It’s a great question to ask yourself semi-regularly. There is little to lose from paying attention to the fringes of human knowledge.

There’s a lot there.

You can study existential risk, learn how to teach an algorithm creativity, or maybe just keep it simple and think about the knock-on effects of the investments you make. Capital is a powerful thing. It would be foolish to ignore the role that your decisions play in the broader world.

Especially when there is so much good to be done. For evidence of that, consider the documentary Living on One Dollar, which records the difficulties that a few Westerners faced trying to live as Guatemalan locals do. One of the more telling bits of the program was when the conversation shifted to a common financial objective among rural Guatemalans: stove ownership.

The wrong thing to take away from that is “Oh, all they need are stoves!” The question worth asking is: “What if they could get a loan?”

Don’t discount the potential of credit access.

Extending credit to underserved communities is one of those easy-to-say, hard-to-do things that is full of controversy. Collecting interest payments from impoverished borrowers is a source of concern that raises challenging questions about the trade-offs between short-term profits and long-term prosperity. Additionally, studies have shown that this kind of activity, broadly described as microlending, is not the most effective way to end global poverty.

However, the expansion of credit offered by microlending has had some notable benefits expanding labor options, boosting business size, and helping families manage their budgets. Access to credit has improved the choices available to global consumers earning and spending money, and these options would not have been explored without the work of microfinance pioneers such as Muhammad Yunus, the founder of Grameen Bank.

By considering economic incentives from a different perspective, Yunus was able to develop a business model that functioned at the intersection of capitalism and social responsibility. He will elaborate on these themes in his keynote address, “Redesigning Economics to Redesign the World,” at the 2016 European Investment Conference.

How big an influence Yunus’s model and microlending in general will have on alleviating global poverty remains uncertain, but the insight and innovation that motivated their development represent the sort of thinking that can truly make finance a force for good.

We could use more of it.

This article originally appeared on the European Investment Conference blog.

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The Fixed-Income Challenge: The Monetary Policy Pit

By Jason Voss, CFA

Fixed-income investors historically needed to worry about only two closed-state factors: the yield curve and issuer credit quality. Smart investors put tremendous energy into evaluating these two considerations at the outset. Once assured an investment was made, investors could apply appropriate asset allocation and clip their coupons.

Gone are those days. The global financial crisis saw to the demise of closed-state fixed-income analysis.

Now contexts requiring attention — even in such previously sleepy fixed-income markets as US government debt — are myriad.

Investors still worry about the yield curve and credit quality. In fact, as the income has disappeared from fixed income, there is no longer yield compensation for risks. So everything is about assessing the factors that affect credit. What considerations have been added to the mix? Global GDP growth, the fiscal policies of major economies, population demographics, geopolitical risks, decreasing liquidity, emerging market capital-flow volatility, and on and on.

Since so many factors affect credit quality, fixed-income investors are now just as fundamental in their analyses as their equity counterparts. They have to be, because the obstacle course is so much more challenging today.

But what is the biggest hurdle to success right now for fixed-income investors? Earlier this week, we asked CFA Institute Financial NewsBrief readers. Is it central bank actions? The vulnerability of emerging market debts to capital-flow volatility? An aging population in the leading economies and the associated pension pressures? A dearth of liquidity in most debt securities? Lagging economic growth? The deteriorating financial condition of credits?

The Monetary Policy Pit

An overwhelming majority of respondents (57%) said monetary policy is the major impediment to fixed-income investors. Why is this not surprising? Because the yield curve of old resulted largely from central bank actions. It is tempting, therefore, to conclude that nothing has changed from the old days of “Don’t fight the Fed.” I think, however, that most fixed-income investors believe the current environment is much different from previous eras.

For starters, there are now many globally important central banks other than the US Federal Reserve: for example, the European Central Bank (ECB), the Bank of England (BOE), the Reserve Bank of India (RBI), the People’s Bank of China, the Swiss National Bank (SNB), and the Bank of Japan (BOJ). Each of these banks can now affect the entire global fixed-income market with a misspoken word. This is a very different situation than ever before, when fixed-income investors only had to concern themselves with maybe two central banks.

What else is different about the current era? Of course, the extraordinary monetary policies adopted by the world’s leading central banks. These measures have scant historical data to support their use. Are they benevolent in propping up the economy for the long-term good? Or are they malevolent and undermining the foundations of the economy — like price discovery and inflation — for long-term ill? Is aggregate demand helped, hurt, or made irrelevant by these policies? Is inflation in check or bottled up and waiting to explode? No one knows, and this uncertainty means it is very easy to be on the wrong side of central bank policy as each nation acts in its own interests with little coordination.

Tepid Economic Growth

Imagine you could hypnotize central bankers and ask them why they adopted extraordinary monetary policies. What would they say? “Tepid economic growth,” most likely, and 17% of poll respondents agree. Global fiscal policy in the post-crisis era provides almost no economic support in most developed nations. Instead, gridlock is the new normal for the United States and the European Union (EU), in particular. But it is not as if fiscal policy is innovative and supportive in other economies either. Can anyone point to a modern equivalent of the New Deal? Nope. What country serves as a global role model for fiscal policy innovation? No one.

Furthermore, can a debt crisis — which is how many characterize the global financial crisis — be solved by issuing more debt? If capital was poorly allocated previously, what makes investors believe it will be better allocated now? In fact, isn’t that the real reason for sputtering economic growth? Misallocation of capital. After all, central banks have injected market-warping amounts of “free money” into the global economy, and yet demand for capital for value-added capital investments remains anemic. Where is all the innovation? Where are the successors to the large-scale innovators of previous economic eras? Crickets. In short, there is an aggregate demand problem: No one wants a piece of the economic future.

If economic growth slows, issuers suffer and, consequently, so will the fixed-income investor. That’s an obstacle if ever there was one.

Graying Populations in Major Economies

But maybe the principal challenge in fixed income is not central bank policies or sluggish economic growth. Instead, perhaps it is the aging demographic profiles of North America, Europe, China, and Japan. After all, it is a near law of economics that as people grow old, they cut back on consumption, save more, and re-allocate what they do spend towards less productive enterprises, like health care, second homes, and vacations.

And, of course, the black lining inside of this cloud is the state of global pensions. Low interest rates make paying for promises made generations ago extremely expensive. Many pension trustees are taking on more risk in a quest for capital gains and higher yields. Increased risk in the safe portions of the portfolio is obviously not helpful to fixed-income investors.

According to 11% of survey respondents, these aging demographics — and the associated pension-related complications —constitute the chief stumbling block for today’s bond investors.

Everything Else

Distinct minorities of poll respondents consider a lack of liquidity in fixed-income markets (7%) or declining credit quality (6%) to be the biggest challenge. Liquidity has never been good. But in the face of monetary policies and recent financial regulations, bond market liquidity is evaporating. The combined total assets of the major central banks have ballooned from $6.4 trillion in 2008 to $17.6 trillion today, for a net increase in assets of $11.2 trillion in just the past eight years, according to Edward Yardeni. This drives other players out of the market and likely is hurting liquidity.

On the regulatory side, the capital requirements and leverage ratio implications of Dodd–Frank and Basel III have discouraged many banks from maintaining large inventories of bonds like they did in the past. These challenges notwithstanding, investors must still contend with credit quality concerns. So it is not surprising that some respondents are so concerned with credit deterioration: This is the part of fixed-income investing that is changing most rapidly. To paraphrase game theorists: All of the other obstacles are now known knowns.

Finally, the volatility of capital flows for emerging market fixed income was identified by only 2% of survey participants.

Apparently few expect another event like the Mexican debt or Asian financial crises of recent decades. Put another way, if there is a problem on the fixed-income horizon, it is likely to come from a larger, more macro context.

And isn’t that a big risk, too? Too much consensus — “It’s the central banks, stupid” — leading to a lack of appreciation for the outsider risk?

For more on fixed-income sectors, security selection, and portfolio construction, the CFA Institute Fixed-Income Management 2016 Conference will bring together researchers, analysts, portfolio managers, and top strategists on 20–21 October, in Huntington Beach, California.

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

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Hiring a Career Coach: Is It Worth It?

By Julia VanDeren

Have you ever considered hiring a career coach?

The use of a coach has attracted considerable attention over the last decade, with various articles highlighting the thought process behind hiring one and why not hiring one “could be limiting your career success.”

In the past, coaches were viewed as part of a last-ditch effort to correct bad behavior at the top rungs of leadership. It was never good news if you were encouraged — or required — to work with a career coach. These days, companies hire coaches primarily to help develop high potential (“HiPos”) employees for leadership roles. Be proud if you are encouraged to work with one on your company’s dime.

But what if your company has not tapped you on the shoulder for coaching? When is it worth hiring your own career coach? And what kind of a coach — “career,” “executive,” “life,” “business,” “branding” — do you need anyway?

A coach’s job is to ask pertinent questions and suggest thought exercises to help you:

Understand your current reality.

Clarify your goals.

Identify the actions needed to achieve your goals.

Assess your progress.

Reflect on your success in achieving your objectives.

Establish new goals.

To determine what kind of coach you need, ask yourself what the change or progress is that you want to make. If you isolate the goal to one of personal branding — say you want to build a reputation as a thought leader in your industry — consider a branding coach. If you want to position yourself for more senior leadership roles, look for an executive coach. If you are in the midst of a job search, a career coach may be the best fit. If your whole life feels as though it’s completely out of control and you want to be forward-facing in how you go about changing it, a life coach could be in order.

Coaching can be extremely helpful, but coaches won’t simply give you all the answers, and they won’t do the work for you. Think carefully whether your personal commitment to the hoped-for change is in line with the time and money required for a coaching relationship.

Here are some tips for connecting with coaches:

Ask coaches about their training and certifications. Coaching is not a regulated industry, so literally anyone can claim to be a coach. Consequently, it is imperative that you investigate your potential coach’s qualifications. One of the industry’s most globally recognized credentialing bodies is the International Coach Federation (ICF), which issues the following designations: Associate Certified Coach (ACC), Professional Certified Coach (PCC), and Master Certified Coach (MCC). The differences among these are primarily a function of the number of experience hours logged.

Ask prospective coaches about their experience with others in your profession. It is not always essential that they have a track record with clients in a specific industry, but it is often preferable. There are coaches who have moved into the field from the investment management industry, including a few CFA® charterholders.

After you provide a summary of your situation, expect the coach to propose a specific course of action — a coaching program — complete with any associated fees. If a coach proposes an open-ended scheme or an indefinite fee structure, ask for more details.

Coaching fees will vary depending on the services provided. For example, entry-level career coaching is likely to be less of a financial investment than senior executive coaching.

Mutual trust and respect is essential to a successful coaching relationship, so it does matter whether you actually like and relate to your potential coach.

Here are a few additional resources you might find helpful if you are thinking about hiring a coach:

“All about Personal and Professional Coaching” (Free Management Library)

“Coaching FAQs” (International Coach Federation)

“What Can Coaches Do For You?” (Harvard Business Review)

“How to Choose a Great Career Coach” (The Guardian)

If you have engaged the services of a coach in the past, what resources did you find helpful in your decision-making process? Please share your lessons learned in the comments.

CFA Institute members and candidates: The CFA Career Centre contains the bios of several career and executive coaches who have been vetted for previous contract experience with financial institutions. If you have questions or would  like connect with these individuals, email your queries to [email protected].

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©iStockphoto.com/ilyast

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Does ESG Boost Returns?

By Will Ortel

Big questions usually come with incomplete answers.

Are you fulfilling your purpose? Is there life on other planets? Do you drink too much coffee? My own answer to the last one is a definite yes, but it would be hard to answer the other two with even a remotely similar degree of confidence.

Sometime between my parents’ generation and my own, the idea that a business could do both well (in a financial sense) and good (in a social sense) has entered the mainstream. Of course, at a general level, that is a bit like saying how great it is to get equity-like returns with bond-like risk: fluffy, sales-y, and skepticism inducing.

But it’s something people say because there is a large and growing body of evidence that it’s for real.

And if you think like a manager for a moment, it should be intuitive why this is. Start with employee engagement and retention: Doesn’t it stand to reason you’ll be better able to tap into the energy of your employees if they feel their work supports a cause they find meaningful? Isn’t it likely that would have at least some bearing on your ability to compete and, indeed, on whether you succeed?

Yes, But . . .

That intuition is great for managers, but it’s hard for investors to translate into something actionable. We can audit the degree to which a company is “doing good” by examining the information it releases on environmental, social, and governance (ESG) issues, but the path from disclosure to value creation is a murky one.

One straightforward reason for this is that a lot of the information that exists is not intended for investors. And though there is convincing evidence that good performance on selected industry-specific materiality data leads to increased returns, translating those aggregate-level insights into portfolio-appropriate ideas is not a linear process.

With these issues in mind, it seemed natural to ask what readers of CFA Institute Financial NewsBrief thought of how examining these disclosures might yield better returns.

Though only 7% of the 535 respondents said “of course” and suggested we Google it, the responses are quite consistent with my own belief that the investment profession sees at least the seed of alpha generation within ESG disclosures.

This is a question quite distinct from one we’ve asked much more rigorously in the recent past: Do you take ESG issues into account? Of CFA Institute members, 73% say they do, mostly because they view the analysis as a way to manage investment risks or because their clients demand it.

The plurality of respondents (37%) said something quite different: that these factors enter into any complete analysis.

CFA Institute agrees, and that’s why this year everyone who sits the Level I exam will find an added reading on ESG in addition to many others. It’s on the test because it matters: Imagine a company that fits your investment criteria but has a board packed with the CEO’s cousins. Or maybe revenue is growing much faster than costs, but the company releases no information about how it sources its materials.

Why would you ignore that?

I picked extreme examples for the sake of brevity, but they’re not impossible. And it’s hard enough to generate investment ideas, so it makes sense that nearly a quarter of respondents pay attention to this data by default. A further 16% of respondents gave the quite reasonable answer that their level of attention depends, since the information can be low quality or priced in.

This is true of information in general.

Another 15% of poll participants likely think that writing this up was a waste of time, that ESG material consists of nonfinancial information, which for such a cohort qualifies as non-important.

So I’d like to close by sharing some additional evidence that there is a link between strong performance on ESG factors and what investors care about by definition: generating cash from business activity.

The vast majority of more than 2,200 studies reviewed by Gunnar Friede, Timo Busch, and Alexander Bassen show a positive association between ESG factors and corporate financial performance.

Of the studies reviewed by Gordon Clark, Andreas Feiner, and Michael Viehs, 88% demonstrated that companies with robust sustainability practices had better operational performance, which translates into cash flow.

An excellent 2012 study by Mark Fulton, Bruce M. Kahn, and Camilla Sharples states “We were surprised by the clarity of the results we uncovered.” All of the 100-plus studies they reviewed found that companies with high ratings for corporate social responsibility have a lower cost of capital.

Those studies say other things too, and are well worth a read. But those excerpts should give a good sense that there is at least the outline of an alpha opportunity to be had by looking at ESG data.

But translating that opportunity into performance is difficult. Just take it from someone who’s done it: David Blood, a founder of Generation Investment Management, notes that he is reluctant to talk about performance “In some respects because [he is] suspicious.” And it’s appropriate for you to hold that same suspicion.

It might be worth examining your suspicion more closely if this passage from a 2015 Morgan Stanley report on sustainable investing has no effect on it (emphasis theirs).

“We reviewed a range of studies on sustainable investment performance and examined performance data for 10,228 open-end mutual funds and 2,874 Separately Managed Accounts (SMAs) based in the United States and denominated in US dollars. In the scope of our review, we ultimately found thatinvesting in sustainability has usually met, and often exceeded, the performance of comparable traditional investments. This is on both an absolute and a risk-adjusted basis, across asset classes and over time.“

That’s not the end of the discussion, but it does move it along. To me, it means that there is room to consider a sustainable approach to investing alongside value investing or statistical arbitrage as a tool that a professional investor can use to generate alpha.

Whether you go out and do it is up to you. If you’d like to, CFA Institute has plenty of information to help.

This post summarizes and extends a 19 July 2016 talk that I gave at the United States Mission to the United Nations. We are grateful to Ambassador Sarah Mendelson and the US State Department for the opportunity.

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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What Is the Focus in Fixed Income? Exogenous or Endogenous Factors?

By Jason Voss, CFA

Is there any doubt that since the onset of the Great Recession fixed-income markets, issuers, regulators, and investors have put their attention squarely on exogenous factors?

First Place: Monetary Policy

Taking first prize in fixed-income celebrity are global central banks, especially the US Federal Reserve and the European Central Bank (ECB). Every player in fixed income obsesses about the doings of Janet Yellen and Mario Draghi like teenagers do with Taylor Swift and Justin Bieber.

So what is in fashion?

Currently it looks as if the Fed is set to part ways with its long-time “cut-rates-only” aesthetic, while the ECB is struggling to find its next direction: Does it stick with its unconventional interest rate policy or opt for a renewal of a more conventional approach? Fiscal disunity, Brexit, an immigrant crisis, a lack of vigorous economic growth, tepid demographics, and lingering hangover effects from the Great Recession debt-binge are likely to lead to “more of the same” monetary policy.

The loose money policies have contributed to more uncertainty than certainty, in my opinion. Every investor is patently aware of the big gray pachyderm in the room: Can the global economy stand on its own? Or is the new normal a form of socialist money formation? And last, but not least: Where is fiscal policy support? Answer: Its manufacture has been exported to China like most everything else. Elsewhere, gridlock has led to policy rust.

Second Place: Tepid Economic Growth

Taking the silver medal when it comes to capturing the attention of the fixed-income community is the anemic quality of economic growth in the globe’s major economies.

For those who long believed in a mechanical mental model that too much money must lead to too much inflation, too much unproductive economic growth, and ultimately to DISASTER! the current environment must be bizarre. Why? Because the mechanism just isn’t working like it used to.

So let’s assume that the mechanism is broken — that too much money leads to too much inflation. Does that make you feel any better? That is, do you believe that the economy is functioning as it should? Is demand for credit strong? Are businesses asking for debt capital to finance new high returns on capital projects? Not really.

Please also do not look at the underlying demographics of Europe, China, Japan, or any other of the traditional economic engines. If you do, you will see a future of low real economic growth on the horizon. And there aren’t many ways out of this pickle.

You might be among the thoughtful who say, “GDP per capita is what’s important.” Granted. But putting GDP on a relative basis (per capita) does not get you off the hook for all of those assets that exist on an absolute basis. Think: infrastructure and real estate built for a population of size x, that ends up being 0.8x.

Furthermore, how do we pay for the enormous Pension Party that sent out so many invitations in the past three generations? Ouch! Is there yield to be had for a pension trustee? Hah! The only solution is to increase your risk by dumbing down your credits. This is going to hurt! Right?

Third Place: Market Structure

Given the two preceding prize winners, is it any surprise that market structure in fixed income is fractured? It’s turning into the market equivalent of the Dead Sea: stranded, drying up, small, and very salty. Where’s the liquidity? Where is the scale? Corporate bond liquidity was never great, and now it is worse.

Attempts to improve liquidity by creating e-exchanges have largely failed. Efforts to develop standardized contracts to improve liquidity look far off. Outright purchases of bonds by central banks are likely eroding price discovery. And on and on. Even the market making in treasury securities looks bad with a major player, the Bank of Tokyo, quitting its Japanese government bonds (JGB) market making job, and atrade settlement company in the United States exiting to leave only one player standing.

Consolation Prize: Endogenous Factors

It is understandable that exogenous factors dominate fixed income, but a wise person — Robert Rubin, in case you were wondering — once said, “By definition the greatest risk is the one you didn’t account for.”

Hard to refute that logic. So what is not being planned for right now by a majority of fixed income investors? Endogenous factors.

When was the last time you sat down as a fixed-income analyst, PM, CIO, or asset allocator and spent the majority of your time considering the quality of the business models of your credits? Or whether or not your portfolio was diversified well enough? Or whether or not the asset allocation served your end clients’ needs? Or whether or not your trading desk is getting the best execution? Or whether or not your firm has communications good enough to ensure an appropriate response to the inevitable shift in the exogenous environment?

One thing you can do to help roll back some of the uncertainty of fixed-income investing is to make sure that you consider opinions other than your own. Want a great place to do this? CFA Institute Conference: Fixed-Income Management 2016 in Huntington Beach, California, 20–21 October. 

Sessions will include a presentation from Michael Pond, CFA, managing director and head of global inflation-linked research at Barclays; a look at emerging market debt with Kristin J. Ceva, CFA, managing principal at Payden & Rygel; and a discussion of quantitative approaches for a variety of fixed-income sectors led by Thomas B. Parker, CFA, managing director and chief investment officer of model-based fixed-income at BlackRock. This October you can, at least, see two kinds of ace wave surfers at work: ocean and fixed income.

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©iStockphoto.com/erhui1979

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Is Technology Making Us Too Bullish on Stocks?

By Mark Harrison, CFA

It’s getting harder and harder to imagine how a momentum-driven bull market can last much longer if almost everyone thinks the markets are overvalued.

US equities have now swelled to nearly 60% of the MSCI World Index, around twice their representation 25 years ago.

Research Affiliates calculates a near record high Shiller P/E of 47-times cyclically adjusted earnings for US small-cap stocks and 27 times for US large caps — valuations that imply future expected shareholder returns of around zero. The picture is a little more sanguine elsewhere: A Brexiting United Kingdom has a Shiller P/E of just 12 times, Germany and France are at 15 times, while in emerging markets, China trades at 11 times and India at 18 times.

But a burst bubble in the United States — caused, let us imagine, by the long expansion of the US Federal Reserve’s balance sheet — suddenly exploding into inflation and currency debasement would endanger highly correlated markets everywhere.

Just in time for the market surge, a novel paper, “The Shiller CAPE Ratio: A New Look,” by Jeremy Siegel, was published recently in the Financial Analysts Journal® and summarized by CFA Digest. Siegel maintains that new US accounting standards adopted since 1993 have led to the overstatement of declining earnings in recessions and generated an artificially high cyclically adjusted P/E ratio.

So those investors gauging the elevation of the US markets with CAPE ratios might actually be too conservative. Yet Siegel, the so-called “Wizard of Wharton,” was similarly optimistic in an interview just before the dot-com bubble burst in 2000.

Is Social Media Turning Us into Stock Market Pollyannas?

Perhaps one reason panglossian market conditions can persist in the age of Twitter and Instagram is that omnipresent social media allow us to edit out anything that vaguely threatens our preferred mindset about stocks, even if such a willfully pollyanna-ish approach conflicts with inconvenient facts.

A new study evaluating Twitter, “Investor Attention on the Social Web,” from the Journal of Behavioral Finance, analyzed the StockTwits trading community on the social media platform. The researchers observed different categories of investors’ attention in real time to determine what drove that attention. They found no single regulatory mechanism or timescale and concluded that much depends on the skill and experience of the individual investor.

This finding is contrary to the tenets of the efficient market hypothesis (EMH), which assumes prompt and uniform attention to all available information. Distractions among investors include the all-too-human search for validation and social proof to confirm their rectitude. The authors conclude that stocks with higher volatility and momentum better capture investor attention.

Price-sensitive information can appear first in social and news media before impacting stocks. One study, “Wisdom of Crowds: The Value of Stock Opinions Transmitted through Social Media,” from the Review of Financial Studies, conducted textual analysis of articles on Seeking Alpha, a popular investor forum. It found that opinions transmitted through social media can actually predict stock returns and earnings surprises.

Similarly, further research confirms that “Media Makes Momentum.” Excess profits accrue to investors in firms with higher levels of newspaper coverage

Investment bubbles are typically assumed to feature individual investors and uninformed momentum trading. But the reality is more nuanced, according to another study, “Are Individual or Institutional Investors the Agents of Bubbles?” Using a study of South Korean markets, the study’s authors found trading by institutional investors, particularly foreign institutional investors, tends to be trend driven.

Conversely, individual investors appear to trade in a contrarian manner. Interestingly, the authors note that the actions of ubiquitous global hedge funds can easily distort local market valuations and quickly swamp local short-selling capacity.

More Dubious Networks

Other examples of dysfunctional networking abound. “Social Interaction at Work,” from the Journal of Financial Economics, suggests that people who work together often invest together. Using a large sample of Norwegian investors, the study finds co-workers invest in similar industries, which tend to underperform, and invest more like their colleagues as their tenure with their employer lengthens. The study is a salutary reminder of the dangers of crowding and the difficulty of exiting overcrowded trades as well as the virtues of keeping social and investment matters separate.

Empirical investor networks (EINs) lie between public media and private information sharing. EINs encompass private conversations, social networking, and blogging. A study of EINs found that comparatively centralized operators have a market advantage over those on the fringes of the EIN: Well-integrated members trade earlier and more successfully than their peripheral counterparts. Perhaps democratization in investing has reached its limits after all.

Conquering Distraction and Quantifying Noise

Distractions caused by vision-narrowing apps and dysfunctional networks can be a menace to investors trying to navigate uncertainty, but solutions are available. Exponentially increasing digital information is driven by the fear of missing out or being out of contact and carries a personal and professional cost, according to psychologist Larry Rosen and technologist Alexandra Samuel. Writing in Harvard Business Review, they propose that solutions to the heavy burden of overstimulation and exhaustion can be found in a psychological approach coupled with better use of technology — by controlling and moderating exposure to social media while also using technology itself to control overuse and prioritize, categorize, and sort new information.

Last but not least, stock market noise and uncertainty is embedded in all valuations, and we can certainly attempt to measure and quantify it. The IPO of Facebook offers an excellent opportunity for a case study of how uncertainty can be quantified. Aswath Damodaran discusses the valuation of the Facebook IPO and identifies three groups of uncertainties, each requiring a different response.

To help readers navigate and stay current on the latest related research, we have compiled a range of informative materials from CFA Digest and other CFA Institute publications.

“Are Individual or Institutional Investors the Agents of Bubbles?”: Bubbles in financial markets are generally believed to be driven by the actions of uninformed individual investors. But the authors’ detailed study of trading activity in the South Korean equity market suggests that trading by institutional investors, particularly foreign institutional investors, tends to be trend driven. Individual investors, however, appear to trade in a contrary manner.

“The Shiller CAPE Ratio: A New Look”: Jeremy Siegel argues that the use of GAAP earnings, which includes mark-to-market requirements, artificially inflates the cyclically adjusted price/earnings ratio (CAPE ratio), which leads to lower forecasts of real stock returns.

“Living with Noise: Valuation in the Face of Uncertainty”: Uncertainty is embedded in all valuations, although the degree varies among companies and countries and across time. Uncertainty in valuation can be categorized into three groups: estimation versus economic, micro versus macro, and discrete versus continuous. Each type of uncertainty needs a different response. Thankfully, tools are available that investors and analysts can use to deal better with uncertainty in valuations.

“Tracking Social Media: The Mood of the Market”: Such social media platforms as Twitter and Facebook generate huge amounts of contemporaneous information. The author discusses how this information can be analyzed but raises questions about its ability to explain investment returns.

“Wisdom of Crowds: The Value of Stock Opinions Transmitted through Social Media”: To determine the value of stock opinions transmitted through social media, the authors conduct textual analysis of articles published onSeeking Alpha, a popular social media platform for investors. They also evaluate the perspective of readers via comments written in response to the articles. Their findings indicate that investor opinions transmitted through social media can predict future stock returns and earnings surprises.

“Investor Attention on the Social Web”: By developing and testing a process to examine practitioners’ conduct in the surfeit of information on social media, the authors evaluate how today’s investors focus their attention.

“Social Interaction at Work”: Positive correlations between the stock market investment decisions of individuals who work together can be identified. These decisions tend to result in stock purchases in companies within the same industry and, more generally, do not lead to improved investment outcomes.

“Conquering Digital Distraction”: The flood of digital information exacts a professional and personal cost. The authors offer differing perspectives on how to manage it.

“Investor Networks in the Stock Market”: In exploring the role of empirical investor networks in information diffusion, the authors find strong support for the existence of stable and relatively diffuse structures on the Istanbul Stock Exchange. Within these structures, more central members trade earlier and more successfully. The finding is consistent with an information-sharing network.

“Media Makes Momentum”: The momentum effect is stronger among firms with higher levels of newspaper media coverage. Excess profits attributed to excess media coverage are found among firms exhibiting higher levels of valuation uncertainty, among firms with a media tone consistent with their formation period return profile, and among firms headquartered in US states ranked as being more individualistic.

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©iStockphoto.com/vDraw

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What Explains the Oil Crash? Not Reduced Demand

By Matthew Borin

The precipitous fall in oil prices was not the result of reduced demand, according to Jennifer Stevenson.

In a contrarian defense of the energy industry, Stevenson, a portfolio manager with Dynamic Funds, explained that the oil market correction — which saw prices fall from around $100 per barrel of West Texas Intermediate (WTI) after the Great Recession to around $26 per barrel last February — was not due to any fundamental supply-and-demand shift.

According to Stevenson, demand has not fallen since 2008 to 2009, despite the precipitous drop in prices. The demand growth rate slowed, and the resulting glut of oil was due to supply outpacing demand, she explained during her presentation at the 2016 Financial Analysts Seminar. Oversupply reached three million barrels per day (bpd) above the 95 million bpd demand.

That alone, however, is still not enough to explain a 75% drop in oil prices.

Another factor was the rapid strengthening of the US dollar in 2015. Since oil is traded in dollars globally, there can be periods of robust inverse correlations between the strength of the dollar and the price of oil. Since early 2014, the inverse correlation between WTI prices and the trade-weighted index of the dollar has been 90%.

“It’s not high all the time because the fundamentals will win out over time,” Stevenson said. “But when there’s an oversupply issue and you’ve got a strengthening in the US dollar, that will play a really significant role.”

Futures trading intensified the fall in oil prices. Commodity markets exacerbate price swings because the volume of oil traded in the top six futures exchanges is 31 times daily consumption.

“The put options in particular were dramatically skewed lower and lower. And you could just watch the oil price trade, and I would call it these little vortexes,” Stevenson explained. “It would get to a point where it was close enough to the next put exercise and it would just whip down two more dollars down to that put exercise price, which were conveniently stacked in $5 increments.”

Stevenson identified several tailwinds that could propel prices higher.

When oil prices bottomed out, many reserves became uneconomical. There were almost 1,900 total land rigs operating in the United States in the second half of 2014. In May 2016, the rig count bottomed out at under 400. Though the rig count is recovering Stevenson noted, there is a six to nine month lag between building a rig and production coming on line, so supply will be lower than the rig count indicates as new operations start producing. She also said that low oil prices will result in a $1-trillion reduction in spending on oil projects between 2015 and 2020, dampening supply growth.

On the demand side, when gasoline is cheap, incentives to buy fuel-efficient vehicles and reduce driving weaken. Fuel efficiency weighted by type of vehicle sold declined after oil prices crashed, as larger and more powerful vehicles gained favor with buyers. Miles driven also increased. As a result, demand for gas went up.

“What drives long-term energy demand growth? People and income,” Stevenson concluded.

A report from Exxon predicted that the global population will grow from 7.3 billion in 2015 to 9.2 billion in 2040, and GDP will rise from $69 trillion to $164 trillion. The report also anticipates 1.3 billion more passenger cars and trucks in use over that time frame. The end result would be a 25% increase in energy demand, mostly from emerging markets. Though Exxon only expects oil demand to grow by 0.7% in that time, a much lower rate than renewables, it will remain the largest energy source, driven by transportation and chemicals.

Even assuming aggressive adoption rates of pure electric vehicles (10% of sales in 2030, 20% in 2050), oil demand would plateau at 105 million barrels per day in 2050, according to Stevenson.

“I worry how we get the supply to get there in the first place,” she added.

Click here to view the whole video. If you liked this post, don’t forget to subscribe to the Enterprising Investor.

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Good vs. Lucky: Assessing Portfolio Manager Performance

By Matthew Borin

There are three intangibles that all good portfolio managers have, says Jacques Lussier, CFA, but factor-based benchmarks are still the best way to distinguish the effective managers from the lucky ones.

Lussier, the CEO of Ipsol Capital, is a proponent of statistically reliable performance because investors often mistake good fortune for alpha.

“I believe that the performances of managers . . . are way more impacted by luck than we would like to admit,” Lussier told Jason Voss, CFA, during a recent Take 15 interview. “Some managers have good performance because they have good process, but some managers have good performance simply because they were lucky or because of a single glimpse of genius never to be repeated again.”

Since portfolio managers’ outcomes are imperfect proxies for their abilities, their processes might be more illuminating to investors. Lussier looks for three qualities in particular when determining whether a manager can generate repeatable alpha. The first is intellectual curiosity. While our understanding of performance drivers and sources of risk is constantly improving, few managers stay abreast of the current literature. Those who do, who are curious, have an advantage over their peers.

Second, managers must be able to distinguish the signal from the noise. According to Lussier, usually no more than 10 factors account for 90% of the variance a manager can explain. Everything else is noise.

Third, the best portfolios are simple and intuitive to investors. Managers embracing the same investment philosophies and levels of risk can build wildly divergent portfolios. But the managers with the least complex portfolios tend to understand the issues best.

Judging managers qualitatively is only necessary because available benchmarks fail to distinguish between luck and alpha. Ideally, investors could evaluate managers using matrices that captured portfolios’ abilities to meet clients’ long-term goals, but no such methods exist. The next best approach is to measure performance against benchmarks that capture market trends and risk tolerance, but these often fall short as well. Factor-model-based benchmarks, which relate systematic sources of returns to the performance of the benchmark, have the most potential to isolate statistically reliable alpha. The industry, however, is reluctant to use more sophisticated benchmarks.

“There’s a resistance to use more evolved factor-based benchmarks because if you do that you would eventually be able to explain way more of the source of performance of managers and a lot of managers would not like their investors to know what their sources of alpha are, because they might find out they’re not exactly alpha,” Lussier said.

Investors need to understand that even good processes do not always lead to good short-term performance, because luck and noise can also be strong determinants of short-term results. Clients do not, however, need to pay exorbitant fees for a manger with good process, according to Lussier.

Click here to watch the full interview. 

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

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Is There a Bond Market Bubble?

By Ron Rimkus, CFA

What is a financial bubble?

A financial bubble occurs when the market price of a security or a group of securities increases well beyond the point where the long-term benefits of ownership fail to compensate the investor for the costs — market price, trading costs, liquidity, etc. — and risks of ownership.

Which brings us to the bond market.

If the results of a recent CFA Institute Financial NewsBrief poll are any indication, at least some of the global fixed-income market is in bubble territory. So if respondents agree with the above definition, then 87% believe that owning at least some types of fixed income no longer makes sense.

Yet clearly many investors do own these bonds. What explains this dissonance?

The global policy response since the financial crisis of 2008 has been massive and unrelenting. While the US Federal Reserve has (at least for now) ceased its quantitative easing (QE) operations, it has struggled to return interest rates back to normal levels or reduce its balance sheet back to its former size. Japan has maintained QE at approximately 15% of its GDP for some time, and recently hinted that it may escalate it in the near future. In March of this year, the European Central Bank (ECB) increased its QE program from €60 billion to €80 billion in bond purchases per month.

All of this bond buying by central banks has been intentional, of course. By providing a bid under bonds, they have lifted bond prices and reduced interest rates. In many cases, like in Europe and Japan, this has created negative interest rates. The ECB now “charges” a negative interest rate of 0.4% for banks that borrow from the ECB. Of course, this means that the ECB is actually paying banks to borrow money.

In June, Germany became the second nation to issue a 10-year bond with a negative yield. In fact, according to a recent report by Bloomberg, more than 80% of German government bonds have negative yields. In Japan, 20-year bonds are now below zero. This is making it hard on global bond fund managers where Japanese bonds typically comprise 20%–35% of the global bond indices. (How would you like guaranteed losses on one-third of your holdings?)

Globally, over $13 trillion of the global bond market is now negative. “It’s surreal,” says Gregory Peters of Prudential Fixed Income.

Of course, this backward, underwater, upside-down world is just fine with some people. Certain investors suggest that negative yields are a “Sign of Prosperity.” And some bond managers have even figured out clever ways to make money in this market. For instance, PIMCO is buying negative yielding Japanese bonds and using swaps to lock in exchange rates, effectively quadrupling the yield on long-only US bonds of similar duration. So, they are buying negative yielding bonds, but using savvy finance skills to transform it into positive yield.

And that’s really the game, isn’t it? Low and negative rates are forcing legions of investors to seek higher yield — and in doing so — they are taking on more and more risk. Maybe it’s because they know that the central banks will maintain these policies despite potentially adverse consequences in the long term.

So, what do CFA Institute Financial NewsBrief respondents make of the fixed-income market today? As noted, 87% of respondents see the bond market in bubble territory in some way. In other words, they believe that bonds today fail to compensate investors for the costs and risks of ownership.

The largest segment of respondents (30%) believe all bonds are in bubble territory. Another 24% see a bubble in sovereign bonds and at least one other class of fixed income. Somewhat surprisingly, only 14% of poll participants think high-yield bonds are over-inflated. And roughly 13% don’t see a fixed-income bubble anywhere. Perhaps this cohort should have attended the Financial Analyst Seminar in Chicago where Edward Altman suggested that “the benign credit cycle is in ‘extra innings‘” — an ominous sign of a coming default cycle.

Most investors recognize the vast power that central banks wield but, by and large, disagree with the wisdom of their policies. In order for the world to return to market pricing of bonds, there has to be a catalyst. The power of the central banks must be more than offset by something else. There has to be a fundamental wave — either positive or negative — to counteract it, or a political wave to change it.

Until then, investors will remain adrift on an ocean of negative yields.

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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Industry Restocking (Views from the C-Suite)

By Scott Krisiloff, CFA

Excess capacity and a surfeit of inventory have figured greatly in weak inflation. Recently we’ve been through a rough economic patch that has exacerbated the problem.

Last week, however, there were signs that inventories have been sufficiently depleted, and that industry is cautiously beginning to restock again. Greater production must be met with equally greater demand though. If inventories are restocked and demand doesn’t concurrently rebound, companies will shortly find themselves in a precarious position once again.

The Macro Outlook

August shows some improvement in industrial sales trends.

“Our sales per day trends included declines in April and May with improvement in June. July somewhat as expected with seasonality, softer than June. And through the early days of August, we’re seeing sequential improvements in that.” — Applied Industrial Technologies president and CEO Neil Schrimsher (Distributor)

Retailers feel that inventory levels are where they should be.

“Whether it’s the Rack or our stores, we’re in one of the best inventory positions we’ve been in, in many years.” — Nordstrom co-president Blake Nordstrom (Department Store)

“We are very comfortable with our inventory levels and the quality of our merchandise.” — Dick’s Sporting Goods chief accounting officer and SVP Joseph Oliver (Sporting Goods)

Companies may be getting back some pricing power.

“Our average ticket was also positively impacted from slight commodity price inflation, mainly from building materials and lumber.” — Home Depot EVP – merchandising Ted Decker (Home Improvement)

“We increased prices across the portfolio in H1 by 5%.” — Carlsberg Group CEO Cees ‘t Hart (Beer)

“The pricing environment remains challenging. . . . We expect stronger pricing in H2 though. We started to take selective price increases in some categories and geographies.” — Nestle EVP and CFO François-Xavier Roger (Packaged Food)

Consumers are willing to spend on their homes as long as they see the value increasing.

“Consumers continue to view their personal finances and home values favorably, with half of homeowners believing the value of their home is increasing. We believe this positive sentiment around home value is driving home improvement spending. Consequently, we continue to see home improvement spending outpace overall consumer spending, as well as positive home improvement project intentions, including strong engagement in big ticket discretionary projects.” — Lowe’s chairman, president, and CEO Robert Niblock (Home Improvement)

But the consumer is spending selectively. Target sees cautious consumers.

“I think we have seen this environment persist now for well over a year. It’s a very cautious consumer. And if we look at the overall trends within retail, we have certainly seen, on a rolling 12-month basis, a slowdown in retail sales growth, but that’s not an excuse for us.” — Target chairman and CEO Brian Cornell (Big Box Retail)

Walmart is cheering 1.6% comps.

“We exceeded our Walmart US comp sales guidance this quarter, with Walmart US delivering comp sales of 1.6%, driven by a traffic increase of 1.2%. This was our eighth consecutive quarter of positive comp sales and our seventh consecutive quarter of positive traffic.” — Walmart Stores president and CEO C. Doug McMillon (Big Box Retail)

Certain parts of the United States are rebounding better than others.

“The West was our best-performing area of the country. . . . The North was our weakest-performing division. There was almost 500 basis-point spread in comps between those two divisions.” — Lowe’s chairman, president, and CEO Robert Niblock (Home Improvement)

“We have seen particular strength in many of our West Coast markets. . . . We have seen pockets of softness on the East Coast.” — Target chairman and CEO Brian Cornell (Big Box)

International

Little to no impact from Brexit continues.

“On the UK question, frankly . . . our sales did not go down. We’ve the loss because of the conversion. Our sales in pound have been the same or what we projected. So there has not been a slowdown.” — Perry Ellis International executive chairman George Feldenkreis (Apparel)

“Urban’s European business also experienced strong comp gains with seemingly little impact on the business from the Brexit vote.” — Urban Outfitters CEO Richard Hayne (Apparel)

However, it would be foolish to jump to conclusions about Brexit after only six weeks.

“The thing that’s important to note, clouds were already gathering over the global economic outlook before the UK’s vote to leave the EU took place. It will take time for the full effect of the vote to be felt and understood. In my view, it would be rash to extrapolate from the economic and political noise of the last six weeks.” — Standard Life CEO Keith Skeoch (Insurance)

But commercial real estate investors do not seem concerned.

“In recent weeks, UK commercial real estate exposure has received a lot of attention from the investment community. In short, we don’t feel overly exposed. Given our history, we’ve had a cautious new business risk appetite in the sector, and we’ve dramatically shrunk our legacy exposure.” — RBS CFO Ewen Stevenson (Bank)

Strong steel demand can only continue for so long.

“From a demand side on the steel, we are quite optimistic. . . . The reason why we are a little bit cautious . . . is because we’re already running at a very, very high rate for many years. So, we do not see it negative. But, as we have already such a strong demand . . . we do believe that the upside beyond that, let’s say, strong demand probably is rather limited. ” — ThyssenKrupp CEO Heinrich Hiesinger (Steel)

Food and beverage market growth in China has stalled.

“In China, the food and beverage market overall saw its growth decelerating to basically zero growth.” — Nestle EVP and CFO François-Xavier Roger (Packaged Food)

Financials

The saga of the asset management industry continues.

“I outlined some of the major challenges facing the asset management industry. These include a shift in investor demand from active to passive strategies, pressures on fees in both active and passive, a growing industry regulatory burden, and rising costs of doing business. Unfortunately, nothing has changed over the last three months to lead me to believe that these challenges are going to abate anytime soon.” — Eaton Vance chairman, president, and CEO Tom Faust, Jr. (Asset Management)

Consumer

A wave of new fashion is starting.

“I saw more fashion excitement in spring than I’ve seen in quite a few years. . . . This is the fashion change that’s happening and my experience is, once it starts to happen, there is not much that stops it.” — Urban Outfitters CEO Richard Hayne (Apparel)

Flow and newness rather than promotional activity is key.

“I think it’s fair to say that the promotional activity has stabilized a bit here in the last quarter or so. . . . There’s vendors out there choosing to participate in different ways than they may have in the past with our competitors.” — Nordstrom co-president Peter Nordstrom (Department Store)

E-commerce forces a lower margin.

“Obviously we run lower margin in dot-com. The actual margin on the product is roughly equal to our brick-and-mortar. But when you put in shipping, it has a negative impact.” — JCPenney EVP and CFO Edward Record (Department Store)

Technology

Target calls out Apple for weak performance in electronics.

“We have to improve electronic performance. It was a significant drag — 70 basis points on our overall comp declines in the quarter. And Apple played a significant role there. So we over-indexed with Apple products.” — Target chairman and CEO Brian Cornell (Big Box)

Tim Cook is not too concerned about skeptics though.

“It doesn’t bother me. Because honestly, they were saying that about Apple in 2001. They were saying it in 2005. They were saying it in 2007 — ‘this stupid iPhone, whoever dreamed up this thing?’ Then they were saying that we peaked in 2010, then it was 2011. We got to $60 billion [in revenue], and they said you can’t grow anymore from this. Well, last year we were $230 billion.” — Apple director and CEO Tim Cook (Consumer Electronics)

Telecoms around the world are spending less on their networks.

“You look at some of the analyst reports on Service Provider CapEx, we actually saw exactly what the analysts have talked about. I saw one report that discussed double-digit declines outside of the United States and maybe flat to slightly up inside the US.” — Cisco EVP and CFO Kelly Kramer (Networking)

Deep learning is the “Thor’s hammer” of computing.

“Deep learning, you may have heard, is a new computing approach. It’s a new computing model, and requires a new computing architecture. . . . Deep learning was really ignited when pioneering researchers around the world discovered the use of GPUs to accelerate deep learning. . . . Deep learning is really machine learning supercharged, and deep learning is really about discovering insight in big data, in big unstructured data, in multi-dimensional data. . . . It’s Thor’s hammer that fell from the sky, and it’s amazing technology that these researchers discovered.” — NVIDIA co-founder, president, and CEO Jen-Hsun Huang (GPUs)

Miscellaneous Nuggets of Wisdom

I spent some time studying the Watergate era this week. I thought this quote was worth posting.

“We think that when someone dear to us dies, we think that when we lose an election, we think that when we suffer a defeat, that all is ended. We think, as T. R. [Theodore Roosevelt] said, that the light had left his life forever. Not true. It’s only a beginning always. . . . Because the greatness comes not when things go always good for you, but the greatness comes when you’re really tested, when you take some knocks and some disappointments, when sadness comes. Because only if you’ve been in the deepest valley can you ever know how magnificent it is to be on the highest mountain.” — Richard Nixon, 9 August 1974, the day of his resignation as president

Each week the team at Avondale Asset Management reads dozens of transcripts from earnings calls and presentations as part of its investment process. If you find these posts useful, click here to receive them every week via email.

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©iStockphoto.com/kupicoo

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Don’t Forget Taxes When Comparing Dividend Yields

By David Allison, CFA, CIPM

Investors have been pouring money into dividend-centric investment strategies lately.

Year-to-date flows into dividend-focused exchange-traded products reached $7.4 billion in June 2016, more than seven times the 2015 total, according to Richard Turnill, BlackRock’s global chief investment strategist.

This “buy yield first, ask questions later” mentality has sent the prices of many popular dividend plays, such as real estate investment trusts (REITs) and utilities, soaring.

As prices rise and yields fall, are certain dividend income strategies no longer attractive? There is no simple answer.

Investors are faced with numerous uncertainties when debating the merits of dividend-paying stocks. Every company is different in its ability to pay or increase dividends, and no one knows for certain what the future holds for competing bond yields. Even shares of high-quality companies are vulnerable to headline risk and temporary price declines. Investment professionals are more likely to add value by helping yield-starved clients focus on issues that are a bit more certain, like taxes. To this point, a recent poll by CFA Institute suggests that focusing on tax efficiency is one of the top ways for active investment managers to enhance client portfolios.

In their overzealous efforts to chase yield, investors often fail to consider the tax implications involved in owning dividend-focused investment products. The tricky thing about dividend income is that not all of it is taxed the same way.

Non-qualified and qualified dividends each have a different tax rate. Non-qualified dividends are taxed as ordinary income at a rate of up to 39.6%, while qualified dividends are taxed at a lower rate of up to 20%. The table below illustrates the current federal tax rates on non-qualified and qualified dividend income.

Note: There may be additional taxes on dividend income that are not included in this table, such as an additional 3.8% net investment income tax and state and local income taxes.

Investors can learn two key points from this. First, income taxes could cut a juicy dividend payment almost in half; and second, those investors in the higher income tax brackets are subject to a spread of about 20% between the federal tax rate on non-qualified vs. qualified dividend income. With a dividend payment of US$5,000, this spread would result in a $1,000 difference in the amount of after-tax income an investor would receive. This is significant if the dividend is expected to be the main contributor to an investment’s total return.

Allocating high dividend paying investments into tax deferred accounts, such as an IRA, helps to negate these tax issues. If this is not an option, below are a few things tax-sensitive investors should consider when gauging which type of dividend income an investment strategy distributes.

Current Holdings and Past Distributions

A list of the investment strategy’s current holdings is the most obvious place to start. Most US listed stocks pay qualified dividends, although there are a few that may not. For example, dividend income strategies that are heavily invested in real estate investment trusts (REITs), business development companies (BDCs), certain foreign stocks, trust-preferred stocks, or preferred stocks issued by REITs distribute at least some non-qualified dividend income.

The tax classification of a strategy’s past dividend distributions is something else to consider. For example, iShares has a table that summarizes the percentage of calendar year dividends paid by their exchange-traded funds (ETFs), which represent qualified dividend income.

Strategy Implementation

The way a strategy is implemented could affect how dividend distributions are taxed. Many investors are unaware that they must meet special IRS holding period requirements in order for dividend income to receive qualified tax treatment. A common stock must be held for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. In the case of preferred stock, investors must have held the stock more than 90 days during the 181-day period beginning 90 days before the ex-dividend date, if the dividends are due to periods totaling more than 366 days. The days in which an investor’s risk of loss on a stock is diminished do not count toward these required holding periods. So strategies with very high turnover, or ones that directly hedge stock positions such as buying protective puts, might end up negating the tax benefits of otherwise qualified dividend income.

Conclusion

Seth Klarman’s 1992 Forbes article, “Don’t Be a Yield Pig,” is still very relevant today. Many stable dividend-paying stocks trade at historically lofty valuations and produce income taxed at unfavorably high rates. This type of environment is ripe for investment advisers to add value by customizing an investment strategy based on each client’s investment objectives and constraints.

By working in conjunction with a tax professional, advisers can help clients sort through the numerous risks and tax implications involved in owning dividend-centric investment products.

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©iStockphoto.com/retrorocket

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Intelligence Training: From Mind to Supermind

By Nathan Jaye, CFA

To understand is human.

Presumably, we would all rather be more intelligent than less. The problem is we aren’t usually given a choice.

We classify ourselves — or are classified by others — as bright, bright enough, or not so bright. But that may be changing.

Researchers at the University of California, Irvine, have tied cognitive training to lasting improvements in fluid intelligence — or the ability to reason and problem solve — traditionally thought to be fixed at birth.

And yet, outside the lab, ideas on intelligence remain vague. Ask your friends the question “What is intelligence?” and you will get a dozen different answers: high IQ, good grades, emotional intelligence, social intelligence, genius, streets smarts, common sense. How do we improve intelligence if we don’t know what it is?

The Game Changer

Intelligence training begins by realizing that intelligence is modular.

In other words, intelligence is made up of skill sets. Rather than an unfathomable display (or lack) of brilliance, intelligence is ability in specific mental tasks. Once those tasks are defined, it’s a short step to begin training in them.

This became clear to me a few years ago when preparing for the Mensa exam. I realized that my scores weren’t just a reflection of “natural intelligence,” but a result of my own training regimen. I even prepared a Mensa training guide designed to help test takers achieve a perfect score.

In presentations on intelligence training, I highlight four main skill sets, or abilities, that I use daily and one big realization. Let’s look at the abilities:

Insight: Yes, insight is an ability and a process. It’s little realized, but our thinking process is based on images (real or in our minds). Aristotle said: “We cannot think without images.” Likewise, every professional sports team “looks at the film” to improve. We can do the same. Using a “daily review” of images from events in our life — meetings, projects and personal interactions — we gain valuable and often overlooked insights.

Simplicity: Thinking can be simple or complex. Unfortunately, much thinking is overly complex and inefficient. This creates confusion. A vital key to decision making is knowing how and when to think simply and when to think in detail. The main technique of simplicity is finding the “packed thought,” or blueprint idea, within the details of any problem, communication, or strategy. This is a practice of distinguishing “the forest from the trees” and is essential for moving forward on any decision. Once this is clear, we can choose to unpack the details as necessary.

Speed: Our intelligence is a potential race car. Simplicity eliminates the repetitive loops and drag of complex thinking. Using packed thoughts filters the noise and clutter of complexity, allowing for much faster mental processing. This is the essence of speed reading, speed viewing (video), and genius in general.

Truth: A right decision for one person, team, or organization may not be appropriate for another. These kind of “wrong” decisions can be disastrous. Clarifying core principles, values, and goals — to the point of second nature — is a priority. The next step is discernment. Ask, “Does this decision fit with who we are?”

Practicing these skill sets leads to an epiphany: Intelligence can be engaged at will. As a set of conscious mental actions, intelligence becomes available on demand. A trained thought process can be “switched on” when necessary, like an athlete shifting into higher gear on game day.

A History of Genius

Higher intelligence is a historical reality — the tool of geniuses and savants from every age. The ancient Greeks called this faculty nous, an ability to access “states of knowing.” To Latin writers, it became intellectus. Indian sages called it buddhi. Scholars of the Islamic Golden Age named it aql.

The word supermind — literally “above the ordinary mind” — originates from the philosophy of Sri Aurobindo. To Aurobindo, this was a future stage in human mental development. In everyday practice, supermind is the conscious use of intelligence skills: insight and vision, simplicity, speed, and truth of thinking.

Like any training, there are obstacles: our rigidly held beliefs, opinions, and emotional patterns. A good diet, exercise, and restful sleep (on the plus side) help clarify the mind. Also useful is any practice that focuses our thoughts, whether through rigorous activity, sheer interest, or meditation.

Intelligence Is Meaningful

Intelligence is always an advantage in any career. But it also enlightens our daily lives and relationships. Insight and discovery — the essence of every “Aha! moment” — add meaning to our lives. They enrich our sense of who we are and the decisions we make. These insights can be the best part of our day. Cultivating our intelligence is a journey of steps. It’s a good one to start.

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: Courtesy of Nathan Jaye, CFA

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Marc Faber on the Changed Roles of Emerging and Developed Markets

By Ron Rimkus, CFA

The global balance of economic power has notably shifted over the past decade.

Now emerging and developing economies account for almost 60% of global gross domestic product (GDP).

Understanding the full scope of these changes, and the new roles of these participants in the global economy, is essential for investors looking to position their portfolios for the future.

Marc Faber, editor and publisher of the Gloom, Boom & Doom Report, shared his perspective on these shifting dynamics along with his concerns that policy makers have increased the risk of unintended economic consequences, at the 2016 Financial Analysts Seminar in Chicago.

China occupies an important space in the current economic landscape. The country embraced the infrastructure growth model to catapult itself into a high-growth phase — following the examples set by Japan starting in 1950 and the Asian Tiger economies of South Korea, Taiwan, and Singapore in the 1960s and 1970s — and it has been the driver of substantial economic activity for other emerging market countries, especially in Asia and Africa. The Export-Import Bank of China overtook the World Bank in 2011 as the biggest lender to sub-Saharan Africa, and China is the leading financier of infrastructure projects on the African continent.

Tourism spending has created additional economic links between China and other countries. Outbound tourism expenditures from China reached US$215 billion in 2015, which was a 53% increase over the total recorded by the World Travel & Tourism Council (WTTC) in the previous year. China’s increased travel spending boosted economic activity in other countries in the region, including a “mini-boom” in money spent by foreign visitors in Japan. During his presentation, Faber estimated that China contributed around 130 million outbound tourists each year to the global economy.

As a key driver of economic activity for emerging markets, what happens if China’s economy stumbles? According to some reports, shadow banking activity, characterized as less-regulated lending that could pose a higher risk of default, accounts for as much as two-thirds of China’s economy. Even regulated lending could pose substantial risks: According to Faber, banks in China don’t write-off bad loans, and eventually the chickens will come home to roost. He was quick to emphasize, however, that other Asian nations are ready to pick up the baton if China falls short.

As the emerging market economies in Asia have developed, they have built up their own domestic needs and capabilities. The increased consumer demand within these countries has created investment opportunities for regional partners: In the first seven months of 2016, the three largest sources of foreign direct investment in Vietnam were South Korea, Singapore, and Japan. While productivity in developed markets has stagnated due to excessive regulation and rising levels of unproductive debt, productivity is booming in Asia.

Faber said the current system in the developed markets is not sustainable and will come to a bad end. He declared that the change in hours of work needed to buy one unit of the S&P 500 composite — which climbed from 20 hours in the 1960s to almost 100 today — was evidence of the massive wealth inequality created by monetary policy that has made it more difficult for those on the lower rungs of the economic ladder to climb up.

Faber takes a dim view of central bank activities that have led to a substantial increase in the size of their balance sheets. Although central banks can continue these policies indefinitely, he noted that eventually they will own everything, resulting in backdoor socialism. The present-day reality of central bank activity is that stock market capitalizations relative to GDP are way above historical averages. Consequently, Faber thinks that US investors will be lucky to earn 1% or 2% returns per year.

With so much latent risk in the financial system, one might be tempted to shift substantial amounts of a portfolio to cash. But even cash is risky today. “Cash is the safest investment in normal times,” said Faber. “However, today the most dangerous asset is cash. Cash in bank accounts may be worthless like in Cyprus,” referring to the possibility of a state-imposed bail-in putting deposits at risk.

Faber lamented that “capitalism requires companies to fail and bad behavior to be punished harshly. And this is not happening.” To protect against runaway central bank interventions, Faber recommends that investors hold real assets that will appreciate with inflation, such as holding 25% in gold and “some” in real estate. He says that once you take into account the dramatic growth of central bank balance sheets, gold is cheaper today than it was when it traded in the $300 range at the end of the 1990s.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: Courtesy of CFA Institute

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Attaining “Flow,” Being Wrong, and “Why Sports Die”

By Lauren Foster

I spend a lot of time thinking about work and what it takes to thrive in one’s chosen profession. In short, to be happy and content. Likewise, about what it takes to make the leap and reinvent oneself in a second or third career. I’ve seen talented people wither in one career, and then thrive in another. What was it that emboldened them to make the leap? Many people labor for years in misery because they lack the conviction to make a change. Yet others find what they love to do and can’t believe their good fortune that they actually get paid to do it.

So I was intrigued recently when I stumbled upon an article in The New York Times by economist Robert H. Frank, “The Incalculable Value of Finding a Job You Love,” that mentioned a concept I hadn’t given much thought to: “flow.” Frank says the happiness literature has identified flow as “one of the most deeply satisfying human psychological states.” As he explains, “It occurs when you are so immersed in an activity that you lose track of the passage of time. If you can land a job that enables you to experience substantial periods of flow, you will be among the most fortunate people on the planet. What’s more, as the years pass, you will almost surely develop deep expertise at whatever it is you’ve been doing.”

It seems obvious, but I hadn’t really thought about satisfying work in this way until I read the article. It also led me to wonder more about the work of Mihaly Csikszentmihalyi, the psychologist and author of Flow: The Psychology of Optimal Experience.

As he tells it in a 2004 TED Talk (that examines the question: “What makes a life worth living?”), Csikszentmihalyi grew up in Europe and was a young boy during World War II. He was puzzled by how few adults he knew were able to withstand the tragedies of the war, and became interested in understanding what contributed to a life that was worth living.

It was a chance encounter with Carl Jung that led him into the field of psychology. Finding himself low on money at a ski resort in Switzerland, Csikszentmihalyi picked up a newspaper and read about a forthcoming presentation in Zurich on flying saucers.

“I thought, well, since I can’t go to the movies, at least I will go for free to listen to flying saucers. And the man who talked at that evening lecture was very interesting.Instead of talking about little green men, he talked about how the psyche of the Europeans had been traumatized by the war, and now they’re projecting flying saucers into the sky. He talked about how the mandalas of ancient Hindu religionwere kind of projected into the sky as an attempt to regain some sense of order after the chaos of war. And this seemed very interesting to me. And I started reading his books after that lecture. And that was Carl Jung, whose name or work I had no idea about.”

Later he came to the United States to study psychology and the roots of happiness.

Which brings me back to where I started this post: the connection between work and happiness, and making choices that lead to increased happiness.

“Few things are sadder than encountering a person who knows exactly what he should do, yet cannot muster enough energy to do it,“ Csikszentmihalyi writes in Flow. “’He who desires but acts not,’ wrote [William] Blake with his accustomed vigor, ‘Breeds pestilence.’”

Here are some other articles I’ve come across recently that may be of interest:

In “Growth Without Goals,” Patrick O’Shaughnessy, CFA, writes about the experience of wondering what it would take to be a great father and, more specifically, what he could teach his children that would help them live good, fulfilling lives. “Inventing the future is another way of saying ‘setting goals,” he writes. “Success, especially in the West, then becomes about achieving those goals. We accumulate accomplishments and call it success. Success means something very different to me, and I think being a great father will be about effectively communicating this different definition of success to my kids. Success is about building a set of daily practices, it is about growth without goals. Continuous, habitual practice(s) trumps achievement-based success.” As for where he sees himself in five years? “Goals still sneak their way into my brain. I try, but sometimes fail, to snuff them out. I am working on it. There is always that stupid interview question: where do you see yourself or your company in five years. Instead, we should ask, what things do you think are important to do every day?” (The Investor’s Field Guide)

I recently heard a radio interview with Olympian Frank Shorter about his book My Marathon, and it reminded me of a 2011 article from Runner’s World that led to “Frank’s Story.” Shorter won the gold medal in the marathon at the 1972 Summer Olympics and is credited with igniting the US jogging craze of the 1970s. But as the magazine article explains, there is much more to his story: “By all accounts, Frank Shorter is the father of the modern running boom. He spins a captivating narrative about winning the ’72 Olympic Marathon, leading the fight against illegal doping, and being the last person to see his friend Steve Prefontaine alive. The story he hasn’t told is the dark truth about his own father, a truth Shorter has run away from all his life but that ultimately has defined him as a runner, and as a man.” (Here & Now)

Barry Ritholtz recently sat down with Michael Mauboussin, author, managing director, and head of global financial strategies at Credit Suisse, for his Masters in Business series. In a wide-ranging interview, the two discuss freestyle chess, the work of Daniel Kahneman, luck versus skill, cognitive dissonance, Ritholtz’s pet peeve of people on television “blaming uncertainty for the economy, stock market, or whatever,” and some of the common behavioral biases, such as framing, overconfidence, anchoring, and confirmation bias. It’s long, but well worth sticking around for the full podcast. (Bloomberg Radio)

During the discussion, Mauboussin mentioned Kathryn’s Schulz’s book, Being Wrong: Adventures in the Margin of Error, and it reminded me of her TED Talkon the same subject. Schulz is a staff writer for The New Yorker. She recently won a Pulitzer Prize for her July 2015 article, “The Really Big One,” about the rupturing of the Cascadia fault line. As editor David Remnick put it in the cover letter for the entry: “Few pieces have shaken readers as much as Kathryn Schulz’s on the Cascadian subduction zone. It is terrifically illuminating about its subject — the hows and whys and what-ifs. But it is also terrifically illuminating about the art of writing — the use of voice, image, and structure to turn lessons in civics and geology into a mind-blowing, heart-wrenching, pulse-pounding, hair-raising story.” (The New Yorker)

Oaktree’s Howard Marks, CFA, has a new memo that delves deeply into economic reality, Brexit, the US presidential election, and the implications for politics in the future. It’s long, so settle in with a good cup of coffee and a comfortable chair. (Memos from Howard Marks)

Richard Thaler’s take on Brexit? Poor choice architecture. (Financial Times)

One of my favorite magazines is Nautilus. Not only does it have beautiful original artwork, it also publishes some of the best content out there. (“We are here to tell you about science and its endless connections to our lives.”) True to form, and in keeping with the spirit of Rio Olympics fever, comes “Why Sports Die.” Here’s an excerpt: “Sports are a human universal, found in every known culture,” writes Allen Guttmann, a professor of English and American studies at Amherst College, and author of The Olympics: A History of the Modern Gamesand From Ritual to Record. “We can hardly imagine England without cricket or the United States without baseball, basketball, and football. Japan without sumo wrestlers is no longer Japan. Cultural change is another human universal. Over the millennia, cultures have emerged, flourished, declined, and disappeared. This cultural ebb and flow raises a question. What happens to a culture’s sports if that culture disappears? The answer is deceptively simple. When the culture disappears, its sports vanish.” I learned that Cherokee stickball is still played, but has been transformed and serves as a tourist attraction. And the Olympics connection? “The Olympics are yet another example of a reinvention so thorough that the original sport is played in name only. Ancient Greek culture did not vanish as did the cultures of Minoan Crete and pre-conquistador Mexico. Indeed, much of what the Greeks achieved is still with us. But the ancient Olympic Games did vanish. They were forbidden after the Roman Empire’s conversion from paganism to Christianity in the fourth century.”

In “The Riddle of the Wall Street Brain Drain,” Noah Smith, Bloomberg View columnist and a former assistant professor of finance at Stony Brook University, notes that a decade ago, “It seemed like everyone with a brain and big ambitions wanted to go to Wall Street,” and that this “flow of smart people to finance inevitably spurs talk of a brain drain that leaves other industries begging for skilled workers.” So, he asks, is it true that many of the brightest minds are being wasted? You’ll need to read the article to find out the answer. But there is one point I would make: The paragraph that jumped out at me was Smith’s description of the importance of finance. He writes, “Finance is absolutely essential to the functioning of a modern, productive economy, which needs to borrow many billions of dollars every day just to function. Corporations must issue bonds and sell stock to finance investment, startups need to do initial public offerings to raise the capital to grow, people need mortgages to buy houses and everyone needs a retirement-savings account. Without finance, the U.S. and most other countries would be much poorer.” It reminded me of something I heard when I was interviewing senior women in Hong Kong about the role of women in finance and the investment management industry. One of them, Rebecca Terner Lechtner, said: “The economy and understanding economics and the way business is done has lifted billions of people out of poverty. If you want to impact the world, finance is a great place to do it.” (Bloomberg View, CFA Institute)

And last, but not least, a few hilarious (and spurious) correlations for your amusement. (tylervigen.com)

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Photo credit: Efren 

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Bronze Trumps Silver? Counterfactual Thinking and the Olympics

By Lauren Foster

There have been plenty of stories of triumph and disappointment thus far at the Rio Olympics.

Hidilyn Diaz became the first Filipino woman to ever win an Olympic medal when she took home the silver in the 53-kilogram weightlifting class. South African runner Wayde van Niekerk (who is coached by a 74-year-old great grandmother) won gold in the 400 meters, breaking Michael Johnson’s 17-year-old world record. Jamaica’s Usain Bolt once again proved he is king of the 100-meter sprint and still the fastest man in the world. US swimmer Missy Franklin, meanwhile, failed to qualify for the 200-meter freestyle and 200-meter backstroke finals, while British canoeist David Florence blew his hopes of an Olympic medal when he finished last in the final.

But the story that really grabbed my attention was that of the Chinese swimmer Fu Yuanhui who won a bronze medal in the 100-meter backstroke (“The Exuberant Chinese Swimmer Who Has Become a Star at Rio“). It reminded me of a 2012 blog post on the psychology on display at the medal ceremonies.

It turns out that if you look at the emotions shown by the silver and bronze medalists, as a team of researchers did following the 1992 Barcelona Olympics, the bronze medalists tend to be happier than the silver medalists. That may sound counterintuitive, but it has to do with something known in psychology circles as “counterfactual thinking,” or the tendency we all have to imagine alternatives to reality — the “what ifs?” and “if onlys” that often accompany defining moments in our lives. Said another way, we are all inclined to ponder what might have been if just one circumstance was different.

In a 2009 essay, “Counterfactual Investing,” Cabot Research noted that “Emotional responses to outcomes often are influenced by what might have been,” and counterfactual thinking often ends in regret. “The emotional response to an event depends on how easily one can conjure up alternate outcomes that are either better or worse,” the article said. “An often-cited example regards missing a flight by [five] minutes or by 45 minutes. People who just barely miss their flight tend to kick themselves more than those who missed their plane by a mile. The closer you were to making the flight, the easier it is to construct an alternative outcome or counterfactual that triggers regret.”

In the 1995 study, “When Less Is More: Counterfactual Thinking and Satisfaction among Olympic Medalists,” the researchers explained their findings by reasoning that, for the silver medalist, the obvious counterfactual alternative is capturing the gold. To the bronze medalist, it is finishing without a medal. In other words, the silver medalists think about how close they came to winning gold (but didn’t) whereas the bronze medalists think about how close they came to not medaling (but did — phew!). So silver medalists compare themselves to only one other athlete, the winner, whereas bronze medalists compares themselves to all the other competitors who didn’t place in the top three.

(As a comedic aside, Jerry Seinfeld explained Olympic medals and counterfactual thinking in one of his stand-up routines: “Think about it, you win the gold, you feel good. You win the bronze, you think, ‘Well, at least I got something.’ But when you win that silver, it’s like, ‘Congratulations, you almost won. Of all the losers, you came in first of that group. You’re the number one loser. No one lost ahead of you!’”)

The philosophical roots of counterfactual thinking can apparently be traced back to early philosophers such as Aristotle and Plato. And more than a century ago, psychologist William James noted: “So we have the paradox of a man shamed to death because he is only the second pugilist or the second oarsman in the world. That he is able to beat the whole population of the globe minus one is nothing; he has ‘pitted’ himself to beat that one; and as long as he doesn’t do that nothing else counts.”

All this got me wondering whether counterfactual thinking could be applied to the world of investing and whether financial advisers could glean any insights from this area of research.

As it happens, a team of researchers published a study titled “Once Burned, Twice Shy: How Naive Learning, Counterfactuals, and Regret Affect the Repurchase of Stocks Previously Sold.”

According to the authors, investors are one-half to two-thirds more likely to:

Repurchase stocks previously sold for a gain rather than stocks they previously sold for a loss.

Repurchase stocks that have lost rather than gained value following a prior sale.

Purchase additional shares of stocks that have lost rather than gained value since being purchased.

All these behaviors were consistent with counterfactual thinking — looking back at what could have been — and investors’ desire to avoid regret and instead feel pride.

“Suppose you sell a stock for $100, trading later for $120. If you buy it back, you’re going to regret it because it’s now more expensive,” said Terrance Odean, professor of finance at the University of California’s Haas School of Business and a coauthor of the study. “On the other hand, if it’s trading at $80, now you feel good because you timed it right. Investors choose what they buy and sell to some extent to manage their own emotions.” (Watch Odean talk about his research.)

The researchers explained that investors who sold for a gain had positive associations with investing in that stock and would repurchase the shares. If the price was higher than the level at which they had previously sold the stock, the investors would always anticipate regretting that it would have been better if he had never sold his investment. But an investor was more likely to re-buy a stock that was valued lower than when he sold for because it would make him feel happy and proud and that he sold at the right time.

While it makes emotional sense that investors would want to avoid stocks on which they’d previously been burned, counterfactual thinking doesn’t necessarily result in the soundest investment decisions. So, how can investors see past the emotional baggage of past trades? As with any cognitive bias, the key to seeing past counterfactual thinking is to actively engage the reflective brain. Wall Street Journal investing columnist Jason Zweig has outlined some simple steps to help investors exercise the reflective brain and distance themselves from the emotions that may be driving their decisions.

Even for Olympic athletes, the key to success is clear thinking: training the mind like you would train the body.

“The physical aspect of the sport can only take you so far,” says Olympic gymnast Shannon Miller. “The mental aspect has to kick in, especially when you’re talking about the best of the best. In the Olympic Games, everyone is talented. Everyone trains hard. Everyone does the work. What separates the gold medalists from the silver medalists is simply the mental game.”

Editor’s Note: An earlier version of this article was first published on 10 August 2012. It has been updated to reflect the 2016 Summer Olympics in Rio.

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©AP Photo/Lee Jin-mane

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There Is No Single Formula for Success

By Julia VanDeren

What is the recipe for success?

Whatever the precise combination of ingredients, most would say that hard work is a critical component. But is it the only one? The most important one?

For insight on these questions, we asked readers of CFA Institute Financial NewsBrief how much hard work and diligence contributed to their success.

Approximately what percentage of your professional success do you attribute to hard work/diligence versus other factors (e.g., luck, education, skill, etc.)?

Of the 1151 respondents, 97% recognize that success takes more than just hard work. The plurality (35%) said hard work was responsible for half of their achievement. Nearly half of respondents (49%) said hard work accounted for more than 50% of their success. On the other side of the spectrum, a mere 16% thought hard work was responsible for less than 50%.

But other than hard work what else contributes to success? Talent and skill, advantage and privilege, not to mention sheer luck, also likely play their parts.

It might be tempting to throw advantage and privilege into the category of sheer luck. After all, no one would begrudge a competitive swimmer of average stature pointing out that Olympians Sun Yang and Michael Phelps, 6’6” and 6″4′, respectively, sure did luck out in the height department.

While there are semantic debates as to what constitutes “luck” to be had, for the purpose of analyzing the factors that most contribute to career success, let’s say luck refers to instances — not states of being — where at the end of exerting whatever control you have over a situation, the outcome could go in any direction, but falls distinctly in your favor.

An example of this is meeting the right person at the right time — someone who knew about a position that would be perfect for you happened to be at a party you were at; a potential mentor takes the seat next to you on a plane; or, a future business partner turns up at the same networking reception just when you decided to start your own firm.

People do not attribute their successes and failures in equal measure to the same elements: Self-attribution bias in investing is a well-recognized behavioral bias. And more generally, we know instinctively this is true of success.

When we have worked hard and applied our skills to an endeavor and the result affirms those efforts with success, we rarely look for evidence to suggest a different causality. When we apply hard work and skill to an endeavor and it doesn’t turn out the way we had hoped, we are forced to take further steps to account for the unexpected outcome. It is worth keeping in mind that we may not be especially objective or diligent about attributing our success to all relevant factors.

So we’re talking about hard work and diligence, talent and skill, advantage and privilege, and sheer luck. Why does it matter that we think at all about how these elements combine to result in our success?

There are two reasons: It helps ensure continued success, and it contributes to our understanding of how to help others succeed.

Ensuring Success Continues

In addition to hard work, communicating what skills and talents you can contribute to achieve specific goals helps distinguish you from every other professional competing for jobs, promotions, and other opportunities. You don’t just need to have this knowledge at the ready in case someone asks. The truth is that there are fewer and fewer circumstances where simply working hard gets you enough attention to be asked. Even if it is uncomfortable to do so, professionals who want to be noticed and to advance in their roles and organizations must take the initiative and let others know how they are uniquely poised to make a positive difference.

Leading — Helping Others Achieve Success

In her book The Loudest Duck, Laura Liswood, a senior adviser for Goldman Sachs, describes the constant, subtle, and unconscious advantaging and disadvantaging that occurs in diverse work environments.

While instances of favoring some and slighting others are small and unintentional, they can add up to a reality of meaningful advantage for a dominant group and unwanted obstacles in the path to success for others. An honest look at how this reality has manifested itself in your own career gives you a chance to mitigate the challenges others in your organization may face, especially those whom you manage, mentor, or otherwise support.

Think about this formula: Hard Work + Skill + Advantage + Luck = Success, or 100%. What values would you give each attribute? This little mental exercise is worth revisiting from time to time.

If you would like to share your formula or thoughts on how each of these factors have mattered to your career, please feel free to do so in the comments section below.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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Weekend Reads: Summer Olympics Edition

By Matthew Borin

Rio de Janeiro kicked off the Summer Olympics last Friday, and, if history is any guide, a temporary boost to Brazil’s stock market could follow. The country’s economy, however, remains in a slide. In the spirit of the Games, this edition of Weekend Reads takes a look at the state of global markets.

Those 306 gold medals, by the way, are worth about $500 each, though that could change as gold demand hits a new record. The doom-and-gloom crowd, with Marc Faber at the forefront, is leading the charge for better or worse. Meanwhile, bitcoin’s potential as an uncorrelated asset was shaken by a recent cyber heist.

Investing

Berkshire Hathaway paid $195 million to exit its last bond derivatives contract. Perhaps Buffett, who has called derivatives “financial WMDs,” doesn’t want them weighing down Berkshire’s balance sheet during the next downturn. Or maybe, with $72.7 billion on hand for a big acquisition, he simply doesn’t need the investable money from a derivatives book. (Bloomberg, Wall Street Journal)

Passive investing has been more popular and more successful lately, but it requires active management to bid away inefficiency. In a sense, passive investors are free riding off their active counterparts, and not everyone can do that. (Financial Times)

Marc Faber is predicting that the S&P 500 will lose half its value, maybe over the next year. While low earnings, lackluster growth, and easy credit raise concerns about the bull market, it’s worth keeping in mind that even a stopped clock is right twice a day. (Marketwatch)

BREAKING: Marc Faber A 1987 Style Crash Will Happen In ..... https://t.co/kb1Lkj6gZN pic.twitter.com/U9vOWytBQP                                         

Sometimes it’s best to ignore warnings, like predictions of a double dip recession in 2010 and 2011 that cost investors 115%. (The Irrelevant Investor)

Though no one has been able to hack bitcoin’s blockchain yet, a popular exchange, Bitfinex, lost over $70 million in bitcoins in a hack last week. The company announced that it will reduce all users’ balances by 36%, even those whose wallets weren’t hacked or who held other currencies. Bitfinex likened this move to a bankruptcy liquidation. (TechCrunch)

Global Markets

The Bank of England (BOE)’s quantitative easing (QE) plan is off to a rocky start, as a lack of sellers left the central bank £52 million short of its goal to buy £1.17 billion long-dated gilts. The bond buying caused a rally that pushed yields on some near-term debt below zero. (Financial Times)

Brazil’s sovereign debt crisis in charts. (Economist)

Abenomics hasn’t fixed Japan’s sluggish economy despite racking up the highest debt-to-GDP ratio of any country. Now public confidence could be eroded by Emperor Akihito’s desire to abdicate the throne. (The New York Times)

Environmental, social, and governance (ESG) investors should take note of a recent report that found an “extreme risk” of forced labor in India and China. (Verisk Maplecroft)

Stocks

To compete with Amazon, Walmart acquired Jet.com and, perhaps more importantly, CEO Marc Lore for $3.3 billion. (The New York Times)

Despite beating earnings expectations, Macy’s is closing 100 stores to double down on its e-commerce business. Macy’s real estate holdings might be worth more than its enterprise value even though only online sales are growing, so this could be a step in the right direction. (CNBC, Bloomberg)

Delta cancelled more than 1600 flights as it struggled to get its computer systems up and running. Is it a fundamental problem or a one-time glitch, and an opportunity to buy a quality stock at a discounted price? (The Street)

Disney is hoping its new 33% stake in a sports streaming service will offset the decline of its cash cow, ESPN. (Wall Street Journal)

The US Macro Outlook

What will we be worrying about in 2046? Labor force participation rate and debt. (FiveThirtyEight)

Economists say productivity growth drives increases in real income, but productivity growth in the developed world has ground to a halt. Could this be a statistical aberration, a holdover from the Great Recession, or a sign that technological progress has peaked? (The New Yorker)

Despite all the talk of making college free, a return to pre-recession levels of workforce participation and productivity among low-skilled workers could be what fuels GDP growth going forward. (The Atlantic)

We’ve all heard that wealth inequality is increasing, but do Americans know just how unequal the wealth distribution is? Participants in one study estimated that the two bottom quintiles held about 10% of all wealth, but the actual figure is 0.3%. (Perspectives on Psychological Science)

The Congressional Budget Office’s (CBO) updated budget outlook from last month predicts that the debt-to-GDP ratio will rise to 141% in 2046 — a more pessimistic view than last year. That doesn’t necessarily mean interest payments will become historically onerous, but the report suggests that something’s got to give. (CBO)

Just for Fun, Olympics Edition

Not sure which Olympic events to watch? This chart identifies the most watchable (hint: not equestrian). (The Ringer)

The Centers for Disease Control (CDC) says the number of people travelling to Rio is small relative to the total number of people travelling to countries with Zika outbreaks. So the Olympics is unlikely to spread Zika, except to Chad, Djibouti, Eritrea, and Yemen. (FiveThirtyEight)

You’d think one of the benefits of being an Olympian would be getting to eat whatever you want, but apparently that’s no longer the case. (Vox)

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©iStockphoto.com/Barichivich