Imagine my surprise when I opened a fortune cookie this week to read “You will find what you lost but first you must remember where you left it.” At first blush, the words don’t seem to make sense. However, I have had luck in being reunited with errant umbrellas, hats and so on by retracing my steps. The lesson learned is to keep a better grip going forward, leading me to write today’s blog post about the importance of investment roadmaps.
It is true that knowing what you want to achieve is paramount when it comes to investment management and related risk control. While it is not always straightforward to identify the unknowable with exact precision, it is possible to create parameters about what you want to avoid and blueprint accordingly. For example, some traders and corporations hedged against a drop in the British pound several weeks or months ahead of the BREXIT vote to stay or leave the European Union. This kind of tactical activity makes perfect sense for an investor with a strategy to minimize significant foreign exchange volatility and a commitment to ongoing analytical analysis to support decisions about hedge size, hedging instrument and choice of counterparty when the “right” time comes.
Although used often for purposes of evaluating employee performance, SMART goals that are Specific, Measurable, Achievable, Relevant and Time-Bound can apply to investment management and the containment of uncompensated risks. A realistic and relevant objective(s) must be identified at the outset, accompanied by an awareness of “worst case” events (to the extent possible) and risk control restrictions. Appropriate metrics must be likewise identified with the understanding that the process of risk mitigation is ongoing even though interim actions such as financial reporting and trade rollovers occur.
The BREXIT hedgers acknowledged their goal of avoiding currency depreciation and then implemented positions to reflect what they were allowed to do and how much protection was deemed necessary. Those who work in a regulated environment know that legitimate (versus rogue) trading takes place only after various authorities (such as trading limits and operational processing) are approved and functional.
As the distinguished writer Ray Bradbury said “Living at risk is jumping off the cliff and building your wings on the way down.” For asset managers and other stewards of other people’s money, a careless attitude towards risk-taking is likely to spell trouble later on.
Like so many, I stayed up late to watch the vote count about whether the United Kingdom should remain part of the European Union (“EU”). With a margin of about 4% or 1.3 million people, “Leave” won the day, despite financial market trades that reflected an expectation to stay. Whatever your preferred outcome, it was certainly exciting to watch “people power” in action and learn more about our neighbors overseas.
No doubt there will be post-mortems by economists, political pundits and pollsters about what led to the British exit from the EU or “BREXIT.” Already, U.S. broadcasters in these early hours of June 24 are drawing inferences about what this historic decision might mean for our upcoming presidential election.
What caught my attention was a Financial Times column by its associate editor Michael Skapinker. In “Two nations but only one trusts business and its allies” (June 22, 2016), he describes opinion poll numbers that reflect a seriously low level of trust in what business executives, economists and those at the International Monetary Fund or the Bank of England have to say. His view is that “None of this is surprising,” due in part to banking and corporate scandals that have eroded Joe Everyman’s confidence in various institutions. What he did find “riveting” was a clear dichotomy between trust levels and how respondents planned to vote on the June 23 referendum. “Remainers” declared a high level of trust. The opposite was true for those in the other camp. Even academics who had little to do with the BREXIT discussion were given short shrift by the “leavers.” His major concern is that doubters don’t engage and are “far harder to win over” when asserting that businesses should not be heavily reined in through regulation.
There is a lot to be said about this concept of broken trust and what commercial and political organizations need to do to assuage fears of those who have been either spurned or were non-believers from the start. This is especially apropos when bad news can travel around the world in seconds, a grumpy customer can influence thousands of people with a single Tweet and a protester needs only a poster board and a magic marker to convey an impactful message. The good news is that there is so much that can be done to showcase leadership and integrity when it exists and there is no time like now to act.
Dr. Susan Mangiero will join a panel of esteemed experts to talk about the U.S. Department of Labor’s Fiduciary Rule on June 21, 2016. Sponsored by the Financial Women’s Association, New Jersey chapter, CPE credit is available (CLE credit is pending). Meeting at the Seton Hall School of Law in Newark, this timely event features the following speakers:
Some of the many topics to be addressed include the following:
For further information and to register, click here. A special thanks to Dr. Dubravka Tosic and Attorney Gregory Jacob for putting this event together and arranging for continuing education credit.
Note: This event did not occur and will be rescheduled for a date this fall.
In watching television news this weekend, I am reminded that not everyone understands the proactive nature of risk management. I’ve heard the mantra before. “Why did I buy insurance? A year came and went and nothing happened. I could have saved the premium.”
The problem with this thinking is that no one has a crystal ball. It’s impossible to know with certainty what could happen. The goal of effective risk management is to ask what could go wrong and then assess both the likelihood of occurrence as well as the economic downside should that adverse event occur. What typically follows would be a ranking of worst case “what if” situations and deciding how best to mitigate potential problems.
As I wrote in Risk Management for Pensions, Endowments and Foundations, “… informed and proactive investors have a chance to meet or exceed return targets while minimizing capital exposure, if they do their homework and stay focused on the fact that things can and do change.” Robust risk mitigation helps to stabilize returns. Without it, the value of any or all holdings could free fall or wildly zigzag with little chance of recovery.
Yes, it is true that a risk management process is going to cost something to implement. The central question is whether one can afford not to manage risks.
Those in the know understand that both qualitative and quantitative factors must be evaluated when estimating enterprise value. The list of appraisal considerations is too long to address in any one discussion. Suffice it to say that one should understand, measure and benchmark multiple facets of an organization’s business such as production processes, distribution channels, sales infrastructure and customer service. A clarity about the industry in which a business operates is likewise essential. Who are the competitors? What regulations prevail and how is the industry responding to new mandates? Are industry sales sensitive to changes in global or local economic conditions? Is the industry poised for growth or fast reaching its apex?
Turning the microscope to narrowly focus on a single company, it would be remiss to ignore the economics of its brands and reputation. An organization’s customer base can reward shareholders if net sales grow and add to free cash flow. On the other hand, disgruntled buyers can decide to go elsewhere or seek redress in a court of law. Both outcomes are costly and can lower share value. Notably, the damage associated with a lost sale can vary depending on how long it takes to recover, if possible at all. For example, a money manager that loses a large institutional client will be reinvesting a much smaller pool of capital over the ensuing months. Should other long-term consumers like peer pension plans get wind of bad news, they too may exit, causing the asset manager’s portfolio to plummet further.
It’s not remarkable then that new research concludes that “high firm and product awareness – or together, brand awareness – could lead to greater retained assets and new inflows.” Nevertheless, the message is one that bears repeating given the significance. While its 2016 survey affirmed the link between reputation and financial wellbeing, eVestment uncovered some startling trends too. They are summarized below:
For details, read “Why Asset Manager Reputation Matters” (Chief Investment Officer, May 19, 2016) or download the white paper entitled “Importance of Brand Awareness” from the eVestment website. As Warren Buffett declared, “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”
If you get a chance to view “The Man Who Knew Infinity,” go for it. Award-winning actors abound in this tale of math wits at Cambridge University who contributed dozens of important ideas that are still being used in business and science. Dev Patel, stars as the self-taught math genius, Srinivasa Ramanujan, who rose from poverty to team with world-renowned scholars such as Bertrand Russell and John Edensor Littlewood. Based on a book of the same name by Robert Kanigel, this biographical tale of talent writ large examines the unlikely friendship between Mr. Ramanujan and his mentor, Professor G. H. Hardy (played wonderfully by Jeremy Irons), the uncertainties of a war torn England and the dire loneliness of the young man who left his home in India to share his insights about numbers.
Sadly, Mr. Ramanujan died in his thirties, leaving a legacy of path-breaking equations that have since been proven right. According to a 2012 article in Business Insider, his work is used by physicists to compute “the entropy, or level of disorder, of black holes.” Last month, the founder and CEO of Wolfram Research, Stephen Wolfram, reviewed Hollywood’s take on this band of merry mathematicians and pondered how they could have saved countless hours had they had access to his Mathematica product that is used by many Wall Street quants. His admiration for this driven wunderkind is obvious, as is his hope “that many more people will take advantage of the tools we have today to follow Ramanujan’s lead and make great discoveries in experimental mathematics – whether they announce them in unexpected letters or not.”
Popcorn aside, The Man Who Knew Infinity is captivating and well worth a trip to the cinema.
When I was a university professor and gave written homework, I frequently found myself in the position of having to remind students that reliance on a spell checker may not always produce good results. “I through the ball” is grammatically incorrect but would not reveal itself as an error. Someone would have to know that “threw” is the appropriate choice. Inevitably, a few individuals would counter that they plan to employ staff to write memos, carry out financial analyses and undertake research. I would then ask how one can adequately evaluate a potential hire, let alone review the quality of that person’s work (if hired) if he or she is lacking sufficient knowledge to recruit and oversee thereafter.
Outside the classroom, selecting and monitoring is no less important, whether it’s an investment security or a service provider. During a recent workshop I was invited to lead about service provider due diligence and the U.S. Department of Labor (“DOL”) Fiduciary Rule, I shared a matrix I created with other investment industry professionals. It showcases some of the many qualitative and quantitative elements that could be used as part of a selection and monitoring endeavor. Big picture categories include, but are not limited to, the following: Client Capabilities, Compliance, Credit Worthiness, Funding Sources and Operational Integrity. See slide 24 of the presentation entitled “Fiduciary Considerations” by Dr. Susan Mangiero.
With its early April 2016 debut, it’s too early to tell how the DOL’s new mandate will influence hiring and subsequent performance reviews. Attorneys emphasize that the bar is set higher than before so it will be important to track how Requests for Proposals (“RFPs”) and vendor interviews proceed. Firms seeking to use a “Hire Me” exemption to avoid being tagged as a fiduciary may not be able to provide sufficiently granular and plan-specific information to ERISA buyers in order for those fiduciaries to carry out their duties. When this question arose during an April compliance conference I attended, several of the presenting attorneys acknowledged that there could be an information gap, adding that buyers and sellers would have to figure out a mutually beneficial path forward. I will defer to the legal professionals to address this issue.
As an aside, the “Fiduciary Considerations” slide deck prepared by Dr. Susan Mangiero includes material produced by others. Efforts were made to attribute the original source. Those seeking to use any or all of this slide deck need to contact the copyright owners of each slide.
The news in pension land is sobering to say the least. Sadly, there are too many examples to cover in one blog post but taxpayers, participants, creditors and regulators are trying to understand the nature of the money trail that has, for some plans, led to trouble writ large. Consider what’s going on in Puerto Rico right now.
In addition to a just missed payment of more than $400 million, Governor Padilla told C-Span viewers on May 6 there is no money to pay roughly $800 million due on July 1 2016 to senior bondholders. As he explains, debt service has gone up faster than what he calls revenue inflows. Elsewhere, Nick Brown of Reuters writes at length about gross underfunding of the municipal pension plans in “Puerto Rico’s other crisis: impoverished pensions” (April 7, 2016). Despite multiple reforms introduced in 2013, funding remains perilously low. Keith Brainard, head of research for the National Association of State Retirement Administrators, is quoted as saying: “With about $1.8 billion in assets to pay $45 billion in liabilities, the 96 percent combined shortfall is among the biggest of any U.S. state pension this century, and probably the biggest ever for pensions ‘of this size and scale’.”
Bad economics is more than a numerical exercise. Real people are impacted. Plan participants, taxpayers and investors all have a stake in what happens next. As I wrote on March 19 in “Puerto Rico: Pensioners Versus Bondholders,” many individuals who own debt issued by this U.S. territory are themselves retirees or saving for retirement.
Should contagion occur, the cost of capital for other municipal borrowers will almost surely increase as frightened investors demand higher yields. Worse yet, some lenders may say “no” to certain new debt, leading to possible tax hikes at the local level. There is a trickle down effect when credit risk heads upward. See “Muni Market Shrugs at Puerto Rico Default, but Next Time Could Be Different” by Bernice Napach (Think Advisor, May 2, 2016).
Whatever you think of the Puerto Rico situation and proposed solutions, the clock is ticking for many cities, counties, states and countries that have not adequately funded their pension plans. Capital markets are paying attention. There is a lot at stake.