LITquidity
How private market liquidity has evolved into the modern era
May 17th 2023
Written by Alec Hubbard, CFA
Within the financial services industry, private equity represents one of the more complex investment vehicles that are accessible to investment strategist for their high net worth clients. A key component of that asset class is its illiquidity, but the nature of how professional private equity managers engage that illiquidity has evolved over time. To cover this evolution, on May 17th 2023 CFA Society St. Louis heard from Bob Long, CEO of StepStone Private Wealth, at the St. Louis Club in Clayton Missouri. A premier speaker on private equity, Bob’s entire career can be summarized by his efforts to expand access to private companies. Prior to becoming the CEO of StepStone private wealth, he co-founded Conversus Capital, and prior to that led Bank of America’s strategic capital division.
To begin the discussion on liquidity in private markets, Long reminded the attendees that illiquidity and returns share a fundamental positive relationship. Therefore, even though illiquidity cannot be eliminated entirely by the evolution of private markets that is a good thing because that illiquidity should generate an illiquidity premium to returns. Even given the benefit to the illiquidity premium, Long characterized the expanded access to private markets relative to a historical lack of accessibility as a good thing before elaborating on how he views his firm’s role as an actor in private markets.
Bob framed StepStone as “the most important asset manager you’ve never heard of”. As one of the largest allocators to private markets, StepStone serves a key role for institutions attempting to access private equity, private debt, private real estate, and infrastructure. Within those asset classes, StepStone proactively stays in the business of solving problems for clients, directly, by operating SMAs, co-mingled funds, and in a less direct capacity in advisory services and analytics where they can use their unique technology and access to data in private markets to help inform the processes of other firms. After the introduction to StepStone, Bob went into a detailed discussion on the history of private markets.
Access to private markets was originally developed via the primary fund. A primary fund is structured as a limited partnership (LP) where the limited partners commit capital to a general partner (GP) who invest those funds over a 5-7 year period in a target company, and then return those commitments with any gains in what is generally stated to be a 3-4 year period after the initial 7 for a standard life of 10 years. In practice, Bob asserted that the historical lifespan is often closer to 15 years. The key takeaway is that these primary funds have a finite lifespan. Within this structure there are several pronounced risks. The first is blind pool risk which exist because you commit assets to a fund and pay fees on those committed assets before investments begin. Second, capital calls are unpredictable which result in a difficulty in getting a client invested, especially without sufficient scale. Finally, a general inconvenience exist wherein the structure of the funds necessitate a K-1 tax form which is issued in October as opposed to the more user friendly 1099 form which is issued in January.
Following the primary fund, 20 years ago secondary markets debuted. Secondary markets were created so that primary investors could sell to a secondary buyer with the consent of the general partner (GP). Bob pointed out that general partners are more likely to give consent when the secondary buyer is one they view favorably which gives strong secondary managers a network effect. Secondaries started as a vulture market because of dramatic information asymmetry. An important reminder Long articulated was that the same protections against insider trading that exist in public markets to not exist in private markets. Because good secondary buyers proliferated the ability to obtain sound information, the secondary market grew to $22 billion by 2010. Hence, while secondaries started as a vulture market, they evolved to become the first source of consistent liquidity available in private markets. Bob then continued on to the advantages of secondary funds relative to primary funds.
Secondaries lessen the blind pool risk of primary funds and also have a shorter duration then a primary fund. For many reasons, but primarily because of active portfolio management, many secondary sales happen at a discount which favors the secondary buyer. For reference, Bob shared that 1/3 of the gains StepStone has managed have come from purchasing private assets at a discount while 2/3 of those gains have come from the continued growth of the purchased assets. These advantages for secondaries eventually encouraged the development of GP led secondaries.
Long dubbed GP led secondaries as “Liquidity 2.0” as general parenters were able to create secondary funds themselves to create liquidity for their primary funds, and in an effort to improve blind pool risk themselves. An important strategic ability these funds had was the ability to retain successful companies. Whereas a general partner in the past would have to sell successful companies and lose future returns to start a new fund, they can now sell just a portion of that company to a 3rd party via a strip sale. This also provided for continuation funds where company can be bought by the continuation fund if a general partner thinks it can continue to hit their return target. The added flexibility for general partners played a part in the massive expansion of GP led secondaries through 2017 and 2018, and the market for them has expanded dramatically even after the COVID pandemic. In terms of client experience, Long stated that GP led secondaries tent to mathematically have the look and feel of a co-investment, and allegorized them as betting on a horse after the race has started. Bob concluded that today we have a robust traditional secondary market where quality assets with strong IRRs can be acquired by buyers who operate in those markets like StepStone.
With the history of primary and secondary funds laid bare, Bob illustrated the evolution of private markets today. In the modern day, a big driver of flows into and out of private investments is the denominator effect, a phenomenon that happens when attempting to rebalance a portfolio of publically traded assets whose valuations are fluid with alternative investments whose values may not immediately reflect current events. Furthermore, buying secondaries isn’t easy. Because the seller needs GP consent there is a lot of work to do and the mechanics of it are different than buying private companies directly. While managers like StepStone are able to navigate these challenges and the expansion and contraction of private company discounts, allowing clients to navigate these challenges more seamlessly has encouraged the next evolution of private markets, the evergreen fund.
The evergreen fund, not to be mistaken with a liquid alternative investments, is a fund with typically monthly entry, points, quarterly exit points, provides a 1099, as well as a daily or monthly net asset value. As a semi liquid fund, there are compromises made and so most funds provide a maximum of 5% of the fund’s assets that can be withdrawn in a quarter meaning there is no guarantee a client could receive their distribution from the fund in a given quarter. This compromise allows the fund to protect itself from being oversold and maintains what Bob argued was most of the illiquidity premium private markets allow for. The ever-present ability to invest capital and withdraw assets, even if it takes a couple of quarters, makes these vehicles an interesting advancement for individuals and smaller institutions. The structure is able to be held in a retirement account which can add further appeal to one looking to invest in something and allow returns to compound over longer periods. Bob finished by stating he believes this tool allows for an access to premium returns that private markets offer, with more transparency, convenience, and liquidity then was historically possible.
As a Matter of Factor April 11th 2023
Written by Alec Hubbard, CFA
Diversification is something of a mantra to financial professionals. In the modern era of investing, the number of axis one can diversify across has expanded profoundly. As a result on April 11th 2023, CFA Society St. Louis was benefited by hosting Chris Busch, CFA from First Trust to speak on factor based investing at the Hilton Inn in Frontenac MO. Busch, as a vice president of strategy research and portfolio manager for First Trust’s active style suite of ETFs, was uniquely qualified to discuss using factors to “know what you own”.
He opened by reminding the audience that the best factor an investor has been able to take on historically is the equity risk factor. He then contextualized that comment to the current economic environment, reflecting on the outperformance of technology in the first quarter and the 2 key inputs to performance year to date, interest rates and the earnings environment.
Moving onto factors specifically, Busch defined 6 factors that he uses in his practice: value, momentum, quality, size, low volatility, and dividend yield. Each of these factors have slightly outperformed the market if observing the period between 1988 and today through either enhancing returns, or removing risk from the broader market. What makes the factors valuable is the additional means of diversification they provide. Chris pointed out that in recent times, the market has become more “basketized” in that assets broadly tend to move up or down together. Factors provide another avenue to find qualities about assets which may reduce their correlation with one another.
Assessing factors is not without risk. Busch cautioned that factors move in and out of favor over time, which warrants a multi factor approach. Factors are also difficult to time because 1) they tend to be tied to the business cycle which itself is hard to predict, and 2) even if the business cycle is completely understood, factors can act contrary to expectations. With those reminders Busch went on to briefly cover how the 6 factors he outlined have acted recently.
Size
Chris commented that small caps are cheap from a price to equity multiple standpoint relative to large cap companies. That said, within large cap companies the highest weighted companies in indexes weighted by market capitalization are expensive relative to even the smaller large cap companies. This has created an environment where the S&P equally weighted index is an entire standard deviation below the S&P 500 on the size factor, and provides an opportunity to find companies which have attractive multiples without moving into asset classes which are widely considered more risky.
Quality
Of the factors, Chris noted that quality is the most ambiguous. Academically quality tends to refer to a company’s profitability and having a good balance sheet. The result historically is a factor that is never the top performing but is never worst performing either. Busch speculated that the number of “zombie companies”, i.e. companies that aren’t profitable, has increased. As seen in the recent banking turmoil, a market that culls unprofitable companies from its ranks provides an environment that can make the quality factor attractive.
Value
Busch noted that growth has become more attractive than it was 2 years ago. He elaborated that while last year was value’s year, growth has since resumed its recent historical trend of outperformance. Chris explained that value tends to be a more innocuous factor, but it has big riffs which can warrant its inclusion in a portfolio. He highlighted a key challenge in value investing is the consistent reconstitution of value indexes. This causes the inclusion of names which are less intuitive in the value universe like META while traditionally value names like XOM and CVX have counterintuitively moved to growth due to the prior year’s broad rally in energy names. Therefore, the key to value investing is ensuring that you are actually getting value in the investments selected.
Low Volatility
Chis noted that he likes this factor as it gives investors a means to stay in equities, but take risk off the table. The factor provides investors a means to get a more defensive profile without being tethered to traditionally defensive sectors like staples and utilities exclusively. He elaborated that it can be a good factor to mix with others because the names this factor captures tend to be bond proxies. His concluded that an interest rate cut could benefit this factor.
Momentum
Busch defined momentum as a factor with a lot of divergence. Momentum is more profound then broader growth because it shifts more regularly. Currently, energy holds a high weight in momentum indexes because of energy’s rally in 2022, but it hasn’t maintained the same level of outperformance as last year. Consequently, an important consideration when investing in momentum is rebalancing frequency.
Dividend Yield
Chris commented that he finds the dividend factor interesting. He advocates for companies who grow their dividends over companies that have a high current yield as the dividend aristocrat index has proved more than competitive with the growth index. He pointed out that the dividend factor can struggle in markets dominated by FANG stocks which in recent years has created a narrow market, but expressed that he liked the factor moving forward.
In conclusion, Chris noted that factors should be used like a toolbox so that investment professionals aren’t limited to single stock risks and sector specific risks when exploring how to diversify risk in a well-structured portfolio. Furthermore, he emphasized that factors work better as an investment strategy when fundamentals matter.
RECENT EVENT HIGHLIGHTS
VICTORY ROAD:
The 2022-2023 CFA Society St. Louis Research Challenge Finals
February 17, 2023
Submitted by Alec Hubbard, CFA
To the layman’s view, the CFA Institute Research Challenge appears to be the most quantitative book report ever written paired with a professional oral presentation. Lying beneath the surface is a rigorous research exercise that combines the talent of students, professors, and professional mentors. On February 17 at The Ritz Carlton in Clayton, five teams took on the CFA Society of St. Louis Research Challenge and presented their research to high-profile judges from across St. Louis’ community of CFA charter holders.
Each team was charged to present on the target company, St. Louis-based food technology firm Benson Hill, for 10 minutes followed by a 10 minute question and answer session. This presentation leveraged their research and their completed report to persuade the judges to their buy, sell, or hold rating on the company. The final score to determine the victor was built with the following components: 20% on financial analysis; 20% on valuation; 10% on ESG evaluation; 20% on the presentation itself; 20% on the following Q&A session; 5% on the team’s involvement and 5% on the quality of the materials used.
Like any good competition, the Research Challenge had real stakes, with the First Place team receiving an invitation to the next level of competition and each of its members receiving a $1,000 scholarship for the CFA program. Each member of the Second Place team received a $500 scholarship for the CFA program.
Opening the event, Joe Lachky, Co-Chair of the CFA Society St. Louis Research Challenge Committee, introduced the judges. The panel was comprised of Mark Keller, Confluence Investment Management’s CIO; Nick Tompras, the CEO and CIO of Alpine Capital Management; Linda Bannister, Edward Jones’ Director of Securities Research; and Robin Diedrich, a Senior Equity Research Director at Edward Jones. The expertise of the panel demanded a high level of polish and contributed to a thought-provoking Q&A discussion for each team. With the competitors aware of the judges’ specific backgrounds, the presentations began.
Team A from St. Louis University, which consisted of Mason Kimbarovsky, Patrick Gosser, and Josh Parney, was the first to present. Their presentation attempted to reconcile Benson Hill’s potential for a 50% upside, suggested by a high growth rate, with rocky financials and volatile cash flows. Comparing the company to Benson Hill’s more developed peers in their industry, Team A provided cause for prudence when approaching the stock, considering lagging key ratios like the weighted average cost of capital. Team A also pointed out unique ESG risk including the high compensation package for Benson Hill’s executives relative to their small size and inconsistent cash flows. The judges asked about these challenges and the nuances of how executives were compensated and how they went about valuing products without profitability.
Team B from Washington University consisted of Samuel Berger, Teja Sunkari, Sam Guo, Lillian Zhao, and Ulrica Wu. Team B asserted a Buy rating with a 50% upside to the stock’s current price. Their bullish recommendation leveraged macro-level demographic trends, an increasing demand for the product pipeline Benson Hill develops, and micro capabilities that observed the capacity for Benson Hill’s unique technology. They assigned a $3.55 share price weighting their thesis and projected likelihood for scenarios including a potential merger to outright business failure and $3.9 using a profit to gross profit multiple analysis. The judges challenged the team on a royalty scenario they presented, with a low probability and specifics on their merger scenario amidst other specifics.
Team E from Southern Illinois University in Carbondale, which consisted of Katherine Held, Ethan Keller, Ivan Vargus, Yunjia Zhu and Matthew Carrazoo, recommended a Sell rating with a target price of zero. Their extremely bearish thesis hinged on Benson Hill’s Management having no credible plan to achieve profitability in the face of an already mature industry. Their analysis projected the company’s cash flow running out as soon as 2029. Using Benson Hill’s debt maturity schedule and discussing the more challenging environment for debt financing moving forward, Team E saw the company moving towards bankruptcy within 5 years. To compound their bearish case, they pointed out the lack of available ESG data from the company. The judges asked if they had considered any scenarios like a merger and if the technology Benson Hill develops has no intrinsic value. They also asked about areas where team E’s cashflow projections varied from Benson Hill’s management.
Next, Team F from St. Louis University consisted of Stephen Rashford, Vrisha Jagdish, and Samad Arif, who presented a buy rating with a price target of $2.36 which implies a 113.6% upside. Team F leveraged a discounted cash flow model considering the weighted average cost of capital throughout Benson Hill’s potential stages of growth. They defended management’s projections with regard to cash flow and asserted that management has managed risk well with respect to public perspective, cash burn, future financial stability and their limited operating history. The judges asked about details to the detailed cash flow model, whether or not certain projected risk could be quantified, and how their risk management encouraged them with respect to management’s capabilities.
Finally, Team G from Washington University, which included Yeetang Kwok, Eric Mafla-Hernar, Ethan Bort, Jacob Daniel, and Ravi Dantuluri, presented an “avoid buy” rating with a target price of $2.44. They pointed out that relative to the international environment, Benson Hill’s approach to products is costly, relative to its overseas peers. In addition, the lack of ESG ratings and data challenges the thesis of Benson Hill as an ESG play, even while admitting some of the company’s processes had merit with respect to ESG. While showing metrics that could be used to justify a more bullish case, the team projected that a challenging macroeconomic environment could influence liquidity to Benson Hill’s detriment. The team used two methods, one based on multiples and one based on beta, to arrive at their price conclusion. The judges asked how they assigned weight to each of their valuation methods relative to one another and the specifics of their valuation models.
After the judges deliberated, the competition came to a close finish. Team B from Washington University scored First Place by winning over the judges with an outstanding presentation and the 2nd highest score on the written exam. Congratulations to Samuel Berger, Teja Sunkari, Sam Guo, Lillian Zhao and Ulrica Wu!
Team F from St. Louis University was awarded 2nd Place with the highest score on the written portion of the exam. Congratulations to Stephen Rashford, Vrisha Jagdish and Samad Arif!
*Benson Hill’s price as of writing was $2.30 per share. **The investment theses, price targets, and other covered points in this article were developed by competitors for the CFA Institute Research Challenge. They are not investment advice and the soundness or accuracy of anything discussed in this piece is not assured.
The Tax Advantaged Ride of a PPLI
November 8th 2022
Written by Alec Hubbard, CFA
Within investment management, and alternative investments specifically, finding strategies which can make effective returns is of paramount importance. That said, for many clients the tax efficiency of their investment strategies and vehicles is nearly as important. On November 8th 2022, CFA Society St. Louis heard from Zach Specht from Winged Keel Group and Ross Van Der Linden from Golub Capital on using private placement life insurance (PPLI) policies as a tax efficient means to access alternative investment strategies at the St. Louis Club.
Zach kicked off the presentation introducing private placement life insurance policies. PPLIs are a form of variable life insurance. Whereas a traditional life insurance policy wants to maximize the death benefit while minimizing premiums, PPLIs, instead encourage a lower death benefit and allow premium dollars to be invested into 3rd party managed investments. Within the policy, investment returns can grow tax deferred making them an interesting vehicle for high net worth clients. Zach cited dynastic trusts as an example of an entity that could take advantage of PPLIs because of a potentially tax free disbursement in the event of the death of the grantor. In addition, because you can withdraw the principal without a tax penalty and take a loan against the policy for 80% of its value, Specht stated that you don't see a lot of these policies surrendered.
He then presented hypothetical performance figures of investments within a PPLI relative to a hypothetical taxable investment. While the impact of PPLI fees/insurance cost were 52bp, the tax drag of comparable taxable investments ranged between 2.83% and 4.57% (assuming 75% of the tax impact was short term capital gains and 25% long term capital gains). Specht made the case with these figures that the advantage of insurance cost relative to the tax consequences of taxable vehicles could be vast.
Moving past the quantitative slide, Specht stated the minimum investment is a $1mm premium commitment spread between 3 or 4 deposits. Within the policy, 3rd party investment managers also have minimums meaning a typical commitment is $5mm for the sake of accessing a diversified set of managers within the policy.
A key constraint to PPLIs is that, in order for investment managers to be made available for the policies' use, investment managers must have an insurance dedicated fund (IDF) to prevent the comingling of taxable dollars and insurance dollars. This limits their investable universe. A second key constraint is that while clients can choose which investment managers and 3rd party managed strategies are used within the PPLI, clients cannot influence specific investment selection within those 3rd party strategies. Due diligence on the 3rd party managers is performed by the insurance providers. With the potential benefits and constraints to PPLIs laid out, Ross then described Golub Capital's strategy and how it fit in the broader picture of PPLIs.
Golub Capital is a private credit manager which provides first lean senior secured loans to private equity companies backed by private equity firms. Ross explained that while traditional banks provided most debt financing to private equity 30 years ago, they have largely decreased the lending they do within the United States in that space. This environment has allowed non-bank lenders to fill the gap. This provides an interesting investment opportunity for Golub especially in this unique interest rate environment where Ross cited the rates they are able to charge are up to 11-13% from historical levels of 7-8%. In addition Der Linden cited improving debt covenants as a reason for a more attractive investing environment today. He articulated that having a private equity partner with the companies Golub works with is important because it provides an entity which can provide capital injections to the company if needed, and affords the company a more objective assessments of management performance relative to something like a family owned business where management can be hard to replace.
Because of the interest payments an investor receives in an investment like Golub, using it within a PPLI could be an effective ways to enhance the investor experience via a more tax efficient vehicle. To that end, Ross concluded that Golub can be a good partner to high net worth families.
To register for the CFA Society St. Louis popular monthly speakers, contact CFA at 314-520-3564 or [email protected] Please tell us if you are a CFA member to receive the member discount rate.
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CFA Research Challenge Kick-Off
October 26th 2022
Written by Alec Hubbard, CFA
The CFA Institute's Research Challenge represents a great opportunity for students to step into the shoes of a sell side analyst and spend a few months in their shoes. This year's competition kicked off the first 20 days of preliminary research at the Ritz Carlton Hotel in Clayton Missouri where 7 teams from Saint Louis University, Southern University of Illinois Carbondale, Washington University, Maryville University and Lindenwood University met Matt Crisp, the CEO of this year's subject company Benson Hill, and Ruben Mella, Benson Hill's head of investor relations.
Matt Crisp led the presentation. He opened encouraging the students with his own experiences stating that his biggest success in school was lobbying his school's endowment board to allow a student managed investment portfolio. He told the students that in participating in the research challenge, they are creating a similar experience. He then went on to describe Benson Hills's history and business model.
Matt described Benson Hill as a St. Louis based food technology company that was co-founded 10 years ago with the Donald Danforth Science Center, the largest independent plant research science center in the country. The company has a wide range of employees representing blue collar and white collar positions alike including engineers, mathematicians, data and plant scientist, sensory experts and experts in ergonomics and plant breeding. The average salaries well into the 6 figures are due to the high expertise of staff.
The value proposition of Benson Hill revolves around a story of technological progress. In the status quo, Crisp described our food system as producing cheap calories wherein food production has become efficient because it was structured with a set of silos each incentivized by scale. Examples of these silos are 1) breeders/seed farmers whom are incentivized to produce as much as possible with as few inputs as possible, 2) ingredient companies who are incentivized to be as efficient as possible so they can sell to 3) consumer packaging companies to distribute to the end consumer. The incentive around costs motivates the addition of additives and flavors to create products customers find attractive and motivates a decrease in nutritional content because breeding for yield prioritizes carbohydrates, which are cheaper for photosynthesis to produce than proteins. Ultimately this sends a less than optimal product to the ingredient phases of production.
To solve for this, Benson Hill seeks to take feedback from the end consumer and link that feedback to seed design with the end goal of building something better for the consumer seamlessly. They hope to leverage innovation to do this while pulling cost from the current systems that produce food. Because technology like AI, sensory systems, CRISPR, and other developments in the space allow humanity to understand and work with the genome better than ever before, Crisp argued Benson Hill's ambition to leverage these tools to accomplish its aims is a strong proposition.
Matt then went on to describe the market opportunity. In the status quo, plant based markets are capturing a premium seen in examples like beyond meat and alternative dairy. The demand for protein is increasing globally, and the impact on inflation on food has been pronounced. Part of the opportunity has an ESG element to it as well. Because breeding for yield decreased proteins and increases carbohydrates, carbon intensive steps in the food production process must be taken to increase the percentage of proteins in an end products. These are steps which Benson Hill can remove eliminating a negative externality as well as costs from the food production process.
In the face of this, Matt described Benson Hill's strategy as 3 pronged 1) Genetics data which he contextualized to say data can help develop plants 2) Technology which he contextualized saying that technology can help develop infrastructure and capabilities to produce faster stronger and cheaper than existing methods, and 3) leveraging multiple markets which he contextualized by reminding the audience that knowing how to sell a mouse trap is important right alongside developing one.
He then went on to describe Benson Hill's technology platform. Its capabilities include, amidst others, predicting outcomes of plant breeding in advance of physical testing and using crop accelerator facilities to force reproduction to speed up the R&D process. The end result is selling texturized flour to use in food production, specialty oils, and aquaculture (livestock food).
Finally Matt answered several student questions about the company's competitors, international strategy, and considerations of the current macroeconomic environment. He concluded that an important consideration for the students would be the macroeconomic environment and what is responsible from a multiple standpoint when attempting a valuation, and encouraged the students to leverage Benson Hill's investor relation's site's videos and archived presentations, including the one he spoke on which can be found at the following URL. (https://s28.q4cdn.com/858570331/files/doc_financials/2022/q2/Q2-2022-Earnings-Presentation-FINAL-1.pdf)
From this point, students will have until November 17th to compile a list of any additional questions motivated by their own preliminary research for Benson Hill's management who will be made available to students at least once before the competition closes. December 17th is the due date for the research presentation's first draft. A final draft will be due in January and the final competition presentations will be delivered on February 17th for prizes including notoriety, vouchers for the CFA program, and advancements to higher levels of competition.
To register for the CFA Society St. Louis popular monthly speakers, contact CFA at 314-520-3564 or [email protected] Please tell us if you are a CFA member to receive the member discount rate.
CFA Society St. Louis October 2022 Career Fair
October 13, 2022
Written by Alec Hubbard, CFA
After the resounding success of the previous career fair in March, CFA Society St. Louis hosted a second career fair for students and recent graduates this year at the St. Louis Club. Amidst the opportunities to network and explore opportunities with local employers, including Edward Jones, NISA investment Advisors, Confluence Investment Management, Asset Consulting Group and Wells Fargo, participants were able to hear about career possibilities for professionals interested in the CFA charter.
Kathleen McGrath, CFA – Wells Fargo
The first speaker was CFA Society St. Louis' president Kathleen McGrath CFA. Kathleen outlined the basics of the charter for interested students. Short for "chartered financial analyst", the CFA charter involves completing a college degree, 3 exams, and 4 years of work experience. She emphasized that the charter is the gold standard within the financial services industry and serves as a toolbox to access a lot of different opportunities in the industry. The curriculum involves financial analysis, performance assessment, portfolio management, quantitative methods, economics, ethics and other topics pertinent to the industry, and McGrath highlighted that even the seemingly odd topics on the exam can become surprisingly relevant as one's career progresses within financial services. To demonstrate, she spoke on her own career journey.
McGrath started her career covering medical device companies specifically which, over a decade in that role, culminated into her becoming an expert in medical technology company valuations. When Kathleen wanted to make a change, the education provided by the CFA charter's curriculum allowed her to make the leap to investment analysis beyond medical device specific companies. Due to the breadth of her knowledge base enhanced by the education behind the CFA charter, she then transitioned to join manager research at Asset Consulting Group.
Kathleen then described her roles with Asset Consulting Group and her current role with Wells Fargo as manager research positions. She elaborated. Manager research is a career field which involves picking investments for clients to use within their asset allocations. She described it as "sitting on the other side of the table" wherein instead of evaluating individual companies as investments, she now evaluates portfolio manager's ability to effectively manage investments. She described the CFA as an important factor to make a large change in career as it proved her abilities in the industry in combination with her more focused experience. Ultimately, she concluded that the CFA charter was vital in supporting her ability to navigate the industry, and that the discipline required to obtain a charter would carry any professional in the financial services industry far.
Aaron Goekner, CFA – Semper Augustus Investments Group LLC
The next speaker was CFA Society St. Louis' Vice President Aaron Goekner CFA who emphasized that he felt lucky to have obtained his CFA charter early in his career. He encouraged students to 1) look into the CFA charter as it proves one's knowledge and discipline to prospective employers, and 2) student memberships within CFA society St. Louis as the membership allows one to participate in all events and networking opportunities the society offers.
He then described his role within Semper Augustus Investments Group where he evaluates the merit of individual stocks within Semper Augustus, which is organized as an RIA as opposed to being organized in a mutual fund structure. As a member of their investment team, Aaron has to keep up with each company his strategy covers as well as generate new investment ideas. All portfolios at Semper Augustus are invested in a concentrated value strategy with relatively low turnover. Specifically, this process involves keeping up with the news on businesses they own, setting a target sales price, and understanding what impacts the businesses they own or consider owning. He emphasized that his process is to look at stocks as a long term business owner as opposed to someone renting a stock and concluded that he enjoys his work as it allows him to explore wildly different businesses.
Dr. Nong Lin, CFA – Commerce Trust Company
Relative to Aaron's process of fundamental analysis, Dr. Lin contrasted his own process as a quantitative analyst. As a quantitative analyst, Nong wants to know factors in the market that capture stock returns and build a model that projects the future returns of those positions. He can look at the S&P universe or other universes, but the portfolios he co-manages are mutual funds that cover large cap value equities, large cap growth equities, and mid cap growth equities. In addition he has environmental focus strategies to create a more environmentally friendly portfolios considering certain values in the large cap growth and large cap value universes.
Influenced by Dr. Lin's expertise, each fund does well according to Morningstar rankings. Elaborating into his process Nong described his starting point as looking into an investment universe and specifically industry or academic publications about which factors were strong predictors of investment returns. From that starting point, Nong test the factors himself to form an opinion on the validity of that academic or industry research. Then, using a model he builds within the context of his research, he ranks stocks by future predicted returns and builds a portfolio around them.
For Dr. Lin, his day-to-day involves reading news and academic papers and a lot of programming to determine the application of the publications he digests. For a quantitative analyst, rolling up one's sleeves and verifying the truth needs a lot of programming expertise to back test and understand if a new factor can better understand and predict returns.
Dr. Lin's application of the charter was also unique to his background. When he got a PHD in mathematics, the CFA program became a good way to transition his raw mathematic abilities into the investment industry. To that end he said that if you need to switch careers or better apply your major to the financial services industry the CFA charter is a good way to get people to believe in you and open your horizons.
He concluded that if one is interested in becoming a quantitative analyst one needs to 1) like numbers 2) have mathematic and statistics knowledge 3) needs programming skills in a software like SPSS, Python, R, and Excel, and 4) an analytical mind that evaluates topics without emotion in an unbiased way. He also hinted that AI and machine learning are very topical areas in the industry today.
Kevin Moore, CFA – Asset Consulting Group
Kevin offered a slightly different angle on the investment industry as he performs research for entities with long term to perpetual time horizons like endowments, insurance companies, family offices, and the like. His work involves leveraging the financial planning team, performance team, and research team to marry the risk and return objectives of the entities he serves with investments, investment managers, and a variety of strategies which can help meet or exceed their long term goals. He described Asset Consulting group as a company that likes to maintain talent and outlined his own career at the firm from intern, to manager research, to his current role as a portfolio manager on the pension side of the business.
Patrick Fearon-Hernandez, CFA – Confluence Investment Management
Patrick Fearon described his work with Confluence Investment Management in Webster Groves MO, a 100% employee owned RIA with about 45 employees. Patrick is Confluence's market strategist transitioning to take over for Confluence's chief market strategist Bill O'Grady. His role involves taking a top down look at the global "bit picture" with respect to the current investing environment. His role involves closely following geopolitical global economics, technology changes, economic developments and financial developments.
Patrick spoke to his own unique background. He started with the CIA where he was an analyst focused on Soviet defense economics. He described his role at the CIA as answering questions like" is more defense spending good/bad for the economy and what are the impacts of it on the military effort". When the cold war ended he got his MBA at Arizona City University with a focus on investments, but used the CFA charter to supercharge his emphasis in the investment industry. He called those two efforts a perfect way to consolidate what he was learning to get in depth in investments.
Patrick mentioned that Confluence was actively looking for another geopolitical analyst. He elaborated that someone with a background in foreign languages, international relations, global economics, and history who can write quickly could make an ideal candidate.
Rusty Froth, CFA – Nisa Investment Advisors
Rusty Groth CFA opened speaking to his own background. He began his career after receiving an MBA at the University of Missouri when his employer, Nisa Investment Advisors, had him get the CFA charter. He said the CFA taught him a lot of lessons and concepts that have held up through his 15 years in the industry.
Transitioning to speak about his employer, Groyh described Nisa as a large bond manager with 350 employees and $450 billion in assets under management. Most assets Nisa holds are physical bonds, and all of the assets are institutional. Unlike a bond strategy like Pimco, where the mandate is the total return of the assets, the clients Nisa serves employ a technique the CFA curriculum teaches called Asset-Liability Management, where bonds sensitivity to interest rate changes is matches to a client's liabilities (like a loan to someone else) sensitivity to interest rate changes. Along the way they make small alpha generating trades to cover their fees. That process means even in an environment seeing sharp interest rate increases like today's Nisa's client's portfolios can accomplish their objective in the context of their liabilities.
Nisa is the largest domestic credit manager in the world because it has $70billion in credit for sale every day (for the right price of course). The size of their clients means that this is all accomplished with just around 250 clients. Given the number of employees that affords a small team to each client. That personalization has earned them the reputation of being a good "go-to" when a large entity is looking for a custom solution to a problem.
Conclusion
Finally Kathleen returned to conclude the session offering some insight. Whether one should choose a CFA or an MBA she speculated that there was not an objectively right answer and that it depends. She reminded potential candidates that many employers in the financial services industry will pay for the CFA program. In addition the local CFA society has scholarships available (on this very website!). She also announced that interested students could participate in the annual research challenge next year wherein teams work with a faculty member and a CFA Society St. Louis Member to learn how to build a financial model and analyze a company.
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How to Not Build Skynet
June 15, 2022
Written by Alec Hubbard CFA
Technology's rapid acceleration is an indisputable fact in financial services and every other industry. Yet, how do we make sure the outcomes of technological proliferation are the ones we truly want? To speak to difficult challenges like this, CFA society St. Louis heard from Dan Conner & Yinka Faleti of Ascend Venture Capital at the St. Louis Club.
Dan founded Ascend out of a relentless passion for innovation and entrepreneurship. As an investor in big ideas, Dan has cultivated a firm that enables the future states of industries. He specializes in new marketplaces and science that pushes the boundaries between fiction and reality. Dan is a recovering engineer from Yale University and holds master's in business and advanced renewable technologies from WashU.
His Co-Speaker, Yinka, joined Ascend out of a passion for ethical impact and social change. Since immigrating to the U.S. at age seven, Yinka's unbridled entrepreneurial spirit was borne from an inspiring journey through poverty, service, and hard-won achievement. Yinka's path at Ascend started after a captivating campaign as a former candidate for Missouri Secretary of State, Executive Director of Forward Through Ferguson, Senior Vice President of United Way of Greater St. Louis, prosecutor at the St. Louis Circuit Attorney's Office, and litigation attorney at Bryan Cave Leighton Paisner. Prior, as an officer in the United States Army, he attained the rank of Captain after deploying in tank units on two tours to Kuwait. Yinka earned his undergraduate degree and officer commission from the U.S. Military Academy at West Point, and holds a law degree from WashU School of Law.
Dan started the presentation by reminding the audience just how prolific technology has become. From the telecommunication industry's transition to 5G, advanced batteries, satellites and solar panel development to cloud computing and artificial intelligence (AI), we are quickly approaching a world in which every successful company, in some form or another, must be a data company. He positioned his firm's insight into these themes as uniquely valuable by articulating that venture capital, now as in the past, is investing in many of the bolder innovations. He argued we could use venture capital as a leading indicator in this regard. Fintech companies alone have received $134 billion in funding from venture capital which represents a year-over-year growth of 177%. That astounding growth is just one example of how these innovation are rapidly garnering attention. The consequence? Dan described the job landscape as quickly changing as computers become more capable of sentient analysis, algorithmic trading, stock price underwriting, and risk management.
This change raises precisely the ethical questions Ascend has spent time exploring. Yinka stepped in to raise some of these questions. He started with an analogy. What if a super intelligent AI (he named Sophie) were put at the helm of a venture capital fund with $100 billion in assets? In theory, Sophie could analyze every startup company in an instant, and optimize company selection beyond any human's due diligence capability. It would have a wider investable universe than any human managed shop and better security selection within that universe which would be a powerful advent in the Venture capital world. Yinka questioned, from there, what is to stop Sophie from overgrowing its boundaries? From its original universe of startups what could stop it from looking upstream? Why wouldn't it find problems and create startups of its own to solve them led by manager teams vetted more thoroughly than the likes of what we've seen? Why would it not acquire media companies to drive its investments via discourse? Why not even invest strategically in political campaigns to impact public policy? Ultimately, the point is that we will have to answer these questions before such raw computing power is widely disseminated through society to make sure the outcomes we want, as financial professionals and members of said society, are the outcomes that come to pass.
Yinka drew parallels to the era of Henry Ford and the dawn of the Model T. At the time, Yinka described farriers as being in one of two camps. EITHER they were fearful or they anticipated participating in the development of the automobile. The most productive course of action as today's "farriers" is cautionary participation. Caution, Yinka pointed out, is widespread about the future of technology with 27% of Americans believing their job will be eliminated due to automation. That number goes up to 37% when the polled sample was between 20 and 30. Professional estimates suggest 30% of labor could be replaced by automation by 2030. Even jobs previously considered prestigious could fall victim to this change as an artificial CEO could improve on their human counterparts with an ability to be multiple places at once, an ability to consider all relevant information without bias, and increase diversity.
AI's second challenge could hamper some of those perceived benefits. At the time of writing, AI are developed predominately by men who live in wealthy countries putting their programming in stark contrast to the 70% of the global population who don't live in a developed country. A recent example was an Amazon AI which had to be shut down because its algorithm led it to pick male candidates over comparable women 60% of the time.
Dan stepped in to conclude the presentation asking the crowd if we wanted there to be a super intelligent AI. As financial professionals, should we bar the door to their development, it could implicate us if the AI can make better investment decisions. Should AI strive for the benefit of individual firms or the greater human good? Should we, in our duty to prioritize clients, desire AI that strives to increase the wealth of everyone on the planet over profit maximizing ends? Ultimately, Dan and Yinka argued that humans need to be in the loop for the purposes of verification, validation, and control. As AI and technological proliferation become more inevitable, human's need to think about and make their opinions known on these crucial questions.
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Breakfast Approved for Television
April 27, 2022
Written by Alec Hubbard CFA
Hightower wealth advisors has a simple pitch, "We help you: make a plan, make an investment, and make a difference". Barbara Archer, a partner at Hightower, introduced Hightower's Chief Investment Strategist and CNBC contributor, Stephanie Link, who spoke for a breakfast at the St. Louis Club for a crowd of around 60 pulled from CFA Society St. Louis' members, members of FPA, and STLWIN members looking for a deeper dive on the investment thought that facilitates Hightower's thesis.
A prestigious speaker, Stephanie Link has a rich background of 30 years managing money in high profile roles including director of research for prudential, managing $170 billion at Nuveen while managing a large cap strategy there and the CIO and Co-PM of Jim Kramer's charitable trust. Her insight as a CNBC contributor is well revered which made her presentation on the economy, markets and where she sees opportunity in the markets, a highly anticipated one.
Stephanie led with comments on the economy. Markets have been anything but simple this year. As of the date of writing, the S&P is down more than 12% and the NASDAQ is down more than 20%. People are uncertain of where we are in the business cycle and a lot of talk has proliferated around the possibility of recession. Russian aggression, inflation, new China lockdowns, and a U.S. Federal reserve behind the proverbial 8 ball have supercharged anxiety in recent times, but Link took the time to remind us that the market always climbs a wall of worry and worry itself is an important reminder that investors should never be complacent. She was generally constructive that, even while Fed governors speculate at various amounts of rate hikes, we will find closure on the rising rate issue. In addition, supply chain recovery should help with inflation even if a precise timeframe is unknown. Another important reminder Stephanie provided is that last year's government stimulus was 60% of GDP which eclipsed even the stimulus from 2008 which amounted to a mere 5% of GDP meaning that even while we have not seen the last of its lagging impact, this year was expected to be weaker than last.
Where Link expressed further confidence was the US consumer. 70& of GDP is constructed by consumer spending, and consumers have an abundance of job opportunities (11.2 million job openings where typically 5 million is considered normal) combined with demand for labor resulting in higher pay. While the consumer is pinched by inflation, and in certain circumstances higher interest rates, other market observations support constructive conclusions. With earnings season in full effect, and consequently an easy to access flow of current information, there is a lot to draw from. Constructive measures Stephanie drew from include the airlines revising guidance to reflect all time high revenues, industry comments on recovering travel and people generally wanting to get out of the house in the post pandemic world. (Note: Stephanie does not own airlines and that observation was not a recommendation for airlines). In addition, companies like Cosco and Target can't keep products in stock and companies like GM can't access materials to produce to consumer demand. These support 2 conclusions Link proposed: 1) supply chain recovery should improve business outcomes, and 2) consumers with a reopened economy will likely transition their spending from goods to services and experiences which should bode well for the economy.
Elaborating further on inflation, Stephanie commented that while some commodities can be "transitory", she generally takes issue with the word because of supply problems (in oil specifically), and because areas like wages and rents are likely to be sticky contrary to what the term implies. Subsequently, the Fed's increasing interest rates may not be able to help unless they do so aggressively enough to prompt a recession. Inflation, Link pointed out, is a novel concept for a lot of the industry as many people managing money today have not experienced an inflation and tightening cycle like this one. Furthermore, the Fed's track record for engineering a desirable soft landing is only about 10%. That has amounted to an environment where earnings multiples are tightening even while earnings themselves are high.
Moving to implementation, Stephanie had a lot of actionable input. First, she argued technology companies are over-owned due to the success of the strategy in the last 5-7 years. She asserted that technology and communication services are currently stock picker's environments with some companies performing for investors and others not. While she concluded it is is likely early to overweight technology now, looking for tech firms with strong free cash flow should be an aspiration should value's recent lead over growth revert. Link also suggested owning commodity exposed companies in energy and industrials culminating to a balanced approach between sectors.
On fixed income Stephanie asserted that she believes the 60/40 portfolio is dead, and of the 40% previously prescribed to fixed income half of it should probably be positioned relatively short on duration, and the other 20% should be reserved for income oriented alternative investments, preferred and bond-like equity sectors (REITs, Utilities).
On domestic vs. international, Link argued that China's ability to appropriate investments outweighs business fundamentals in a large emerging market player. She also argued Europe's increasing natural gas costs paired with their reliance on natural gas as an energy source makes it susceptible to recession. Those concerns, combined with a less friendly regulatory environment abroad, lack of transparency in international firms, and the ability to access international consumers through domestic companies, were the backbone of her arguments for a heavy domestic overweight in portfolios.
Link expressed conviction in financials as well. She stated she is overweight the sector and that 4 of the 5 names she owns are in banks. She asserted her strategy in financials involves looking for special situations, citing a bank with a new management team and cost cutting opportunities and a payment processing company that has played well with the increasing demand for services. She also cited insurance companies, along with banks, as a potential beneficiary to a rising rate environment.
After answering other questions, Stephanie concluded with some sound advice. As a TV personality, she reminded us to turn off the TV and divorce ourselves from emotion, and while she is positive on the economy at large she reminded us that hope is not an investment thesis. Stephanie Link recommended being data dependent and balanced this year as a closing remark.
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Mighty Things from Small Cap Beginnings Grow
February 16, 2022
Written by Alec Hubbard, CFA
Before the Russell 2000 was the face of the small cap universe, Royce Investment Partners already had an established shop specializing in the research and investment of Small Cap Stocks. CFA Society St. Louis had a lunch at the St. Louis Club hearing from two speakers from Royce's organization on February 16th. First, Steve Clarke, a local member and Royce's head of distribution, and second Steve Lipper who led the presentation. "The good thing about being a specialist in a boutique asset class is you can share things with people thy don't know" Lipper pronounced, and living up to that claim, Lipper delivered a compelling and thought inducing presentation on the small cap stock universe.
The presentation started with Steve pointing out that more homogeneity exist in the small cap asset class than is immediately apparent, and supported that claim laying out some illuminating metrics to frame our conversation. The first metric he presented on was the preverbal elephant in the market environment's room, inflation. In regards to inflation, Steve pointed out that small cap equity is the only major asset class to outperform inflation in every decade since the 1930s. Furthermore, Lipper shed some light on other useful metrics specific to the small cap asset class. An oversimplification that happens in the status quo, he pointed out, is the Price to Equity ratio vs its historic norm. He warranted this simplification as counterproductive because 1) it ignored the interest rate levels over the last 10 years and 2) it ignored free cash flow for earnings after taxes. He proceeded to make the argument that if you think multiples will be flat to declining due to a hawkish Federal Reserve, you want to be aware of valuations (measures by which small cap positions sit at a near 20 year low), as if valuation compression becomes a concern, being in a lower multiple asset class is a logical strategic decision. He also shared data around the risk premium of small caps showing the asset class as persistent even while volatile.
Additionally, Steve detailed a big distinction between small cap value and small cap growth. In 5% of calendar years, the spread between the performance in small cap growth and small cap value was greater than 500bps and in 47% of calendar years, the spread was more than 1000bps. As a consequence of that and the unique headwinds and tailwinds of each, Steve argued that small cap value equities and small cap growth equities should be thought about as distinct asset classes more so than two subsets of the same asset classes. As a demonstrated impact of that delineation, Lipper showed Nominal GDP growth as a predictor of performance between the two. In periods where nominal GPD was greater than 5%, value outperformed growth 70% of the time. In periods where GPD was between 3 and 5%, value outperformed growth only 32% of the time. With those statistics, small cap value could be thought of as a cyclical beneficiary. In addition, Lipper brought our attention to an interesting historic trend wherein the risk premium of small cap value equities relative to the 10-year treasury ballooned to 1.2%, double relative its 0.6% historic average which was already ahead of the 0.3% risk premium over the 10-year growth sported in the same period (12-31-2001-12-31-2021).
Diving more specifically into small cap value managers, Lipper commented that both quality and value are revered. The difference, he defined, is how managers prioritize between the two. With that distinction in mind Lipper segmented the conversation into 3 sections, Quality Value, Deep Value, and International Value.
Within Quality, Lipper pointed out that the top decile of companies (sorted by ROA and ROIC) outperformed the Russell 2000 index while valuations tended to settle lower as investors gravitated towards growth. He drew an analogy of the tortoise and the hare with quality value small cap companies being slow but underpriced consistent compounders. He suggested one could think of them as BB bonds in a high yield index insofar as they provide strong downside capture but can lag coming off the bottom.
Deep value was illustrated as a very different animal. Steve argued the opportunity set in deep value is really entrenched in behavioral finance. The standard deviation of deep value is 4% above the index making it extremely difficult to hold even for the most resilient clients as periods of dramatic underperformance sow amnesia even among clients who were consulted well in advance. Lipper recommended pairing deep value with an ETF or a High Quality complement and then rotating as a means of acting on these ideas. While he gave everyone attending a pass to blame the clients for discomfort at the bottoms, he also reasonably reminded us that our brains are subject to the same emotional pitfalls. Nonetheless, with data in hand Lipper concluded that deep value is a reliable asset class even if it can be painful at times.
Finally Lipper stressed the importance of International value as an asset class, stressing that if one thing should be taken away from the lunch it should be the importance of international value. First, it is extremely inefficient accounting for less than 1% of mutual fund assets. Second, 1300 of the over 4000 companies in the universe have 0 or 1 analyst covering them allowing for skillful mangers to add value by finding companies that can consistently compound into broader recognition. As a result, the average international small cap manager beat the index after fees. Finally, he noted the downside risk profile is more attractive than conventionally understood. While small cap international will lag its larger peers in terms of maximum drawdown in market volatility, the probability of loss of international small cap is actually lower than large international (82% vs 75%). In addition, in 85% of historical cases international small cap outperformed international broadly. These statistics and others drove both the conclusion that home bias could be a good explanation to the underutilization of the asset class and that international allocations should be properly diversified between international large cap and international small cap positions.
To register for the CFA Society St. Louis popular monthly speakers, contact CFA at 314-520-3564 or [email protected] Please tell us if you are a CFA member to receive the member discount rate.
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CFA Society St. Louis 2022 Forecast Dinner
February 10, 2022
Written by Alec Hubbard, CFA
Investing is like Salsa Dancing, it's an exercise of seeing the expansion and contraction of your partner's muscles and responding.
That was the theme of CFA Society St Louis' February 10th forecast dinner event held at the Saint Louis Club. That theme was instilled by Dr. Camila Henao Arbeláez who presented on behalf of this year's forecast event sponsor T. Rowe Price. After earning her PHD in economics from University of Illinois Urbana-Champaign, Dr. Henao Arbeláez joined T. Rowe Price's multi action division as a quantitative multi asset analyst. She is no stranger to markets as a dancing partner and the importance of understanding where markets are within the dance of the business cycle. Evaluating 15 bear markets she demonstrated that 13 resulted during or soon after an official recession warranting why identifying where we are in a business cycle is so important to investment strategy.
To the benefit of our society, Dr. Henao Arbeláez methodically spoke on a model she pioneered that 1) defines where we are within the business cycle, 2) captures turning points in the business cycle, and 3) uses cycle classifications to identify asset classes with the potential to outperform in the current state of the markets.
The caveats that challenge investment professionals today are twofold. First, the reliance on traditional macroeconomics data. Because it is reported quarterly or monthly, macroeconomic data struggles with increasingly short business cycles. Indeed, the Covid recession took only 2 months meaning one who relied entirely on traditional data could have missed it entirely. Second, past data is often revised backwards which introduces biases when that data is used for investment purposes.
Camila's solution to these modern problems included leveraging big data. By obtaining high frequency data she accesses factors that are 1) high frequency, 2) not backwards revised, and 3) separated enough from explicit market returns to classify the differentials in asset class performance. With this enhanced access to data, Dr. Henao Arbeláez can better contextualize portfolios to signals in the current economic environment and the stage of the market cycle they communicate. Because of the recent lightning speed cycles, high quality high frequency data is becoming more necessary.
As far as input on the current environment, the model reads that we recently entered an expansionary phase with momentum performing positive. Dr. Henao Arbeláez holds, amidst other things, that the primary risk to the current market are external as opposed to something inherently wrong with the market. She encourages watching the Federal Reserve as it is likely to prioritize its mandate over the market which could create ripples.
Thank you to all in attendance both in person and digitally!
Congratulations to the Bullseye award winners. Tom Eidelman won the award for the S&P 2500, Clint Baur won the award for the crude spot price, and Mike Cody won both the 10 year treasury and stock selection awards.
Mike's impressive performance in the stock selection category paired with his background in fixed income motivated President McGrath to issue a call to action to the equity minded among us "do better!"
Should you seek to dethrone these champions, a link for this year's bullseye competition can be found here. (https://www.dropbox.com/transfer/AAAAAC-e68jc_JY0fPKCl_ihVAYWlYufIX4wtRvBDkA73qVrpn4VxvI)
To register for the CFA Society St. Louis popular monthly speakers, contact CFA at 314-520-3564 or [email protected] Please tell us if you are a CFA member to receive the member discount rate.