Scientific (Employment) Method

Does the world need more science majors?

That’s what a lot of people think. And as a science major myself, the husband of a science major, and the father of three science majors (so far), I certainly believe in the utility and importance of studying science in college. It helps young people develop many important skills.

But some proposals to provide special encouragement for kids to study science seem misguided, like college-loan forgiveness or differential tuition rates. That will lead institutions to just game the system. Incentives are already out there for all to see: last year’s top-paying majors were petroleum, aerospace, and chemical engineering. The bottom-paying fields were social work, culinary arts, and child and family studies.

Sometimes an industry sees a potential talent shortage and needs to take action to encourage, recruit, and retain qualified talent. Such was the case with nuclear power 20 years ago. Nuclear power wasn’t “cool”—it was where Homer Simpson worked—and its workforce was aging. But employers worked with universities, community colleges, unions, and the military to fill find good workers. Now nuclear engineering majors are also among the highest paid grads.

Such micro-initiatives are generally much more successful than massive programs. Big plans require rigid rules that people can play with and distort to reclassify cooking into alimentary-engineering. Most of the money then gets eaten up by bureaucratic oversight.

The marketplace knows what it needs and pays accordingly. That’s the most scientific recruitment tool there is.

Douglas R. Tengdin, CFA

Chief Investment Officer

Moving the Standards

Sent: Friday, September 11, 2009 5:26 PM
Subject: Global Market Update 9-14-09

Are your investments suitable? Or ideal?
That’s the question being asked these days in Congress. Because in the shake-up of financial regulations, Congress is reviewing how investors get advice.
Most stockbrokers are governed by a suitability standard. This requires that brokers offer advice that is appropriate for investors considering their situation. But if the broker knows of a similar investment that generates less income for him, he’s under no obligation to offer it. He just has to make sure that what he sells isn’t fraudulent and fits the buyer’s circumstances. In other words, let the buyer beware.
By contrast, fiduciaries are held to a different standard. They have to render advice as if they were the client. That means if they’re working with a mutual fund company and they find out that a similar one is available that costs less, they have to offer the cheaper one. Fiduciaries are required to put themselves in the client’s shoes.
Full disclosure here: I’m a fiduciary, and I work for a fiduciary firm. I think the world would be a better place if everybody acted like one. But I can see problems if Congress abolishes the suitability standard and replaces it with a fiduciary standard. For one thing, lawsuits would multiply like rabbits. But I also see the need to have a diverse way for people to get their investment advice. Competition usually leads to better results.
Appropriate investments are good. Ideal investments may be better. But its best when everyone has to compete.

Douglas Tengdin, CFA
Charter Trust Company

Classical Investing (Part 8)

Sent: Tuesday, May 19, 2009 5:39 PM
Subject: Global Market Update 5-19-09

Is virtue boring?
In Jane Austin’s Sense and Sensibility Marianne Dashwood falls for the debonair Mr. Willoughby, while the staid Colonel Brandon watches from the side. Eventually, the mercurial Willoughby breaks Marianne’s heart, and the patient Colonel Brandon helps her pick up the pieces of her life.
Austen’s point seems clear: sensible decisions often seem unimaginative and dull, while romantic adventure seems exciting. But with excitement can come risk, and often we would have been happier with the sensible choice.
Many investors have learned this lesson the hard way. First the dot-com bubble offered a whole new way of doing business, where profits didn’t seem to matter. After that went bust, the housing bubble promised ever-growing riches built on a rising tide of home equity. But home prices can’t outstrip household income forever, and that bubble burst. In investing as well as in relationships, value must be based on fundamental stability.
As the market readjusts, it’s timely to remember that stock prices ultimately depend on a company’s profits. At present, many great companies with rock-solid plans are selling at historically low values. The business may be boring, but in the long run, its stability and character are likely to make us happy.

Douglas Tengdin, CFA
Charter Trust Company

Of Bookies and Brokers

Is investing just gambling?

On the face of it, there are a lot of similarities. People have money left over after buying all the goods and services they need or want, and they use that money to express an opinion. In the investing world, they buy stocks or bonds—or some derivative, like ETFs or mutual funds. In the gambling world, they go to a casino or buy a ticket at the racetrack or take a position on a sports team.

Now, most sports betting is just recreation—ways for fans to show their support and have a little fun. And the Super Bowl turns America into a giant sports book. Last year Nevada bookies registered almost $100 million in Super Bowl bets—and kept over $7 million for themselves. And bookies describe their job similarly to that of brokers: a little math, a lot of gut, and a premium on customer service.

But the Nevada sports book is a zero-sum game: for every winner, there’s a loser—minus the bookies’ 10% “juice.” No expansion franchise ever raised capital by setting up an offering-line at Wynn Las Vegas. For all its hype, the $400 billion sports-betting business is just part of a global entertainment industry that has grown as leisure time has grown.

By contrast, capital markets are a positive economic force. When new businesses go public they raise money for expansion, and a public stock price allows them to offer long-term incentives to thousands of key employees. Also, a public market for stocks and bonds allows investors to get their money out of their investments if they need it for any reason. There’s a reason why healthy financial markets are crucial to a healthy economy.

Still, the thrill from a winning an NCAA bracket or a Super Bowl bet can feel like a “two-fer” in the stock market. In both cases “you pays your money and you takes your chances.”

Douglas R. Tengdin, CFA

Chief Investment Officer

Emerging Issues

It’s the end of January and global markets are shifting.

In the US and Europe, the stock markets have pulled back 2-3% after a very strong 2013. But emerging markets are down almost 10% after last year’s lackluster returns. What’s going on?

When the Fed announced last June that they were ready to slow the expansion of their balance sheet, emerging markets balked. They had grown accustomed to massive cash-flows from the developed world. With the Fed signaling that the era of ultra-easy money might be ending soon, those capital inflows could slow, threatening their economies.

Now the taper is happening, and some of those economies are facing a cash crunch. Argentina devalued its currency by 10%. Turkey raised its discount rate by over 4%. And emerging stock markets have sold off.

But not all emerging economies are created equal. There’s a world of difference between those with a trade surplus and excess reserves—like China, Korea, and Mexico—and those that rely on imported goods and capital to keep their economies afloat—like Argentina or Ukraine. While currently a wave of “risk-off” selling seems to have depressed them all, such waves and troughs create opportunities when investors move en masse.

In the long-run, quality wins. But sometimes it takes time for markets to differentiate between fool’s gold and the real thing.

Douglas R. Tengdin, CFA

Chief Investment Officer

The Road To Where?

Why do good intentions so often fail?

It happens all-too-often. A new approach to poverty is announced, there’s excitement, there’s publicity, tens—no, hundreds of millions of dollars are raised, and it’s declared that the end of poverty is in sight. Such hope! Such vision! But when plans hit the ground, things are more complicated, systems collide with systems, and often people end up worse than they were before any of this help ever arrived.

Some development experts went to Africa looking for “quick wins”: innovations that could dramatically improve people’s lives. One idea was to give people fertilizer so they could produce more food on their farms to reduce malnutrition. Bang, the villages they worked with grew so much corn they had a surplus—yields tripled. But then a funny thing happened. The roads were so poor the surplus couldn’t be marketed. So some farmers discarded their surplus, but then rats arrived. In the end, most of the growers sold their corn for less than it cost to produce it.

This is the tragedy of development. Plans look good on paper, but the world is more complex than we think. People resist change, sometimes for bad reasons, but sometimes for good ones. Self-help, micro-enterprise, and small, sustainable solutions are possible, but we need to be humble. Africa’s landscape is littered with rusted tractors, broken water pumps, and neonatal incubators that can’t be plugged in because there’s no power.

Good intentions fail when big money funds grandiose plans with no accountability. Small initiatives grown little-by-little do better.

Douglas R. Tengdin, CFA

Chief Investment Officer

27 January, 2014 11:27

Microsoft’s Muddle

Why is it so hard to fill this job?

In August Steve Ballmer announced that he would resign as Microsoft’s Chief Executive. Since then the stock has rallied 20%, mainly on hopes that a new CEO could turn things around. During his time as CEO, sales tripled and earnings rose 16% per year. But the company missed all the major innovations: search, social, and mobile, while issuing disastrous Windows updates. So the stock has languished. Only after his resignation was released did the shares show any sign of life.

So why is it taking so long to find a successor? Five months is a long time for big company to be in leadership limbo. It can’t be the pay: he made $1.3 million last year. And the potential for a turnaround is significant. Surely someone could put Microsoft’s $28 billion in operating cash flow to work profitably. But a specter haunts Microsoft: its founder and Board Chairman Bill Gates.

Gates is leading the search for a new CEO. He leads a weak Board filled with people who used to have tech credentials. He facilitated Microsoft’s miss of new tech trends. He’s still the name most folks associate with Microsoft. And he’s the reason the company has founder’s fever—the malady that can afflict once-great organizations when times have moved on but the original leader won’t. He still has his partisans and loyalists, and they’re poisonous.

Apple has this advantage over Microsoft. Steve Jobs is gone. If Microsoft wants a strong leader to take it in a new direction, Gates has to get out of the way.

Douglas R. Tengdin, CFA

Chief Investment Officer

Confidence in Confidence?

Are people overconfident?

Studies published over the years demonstrate that people overestimate their abilities and potential for reaching their goals. Julie Andrews illustrated this 55 years ago when she sang “I have confidence.” The ironic point the song makes is that her (over)confidence is misplaced. She had very little reason to expect everything to “turn out fine” given the circumstances she was facing.

It’s easy to see how people are overconfident today. Just ask a room full of people to raise their hands if their driving is above average. About 90% of people raise their hands. Of course, it’s mathematically impossible for 90% of people to be above average. We don’t live in Lake Wobegon.

Our overconfidence affects us financially as well. People under-save and over-consume, figuring everything will turn out fine. Some people over-trade their investment portfolios, chasing hot ideas and suffering when these fail to live up to the hype. But more common is intense inactivity. An analysis of 1.2 million 401(k) investors revealed that over 80% of investors did nothing over a two-year period, and an additional 11% made only one transaction.

At a minimum, people should review and rebalance their portfolios annually, especially when their life-circumstances change: marriage, having kids, retirement, and so on. There’s nothing to save us from our own financial mistakes. The most common mistake is making no decisions at all.

Douglas R. Tengdin, CFA

Chief Investment Officer

Debt Dynamics

What are we going to do with all our debt?

Since 1950 private debt as a percentage of the economy has grown from 50% to about 160% of the world’s 22 most advanced economies. The ratio had been steadily advancing for years, but accelerated between 1998 and 2008, when it grew from 100% to 170%. It has retreated modestly since the financial crisis, as corporations and consumers have delevered.

This is a global phenomenon; no single government is responsible. The debt has grown as global commerce has grown. In the late ‘90s there was dramatic increase in trade along with technological improvements in finance that encouraged credit to grow faster than the economy. (As an aside, in 1998 Long Term Capital almost destroyed the world’s stock and bond markets).

The level of debt is an issue because it makes everything more fragile. Legitimate businesses can become insolvent and entire economies can experience debt-deflation when leverage is excessive. There are basically four ways to reduce debt relative to the economy: growth, austerity, default, inflation, or some combination.

None of these are popular. One might think growth would be, but the economic liberalization necessary to increase growth significantly requires a political consensus that is rare. After World War I, a lot of countries simply defaulted on their debt.

For now, it looks like the world is rationally headed towards a combination of growth and austerity. But nothing is certain.

Douglas R. Tengdin, CFA

Chief Investment Officer

Great Manager Theory?

Do managers matter?

That’s what I wondered when I read that Mohamed El-Erian, CEO and co-CIO of the Pacific Investment Management Company—PIMCO—is resigning. PIMCO is the largest bond manager in the world, and one of the most successful asset managers of all time, with almost $2 trillion in assets. Their flagship total return bond mutual fund has over $200 billion.

Some have linked El-Erian’s resignation to the $40 billion in outflows from the bond fund last year, or the difficulty that PIMCO has had in diversifying its business model by providing equity-oriented funds. But that’s just silly. A massively successful manager doesn’t get the boot just because he had a bad year, or a difficult initiative. Under El-Erian, the firm more than tripled its size.

El-Erian has taken time off before. He left PIMCO in 2005 to run Harvard University’s endowment, then returned in 2007. Harvard needed a high-profile manager after compensation disputes gutted its endowment management team. It’s far more likely that Mohamed has another public-service initiative in mind. He’s the son of an Egyptian diplomat who’s fluent in English, French and Arabic. Egypt could certainly use his expertise, and he’s indicated before that he’d like to serve that country in some way.

In any case, PIMCO is unlikely to suffer greatly because of his departure. Founder and co-CIO Bill Gross is still around, with his “batteries 110% charged and ready to go another 40 years” as he tweeted yesterday, and the company has a deep bench of manager talent.

But one thing’s certain: El-Erian’s star isn’t fading.

Douglas R. Tengdin, CFA

Chief Investment Officer