Athletic Madness

Are college athletes exploited?

With the NCAA Basketball tournament reaching the heights of hype and football players from Northwestern University trying to unionize, it’s a reasonable question. After all, the schools make a lot of money off these sports—TV rights, merchandizing, ticket sales—not to mention the cachet that comes from being a national champion. In an era of branding and name-recognition, it pays to be number one.

So the question is, should these athletes be paid—or paid more, since they do receive scholarships. First, let’s note that we’re talking about football and basketball. Other sports are money-losers for colleges, no matter how we may personally feel about our alma mater’s ski or swim teams. Those sports are part of the educational process, but there aren’t enough gate-receipts to pay for the equipment, trainers, coaches, and facilities necessary for a top track or soccer program.

But football and basketball are big business. And the schools treat them as such, booking tens of billions in revenues. We should note that the professional football and basketball don’t have their own farm systems—they use the NCAA. And the glamour and pressure of a national championship serves a high-visibility try-out for the pros. It did for Michael Jordan and Andrew Luck.

But all the cheating scandals, convoluted NCAA rules, and off-the-books booster outrages are indications that the simplest way to value labor—wages—is being suppressed. And the athletes at Northwestern aren’t necessarily looking for cash; they want scholarship-security and health protection if they suffer career-threatening injuries.

It’s hard to argue that these athletes don’t deserve better compensation. Without their labor, the schools have no TV-rights to sell to ESPN and CBS. Adam Smith noted 238 years ago that businessmen rarely meet together without contriving some scheme against the public. These workers should tell the schools: no pay, no play.

Douglas R. Tengdin, CFA

Chief Investment Officer

Reaching the Top (Part 3)

How do you achieve your goals?

Ed Viesturs didn’t just decide to climb the world’s highest mountains one day and get on a plane for Nepal the next. Scaling these summits took years of preparation. Only a superbly conditioned athlete can climb above 25,000 feet—7,600 meters—without supplemental oxygen. It took time, energy, and lots of planning to reach his goal.

It’s like this with many things in life. A runner doesn’t hop from jogging around the block to running a marathon without a clear plan. Surgeons need to undertake decades of preparation before they’re ready to operate. Achievement is like an iceberg: one-fifth execution, four-fifths preparation, under the surface, only visible to those who understand the process.

Attaining your financial goals is no different. The most important part of any portfolio is the financial plan that underlies it. It’s not enough to own stocks that double in a year. Anyone can get a two-for-one payout if they buy enough lottery tickets. But getting lucky is not a plan. In the mountains that attitude gets you killed; and investors get poor.

Climbing mountains requires planning, patience, and knowing when to advance or retreat. Investors need to take a similar approach. Because sometimes the most important investment is the one you don’t purchase.

Douglas R. Tengdin, CFA

Chief Investment Officer

Reaching the Top (Part 2)

“Getting to the top is optional. Getting down is mandatory”

That’s the formula Ed Viesturs developed as he pursued his quest to climb all 14 of the world’s 8,000 meter peaks. When he accomplished this in 2005 he was only the 12th person ever to do so. Since then only 19 others have climbed all 14. On a mountain, Ed describes himself as a risk-manager, continually evaluating whether the conditions or circumstances support the next move.

Similarly, risk management is an integral part of investing. Investors can’t control the markets and how the markets will behave. But they can control how exposed they are to the markets—what risks they’re willing to take, and what risks they need to walk away from.

If I were to re-state Ed Viesturs’ credo for investing, it would go something like this: “Return on capital is optional; return of capital is mandatory.” This has several significant implications. First, every investing activity involves risk. Even a small bank CD can be tied up for a period of time if the bank experiences financial difficulties and needs to merge with another institution.

Second, economic investments should generate cash for their owners. The cash may not immediately come back to the investors, but that is their purpose. So Google, which doesn’t pay a dividend, still generates cash. The managers just believe that the $60 billion per year of operating cash-flow should be reinvested into the business. Eventually, all maturing companies pay a dividend, as Apple started to a couple of years ago.

Third, bonds—which pay their investors back according to a pre-determined schedule—are deeply mathematical instruments. As time passes, their profile changes. They get shorter and the risk of non-payment becomes less. There’s less credit risk in a three-year instrument than in a 30-year obligation.

Climbing the 8000-ers requires understanding and determination. Reaching your investment goals can also be daunting. But by managing risk investors can improve their odds.

Douglas R. Tengdin, CFA

Chief Investment Officer

Reaching the Top (Part 1)

Is investing like climbing mountains?

I thought about this when I looked at the career of Ed Viesturs, the first American to climb all 14 of the world’s 8000-meter peaks—all without supplemental oxygen. He has sometimes been called a risk-taker, but he bridles at that description. He defines himself as more of a risk manager, continually assessing the conditions and deciding whether to go forward to not.

Because the air is so thin and conditions are so extreme where these high peaks jut up into the jet stream, high-altitude climbing is extremely dangerous. Some have calculated that just being part of an expedition gives someone a 1 in 34 chance of being killed. But climbing isn’t like playing roulette. Yes, unlucky events like a random rockfall can be fatal, but there are prudent ways to avoid such un-chancy occurances.

In his quest to summit these peaks—an 18-year odyssey—Viesturs was on 30 expeditions. While climbing, he decided to turn back ten times—four times when he was within 350 vertical feet of the top. His conservative perspective led him to adopt the credo, “Getting to the top is optional, getting down is mandatory.” This approach kept him around to come back another time.

If I were to adapt his doctrine for money management, it would be say “Return on capital is optional, return of capital is mandatory.” This has implications for asset management, economic analysis, portfolio rotation, and security selection.

Investing, like climbing, involves a combination of luck and skill. By managing risks rather than blindly taking them, we improve our odds and avoid becoming victims of the mountains—or markets.

Douglas R. Tengdin, CFA

Chief Investment Officer

Fed Watching for Fun and Profit (Part 2)

Can dissent predict the future?

Sometimes, when you look at a decision, the most interesting part of the debate isn’t where people agree it’s where they disagree. That’s often the case with legal discussions. When the Supreme Court decides a case, they usually publish two opinions: a majority opinion that explains the ruling, and a dissenting opinion that points out holes in the majority’s argument.

Dissenting opinions often contain a key to understanding where the future will lead. In his insightful dissent in the 19th-century school segregation case Plessy v. Ferguson, Associate Justice Harlan noted that legal segregation between the races would impose a badge of servitude on African Americans and violated the 13th Amendment. 60 years of civil-rights struggles followed.

In the Fed’s decision last week the President of the Minneapolis Fed dissented. The Fed reported that it was because he didn’t like the wording of the official statement—an unusual reason to disagree. But the Fed is unique. It’s not a single government committee, but an aggregation of several constituencies, including regional leaders. President Kocherlakota explained his dissenting vote on the Minneapolis Fed’s website.

In his note he makes it clear that the Fed is concerned about the falling inflation rate. PCE inflation is currently running around 1%–the core is even lower than that. If deflationary expectations take hold, this would have a deeply corrosive effect on the economy. Japan’s 25-year struggle with deflation shows just how poisonous it is. And the Fed is aware of the issue. Kocherlakota wanted the market to understand that interest rates will be extremely low as long as inflation remains below its 2% target.

So as markets embark on what seems like another “taper-tantrum,” keep in mind: sometimes dissent is decisive. Until inflation increases, don’t expect interest rates to move.

Douglas R. Tengdin, CFA

Chief Investment Officer

Fed Watching for Fun and Profit

In the ‘90s we had dot-coms. In the 00’s we had to connect-the-dots. Now the Fed is issuing dot-plots.

Buried in the blizzard of information that the Fed released Wednesday was a dot-plot of all of the Fed officials’ predictions. And while Janet Yellen did a fine job in her first press conference reiterating how future Fed actions are data-dependent, market participants were able to compare what the Fed is thinking now versus what they thought three months ago.

The dot-plot places a mark where each official projects the Fed Funds rate to be at the end of 2014, 2015, 2016, and in the long-run. And since the Fed is currently removing its extraordinary stimulus—tapering—it’s natural to wonder when they might start returning short-term interest rates to normal. The dot-plot gives us a convenient picture of what the Fed thinks.

And what do they think? Most Governors and Presidents think that rates will be at 1% by the end of 2015, and 2% by 2016. Long term expectations are unchanged from December, at 4%. But their short-term projections are about a quarter of a percent higher.

While Yellen is correct when she insists that “it depends what conditions are like” as to when the Fed will begin tightening, it’s also true that the dots show a more hawkish Fed than the market expected. So while the Chair may have been trying to sell a more dovish picture, the market wasn’t buying. When she told the press-gathering not to look too closely at the dot-plot, I thought: “The lady doth protest too much.”

The Fed has changed its communication strategy from Greenspan’s “creative obfuscation” to its current “blinding transparency.” Fed watching has always been an art. These charts make it a little more of a science.

Douglas R. Tengdin, CFA

Chief Investment Officer

A GPS, a Whale, and the Financial Crisis

What does a GPS have to do with the recession?

Like many, I use a GPS app on my phone when I drive to a new place. Normally, this is a convenient way to get from A to B—no fussing with maps and obscure directions: “Turn left a half mile after the second railroad crossing where the 7/11 used to be, I think they replaced it with a Benny’s.” But when the GPS malfunctions, or has the wrong map coordinates, it can literally lead me into trouble: one-way roads, missing landmarks, or other difficulties.

Part of the problem is when we rely on a tool, some of our other skills get rusty. With the GPS, the effect has been significant. It’s hard to find detailed maps any more. And I’m not as familiar with the landscape as I used to be, since I now have that endless road scrolling in front of me on my smartphone.

What does this have to do with the mortgage crisis? Banks developed a new risk-management tool in the ‘90s: Value at Risk (VaR). It used financial theory and empirical inputs to measure the how risky a bank’s portfolio might be. The tool was fine. But some of the inputs were wrong—or even backwards. Experience told the risk managers that housing values don’t fall nationwide. Oops. Also, their volatility measures were about half of what they should be.

As a result, when things got dicey, senior management seemed out-of-touch. They had come to rely on a tool that told them that their risk was only a fraction of what it actually turned out to be. Incidentally, a similar thing happened with the London Whale trade. Bad VaR inputs led to terrible trading results.

The problem isn’t the tool, it’s data input. In the early days of computing we had a phrase for this: garbage in, garbage out.

Douglas R. Tengdin, CFA

Chief Investment Officer

20 March, 2014 10:12

A GPS, a Whale, and the Financial Crisis

What does a GPS have to do with the recession?

Like many, I use a GPS app on my phone when I drive to a new place. Normally, this is a convenient way to get from A to B—no fussing with maps and obscure directions: “Turn left a half mile after the second railroad crossing where the 7/11 used to be, I think they replaced it with a Benny’s.” But when the GPS malfunctions, or has the wrong map coordinates, it can literally lead me into trouble: one-way roads, missing landmarks, or other difficulties.

Part of the problem is when we rely on a tool, some of our other skills get rusty. With the GPS, the effect has been significant. It’s hard to find detailed maps any more. And I’m not as familiar with the landscape as I used to be, since I now have that endless road scrolling in front of me on my smartphone.

What does this have to do with the mortgage crisis? Banks developed a new risk-management tool in the ‘90s: Value at Risk (VaR). It used financial theory and empirical inputs to measure the how risky a bank’s portfolio might be. The tool was fine. But some of the inputs were wrong—or even backwards. Experience told the risk managers that housing values don’t fall nationwide. Oops. Also, their volatility measures were about half of what they should be.

As a result, when things got dicey, senior management seemed out-of-touch. They had come to rely on a tool that told them that their risk was only a fraction of what it actually turned out to be. Incidentally, a similar thing happened with the London Whale trade. Bad VaR inputs led to terrible trading results.

The problem isn’t the tool, it’s data input. In the early days of computing we had a phrase for this: garbage in, garbage out.

Douglas R. Tengdin, CFA

Chief Investment Officer

Foxes and Hedgehogs

“The fox knows many things, but the hedgehog knows one big thing.”

The Greek lyric poet Archilocus coined this phrase almost 3000 years ago. Its original context has been lost, but as a principle, it can describe two approaches to life. On the one hand, you have people who pursue many ends—often unrelated and contradictory—eclectic, diffused, omnivorous. On the other are souls who pursue a singular, unitary vision, an all-embracing organizing principle that gives the world coherence.

We see this in many walks of life. In literature, Dante was a hedgehog, Shakespeare a fox. In philosophy, Plato was a hedgehog, his pupil Aristotle a fox. In American history, George Washington was a hedgehog, Jefferson a fox. And in modern life, great business leaders are hedgehogs—think of Steve Jobs with his focus on design and functionality—while great investors are foxes: Warren Buffett, Peter Lynch, John Templeton.

Both approaches are needed. In business, a firm needs a singular vision to cut through the clutter and keep the main thing the main thing. It’s too easy to get distracted by the crisis of the day and never spend time or energy on what’s important. Hedgehogs get things done.

But with investing, foxes rule. A portfolio needs to be diversified, limiting its exposure to any single area–reducing risk—while spreading its assets among an array of industries that generate new products and ideas—improving return. Investors need to be fox-like and flexible.

Foxes and hedgehogs both have their place. Indeed, they often marry each other. Which are you?

Douglas R. Tengdin, CFA

Chief Investment Officer

Who Watches The Watchers?

Are ratings agencies fatally conflicted?

During the financial crisis the credit-rating agencies came under heavy fire for giving AAA ratings to subprime conduits that later experienced losses. Calpers and other investors filed lawsuits, alleging that the agencies knew, or should have known, that the bonds they rated were junk.

The ratings agencies are supposed to tell investors how creditworthy a borrower is. The three largest agencies—Moody’s, S&P, and Fitch—control 90% of the market. They operate under an issuer-pays approach: the issuer engages one or more agencies; the agency conducts its due diligence and publishes a rating; and investors use this rating to help them evaluate the bonds. Ratings are publically available, free of charge, to all investors. The ratings provide a standardized reference point for portfolio managers.

There’s a conflict: borrowers pay the agencies to have the agencies tell the world what they think of the borrower. But the alternatives—user pays, or public funding—have their own problems: agency costs, or lack of visibility. Unless you subscribe to Morningstar, you don’t know their ratings. They don’t put out press releases. And internal ratings, which professional money-managers like Charter use, aren’t much good for public policy purposes..

The ratings agencies are the guardians of the credit market. But who will guard the guardians?

Douglas R. Tengdin, CFA

Chief Investment Officer