The Investor’s Dilemma

Why is investing so hard?

Investing should be simple: spend less than you earn, and sock away the extra. But we get in our own way. First there’s the lure of excess spending. People’s lifestyles are determined more by their peer-group rather than their financial goals. That’s why young athletes with seven-figure incomes end up bankrupt just a few years later. Then there’s predatory financial products: lottery tickets, overly-complex structures, high-fee mutual funds. These confidence games are designed to turn your savings into someone else’s income. Finally there’s contagion: we like to chase performance and get sucked into markets just as they top out. So we cycle between fear and greed at just the wrong time.

When it comes to investing, our emotions are our worst enemy. Investment strategies fall in and out of favor. The time to buy straw hats is in February, but people rarely do. It’s hard to look past the snow and the cold and realize that summer will come again with its heat and humidity. People like to be with other people, and when the crowd is headed one way, it’s hard to go in the opposite direction, or even stand still. But euphoria is the enemy of reason, and financial performance is a coldly rational business.

Great investors say to be greedy when people are fearful and fearful when they’re greedy, but I’d settle for being emotionally stable. Neutrality can be the best policy.

Douglas R. Tengdin, CFA

Chief Investment Officer

Too Much Information?

Is Big Data the future?

It seems that everyone is talking about Big Data. Big Data refers to data sets so large and complex that normal database management tools aren’t powerful enough to handle them. Because so many people are using the internet in so many diverse ways there are billions and trillions of gigabytes out there to be studied. The hope is that all this information can be crunched in such a way so that researchers can spot trends, prevent diseases, fight crime, and avoid potholes.

Wikipedia is an example of Big Data. So is all the GPS data generated by smartphones on the road, so when you’re driving somewhere you can avoid the traffic-jam five miles ahead. Because computing power is improving, scientific processes that once took 10 years can be done in less than a week.

This new technology will likely fall short of its over-inflated promises. All their sophisticated big-data credit models didn’t help the big banks to avoid the Financial Crisis. In fact, over-reliance of managers on their models probably made it worse. Google Flu is another example of a Big Data flop.

People who work with data know the perils of confusing correlation with causation, trend extrapolation, data-mining, confirmation bias, and data quality. Quantity is no substitute for quality. Too often, Big Data leads to big hype and hubris,

Data sets will continue to grow as the world becomes more complex. Computers may be able to turn information into knowledge, but it takes insight to make that knowledge useful. Wisdom just doesn’t grow on database-trees.

Douglas R. Tengdin, CFA

Chief Investment Officer

European (dis)Integration?

What good is the European Union?

The conventional wisdom is that the European countries that are part of the European Union have done better economically, but by how much? The Euro crisis made that question pretty important. The countries that had traditionally devalued their currencies to compete—Italy, Spain, Portugal—couldn’t do so anymore. So their exports—and their economies—suffered. If the benefits aren’t worth the cost, the Euro won’t survive.

So what is the advantage? Several researchers have looked into the question. They found that EU membership added significantly to almost every country’s income. On average, per-capita income across the EU would be 12% lower without the connection. This holds true for each individual country, with the exception of Greece. The gains came from three sources: increased trade, improved labor productivity, and institutional reform.

Trade is clear—everyone benefits from selling what they do best. Labor reforms help: when workers are free to work where the jobs are, they are more productive. And institutional reforms—like freeing up lending rules, or decreasing subsidies to preferred sectors—reduce a lot of waste. Until the Euro crisis, Greece hadn’t changed many of these rules, and that has held them back.

Making connections is hard, and adjustments are never easy. The United States had several secession crises in its early years. Let’s hope the EU’s long-term benefits remain clear to everyone.

Douglas R. Tengdin, CFA

Chief Investment Officer

Hard and Soft

Hardware makes it possible. Software brings it.

That’s what I thought when I read about the robotics innovations that are poised to change our lives: drones, driverless cars, virtual assistants. These technologies are build around things we already know pretty well—the car, the helicopter, and the PDA. But by adding sophisticated software, they are about to make a big difference in the world.

Take driverless cars. I had a driver once, and loved it. I had broken both of my elbows in a bicycle accident, so my employer hired someone to drive and type for me. I could read and talk on the phone, though. It was great to just get into the car and tell my driver where to go. She figured out how to get there, while I concentrated on business.

That’s what many top executives have already: personal assistants to take care of minor issues, while they focus on the big stuff. In the future, just having a smartphone will mean you have an assistant. And advances in programming just make it cheaper.

The hardware’s been around. But improvements in software are about to change the way we live. The future is already here. It just isn’t evenly distributed.

Douglas R. Tengdin, CFA

Chief Investment Officer

Trading Partners

Don’t look now, but global trade is accelerating.

In the first quarter, the volume of goods imported and exported surpassed the high previously recorded in early 2008. Trading volume continues to increase, especially exports from emerging Asia to the rest of the world. Japanese trade fell, even before the earthquake-tsunami-nuclear disasters. In the US, imports rose and exports fell, which will drag on first quarter GDP. Nevertheless, economic activity is strengthening around the world, and what goes around comes around.

Industrial production seems to be picking up as well, expanding everywhere. Again, emerging Asia leads the pack, with production up 5.5% quarter-over-quarter. China and India continue to expand their production base in order to meet the rest of the world’s demand. Global industrial production continues to hit new highs. The biggest problem that manufactured exports create is too many dollars for investment. We all should have such problems!

The gloom crew is missing this. Without any fanfare China Mobil, Mittal Steel, Tata Motors, and Taiwan Semiconductor are capitalizing on the global recovery. Their plants are efficient, their trading partners well-capitalized, and their markets are growing. As long as trade and profits continue to grow, the world’s economy will continue to recover.

Douglas R. Tengdin, CFA
Chief Investment Officer
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The Dream Factories

Why do people start companies?

At the heart of capitalism is the small start-up—the new project founded on an idea and some hustle that creates something new out of nothing. If the idea catches on, the founders can become quite wealthy. If the idea falters, the founders learn what doesn’t work and move on.

Many entrepreneurs fail in their first few tries. It’s an expensive tuition. That’s because there are far more things that don’t work than do. It’s like science: knowledge grows by proving what doesn’t work. But experimenting with your life can be a volatile experience.

Most startups are founded by technicians—engineers, design professionals, cooks—who understand how to make a product, but not necessarily how to run a business. They pick up the business skills along the way. Sometimes, the idea is so good that they never have to pick up the skills. But they don’t usually do it for the money; they do it for the adventure, or because they have a vision, or because it gives them a sense of control over their own future, instead of wilting inside a corporate bureaucracy.

Start-ups succeed because new ideas often do not scale well. Sometimes there is a payout at the end, more often there is not. But a startup allows its founders to dream. And they believe, as some have said, that if you can dream it, you can do it.

Douglas R. Tengdin, CFA

Chief Investment Officer

Money Market Mischief

Are money funds too big to reform?

At the heart of the Financial Crisis were money market funds. When Lehman filed for bankruptcy in September of 2008, one of its creditors was The Reserve Primary Fund, an independent money fund with $125 billion in assets. Because it held almost $800 million in Lehman debt, it was forced to mark down its stable Net Asset Value, causing investors to take a loss.

Financial chaos ensued. Over $500 billion fled the $13 trillion money market sector. While the Primary Fund was the only one to “break the buck,” at least 62 other money funds had to receive support from their sponsors or parents. Companies that borrow from money funds lost their funding and went into a panic. Millions of workers were laid off. The run on money funds intensified the recession.

The SEC was charged to study the systemic risk and develop policy responses. The core of the problem is money-market funds’ stable Net Asset Value, which incentivizes a rush for redemptions if holders sense trouble. The SEC came up with two proposals (that have elicited thousands of comment letters): one to impose “gates” on redemptions, and the other to force money funds to float their price.

But nothing fundamental has been done. The stakes are huge—for the economy, and money-fund providers—and legislators are being lobbied by voters, advocates, think-tanks, and, of course, the financial industry. Any new rule will gore someone’s ox.

The humble money fund has become a source of financial and economic insecurity. Something has to change.

Douglas R. Tengdin, CFA

Chief Investment Officer

The Dragon and the Bear

Could China reconcile with Russia?

The crisis in Crimea and Ukraine seems to have had little impact on the markets. Germany, the European economy most closely affected by what happens in Russia, has seen its stock market hover near its all-time highs. German newspapers have more coverage of Edward Snowden and the NSA revelations than they do of the military upheaval close to their borders. The markets seem to have concluded that Ukraine is not that important.

But the confrontation may have implications with an economy further afield: China. China has been isolated by suspicious neighbors who are worried that their economies and cultures will be overshadowed by the global giant. Both China and Russia have bristled as America has sought to contain their influence. Could they work together to frustrate American foreign policy goals?

The two powers tried it before, in the ‘50s, when both were pursuing global Communism. That connection ultimately foundered, however, over personality conflicts and the desire each had to lead the communist movement. While past problems may be instructive, they are not necessarily prologue. Global powers have found common cause before. Could the enemy of their enemy be their friend?

America is no longer the unipolar power it was following the Cold War. The world is now multi-polar, and dangerous. Both China and Russia are deeply suspicious of American containment strategies. An alliance between the two could spell trouble for global trade, and make budget-cutting in the US military more difficult.

Christians look for the lion to lie down with the lamb as a sign that peace is breaking out. But right now it looks more likely that the Dragon will lie down with the Bear.

Douglas R. Tengdin, CFA

Chief Investment Officer

Wishing Upon a Star?

Be careful what you wish for.

Years ago the organic food movement was a fringe activity. You could find organic food at a few health-food stores and farmer’s markets, but not very easily. Now almost every supermarket has an organic food section, and entire chains, like Whole Foods, are devoted to the concept. Organic food sales now comprise over 4% of total food sales in the US, doubling every 10 years or so.

Not so long ago, index funds were the province of finance professors and pension-fund consultants. The market-matching concept was a minor part of the investment landscape. Then came the evelopment of index-dependent ETFs and the growth of index-oriented mutual fund family Vanguard. Now it seems that everyone offers some kind of index-alternative.

When niche products go mainstream they bring their own sets of problems and policy fights to the table. Regulators get involved. Some consumers and providers long for the “good old days” of obscurity and minor-player status. But you can’t go back. Once a product becomes big business, billions of dollars are at stake. Conflict is inevitable

Years ago Richard Bach wrote, “Be careful what you pray for, because you’re going to get it.” Whether it’s in the grocery aisle or a broker’s office, the world often molds itself to our expectations. We just don’t always like what we get.

Douglas R. Tengdin, CFA

Chief Investment Officer

Being Smart

Is smart beta the future?

Beta is a measure of risk. If a stock has a beta of one, it goes up and down by the same percentage, day-to-day, as the market does. Investment portfolios have a beta component, which corresponds to their general exposure to a broad market average, like the S&P 500. By definition, if you own an index of the entire market, your beta is one.

Smart beta is a rules-based approach that reduces costs by limiting investment discretion. It is attractive because it is inexpensive and has the potential to add value when compared to traditional active management. It’s is a way to have broad market exposure and diversification but not hold the same weightings as the general index. Fundamental indexing, that holds companies in proportion to their earnings, or revenues, or dividends, is one such approach. So are sector allocation limits.

The key is the cost to the investor. If these managers charge just as much as the average mutual fund—1 ½ percent—then the lower costs of these strategies lining the manager’s pocket. But if the fees are lower, then investors benefit.

Smart beta can be a reasonable way to limit expenses and grow returns. But don’t be dumb about reading the fine print!

Douglas R. Tengdin, CFA

Chief Investment Officer