Smart Growth

What’s happening to demand for smart phones?

Photo: Alexandre Vanier. Source: Pixabay

Once, it seemed like smartphones would reach everywhere and do everything. But even Apple seems to be running out of room to grow. People will buy around 1.4 billion smartphones this year. That’s up less than 1% from 2015, when sales grew by over 10%. And it’s way down from the earlier part of the decade, when sales were growing by almost 50% per year.

Android phones are still growing. The free operating system is being used by several low-cost manufacturers in China and India—the places where smartphones are still growing. But Apple looks like it will post its first sales decline in 2016—over 10%. Apple’s 5-year revenue growth has fallen in the last two years from over 30% to just 10%.

Apple 5-year revenue growth. Quarterly data. Source: Bloomberg, Apple

I wrote yesterday that trees don’t grow straight to heaven. Five years ago it seemed that Apple would never stop growing—that there were four major asset classes: stocks, bonds, cash, and Apple. And the only correct decision to make regarding those shares was to buy them and never sell them. Obviously, that’s not the case anymore.

Apple share price. Source: Bloomberg

But they’ve grown into a new problem: not enough customers. There are only 7 billion people in the world—and not all of them can afford iPhones. Unless phone makers do something radically new, smartphone sales growth will be limited by the growth of the global economy. It’s time to think different.

Douglas R. Tengdin, CFA

Chief Investment Officer

Investing Rationally?

What do investors want?

Photo: Simon Steinberger. Source: Pixabay

Fifty years ago analysts assumed that all investors should care about is getting high returns with low risk. People who traded a lot, or concentrated their portfolios, or did something other than what conventional finance recommended were labeled irrational.

But what we do seems rational to us at the time. A dress from Filene’s Basement may be just as functional as a $2,000 designer dress, but it may not be as beautiful, or it may not convey the right message those around us. Clothes have a utilitarian purpose, but they also serve our expressive and emotional needs.

The same thing happens when we invest. We want the same things from our investments that we want from the rest of life. We want to feel secure. We want to be true to our values. We want to believe that we can do better. And we don’t want someone taking advantage of us. Our finances should serve these larger objectives – toward the goal of our well-being.

That’s why a company that has no debt, strong management, and a high growth rate may not be a good investment for you if it keeps you up at night. At the same time, we need to know – not just believe – that diversification works: trees don’t grow straight to heaven, and what’s out-of-fashion eventually changes places with what’s in fashion. Investing is an ever-shifting kaleidoscope of fundamentals, trends, and economics.

Artist: Martha Sky Radford. Source: Wikipedia

Behavioral finance teaches us that how we invest can be just as important was what we invest in. Investors want what everyone wants: to feel good about their money.

Douglas R. Tengdin, CFA

Chief Investment Officer

Postmodern Portfolios

What’s the best way to hit your investment target?

Photo: Eddi Laumans. Source: Wikipedia

There’s a school of thought that says people are basically the same: apart from our individual quirks, we all want a little income and a little growth from our investments. So we should combine a balance of stock and bond funds together to have a low-cost, broadly-diversified portfolio.

There’s a lot to be said for this: it’s cheap and it gets people started on the investment process. And people usually get more conservative with their money as they age, so reducing risk by increasing the bond allocation isn’t unreasonable.

But this ignores some important issues. People aren’t all alike. Once you scratch under the surface, we all have very different hopes, dreams, fears, and constraints. And everyone brings a different set of resources to the table: financial, emotional, intellectual, and so on. Using a “cookie-cutter” approach with mutual funds and investment models neglects our unique assets.

Building an investment portfolio is a lot like building a house. We all need shelter, but no two living spaces are alike. Every structure may all have a foundation, walls, and a roof, but the similarities end there. Homes in southern California are very different from dwellings in New England, which is different than the Midwest. And like our homes, our investments need to fit our current lifestyle and future plans. It needs to use the materials at hand to provide resources for the future.

Investing, like all of life, is complex and multifaceted. Managing our money is as much an art as it is a science. Some generalizations may be useful, but at its core all finance is really personal finance

Douglas R. Tengdin, CFA

Chief Investment Officer

Thanks and Thanksgiving

What is Thanksgiving for?

Photo: Chef Sean Christopher. Source: Wikipedia

Oh, I know that millions will be full of turkey and stuffing and potatoes and football, but why do we make a national holiday out of it?

Part of it has to do with remembering our national legends, the self-image we have of pioneers carving out a life for themselves in the wilderness. We imagine ourselves having the initiative, ingenuity, and cooperation that enabled the early Pilgrims to come, learn, and grow in the New World.

Part of it is a celebration of family, both near and far. Thanksgiving is a time of gatherings and traditions. At a time of economic stress and political turmoil, family ties are more important than ever.

And simple pleasures have always been an important part of the holiday. Sports, basic food, and relationships: there’s little controversial or divisive about these icons.

From the moment that Abraham Lincoln declared a “National Day of Thanksgiving” during the Civil War, Americans have paused in November to count their blessings. Sometimes simplest pleasures are best, and the best things in life aren’t things. As we look back at a year of tumult and forward at an uncertain future, let’s give thanks for how far we’ve come, and for all the potential we see in one another.

Douglas R. Tengdin, CFA

Chief Investment Officer

Ivy League Returns, 2016

Photo Source: Dartmouth Investment Office

For the fiscal year ending 6/30/2016, Ivy League endowments were all over the place, from Cornell at -3.3% to Yale at 3.4%. How are these large endowments managed, and what makes it so hard to hold onto a good Chief Investment Officer? Dartmouth’s endowment returned -1.9%, and they’re looking for a new CIO for the third time in ten years.

Dartmouth’s endowment is one of the largest in the country. And it plays a crucial role in the College’s financial picture. The endowment is worth about $4.5 billion and contributed over $200 million to College operations during fiscal year 2016 – about 4.5% of the portfolio’s value. Needless to say, the portfolio’s investment return matters a lot.

But this isn’t your parent’s investment portfolio. Less than half of it is invested in liquid, publicly-traded securities. Most of the portfolio is committed to non-public investments. This is the strategy described by Yale CIO David Swensen in his book, Pioneering Portfolio Management (2000). It’s often called the “Endowment Model.” It has four major tenets:

  1. It is equity-biased and return-seeking. Income is an afterthought. This approach looks to maximize total return, so it favors subordinated claims on cash-flow, as these tend to have the most upside potential. Bond holdings are minimized.
  2. It is broadly diversified. Diversification is embraced as a way to mitigate risk. That means that the endowments invest globally, in public or private markets, in developing or developed economies. Diversification is applied to asset classes, but also to risk factors – like company size, exposure to commodity prices, geopolitical risk, currency risk, and so on.
  3. It has a perpetual investment horizon. The portfolio doesn’t restrict itself to public securities. It’s important to keep enough liquidity to meet and needs for cash, both inside and outside the portfolio. But all things being equal, less liquid investments should return more than liquid investments. They have to compensate investors for their illiquidity. Illiquid investments also imply that year-to-year measurements can vary a lot. Private market valuations can be more art than science. Long-term performance matters far more than annual comparisons.
  4. It relies upon active management, headed up by a strong Chief Investment Officer. The CIO leads a team who oversee a group of highly-qualified external managers. The external managers focus on specialized areas. Discovering, understanding, and evaluating these asset managers is principally what an endowment investment office does. It’s critical that the office establish high-conviction long-term relationships, and structure them so that everyone’s incentives are aligned.

This model divides the portfolio into five or six roughly equal classes, then uses two or three managers within each asset class to select the actual investments. With 15 to 20 external managers, the CIO’s job can be quite demanding. So it’s no wonder that Dartmouth’s CIO wants to take a little time off.

Dartmouth’s portfolio owns public equities, private equities, hedge funds, natural resources (like oil and timber), real estate, and bonds/cash. This is a large portfolio that only provides a modest level of support to the College every year – about 4%.


Source: Dartmouth Endowment Report, 2015

The proof of the pudding is in the eating. Most large endowments work on a fiscal year ending June 30th. It takes a while to determine performance. As mentioned above, private market valuation can be challenging. It’s not just that Uber or Canary Wharf are hard to evaluate. Valuation relies on accounting reports, among other factors, and these may not be ready until August or later. And a fair valuation depends on more than free cash flow and discount rates. You also need to look at management skill, industry structure, competition, economic growth, and other factors.

After the all managers deliver their performance, the College prepares its aggregate performance. A school’s performance can be compared with a 60/40 stock/bond index, as well as with its peers. Everyone talks about performance, though, but hardly anyone mentions risk. But using the variability of returns as a proxy for risk, we can see how Dartmouth’s 10-year return stacks up compared to with its classmates:


Source: University Endowment Offices and Charles A. Skorina Associates

Dartmouth, Penn, and a 60/40 stock/bond index have had middling performance, although the index got there with a lot less downside. Also, an index costs a lot less to administer. Columbia, Princeton, and Yale have had the best performance, but Columbia experienced a much lower drawdown during the financial crisis, so their risk numbers are lower. The back-row kids are Brown, Cornell, and Harvard. Both Cornell and Harvard have both gone through four CIOs in the past 15 years. Their high-risk/low-return results have been a source of heartburn for the schools.

This brings up an interesting issue. Columbia, Princeton, and Yale have had stable management in their Investment Offices. Yale’s David Swenson has there been over 30 years; Andrew Golden worked with Swenson until he went to Princeton in 1995; and Narv Narvekar spent the last 14 years with Columbia. By contrast, management changes seem to be associated with lower returns.

The “Endowment Model” requires talented managers, talented staff, and a strong commitment to long-term returns. This commitment comes from the stability of the parent institution. But strong returns also require strong leadership. Management matters.
Douglas R. Tengdin, CFA
Chief Investment Officer

After Trump …

Who’s next?

Mussolini before crowd. Public Domain. Source: Quarterly Review

Donald Trump’s election is just the latest development in a global trend towards nationalistic populism. It’s not that atypical. When an economy struggles to recover following a downturn, the political system is volatile as people search for solutions. This is what happened in Japan in the ‘90s. After their economy crashed, the Liberal Democratic Party was voted out of power for the first time in 38 years. A series of new governments were formed and then dissolved in quick succession.

On December 4th Italy will hold a referendum on a set of constitutional overhauls designed to make it easier for the government to pass laws. These reforms are also designed to slim down Italy’s cumbersome bureaucracy. Prime Minister Matteo Renzi has pledged to resign if the country votes “no.” Polls currently show the “no” vote is narrowly ahead, with about a quarter of voters yet to make up their minds.

The referendum gives voters another chance to kick the establishment in the teeth. Italy may muddle through after a “no” vote, but the government will be weakened until the general election in 2018. Italy’s “Five-Star” movement, led by Beppe Grillo – a former comedian – will gain influence.

Spread between Italian and German 10 yr govt bonds. Source: Bloomberg

Markets are nervous. Spreads on Italian government bonds have widened. If Italy can’t pass the reforms it needs to grow its way out of its debt burden of 135% of GDP. Italy then becomes the biggest risk to the financial stability of the Eurozone – something markets haven’t worried about for a while.

It’s never dull, is it? Of course, with volatility comes opportunity – sometimes. But often, volatility can also lead to just more volatility.

Douglas R. Tengdin, CFA

Chief Investment Officer

Trade War Worries

Are we headed for a trade war?

Author: Tony Cohen. Source: Wikipedia

The rhetoric from the Presidential election would make you think so. Donald Trump campaigned on renegotiating trade deals with countries around the world. While some of the more extreme measures – like an across-the-board 45% tariff on all imports – would require Congressional action and are therefore less likely, he will have the authority, as President, to pull the US out of the North American Free Trade Agreement or the World Trade Organization without approval from Congress.

And Trump has signaled that he is serious. It appears that Wilbur Ross is likely to be named Secretary of Commerce. Ross has been an outspoken critic of trade deals, saying that they cause the US to import products and export jobs. At the very least, Donald Trump’s election signals an end to any more trade liberalization. Protectionist parties are on the rise around the world, and after the US election and the UK’s Brexit vote, free trade has lost its two biggest national champions.

But there are two sides to every conflict. If we engage in a trade war with China, they will likely retaliate. Punitive tariffs on Chinese electronics would be matched by restrictions on US-made cars and aircraft. And China wouldn’t be limited to tariff increases. In 2010, the dissident Liu Xiaobo was awarded the Nobel Peace Prize. China responded by lengthening quarantine procedures for imported food, causing Norway’s salmon exports to China to fall by 50% the next year. China can also order its state owned enterprises to stop using non-US made goods and services.

Atlantic Salmon. Artist: Tim Knepp. Source: Wikipedia

Donald Trump’s election is just the latest development in the trend of nationalist populism we see growing around the world. While the market has focused on Trump’s stimulus plan and the prospects for increased domestic growth, inflation, and government deficits, the impact of escalating trade hostilities should not be ignored. The Smoot-Hawley Tariff and its aftermath is part of what led to the Great Depression in the 1930s.

Wars aren’t rational. But if our domestic problems refuse to go away, initiating a foreign conflict – even a trade war – has always been a way for politicians to get people’s attention away from home. Let’s hope that it doesn’t come to that.

Douglas R. Tengdin, CFA

Chief Investment Officer

Markets, Morals, and Money

Why do business people care about morality?

Source: Wikipedia

Ben Franklin once said, “I’m not moral because it’s the right thing to do, but because it’s the best policy.” A market economy can only be sustained by certain standards, like trust, honesty, and fairness. It’s wrong to deceive people — and it’s also bad business. If I buy a bag of potato chips and find that it’s mostly air, I’m less likely to purchase that brand again. That’s why our government has a bureau of weights and measures.

Friedrich Hayek, a champion of free markets, called this set of shared standards “tradition.” Tradition, he says, encodes the accumulated wisdom of earlier generations in a way that no single generation, however sophisticated, could discover for itself. By learning these traditions and passing them on our children, we avoid costly mistakes. Ironically, societies that have strong moral traditions form the best environment for commercial and technological innovation. Property rights, the rule of law, and sound money are essential to sustain a market economy.

But we’re individually subject to cognitive errors that can take us down the wrong road. We’re self-interested: we tend to find excuses for little errors when they benefit us. And little things add up to big things. There’s denial. We don’t like to look at things that challenge our prior assumptions. It’s the flip side of confirmation bias. And there’s social proof, a type of herd-mentality, where a questionable practice becomes acceptable because it seems to be commonplace. It’s why terrible behavior spreads, and some firms seem like ethical and moral sewers.

Photo: Dietmar Rabich. Source: Wikipedia

People try to do the right thing because they have to look at themselves in the mirror every morning. But it’s also a good business practice to take the high road. It’s far less crowded.

Douglas R. Tengdin, CFA

Chief Investment Officer

Emerging Where?

What’s happening in emerging markets?

Souk in Rabat, Morocco. Photo: Cloudzilla. Source: Wikipedia

For much of 2016, emerging markets have performed well. Higher oil prices and a steady dollar have allowed these markets to stabilize and even do slightly better as the year progressed.

But the election of Donald Trump and Republican majorities in both houses of Congress on November 8 may represent a pivot point. There is potential for significant fiscal stimulus, protectionist trade policies, and a different outlook for interest rates by Fed. Winners and losers among the various markets may vary dramatically going forward.

The most important variable for emerging markets is trade policy. Protectionist policies will especially hurt countries that depend on exports to the US for their growth, like China, India, and Mexico. On the other hand, relatively closed countries that less dependent on trade — like Brazil or Columbia or many African nations – will tend to do better. Also, Fed policy and the value of the dollar will have a major impact. If the Fed raises rates aggressively and the value of the dollar rises, that will be quite negative. Many developing nations have debt denominated in dollars and will struggle to service their debt if the dollar goes up.

The good news is that most emerging markets come into the present situation with relatively attractive valuations. The dollar’s rise since 2014 – along with other factors – has caused those markets to pull back. In addition, emerging markets have more growth potential than elsewhere.

Emerging Markets. Source: Bloomberg

Donald Trump’s election has caused many investors to pull back from emerging markets. But all markets are not created equal. Differing economic structures will lead to differing outcomes for different nations. The prospects are far more nuanced than they have been in the past.

One thing is certain: the election has made investment analysis a lot more complicated.

Douglas R. Tengdin, CFA

Chief Investment Officer

Un-Locke-ing Markets

Un-Locke-ing Markets

Is price-gouging a problem?

US Postage Stamp. Source: Wikipedia

John Locke is an important source for the ideas that went into our Declaration of Independence. But he also has a keen sense of economic justice.

During his time in Europe the price of wheat would vary by location. What was available in one city might be scarce in another. Locke noticed two towns—one where grain was plentiful and the price was five shillings a bushel, and another where people were practically starving and the price was 20 shillings. If it costs me the same to transport the grain to either town, Locke asks, which should I ship to and what should I charge?

The answer seems obvious to us: go to the 20-shilling town, and charge the market price. Not only do we maximize our own profit, but we help folks who are hungry. But if it only costs us 3 shillings to grow and transport the wheat, is it moral to sell grain for 20 shillings, when we could only get 5 shillings somewhere else? Locke says yes: not only are we satisfying a contract, but if we tried to sell the grain for less, others would snap it up and sell it at the higher price. We would impoverish ourselves without helping anyone else.

Grain silos, Western Australia. Photo: Darren Hughes. Source: Wikimedia

There’s a lesson here about price gouging. Many States have anti-gouging laws that make it a crime to raise prices more than 10% after a natural disaster. When hurricanes hit the East Coast, many gas stations don’t have power and their pumps don’t work, so there’s a gasoline shortage. People sometimes wait hours to get gas. If the price were allowed to rise, owners could rent generators to get their stations going. Or they could bring gas in from other locations. The storms don’t cause a shortage, price controls that set the price too low lead to a shortage. There’s too much demand and not enough supply. You can’t repeal the law of supply and demand.

People aren’t heartless. It’s wrong to charge more than the market price. But market prices can vary by location. Voluntary, informed, competitive markets produce efficient outcomes, and everyone is better off. Locke understands this. It would be great if our lawmakers did, too.

Douglas R. Tengdin, CFA

Chief Investment Officer