Insights from the CFA Conference
Thursday, May 8, 2014

This week, I was at the CFA Conference in Seattle and thought I would share some of the highlights with you. As is often the case when I attend investment conferences, meetings with speakers and other attendees prevent me attending all the sessions I’d like to get to. But I was able to attend several and heard some insights I think you will be interested in reading about.

Director of investor education at the BAM alliance of financial advisers, Carl Richards, does a great job of conveying complex investment concepts with hand-drawn sketches. He spoke about how to reduce the impact of behavioral errors. He believes investors can realize better returns if they focus on simply avoiding behavioral mistakes instead of focusing on finding above-average investments. Richards thinks the investment community can help by admitting they are part of the problem as well as focusing more on making things simple for investors and on client goals and objectives than creating products investors think they want, but don’t need. He said investors can help themselves by focusing more on achieving personal goals and less on their portfolio performance relative to an index.

A BNY Mellon forum focused on risk management. The discussion was oriented toward institutional investors, but there were two key nuggets of interest to individual investors. The first was an observation of an increased focus on matching assets and asset returns to expected liabilities rather than pegging returns to a benchmark. (In other words, ensure you have enough to fund your future withdrawals, rather than trying to beat the S&P 500.) The second was the danger of alternative investments. They warned that alternative strategies don’t always provide diversification benefits in a crisis, and may in fact go “down in flames at the same time traditional asset classes are struggling.”

Former FDIC Chair Shelia Bair spoke about the banking reform. One point she kept referring back to was the industry’s complexity. Bair opined, “Complexity leads to people making mistakes.” She thinks banks should consider breaking each of their main business lines (e.g., investment banking, lending, etc.) into different “silos,” each with their own manager. She also advised investors who don’t understand the complexity of JPMorgan Chase (JPM) and Citigroup (C) to consider investing in companies with simpler business models, such as Coca-Cola (KO). Bair believes “bank bailouts are not the new paradigm,” but that more—and smarter—regulatory reform is needed.

William “Bill” Sharpe, Nobel Prize winner and founder of Financial Engines, did a moderated question and answer session. I sat down with him after he spoke and will publish a transcript of our conversation in a future issue of the AAII Journal. One thing I will share now is that when asked whether he thinks the market has become more efficient, he said the research on the subject is inconclusive. He does believe that finding mispriced investments requires more effort than just reading brokerage research.

C. Thomas Howard of AthenaInvest says young, small and focused funds earn superior returns. He favors going for funds with portfolios that are different than the broader market, particularly those with a solo manager. Among the key characteristics he likes in a fund is asset size below $1 billion and a low R-squared value, meaning it has low correlation to the general market. Howard pointed to Warren Buffett’s success as an example, noting Buffett’s narrowly defined, consistently pursued strategy.

Arjun Divecha, chairman of the board and head of emerging markets for GMO, summed up his views by saying investors should never fall in love with a single emerging market, but rather should “date them, and date promiscuously.” As in the culture of his firm, Divecha is a value investor. He believes value works because while the earnings of high P/E stocks do grow strongly, they tend to grow at a rate slower than expectations. In contrast, value stocks tend to have stronger-than-expected earnings growth. He described the essence of value investing as “buying and holding onto something that is truly uncomfortable.” He added that investors in emerging markets make more money when things go from truly bad to merely awful than when they go from good to better.

He also had an interesting take on political risk. Divecha views political risk as being country-specific. He used the example that the Ukraine crisis has no bearing on the outcome of the Indian elections. Thus he believes geopolitical risk can be diversified away by investing in separate emerging market countries with cheap valuations.

I was unfortunately unable to stay for all of Nicholas Barberis’ presentation on behavioral finance. During the part I did hear, Barberis, a professor at Yale, honed in on how people weight expectations and view losses. He described investors as being overconfident when they trade because they commonly think the person on the other side of the trade is wrong. In regard to stock market returns, he thinks the brain overweights the possibility of a crash. He balanced this statement by discussing lotteries and how people focus too much on the tiny chance of winning the big jackpot rather than the likely outcome of losing their entire bet. (I am planning on speaking to Barberis about an article for the AAII Journal.)

Vanguard’s Walter Lenhard gave interesting insight into indexing. Vanguard’s use of indexes is not based on an opinion of how efficient or inefficient the market is, but rather on how active management is a zero-sum game and costs matter. He did, however, acknowledge that low-cost active management can provide benefits. Lenhard further suggested using market indexes as the core investment strategy and then overlaying either index-specific or actively managed strategies along the perimeter. Lenhard also offered insight into two of Vanguard’s bigger decisions of past few years. The firm got into the ETF business in part to satisfy requests for a short-term trading product. By design, ETFs are better able to handle short-term inflows and outflows than mutual funds are. The decision to change its underlying benchmark indexes was based on cost. Lenhard says the differences between index providers have narrowed, and now the differences in returns and volatility among similar indexes are very minor.

Those of you interested in reading more about the conference can see the various notes I took on my twitter feed ( I’ll also refer you to The CFA Institute’s blog, which has an extensive blog about the conference.

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The Week Ahead

Earnings season is beginning to wind down with only 13 members of the S&P 500 scheduled to report. Included in this group are Dow components Cisco Systems Inc. (CSCO) on Wednesday and Wal-Mart Stores, Inc. (WMT) on Thursday.

On Monday, the government will release Treasury budget figures for April. Tuesday will feature retail sales figures for April, April’s import/export prices and business inventories for March. The Bureau of Labor Statistics will release April’s final demand Producer Price Index figures on Wednesday, along with May housing market index figures. Thursday is packed with economic releases, including April Consumer Price Index figures, the May Empire State manufacturing survey, Treasury international capital data for March, April industrial production data and the May Philadelphia Fed Survey. Friday will end the week with April housing starts data and the May University of Michigan’s consumer sentiment survey.

On Monday, Philadelphia Federal Reserve Bank President Charles Plosser will give a speech on labor and economic trends in older communities. Tuesday, Jeffrey Lacker of the Richmond Federal Reserve Bank will speak regarding the credit markets. Federal Reserve Chair Janet Yellen will give a speech at the Small Business Administration event in Washington on Thursday. Also on Thursday, New York Federal Reserve Bank President William Dudley will issue opening remarks at the small business credit conference in New York. St. Louis Federal Reserve Bank President James Bullard will wrap up the week with a speech on the economy and monetary policy on Friday.

Local Chapter Meetings

AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!

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AAII Sentiment Survey

Investor optimism and pessimism continues to fall while neutral sentiment remains very high.

Bullish sentiment, expectations that stock prices will rise over the next six months, dropped for the second straight week, falling 1.4 percentage points to 28.3%. After sharply rebounding two weeks ago, optimism is now substantially below its long-term average of 39.0%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rose 2.2 percentage points to 43.0%. Neutral sentiment has now been increasing for four straight weeks. It also the 18th consecutive week neutral sentiment is above its historical average of 30.5%.

Bearish sentiment, expectations that stock prices will fall over the next six months, fell 0.8 percentage points to 28.7%. This puts pessimism below its historical average of 30.5% for the third straight week.

The current streak of below-average bullish sentiment readings is the longest since a 13-week stretch between August 30 and November 22, 2012. Neutral sentiment is above its historical average for the longest consecutive period since a 24-week stretch between January 28, 1999, and July 8, 1999. Bearish sentiment has not been above average for three consecutive weeks since August 22 through September 5, 2013.

Neutral sentiment remains very high; this is a characteristic of investors that we have noticed since the beginning of 2014. There are several factors in play. The market environment (low interest rates, Fed bond buying, solid earnings, etc.) is favorable for equities, but factors such as international unrest, European economic fragility and valuations have investors worried. There has not been a strong catalyst to drive investors, and the market, in a clear upward or downward direction.

This week’s special question asked AAII members if they are holding onto stocks they consider to be overvalued or overbought. Responses were mixed, but roughly half of responders flat-out said no, they are not. Roughly 35% of responders said yes, they are, providing reasons such as long-term growth, dividends and a desire to avoid capital gains. A few investors noted that they did not believe the market was overvalued.

Here is a sampling of the responses:

  • “No, I am holding those I believe are fairly valued and not overbought.”
  • “The stocks I have are longer-term investments. They may at times be overvalued/overbought, but I am not a trader. I aim to keep fees low and grow dividends/stock value.”
  • “Yes. I have found that too often I outsmart myself. I may think a stock is overvalued, but the market often doesn’t agree.”
  • “No. I can always buy back in if the data says it is reasonable to do so.”
  • “Once a stock is overvalued it is sold. Then I purchase an undervalued stock or wait until I find a value stock.”

This week’s Sentiment Survey results:

Bullish: 28.3%, down 1.4 points
Neutral: 43.0%, up 2.2 points
Bearish: 28.7%, down 0.8 points

Historical averages:

Bullish: 39.0%
Neutral: 30.5%
Bearish: 30.5%

Take the Sentiment Survey.