Inverting the Logic on Inversions

Thursday, July 31st, 2014

And now for something completely different…

Why tax inversions – the practice of a US company merging into a non-US company to lower/avoid income taxes – could ultimately produce different, better results for the economy.

First some interesting reactions and ideas:

From Andrew Ross Sorkin of the New York Times, a look at how Wall Street banks are profiting from advising companies on taking advantage of this tax maneuver.   We’re talking over $200 billion in fees…for Goldman Sachs alone…while these ‘too big to fail’ banks preach the importance of investing in America.

Let’s not forget that America (that’s we the taxpayers) bailed out those same banks who are now advising companies to merge and redomesticate for tax purposes to lesser taxing shores.

Meanwhile, the famous hedge fund investor, Stanley Druckenmiller, says the debate over inversions gives the U.S. a chance to debate tax policy from an investor’s perspective. He correctly notes that inversions have produced a windfall in capital gains for shareholders.  And, since shareholders ultimately benefit, they should see their taxes rise (via a capital gains or dividend income tax increase) to offset the lost tax revenues.

Of course, raising capital gains taxes on all investors just to offset inversions that benefit a few does seem a bit self-serving in favor of investors who benefit from inversions.  But, I suppose the venerable Mr. D believes he can ferret out those inversion candidates better than most.

Now, let’s put this discussion in perspective and provide a modest proposal:

First, Wall Street advising their clients to take advantage of loopholes in the tax code is as old as…the tax code.  One wonders if this dates back to one Babylonian advising another how to get around one of Hammurabi’s codes.  So, this is truly a ‘dog bites man’ story.

Second, Wall Street banks acting in their own self-interest is probably as old as, well, humans.  Have you heard any Wall Street CEO even say ‘thank you, fellow taxpayers, for supporting your local too big to fail bank?’

Meanwhile, Mr. D does say that inversions have raised talk of changes in the tax system.  So, why not consider something completely different?

How about treating corporations like people?  You know, people like you and me, who get to pay tax US tax on income earned anywhere – probably even Mars, if the government had its way.  So, invert away, Mr. and Ms. Corporation, but you will still be paying US income tax.

And, what of those who have already inverted?  Or, companies holding cash overseas because bringing it to the US would incur US income tax?  Work out a gradual payment plan…just like the government would do with any debtor…to get those taxes paid.

But, let’s treat corporations like people and tax universal income, only if this is specifically tied to lower corporate tax rates for all corporations – large, medium and small.  The net impact to Federal revenues would be zero, and, with a lower tax burden on all the Mr. and Ms. Corporations, we might even see a better uptick in economic activity.

So, under this modest, simplistic proposal, corporate tax rates go down, which may lead to improved economic results, and Wall Street banks have to find new ways to game the tax code.

But, they will always find new ways of doing that.  We should expect nothing less.

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Is Putting Investors First the Future of Finance? It Better Be

Tuesday, May 20th, 2014


Is Putting Investors First the Future of Finance? It Better Be

By Alton Cogert

Recently, the CFA Institute began an important new initiative called the Future of Finance.  It was the result of an important study that the Institute conducted earlier, and that we discussed in this blog back in November, 2013: “Whom Do You Trust? A Brewing Crisis in Investment Management.”

Basically, the Future of Finance consists of 50 ways to restore trust in the investment industry.  Why this initiative now?  That study showed that, even among institutional investors, 40% do not trust investment managers.  Of course, we must assume they do trust their existing managers, else those managers would be replaced.

However, the sight of investment professionals being considered near the bottom of the ‘whom do you trust’ list of occupations makes one ponder.  What could be the reasons?  Numerous examples of immoral if not illegal activities?  Unaligned incentives, also called the agency problem, where the manager and investor have different incentives?

What is the Future of Finance?

Well, the CFA Institute’s Future of Finance initiative focuses on six areas to tackle this problem:

-   Putting Investors First

-   Financial Knowledge

-   Transparency and Fairness

-   Retirement Security

-   Regulation and Enforcement

-   Safeguarding the System

Did you know that this month is Putting Investors First month?

I did not either, until I attended the CFA Annual Conference.  Of course, less than 2% of CFA’s attended, but that still meant nearly 2,000 got the message directly.

How Can You Put Investors First?

Putting Investors First includes:

-   Statement of Investor Rights

-   Asset Manager Code of Professional Conduct

-   Fee Structure Guide for Investors

-   Board assistance in the form of a self-assessment tool and best practices guide

We highly endorse these actions, but are deeply concerned that they have not been more quickly and forcefully adopted by the investment industry.

For example, there are many investment managers who are knowledgeable about investments for insurers, yet have not yet adopted the Asset Manager Code.

Also, with investments and the investment process becoming more and more complex, I wonder how many investment managers know that their clients fully (and I do mean fully) understand all salient aspects of an investment and how it impacts their portfolio.  You can find that imbedded in the Statement of Investor Rights.

The Principles of Investment Reporting

Of course, each of those six areas has their own details and investment professionals would do well to take all of them to heart.  One of my favorite details is the Principles of Investment Reporting.  Item four is: “Clear and transparent presentation of investment risks and results.”

If that is true in all instances, why do Strategic Asset Alliance and InsurerCIO spend so much time in crafting investment reports that focus on those key risks and results, while many manager reports may not be similarly focused?

One possible answer:  Manager reports focus on how they see the portfolio from their vantage. Those reports help them do their job.  However, they may not always focus on the key issues that are unique for your insurance company.

The Future is Up to You

Nevertheless, the most important point remains.  It is incumbent upon all investment professionals to internalize the key activities and responsibilities inherent in the Future of Finance initiative.  And, it is even more important that investors require such compliance.

The Future of Finance is really up to all of us.

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Public Enemy #1 of Good Investment Decisions: Groupthink

Tuesday, March 25th, 2014


Public Enemy #1 of Good Investment Decisions: Groupthink

By Alton Cogert

Virtually no important strategic investment decisions are decided by one individual at an insurer.  Of course, one person may be ultimately responsible for performance, process, etc.  But, mostly key strategic decisions are made in group settings.  This is even more likely at external investment managers.

At this month’s Insurer Investment Forum XIV, I discussed several issues, including cognitive limitations and biases that cloud our ability to make good (investment) decisions.  I discussed several biases found in the behavioral finance literature that generally apply to an individual decision maker. I also mentioned the largest cognitive limitation and bias for groups of decision makers:  Groupthink.

Groupthink is a psychological phenomenon that occurs within a group of people, in which the desire for harmony or conformity in the group results in an incorrect or less desirable outcome. Group members try to minimize conflict and reach a consensus decision without critical evaluation of alternative ideas or viewpoints, and by isolating themselves from outside influences.

Read that definition twice and you will undoubtedly be able to think of numerous instances where Groupthink has been at work.  I worry about that at just about every board or investment committee that I attend.


Many times, of course, general agreement is OK.  But one cannot help but wonder if general agreement may be getting high jacked by Groupthink.

How to guard against Groupthink?  Here are the activities suggested by Irving Janis in his book “Groupthink.” , with my initial thoughts in parenthesis.

1. Leaders should assign each member the role of “critical evaluator”. This allows each member to freely air objections and doubts.

(This rarely occurs.)

2. Leaders should not express an opinion when assigning a task to a group.

(This is important, but occasionally forgotten.)

3. Leaders should absent themselves from many of the group meetings to avoid excessively influencing the outcome.

(Done occasionally, as when a CEO leaves a Board meeting to allow for discussion amongst Board members only.)

4. The organization should set up several independent groups, working on the same problem.

(I have never seen this done at an Investment Committee in twenty years as an investment consultant.  If a separate group is set up, the problem is not also assigned to another group.)

5. All effective alternatives should be examined.

(This is more difficult than it sounds, but Boards and Committees do try to do this.)

6. Each member should discuss the group’s ideas with trusted people outside of the group.

(This can occur informally.)

7. The group should invite outside experts into meetings. Group members should be allowed to discuss with and question the outside experts.

(That is where our firm comes in, and that is one of the ways Boards and Committees utilize our firm.)

8. At least one group member should be assigned the role of “devil’s advocate.” This should be a different person for each meeting.

(I worked at a company where one group member was ALWAYS the “devil’s advocate” due to his nature, not because he was formally assigned as one.  That “devil’s advocate” soon became, shall we say, less than respected by the group.)

SAA does not provide consulting for improved group dynamics, but we are concerned that senior management teams, Investment Committees and Boards of Directors are making the right decisions.  We focus on improving an insurer’s investment process, but this can only occur with a solid group decision making process.

Insurance Regulators to Add Russian Sanctions?

Tuesday, March 25th, 2014


Insurance Regulators to Add Russian Sanctions?

By Alton Cogert

Notice there is a question mark after that headline.

“How preposterous!” you might say, “State departments of insurance have no power to practice foreign diplomacy.  Besides, what kind of sanctions could they possible impose on Russia.”

Well, with Russia and the West adding to their list of sanctions, don’t be surprised if the insurance regulators pile on.

Why? It has been done before.  Not against investments in companies doing business with Russia, but with Iran.

Enjoy this link to an article published in 2010.  The California Insurance Commissioner, preparing a run for governor, decided to practice foreign diplomacy.  Most insurers abided with the ruling, while some of the largest insurers and trade organizations railed against the action.  The Commissioner published a list of 296 insurers doing business in the Golden State who agreed to comply.  For them, as for the larger non-compliant insurers, it was a small issue blown out of proportion.  However, for the 296 it was easier to switch than fight.

Would Dave Jones, no relation to the late Monkees member, but current California Commissioner, take his own last train to Clarksville and follow in his predecessors’ footsteps?

It is doubtful.  Please remember that the previous Commissioner Poizner was trying to differentiate himself in a gubernatorial election year, while Democrat Jones is not about to challenge his boss, Jerry Brown, running for his fourth and final cumulative term.

However, what of another commissioner?  Although there only twelve elected commissioners, some may consider the office a jumping point for higher office.  To the extent politics is involved, we may very well see a state commissioner or, perish the thought, the Federal Insurance Office, decide to waive the anti-Russian flag.

Is this just silly, peripheral nonsense?

Maybe not, as we’ve already seen the Russian billionaire owner of the Brooklyn Nets consider re-domiciling his NBA team to Moscow.   Stranger things may be afoot.

In this world of mutually assured sanctions,  don’t be surprised if a ban on a list of companies doing business with Russia is proposed for insurers,  or even adopted by other institutional investors (especially politically sensitive pension plans).

Spasibo, comrades.

Which Strategic Asset Allocation Model is Best?

Monday, October 21st, 2013

We have all heard that choosing the asset allocation for your insurer will basically define your investment results. In other words, strategic asset allocation explains about 90% of the variance in performance.

Tactical asset allocation can add value, but is difficult to achieve in the long run for a host of reasons. These include transaction costs, taxes and issues in the ability of managers to add material value over passive benchmarks over long periods of time. Quite frankly, common sense dictates that the more efficient the market for the asset class, the more difficult it will be to add value with tactical asset allocation.

Thus, we are back to starting our discussion about the importance of asset allocation with strategic asset allocation

But, where should we start?

Most practitioners will reach for their Markowitz efficient frontier models (or MPT, Modern Portfolio Theory), plug in historical values for return, standard deviation and correlation amongst asset classes, beginning the discussion in that manner.

Those same practitioners, if prompted, may point to the inadequacy of using historical values and suggest more reasonable expected returns, standard deviations and correlations. Assuming these projected values are reasonable, we are still left with some of the major issues in MPT, including:

  • Asset returns are normally distributed. Alas, they are not. Even something that may seem to be normally distributed, like US equity returns are not. Upon further inspection, a log normal distribution (with thicker ‘tails’ on both the far upside and far downside) seems to do a better job of approximating historical returns. And even that can understate strong downward moves.
  • Correlations are fixed and do not change. Alas, that is not the case. There is actually a web site that helps prove the point. Just focus on a simple correlation between US Large Cap (e.g. S&P 500) and the Barclays’ Aggregate Bond Index, and you will see correlations go from .05 to -.05 to 0 to .18, depending upon the time period chosen. A big difference? Not much by itself, but when combined into the MPT model, especially with other assets, it can make a big difference.
  • All investors are rational and risk-averse. In other words, all investors will want to be on the efficient frontier (e.g. highest return per unit of risk) at all times. I don’t know about you, but I have yet to meet a completely rational human being. Importantly, we see ‘irrational exuberance’ to some degree in many situations, especially the financial markets.
  • If all investors followed MPT’s recommendations, it would probably invalidate some of the assumptions in the model. In other words, if everyone used MPT because it provided the ‘best’ asset allocation mix, it would then not provide the ‘best’ asset allocation mix. In other words, model inputs change if everyone follows MPT.

There have arisen changes to the MPT that answer some of these major issues.

For example, post-modern MPT uses non-normal distributions. And, with the Black-Litterman model, the investor is required to state how his or her assumptions about expected returns differ from the market. And, then the investor must state his degree of confidence in the alternative assumptions.

Also, another look at strategic asset allocation is provided by an approach that uses regime changes in market turbulence, economic growth and inflation to forecast expected asset returns. Determine the regime and you will get a better idea of returns, risks and correlations. There is much more work to be done on this approach, although it does move a step closer to a tactical asset allocation approach than a strategic one.

Of course, the major problem with 100% of these models is the nature of the beast: Financial market returns, risk and correlations are all somehow related to that which has occurred in the past. This works with things that do not change and only have to be ‘discovered,’ such as we find in traditional physics (less so in quantum physics), chemistry and biology.

However, how many of us remember the last time central banks played such a major role in world economies and in the financial markets? I don’t see any hands being raised, so I think you see what I mean.

We are operating in an environment where all the fancy models in the world may not be a very close analogue to what we may see going forward…in addition to the major issues and approaches in those models, already noted. Thus, we must be careful to shy away from ‘physics envy.’

With that in mind, we must think creatively when it comes to strategic asset allocation, and that probably starts with a simple mindset.

What are the reasonable returns we can expect on a given asset class over the next 3-5 years (assuming that is your relevant timeframe)? How might correlations change over that time frame (we can perform a sensitivity analysis to see if and how much that might matter)? And, really, what is the ‘worst case’ returns one can expect in a given asset class performance, given what we know about today?

These are very, very difficult questions that should lead to very productive discussions with your investment consultant and investment manager.

Are you ready for some Fumbling?

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I Miss the Fiscal Cliff

Wednesday, October 16th, 2013

Remember the good old days…of last year?

Remember, when the financial press warned about the US economy going over the ‘fiscal cliff’, because our so-called ‘leaders’ in D.C could not stop a fiscal contraction that would hurt a still limping economy?

Although the academically inclined chair of the Federal Reserve, Mr. Bernanke, mentioned the phrase, it really brings to mind a battle between two hard charging racers, heading for their potential demise…as brought to life in this video :

The result of this fiscal cliff wrangling was modifications to the income tax code plus another new word added to our collective vocabulary: ‘sequestration’. Eventually, then Treasury Secretary Geithner added the country’s debt limit into the stew of fiscal issues, and another ‘crisis’ was born.

As you read this, perhaps the D.C. Fumblers (that is a much better name for their hometown football team than Redskins) will have ‘solved’ the budget and debt limit issues that, once again, threaten the U.S. economy, financial markets, and, more importantly, the preeminence of the US dollar as a global reserve currency.

Perhaps not.

But, more likely than not, the Fumblers will trade a disastrous result today for the potential of a disastrous result to be named later (in just a few months). Another bad Fumblers trade.

The point is that we, as sentient humans, should not be fooled into using simplistic shorthand like fiscal cliff, sequestration or even the previous word d’jour,’ tapering.’ By falling back on this shorthand, we are conning ourselves into thinking that these problems are two sided or easily explainable. They are not.

Coke or Pepsi?

Left or Right?

Tapering Now or Later?

Fiscal Cliff or Not?

Sequestration or Not?

We must look behind the issues and apply reason to develop the vast array of choices that are open to us. And, most importantly, consider the intended as well as unintended consequences from those choices.

As for our portfolios, it is truly difficult to position them for all possible Fumbler scenarios as we approach what used to be called the fiscal cliff.

Some ‘experts’ tell us that markets have not fully discounted the probability of US default, or of the impact of a continuing government ‘shutdown’ on GDP. Others say that the markets already discount such probability efficiently (in concert with the ideas of Nobel Prize winner and efficient markets proponent Eugene Fama).

So, we are left to doing what is best based upon the unique requirements and risk appetites of our clients. In other words, no material change in operating procedure.

Meanwhile, one thing can be sure at this point in the political cycle. The D.C. Fumblers will continue to be true to their name.

The markets will now have to discount the possibility that watching the Fumblers deal with another ‘crisis’ will become a regular event, with increasing frequency….

Are you ready for some Fumbling?

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Hank at the Brink…Again and Again

Tuesday, September 24th, 2013

“I didn’t have to have long debates with President Bush about how bad the harm to the economy would be if the financial system went down. He had a good feel and he understood markets.”

That’s former U.S. Treasury Secretary Henry Paulson explaining his relationship with former President George W. Bush during the financial crises, in Bloomberg Businessweek’s initial foray into filmmaking – basically a visually annotated interview with Paulson.

The movie is only available on Netflix, much like one of my own personal favorites, House of Cards, the multi-episode fictional story of slimy, unethical practices in the day-to-day maneuverings in Washington, D.C. Most people who have seen it can hardly wait for Season 2 later this year.

Like House of Cards, Hank Five Years from the Brink, is about slimy, unethical practices, but this time in the financial industry. Unlike House of Cards, it spares most all of those at the top from criticism, while providing an explanation that ostensibly is reasonable, but is filled with holes. Most people who see this movie will not want to see a financial crisis 2.

In Paulson’s defense, he actually does a good job of initially answering a difficult question: Why let Lehman Brothers go under and not AIG?

His answer: The Treasury could make a loan to AIG with viable insurance subsidiaries as collateral, while Lehman had no such similar subsidiaries. True, but…

A side benefit: His former employer, Goldman Sachs, had some rather complex and hidden dealings with AIG. Some of which could be said to have forced the hand of then NY Fed president Tim Geithner to make the big banks whole on CDS from AIG. Other dealings are probably still open to interpretation ( In any event, for Paulson to not even mention this in passing is akin to the famous line in a much better movie, the Wizard of Oz,: “pay no attention to the man behind the curtain.”

Another “pay no attention” moment in the movie is when Paulson says that while he, Bernanke and Geithner were trying to come up with a solution for the Lehman mess, ex-Goldman buddy and then head of Merrill Lynch John Thain struck a deal to have Bank of America purchase ML. It is hard to believe that “the man behind the curtain” had nothing to do with that acquisition.

Paulson also does a poor job of explaining why the use of the hastily approved TARP money changed almost overnight, from purchasing bad assets from banks to providing capital to banks.

As I remember, one reason was that the government said it was so difficult to value those bad assets. Of course, this belied the reasoning behind an earlier, successful bank “bailout” program run via the Resolution Trust Corporation in the 1980s. But, Paulson does not mention that publicly stated reason. Oops.

And, of course, Paulson only raves about his close relationship with Fed Chair Bernanke and NY Fed President Geithner, saying they worked very closely together. However, this fails to account for the importance of an independent central bank. I guess Hank may not have paid full attention in his economics courses at Dartmouth.

What about the Special Inspector General of TARP? What was Hank’s relationship with this Congressionally mandated office, designed to monitor and audit the TARP program? In the movie, it was as if SIGTARP never existed. Of course, former SIGTARP head Neil Barofsky would probably agree with that assessment, as outlined in his well written book, “Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street.” (amazon link here).

At the end, Paulson says he ‘did’ this movie because he does not want to see a replay of what happened. Of course, he says that after he unequivocally states that there WILL be another market meltdown. Perhaps, a better title for this Netflix only stream should have been, “Hank at the Brink…Again and Again.”

Although I am not a movie critic, please allow me to briefly remember the two great movie critics, Siskel and Ebert, and give Bloomberg Films a ‘thumbs up’ for trying to present a complicated subject. And give ‘Hank at the Brink’, ‘two thumbs down’ for pandering away from the truth.

Until next time, the balcony is closed.

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5 Years After Lehman Brothers: Still a Whodunit

Wednesday, September 11th, 2013

Here we are, five long, winding years after the demise of the venerable Lehman Brothers investment banking firm (recaps and outlooks by Bloomberg and Institutional Investor). What have we learned from that event, the beginning of the Great Recession, the most recent financial crisis? And, just as importantly, like a good mystery novel, whodunit: Who was the firestarter that ignited the financial storm that brought down Lehman, and, with it, started the Great Recession?

What have we learned? Perhaps obvious to all of us now, but not as obvious in mid-2008:

- The Fed is NOT infallible. All this Greenspan-speak about letting the market discipline itself only goes so far. After a while, the market moves to extremes (in both directions) and sometimes intervention can be a good thing. Since 2008, we’ve been arguing about what kind of intervention (monetary and/or fiscal related, and how much). That is an argument that will undoubtedly continue, because we also have learned…

-Economics is NOT a science. It is basically a social science with a lot of mathematical formulas used to ‘approximate’ reality. To paraphrase what we say at SAA during our own analyses, “Just keep repeating: It is only a model, it is only a model.” Alas, economists have tried to take on a position in society similar to physicists. Sorry, folks, but when reality is impacted by human nature, it has difficult following ‘natural laws.’ We’ve got a better chance of understanding quantum mechanics than micro or macro economies. Think about that last sentence and you will see how difficult economic forecasting and policymaking is, which also relates to another learned concept.

- Those rocket scientists in Wall Street might have served society better by keeping staying rocket scientists. Back to the problem with modeling human behavior, only this time tied to valuing complex securities. One bad assumption like: ‘house prices in the US can never go down more than post World War II experience’ can ruin a rocket scientists day…although not for long, because he or she can always get a new job at one of those…

- “Too Big To Fail” banks. Yes, we thought that failing banks are supposed to be taken over/reorganized by the FDIC, with bad assets purchased by the Feds and good assets and deposits purchased by a healthy bank. We were partially correct, as that happened time and again with non-TBTF banks. It is only those large enough to have outsized market, and more importantly, political influence that were automatically saved via TARP. No need to go into the abuses on that program, since Neil Barofsky, the TARP Special Investigator, tells us all about it in “Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street.” (include Amazon link) Most book titles are hyped up by the publisher to sell books. No hype needed here. And, that may cause some in government to say…

- “You never want a serious crisis to go to waste.” That sums up the focus of many in government, who automatically assume increased regulation will be better for the economy, for consumers and, most importantly, for themselves (as they rake in contributions from both sides of an issue). Does more government regulation help or hurt the overall economy? Once again, this is an ‘it depends’ answer, further clouded by the fact that economics is NOT a science. There are no petri dishes to test the impact of a given regulatory change before implementing it. And, that means any change in regulations is an experiment to some degree. Doesn’t this make you feel a bit like a guinea pig? Which reminds me…

Whodunit? Who was the fire-starter of the financial crisis?

My number one candidate is FASB, the Financial Accounting Standards Board. Let’s harken back to 2008, the first calendar year that FAS 157, “Fair Value Measurements” became effective. In essence, FASB had finally decided (after numerous comment periods, etc) that banks would have to mark to market assets (including their loan holdings available for sale, or impaired), putting the change in value on the income statement for all to see.

As stresses started to move through the sub-prime mortgage market (mortgages issued just two and three years ago were starting to re-set at onerously high rates), the banks were forced to face reality and unable to shy away from FAS 157. One of the most levered, Bear Stearns, became the ‘canary in the coal mine’, going out of business in a shot-gun marriage arranged by the Fed to J.P. Morgan in March, 2008.

At the CFA Institute Annual Meeting in May, 2008, one of the sessions focused on FAS 157, where panelist and chairman of FASB, Robert Herz put the controversies in perspective, by noting that mark-to-market was just an “implementation problem.” Right-o, Bob.

Stresses in the mortgage market grew, and we all know about the Lehman story in September, 2008.

Oh, and by the way, if you think accounting was not the fire-starter? After Congress passed a law requiring the SEC to study the issue in October, the SEC, in December, said mark-to-market should not be changed and that mark-to-market was not a cause of the financial crisis. Well, we all can trust our government to be forthright and honest, right?

In March, 2009, Congress stayed on this issue and heard from the not-so-prescient Mr. Herz, warning him to re-write mark-to-market or Congress will do it for him. That may have been the scariest warning during the entire financial crisis.

Four days later. Four days later! The FASB proposed changes to mark-to-market that let banks abandon the required mark downs of sub-prime mortgages.

(It is notable that during the past week of activities, the S&P 500 had reached its nadir for recent history, having dropped about half in value from its previous high. From henceforth, the S&P 500 recovery had begun.)

So, was it really sub-prime mortgages that were the fire-starter of the financial crisis, or was it the way banks were forced to account for them? I believe it was the latter and with that, I think another important lesson has indeed been learned for the future….maybe.

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Whom Do You Trust? A Brewing Crisis in Investment Management

Thursday, August 29th, 2013

The CFA Institute is out with its Investor Trust Study and the results are not good for investment managers everywhere.

Whom Do You Trust?

Only a bit more than 60% of institutional investors trust investment managers.

Of course, this could be a bit like the surveys that tell us the US Congress is liked by 9% of the US electorate , putting them just below cockroaches and traffic jams in popularity. However, voters seem to like their own representatives quite a lot, judging by how often incumbents get reelected).

And, since investors can indeed vote with their feet when they don’t like their managers for one reason or another, we may be able to conclude that most institutional investors like their current investment managers.

But, what that does mean is that about 40% of institutional investors just don’t trust investment managers, as a whole.

Later in the survey, we find out how important trust really is. When asked to indicate which attributes are most important when choosing a manager, “Trusted to act in my best interest” is by far and away the most important attribute (35% of respondents), followed by “Ability to achieve high returns” (17%), “Commitment to ethical conduct” (17%), and “Recommended by someone I trust” (15%).

Now, I will not comment on that ‘high returns’ attribute, since as lowly investment consultants, we know that returns, in and of themselves, tell only a partial story of performance (risk adjusted returns, attention to book yield for core fixed income, comparison to risk adjusted performance of peers, etc, are other good measures). But, outside of ‘high returns’ all of the top attributes for picking an investment manager center around this idea of ‘trust.’

I did not see the questionnaire for this survey, nor did I participate in it. So, perhaps these answers may be a bit skewed. For instance, if you tell someone your survey will focus on the idea of ‘blah-blah’, you will get a lot of answers saying how important ‘blah-blah’ is. That is just human nature.

But, it cannot be denied that trust is key in any successful relationship among we humans. What does that trust entail for institutional investors?

The survey notes the top attributes that build trust in an investment manager as:
     Has transparent and open business practices                 53%
     Takes responsible actions to address an issue/crisis     52%
     Has ethical business practices                                            51%
     Delivers consistent financial returns                                 48%
     Offers high quality products or services                            47%

OK, we will ignore the obvious item about ‘delivers consistent financial returns,’ since it really could be applied to Bernard Madoff, as well as other practitioners of the scheme of Ponzi.

But transparent and open business practices, per the Survey’s authors means:
     - Articulating triumphs and failures
     - Clearly disclosing unavoidable conflicts of interest
     - Bringing potential issues to the forefront early and often

One of these reminds me a bit of what an old boss of mine once told me: “I don’t mind bad news,” he said, “as long as you are honest and tell me about it right away.”

Conflicts are rife in many business environments, but they can cause major issues in the investment arena. So, disclosure and understanding those conflicts is very important.

And, as stated over the years in this blog, I am amazed at how often every manager’s performance is always shown in the top quartile. A mathematical impossibility if analyzed fairly, since everyone cannot be well above average….except of course, in Lake Woebegone.

But, what can a manager do to change the perception that about 40% of institutional investors have of them?

We’ve said this in an earlier blog (ICIO page link here), but we’re back to managers self-identifying as being in compliance with the CFA Institute Asset Manager Code of Professional Conduct. Of the managers with the most insurance assets under management, only one has self-identified. Wow!

There are other suggestions noted in the survey, to which I would also agree (see page seven of the Executive Summary). However, one suggestion is paramount and is summarized by one simple philosophy “Put Clients First.”

I am proud to say that our firm, Strategic Asset Alliance, has operated on that philosophy from the start. And, more importantly someone much, much smarter than me, Charles Ellis, has written as such in his latest book “What It Takes: Seven Secrets of Success from the World’s Greatest Professional Service Firms.”

Will investment management firms take this Investor Trust Survey to heart and act on its important suggestions? Or will some see the Survey as conflicted in itself and ignore many of the findings (since the CFA Institute has an agenda of improving the ethical profile of the investment management industry)? Or will some simply see many of the suggestions not feasible within a cost/benefit analysis framework?

My suggestion would be for managers AND consultants to heed the advice. And, in the case of consultants, we should decide how to utilize it effectively both when evaluating managers and our own consulting firms.

Return to “From the Northwest Quadrant”

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Summers or Yellen for Fed Chair: The Battle of the Chromosomes?

Wednesday, August 21st, 2013

While many of us contemplate or are currently enjoying our summer vacation, the financial press still has a job to do.  Staring at that empty white computer screen, they must kindle our interest in an “important story” whether or not it really deserves our immediate attention.

One of the best “breaking news” stories of the summer has been the “battle of the XX versus XY chromosomes for the chair of the Federal Reserve.”

Although he has not formally stated he will be stepping down from his post as one of the most powerful people in world economics and finance, Ben Bernanke is assumed to be part of history come February when his current term ends.  Remember, there are no term limits for Fed Chairmen.  (And the record holder for time served is held by Bernanke’s predecessor, Alan Greenspan, who served over 19 years.)

But, Uncle Ben is in his second four year term, and his current boss, also in his second term, has already said on the Charlie Rose television show, “He’s already stayed a lot longer than he wanted or he was supposed to.”  I am not sure when Charlie Rose’s show became the most important platform for major Federal Reserve news, but perhaps I am spending too much time applying logic to that ‘announcement.’

However, we are talking about “breaking news” here and, though many times that title is applied to a barbeque fire in a seldom visited part of your home town, this is really big “breaking news.”

Assuming Uncle Ben is not picked for another term, the choices have apparently boiled down in the press to Janet Yellen versus Larry Summers.

Ms. Yellen, she of the XX chromosome, is currently Vice Chair of the Fed and has been since 2010.  She brings a very strong academic and government resume, including a stint running the San Francisco Fed.  Thus, if continuity is of paramount importance, one would expect her to have the inside track.

However Mr. Summers, brings his XY chromosome, and a considerable resume that includes a stint as Secretary of the Treasury from 1999 to 2001.  It was a glorious and forgetful time for the US economy, highlighted by the dot-com boom and bust.  Mr. Summers even managed to seep into popular culture during the movie, “The Social Network,” the story of how Facebook started.  In his post as president of Harvard, he seems clueless as to the value of the now ubiquitous web firm.  Boom and bust indeed.

But, let’s face it, the press needs a good back story to this ‘battle’ and thanks to Mr. Summers, they have it.  As Harvard president, he did more than not understand Facebook.  He suggested that the under-representation of women in science and engineering could be due to a “different availability of aptitude at the high end.”

So, here we have Mr. Summers known for flaunting his XY chromosome with a ‘challenger’ for Fed Chair with a XX chromosome.

But, really, does that matter?  To the press it does, because it simplifies the situation.  Even noted ‘economics expert’ and full-time former star Bette Midler has weighed in.  Truly ridiculous.

But, let’s move away from the simpletons of summer for just one moment.

Most experts realize that Bernanke did all he could in leading the Fed during the Great Recession.  However, many of those same people also say the Fed has left us in a very precarious situation, including:

     – Interest rates at historical lows, much lower than they should be in order to encourage saving and investing for the long term (as exhibited in the Fed’s own Taylor Rule).

     – Risk assets supported to a degree by those unusually low rates.  However, no one seems to agree to what degree.

     – A shaky market for equities (and many other risk assets), when just the slightest hint of reducing bond purchases by the Fed causes a strong sell-off.

     – And, those bond purchases, if continued through year end, will see the Fed’s balance sheet approach a record $4 trillion.

The latest research from inside the Fed is starting to say that ‘forward guidance’ is more important than bond purchases in boosting economic growth.  And, interestingly, that research came from Ms. Yellen’s former haunt, the San Francisco Fed.

So, picking the next Fed Chair will make a difference.  But, the selection will not hinge on the side issues noted by the press.  It will, undoubtedly, be based upon cold, political calculations (and major players are already lining up on one side or the other).  However, if the decision is to be a good one, it should be based upon deep discussions on the future course of Fed policy, including:

     – Can the Fed, acting alone, really materially impact sustainable, long term economic growth?

     – Is $4 trillion the new standard for the Fed’s balance sheet? (It was a bit over $1 trillion when the Great Recession started).  And, if not, how does the Fed unwind its balance sheet, without major market disruption?

     – And, most importantly, what should be the ongoing tactics used by the Fed to meet its mandates of  “maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”?

So, it’s time to shut out the noise of the simpletons of summer, and think carefully about this important decision…and its potential impact on investment portfolios everywhere.

“We the people” deserve answers to these and other important questions about the next Fed chair.  Alas, it is doubtful we will hear the answers.



From the Northwest Quadrant. We chose that name for this blog for its multiple meanings and to highlight a new beginning. Investment professionals are all familiar with the preference for building portfolios that are in the Northwest Quadrant of the risk/reward graph — improved return with lower risk. And, those of you who know Strategic Asset Alliance (SAA) know that our headquarters are located in the Northwest Quadrant of the lower 48 United States - Bellingham, WA. Of course, those of you who know SAA also know that our approach to improving the investment process, and with it the financial results, of our insurer clients goes well beyond the typical efficient frontier risk/reward graphing so familiar to pensions, endowments, foundations and others. And, that is the main purpose of this blog. To provide an ongoing commentary on how INSURERS can go beyond the business as usual approach to investments and improve their financial results, with the Northwest Quadrant as a point of departure. Your comments are most welcome on any entry in this blog. And, simultaneously with the introduction of this blog, SAA is introducing the Insurer Investment Forum Online - an opportunity to enjoy an ongoing Q&A with your peers and other experts on the investment process for insurers. Like Lewis and Clark, we stand in the Northwest Quadrant together ready to forge a new approach, but this time to improve the insurance invesment process for insurers. I hope you will join me on this adventure.




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