Two Truths and a Take, Season 2 Episode 33
|Alex Danco||17 hr|
Hello! This week we have another very special interview guest: I’m delighted to share this conversation with Margaret Franklin, CFA. She serves as the President and CEO of the CFA Institute.
Software and the internet haven’t yet made their real impact across the world of professional services, especially when it comes to professional designations and certifications that demonstrate proficiency. On the one hand, the internet has created access we could’ve only dreamed about decades ago, both in terms of access to knowledge and advice, access to financial products like diversification, and access to career opportunities for talented people. On the other hand, that kind of abundant access doesn’t mean there’s less work to do. It just requires a different kind of work.
I’m sure that for many of you reading this newsletter, getting your CFA charter was an important moment in your life. For bright young people around the world who will do the same over the next decade, it will be too - but probably for different reasons than it meant a generation ago. I think you’ll enjoy our conversation about that transformation.
AD: There’s a whole lot I don’t actually know about CFA Institute. When was it founded?
MF: The first charter exams were taken in 1963 at UCLA. But when we think about CFA Institute, we tend to hark back to the New York Society of Security Analysts and Ben Graham who really had the idea that a professional designation for analysts would provide an attestation to knowledge and skills, and it would confer prestige on those market professionals who had it.
So in that context, what was considered the scarce and valuable thing that people were after?
If you think about markets back then, they were inefficient. There certainly wasn't fair disclosure of information. What was rare was the ability to actually analyze securities, and to do that in a professional and standardized way. Investing at that time was dominated by the stock brokerage world, while these pioneers of analysis thought about it from a portfolio perspective. Ben Graham’s Security Analysis book is legendary -- first published in 1934 -- and put professionalism into the whole activity. He thought a certification would be a good way to do that. So back in the '40s, a group of them got on a train and went around the country.
It's such a great story of these deans of Wall Street going around trying to drum up professionalism. But it’s always been a core value and tenet of CFA Institute to focus on investor outcomes, making it better and fairer for investors. 1963 was when the first charter exams occurred. Ironically, now it's early market entrants that tend to be taking the exams. Back then the average age was 45. I think they had 300 people write it, and 33 of them were over 60. These were seasoned professionals.
As I think about my whole time being involved in CFA Institute through a number of lenses, and now as CEO, and I look at the history, it's remarkable how seasoned, influential market professionals dedicate time, effort, thinking, and whatever resources they have available to making the profession better.
So what about now though? Because clearly the world has changed a lot since the Ben Graham days and since the '60s, when people started writing the exams, a lot of things are different.
First of all your ability to access information of all kinds has changed a lot. Your ability to access diversification, either as a retail investor or as a professional or anything has changed a lot. But clearly new things are becoming scarce. There are a lot of things that are still valuable here, but they might be different from what they used to be. What do you think those are?
So even thinking about the 30 years I've been in the business, and I guess 23 years since I received my charter, you're right: the availability of instruments in efficient and cost effective ways has changed. We've moved more from individual securities to really thinking about portfolio construction; a total portfolio approach.
Now we're adding a third dimension. We’ve got risk and return which are the basic measures of investment management, that’s two. Now we think about a third: impact. You’re starting to see material movement towards more environmental, social and governance elements added into the portfolio: the connection to that real stakeholder theory.
In the last year, we've seen carbon rise to the top of important ESG factors in portfolios. Ways to think about risk from an ESG perspective includes, for example, stranded assets of mining companies: who pays for those stranded assets? Are there unintended liabilities or undisclosed liabilities associated with environmental factors? These all manifest in portfolios.
How can one generate returns in an interest rate environment that has really never been present for almost anybody practicing right now. The meaningful impact of central bank activity as it relates to asset allocation and portfolio management is extraordinary in this environment.
That's a good point. So when I think about the timeless lessons of personal finance that I’ve heard, it’s always just: your goal is basically to beat inflation. This is what you're running in place against. This was in a mindset where it's CPI inflation. So, here's what the cost of living is, you're trying to run in place against that.
Now today, that's not really what my friends and peers are worried about. They're worried about asset inflation, not CPI inflation. A house is getting more expensive, a university degree is getting more expensive, stocks themselves are getting more expensive. It's a very different kind of thing that you're running in place against. At some level it's like, the solution is the same. It's just to generate returns for your customers. But it is a different mindset though.
So, today's a great day to be talking about it. You may have noticed because you've spent time on the west coast that CalPERS has a target return objective of nominal 7%. That is just becoming harder to do.
Especially if you have a requirement to have a certain percentage of your assets in fixed income.
Exactly. In 1995, you could do that with 100% high quality bonds. 2005, you could do that in a 50/50 stock bond portfolio, and really without using anything esoteric. Now there’s a kaleidoscope of assets with a significant portion that have real illiquidity built into them. So, you're pushing people further and further out on the spectrum.
So, you’re right, there's asset inflation, part of which is driven by central banks having such ultra-low rates that, at some point, are going to have some consequences. But other things are actually totally deflationary. So there's a bit of a knife's edge in that, which makes portfolio construction way more complicated.
It also probably requires investment professionals to have much different conversations with their clients, be they institutional or individual. The pricing of services becomes much more consequential to your ultimate net return. It's a business that has still very healthy profit margins. We're probably going to become an industry with more normal profit margins because the distribution of returns to the investor, versus the provider is skewed.
Well, speaking of those profit margins, the obvious criticism on all of this is: as you see these big flows into passive management, it's like what exactly are you charging 100+ basis points for? If you’re a retail client, and can get the same returns in a Vanguard target retirement date fund. Then go have a nice life and then go be pleasantly surprised in 30 years when you look at your portfolio.
On the other hand, you can look at the sticker price of an advisor rather than as a percentage of AUM for your returns, and instead as a price for something like education and engagement.
So, I think we still see the same human behavior manifest itself in portfolio destruction.
I mean, 100 basis points a year is a huge amount in the context of what compounding does, but it also is small compared to the destructive effects of human impulse.
I’m curious as to how you see software robo-adviser offerings improve and expand - these online services, which started out as simple “we’ll auto-balance a portfolio for you” products, are now getting into all sorts of banking products - they’ll give you savings accounts, they’re getting into tax advice; you’ll be able to get your mortgage through these services before too long. Young people certainly seem to be embracing this trend. Are there any second-order consequences of that adoption you anticipate?
So here's what I would say about pricing and that is FinTech will change this. Our ability to apply technology, particularly machine learning, natural language processing, all that artificial intelligence thinking, to financial inclusion will make a difference. If you think about a $5,000 portfolio, you're not able to run that cost effectively with a lot of human intervention, because you can only have so many contact points and so many one-to-one client relationships. But technology really does change that -- it provides cost-effective portfolio management at scale. Generally, people with smaller portfolios don't have the complexity as those with a much bigger pool of assets.
With bigger portfolios, complexity in and of itself generally creates a need for more specialized service and that generally comes with size. Even with those big complex portfolios, what we see is that they have a barbell approach. They can get cheap, passive, exposure for certain things. Then they may concentrate their efforts on those that require much deeper skills. So the portfolio construction becomes more complex.
Complexity is also really multidimensional in the sense that it includes more than the portfolio itself. It's also like the client changes over time.
The rough equivalent for me, I think, is my tax guy Brian. I get so much out of him beyond what he charges me, because not only does he deal with my horrifying taxes every year, but he spends dozens of hours per year teaching me things I need to know. That is like some of the best money I spend on anything.
Yes. So I think there are really two aspects to that. There'll be some people who will say, "I'm really only minimally interested. Here are my key objectives. I want to be able to trust you. I want to be able to trust you to have an honest dialogue, what the competing priorities and trade-offs are.”
All of us want 7%, no variability, no ups and downs. If we had all of that, it would be Nirvana depending on what the inflation rate is. So if you think about the value of advice, it is meaningful. What's charged for that advice though, needs to relate to what investment return can be had. I will say, our Trust study that we recently published shows that investors who have an advisor actually have much more confidence in the financial system, because they're much better educated. Ergo they don't abandon what might be a very well thought out program because they didn't understand it and they panicked in the moment.
That has mathematically beneficial properties to it. So then you say, "Okay, what do we want from the advice system?" We want to make sure that they're well-educated, they're ethically oriented, and that they pursue professional excellence because things change over time. So that's really where CFA Institute becomes very valuable for those in the system.
It does seem like, especially what you said is there is a professional excellence in getting people to not self-sabotage. Which is a hard problem to do. No amount of robo-advisors are really going to be able to help with that. Unless, software can convince themselves to lock their portfolio for the long term.
Well, here's what I'll say about active management. I think there is a role for active management in portfolios. So if you have inefficient asset classes, active management generally pays off. There are also spots where in portfolios, the benchmark may not actually be your objective. So here we are in Canada where let's just say bank stocks have historically provided a reliable tax- efficient dividend yield. So if cash flow is important to you and you can count on that cash flow, I've certainly seen people's portfolios where the bank stocks cost-base was absolutely ridiculously low. What ends up happening? So they compound tax-free because they're loath to pay the taxes, so they don't actually ever sell the sucker. They get a tax-efficient dividend.
That's the kind of behavior you want to see so they can withstand the ups and downs. You have to manage the clients to say your objective isn't the broad benchmark, the broad market. You have some quite precise things that you're trying to solve for. The benchmark for the indices tends to be shortcut ways to describe the market. Now, there are definitely moments where you say, "I want market exposure." You might just want cost-effective market exposure.
We have indices for everything now. Some of those markets are efficient and some of them aren't. So there are opportunities for sure, for active management on both the risk management side and on the return side. It's what you pay for.
It sounds like what you're saying is just like a lot of active management is just becoming active management of the client. Then just saying "We can do some security selection, but that is mostly based on knowing you."
As opposed to, "Well, my job is to sit here and pick stocks all day and I really think that we should go buy some Amazon today.” Unless you have this born gift to be a stock picker, which few people do, or you sit in an information flow that gives you some unusual information - which as a financial advisor, you're probably not going to have - then what is left is the unique needs of the client. Which are not insignificant, but that really becomes what it's about.
This is getting into the next question I wanted to ask you about, which is the idea of craft. The idea that security analysis and being a good steward of this relationship between owners and their assets really has some craft-like elements.
We’ve spoken about this before, about how many of these industries (like software, for instance) are very much a craft. I like to say, look at the difference between the engineers in Office Space versus in Silicon Valley, the TV show, they're practically from different planets. Just based on the difference between how deeply they care about what they're doing.
CFA Institute is in some sense, a torchbearer for this craft, and you have to figure out how to signal this in a way that is equitable and fair and somewhat codifiable. But at the same time, you can’t lose the magic of the craft.
So, that's a great question. I do think that the very best of our profession think about it as craft. They think deeply about how they apply their trade. What is it that they're uniquely capable of? What is it that they're trying to achieve? How do they express that to clients where they're investing or using other people's capital, and where they're investing for someone else as a fiduciary?
So if I think about the early roots, which we talked about, with Ben Graham, that's just such apparent craftsmanship. Yes, the tools have changed but if I think about someone like Howard Marks or some of the investors who've had long tenure in their career, we all look to them as masters of their craft.
Well, Howard Marks can communicate his craft because he writes beautiful essays that everybody reads. But most people can't do that, nor even if they did they don't have the brand for people to go read them. Unless you think that, that's something people should more actively be doing...
You can create some level playing field. That was Ben Graham's original idea, to certify a certain level of knowledge, skills, and ability, which I think the CFA program really does. There's a global standard to it, it's an elite program. Then from there you launch into your craft, which I think is lifelong learning. It’s a lifelong commitment to professional excellence and understanding who you're serving. That can sometimes get lost in translation. So I think the ability to be part of an ecosystem that reminds people of who you're ultimately serving is critically important.
So how do you communicate that though? Because in software, for instance, you can communicate a lot more information about how deeply someone cares about a craft based on what internet forums they hang out on, or what commits they might have to an open source project. Is there an equivalent for this in this world that can be easily understandable by somebody who's not in it?
So I'm totally biased, but I think participation in and commitment to the CFA charter world is one of those things. For somebody like me, I didn't start in the business, but getting the CFA charter gave me an amazing career of almost 30 years. It’s a vibrant, aspirational community. It sees the purpose of finance, and the purpose of investing, in this particular dynamic and context that we're in right now as a social good if done well.
Who is that community? Because I know that you care a lot about diversity, inclusion and the CFA program as a great opportunity leveler. Anybody can write this exam. It's a lot cheaper than an MBA, it's not completely equal opportunity, but it's pretty good in terms of saying "If you were able to get into the door, here is this path that's available to you." Are you where you want to be in terms of who is represented?
So I would say that the CFA program diversity numbers right now are pretty consistent with the industry, which is absolutely not where it should be. So if we just look at gender diversity, when I wrote my exam, when I got my charter in 1997 there were 19% females. It's largely the same number 23 years later. On the brighter side, our pipeline of candidates looks dramatically different: 40% plus are females.
So I think there are a couple of aspects to that. First of all, it is a culture that is seen as particularly male-dominated. We haven’t done a good job of positioning what a career could look like to a broader audience. We know many young people entering the job market are interested in careers that are meaningful, fulfilling and challenging. The investment management industry has all of that. Financial security is a very important aspect of a well functioning economy, and well functioning individuals. It's necessary and it can be very noble work.
One of the things that we have not done as well, and we are changing, is how we're attracting a diverse set of candidates to the program. You're right, it is by and large very cost effective. I think of it as democratic on the way in and meritocratic on the way out. So unlike many elite programs, MBAs, and finance programs, where the hardest thing is to get into the program but almost everybody gets through it, ours is one where anybody can undertake it, but only one in five will actually successfully complete the program and successfully get their charter. It’s democratic on access but meritocratic on achievement.
The CFA program, however, does not fit all purposes and I think we have a unique opportunity to expand our credentials and certificates to serve the needs of a broader set of investment professionals. If I think about the investment management industry when I started, our whole ecosystem was largely portfolio managers and research analysts. Now we see data scientists, risk managers, wealth advisors -- it's a much more complex group of participants. So we're adapting and modernizing to meet the needs of those people where they're at from a learning and professional development perspective.
I opened up my Twitter a few weeks ago and saw that everyone was unhappy about the new online exam format: "When I failed the CFA exam, I had to wait a whole year in agony for writing again. Now kids can just write the entire thing straight through as many times as they want in a year."
It feels to me a little bit like doctors complaining that new residents don't have to do 36 hour call shifts anymore. There's a cult-like experience around the exam, right? Are you getting pushback from your charter holders?
So that's always been the case. Every 10 years we get some sort of a pushback. Computer-based testing does a couple of things. First of all, it does increase our accessibility so we can be in more places, we can offer more windows, and that's more suitable for learning styles. We just know so much more about how people learn, who our candidates are. We can meet them in a better, more effective way. I think you're going to see that change over time.
There were security risks with the old paper-based exams. I mean, getting them to places and then more importantly, getting those tests back is an extraordinary operation. It increases our accessibility. It does open up more windows for people. Again, it's about attracting the right people and doing a better job in making the exam accessible. The quality of the exam, and our ability to test and get at those knowledge, skills and abilities actually does not diminish at all under computer-based testing. We've done a tremendous amount of research and testing to validate this.
So it’s true that we have this cult-like experience. Everybody remembers how they studied for the exams and that cult-like experience of getting through it and getting your charter. That does not sustain you through the whole of your career, however. So it has its own half life, that particular experience. CFA Institute is so much more and will become so much more over the next few years.
So what charterholders should really care about whether they wrote in 1963 or whether they're writing in 2020 or 2021 is our ability to get at and certify that knowledge, skills, and ability. Is it suitable for modern times? I think that improves as we go along.
Do you think that in 20 years the exam will be as central as it has been to the myth, the cult, the idea of the CFA?
I think in our world, the CFA charter will continue to be a really prestigious program. One that is very suitable for particularly the early market entrants. It will distinguish people. If I look 20 years hence, I think we will have a really robust suite of learning strategies that will meet the needs of professionals across their entire career. We know, for example, that the average professional will have six very meaningful changes in their career. For instance, think about a research analyst who goes on to become a portfolio manager, who then takes on risk responsibility, who may now be in a leadership capacity running an entire ecosystem.
We can see where our ability to develop those really strong learning programs, both experientially and test-based, the rigor and quality with which we’ve done that globally, and if we can capitalize on and leverage that history and legacy into the modern world, we will be able to meet the needs of investment professionals over their entire career. That will be a bit of a game changer for us.
Thank you so much for taking the time for this interview, and for sharing all of this with the newsletter! You can find a permanent link to this interview here:
Thanks to all of you who wrote in about last week’s post on founders and pre-truth telling. As anticipated, some of you did not like it! In particular, see this Twitter thread about the Microsoft story, which I’d passed on from Byrne’s newsletter but had also understood as commonly accepted tech industry lore.
I do appreciate that Tren is much closer to the real story and certainly knows what factually happened better than I do. I’ve updated the original story with a note on this dispute. But in all honestly, the story has been so widely accepted and retold that it’s here to stay. If everyone says it happened, then you know what, it therefore kinda happened. I have heard this story repeated so many times that it is effectively just part of the background context at this point. It may not have factually happened, but that’s a small detail.
Furthermore, I feel like this kind of just proves my original point: whether or not the deal was based on a complete fabrication or the full truth or somewhere between does not matter, because the point of the story is about what is considered “genuine”, not what happened. Microsoft’s reputation is not diminished in any way by this! And the fact that this is the story now - factual or not - communicates a form of truth that’s a lot more about what’s genuine than what’s factual. You might as well ask a roller coaster enthusiast, “you know that’s not really a runaway mine car, right?” Thanks to Tren for weighing in and for Byrne for the context (see the Twitter thread.)
Another great interview to check out on semiconductors, software, AI, and Taiwan:
And here’s a great catchup on our friends at Pipe:
And finally, this week’s Tweet of the Week:
Have a great week,