Explore the Thinking behind our investment approach

Have you ever noticed that the words listen and silent are spelled with the same letters? Perhaps this is no accident, because in many ways, they mean the same thing. Have you ever talked to someone and walked away feeling enriched because they were such a good listener, even if they were a complete stranger? This talent is what accounts for some of the best psychologists in the world—and some of the best salespeople. Interestingly, the ability to listen is also the trait most people refer to in a great relationship partner or leader. My own understanding of the power of listening came about many years ago, when I arrived for an appointment with a client of mine. He was a doctor, was having a bad day, had gotten home late, and was running around trying to get ready for me. He and his wife were frazzled, and their eight year old daughter was bouncing off the walls, happy to have her parents home, and craving their attention. I remember being acutely aware of how much these people just needed some calm stillness more than anything else. It was one of the first moments where I really started to put my attention consciously on my clients, and I gave my attention 100 percent to this family. I don’t even remember what we spoke about. I mostly just listened to them. And within about ten minutes, the doctor’s daughter fell asleep on her mother’s lap, and the mother leaned back in her chair. The doctor loosened his tie, his breathing calmed, and the frenzied atmosphere in the room relaxed. He turned to me at the end of the appointment and said I must have hypnotized his family. Half joking, he asked me if I could come and do the same thing at 5 p.m. every day! Have some faith that life has brought you and people you are interacting with together for a more important reason than what you can get out of it in the moment. And if that’s true, the only way we are going to see that purpose is to become silent, truly listen, and see what happens next. To clarify, silence doesn’t only mean refraining from speaking. It also means quieting the ongoing dialogue in our head—the mental noise—so that we can really focus on another person and what they are communicating to us. The first thing that people often say to this is, “If I’m not looking out for myself, I’m going to get walked all over!” Many people assume that if they come from a position that isn’t fixed, they’re going to get taken advantage of. I’ve actually found the opposite to be true, because when another person isn’t met with resistance, they then begin to back down from their fixed positions, which creates a space for something new to occur. And in that space, it often becomes easier to find the right course of action, because there isn’t a sense of desperation driving you to try and get something specific from the situation. Give your attention completely to another person—and see what happens. When you’re in that space, you’ll know exactly what decision to make when it comes to your relationships, and your business. Unfortunately, too many of us spend our whole lives waiting to get something from the world so that we can show up as the person we always knew we could be. Deep in our hearts we think there’s something missing. But when we flip that mindset, we can discover that by becoming a giver rather than a taker, we can become agents for change in the world.

As if the U.S. Federal Reserve did not already have enough on its plate heading into its meeting on interest rates this week, chaos deep inside the plumbing of the U.S. financial system has thrown policymakers an unexpected curve ball. When rates on the typically steady overnight re-purchase agreements behave like the stock market, as they did this week, even the broad market pays attention. But despite the flashing red lights, this increase in short-term rates is being driven by technical factors, rather than credit concerns. The FED made an emergency injection of more than $125 billion over a two-day period, its first major market intervention since the financial crisis more than a decade ago. The exact cause of the stress is a matter of some debate, but the source is well known: the $2.2 trillion repurchase agreement, or “repo” market, a gray but essential component of the U.S. financial system. Technical factors led to a sudden shortfall of cash in the banking system, and the FED pumped money into the market to keep borrowing costs from creeping above the Fed’s target range. The rate on overnight repurchase agreements hit 5% on Monday, September 16th, according to Refinitiv data. That’s up from 2.29% last week and well above the target range set in July by the Federal Reserve, which is 2% to 2.25%. The surge continued Tuesday, with the overnight rate hitting a high of 10% before the NY Fed stepped in. Giving this some perspective: if you want to borrow money for 30 years, the US government will give it to you for 2.25%. But if you need to borrow some money for the next 24-36 hours, you’re paying double digits.1 To help rectify this issue, the FED intervened by adding liquidity to the markets, as previously mentioned, in an unrelated move they cut the federal fund’s rate by a quarter point, boosting lender and investor moral, and by cutting the Interest Rate on Excess Reserves (IOER) by 30 basis points. The IOER was introduced in 2008 as a way to incent banks to maintain a larger basket of excess reserves, so the FED would not have to engage in daily transaction in the money markets. We have enjoyed large amounts of excess reserves ever since. However, since the inception of the IOER we have also seen a lot of regulations put on banks regarding liquidity and capital standards, such as Dodd-Frank. The regulations have been successful at improving reserve levels and capital standards of banks, but they have made it more difficult for the FED to estimate how much money the banks need to meet all their liquidity and regulatory needs. 1,2,3 In this case, some of the technical factors that caused the cash crunch include: Payments on corporate taxes were due on September 15th, leading to high redemptions of more than $35 billion in money market funds. 4 Cash balances increased by an additional $83 billion in the U.S. Treasury general account, which reduces excess reserves and simultaneously acts to reduce the aggregate supply of overnight liquidity available in funding markets. 4 Dealers needed an additional $20 billion in funding to finance the settlement of recent scheduled U.S. Treasury issuance. 4 The latest rounds of quantitative tightening saw the FED cull its balance sheet to $1.47 trillion, the lowest level since 2001 and nearly 50% below its peak from five years ago, leaving the opportunity for a liquidity crunch. 3 What is a Repo? Repos are very short-term collateralized loans. In a repo trade, Wall Street firms and banks offer U.S. Treasuries and other high-quality securities as collateral to raise cash, often overnight, to finance their trading and lending activities. The next day, borrowers repay their loans, plus what is typically a nominal rate of interest, and get their bonds back. In other words, they repurchase, or repo, the bonds. 2 The system typically hums along with the interest rate charged on repo deals hovering close to the Fed’s benchmark overnight rate. 2 Why is the Repo Market Important? Although it doesn’t get as much attention as the Dow or the 10-year Treasury rate, this overnight market plays a central role in modern finance. The repo market underpins much of the U.S. financial system, helping to ensure banks have the liquidity to meet their daily operational needs and maintain sufficient reserves. But when investors get fearful of lending, as seen during the global credit crisis, or when there are just not enough reserves or cash in the system to lend out, it sends the repo rate soaring above the Fed Funds rate. When this occurs, trading in stocks and bonds can become difficult. It can also affect lending to businesses and consumers, and if the disruption is prolonged, it can become a drag on the U.S. economy that relies heavily on the flow of credit. 1,2 Who is involved in the Repo market? Participation in the repo market is broad. Direct participants include depository institutions like commercial banks, the U.S. government and its agencies, investment funds, primary dealers, money market mutual funds, investment banks, hedge funds, insurance companies, and non-banking financial institutions. Indirect participants include anyone with a loan or mortgage; residential mortgages, auto loans, and credit card loans, etc. The federal government is the only entity with a large enough balance sheet to finance the repo market should liquidity dry up. A historical perspective By now, nearly everyone knows that the financial meltdown of 2007/2008, and the subsequent recession, began with the collapse of the housing market and the subprime securities market. Understanding exactly what happened, and why, has been the subject of a good deal of academic work, much of it pointing in different directions. In the years leading up to the crisis, these institutions held a wide variety of loans, including residential mortgages, auto loans, and credit card loans, which traditionally were held by the commercial banking sector. Instead of being financed by deposits in commercial banks, the loans in the years leading up to 2007/2008 were funded by repurchase agreements, popularly called “repos,” and asset-backed commercial paper. In 2007, the shadow banking system suffered a severe contraction. Why this happened is poorly understood, but a popular theory is that a lot of the short-term funds received by shadow banks prior to the crisis took the form of repurchase agreements, and many of these repos were backed by securitized mortgages as collateral. According to this view, the shadow banking system collapsed when money market funds and other cash lenders became concerned about the quality of the collateral that backed repos and withdrew their funding.5 Most repos were collateralized by safe government securities, not riskier securitized mortgage products. So, while the “run on repo” may have contributed to the problems of a few repo borrowers that were relying heavily on repo with riskier collateral, this was not the main cause of the crisis. The main cause lay in asset backed commercial paper, whose risks were hidden from the balance sheets of commercial banks, but when those securities went bad and could not find buyers, they migrated back to the balance sheets of the banks depleting their capital. 5 A month before Lehman Brothers collapsed, the banking system held cash reserves equal to around $50 billion, while clearing $2,996 trillion in trades per day. That means the banks were technically liable for all those trades at any given point in the day. Thus, private capital trusted the banks to clear and process their trades, pay them if anything went wrong, and pay them interest on the loans they extended to them to make it all happen. 6 Confusing? Yes. Madness? Depends on who you talk to. If Bear and Lehman had had fatter capital cushions, they may have lasted a couple days longer before collapsing, but no more. At the end of the day, though, it really doesn’t matter how big a bank’s capital cushion is or even what it is made of. The loss of repo funding will overwhelm any bank even if it has a lot of great capital as it would be difficult to liquidate those assets fast enough. 6 What does this mean for markets and portfolios? The answer seems to be, not much. The overnight lending rates have calmed down as a result of liquidity infusion. The New York Federal Reserve has agreed to offer up to $75 billion a day in liquidity as needed as well as three 14-day Repo operations of at least $30 billion to quell this liquidity crunch. It seems that as the FED is figuring out a more optimal cash reserve level to keep the economy running smoothly. Over the next several months, as they undertake this challenge, liquidity crunches like this are likely to keep occurring, but the FED is ready to step in again should the situation demand it. 6 Investors should be prepared for deteriorating liquidity in the funding markets into year-end, and the impact of this on the financial markets as a whole is increased volatility. This volatility will hit sharp ratios and percolate through the system with potential costs for levered strategies and risk assets in particular. As the past few days have shown, current market liquidity conditions warrant defensive positioning overall but can also present opportunities for investors who are in a position to take them. 7,8 Over the longer-term, more structural changes will likely be made. The quantitative tightening that the FED had engaged in seems to have gone too far, and at some point, the FED will have to expand its balance sheet again to put these short-term liquidity crunches to bed. This action would create significant demand for duration, layering on top of the QE that the ECB is already engaging in. Investors around the world remain concerned that there are economic risks on the horizon and the FED will need to be careful about how and when they start to rebuild their balance sheet. 4

Why are we in a trade war? China entered into the World Trade Organization in 2001, under rules that granted it concessions as a developing country, which greatly accelerated its integration with global markets and supply chains. Studies have shown that Chinese exports led to lower prices for U.S. consumers, and helped lift millions of Chinese people out of poverty. The country’s ascent also resulted in the loss of millions of U.S. factory jobs. China’s power, especially its technological prowess, is now at a point where it risks eroding American military and economic advantages. China insists it plays by global trade rules, and it sees the U.S. as seeking to contain its rise.1 President Trump says China and other trading partners have long taken advantage of the U.S. He points to the trade deficit (the difference between imports and exports) as evidence of a hollowing out of U.S. manufacturing and the loss of American might. For more than a year, he has ratcheted up tariffs, which are a tax on imports, and encouraged U.S. companies hurt by them to move production and factory jobs back home. Trade tensions escalated this weekend between China and the US as both countries continue to engage in a tit-for-tat trade war. Friday evening, Aug. 23, Beijing time Before U.S. stock markets open, China’s Ministry of Finance announces on its website that it will apply new tariffs of between 5% and 10% on $75 billion worth of goods from the United States. 2 The move is a response to the U.S. government’s announcement on Aug. 1 that it is adding a 10% tariff to $300 billion worth of Chinese goods. Washington eventually delayed some of those tariffs, saying they will be implemented in two tranches: on Sept. 1 and Dec. 15. 2 The bulk of the Chinese tariffs will take effect on Sept. 1, while the rest of the duties will be implemented Dec. 15. 2 Saturday, Aug. 24, Beijing time Trump tweets that duties on goods imported from China will be increased: “On Oct. 1, tariffs on $250 billion of products will rise from 25% to 30%. Tariffs planned for Sept. 1 on $300 billion worth of Chinese goods will now be 15%, instead of 10%.”2 Sunday, Aug. 25, Beijing time President Trump threatened use of the International Emergency Economic Powers Act (IEEPA). In theory, this authority could be used to impose non-tariff restrictions by prohibiting the transfer of credit or payments to any banking institution, and by compelling / regulating acquisitions of any property with foreign interest. Monday, Aug 26, EST Stocks jumped on Monday after President Donald Trump said China is ready to come back to the negotiating table following a phone call Sunday. In pre-market trading, The Dow Jones Industrial Average traded 163 points higher, or 0.6%. The S&P 500 climbed 0.7% while the Nasdaq Composite advanced 0.9%.2 US-China trade: A Historical Perspective The US trade deficit with China has soared since 1985 to $419 billion in 2018. The trade deficit is the difference between how much the US imports from other countries and how much it exports. Reducing the gap is a key part of President Trump’s trade policies. 3 The above graph on the left side of the page is a visual representation of the US-China trade deficit from 1988 through 2018. You can see from the graph why the Trump administration has focused so much of its attention on China. It is the United States’ largest trading partner, followed by Mexico, who is a distant second with a $78 billion trade deficit when seasonally adjusted for goods and services. 3 On the right side of the above chart, you will see the magnitude of our trade relationships in imported dollar terms for both the US and China. The US imported just over $539 billion of Chinese goods in 2018, and China imported just over $120 billion of US goods over the same time period. From the sheer size of these numbers you can tell that the US has a structural advantage in a tariff tit-for-tat relationship based on the size of the imports for both countries. The US is a much larger buyer of Chinese goods than China is of US goods. This means that tariff increases should affect China disproportionately if tariffs were the only tool utilized in a trade war. 3 Are the Currency wars next? Another lever that countries can pull in a trade war is the valuation of their currency. Having a weaker currency relative to the rest of the world can help boost exports, shrink trade deficits, and reduce the cost of interest payments on outstanding government debts. Earlier this month, China allowed its currency to slide below what has been a psychological red line, the key 7 yuan to one-dollar level, for the first time since 2008. This prompted the US Treasury department to designate China as a currency manipulator. The Chinese central bank has a very firm control of its currency. It sets a daily rate for the currency, allowing it to trade in a band against the greenback within a 2% target range. Given this level of control, any major dislocation is seen as a conscious decision by the PBOC (People’s Bank of China). 4 Worst case scenario China was the largest foreign holder of U.S. Treasury’s until June, when it was surpassed by Japan. According to data by the U.S. Treasury department, China held $1.11 trillion of U.S. debt in June. “We have a debtor-creditor relationship, not just a trade relationship. And that can be a dangerous thing,” says Ray Dalio, founder of the world’s largest hedge fund, Bridgewater Associates. Analysts and investors have said that amid escalating trade conflict between the world’s two largest economies, China could resort to the so-called nuclear option to hurt the U.S. by selling its large Treasury holdings. But many dismissed that suggestion, saying such a move will harm China as well. 5 Are Tariffs working? The U.S. trade deficit increased to a 10-year high of $621 billion in 2018. Economists say the trade war actually helped to widen the gap by contributing to an economic slowdown in China and Europe. Meanwhile, American farmers have lost markets and income as China and other trading partners raised tariffs in retaliation. Trump is holding tight to his view that the trade war is helping the U.S. economy, although some economists are warning of recession risk. U.S. gross domestic product grew in the second quarter at 2.1%, slower than the 3.1% in the first three months. Analysts surveyed by Bloomberg project GDP expansion to slow to a 1.8% annualized pace in the third quarter as Trump’s trade policies and slower global growth make companies more hesitant to hire and spend. 4 U.S. imports from China were down 26% year-on-year in the first quarter of 2019. In the same period, Taiwan and South Korea saw sales of electronics components accelerate, and Vietnam saw the same with furniture, a sign that tariffs might have accelerated the shift of low-end manufacturing out of China, a move that has already been underway as Chinese working wages rise. The jury is still out on whether tariffs have achieved their desired trade goals as both administrations continue to deliberate and try to find a middle ground. 4 Investment Implications In our last quarterly memo, we discussed three key conditions that we believe must continue to be met in order for this bull market to last, and for the US to avoid recession. Those three key conditions are as follows: (1) The global economy is slowing but will remain steady, hitting the long-term 2 percent growth target. (2) Low interest rates, which are supporting higher equity valuations, will remain in place. (3) Trade tensions have peaked, and the US & China will ultimately reach a mutually beneficial truce. Although 2019’s tepid earnings growth has not inspired strong confidence in the market’s current advance, we believe that equities are likely to continue their ascent as long as these conditions remain. This month’s events represent a pronounced escalation in trade tensions between the world’s largest economies and marks a new and potentially more volatile phase in this trade war. Although the odds remain in favor of continued expansion, these policy risks highlight growing probability of global recession, the importance of focusing on securities and sectors that look attractive from a valuation perspective, and increasing global diversification.

The white paper for Investments and Wealth Monitor by Jeff Gitterman and author/consultant Paul Ellis titled “ESG Data Drives Demand for Sustainable and Impact Investing” was recently released.

It’s time for advisors to “get off the sidelines” when it comes to ESG investing. The world has changed. New data sets are needed to understand how investments may perform over the long-term. While myths persist with respect to performance, ESG is not the socially responsible investing of years ago. In this Barron’s piece, Jeff explains why “we use the global positioning system analogy: 25 years ago, you took a road trip, you used a map. Today, you get in your car, and you turn on your GPS, and it’s a three-dimensional view of the trip. The 10-K is very one-dimensional. It gives you stale data of the company you’re investing in. You need to wait until the next quarter to get new data.” ESG topics and data provide additional insights into corporate performance that just are not available via traditional financial metrics. Advisors who are still not incorporating ESG into their practices are missing out on both potential performance and risk mitigation, as well as an increasingly large client base of individual investors who want to know how their investments are contributing to a better world, or not.

The earth aware days have arrived. April 22, 2020 will mark the 50th anniversary of Earth Day. Just as active managers use shareholder resolutions to address corporate governance, social, and environmental change, on the other side of the trade are individuals driving the demand of goods and services. Understanding your personal metrics and carbon footprint amidst this symbiotic relationship is an empowered act. I grew up in Texas, and as a tomboy, spent much of my energy in nature catching horntoads and building tumbleweed forts. My wildcatter grandfather, “Big Jim,” as he was known, was no stranger to risk-taking and betting on shale deposits. He navigated through multiple boom and bust cycles in the oil business during his 50-year career, including OPEC disruptions and the Texas Recession of the 80s. How I went from a Texas wildcatter family to a climate advocate frames the value of advocacy and impact as a mechanism to direct capital towards a regenerative economy. In college, my interest in the natural world grew with the discovery of wind and solar energy, and I will never forget my first advocacy engagement with my grandfather. He stood 6’4, listened more than he talked, and was what you would call “a man’s man” when it came to business. One day, over breakfast, I proposed he earmark a portion of operating profits towards research and development of alternative energy, to which I received thunderous laughter in response. He replied that building was cheap, energy was cheap, and alternatives were not only impractical, but start-up costs for wind and solar prohibited it from becoming a viable industry any time soon. Regardless, I was undeterred and my desire to birth a low carbon (CO₂) revolution continued to grow. After college, I established a career in financial services, seeing it as a great sector for women to make a difference. In 2008, when WT Crude topped $149 a barrel, I again reached out to my grandfather. “What about now?” After a pause and no laughter, he said that while plenty of oil is left, all the easy oil is up, and so alternative energy now made sense. Just as my grandfather never envisioned Crude topping $149 a barrel, I don’t imagine any of us anticipated the recent FRSB Economic Letter¹ related to climate change or the recent Mercer report: Investing in a Time of Climate Change – The Sequel, which called climate change the existential threat of our time: “The last time the global mean surface temperature was comparable to today was more than 100,000 years ago. The last time CO2 concentrations were as high as today (over 400 ppm) was three to four million years ago.”² Earth Day underscores the importance of personal carbon examination for all of us, and here are three easy things we can do right now to better understand our carbon footprint and make strides towards a net zero world: Measure: Establishing our baseline Our carbon footprint describes the amount of carbon that is emitted as a result of our choices. This footprint is influenced by the mix of utilities in your area. For example, the State of Washington, where I reside, is a leader in the country deriving 44% of energy from renewable sources, second only to Oregon.ᶾ The amount of hydroelectric energy produced at the Grand Coulee Dam on the Columbia River produces electricity for 2.3 million households per year, accounting for 25% of U.S. production.⁴ To learn more about your state, click here. ⁵ There are several other pieces of personal information that can also be helpful to know: Home: A recent utility bill Transportation: Vehicle type, MPG and mileage/any transit usage/ flight mileage Food Consumption by category: Breads/dairy/fruits/meat/vegetables Services: Average monthly spending (i.e. healthcare/education/entertainment) Goods: Average monthly spending (i.e. Amazon Prime /Costco/Home Depot/Staples) Establishing our carbon footprint helps to form awareness. Any number of websites offer free carbon footprint calculators and comparison tools alongside educational resources. Type “climate footprint” or “carbon footprint” into any search engine and try a couple out. Here are a few of my favorites: CoolClimate Network – CoolClimate Calculator is research based out of UC Berkeley CarbonFootprint.com – UK-based free calculator with loads of tips and carbon credit offsets The Nature Conservancy – Arlington, VA-based charitable environmental organization Redirect: Knowledge is the gateway to reducing CO₂ emissions The average US resident creates 20 tons of CO₂ emissions annually, according to an MIT study. whether a person can live climate-neutral is a question of lifestyle choices and making improvements over time. Consider adopting these actions to reduce your footprint. Replacements naturally occur in the life of items around the house as daily habits shift. Save Energy: Retrofit your house, travel less, and use efficient vehicles and appliances. Clean Energy: Switch from gas and oil to electricity. Food: Eat less meat and dairy, waste less food. Buy locally, it is thousands of miles fresher. Goods: Employ a refuse-reduce-reuse-recycle mindset and buy locally produced goods. Offsets: Purchase Carbon Credits for remaining unavoidable emissions A carbon offset compensates for our emissions by funding an equivalent CO₂ savings elsewhere. It is important to remember that when we buy these offsets, we are paying someone to cut emissions so we can keep ours. To effectively address climate change, individuals, businesses, and government organizations must take responsible steps to curb CO₂ emissions as much as possible before seeking an offset solution for any remaining unavoidable emissions. When a balance is struck between emissions and offsets, one is said to achieve “carbon neutrality.” In accessing carbon credits today, most are verified by a third-party standard. The acronym VALID is loosely used as a guide. Projects must abide within the following parameters: Verifiable – The offset uses a robust audit process like Gold Standard or Kyoto Protocol. Additional – Would it occur anyway without the investment raised by selling offset credits? Leakage avoidance – This means the emissions are not moved elsewhere beyond the boundary. Impermanence –The project is sustainable; the reductions are not reversible. Double-counting – Carbon reductions are claimed only once, not counted multiple times. A few other tips to keep in mind when buying carbon offsets: Rather than buying trees and promised emission cuts which are often thin on independent research, consider giving to Gold Standard-approved wind or solar energy projects instead. You can find Gold Standard VER projects on the Gold Standard website and you can buy Gold Standard CERs directly through the UN’s platform. DIY carbon offsets related to educational projects are another interesting opportunity at Skeptical Science. Thirty years ago a proliferation of horntoads sparked my curiosity about the natural world. Today they are a threatened species bred in captivity.⁶ With the increase of drought- prone areas, our kids and grandchildren will inevitably find more tumbleweeds for building forts. Given the consensus of expert, peer-reviewed scientific literature as undisputed, the easy days of “climate” are over. What lies ahead requires planetary cooperation to shift towards a low-carbon economy. What are you doing with the next 365 days of your life on planet earth? Here’s to making it count.