"Time for a cool change; I know that it's time for a cool change..." —Little River Band, 1979 Changes occur for a variety of reasons. Sometimes a major event makes it clear that an immediate course correction is needed. Other times, a series of occurrences allows a decision to evolve gradually. And often, as in the present instance, it just “feels right.” After more than 50 years of writing research reports and investment letters (including the last 20 with Brown Advisory), it’s time to pass the baton to a better qualified, more knowledgeable and—yes—younger colleague who can take Investment Perspectives forward. Meanwhile, I plan to focus my time on working with the many clients I’ve come to know over the years. A cool change indeed. I could not be more pleased to introduce my colleague Taylor Graff into this equation. Ever since Taylor joined our firm in 2010, I’ve been deeply impressed with his understanding of the markets and his intellectual curiosity with respect to all types of investments. As head of asset allocation research in our Investment Solutions Group, he is responsible for analyzing the relative attractiveness of various asset classes and investment strategies. In fact, I’ve borrowed numerous insights from him and his team in preparing to write these letters, so it’s time to give him the byline. Taylor is also an excellent communicator and regularly shares his thoughts with our balanced portfolio managers serving private clients, endowments and foundations. Taylor and I will collaborate on Investment Perspectives in 2019 (you will hear from Taylor directly on the next page), and he will take over fully in 2020. Of course, I look forward to continued conversations with him about the markets and this publication. Analysts and other observers of the markets are expected to focus on the future, helping clients evaluate an array of strategies and navigate uncertainty. Investment Perspectives is intended to do just that, but at this juncture, if I may be permitted a momentary look back at the past, it may add some, well, perspective. Changes in the Investment Landscape By far the greatest change in the investment business during the last half-century has been the introduction of technology and its impact on information flow, productivity and market efficiency. In my early days as an equity analyst for Alex. Brown, we thought we were being timely if we produced a quarterly update on a company within a week of its earnings report. The news came across the “tape,” or Dow Jones Newswire, and then we traded calls with the CEO or CFO of the company until eventually making contact to ask a few questions. We updated our earnings forecast on a sheet of columnar accounting paper (in pencil with a good eraser, using a cumbersome electromechanical calculator), wrote out our report in longhand, had it typed and retyped until it looked presentable, and then mailed it out to clients. In today’s world, research updates appear on client screens within hours (or in some cases minutes) of the release of a company’s earnings report or any other meaningful event. Information is released simultaneously to market participants. Broadly inclusive conference calls among management, the research community and the press mean that investors have little opportunity to cultivate relationships with management that could lead to an information edge. Importantly, too, securities law has evolved in an effort to level the playing field among investors. These factors have combined to increase the value of “independent” research—digging into sources of information away from a company in order to assess its prospects. In a word, the internet has changed everything. Technology has also enabled analysts, portfolio managers and traders to improve their productivity. Instant access to information allows analysts to monitor a greater number of stocks, and portfolio managers are able to analyze their holdings and track performance in myriad ways. Growth in the markets, together with the minimal need for capital in order to manage money, has caused a huge increase in the number of professional investors over the years, institutionalizing the markets and making them far more “efficient.” This trend is particularly visible at the transaction level. Traders can choose among several markets and numerous dealers to find the best price for transactions. Commission rates that used to be 40–50 cents per share are now routinely 1 or 2 cents, or less. These changes generally have been positive for the markets and for investors. Lower transaction costs allow market participants to trade in and out of positions with less “friction,” and for the most part, markets are much more liquid today than 20 or 30 years ago. The rise of trading-oriented hedge funds in the 1990s resulted in part from—and contributed to—higher levels of liquidity. At the extreme, advances in computing power have led to the phenomenon of high-frequency trading, or the use of algorithms to move in and out of stocks in fractions of a second in an attempt to capture tiny profits on each trade. Even without this type of computer-driven trading, portfolio turnover has increased dramatically. To a certain extent, greater market efficiency has meant a decline in the profitability of trading for Wall Street firms, leading to fewer dealers in some markets, such as municipal bonds, and raising the effective minimum size threshold for being a public company. Moreover, merger and acquisition activity coupled with the growth of private equity (providing ample capital for companies to remain private or, in the case of buyouts, to go private) has caused the number of public companies to drop by half since the late 1990s. Those that remain are more or less adequately covered by the Street from a research perspective, but to be successful, professional investors have needed to build their own, independent research capabilities in order to compete in terms of investment performance. Over the last 20 years, our team of equity research analysts has grown from five people to 26 as of June 30; today, about 200 of our colleagues are entirely focused on investment research and portfolio management. As the investment world has evolved and our team has grown, one thing has remained constant: our unwavering commitment to an independent, fundamentally based research process as the key driver of investment results. In the quarter-century since our founding, technology may have accelerated the speed of data flow, but it has also allowed us to find and analyze more sources of information. Greater access to an array of independent sources provides us a deeper and more diversified view of the companies we own for clients or are considering owning. Further, we continue to refine our decision-making process, with a strong emphasis on teamwork. It’s been a privilege to observe this evolution and to share my perspective with our clients over the years. THEN AND NOW: The Value Of Historical Perspective by Taylor Graff, CFA "Finding patterns is easy in any kind of data-rich environment. The key is in determining whether the patterns represent noise or signal.” —Nate Silver, 2012 I'd like to begin by saying that it is, and will be, an honor for me to interact with so many clients through this publication, and to continue the tradition that Bill has built over the years. In my nearly 10 years at Brown Advisory, I’ve enjoyed reading Bill’s perspective on the markets and investing, and I look forward to this opportunity to share my own perspectives and those of our broader investment team with all of you. Further, I hope it can be a two-way conversation, as it has been for Bill, so please feel free to provide your thoughts in response to mine. Bill’s reflections on the changes that have occurred in the markets over the last few decades brings to mind the importance of understanding history as a key to successful investing. One of the things I enjoy about Brown Advisory is that, in tracing our roots back to 1800, we tend to have a deep sense of history that promotes a long-term perspective. Those of us coming up in the business benefit from the experience of veterans in the firm who have invested for decades, through different market cycles and across asset classes. Being able to draw on their knowledge has been helpful for me personally and for many of my colleagues, who are better able to make thoughtful investment decisions on behalf of our clients due to the senior guidance and mentorship they have received. As a student and lover of history, I enjoy the opportunity to discuss key market events with those who were active in the investment markets at the time. Examples that come to mind include the decline of the Bretton Woods system in the late 1960s, the “Nifty Fifty” bubble, the oil embargoes and the high inflation of the 1970s, Paul Volcker’s hiking short-term interest rates to 20% in the early 1980s, and the stock market crash of 1987. A better historical understanding of these events helps us take into account a wider range of possibilities as we consider potential market and economic outcomes in the future. Moreover, it provides an antidote to what I see as a recurring defect in market commentaries: historical analyses that only look at relatively recent U.S. data. We understand why many analyses have this narrow focus—market data that is complete and readily available to most investors dates back just a few decades, and U.S.-based data tends to be more complete and reliable than that of other regions. Nonetheless, we believe a more comprehensive view is needed. To illustrate this point, let’s look at the ongoing debate about the probability of a near-term recession. Investment letters and research pieces across the industry are divided on the topic of recession, although they are often quite certain of their convictions. According to many pundits, a recession either must be on the horizon, or, alternatively, cannot possibly be on the horizon. Optimists point out that every recession in the last 45 years was preceded by either a large financial bubble (technology stocks in 2000, U.S. housing in 2007) or a spike in oil prices (1973, 1980 and 1990)—conditions that are not present today. Pessimists, however, note that it has been more than 10 years since our last recession—longer than any previous expansion, suggesting that a recession may be overdue. In the wider context of history, however, these “analyses” seem simplistic. For example, it is true that the asset bubbles and oil spikes that have preceded recent recessions aren't present today, but looking further back, we can find many postwar recessions where those conditions weren't present (see chart below). Additionally, while it is true that the U.S. has not seen 10+ year economic expansions, other developed markets certainly have. Japan experienced just one recession (around the oil crisis of 1973) between the end of World War II and 1990; that recession was bookended by two very long economic expansions of more than 15 years each. Additionally, the Australian economy has not experienced a recession since 1991. This is an excellent example of how a broader historical and geographic context can help us avoid making unwarranted assumptions or predictions. HISTORY HELPS US THINK ABOUT THE FUTURE—IF WE LOOK BACK FAR ENOUGH Some observers are comforted that recessions since the 1970s have been preceded by oil price spikes or asset bubbles—conditions that do not exist today. However, looking further back in history, we see many recessions that occurred without those preexisting conditions. Source: Bloomberg. Rising trade tensions provide another example of the value of historical perspective. Since trade barriers have been falling across the globe since World War II, there are no recent analogues to help us understand the effect of rising tariffs in today’s world. However, in the decades before World War II, there were several periods when trade barriers increased. Most famously, the Smoot–Hawley Tariff Act passed in 1930 and dramatically raised U.S. tariffs. Historians generally believe that Smoot–Hawley’s negative impact on trade deepened and prolonged the Great Depression. By looking at the magnitude of these various trade actions and how they impacted global trade, we are better able to consider the likely ramifications of rising trade tensions today. This is especially important for us, considering that trade today is a notably greater percentage of U.S. GDP than it was 100 years ago. So what, on balance, does this historical perspective imply about the current environment? The short answer is that it’s very much a mixed picture. Valuations are elevated but nowhere near the bubble levels of the late 1990s. Interest rates are low, but not nearly as low as those in Europe and Japan. In terms of the economic cycle, we think the risk of a recession is at its highest level since 2009, but it is still far from a certainty. Monetary conditions have tightened, the labor market is also tight and the chance of supply pressures resulting from trade barriers create further risk. On the other hand, inflation is subdued, and leverage levels are reasonably modest in the private sector, particularly for household and financial companies. All of the factors listed above are oft-cited precursors of recession based on history, but these indicators are not pointing in a clear and consistent direction. Unfortunately, the market rarely sends clear, ringing signals to us about how to proceed. It is far more common to find a noisy environment like the one we see today, where we can find plenty of reasons for both optimism and caution. As a result, we never build portfolios whose success depends heavily on a particular market outcome. Rather, we aim to position clients for success in a wide variety of market outcomes. Today, we are fully allocated to fixed income, emphasizing higher-quality parts of the bond market. In addition, we are encouraging clients to build allocations to other, more stable asset classes, such as cash-flowing real estate and hedged strategies. At the same time, we continue to embrace bottom-up, company-specific opportunities in the equity market that we believe can thrive through market cycles, particularly in less-efficient corners of the market where valuations are less stretched. Our aim is to position portfolios for long-term success through good markets and bad. Our research helps us to understand the past and the present, and to make educated decisions about the future. However, we never know what is going to happen next. Accordingly, we tend to take a balanced approach. I look forward to sharing our research and thinking with you in the future. The views expressed are those of Brown Advisory as of the date referenced and are subject to change at any time based on market or other conditions. These views are not intended to be and should not be relied upon as investment advice and are not intended to be a forecast of future events or a guarantee of future results. Past performance is not a guarantee of future performance and you may not get back the amount invested. *Alternative investments may be available for accredited investors and qualified purchasers only. The information provided in this material is not intended to be and should not be considered to be a recommendation or suggestion to engage in or refrain from a particular course of action or to make or hold a particular investment or pursue a particular investment strategy, including whether or not to buy, sell, or hold any of the securities mentioned. It should not be assumed that investments in such securities have been or will be profitable. To the extent specific securities are mentioned, they have been selected by the author on an objective basis to illustrate views expressed in the commentary and do not represent all of the securities purchased, sold or recommended for advisory clients. The information contained herein has been prepared from sources believed reliable but is not guaranteed by us as to its timeliness or accuracy, and is not a complete summary or statement of all available data. 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