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November/December 2011 VOL. 22, NO. 6
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C F A MA G A Z I N E / N O V D E C 2 0 1 1 4
Heard melodies are sweet, but those unheard
Are sweeter; therefore, ye soft pipes, play on;
Not to the sensual ear, but, more endeard,
Pipe to the spirit ditties of no tune.
John Keats, Ode on a Grecian Urn
John Keats classic meditation on finitude depends on
mysterious paradoxesthe eloquence of a mute object
and the sweetness of unheard melodies, among others.
On the surface, the poem describes
how the images decorating the silent
form of an ancient Greek urn can
express a flowery tale more sweetly
than our rhyme. But the real silent
form at work in the poem is the
marriage of truth and beauty.
Beauty is truth, truth beauty
as Keats famously put it. To be mortal
is to experience a beauty (the wonder
of self-conscious existence) that is intensified by the
knowledge that all is fleeting, transient. In that respect,
financial markets might have provided Keats with another
apt metaphor. The valiant never taste of death but once
investors die many times before their deaths.
Economic history cycles through periods in which
markets temporarily appear to defy the second law of ther-
modynamics. Some investors begin to act as if their port-
folios are immortal. The zeitgeist proclaims, This time is
different! The phrase was used ironically as the title of
a recent book about the history of financial crises. Accord-
ing to the books co-author, Kenneth Rogoff, The broad
parameters of what happens in the aftermath of a crisis
(in terms of macroeconomic variables) are surprisingly
consistent across time, place, historical circumstances,
legal institutions, and political systems. So, if the patterns
are so predictable, what will happen next? Rogoff answers
that question in this issues feature interview (The Second
Great Contraction, p. 44).
With discontinuity comes opportunity. Could the con-
traction clear the way for a fundamental reconsideration
of standard methods? Take asset allocation, for example.
The field has been relatively fallow for some time, but an
award-winning article by William Sharpe has proposed
a new approach. The idea is to develop an asset allocation
policy that would readjust asset class weightings not in
relation to constant, predetermined proportionsthe
traditional asset allocation approachbut relative to their
proportion of total market value (Adaptive Asset Allo-
cation, p. 47).
In his ode, Keats envies a fair youth who is depicted
on the urn sitting under a tree and piping a tune. The lad
seems to exist in a state of timeless potential forever
Ode on a Grecian Downturn
piping songs forever new. Oddly, the Chinese renminbi
(RMB) comes to mind. Over the past decade, Chinese
monetary policy has definitely changed its tune, going
from a strictly domestic currency tightly controlled by the
central bank to a peculiar state between restriction and
openness, with the current account open and the capital
account closed. Unlike the urns happy melodist, how-
ever, the currency cant remain poised in the threshold
between potential and actual forever. Could a confluence
of circumstances enable the RMB to emerge as an interna-
tional reserve currency (A Half-Open Door, p. 36)?
The unheard melodies of investing (say, undetected
market signals or opportunities missed as a result of
inaccurate valuations) could be bitter or sweet, depending
on the outcome. Do they go unheard because investors
need to listen more attentively? Although effective project
management is essential to the fortunes of many compa-
nies, many analysts havent opened their ears to what
this important value driver can tell them (Analyst Agenda,
p. 31). Investors are increasingly vocal about say on pay
issues, but their calls for reform have not been fully
heeded (Market Integrity, p. 22). A different kind of deaf-
ness may result from humming the same tune along with
everyone else. If your belief about a company is the
same as the market opinion, there is no point in spending
much time on this company, writes Ralph Wanger, CFA
(Chapter 10, p. 56).
Sadly, the vivid intensity of Keats poetry, notably
the recurring themes of mortality, owed much to his early
death fromtuberculosis at 26. Had a life-settlement market
existed at the time, he might have been a participant.
Life settlement became highly attractive to some investors
when annual returns as high as 20 percent appeared
achievable, but these instruments later suffered from a
variety of ailments (declining returns, scandals, high fees).
Could institutional investors find an opportunity in what
may have become a buyers market (Portfolio Perform-
ance, p. 28)?
Keats final stanza addresses the urn directly: When
old age shall this generation waste, / Thou shalt remain in
midst of other woe / Than ours, a friend The urns
friendly message of consolation is the truthbeauty for-
mula. If that seems like cold comfort, Keats might agree
with you. Cold Pastoral! he exclaims. Why then should
the urn console us? The spirit listens for ditties beyond
the range of sensual ears. If truth really is beauty, a disso-
nant truth must have beautiful overtones, even if the
sweetness of the melody remains unheard. There is a word
for this: hope.
ROGER MITCHELL
Managing Editor (roger.mitchell@cfainstitute.org)
IN SUMMARY
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In Focus
BY JOHN ROGERS, CFA
ver the course of the past 18 months, we have
been evaluating the issues affecting markets,
consulting with our members, and discussing
educational and standard-raising concepts with
employers and regulators. A common theme has emerged
that the investment industry would benefit from a global
introductory-level program designed for
people who work in the investment
industry but who may not be directly
involved with investment analysis or
decision making. I am therefore excited
to give you an update on a new initiative
CFA Institute is undertaking to raise the
standards of ethics, education, and excel-
lence throughout our profession.
Based on helpful guidance, particu-
larly through CFA Institute members, we have identified
an opportunity to support the investment industry by
creating a new educational certificate. This program will
embrace those involved in our industry who fall outside
our traditional membership and will target those who
need a fundamental level of understanding about invest-
ments and the investment industry. This program will
directly target people working in roles such as compliance,
legal, client service, information technology, human
resources, marketing, and sales, thereby acting as a natural
complement to the many varied roles at work in the
investment industry.
This program fills an unmet demand in the industry
for a widely accessible, globally consistent, and ethics-
based study program. By drawing on our core educational
strength and directly contributing to the mission of CFA
Institute to raise standards globally, the program also
could provide development opportunities for CFA Insti-
tute member societies.
This program is specifically designed to target an
audience distinct from that of the CFA Program, which
remains the gold standard of the investment industry. The
fundamentals certificate will expand the educational reach
of CFA Institute beyond the CFA and CIPM Programs.
The program will be aimed at individuals with no formal
training in finance or investments, including industry
participants who do not wish to pursue or are at least
several years fromstarting the CFA Program. The level of
difficulty is also substantially different from other CFA
Institute programs, and we currently estimate it will require
approximately 50100 hours of study and successful com-
pletion of a 2-hour computer-based exam. Upon comple-
tion, successful individuals will receive a certificate of
knowledge from CFA Institute. The program will represent
O
Back to the Basics
an essential understanding of investment fundamentals
and how the industry works. There will be no connection
between the program and CFA Institute membership or
the CFA designation, and certificate recipients will not be
entitled to a designation or letters after their names.
To measure demand for entry-level education, we
asked CFA Institute members some key questions through
our annual member survey. The results were clear: 68
percent of respondents believe that its important for
employees not directly involved in the investment deci-
sion-making process to increase their knowledge of the
fundamentals of investments. In addition, more than half
of respondents would be likely to recommend a CFA Insti-
tute fundamentals program to their colleagues, and 75
percent of respondents told us that staff throughout their
organizations could benefit from investment-related edu-
cational development at the fundamentals level.
This new program is scheduled to launch in 2013.
The examination is expected to be delivered as a computer-
based multiple-choice test and be made available on
demand at test centers around the world. The examina-
tion initially will be delivered in English, but there are
plans to expand to other languages in the coming years.
The program and all supporting elements are currently
under development.
This is an exciting time for us at CFA Institute. We
anticipate that this new program will serve our members
by increasing professional excellence at many levels
within their firms. As we continue to work on finalizing
the details of the new program, we will be working with
many of you to develop the product, introduce it to the
industry, and launch it in 2013. As always, thank you for
your continued commitment to professional excellence
and support.
John Rogers, CFA, is president and CEO of CFA Institute.
The investment industry would bene-
fit from a global introductory-level pro-
gram designed for people who work
in the investment industry but who may
not be directly involved with invest-
ment analysis or decision making.
C F A MA G A Z I N E / N O V D E C 2 0 1 1 6
C F A MA G A Z I N E / N O V D E C 2 0 1 1 7
How to Think about the Unthinkable
In 1997, I had my first contact with quant models. The
project was to develop risk controls for a large insurance
company. Six months later, we were able to compute
weekly a daily value at risk (VaR) for a portfolio com-
posed of about 25 funds.
Today, we can compute the same daily VaR for, say,
400 funds in a couple of minutes. Great! Other things also
became better, like risk-control usage, but unfortunately,
not risk-control understanding.
I strongly agree with Mark Kritzman (Viewpoint,
Long Live Quantitative Models, July/August) that we
should not reject quantitative models. What we should
really do is better understand them. But when Kritzman
says VaR models failed spectacularly and suggests a new
approach (new from 1999), I must disagree.
According to Kritzmans analysis, an expected VaR
with 99 percent confidence showed a 9.9 percent risk.
The real world recently showed us a 35.5 percent drop!
I would say that is not a failure but a misconception! VaR
does not mean a maximum loss. VaR also does not mean
a number to be observed but a number to be interpreted.
It is not a loss limitation with 100 percent probability but
only with 99 percent. Remember, that 1 percent remain-
ing is for distribution tails and goes from 9 percent to
100 percent (if possible) loss! My conclusion: Real results
just showed us that 99 percent confidence alone was
not enough for that scenario.
What did risk controllers do wrong or what could
they do differently? Should they increase it to 99.9 per-
cent confidence? Of course not. It is very difficult to match
the right confidence interval. I would say that 99 percent
is far enough. Should they use more sophisticated models?
Perhaps, but we need should fully understand what
actually went wrong.
The main concern is correlations, as Kritzman
explains. Regular VaR models are parametric, which means
they use the past to infer about the future. Correlations
in the past could not be the same in the future. I would
like to add distribution tails to the problem too.
Risk managers should notice that VaR models are not
enough to build a risk profile, even with an extremely
high confidence level. Risk controls must be comple-
mented by other pillars that deal with correlations and
tails. The old-fashioned stress-test is my personal favorite.
It is difficult to build a stress scenario due to absence of
metrics. Percentiles, quartiles, and other iles may help,
but stress scenario levels are, in the end, based on the
historical experience of risk controllers. Why use them?
Because stress-tests (being empirical) break the correla-
tions rules. Because stress-tests go to tails. Because
stress-tests force risk managers to think about the
unthinkable. That is risk control.
The Euros Critical Weakness: Hubris?
Bruno Colmant, CFA, in his article The Euros Existen-
tial Challenge (Viewpoint, July/August), made several
unsubstantiated claims. As background, I should explain
that I have always been pro-European in the sense that I
would have liked to see the people of the various Euro-
pean nations ultimately choose to have a common govern-
ment. This project would have taken decades and would
have led to common monetary and fiscal policies if the
people so chose. Thereafter, a common currency could
have been introduced. None of this happened.
Virtually all of the governments of the euro countries
refused to allow their people to vote on this loss of sover-
eignty (which, to repeat, I would have supported eventu-
ally), and indeed, if the rhetoric is reexamined, it can be
seen that the various parliaments were told that the estab-
lishment of the new currency would in no way under-
mine their various existing sovereignties. Colmants claim
that economists who understood the consequences that
such a choice (viz. membership of the euro) would bring
about were rare is made without any evidence and in my
experience is the opposite of the truth.
More importantly, Colmants assertions that the
choice of a common currency was an excellent one and
the socioeconomic models of the member states cannot
simply be stowaways on board a monetary godsend are
self-contradictory and anti-democratic. If the people of
France, Germany, Belgium, etc., had been told that
LETTERS
The example shows that this particular
quantitative model, which most
assume failed spectacularly, would
have worked fine had we implemented
it with just a bit more rigor and a
slight nod toward realism.
MARK KRITZMAN, CFA
Long Live Quantitative Models!
CFA Magazine (July/August 2011)
I cannot say that a well-done stress-test would have
predicted a 35.5 percent drop. I can say that it would
have turned the yellow light on for a drop larger than
9.9 percent, and that would make asset managers think
twice about the future.
I also advocate for quantitative models. I really do!
But there is no efficiency in risk control without stress-
tests. Long live quantitative modelsand stress-tests!
Luiz Veiga, CFA
So Paulo, Brazil
LETTERS
C F A MA G A Z I N E / N O V D E C 2 0 1 1 8
control of their socio-economic systems would be trans-
ferred to Brussels and had voted for this, so be it. The fact
is, however, that they were not asked this question and
were predominately told that they would not lose socio-
economic self-government. Instead, the political elite
decided to push through this monetary union with the
intention of creating an environment in which fiscal and
monetary union would occur without asking their people.
This hubristic and profoundly anti-democratic approach
has now met its inevitable nemesis.
If the correct democraticbut much slower
approach had been followed, a viable euro could have
been achieved without the current absurd pain.
Geoffrey Lindey, FSIP
London
A Matter of Due Diligence
In the article A Matter of Trust: Regulatory call risk and
trust preferred securities (Analyst Agenda, July/August),
author Dennis Dick, CFA, highlights the risk of investing
in this type of hybrid callable security. Regardless of the
type of fixed-income security, investors should always
carefully review the prospectus/indenture for a particular
issue. As the article points out, what appeared to be black
and white in print at the time of original issue may later
become a shade of gray for contractual interpretation.
Furthermore, the U.S. Federal Reserve makes banking
rules and provides clarification about those rules through
its supervisory notices, but it does not seek to be the
arbiter of contract law for securities indentures! There are
several characteristics of trust preferred securities (TruPS)
that need to be understood before investing in these
hybrid securities.
First, almost all TruPS issued by bank holding com-
panies fall into two core categories: regular TruPS and
enhanced TruPS (commonly referred to as E-TruPS). All
TruPS were issued with early call trigger mechanisms for
potential changes in capital treatment, tax laws, and
rating agency views of the securities. The E-TruPS are a
second generation of trust preferred securities that were
issued by bank holding companies, mostly in the years
leading up to the 2008 financial crisis, and tend to have
higher coupons and longer final maturities than the older,
original TruPS. These E-TruPS have a few other unique
features that regular TruPS do not have. The author
rightly points out the ambiguity and potential for call risk
from a capital treatment event created by the Dodd
Frank Act on 21 July 2010. The early call risk potential
of E-TruPS is the primary concern, however, because quite
a few of these issues are still one to two years away from
their regular call dates. (TruPS typically have a five-year
non-call from the issue date.) Most regular TruPS are
already well past their initial call dates, so a regulatory
event is a nonevent. Therefore, investors should check
the prospectus on a particular issue to determine whether
it is a regular TruPS or an E-TruPS.
Second, almost all E-TruPS have a replacement capi-
tal covenant (RCC) feature that requires the bank holding
company to issue new Tier 1 capital (with a six-month
lookback option) to initiate any call. Regardless of the
capital treatment event date that would be used to trigger
an early call, new Tier 1 capital would have to be issued
by the company. Third, many E-TruPS require that the
early call election be made within 90 days of the regulatory
capital treatment event. This characteristic, together with
the replacement capital covenant, tends to place additional
constraints on a potential call. A few companies, most
notably Comerica and City National Bank, chose to use the
DoddFrank Act date last year to early call their securities
within the 90-day period. Both companies had previously
issued common equity within the six-month lookback
period to satisfy the Tier 1 replacement capital covenant.
Still, even if an investor understands these important
differences and features of TruPS and other economic
considerations of the issuer that might not be outwardly
transparent, exceptions to the expected rules can occur
sometimes. For instance, as the author points out, Fifth
Third Bank called its FTB-C (an E-TruPS) earlier in
2011well after 90 days from the signing of the Dodd
Frank Act. While using the DoddFrank Act as the basis
for a capital treatment event might be debatable, in this
case, the indenture language did not contain the 90-day
window. More recently, in early September 2011, Wells
Fargo early called one of its E-TruPS (the WCO). The
capital treatment event language in the prospectus might
be considered on the gray side of black and white, but
this E-TruPS issue had neither the replacement capital
covenant nor the 90-day window language that might
July/August 2011
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The investment industry is not equipped
to understand the impact of global political instability,
says one expert on political risk.
What can investors do?
LETTERS
C F A MA G A Z I N E / N O V D E C 2 0 1 1 9
otherwise have limited the companys ability to call the
security. Even with this language found in most other E-
TruPS, investors should take nothing for granted. It is
possible for an issuer to pay to eliminate certain restric-
tive features, such as the replacement capital covenant
through a consent solicitation offer to other more
senior securities holders. In fact, PNC Bank did a consent
solicitation in November 2010 for a series of E-TruPS
(National City A, B & C), although the company has not
yet called these securities.
With many tens of billions of dollars worth of TruPS
still outstanding, the pool will steadily dwindle because
changes in banking regulation directed by the Dodd
Frank Act have shortened the economic life of TruPS. A
legal skirmish may yet emerge over the timing and inter-
pretation of capital treatment event before the sunset
begins on TruPS in January 2013. Regardless, investors
always need to read a prospectus carefully rather than
assume that certain protections will always protect. By
doing so, perhaps they can build in a bit more of a yield
buffer when buying these securities.
Eric Grubelich, CFA
New York City
Is Clean Tech Cost Competitive?
The article Sol Survivors (Analyst Agenda, July/August)
was interesting but misleading. The first line about clean
technologies having a dirty little secret and not being cost
competitive is just the sort of thing which climate-change
deniers like to latch on to. The reason nuclear power is
cheap is that national governments funded a lot of the
start-up costs. And what would have happened had the
recent disaster in Japan been worse? Taxpayers would
have been asked to fund the clean up.
Likewise coal it appears to be cheap energy, but
the health costs associated with illnesses caused by air
pollution are being met by the public, largely through
increased health insurance premiums.
So, by all means, point out the subsidies to solar and
wind power, but please compare like with like and look at
the overall costs of the alternatives.
Andrew Doble
Bermuda
The Benefits and Importance of Public Service
I would like to thank you for publishing the article on
public service in the January/February 2011 issue (At
Your (Public) Service). I applaud the efforts to highlight
this important sector of the economy where our profes-
sion makes a valuable contri-
bution. I also left the comforts
of private industry for the
opportunities and challenges
of public service during this
historic period of change in
financial services. As a bank
examiner for the FDIC (Fed-
eral Deposit Insurance Com-
pany), I have encountered
experiences more diverse
than I would have ever seen
with a single firm or even
with a consulting company.
My decisions have a significant
impact on the future of an institution, and I often con-
duct critical discussions with boards and executive man-
agement. The ability to present well-supported conclu-
sions, as promulgated by the CFA Institute principles and
standards, has enabled me to maintain productive com-
munication even in the face of negative circumstances.
Public service can be beneficial at any phase of ones
career. For young professionals, its a great way to acceler-
ate career development. I have valued assets ranging from
mainstream securities to portable toilets (no kidding).
Resources are always stretched in government agencies,
which means youll have the opportunity to assume
responsibilities years before you would be allowed to in
the private industry. The lower prevalence of CFA charter-
holders also translates to a higher value and demand for
our unique skills. As one progresses up the ranks in the
corporate world, opportunities decrease and competition
increases. Often, people find themselves plateauing at
points in their career when they still have ambition but
their organization may no longer provide the same poten-
tial for growth. Transitioning to public service can be a
great way to reenergize your career and find a renewed
purpose in your work. A stint in public service can also
be a great sunset role when one has achieved a full career
in the private sector. Senior professionals have the oppor-
tunity to use their experience to achieve goals of public
policy in addition to profitable enterprise. While compen-
sation in general is relatively lower than the private sector,
one can still earn a good living in public service. Depend-
ing on how one values the quality of life that public service
allows, the total return of benefits for your time invested
on the job may be no different for private industry.
Like earning the CFA credential, public service adds
a new dimension of experience that increases your total Source: Yahoo! Finance
First Solar
(share price in US$)
2008 2007
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100
50
0
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ALL IT PUBLIC SERVICE, civil service, or working for the Fed. Does it sound like the last place you would look for a job? Maybe it is, because the last place you look for something is where you find it.
(Read the last sentence twice. It does make sense.)
If you need to broaden your job search, you might set your sights on one of the U.S. federal agencies linked
to the regulation of the capital markets.
Although opportunities abound in Washington, DC, for job candidates with financial services and investment industry experience, moving to the nations capital isnt necessary for most positions. The vast
majority (85 percent) of civil service employees do not
work in Washington.
That may not be the only surprise. Although the
public sector pay scale for investment professionals has
not kept pace by and large with private sector salaries,
many people willingly take a pay cut to enter government
ranks. They do so out of a spirit of serving their country.
Or they may seek to improve the quality of their lives,
cutting back their workweek from 80 hours in the private
sector to 40 or 50 hours on the governments payroll. A
strongly shared sense of mission, job security, and attrac-
tive employee benefits can be an appealing alternative to
the pressure-cooker environment of a Street firm. Moreover,
federal agency jobs can be intellectually challenging and
introduce new hires to an interesting group of people.
I think people from Wall Street would be impressed
with some of the talent they would meet at the Treasury
Department, the SEC (U.S. Securities and Exchange
Commission), and some of the other financial organiza-
tions, says Charles Ingersoll, senior client partner of
executive recruiter Korn/Ferry and head of its government
sector practice. Unfortunately, in the past the govern-
ment hasnt done a good job of selling the opportunities. Adjusting the Language The mentality of post a job and they will come is
gradually passing. Consider the leads of these two job
summaries that were posted on the SECs website. The
first advertises for a program analyst and the second seeks
an attorneyadviser. Both positions pay around US$68,000.
(1) As a Program Analyst in the Office of International Affairs, you will provide program management, research,
and logistical coordination associated with the administration of the technical
assistance function. You will also assist with the regulatory policy, comparative law and regulation, and enforcement functions as needed. Relocation expenses
will not be paid by the hiring agency. (2) Do you want to perform chal- lenging work in a collegial environment,
while enjoying quality of life and a com-
petitive compensation package? Invest
in your career at the U.S. Securities and Exchange Com -
mission! The SEC has retained Futurestep, a Korn/Ferry
company, to provide strategic talent acquisition solutions
to help the agency address its continuing talent needs.
The second pitch obviously has more punch, and
Futurestep is the reason why. Futurestep works as an out-
sourced recruiting department for public and private
clients, installing its own employees on site. The size of
the team expands and contracts with the volume of hiring
assignments, so the clients investment in permanent
human resource headcount is held in check. Futurestep
first proved its mettle with the SEC during the commis-
sions hiring surge following the passage of the Sarbanes
Oxley Act of 2002. It stepped into its latest SEC assign-
ment after winning a competitive bid. A small team of
Futurestep employees is embedded at the SEC in
Washington, DC, assisted by colleagues at the companys
Houston headquarters. I see ourselves as an enhancement to the SECs
recruiting efforts, says Cynthia Gervais, Futuresteps
program manager at the SEC. The markets are moving
very quickly, and if the regulators want to keep up, there
is a need to add more expertise. Our task is to assist the
SEC in recruiting and to reach out to pools that the
SEC has not reached before. [See interview with Dwayne
Boyd, chief recruiter for the SEC, on page 44.]
Gervais, acknowledging the upbeat tone of SEC job
postings ghost-written by Futurestep, explains, When
youre talking to a different audience, you need to adjust
the language.
C F A MA G A Z I N E / J A N F E B 2 0 1 1
42
Looking for a new employer?
For some investment professionals, the federal
government
may be the answer
and
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Thomson Reuters 2011. All rights reserved.
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