CFA Magazine Jan - Feb

January/February 2012
How Wall Street has gone astray

Career moves in the current market
Hindsight: an insidious cognitive error?
Goals-based reporting and client metrics
Overhauling Europes securities markets
Trading mechanics and hidden shorting costs
TIPSy
After a decade of outperformance,
have inflation-linked bonds
reached a tipping point?
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COLUMNS
7 In Focus
The Echoes of
Occupy
BY JOHN ROGERS, CFA
51 AsiaPacific Focus
CFA Institute Moves
with the Times
BY ASHVIN VIBHAKAR, CFA
53 EMEA Voice
Streams of Professional Education
BY USMAN HAYAT, CFA
COVER STORY
34 TIPSy
After a decade of outperformance, have inflation
linked bonds reached a tipping point?
BY ED MCCARTHY
38 On a Mission
Analyst Mike Mayo, CFA,
explains how Wall Street
has gone astray.
BY JONATHAN BARNES
38
34
46 A Pioneering
Spirit
Where you have prob-
lems to solve, you have
investment opportuni-
tiesRene Blasky, CFA,
on why shes very posi-
tive on East Africa
BY JONATHAN BARNES
46
VIEWPOINT
8 The Leadership Gap
The investment community will be
well served to develop more rigor-
ous analytical tools to determine
the quality of leadership within po-
tential investment opportunities.
BY DAVE ULRICH, NORM SMALLWOOD, AND
MICHAEL ULRICH
10 Encouraging a Behavioral Shift
We need to find not only new
answers but new ways of finding
these answers.
BY PHILIPPE SARASIN, CFA
11 Goal-Based Reporting and
Traditional Metrics
Empowering investors means cre-
ating goals-based reporting tools
that resonate both objectively and
subjectively.
BY CHARLES M. OPINCAR
42 You Must Remember This
Is hindsight an insidious cognitive error that will
prevent us from learning the right lessons about the
global financial crisis?
BY MAHA KHAN PHILLIPS
DEPARTMENTS
3 In Summary
Finding What Youre Not Looking For
4 Letters
Demanding Full Disclosure
from Congress
50 Briefs
CFA Institute, member, and
society news
55 Chapter 10
How Do You Know When
Youre Done?
BY RALPH WANGER, CFA
Ethics
FORUM
20 An Inside Look at the
Disciplinary Process
The basic process hasnt changed
much over the years, but how we
execute it has changed quite a bit.
BY DOROTHY KELLY, CFA
Market
INTEGRITY
13 MF Global: Another Ethics
and Regulatory Blunder?
What has changed since similarly
risky behavior brought the global
financial system to the brink of
collapse?
BY KURT SCHACHT, CFA
14 Overhauling Europes
Securities Markets
After nearly a year in the making,
the legislative package puts trans-
parency at the forefront with ambi-
tious proposals to shed light on
trading in practically all financial
instruments.
BY RHODRI PREECE, CFA
15 Have UCITS Grown Too Complex
for Retailer Investors?
Even though we are concerned
about the protection of investors,
it seems to us that prohibiting the
sale of structured UCITS outright
to retail investors may not be the
right answer.
BY AGNS LE THIEC, CFA
Professional
PRACTICE
24 Career Connection
The voice of experience: making
career moves in the current market
BY LORI PIZZANI
28 Trading Tactics
Trading mechanics and the
hidden costs of shorting
BY DENNIS DICK, CFA
30 Private Client Corner
How advisers are using social
media to get an edge
BY ED MCCARTHY
32 Standards in Practice
Will the SECs new enforcement
regime work?
BY LORI PIZZANI
55
24Sometimes people sit back too much.
Dont be afraid to stretch yourself.
But be prepared for a lot of work.
Transition is a lot of work, and there
are always new challenges.
CAREER CONNECTION
POI NT COUNT E RPOI NT
56 Agree or Disagree:
The Chinese renminbi (RMB) will
emerge as an international reserve
currency sooner rather than later.
53
C F A MA G A Z I N E / J A N F E B 2 0 1 2 3
IN SUMMARY
Janna soon found that people
dont see what they dont look for.
Hilda van Stockum, The Borrowed House
The Borrowed House is about Janna, a 12-year-old German
girl during the Second World War who moves to Amster-
dam to live with her parents (an actor and actress enter-
taining the occupation force). Janna gradually pieces to-
gether disturbing clues about the Dutch family who owned
the house before being forcibly evict-
ed. She later makes an even more star-
tling discoverya member of the un-
derground resistance, a young Jewish
man named Sef, is living in a secret
recess within the house.
When she discovers Sef, Janna has
already begun to unravel the lies she
has been told about the war. She de-
cides to keep Sefs secret but suffers
great anxiety. The Dutch maid has been secretly supplying
Sef with food and other assistance. Surely people will no-
tice discrepancies. Then she stumbles on another discov-
ery, this one about human nature: people dont see what
they dont look for.
This principle has applications for investing. In fact,
given the complexity involved, even when you know what
youre looking for, a sure solution can be hard to find. For
example, take the outlook for inflation-linked bonds (or
TIPS). As an asset allocation shop, we think theres a good
chance that inflation will pick up at some point, says Mark
Willoughby, CFA, but we have no idea by how much and
when (TIPSy, p. 34).
Similar uncertainty haunts Janna: How much will
she be asked to do and when? Fortuitous events can open
doorsliterally for Janna on more than one occasion and
figuratively for professional life. When youre least likely
to be looking, the opportunity comes along, says one CFA
charterholder of his recent experience with a career move.
Yes, but to what degree can savvy planning help profes-
sionals take advantage of career opportunities? To help
answer such questions, this issue features the first install-
ment of a regular section (Career Connection, p. 24).
Hiding an enemy from her own parents tests Jannas
conscience. In a different context, analyst Mike Mayo, CFA,
faced his own ethical challenge when contemplating an un-
popular decision to downgrade a bank. Theres soul search-
ing at a time like this, he says (On a Mission, p. 38).
The theme of what Mayo calls competing loyalties runs
through von Stockums novel loyalty to family, friends,
country, truth, human dignity. Jannas Dutch tutor Hugo is
loyal to a cause greater than himself. Begging his neighbors
Finding What Youre Not Looking For
to allow him to help them escape persecution, he asks,
Whats my life worth? why cant I risk it for you?
Mayo also found himself asking existential questions:
Do I matter? Does my job matter? Finally, he reasoned,
Either I would do the job in the way that is described in
the Standards of Practice Handbook, or the CFA charter is
completely irrelevant. CFA Institute shares his conviction,
and fostering the influence of the Code of Ethics and Stan-
dards of Professional Conduct is a key motivation for the
CFA Program scholarships (Briefs, p. 52).
A recurring problem is the tendency of the human
conscience to insulate itself with self-assurance. When Jan-
na raises troubling questions about the war and occupa-
tion, her father explains that their side is just and humane.
He allows war propaganda to deceive him into believing
convenient distortions of reality. In trying to draw the right
conclusions about our own historical circumstances, such
as learning lessons from the financial crisis, how vulnera-
ble are we to insidious cognitive errors? What I would
say to people is that you need to be particularly careful to
investigate things that you dont want to think about, says
David Tuckett, discussing problems associated with finan-
cial memory. If you sense within yourself any kind of feel-
ing of not wanting to examine something, then thats ex-
actly what you should start thinking about. (You Must
Remember This, p. 42).
Motivating clients to examine somethingtheir
own financesis one aim of goals-based reporting. Tradi-
tional reporting metrics are insufficient, writes Charles
Opincar, because they are strictly quantitative and fail to
provide life signals (Viewpoint, p. 11). Ralph Wanger,
CFA, has found this behavioral principle to hold true dur-
ing his long career: Numeric tools provide nothing but
numbers, and it is hard to get people to act on numbers
alone, he argues (Chapter 10, p. 55).
Janna initially struggles to decipher the life signals
of her own situation, which is essentially human. We all
find ourselves thrust into historical conditions beyond our
direct control, yet by making courageous choices in our per-
sonal sphere, we can have a profound influence on others.
And ethical action goes beyond legality. Too often, as Jan-
nas friend Sef observes, People confuse law with virtue.
On a larger scale, we may look to regulation and political
reform (Market Integrity, p. 13). These have a place, but
Patrick Guthrie, CFA, points out that laws can have critical
blind spots, even where insider trading by policymakers is
concerned (Letters, p. 4). We must rise up, he believes,
when the opportunity presents itself to do what is right.
Janna, Sef, and Hugo would agree.
ROGER MITCHELL
Managing Editor (roger.mitchell@cfainstitute.org)
My point is not to say that
members of congress are like bankers
(despite similar approval ratings)
but that the rest of us should be vocal
in standing up and denouncing
this type of outrageous behavior.
CFA INSTITUTE PRESIDENT & CEO
John Rogers, CFA
john.rogers@cfainstitute.org
MANAGING EDITOR
Roger Mitchell
roger.mitchell@cfainstitute.org
ONLINE PRODUCTION COORDINATOR
Kara Hite
ADVERTISING MANAGER
Tom Sours
tom.sours@cfainstitute.org
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January/February 2012 VOL. 23, NO. 1
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COVER PHOTOGRAPHY
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LETTERS
Demanding Full Disclosure from Congress
Scoundrelsthis was the first word that came to my mind.
In mid-September 2008, congressman Spencer Bachus,
an Alabama Republican, purchased options to short the
market after having closed-door meetings with Treasury
Secretary Henry Paulson and Federal Reserve Chairman
Ben Bernake. When the markets subsequently fell, Bachus
options went up in value, and he appeared to be acting in
his own self-interest and not acting in the best interest of
the American people. Such an act by a member of Con-
gress would seem reprehensible and despicable. However,
according to a report on the CBS News program 60 Min-
utes (Congress: Trading Stock On Inside Information?
broadcast on 13 November 2011), which was based on
research in Peter Schweizers book Throw Them All Out,
this type of behavior is neither uncommon nor unlawful.
Moreover, Bachus is currently chairman of the House
Financial Services Committee.
As an analyst actively engaged in the dealings of the
capital marketsand more fundamentally, as an American
citizenI strongly condemn this type of behavior. The in-
tegrity of the markets and its participants is essential to the
continued growth and prosperity of all in our society. When
a few individuals decide that they do not have to play by
the rules, they put cracks in the foundation of free markets
that lead to greater suffering for everyone else. For example,
several years ago, a number of bankers did not follow the
rules when they manipulated loan documents to approve
mortgage loans. The surge of bad loans was a catalyst for the
financial meltdown of 2008 and the resulting high unem-
ployment we have today. My point is not to say that mem-
bers of congress are like bankers (despite similar approval
ratings) but that the rest of us should be vocal in standing
up and denouncing this type of outrageous behavior.
CFA Institute encourages members to practice their
craft according to the highest ethical standards. According
to the CFA Institute Code of Ethics, CFA charterholders
should promote the integrity of the capital markets. Con-
gress is in the process of drafting legislation to limit insider
trading by its members, but there is concern that the legis-
Corrections
Chip Dillon, CFA, should have been listed in the Septem-
ber/October 2011 CFA Institute brief CFA Charterholders
Recognized in Wall Street Journal. Dillon was profiled
as a top industry analyst for two general industries sector
picks while working for Credit Suisse.
The cover story in the September/October issue (Emerg-
ing Threat Funds? by John Rubino) incorrectly stated
that the first exchange-traded fund was Standard & Poors
Depositary Receipts (SPDR or spider), introduced in
1993. It was actually the second. The first ETF was Toronto
35 Index Participation Units (TIPS), which began trading
in 1990 on the Toronto Stock Exchange. Thanks to Bruce
Thompson, CFA, of Toronto for pointing out the error.
lation may have loopholes or that the U.S. Securities and
Exchange Commission would not actively pursue an inves-
tigation against a sitting member for fear of congressional
retribution. The court of public opinion may provide more
justice than any investigation. What we must demand from
congress is full disclosure of all market transactions on a
public database that is updated regularly. Only then can we
identify which members of congress are acting inappropri-
ately and act accordingly in stopping such behavior. We
have a duty to secure the integrity of the markets, and we
must rise up when the opportunity presents itself to do
what is right.
Patrick Guthrie, CFA
Lutherville, Maryland
Bridging the Gap between Goals and Operations
Regarding Sherree DeCovnys article about the financial
impact of project management [Analyst Agenda: An
Overlooked Value Driver? (November/December 2011)],
I feel there is another point that the article did not men-
tioncritical thinking/solution finding. To me, a project
manager is like a leader that helps bridge the communica-
tion gap between the firms desired goals and its operations
people. Thus, a project manager needs to have certain
leadership qualities.
The first quality is observation, which means having
a holistic view at the firm level, including the firms prob-
lems and the market condition of the industry. How obser-
vant a project manager is could be measured by the amount
of continuing education the manager engages in. The sec-
ond quality is comprehension, which means understanding
each departments role within the firm, the specific purpose
of each departments function, and how each department
interacts with other departments within the organization.
There are different ways to measure this skill, such as hav-
ing face-to-face interviews with employees responsible for
the functions, but I feel the best way to obtain this knowl-
edge is to have working experiences.
In certain industries, maybe all a project manager needs
are the points stated in the article and no more. In a more
dynamic business or a business undergoing a paradigm
shift, such as asset management, I would argue that a proj-
ect manager will need critical thinking skills as well. In a
constantly changing business environment in which solu-
tions probably are rarely available in textbooks or over the
internet, firms need to develop their own creative solutions.
Firms can benefit greatly from project managers who look
inside and outside of the box continuously and try to find
creative solutions.
Tony Chan, CIPM
Queens, New York
Thinking Outside the Quantitative Box
Better risk management tools sound great in theory but
seem to backfire in practice [see Viewpoint: Long Live
Quantitative Models (July/August 2011) and Letters: How
to Think about the Unthinkable (November/December
2011)]. Banks and others may have gained a temporary
advantage as they began incorporating better risk manage-
ment techniques than their competitors. But their growing
confidence in their use only justified taking on more risk.
And as more institutions copied these successful firms,
they succeeded in creating systemic riskthe exact oppo-
site of what they were attempting to do. Sometimes a great
notion isnt so great. Lets just hope that more people think
outside of the quantitative box.
John Barber, CFA
San Diego
The editor welcomes the views and opinions of readers.
Please e-mail comments to roger.mitchell@cfainstitute.org.
LETTERS
November/December 2011
Now playing: Great Contraction 2
Unhedged China risk in your portfolio?
Climate change disclosures and valuation
Project management: analyst blind spot?
Adaptive asset allocation and performance
10 years on: 9/11 memorial scholarship fund
A Half-Open Door
Will the renminbi emerge as an
international reserve currency?
The Third Annual Middle
East Investment Conference
As the fagshlp CFA lnstltute event ln the reglon, the thlrd annual
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In Focus
BY JOHN ROGERS, CFA
am not ashamed to call myself a capitalist, and I
would venture to speak on behalf of most CFA Insti-
tute members as believing in capitalism as well. Capi-
talism is an ideology and economic system that does a
decent job of allocating resources according to merit while
providing sufficient tax revenues for governments to fund
social services and defense.
That doesnt mean we dont pay at-
tention when the system has run amok,
as many people worldwide (capitalists or
not) have noticed. The Occupy Wall
Street movement captured global atten-
tion with surprising speed, despite criti-
cism that it lacks leadership and is taking
on too wide a range of issues. In fact, it
has gone viral so fast that Chinese au-
thorities have banished the search keyword occupy from
their internet in the hope of preventing similar protests.
The movement claims inspiration fromthe Arab Spring
of this past year and is fueled with populist anger over
tough economic times and rolling financial crises. As win-
ter arrives in the northern hemisphere, the physical occu-
pation may be winding down, but the echoes of the pro-
testers claims continue. Now is a good time to ask whether
weve learned anything from the Occupy movement.
First, it is clear that the financial industry needs a
makeover. More than three-quarters of people responding
to a recent CNN poll said financiers are greedy and over-
paid, and two-thirds said theyre dishonest. A Global Mar-
ket Sentiment Survey conducted by CFA Institute and re-
leased in December (visit cfainstitute.org) makes clear that
our own members recognize the serious ethical challenges
facing our industry. Theres no need to rehash the news
stories of the past few years, but financial firms have been
in the crosshairs of the media and finance professionals
have been soft targets for criticism far too often for my
comfort. While it may be unfair to paint our industry with
a single broad brush, particularly for those of us who abide
by high ethical standards and put investors interests first,
the reality is that our image has been tarnished by those
who placed the business of finance or personal interests
above the profession.
Another lesson from the Occupy movement is that
misconduct imposes a set of expensive but largely unseen
costs on financial markets. The biggest of these is the price
of mistrust. When both parties in any transaction feel rea-
sonably informed and bound by some level of trust (or at
least accountability), markets function fairly well. When
this equation gets out of balance, when the seller knows
a lot more than the buyer, when one partys incentives are
I
The Echoes of Occupy
masked, then markets quickly become unbalancedto
the detriment of all participants. These are moments when
professionalism comes to the fore. The medical field is an
example of information asymmetry. The physician knows
much more than the patient, but this is more than offset
by the professional standards of those providing the service.
In finance, sadly, trust has been broken too many times,
and we see the current fashion of risk onrisk off mas-
querading as an investment strategy.
Regardless of how we might feel about the Occupy
Wall Street movement, it presents an opportunity for all of
us. This window of opportunity has in fact been open since
2008, and now is the time to put a laser focus on our mis-
sion of promoting ethics, education, and professional ex-
cellence. The CFA Institute Board of Governors recently
conducted strategic planning for the coming decade and,
in the process, endorsed a renewed and sharpened focus
on leadership in this arena. Its critical for us to be the lead-
ing voice on behalf of investors, educated professionals,
and ethical practices in the investment industry. Our annu-
al member surveys support this mission, with more than
90 percent of respondents saying that advocating effective-
ly for members for ethical markets is important.
As one example of our work, the regulatory communi-
ty continues to take the opportunity to seek our advice and
counsel, which has magnified our reach and ability to posi-
tively impact the profession on behalf of our members. We
recently served on the Private Sector Taskforce to the G-20,
which has published a set of recommendations on regula-
tory convergence in our industry.
There is likewise a window of opportunity for partici-
pation by all CFA Institute members in our promotion
of ethics and trust. For those of you who live by the CFA
Institute Code and Standards, I encourage you to advocate
for adoption of the CFA Institute Asset Manager Code
of Professional Conduct. If you are a trustee or work with
trustees, please consider adopting of the CFA Institute
Pension Fund Trustee Code.
To be clear, I believe that the vast majority of finance
professionals are ethical and hard working and want the
best for their clients. But to paraphrase Charley Ellis, CFA,
(formerly a chair of this organizations governing board),
the business of finance has overshadowed the finance pro-
fession. The Occupy Wall Street movement protesters may
well pack up their tents and placards for the winter, yet its
our duty to continue to hold ourselves and those around
us to the highest possible standards of professionalism.
John Rogers, CFA, is president and CEO of CFA Institute.
Viewpoint
BY DAVE ULRICH, NORMSMALLWOOD, AND MICHAEL ULRICH
hy do active, long-terminvestors prefer to
invest in some companies over others? This
simple question is important because under-
standing investor logic and emotions can
help company leaders better position their company to gain
investor confidence. Ultimately, investors make decisions
based on information that they believe can improve their
performance and mitigate their risk. If leaders know what
investors are looking for when making investment choices,
they can share better information with those targeted
investors.
To answer the question about why investors invest, we
interviewed about 30 senior investors and reviewed papers
on the topic. Fromthis preliminary work, we defined three
broad domains of information most important to investors:
(1) industry favorableness, (2) company performance, and
(3) quality of leadership.
Industry favorableness refers to the characteristics of the
industry, such as its growth potential, barriers to entry,
competitiveness (or rivalry), social trends, customer oppor-
tunity, regulatory opportunities, and so forth. Industries
may be more or less favorable (e.g., demographics favor
elderly care and technological changes and are less favor-
able to traditional printing).
Firm performance refers to consistency of financial re-
sults as indicated by a variety of metrics (e.g., working cap-
ital, economic value added, operating margin, return on
capital, and so forth). Firmperformance also refers to the
intangibles related to strategy, technological advantage, and
organization capabilities (e.g., speed to market, degree of
innovation, ability to collaborate, customer service, social
responsibility, and so forth).
Quality of leadership refers to the confidence investors
have in the leadership capability of the company. Investors
are more likely to invest in companies with leaders who
have a strong record and have proven ability to set and exe-
cute strategy, to manage current and future talent, and to
develop future leaders.
Next, we determined the relative weight of each of
these three domains for investor decisions. Additionally, we
wanted to find out how much confidence investors have in
their ability to assess each of the three domains. Thus, we
designed a survey (available fromthe authors) to answer
two relevant questions: (1) What is the relative weight of
each of the three domains on investment decisions? (2)
How much confidence do investors have in their ability to
assess each domain?
We used a snowball sampling technique that identi-
fied investors who could complete the survey based on our
personal contact with them, their attendance at investor
conferences, individuals with whomwe conducted pilot
interviews on the topic, and lists of registered investors.
1
Investors were asked to complete the survey and recommend
others to complete it. In total, we received 430 responses
fromportfolio managers, institutional investors, mutual/
hedge fund managers, private equity investors, and venture
capitalists. These 430 investors averaged more than 15
years of professional investment experience.
Table 1 reports the relative importance of each domain
and investors confidence in their ability to assess each area.
TABLE 1
RELATIVE IMPORTANCE TOINVESTORS AND
INVESTOR CONFIDENCE TOASSESS
Importance Confidence to Assess
(standard (standard
Domain deviation) deviation)
Performance 38.5%(15) 4.47 (0.58)
Industry favorableness 33.1 (16) 4.33 (0.66)
Quality of leadership 28.4 (14) 3.75 (0.96)
Note: To rank importance, survey participants were asked to divide 100 points
based on howimportant each domain is for investment decisions. To evaluate
confidence in ability to assess, they were asked to rate themselves on a scale
of 1 to 5 (highest) for each domain.
Investors consider company performance the most impor-
tant domain for making investment decisions (38 percent)
and also have the highest confidence in their ability to as-
sess it (4.47). The standard deviation of 0.58 is the lowest
of any domain. The written comments on company perform-
ance include the following:
Firmperformance is the most important ingredient to a
successful investment. The firmmust execute to a certain
level to create value for its investors.
The Leadership Gap
Assessing company leadership is investors most glaring weakness when making investment decisions
W
1 We used our personal contacts to invite investors to participate in this study.
These contacts included contacting academic colleagues who had published
about investment criteria, colleagues who served as board members or in ex-
ecutive positions, and investors with whom we had worked. We were able to
invite investors who attended BYUs Investment Professionals Conference,
who included professionals in private equity, venture capital, investment
banking/capital markets, and asset management/hedge funds. In our pilot
interviews, we interviewed 30 active investorsventure capitalists, invest-
ment advisors, asset managers, and sovereign wealth fund managerswho
were able to recommend their investor colleagues. A list of registered in-
vestors from Harvard Business School library out of the Thompson One
Banker Database was used.
(2) if high quality of leadership is required for an invest-
ment to succeed, then there may be other investments out
there (favorable industry, performing firm) with fewer
hurdles to success. There is a Warren Buffett quote along
the lines of preferring to invest in businesses that even a
monkey could run because at some point, one will. This
is the most important factor to us. At the end of the day, it
always comes down to people.
We care a LOT about this. This is what drives a firmto
capture opportunity. Nearly all the pathologies of leader-
ship are easy to find if you know where to look. Too many
CEOs are such great toadies (some seemto be sociopaths)
that you cant depend on just meeting themthey will
charmyou, and theyll figure out what you want to hear.
So, you have to get out into their operations and walk
around. If you know what real leadership is and what real
integrity is, you will find it or the absence of it out on the
front lines where products and services are being forged
and delivered to customers.
Much rises and falls on leadership, so this is key, though
we are always looking for ways to make companies better,
and we are willing to recruit leaders to lead.
Leadership is one of the most important considerations
that our fund makes when considering a potential invest-
ment. If we are not comfortable with the management
team, we will usually not invest until changes are made.
This is a leading, non-financial indicator, yet all informa-
tion systems and research services are designed to provide
financial metrics. Quality of leadership, culture, and rela-
tionships with core stakeholders are critical to understand
but are also difficult to gauge. Weve spent four years try-
ing to get better in this area.
Clearly, leadership matters to investors but is difficult to
define, measure, or track. Investors vary more on howmuch
confidence they have in their ability to assess leadership. For
example, one investor who managed a sizeable portfolio said
that his firmstarts with choosing to invest in a growth
Firmperformance is quantifiable and measurable [and]
thus given more weight.
We look at a companys long-termhistory in an effort to
assess its future earnings power. Understanding firmper-
formance relative to peers is very important an under-
earner is a more attractive investment than a company
earning more than its peers, all else equal and assuming
these are comparable businesses with no structural reason
for marginal differences.
Not surprisingly, company performance gains most investor
attention because financial and strategic performance is
more objectively measurable, comparable across firms, and
consistent with most investor training.
Industry favorableness also matters (33 percent) to
investors, and they have high and consistent confidence in
their ability to track it (average score of 4.33 with a standard
deviation of 0.66). Several survey comments are illustrative:
The better the industry structure and prospects, the
higher the potential for strong, stable returns.
Industry favorableness makes investing a lot easier.
A rising tide lifts all boatsas long as the company does
not make mistakes it should benefit.
It is quite possible to find great investment opportunities
in industries with mediocre prospects. However, it is diffi-
cult to find outstanding opportunities in industries with
very poor characteristics, especially in industries with in-
tense price competition or those in a secular decline. Nev-
ertheless, industry characteristics can be outweighed by
firmcharacteristics and by valuation.
I want the industry to provide a tailwind.
Although ranked lower among the three domains, quality
of leadership clearly matters to investors (28.4 percent) in a
consistent way (standard deviation of 14). But investors
have much less confidence in their ability to assess quality
of leadership (3.75) and they sense a much higher risk
(standard deviation of 0.96) associated with their evalua-
tions. Their comments reflect these findings:
Quality of leadership is important but I offer two obser-
vations: (1) this domain may be difficult to assess and
Leadership matters to investors
but is difficult to define, measure,
or track. Investors vary more on how
much confidence they have in their
ability to assess leadership.
The investment community will be
well served to develop more rigorous
analytical tools to determine the
quality of leadership within potential
investment opportunities.
Viewpoint
industry. Next, they focus on the four or five highest per-
forming firms in their selected industry based on a set of
financial criteria. Their final choice about how much to
invest in each firmcomes after they meet for a day with the
CEO of these targeted firms. In that day, they would meet
not only with the CEO but try to get outside the CEOs
comfort zone by going sailing. He felt that a lot could be
learned about the CEO as a leader in this setting.
This story was consistent with our finding that compa-
ny performance, industry favorableness, and leadership
matter, but it also demonstrates that investors have a long
way to go in determining quality of leadership. Neither com-
fort in sailing nor strong interpersonal skills equate to lead-
ership success. Additionally, looking at one leadereven
the CEOdoes not ensure leadership depth within a firm.
Conclusions
Our preliminary study captures broad trends with clear and
challenging implications. Investors tend to focus on com-
pany performance and industry favorableness and have rel-
atively high confidence in the assessments they make in
these areas, but they also pay attention to quality of leader-
ship, despite having much less confidence in how to meas-
ure it. So, how can investors better judge quality of leader-
ship? We propose that the investment community will be
well served to develop more rigorous analytical tools to de-
termine the quality of leadership within potential invest-
ment opportunities.
If investors had better information about the quality of
leadership within a company, they would reduce their risk,
increase their confidence, and make more informed deci-
sions. Likewise, if regulators doing stress-tests on companies
within an industry (e.g., financial services) could stress-test
the quality of leadership as well as financial ratios (e.g., liq-
uidity), they could make more informed decisions.
Dave Ulrich is a professor at the Ross School of Business of the
University of Michigan and a partner with The RBL Group in
Provo, Utah. Norm Smallwood is a partner with The RBL
Group. Michael Ulrich is a doctoral student at the University
of South Carolina.
Encouraging a Behavioral Shift
We need to find not only new answers but new ways of finding these answers
BY PHILIPPE SARASIN, CFA
Excerpted from remarks made in accepting the Alfred C.
Pete Morley Distinguished Service Award
hat is it about CFA Institute that brings the
best out of individuals? Why do volunteers
put aside personal or corporate interests and
give so much time, intelligence, and experi-
ence to set higher standards for the industry?
Is there something specific about the CFA Institute
model that motivates successful men and women (who
have demonstrated their ability to climb to the top of the
pyramid for their own benefit) to seek action in the collec-
tive best interest?
At a time when so many questions are being asked,
so many changes occurring and brewing, and when money,
power, and old-boys networks are becoming suspect, we
need to find not only new answers but new ways of finding
these answers.
What is different today? Complexity? No, complexity
has always been rising with the directionality of time. Ris-
ing complexity is a biological characteristic of life itself.
What is new in todays world is that we are about to reach
limits we thought were nonexistent or still far away. Demo-
graphic expansion will come to an end sooner than we
anticipate. We are approaching singularity, the moment
when computers become more intelligent than humans.
And we have the limits imposed by climate change, popu-
lation density, and scarcity of resources that will lead to
challenging mass migrations.
Just think of the implications of increased complexity
combined with these new limitsthe potential impact on
economic theory, valuation models, public policy, and for-
eign relations (to mention only a few).
Not only does the task of addressing these challenges
offer an amazing opportunity for forward thinking and cre-
ative research, but we need to move from the primal indi-
vidual predatory survival instinct mode imbedded in raw
capitalism to a higher functioning mode of collective intel-
ligence.
And this is where the CFA Institute higher sense of
purpose and the behavioral shift witnessed in volunteer
leaders come to mind. Could this combination be an inspi-
ration for other professions or other areas of corporate and
public life?
If only leaders from all walks of life could use their
positions of power to serve a notion of higher purpose and
greater good and seek to encourage the kind of behavioral
shift from predator to team player, our society would be
a better place and would offer more of what the younger
generation badly needs: goals and purposes of a nature
worth fighting for.
Philippe Sarasin, CFA, is a former chair of the CFA Institute
Board of Governors.
W
Goals-Based Reporting and Traditional Performance Metrics
BY CHARLES M. OPINCAR
principal preoccupation of traditional perform-
ance reporting is calculating a portfolios rate of
return either in absolute or relative terms, with
the emphasis on relative comparisons: measur-
ing returns against some generally accepted benchmark,
peer group, or risk-adjusted return.
Consequently, the performance metric for the individ-
ual investor is the portfolios return relative to an index
or median managers performance in a similar investment
style. A major goal of the investor and designated invest-
ment manager is to create alpha or excess return of the
portfolio relative to the benchmark, with success defined
as beating the benchmark.
Although investors generally focus on portfolio rela-
tive returns, the advent of behavioral finance suggests that
a larger spectrum of investor behavior should be embraced.
Rather than the narrow focus of portfolio allocation based
on riskreturn calculation, there is the ongoing realization
that investors have more experiential, real-world goals than
those accommodated by standard riskreturn models.
For example, a highly desirable goal for a retired or
near-retirement demographic is to have a spending stream
or target spend rate that keeps intact the principal of the
investment portfolio and that, at the same time, affords a
realistic spending stream of income in the retirement years.
An important concern of goals-based reporting is avoiding
the twin fears of exhausting retirement income premature-
ly or not leaving a financial legacy to family members.
The standard metric used by traditional performance
reporting is incomplete in measuring the attainment of
such goals. This is not to say that the retired investor is
totally indifferent to their portfolios return relative to a
benchmark. Rather, a complementary performance metric
is required in assessing the achievement of a retirees goal.
Goals-based reporting is the missing element in the
performance story and represents a true understanding
of an investors experiential preoccupations, worries and
dreams. For that reason, the industry should move to
goals-based performance metrics and reporting, which
enables investment managers to produce performance
reports that reflect the true aspirations of each investor.
Life Metrics
Disciplined spending and its associated depletion of accu-
mulated assets in retirement can be a challenge. As James
Tobin, a Noble Prizewinning economist, noted in the con-
text of endowment spending, there is a trade-off between
current spending and the growth of the endowments
principal. This trade-off applies to the retirees situation
as well. By spending in excess of some targeted spend rate,
the retiree runs the risk of depleting assets and reducing
the intergenerational wealth transfer to family members.
Investors must therefore be sensitive to their spending
habits and establish an asset structure or asset allocation
that permits the realistic possibility of maintaining or
growing portfolio value.
The purpose of traditional performance metrics is as-
sessing the growth of the portfolio and the success of the
investment manager. Knowing your small-cap manager
beat the Russell 2000 by 150 bps is reassuring. In addition,
a Sharpe ratio higher than the median manager in a peer-
group ranking reduces fears of unacceptable risk for this
150 bps alpha return. All of these traditional metrics serve
a very useful and informative purpose. I do not suggest
discarding these performance tools. Instead, they are indis-
pensible complements to goals-based performance report-
ing. But a different metric is required to monitor behavior
and ensure that current spending habits do not exceed the
pre-defined targeted spend rate.
Consistent with Tobins suggestion, an optimal spend-
ing rule or targeted spend rate is one that combines stable
elements with market elements. Specifically, the stable
term is a percentage of the previous years spending plus
an adjustment for inflation. In addition, the spending rule
incorporates a market term for a long-run sustainable rate
of distribution multiplied by the market value of the port-
folio. By varying the proportions between the two terms,
investors can influence how sensitive their spending is to
market variation. For example, more risk-tolerant retirees
could select a higher proportion for the market term in
the spending rule, which would make current spending
more sensitive to market fluctuations. Overweighting the
market term might be enjoyed during bull markets but
could lead to an anxiety-inducing and belt-tightening sce-
nario in bear markets.
Layering: Assets and Spending Habits
Spending requires cash, and a targeted spend rate requires
a predefined amount of available cash. Without adequate
cash, a steady spending stream as mandated by a spending
rule is impossible.
In addition to cash, goals-based reporting can have
additional layers or asset classes, such as stable and growth
assets differentiated by their liquidity properties and vari-
ability of returns. Because cash and cash equivalents have
zero or minimal variation, they occupy the foundation of
the asset layering. Stable and growth assets are less liquid
and experience varying degrees of return variability. Con-
sequently, they account for a smaller proportion in the lay-
ering of assets.
The spending rule in general (and the weights associ-
ated with the stable and market terms in particular)
A
determine the amount of cash and cash equivalents re-
quired for the investors targeted spending. The remaining
stable and growth assets are determined by a clients risk
exposure. The stable assets would sit above the founda-
tional layer of cash and usually account for a large share of
portfolio value.
Finally, growth assets would add the top the layer
and usually would constitute the minority of the asset mix.
Notice that the asset mix is viewed from the perspective of
liquidity and the requirements for a stable spending stream
as opposed to traditional view of asset allocation (namely
risk diversification).
Cash does not fall from the sky but must be raised by
selling other assets. Moreover, knowing when to sell assets
requires some forethought and rule generation. This raises
the challenge of the optimal, market-timing trading rules to
refill the cash bucket and to maintain the targeted spend-
ing rate. Trading rules are developed to satisfy the various
types of markets (i.e., range bound, rising, and falling). For
example, it is better to replenish the cash bucket in a bona
fide bull market than to sell assets at distressed prices in
a raging bear market.
A minimum floor of cash (e.g., three months of cash to
satisfy targeted spending) is established and automatically
replenished when it falls below the minimum regardless of
market conditions. For other amounts of cash, using tech-
nical trading indicators (i.e., moving averages, mid- to
long-term trend analysis, etc.), sell signals are triggered in
order to refill the cash bucket. In turn, the freed up cash
flows to spending in alignment with the targeted spend
rate. Hence, the foundational layer of the asset model (that
is, cash) supports the spending habits of retirees and pro-
vides a very different depiction of portfolio allocation than
typical variance of return model. In a behavioral sense,
assets are chosen not necessarily for their expected return
relative to their risk but rather as a conduit of cash flow to
support distribution and spending behavior.
Life-Metric Signals
The spending rule and ensuing spending behavior are sen-
sitive, by varying degrees, to a market term. Statistical meth-
ods can be used to estimate the impact of the market term
on spending. Monte Carlo simulation is used to produce
statistical estimation of various market scenarios and their
impact on spending. Specifically, for various parametric
values of the stable and market terms within the spending
rule, Monte Carlo simulation can estimate the portfolio
returns and spending scenarios and can provide a measure-
ment of important life-metric signals, such as the number
of years the current spending stream can continue before
an investors assets are exhausted.
A more immediate and compelling performance metric
is the comparison of a historical current spend rate with
the theoretical target spend rate. The current spend rate
can be a moving average of historical spending or a pro-
jected spend rate based on current spending behavior. By
developing and including additional rules that affect the
functional interplay between the current and target spend
rate, it is possible to provide investors with advisory sig-
nals when their spending exceeds the target spend rate.
These life signals are not intended to replace the tradi-
tional performance metrics of portfolio analysis. Clearly,
investors should be concerned about the upper tiers of
their asset mix. As noted, the market term of the spending
rule can have an important and decisive impact on a spend-
ing stream depending on an investors risk tolerance. In-
vestors need to know if their portfolio or investment man-
ager achieves excess return relative to some benchmark.
Not surprisingly, when investors open a monthly or quarter-
ly investment statement, they appreciate the plethora of tra-
ditional performance metrics: alpha, Sharpe ratios, Treynor
ratios, time- and money-weighted returns, and attribution
analysis. Performance life metrics will experientially res-
onate with the investor in a different way than the tradi-
tional tool set of performance metrics.
Putting the Investor First
An effective way of putting the investor first is to empower
them. This means creating goals-based reporting tools that
resonate both objectively and subjectively with the in-
vestor. In addition, these tools should promote proactive
investor behavior. Reviewing a monthly or quarterly in-
vestment statement and noticing a spend-limit violation
the penalty of which is facing the retirement years with
quickly dwindling financial resourcesis sufficient reason
to reassess ones spending habits and to initiate a portfolio
review with the investment manager.
Such a review should encompass both personal spend-
ing behavior as well as noting excess returns relative to
benchmarks as a result of the choice of asset buckets or in-
vestment manager selection. This approach is a winwin
for the investor and investment manager. Combining this
client-centric focus with traditional and goals-based per-
formance metrics can truly optimize an investors reporting
experience.
Charles M. Opincar is a senior reporting analyst at Fiserv
in Jersey City, New Jersey.
Viewpoint
An effective way of putting the
investor first is to empower them.
This means creating goals-based
reporting tools that resonate
both objectively and subjectively
with the investor.
C F A MA G A Z I N E J A N F E B 2 0 1 2 13
INTEGRITY
Market
MF Global: Another Ethics and Regulatory Blunder?
institutions were other goals. Now it appears they were
mere pipe dreams of the regulatory improvement effort.
It all begs the question, What has changed since simi-
larly risky behavior brought the global financial system
to the brink of collapse?
I think you know the answer. Although MF Global
wasnt deemed systemically important, and perhaps had
less oversight as a result, this small fry by Wall Street
standards is still the eighth-largest bankruptcy ever and
has become a new poster child for U.S. regulatory failure,
not success. In fact, we are left to wonder whether Dodd
Frank rules and current regulatory oversight capabilities
are adequate in any circumstance, much less a larger fail-
uresomething along the lines of Lehman Brothers. Our
regulatory capabilities seem particularly hard pressed to
even recognize, much less prevent, industry firms from
getting into similar trouble in the first place.
Even amid greater emphasis on financial institutions
following the 2008 financial crisis, the fall of MF Global
underscores that its still relatively easy for a major Wall
Street player to flaunt the rules and disregard customer
interests. The fact that MF Global did not take down the
system is hardly grounds for patting ourselves on the back
and saying regulation works.
In the end, I and many others are hoping this situa-
tion will all be sorted out, with customers made whole
and wrongdoers held accountable. Unfortunately, there is
something all too familiar about these problems. Despite
the harsh lessons from the 2008 crisiswhich has left a
shadow were still trying to escapeone has to wonder
whether our industry has learned anything at all.
Kurt Schacht, CFA, is managing director of Standards
and Financial Market Integrity at CFA Institute.
BY KURT SCHACHT, CFA
My MF Global odyssey continues. A disgruntled account
holder, Im looking for both answers and a check for the
proceeds of my account neither of which has been forth-
coming. I am angry not just about the money but also
about what this situation reveals about
our industry and efforts to improve
trust and ethics. Let me explain.
Despite many well-intentioned
proposals to curb excessive risk taking
on Wall Street, weve witnessed the
collapse of another securities firm,
this time under the weight of huge
and risky bets on European debt.
Although this is one of the biggest
investment industry failures of all
time, several insiders have been saying that this is an
example of industry regulation working the way it is sup-
posed to work. No government bailouts heremake sure
they are not too systemic, let em fail, and move on. But
what about those 50,000 account holders?
Although the recent bankruptcy filing by MF Global
didnt send shockwaves across the global financial markets
like the fall of Lehman Brothers, to be sure, its further
proof of just how little things have changed on Wall Street.
MF Globals demise comes at a time when regulators
are stalled on any meaningful DoddFrank reforms in the
U.S., including how stringently to implement the contro-
versial Volcker Rulewhich sets out to segregate propri-
etary trading from customer deposits. Stricter rules and
oversight of the use of leverage by regulated entities, better
record keeping and risk management practices at such enti-
ties, and assessing the systemic risk of non-bank financial
CFA Institute Announces New Appointments to Capital Markets Policy Council
CFA Institute has announced the appointment of two new
members to the Capital Markets Policy Council (CMPC)
to provide expertise and perspective on critical issues relat-
ing to the capital markets. Tony Tan Boon Leng, CFA, and
Nicola Ralston, FSIP, were appointed to one-year terms,
renewable up to six years.
The CMPC is composed of a diverse group of invest-
ment professionals who provide a global watch on market
issues and events. Their practitioner expertise and analysis
on such issues as regulatory proposals and structures
enables CFA Institute to provide ethics-based responses
that are sound from a practical perspective.
Tony Tan Boon Leng is CEO of Governance & Treas -
ury Advisory Services in Singapore and has significant
experience in corporate governance, capital markets, cor-
porate finance, and risk management. He previously held
positions with VTB Bank Europe, Tokai Capital Markets,
BP Asia Pacific, and Overseas Union Bank. He is the CFA
Singapore Advocacy Committee co-chair as well as chair
of the societys Senior Members Committee.
Nicola Ralston is a director of PiRho Investment
Consulting in London, with more than 30 years of invest-
ment experience as an analyst, portfolio manager, and
investment consultant. She previously managed the U.K.
institutional business for Schroders and was head of global
investment consulting at Hewitt Associates. Ralston, who
is a fellow and former chair of CFA Society of the UK,
was a governor of CFA Institute between 2003 and 2009.
INTEGRITY
Market
Overhauling Europes Securities Markets
BY RHODRI PREECE, CFA
Recently, the European Commission commenced its over-
haul of securities markets regulation in Europe with the
publication of legislative proposals for the revised Markets
in Financial Instruments Directive, dubbed MiFID 2.
After nearly a year in the making, the legislative package
puts transparency at the forefront with ambitious proposals
to shed light on trading in practically all financial instru-
mentsfrom equities to bonds, derivatives, and even
emissions allowances.
The transparency agenda stems
from the European Commissions
desire to implement the Group of 20
(G20) mandate to make financial
markets safer and more resilient by
pushing trading onto regulated, trans-
parent electronic trading venues
wherever appropriate.
CFA Institute has contributed to
the transparency debate with the pub-
lication of a recently released report, An Examination of
Transparency in European Bond Markets.* The report, au-
thored by Heidi Learner, CFA, examines the existing state
of transparency in bond markets, drawing from the experi-
ences of ItalyEuropes largest bond market and one of
only a few to have already mandated public reporting of
fixed-income transactionsand the United States, which
has required public post-trade transparency in the bond
market since 2002 via the TRACE (Trade Reporting and
Compliance Engine) system. The report broadly concludes
that careful implementation of post-trade transparency re-
quirements in European bond markets can benefit investors
by improving access to pricing information, thereby bridg-
ing the information gap between investors and dealers,
and increasing competition among liquidity providers.
Consolidated Tape
On the issue of transparency, another welcome develop-
ment under MiFID 2 is the requirement for a consolidated
tape for equity markets, an issue supported by CFA Insti-
tute members and advocated for consistently by our organ-
ization over the past two years. Given the fragmented
nature of Europes equity markets, a consolidated tape is
essential to provide investors with the transparency they
need to compare prices and evaluate best execution across
multiple markets.
Rather than mandating a single entity to establish the
consolidated tape, MiFID 2 provides for the creation of
consolidated tape providers (CTPs) that must meet the
same minimum standards and register with regulatory
authorities. CTPs will have to consolidate post-trade data
into a continuous electronic stream, to be made available
as close to real time as possible. It is hoped that competi-
tion among providers will lead to high-quality, innovative
consolidated data offerings.
The approach prescribed by the European Commis-
sion seems appropriate at this stage, given current industry
initiatives, expertise, and infrastructure. However, if the
commercially driven approach fails to meet the prescribed
standards, lower costs, or live up to investors needs, then
the European Commission should look at other approach-
es, including establishing a single public utility to run the
consolidated tape.
New Trading Venue Classification
A new aspect of MiFID 2 is the establishment of a trading
venue category called the organised trading facility
(OTF), which is essentially any type of electronic trading
platform that matches orders multilaterally amongst users
of the platform but where there is some discretion over the
way in which orders are executed. Ostensibly, the OTF
category has been created as a means to ensure that all sys-
tematized trading is captured under the MiFID framework,
in an attempt to minimize regulatory arbitrage. For exam-
ple, the OTF category will include certain broker crossing
systems, often referred to as dark pools operated by
banks. Such broker crossing systems would not be able to
combine the crossing of client orders with bilateral execu-
tion against the brokers own account under the OTF
framework. This should lead to a more consistent ap-
proach for the operation and regulation of dark pools.
Moreover, the OTF concept also applies to the trading
of derivatives. In essence, it is a broadly equivalent con-
struct to the swap execution facility (SEF) trading venue
established in the United States under the DoddFrank Act.
Whilst MiFID 2 addresses the trading of financial
instruments up to the point of execution, post-trading
issues, such as clearing and settlement, are covered under
the European Market Infrastructure Regulation (EMIR),
which is nearing the end of the legislative process in the
Euro pean Parliament. Like DoddFrank, EMIR requires
certain standardised, sufficiently liquid derivatives con-
tracts to be cleared via central counterparty clearinghouses.
High-Frequency Trading
Another key development under MiFID2 is the regulation
of algorithmic trading firms, including high-frequency trad-
ing (HFT) firms. Recognizing that HFT accounts for more
*Members can access An Examination of Transparency in European Bond
Markets at bit.ly/bondmarket.
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than one-third of total trading volume in European equity
markets and the potential systemic risks associated with it,
MiFID2 requires HFT firms to register with local regulators
and imposes additional constraints on the way they operate.
Among other things, there will be a cap on the ratio
of orders to transactions in an attempt to limit some of the
costs associated with the voluminous message traffic exert-
ed on the market ecosystem, where currently more than 90
percent of orders end up being cancelled. Whilst this has
some appeal, a risk of pricing inefficiencies across related
markets and instruments remains if HFT firms engaging in
statistical arbitrage are constrained from adjusting their
quotes in response to changing market conditions. MiFID
2 also effectively requires HFT firms to provide liquidity
on a continuous basis through the trading day, regardless
of market conditions. The view of CFA Institute on this is-
sue is that if HFT firms benefit from certain privileges not
available to other investors, such as faster data access to
exchange servers or an advanced look at the order book,
then they should be bound by such requirements as pro-
viding continuous liquidity like traditional market makers.
Another risk associated with HFT is the potential for
an erroneous algorithm to create market instability and
propagate systemic risk across markets. Whilst this wasnt
the cause of the flash crash in the United States in 2010,
HFT was considered to have amplified the transmission
of instability from the futures markets to the cash markets
and beyond. To avoid any such occurrences in Europe,
MiFID 2 contains a number of provisions related to risk
controls for both firms, broker/dealers who provide direct
electronic access, and exchanges. These measures are wel-
come and should help protect the integrity and efficient
functioning of the market.
HFT is also addressed under the revised Market Abuse
Directive, published by the European Commission at the
same time as MiFID 2. New provisions under this directive
clarify which HFT strategies constitute prohibited market
manipulation, such as submitting orders without an inten-
tion to trade but to disrupt a trading system, known as
quote stuffing. This is another welcome development to
protect market integrity in todays technology-driven mar-
ketplace.
MiFID 2 contains more proposals, such as strength-
ened conduct of business requirements for investment
firms. Indeed, yet more directives lay in store for 2012.
Most of these provisions are a step in the right direction,
but as with all legislation, the devil will be in the details.
These will be worked out at a later stage in conjunction
with technical advice from the European Securities and
Markets Authority. Ultimately, only time will tell if MiFID
2 serves the best interests of all investors.
Rhodri Preece, CFA, is director of capital markets policy
for CFA Institute.
BY AGNS LE THIEC, CFA
UCITS: A European Success Story
With Greece on the brink of default, solidarity between
European Union (EU) member states tested by deep finan-
cial and economic imbalances, and the future of the euro-
zone endangered, to say that Europe is not a particularly
hot asset at the moment would be
an understatement.
However, Europe can still claim
some success stories, including in
the financial sector. One of them is
UCITS (Undertakings for Collective
Investment in Transferable Securi -
ties). The UCITS story is a major and
lasting testament to the vision of a
single European market. With a com-
pound annual growth rate of more
than 11 percent over the last 20 years, UCITS assets now
exceed 5 trillion, and the UCITS brand has gradually
become a global marque representing well-regulated and
risk-diversified investment funds that can be marketed to
retail investors.
The UCITS phenomenon started in 1985 with the first
UCITS Directive, which established a framework for col-
lective investment schemes across the EU and took the
Have UCITS Grown Too Complex for Retail Investors?
first steps toward creating a single European market and
regulatory framework for investment funds. It enabled
UCITS to benefit from a passport that allowed them,
subject to notification, to be offered to retail investors in
any jurisdiction of the EU once registered in one EU
member state. UCITS I particularly aimed at facilitating
cross-border offerings of investment funds for retail
investors, but it also aimed at enhancing investor protec-
tion, notably through strict investment limits and capital,
organizational, and disclosure requirements.
The Evolving Story of UCITS
The UCITS framework has evolved greatly since 1985.
The first directive allowed UCITS to invest only in trans-
ferrable securities, such as equities and bonds. UCITS funds
were permitted to use derivative instruments only in strict-
ly defined instances, effectively limiting their use. This
restriction led UCITS funds to be traditionally regarded as
plain-vanilla investment funds. However, the UCITS III
Directive of 2001 and the Eligible Assets Direc tive of 2007
introduced great flexibility for UCITS managers by broad-
ening their investment scope. Under the UCITS III Direc-
tive, more and more funds today are using a wider range of
techniques and instruments and pursuing strategies that
were previously more common in the alternative investment
fund sector. Indeed, a growing number of funds are
INTEGRITY
using derivatives to gain both long and short synthetic ex-
posures as well as to implement complex macro, arbitrage,
and commodity investment strategies. Some funds have
also increasingly been using leverage. Acknowledging the
potential increased risks associated with this broadened
investment scope, the EU regulator, in turn, asked for
strengthened risk management processes.
Concerns for Investor Protection
As a result of these changes in investment strategies and
the use of sophisticated financial instruments, references
are now being made to the so-called Newcits phenomenon.
With more than 200 Newcits on the market, and with more
every week, the so-called retailization of UCITS-compliant
hedge funds has caused concerns among regulators.
Another recent worry expressed by regulators world-
wide is the rapid development of exchange-traded funds
(ETFs) and the move away from tradi-
tional ETFs into synthetic and more
complex structures. Both the Financial
Stability Board (FSB) and the Bank for
International Settlements (BIS) pub-
lished reports in April 2011 on the
associated potential impacts for
investor protection and financial sta-
bility. These concerns led the newly
established European Securities and
Markets Authority (ESMA) to conduct
a consultation on the subject. The
objective of the consultation, which closed in September
2011 and to which CFA Institute responded, was to help
ESMA develop guidelines applicable to UCITS ETFs and
structured UCITS.
In our view, the two main risks to investors in synthetic
ETFs and structured UCITs are as follows:
Counterparty risk: when the fund enters into a deriva-
tive transaction with a counterparty(ies)
Collateral risk: when, through the use of a derivative,
the collateral held by the fund is possibly of lower qual-
ity and liquidity than the securities held in the tracked
index, for example, and when access to the collateral
is potentially cumbersome
Even though we are concerned about the protection of
investors, it seems to us that prohibiting the sale of struc-
tured UCITS outright to retail investors may not be the
right answer because it would deprive retail investors of
the benefits associated with these products. For example,
when compared with plain-vanilla ETFs using physical
replication (i.e., directly investing in stocks or bonds that
replicate an index), synthetic ETFswhich replicate the
return of an index through the use of derivativesprovide
significant advantages to investors. First, they widen the
investment spectrum. Second, they offer lower costs and,
therefore, potentially higher returns. And finally, they tend
to offer lower tracking errors in the case of index-tracking
ETFs. Therefore, the best way to protect investors inter-
ests in this instance would be to significantly improve
disclosures to investors on the characteristics and risks
of structured UCITSa move that would benefit retail
and professional investors alike.
Future Regulation May Qualify Structured UCITS
as Complex
Another point of contention is the fact that UCITS prod-
ucts, by definition, are currently deemed non-complex
products under MiFID (the Markets in Financial Instru-
ments Directive). Qualifying as a non-complex product
under MiFID allows the product to be sold to retail in-
vestors on an execution-only basis, meaning that the
product can be sold without a prior appropriateness test.
The purpose of this test is to prevent
complex products from being sold to
retail investors who would not have the
experience and/or knowledge to under-
stand the risk of such products. This
situation is likely to change because the
European Commission (EC), in its pro-
posed revised MiFID text published in
October, would now qualify structured
UCITS as complex instruments. Forc-
ing investment advisers to go through
this appropriateness test before selling
a structured UCITS is, in our view, not the only conse-
quence of such a rule change. We believe that this require-
ment could also have a significant impact on professional
investors, who are, in fact, the main buyers of structured
UCITS (about 80 percent of the money invested in Euro-
pean ETFs comes from institutional investors). Qualifying
structured UCITS as complex under MiFID is likely to
increase the due diligence obligations of a large number of
professional investors and to possibly somewhat limit their
desire to invest in these products.
This isnt likely to be the end of the story, however,
because the revised MiFID text proposed by the EC must
be approved by the European Parliament and the Council
of the EU and would not come into force before the end of
2014. Then, the main challenge will be to define struc-
tured UCITS and what would qualify them as complex
meaning that their suitability for retail investors and
their risk profiles would have to be checked by the invest-
ment adviser prior to sale.
Stay tuned for the continuing story.
Agns Le Thiec, CFA, is director of capital markets policy
for CFA Institute.
Market
The main challenge
will be to define
structured UCITS and
what would qualify
them as complex.
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INTEGRITY
Market
A leading global organization working to promote good
corporate governance practices recently recommended
that asset holders ask investment firms to comply with
the requirements of the CFA Institute Asset Manager
Code of Professional Conduct. The International
Corporate Governance Network (ICGN), in its ICGN
Model Mandate Initiative: Model Contract Terms between
Asset Owners and Their Fund Managers, suggests com-
pliance with Asset Manager Code provisions as part of
its model contract terms relating to a managers adherence
to standards.
The ICGN is a global membership organization com-
posed of more than 500 entities in 50 countries represent-
ing over $18 trillion in institutional assets under manage-
ment. The specific reference to the Asset Manager Code
in its model contract recommendations demonstrates
growing recognition among leading industry practitioners
of the value and importance the Code has for investors
seeking a commitment to ethical investment practices
from their investment managers.
The Asset Manager Code enhances investor protection
by encouraging investment firms to voluntarily adhere to
a strict set of ethical standards. Nearly 600 firms in more
than a dozen countries now claim compliance with the
Code, which CFA Institute last updated in 2009.
The ICGN Model Mandate Initiative was approved
at the organizations annual general meeting in September
after consultation over the course of the year with its
members, its committees, and the ICGN board. The docu-
ment is subject to further ratification by IGCN members,
and the final version will be published in March 2012.
For more information on the Asset Manager Code of
Professional Conduct, visit www.cfainstitute.org/assetcode.
Asset Manager Code Recognized as
Best Practice by International Corporate
Governance Network
Claire Fargeot Appointed Head of
Standards and Financial Market
Integrity, EMEA
Claire Fargeot has been named head of the CFA Institute
Standards and Financial Market Integrity division for the
Europe, Middle East, and Africa (EMEA) region. She is
responsible for leading CFA Institute efforts in advocacy,
policy development, and regulatory outreach in EMEA,
including the development of policy papers, research
projects, and regulatory consulta-
tions to help position CFA Institute
as a thought leader in the areas of
market integrity, investor protection,
and ethical practice within the finan-
cial services industry.
Before joining CFA Institute,
Fargeot was head of the investor
relations practice at Buchanan
Communications, one of the leading
financial communications advisers in
the United Kingdom. Prior to joining
Buchanan, she was responsible for
setting up and running the investor relations advisory
department of Fins bury, a financial, regulatory, and politi-
cal communications agency. Fargeot previously set up and
ran the strategic communications management business
in Europe for PricewaterhouseCoopers, overseeing global
shareholder value projects, and was a top-rated analyst
and trader at HSBC Investment Bank. She currently serves
as a member of the London Stock Exchanges Primary
Markets Group Advisory Panel, which sets standards and
policies for the U.K. regulated markets and associated
products.
She holds a bachelor of arts degree in bilingual Euro -
pean business studies.
CFA Institute Seeks Volunteers for Advisory Committees
CFA Institute is seeking volunteers to serve on advisory
committees that address critical issues relating to the capital
markets, financial reporting, and investment performance:
The Corporate Disclosure Policy Council (CDPC),
which addresses issues affecting the quality of
financial reporting and disclosure worldwide.
The Capital Markets Policy Council (CMPC), which
provides expertise and perspective on critical issues
relating to the capital markets.
The GIPS Executive Committee, which serves as the
decision-making authority for the development, inter-
pretation, and promotion of the GIPS standards. The
GIPS Executive Committee is seeking nominees to
serve as chair of the Verification/Practitioner
Subcommittee that serves as a forum for discussing
issues pertinent to verification from various aspects of
the investment industry.
If youre interested in these or other opportunities, please
visit the Collaborate & Network section of My CFA to
learn how you can get involvedand registeras a CFA
Institute volunteer.
Claire Fargeot
M
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CFA Institute Helps Influence G20 Financial Reform Agenda
While Europes debt crisis dominated the recent Group of
20 (G20) sum mit in the French city of Cannes, financial
market reform and investor protection were high on the
agenda. Indeed, several of the strategic priorities of a cross-
industry task force in which CFA Institute participated
were highlighted in the official announcements following
the summit, including better regulation of derivatives trad-
ing and monitoring of systemic risk.
The Private Sector Taskforce of Regulated Professions
and Industriesformed in May 2011 at the invitation of
then French finance minister Christine Lagarde on behalf
of the presidency of the G20was charged with making
recommendations to harmonize financial regulatory stan-
dards worldwide. The accounting, auditing, banking, and
insurance industries were represented in addition to CFA
Institute.
The final report, presented to the G20 deputies in
October, is consistent with many of the key positions and
recommendations of the U.S. and European Investors
Working Groups formed by CFA Institute during the crisis.
Need for Global Systemic Risk Oversight Framework
Despite some progress in identifying information gaps and
examining strategies for identifying and managing systemic
risk, the lack of a global systemic risk oversight framework
leaves us vulnerable to a new crisis, the report states. To fill
gaps in global regulatory tracking and response capabilities
for systemic risk, the task force recommends that the G20
enhance the mandate of the Financial Stability Board (FSB),
or set up a specialized body under the FSB, to monitor sys-
temic risks to the global financial system. This body would
promote macroprudential coordination, identify emerging
international risks to stability, make recommendations for
standardization of data, and recommend responses.
Both Europe and the United States have set up their
own systemic risk regulators. However, the report states
that its not clear how the European Systemic Risk Board
(ESRB) will coordinate with national systemic risk boards
in Europe, and the U.S. Financial Services Oversight Coun -
cil mandated by the DoddFrank Act has not fully staffed
its investigative arm (the Office of Financial Research).
We must cast a wide net because, as the last crisis
illustrated, systemic risk episodes can have catastrophic
consequences on an increasingly interdependent and inter-
connected world, says Kurt N. Schacht, JD, CFA, head
of the Standards and Financial Market Integrity Division
of CFA Institute.
Gaps in the Regulation of OTC Derivatives
The task force recommends that the International Organi-
zation of Securi ties Commissions continue to work toward
convergence of national regulation and oversight of capital
markets, including the establishment of cross-border mu-
tual regulation recognition and enhanced coordination and
consistent regulation of OTC derivatives. This recommen-
dation echoes the U.S. Investors Working Groups recom-
mendation that OTC derivatives be subject to enhanced
disclosure requirements and be exchange traded and cen-
trally cleared wherever possible.
The report notes that current differences in the way in
which derivatives and end users are treated under pro-
posed U.S. and European Union rules could hinder global
coordination efforts.
Several years after the market meltdown, CFA Institute
members still express strong concerns about the potential
for derivatives to cause serious harm to the worlds finan-
cial markets. In the 2011 CFA Institute Financial Market
Integrity Outlook Survey, derivatives ranked as the most
critical issue facing global financial markets in the coming
year, with respondents ranking it as the area needing
the most urgent regulatory attention in order to enhance
market integrity.
Resources for Regulators
The report laments the gaps in the enforcement capabilities
of many jurisdictions in the regulation and supervision
of financial institutions, stating that virtually all enforce-
ment bodies are significantly resource constrained. Failure
to enforce existing rules and regulations contributed in
part to the global financial crisis.
In the United States, both the Securities and Exchange
Commission and the Commodities and Futures Trading
Commission (CFTC) are subject to flat legislative budget
allocations despite being charged with implementing sweep-
ing new financial regulations demanded by DoddFrank.
Meanwhile, in Europe, common regulatory standards
are subject to different enforcement regimes among EU
member nations, with the potential to create disparities
and confuse investors and threaten the integrity of capital
markets.
The need for regulators to effectively pursue their
missions and responsibilities, as well as keep pace with in-
novations in the financial industry, is critical to the stabili-
ty of our financial markets, Schacht notes.
Impact of the Report
Based on the contents of the communiqu issued following
the Cannes Summit, G20 leaders responded positively
to several of the task forces recommendations. Indeed, the
statement stresses the importance of regulation and over-
sight of financial markets as well as the need to improve
the capacity of the FSB to coordinate and monitor financial
regulation.
In the Final Declaration, G20 leaders discussed
reform of the OTC derivatives markets, stressing that all
standardized OTC derivatives contracts should be traded
on exchanges or electronic trading platforms, where appro-
priate, and centrally cleared by the end of 2012.
Access the task force report at bit.ly/G20report.
BY DOROTHY KELLY, CFA
David Stevens, CFA, chair of the Disciplinary ReviewCom-
mittee (DRC), and Christine Koppel, CFA, the Designated
Officer responsible for overseeing the CFA Institute Profes-
sional Conduct Program(PCP), sat down to discuss the
CFA Institute disciplinary process, the work of the PCP and
the DRC, and howeach process has adapted over time.
Howdo you describe the CFAInstitute disciplinary process
to members and other individuals?
Koppel: Our disciplinary process is a multilevel peer review
process.
Howwould you explain peer reviewto those who are
unfamiliar with the concept?
Stevens: In a peer reviewprocess, a group of professionals
in a given field is charged with reviewing or evaluating a
colleagues performance or work to ensure it meets the stan-
dards of the profession. Peer reviewis a way for a profession
to exercise self-regulation, maintain standards, and enhance
the profession and its credibility in society. Many professions
(including academia, health care, software development,
and the legal profession) use the concept of peer reviewto
uphold standards in their specific fields. For example, in
academia or software development peers evaluate the work
of a fellowmember to ensure the work meets certain stan-
dards. CFA Institute applies the concept of peer reviewin
disciplinary matters to determine whether certain conduct
meets the CFA Institute Code of Ethics and Standards of
Professional Conduct.
So members and candidates are judged by their peers?
Koppel: In the concept of peer review, peer refers to a quali-
fied member of the profession, someone who is of the same
or higher ranking in the profession. At CFA Institute, the
peers are CFA charterholders.
What makes it a multilevel process?
Stevens: The Designated Officer conducts an initial peer re-
view; in certain cases, the DRC contributes additional levels
of peer review. The multilevel aspect provides a process of
checks and balances to ensure fairness and consistency.
Koppel: Its similar to the checks and balances built into the
CFA Institute grading process. Each June, CFA charterhold-
ers grade all of the Level III essay answers. When thats com-
pleted, a second set of graders review exams that fall with-
in a range of scores to ensure that the scores are appropriate
and consistent. Consistency is important for both the CFA
Program and the disciplinary process.
An Inside Look at the Disciplinary Process
Ethics
FORUM
Howdoes the DRC contribute to the checks and balances?
Stevens: Members of the DRC serve on disciplinary panels
that hear all contested disciplinary casesmatters where
the member or candidate rejected the Designated Officers
findings and/or recommended sanction. In addition, DRC
members serve on disciplinary panels to reviewmatters in
which the member and Designated Officer have agreed to a
sanction of censure, timed suspension, or revocation. Dur-
ing the first three quarters of 2011, members of the DRC
served on 103 disciplinary panels.
Koppel: During that same period, the PCP staff concluded
an additional 728 professional conduct matters. Its a lot
of cases, but they represent a very small percentage of CFA
Institute candidates and members.
Has the disciplinary process changed much over the years?
Koppel: The basic process hasnt changed much over the
years, but howwe execute it has changed quite a bit. The
growth in the CFA Programmeans that our jurisdiction now
includes 111,000 members and more than 200,000 candi-
dates in at least 90 countries. So both CFA Institute staff and
the DRC have adapted to deal with the increased volume
and the geographic and cultural diversity.
Weve added staff to handle the increased volume,
and we now categorize disciplinary matters as either exam-
related, or non-exam-relatedalso known as industry cas-
es. Industry cases are generally associated with practitioner
issues and currently represent about one-third of the case-
load. We divide the cases among exam investigators and
industry investigators because the knowledge, skills, and
abilities needed for the two types of cases are quite different.
Stevens: On the DRC side, we changed howwe conduct
exam-related disciplinary proceedings. Exam-related pro-
ceedings are nowbased entirely on written submissions.
Eliminating verbal testimony fromexam-related proceed-
ings means that candidates for whomEnglish is a second
language need not be concerned about howwell they com-
municate verbally.
Koppel: We adopted an electronic case management system
and eliminated a lot of the paper associated with discipli-
nary proceedings. Investigations and disciplinary proceed-
ings can be extremely paper intensive. In the past, each of
the five panel members would receive a copy of the written
submissions and documentary evidence submitted for a giv-
en hearing. Panelists would often receive four-inch binders
sometimes more than oneto reviewprior to a discipli-
nary proceeding. Nowall these documents are distributed
to panelists electronically and they download the materials
onto electronic tablets. Were saving trees, staff resources,
paper costs, and shipping costs.
Has the changing geographic and cultural diversity of the
membership and candidate base had an impact on the dis-
ciplinary process?
Koppel: Yes and no. CFA Institute is a global organization,
and the rules and the Code and Standards are applied glob-
ally. Every member and candidate is required to abide by the
same rules and the Code and Standards. Nonetheless, weve
made a conscious decision to be more culturally aware in
all of our activities and communications.
Stevens: Two years ago, DRC members worked with staff
fromthe PCP and the office of general counsel to revise the
Rules of Procedure for Professional Conduct to provide
greater clarityparticularly for those involved in the disci-
plinary process. The overarching goal was to make the
process more transparent and, as a result, increase fairness,
but a major consideration was the cultural diversity and lan-
guage abilities of our global membership and candidate base.
We wanted to make the document understandable for mem-
bers and candidates for whomEnglish is a second language.
Before I joined the DRC in 2006, the committee had about a
dozen members, many of whomwere fromNorth America.
To tap into and reflect the broad diversity of our member-
ship at the time, the CFA Institute Board of Governors ex-
panded the DRC by about 50 percent and appointed mem-
bers fromaround the globe. At the same time, the Board of
Governors created the hearing panel pool fromwhich we
could drawother volunteer members to serve alongside
DRC members on disciplinary panels. The creation of the
hearing panel pool was based on the belief that members and
candidates facing disciplinary charges should be judged by
panels that resemble the broad membership. It makes sense
given that our process is based on the concept of peer re-
view. We have a globally diverse membership and candidate
base, so the disciplinary panels should reflect that diversity.
Koppel: More than 150 members fromaround the globe
volunteered to serve in the hearing panel pool. Its a testa-
ment to the commitment and volunteer spirit of our member-
ship that so many members stepped forward to contribute
to the effort.
Stevens: In the end, we found that training such a large pool
of volunteers on a continual basis was a significant challenge,
so the Board of Governors made the decision to disband the
pool and further expand the DRC.
What is the current composition of the DRC?
Stevens: We nowhave 30 CFA charterholders from11 coun-
tries serving on the DRC. Many of the committee members
have lived, studied, and/or worked internationally, so the
global diversity is actually a bit higher than what is reflected
in those numbers. The committee is also professionally di-
versewe have academics, asset managers, analysts, regula-
tors, and consultants serving side by side. The geographic,
cultural, and professional diversity in the committee reflects
the diversity of our membership and candidate base and
ensures a global perspective.
And they receive ongoing training?
Stevens: Yes, and the training has become more rigorous.
Weve had training in the past, but committee members
nowreceive live training regularly, with more intensity, and
through a variety of methods. Training topics include ques-
tioning skills, howto lead a disciplinary panel, and proper
global etiquette and decorum. Additionally, this year we
offered a boot camp event for newDRC members. They
came to Charlottesville, Virginia, and received two days of
training. The first day staff provided training on the discipli-
nary process; the second day members participated in a
mock disciplinary hearing.
Howelse have you adapted?
Stevens: After we expanded the DRCto 30 members, we cre-
ated an executive team, which includes a deputy chair posi-
tion, to provide additional leadership. At least one executive
teammember is assigned to each disciplinary panel. The
executive teamalso works on policy reviewand contributes
to member evaluations, which we use to determine whether
a member needs additional training or coaching. The deputy
chair serves as liaison to the Code and Standards of Practice
Council and leads meetings when the chair is absent.
Koppel: We have become more transparent with regard to
the disciplinary process as well as the sanctions imposed.
Notices of disciplinary action include more detailed descrip-
tions of the misconduct and are published both in CFA Mag-
azine and on the CFA Institute website. Our website also
includes a list of individuals who are currently under sanc-
tion by CFA Institute.
Why does CFAInstitute do all of this?
Koppel: Our job is to protect the integrity of the CFA mem-
bership, designation, and examination, so while fewer than
1 percent of our members and candidates are involved in the
peer reviewdisciplinary process, our work affects every
member and candidate.
Stevens: On a personal level, I enjoy the opportunity to
work with other charterholders who are passionate about
ethics and fairness. It has been an honor to be a part of this
process.
Dorothy Kelly, CFA, is director of training and outreach for
the CFA Institute Professional Conduct Program.
For more information on how to volunteer
for the DRC, see p.50.
For guidance in applying the Code and Standards,
contact ethics@cfainstitute.org.
To report misconduct by a member or candidate,
contact professional_conduct@cfainstitute.org.
Ethics
FORUM
DISCIPLINARY NOTICES
Summary Suspensions
On 3 August 2011, CFAInstitute imposed a Summary Suspension
on O. SamFolin (U.S.), a charterholder member, automatically
suspending his CFAInstitute membership and right to use the CFA
designation. Folin was suspended after the U.S. SEC permanently
barred himfromassociation with any broker, dealer, or investment
adviser on 29 July 2011.
The SEC found that Folin misappropriated approximately
US$8.7 million fromadvisory clients, friends, and family through
material misrepresentations and omissions. According to the SEC,
Folin offered and sold securities promising investors that their
funds would be invested in socially responsible companies, but
he then diverted a portion of the investors funds to pay previous
investors, the expenses of his affiliated companies, and his own
salary. In addition to the permanent bar, Folin was ordered to dis-
gorge more than US$10 million in ill-gotten gains and to pay a civil
penalty of US$150,000.
On 25 March 2011, CFAInstitute imposed a Summary Suspension
on Benjamin Chui (U.S.), automatically suspending both his mem-
bership and right to use the CFAdesignation. This action resulted
froman order issued by the U.S. SEC on 21 December 2010 barring
himfromassociation with any investment adviser and with the
right to reapply after five years. The SEC determined that Chui, the
former CEOof two registered investment advisersAmerican Pe-
gasus and American Pegasus Investment Managementengaged
in improper self-dealing, misused client assets, and failed to dis-
close conflicts of interest.
Without notifying investors, Chui used more than US$18 mil-
lion in loans and advances fromhis American Pegasus Auto Loan
Fund to acquire the funds sole supplier of subprime auto loans.
According to the SEC, this created a pervasive conflict of interest
as Chui had a duty to maximize the funds performance while at
the same time generating profits for the loan supplier he secretly
owned. The SEC also determined that Chui borrowed millions of
dollars fromthe Auto Loan Fund to support other funds he man-
aged. At one point, 40 percent of the Auto Loan Funds assets con-
sisted of loans to Chui-related businesseswith fund investors
being charged fees based on these undisclosed related-party
transactions.
Timed Suspensions
On 12 August 2011, a Hearing Panel imposed a Two-Year Suspen-
sion of CFAInstitute membership and the right to use the CFAdes-
ignation on John PhillipWatts (Canada), a charterholder member.
The Hearing Panel found that Watts violated Standards I(A)
Knowledge of the Law, I(D)Misconduct, IV(A)Loyalty, V(A)
Diligence and Reasonable Basis, andV(B)Communication with
Clients and Prospective Clients of the CFAInstitute Code of Ethics
and Standards of Professional Conduct (2005).
The Hearing Panel found that between November 2006 and
April 2007, Watts provided research, recommendations, and sales
materials to clients without the prior knowledge or approval of
Berkshire Securities, his employer firm. Several of Watts communi-
cations to clients contained unsupported price predictions, failed
to distinguish fact fromopinion, and failed to discuss the potential
risks associated with the recommended investments. Watts also
sent newaccount forms to clients and asked that they be signed
and returned in blank so that he could complete themlater, in vio-
lation of his firms internal policies and the rules of the Investment
Dealers Association of Canada (the IDA, nowknown as the IIROC).
As a result of the foregoing misconduct, the IDAfound that Watts
violated its bylaws (29.1 and 29.7), and it imposed a C$10,000 fine,
ordered himto pay C$10,000 in costs, and required that he pass
an examination on the IDAs Conduct and Practices Handbook.
The Hearing Panel also determined that in April 2007Watts
deliberately misrepresented to his firms compliance department
that he had not disseminated to his clients an unapproved re-
search report he had prepared when, in fact, he had already dis-
tributed the report. The Hearing Panel concluded that Watts state-
ment was dishonest, disloyal, and reflected adversely on his pro-
fessional reputation and integ rity, in violation of CFAInstitute
Standards I(D)Misconduct and IV(A)Loyalty.
On 3 June 2011, a Hearing Panel imposed a One-Year Suspension
of membership and the right to use the CFAdesignation on David
M. Garrity (U.S.), a charterholder member. The Hearing Panel
found that Garrity violated Standards I(A)Fundamental Respon-
sibilities and IV(B.7)Disclosure of Conflicts to Clients and Pros -
pects of the CFAInstitute Code of Ethics and Standards of Profes-
sional Conduct (1999). This result was subsequently reviewed and
affirmed by an Appeal Panel on 12 October 2011.
The NASD(nowknown as FINRA) found that on nine occa-
sions between 7 July 2004 and 23 May 2005, Garrity purchased
and/or sold securities in violation of NASDRule 2711s restricted
period. On 8 July 2004 and 23 May 2005, Garrity also published
research reports that failed to disclose his financial interests in the
securities that were the subject of his reports. According to the
NASD, Garritys failure to make this disclosure violated Rule 2711s
requirement that a research analyst state in a research report
whether he or she has a financial interest in the securities of the
company that is the subject of the analysts report and the nature
of that financial interest.
The NASDalso found that Garrity violated NASDRules
3050(c) and 2110 when he failed to notify two firms by which he
was employed, promptly andin writing, that he heldthree accounts
at other NASDmember firms. He also failed to notify properly the
firms at which he maintained these outside accounts that he was
employed by another broker/dealer. Based on these violations,
the NASDfined Garrity US$10,000 and suspended himfromasso-
ciating with any NASDmember in any capacity for 45 days.
The Hearing Panel determined that by failing to disclose his
financial interests in securities that were the subject of his re-
search report, Garrity failed to disclose to clients and potential
clients all actual and potential conflicts of interest that could rea-
sonably be expected to impair the independence and objectivity of
his research reports. Thus, Garrity violated Standard IV(B.7). Final-
ly, the Hearing Panel determined that by violating NASDrules and
CFAInstitute Standard IV(B.7), Garrity failed to maintain knowl-
edge of and comply with applicable requirements governing his
professional conduct in violation of Standard I.
Censures
On 7 September 2011, a Hearing Panel imposed a Censure on
DavidTravis Weitz (U.S.), a charterholder member. The Hearing
Panel determined that Weitz violated Standards IFundamental
Responsibilities, IV(B.2)Portfolio Investment Recommenda-
tions and Actions, and IV(B.7)Disclosure of Conflicts to Clients
and Prospects (1999), I(A)Knowledge of the Law, V(B.1)Com-
munication with Clients and Prospective Clients, andVI(A)Dis-
closure of Conflicts of the CFAInstitute Code of Ethics and Stan-
dards of Professional Conduct (2005).
Starting in late 2001 and continuing through early 2007,
Weitz co-authored a quarterly investment newsletter called The
Georgia Small Cap Stock Monitor. The newletter was distributed to
approximately 2,000 individuals, including clients and potential
clients of his firm. Each edition of the newsletter included a Stock
Pick section that provided a brief analysis of a featured company,
a recommendation to buy, and a specific price target.
In June 2009, FINRAaccepted a Letter of Acceptance, Waiver,
and Consent (AWC) submitted by Weitz to settle the self-regulato-
ry organizations allegations of misconduct. While neither admit-
ting nor denying the allegations, Weitz consented to the entry of
findings that he violated Rules 2110, 2711(c)(2), 2711(g)(2),
2711(h)(1)(A), 2711(h)(7), 2210(d)(1)(A), and 501(A) of SEC Regula-
tion Analyst Certification.
Specifically, FINRAfound that (1) Weitz improperly shared a
draft research report he had prepared with the CFOof a covered
company, (2) he failed to disclose that he personally owned a
small number of shares in three of the companies he featured as
stock picks, (3) on at least four occasions Weitz purchased stocks
for his own account, or accounts he controlled, within 30 days pri-
or to when he featured the companies as stock picks, (4) he failed
to disclose the valuation methods he used in determining price
targets for eight of his stock picks, and (5) in seven stock picks he
failed to include the required analyst certifications confirming that
the reports accurately reflected his personal opinions of the sub-
ject securities and that he had not received any compensation that
might have improperly influenced his opinions. As a result of the
foregoing misconduct, FINRAsuspendedWeitz for 30 days in all
capacities and fined himUS$10,000.
Private Reprimands
On 21 September 2011, CFAInstitute imposed a Private Reprimand
on a Charterholder Member. CFAInstitute found that the Member
violated Standard III(B)Duty to Employer of the CFAInstitute
Code of Ethics and Standards of Professional Conduct (1999).
In 2005, while arranging to move to a newfirm, the Member
participated in removing copies of his employers client lists, new
account forms, account statements, and other documents and in-
formation to be used to solicit the employers customers to move
their business to the newfirm. In mitigation, the Member promptly
returned the documents when asked to do so.
violated the CFAInstitute Bylaws Articles 2.17 and 11.3, and Stan-
dards I(A)Knowledge of the Law, I(C)Misrepresentation, I(D)
Misconduct, andVII(A)Conduct as Members and Candidates
in the CFAProgramof the CFAInstitute Code of Ethics and Stan-
dards of Professional Conduct (2005).
Between November 2007 and October 2010, the Member was
a party in a lawsuit in which his professional conduct was at issue.
But, in his 2008 and 2009 Professional Conduct Statements, the
Member denied that he was a subject or defendant in any litiga-
tion in which his professional conduct was at issue. The omissions
occurred because the Member improperly delegated his reporting
obligations to a subordinate, and there was no evidence that the
Members actions were taken intentionally to avoid or put off in-
quiry by the Professional Conduct Program.
violated Standards IV(A)Loyalty andV(A)Diligence and Rea-
sonable Basis of the CFAInstitute Code of Ethics and Standards of
Professional Conduct (2005).
In August 2008, the Member forwarded to several acquain-
tances in the investment community an e-mail description, pre-
pared by an unidentified attendee, of a public companys presen-
tation to financial analysts. The Member noted in the cover line for-
warding the report that there were rumors that this company was
committing accounting fraud and could go bust. This e-mail
was written and disseminated in such a way that it appeared to be
a research opinion, unsupported by reasonable analysis, of the
Members employer. The public companys stock price declined.
In mitigation, no nonpublic information was involved, and there
was no indication that the Member intended to make a stock rec-
ommendation or manipulate the market when he imprudently
forwarded the e-mail.
On 21 September 2011 CFAInstitute imposed a Private Reprimand
violated Standards I(A)Knowledge of the Law, I(C)Misrepre-
sentation, IV(A)Loyalty, and IV(B)Additional Compensation
Arrangements of the CFAInstitute Code of Ethics and Standards
of Professional Conduct (2005).
In 2007 and 2008, the Member had an unauthorized oral
agreement with an estate-planning specialist associated with his
firm, pursuant to which the Member would refer clients to the spe-
cialist without actually talking to the clients before making the
referral. This arrangement caused insurance companies to be in-
formed, incorrectly, that the Member was servicing those clients
and allowed the Member to receive additional compensation from
the specialist for making the referrals. The Member did not secure
written authorization fromhis firmfor the arrangement, which vio-
lated technical aspects of firmpolicy. The Members truthfulness
and cooperation with the PCPwere exemplary during inquiries,
and there was no evidence of any actual damage to clients, the
employer, or the insurance companies.
KEY POI NTS
When considering a career move, begin by evaluating
strengths, weaknesses, values, and both professional
and personal goals.
Having a plan helps, but in the current market, job seekers
should be open to different directions and opportunities.
Personal contacts can open doors. Networking remains a
very powerful tool.
Social media can help, but many succeed without it.
Recruiting can still play an important role.
Career
In Transition
Nine charterholders share advice on career moves
BY LORI PIZZANI
ooking for a new job or new career challenge?
Considering sliding over to work for a firm affili-
ated with your present employer? Wondering
what does and doesnt work in the current job
market? To answer these and related questions, CFA Mag-
azine spoke to several CFA charterholders who recently
changed jobs and asked them to share their experiences,
including their tips for a successful transition.
Tired of Retirement
For all intents and purposes, John Manley,
CFA, was retired. He had held several in-
creasingly responsible positions at Smith
Barney in New York City and then UBS
over his nearly 30-year career. He had won
accolades for being a seven-time member
of the Institutional Investor All-America Re-
search Team as well as being voted multi-
ple times as the most popular analyst in a Smith Barney
Financial Advisor poll. But when his boss at UBS decided
to retire, he declined to follow. There were tool sheds to
be fixed and DVD collections to be put in order, he quips
about taking the plunge into retirement.
Several months later, boredom hit and he launched a
desultory campaign to find a job. A friend told him that a
Wells Fargos mutual funds unit had posted a job online
but the application deadline loomed. He applied online at
the 11th hour. Several interviews followed, and he was
hired as the fund groups chief equity strategist, based in
New York City.
Keep your rsum as current as possible, he says.
Doing so paid off when he was able to apply for a
serendipitous job opportunity with lightning speed.
Manley openly admits that he used social media plat-
form LinkedIn, which provides the right amount of access
to connect with many people in order to stay in touch
with colleagues and friends. [For more on how advisers
are using social media, see Private Client Corner on p. 30.]
But one-on-one networking was useful as well. They
called it networking even before there was a net, he
says. He learned from his early years as a stockbroker that,
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ultimately, the more people you speak to, the more clients
you attract. The same is true of networking for a job. It
depends on how badly you want the job, Manley says.
Looking back, he says he used his brief retirement as
an opportunity for reflection. I had a few months when I
was retired to walk, think, and consider what my strengths
and skills are. His new job allows him to leverage those
precise skills.
In his view, the key to securing a new job, especially
for someone who may be discouraged and feel unable to
do it one minute longer, is to not give up, exude self-confi-
dence, and sell yourself. Dont think about what you want
but what the other person needs, he says. You have to
sell yourself and see yourself in that job. In addition, job
seekers need to be able to accept rejections on the road to
finding that next job.
Getting to Know You
Michael Swinney, CFA, wasnt actively looking for a new
position when a friend, also a CFA charterholder, intro-
duced him to someone at San Franciscobased investment
consulting firm Callan Associates. At the time, he was con-
tent and doing well working as an investment consultant
with Hewitt EnnisKnupp. An informal lunch with a Callan
manager followed. He subsequently met
with others in the Atlanta office and was
intrigued by what Callan was doing. The
thought of joining a private, best-in-class
investment consulting firm became attrac-
tive to me, he says. But the key was for
them to get to know him and for Swinney
to get to know them.
At the time, Swinney says that he real-
ly didnt look to other Atlanta investment
consulting firms he knew were hiring, but he had consid-
ered looking. The more he spoke to the folks at Callan, the
more he turned his attention solely to that firm.
Conversations progressed and Swinney, whose casual
first meeting had taken place in February 2011, went to
work for Callans Atlanta office in August as a vice presi-
dent in Callans Fund Sponsor Consulting group. The
work I am doing hasnt really changed, he says.
Although he did not use Facebook or LinkedIn as
networking tools, he reached out to a core group of six to
CONNECTION
L
Career Connection is a new column that will appear in each issue of CFA Mag-
azine. Want to ask a career-related question or suggest a topic for us
to explore? Please contact Lori Pizzani at dapizzanis@aol.com.
Manley
Swinney
eight investment management contacts to network with, to
bounce ideas off them, and to seek their independent opin-
ions about his potential new employer. They all said,
Great culture, youd be a good fit, he says. That positive
feedback gave him the confidence to continue having dis-
cussions. Since joining Callan, Swinney says that a lot of
people have been reaching out to him via LinkedIn.
I think youve just got to assess the personality and
cultural fit as much as the technical capabilities you
bring, Swinney says. Be yourself and let your profession-
al capabilities come through.
The Right Opportunity at the Right Time
Sometimes the right new opportunity finds you.
Case in point: Andy Walker, CFA, who joined the San
Franciscobased investment management company RS In-
vestments in September 2011 as an equity analyst covering
industrial and power companies as part of the hard assets
group. He had previously worked for a decade at Colorado-
based Janus Capital and before that at Goldman Sachs.
I wasnt looking to move on, but this
opportunity came along and was a good
fit, Walker says. He had personal connec-
tions with people at RS Investments, in-
cluding one peer he had gone to school
with. When he learned through a contact
that the firm was looking for an analyst,
he spoke to people socially and inter-
viewed with the firm to learn more about
its corporate philosophy and goals. The
insight piqued his interest.
A personal and stylistic fit was an impetus for the job
as well as knowing some of the people I had worked with,
he says. From first contact to being hired took about three
months, and he relocated from Denver.
Walker did not use Facebook or LinkedIn but admits
that he might have used the social media platforms had he
been actively looking for a new job. He believes maintain-
ing personal connections, as well as continuing social in-
teractions, is vital. At the end of the day, this job came
about through a personal connection. You have to have the
basis for talking to people, even if youre not looking for a
new job now but may be down the line, he says.
Make sure that the place you are going to is a good
fit, he says. Is there a personality fit, and do you know the
people from previous jobs that you can work closely and
collaboratively with? He also suggests looking at the new
companys approach to investing: Does it fit into your val-
ue system? he asks.
Doors Wide Open
The formal job transition of Paul Hamilos, CFA, took nine
months, although he admits that the cogs were set in motion
more than two years earlier when he learned about the firm.
He was also recently hired by RS Investments and joined
its value team as a financial institutions analyst. He was
previously a vice president and analyst at Macquarie Group.
Hamilos had helped a former colleague with a search
that landed a position at RS Investments. When he took the
job, I kept in touch. I left doors openandlet
himknowthat Idbe interestedif anything
came up, he says. When he later traveled
to San Francisco to visit his friend, he was
introduced to people at the firm, but at that
time there were no jobs available.
Expect the process to be lengthy.
Keep your options open even if you are not
looking, Hamilos says. Its worth taking
the time for the introspection and to fig-
ure out what career you want, then pursue that. I really
made sure I was pursuing the position I had an interest in
long term and that it would be a good career move.
Carpe Diem
Greg Tornga, CFA, head of fixed income and a portfolio
manager at Edge Asset Management in Seattle since July
2011, seized a job opportunity he saw posted on the CFA
Institute career website as well as the website of parent
company Principal Financial Group.
1
His job transition
took about six months, and he relocated from his previous
job as a senior vice president (head of investment-grade
credit) at Payden & Rygel in Los Angeles.
Quality of life played into his decision
to move for the new job opportunity. You
have to enjoy where you live, what you
do, and the people you work with, he
says. If you hate it, it can grind on you.
He says he didnt use social media be-
cause, given his role, he didnt feel com-
fortable doing that. But he did research
the new company online. Now that Ive
changed jobs, I do see that there is a lot more information
on LinkedIn about jobs, but that was not so a year ago.
The key, according to Tornga, is to be patient and pre-
pared for an opportunity. If youre going to look for newem-
ployment, you need to be ready and not give it a half effort
because it shows. Obviously, with whats going on in the
job market, there are fits and starts, he says. When youre
least likely to be looking, the opportunity comes along.
In the current buyers market, job seekers have to set
realistic expectations for compensation, the people, the job
cycle, and your expected longevity. There is no one-size-fits-
all and different people in their careers want different
things, he says.
Opportunity Calls
Despite independent job search efforts, recruiting is far
from dead.
Duncan McKeen, CFA, who joined Lockwood Finan-
cial of Montreal in September as a senior mining company
analyst after working at Macquarie Capital Markets
1 CFA Institute members can access the CFA Institute Career Centre at
http://careercentre.cfainstitute.org.
Walker
Hamilos
Tornga
R E C O MME N D E D R E S O U R C E S
Career Conversations: Getting the Recruiter Perspective
CFA Institute podcast with Deon Brenner, CFA
(www.cfawebcasts.org)
The Role Social Media Can Play in Managing Your Career
CFA Institute webcast featuring Matthew Youngquist
Canada, was initially called by a recruiting
firm. At the time of the call, McKeen says
he had already been seeking other oppor-
tunities, specifically an ambitious young
company looking to grow. The entire job-
changing process took about six months
and included a bit of courting. Since the
team at Lockwood is small and tight-knit,
we both wanted to make sure that it was a
good fit, so we spent a lot of time getting to know each
other before we signed a contract, he says.
How did he know it was time to change positions?
I had worked for small, entrepreneurial companies in the
past and was looking to relive that experience again, he
says. Small companies have the ability to make decisions
and adapt very quickly, often having ad hoc meetings in
person or on the phone and we avoid heavy e-mail use and
calendar scheduling. This keeps the environment dynamic,
efficient, and fun, McKeen adds.
His best tip? Speak or meet with people you already
know and use that as a starting point to build a network,
he says. People who are hiring often start by considering
candidates they know and those who have been recom-
mended by friends and colleagues. By the time the employ-
er has progressed to external posting, the competition has
increased considerably, McKeen adds.
Resetting Your Mindset
The right attitude is to be confident and say, Im not sure
this is the job for me, but I am going to get out there and
show my best, says Daniel Kern, CFA, who in August
2011 became the president of Advisor Partners, an invest-
ment advisory firm in Lafayette, California. Previously a
managing director and portfolio manager at Charles Schwab
Investment Management, Kern decided it was time to leave
after having 16 different bosses over an
eight-year period. All of the bosses who
knew of my successes were gone, he says.
Kern admitted that he drifted for a
while before drawing up the blueprint to
find a new job. I spent lots of time plan-
ning to plan a job search, he says. He was
discouraged and initially had a very differ-
ent type of job in mind. When friends told
him he was setting his sights too low and
suggested he pump up the job level based on his skill set, he
reworked his resume and reset his expectations. It came
from people who knew me well professionally. Having that
kind of feedback allowed me to interview better, he says.
Kerns best advice for those seeking newjobs is to be as
prepared as possible. Candidates win or lose not on talk-
ing about their career and background but by having done
thoughtful research on a [potential] company and asking
insightful questions.
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A New Role
This past August, Ken Schiebel, CFA,
moved to head up the newly formed Port-
folio Strategies Group, a spin off from
PFM Asset Management in Harrisburg,
Pennsylvania. He had been a managing di-
rector and 15-year veteran of the firm. The
new position offered him a bigger, better
role. The transition began with a review,
begun earlier in the year, about how the
firm provided services to clients. Execu-
tives elected to reorganize and create a new group that
would focus on the firms fixed-income portfolio manage-
ment and marketing along with research, analysis, and cus-
tomized solutions for clients.
A broader perspective can often be a step toward real-
izing opportunities. It may make sense to step back and
look at the bigger picture and future needs of the organiza-
tion and the way to effect positive change, Schiebel adds.
Expect Surprises
Christopher Sheldon, CFA, had been working in various
functions for BNY Mellon Asset Management since 1995.
He had most recently been president of the BNY Mellon
Funds and had been the chief investment
strategist of the banks wealth manage-
ment division. The firm decided to com-
bine wealth management and asset man-
agement into one division, which includ-
ed bringing the Dreyfus Corporation into
the fold. In April 2011, the former chief
investment officer at Dreyfus announced
his retirement. After considering several
candidates, Sheldon was chosen and as-
sumed the new position in November. He had not been
seeking a new position externally.
Ive been at the other group for 16 years. I had an im-
pact. I felt that I was gaining something, not losing some-
thing, he says of the transition.
Sometimes people sit back too much. Dont be afraid
to stretch yourself, he counsels. But be prepared for a lot
of work. Transition is a lot of work, and there are always
new challenges.
Lori Pizzani is an independent financial services journalist
based in Brewster, New York.
Kern
Sheldon
Schiebel
McKeen
Career
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KEY POI NTS
Whether long or short, investors need to understand the
impact of trading mechanics.
Borrowing fees and other costs (as well as the threat of a
buy-in) can make short positions cost prohibitive.
In some cases, borrowing rates can lead to toxic security
prices and a no-win situation for both the buyer and the seller.
Short It and Forget It?
The trading mechanics of shorting can be costly
BY DENNIS DICK, CFA
he recent Groupon IPO has garnered a lot of ana-
lyst attention. Some analysts have said the stock
isnt worth the $15 billion market cap and is a no-
brainer for shorting. Groupons business has few
barriers to entry, and the stock is even-
tually going to fall as competition in-
tensifiesor so goes the argument.
Well, Groupon might be overvalued,
but the case is not as simple as short it
and forget it.
A lot of factors must be consid-
ered when shorting a stock. Can the
stock even be shorted? Is the stock
easily borrowable? If not, how much is
the borrowing rate to short the stock? How great is the risk
of a possible buy-in if the stock becomes hard to borrow
after I have shorted it? All of these questions need to be
answered before initiating a new short position.
Take a closer look at the mechanics behind shorting a
stock like Groupon. The first step is to find out whether
the stock can actually be shorted. In order to short a stock,
the stock has to be borrowed from an investor who is long.
Many stocks that are highly traded can be shorted easily if
the customers broker has ample inventory. Other stocks are
hard to borrow, and the trader must call the brokers secu-
rity lending desk to obtain a locate on these shares. The
broker will charge the trader a fee for lending these shares.
For less-liquid stocks, such as Groupon, the brokers lend-
ing desk may have no inventory, and the trader may have
to go outside of the brokerage to locate the stock.
This situation is where a company such as Locate-
stock.com can get involved. Locatestock.com operates an
electronic platform that brings lenders of stocks and short
sellers together and specializes in locating hard-to-borrow
stocks for traders.
Large institutions who would like to lend their stock
populate our inventory and advertise a rate that they would
like to be paid on the stock they lend, says John Tobacco,
CEO and founder of Locatestock.com, explaining the me-
chanics behind his business. We then advertise that rate
to traders who would like to short the stock. We charge
a transaction processing fee to the trader for facilitating
the transaction.
The rate that lenders demand for borrowing their stock
is a factor of supply and demand. If ample supply exists
T
and the demand is relatively low, the rate may be as low as
a fraction of a percent. But in the case of a stock like Groupon,
the demand is very high (because many investors feel the
stock is overvalued). The supply is also limited because
the float is small. In addition, underwriters of new IPOs
are restricted from lending their shares for the first 30 days
of trading, which limits the supply further. In such cases,
an institution holding the stock long will demand more
compensation for loaning its shares.
In the case of Groupon, three days after the IPO, the
daily borrowing rate at Locatestock.comwas 9 cents a share.
Keep in mind that this rate changes continuously, so the
rate may fall later as the stock becomes easier to locate and
the demand to short the security drops. But if Groupon
stayed at this borrowing rate for over a year and a trader
held the stock short the entire time, the trader would pay a
total of US$32.85 a share ($0.09 x 365). With Groupon cur-
rently trading at US$24 a share, the stock could potentially
fall to zero and the short trader would still lose money.
In other words, the short trader has a considerable
amount of risk. For short-termtraders, this fee is feasible be-
cause Groupon can have excessive intraday moves. But for
traders that want to short the stock for longer time periods,
this fee would make that short position cost prohibitive.
In some extreme cases, these borrowing rates can actu-
ally lead to toxic security prices that cause both the buyer
and the seller of the security to lose.
For example, Ford Motor Company has an exchange-
traded debt note (Ford Motor Co., 7.50% Notes trading
under ticker symbol F.PRA on the NYSE) that pays quarterly
distributions of US$0.46875 a share. The next distribution
was due on 15 December. The security traded on 15 Novem-
ber for a price of US$27.00 when the security was callable
In some extreme cases, these
borrowing rates can actually lead
to toxic security prices that cause
both the buyer and the seller of
the security to lose.
Trading
TACTICS
Short Arbitrage, Return Asymmetry, and the Accrual Anomaly
Summarized in CFA Digest (November 2011)
(www.cfapubs.org)
at the issuers option at a price of US$25.00. Considering the
high rate of the coupon (7.5 percent per annum) and the
fact that Ford recently called in a similar security back in
March, Ford logically might have called this security early, a
move that would have made the price of US$27.00 look
like an attractive short because a trader could have banked
US$2 if the security was called the next day.
But significant fees were associated with shorting this
security. The borrowing fee on 15 November was 7.1 per-
cent per annum at Interactive Brokers (a retail brokerage
firm). Thus, an investor shorting this security would have
paid US$1.917 per annum in borrowing fees to stay short
the security (assuming the borrowing rate remained the
same throughout the year). The investor also would have
been required to pay the distributions of $1.875 per annum.
The total annual cost would have been US$3.972or
$0.010389 a day.
If the short trader was banking on the security being
called, the call would need to have happened in the next
192 days for the short trader to make money (US$2 poten-
tial gain divided by daily cost of $0.010389). In other
words, for the short to be profitable, Ford would have to
call the security by 26 May 2012. If it was called after this
date, the short trader would lose.
Now take a look at the other side of this tradethe
investor buying the security. The investor can currently buy
the security at US$27. Considering the US$27 purchase
price and the potential callable price of $25, a long investor
would stand to lose US$2 if the security was called the
next day. But the investor would continue to receive quar-
terly distributions of $0.46857 each quarter if the security
was not called. The next quarterly payment was due on 15
December 2011. The interest would continue to accumu-
late on this security after this date at the rate of $0.46857
each quarter. The investor would need to receive a mini-
mum of four more quarterly distributions plus an addition-
al 24 days of interest in order to make money at the US$27
purchase price. The breakeven date for this would be 9
October 2012. If the security was called before this date,
the investor going long would lose on the investment.
Therefore, if the security was called between 26 May
2012 and 9 October 2012, the current price of the security
would be toxicbecause both the investor going long and
the investor going short would lose. As can be seen, these
borrowing costs are a very important consideration when
shorting a security.
Not only should investors consider the borrowing costs
when initiating a short position, but they also need to con-
sider the possibility of a potential buy-in, especially if illiq-
uid issues are being shorted. If the brokerages clearing firm
is unable to locate a previously shorted stock, that short
position may become subject to buy-in so the brokerage can
stay in compliance with restrictions on naked short selling.
Typically, a notification is sent to the trader who is
short, stating that the security has become hard to borrow,
and if new shares cannot be located, the security may be
bought-in. Buy-ins usually occur on less-liquid securities,
which often have a very small float. The lack of liquidity in
these securities can pose some substantial risks to traders
who are short.
It is dangerous to short an illiquid stock because at
anytime the clearing firm can buy you in, says Jeff Gold-
man, managing partner at JC Trading Group. Sometimes,
they give you a warning that you have so much time to
cover the position, but other times, they give little or no
notification at all. They just buy-in the position. If the se-
curity has little liquidity on the sell side, these buy-in
prices can get pretty ugly.
To compound problems for the short traders, stocks
often become difficult to locate in multiple brokerages si-
multaneously. Other shorts may be subject to buy-in at the
exact same time, putting a further demand on sell-side liq-
uidity, which can press the buy-in prices even higher.
In any event, it is important for traders looking to ini-
tiate a new short position, to analyze the costs of putting
that position on as well as the costs and risks in holding
that short position for longer periods of time.
But understanding these costs and risks can be valu-
able information for long-only traders as well. Excessive
borrowing rates and potential buy-in risks are two serious
deterrents in shorting illiquid securities. With fewer shorts
to keep the prices in check, these deterrents could possibly
lead to over-inflated prices. A stock such as Groupon could
remain at lofty prices for quite sometime, even if the funda-
mentals of the company are hurt by increasing competition.
Whether youre a long trader or short trader, it is im-
portant to consider the overall trading mechanics when
making an investment decision. Being right on the funda-
mentals can still result in being wrong in the P&L.
Dennis Dick, CFA, is a proprietary trader at Bright Trading
in Detroit and a member of CFA Detroit.
Not only should investors
consider the borrowing costs
when initiating a short position,
but they also need to
consider the possibility of
a potential buy-in.
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Private KEY POI NTS
Financial advisers increasingly are using social media as a
communications channel.
Advisers face the challenge of making their messages stand
out from the online noise while meeting compliance regula-
tions.
Different strategies have proven successful for advisers and
financial professionals in varying capacities. The key is
adapting effectively to your own circumstances.
C F A MA G A Z I N E J A N F E B 2 0 1 2
BY ED MCCARTHY
ocial media have gone from leading edge to every-
day use within a few short years and continue to
grow. The latest social media forum, Google+, has
more than 25 million users already. At times, it
seems everyone is tweeting, blogging, and participating on
networks such as Facebook, Twitter, LinkedIn, and others.
And financial advisers are no exception.
Participating in these technologies can pay off. Rick
Ferri, CFA, founder of Portfolio Solutions in Troy, Michi-
gan, estimates that 95 percent of his leads for prospective
clients come from the internet. Hes an active publisher of
online content and user of social media, and these tech-
nologies drive his marketing plan: We hit a billion dollars
in assets, and so the question is, How do you get to three
billion? And the answer is you get to more people. How do
you get to more people? Well, through the internet.
Although social media have become standard commu-
nication tools, they pose several challenges for financial
advisers. Compliance is frequently cited as a deterrent.
How can advisers reach their target audiences without vio-
lating the rules? The second challenge is making messages
stand out in an environment where many advisers pursue
similar messaging strategies. We asked several advisers and
industry consultants who have been successful with social
media for their insights on participating effectively while
avoiding regulatory problems. Without exception, they be-
lieve these media can benefit advisers who are willing to
spend the time required.
A Virtual Network
Ferri started using the internet to build his business about
12 years ago. He began by writing articles for his website
and publicizing those articles in investment chat rooms
and online message boards. He also put the chapters of his
first book, Serious Money, into PDF format and allowed
readers to download them. Subsequent books (he has pub-
lished six) led to more online writing opportunities, in-
cluding a column for Forbes.com on index investing.
As the volume of Ferris writing grew, he decided to
centralize it on a new site, RickFerri.com, which serves as
his online publishing hub. He uses multiple social media
platforms to publicize his writing and to engage readers
with cross-links among the media that create a virtual net-
work to leverage his online presence. There are links on
Forbes website back to my website, and there are links on
Social Graces
Advisers are using social media to get an edge
S
CLIENT CORNER
the Morningstar website and links on the Bogleheads.org
website that link back to my website, he says. When I
write something that I think is worthy of telling other ad-
visers about, I put a post on LinkedIn [that there] is a new
article or a new interview I just did, a new video that I
think has interest to the adviser community.
The writing and social media marketing take signifi-
cant time. Ferri recently hired a director of interactive mar-
keting to oversee the firms online marketing efforts. In
Ferris mind, marketing with social media is no longer op-
tional. Its not easyit really isnt, he says. Youve got
to do a lot of work, but if you dont do the work, you may
not survive.
Dealing with Constraints
Advisers communications, including social media, are sub-
ject to regulatory constraints. Mike Langford, senior social
business strategist with Socialware, a social media software
firm in Austin, Texas, says following the general guidelines
of recognizing what constitutes advertising and what con-
stitutes advice can help avoid regulatory problems. If
youre on a social network, consider it to be akin to being
on a television interview or a radio interview, he says.
What type of information would you share there versus
what would you share in a client situation?
Advisers affiliated with broker/dealers usually operate
under more constraints than their registered investment
adviser (RIA) counterparts. Bill Winterberg, owner of FP-
Pad.com in Dallas consults on technology and practice
management with independent financial advisers. He
points out that registered reps affiliated with FINRA-regu-
lated broker/dealers typically operate in much more conser-
vative compliance environments. Additionally, there is no
common guidance among broker/dealers, and some firms
prohibit their reps from using social media altogether. U.S.
SEC-registered advisers have more leeway, according to
Winterberg. I feel they [SEC-registered advisers] have a
bigger opportunity because the rules that the SEC has pro-
vided are fairly general and fairly open as they pertain to
social media, he says. So, certainly, independent advisers
will want to avoid testimonials, they want to avoid posting
any performance information relative to the portfolios
that they manage. But outside of those specific areas, I
think that most topics are fair-game discussion on social
media sites.
Tweet Success
CFA Magazine (Nov/Dec 2010)
(www.cfapubs.org)
The Role Social Media Can Play in Managing Your Career
CFA Institute webcast featuring Matthew Youngquist
Stepping Out
CFA Magazine (Nov/Dec 2009)
(www.cfapubs.org)
31 C F A MA G A Z I N E J A N F E B 2 0 1 2
Circumstances vary widely, however. Kerry Jordan,
CFA, a managing director who handles development and
capital raising with Phalanx Capital Management in Chica-
go faces an additional constraint with her social media ac-
tivities because Phalanx is a hedge fund for private in-
vestors. Consequently, she cant discuss the firms products
with prospects until she has verified that they are accredit-
ed investors. She cant even link her LinkedIn profile to
Phalanxs site because that might be construed as an offer
for sale.
Nonetheless, Jordan maintains an active and success-
ful social media presence within the restrictions. She par-
ticipates on LinkedIn and sites such as Opalesque and Al-
bourne Village that focus on alternative investments. Jordan
believes her participation builds her credibility, which in
turns leads to inquiries about Phalanx. As an example, she
cites her activities on LinkedIn, where she belongs to rough-
ly 17 focused groups. Whenever I have a questionfor
example if I am looking for someones best practices or if I
am going to be speaking at an eventI will post something
on my LinkedIn site, she says. I will probably get 4050
people looking at my profile just as a result of that one
posting. Of those 4050 hits on my profile, I generally will
get six LinkedIn requests, people making inquiries of me.
Her online participation doesnt take much time or ef-
fort, says Jordan. Its a marketing tool. It leads me to peo-
ple that may be investors for the fund, so its a low-cost
way to market, to help me develop my business, and it
takes very little time. It takes three seconds to post that
[announcement], and its all going on in the background
while Im actively doing my job.
Advisory firms can use social media for multiple pur-
poses. Andy Zimmer, managing director with Vestor Capi-
tal Partners in Chicago was seeking to hire financial advis-
ers but wasnt satisfied with the results professional re-
cruiters were delivering. He decided to try contacting po-
tential job applicants via LinkedIn. Once he identifies
potential hires, he sends them basic information about the
position hes trying to fill and asks if anyone in their net-
work meets the criteria. The contacts often express interest
themselves, he says: Youre asking for the opportunity to
speak to people that they know, but on occasion, they raise
their hand and indicate that they might have an interest in
interviewing for the position as well. So, its pretty effec-
tive. Using LinkedIn has led Vestor to offer positions to
several advisers. Factor in the searches cost savings, Zim-
mer adds, and his firm is very happy with the results.
Get Creative
As more financial advisers adopt social media, it becomes
more difficult for messages to be heard above the online
noise. Overcoming that problem is possible but requires a
creative approach to using the media. Consider the follow-
ing suggestions for improving your social media business
development efforts:
Focus your network. You dont need a massive network
with hundreds of participants to succeed, says Langford.
Building a smaller network of qualified prospects and refer-
ral sources of roughly 100 connections lets you tailor your
content and participation to that groups interests.
Avoid the overcrowded networks. Langford cites the
Chamber of Commerce-style meeting in which there are
18 financial advisers and three to five insurance agents and
accountants and so forth all circling around the one or two
people in the room who dont already have a financial ad-
viser, an insurance agent, or what have you. His advice is
to look beyond the overcrowded forums and become active
in groups based on the things that interest you. As an ex-
ample, Langford cites his active participation with groups
that enjoy the Red Sox, craft beers, and good food. Sharing
these personal interests with others online can help form
the personal bonds that lead to business.
Provide quality and not just quantity. A financial profes-
sional needs to be a thought leader, and in order to be
viewed as a thought leader online, you must publish con-
tent, says Stephanie Sammons, founder of social media
consulting firm Wired Advisor in Dallas. That means pro-
ducing quality articles, videos, podcasts, white papers, pre-
sentations, and webinars that will interest your target mar-
ket. If youre not publishing online, then youre really
nothing online, says Sammons. And this content that
you produce to position yourself as an authority in your
target markets can easily be syndicated out to your social
media communities and can also be a great way to position
yourself within your target markets as an expert.
Participate. One-way conversations wont build rela-
tionships, says Winterberg. What doesnt work is people
using social media as their personal megaphone or their
personal bullhorn, and all they do is push and push and
push content. They fail to follow up with conversation and
dont respond to inquiries or comments and feedback.
Ed McCarthy is a freelance financial writer in Pascoag,
Rhode Island.
What doesnt work is people using
social media as their personal mega-
phone or their personal bullhorn.
BILL WINTERBERG
KEY POI NTS
The U.S. SEC has now twice used new deferred-prosecution
agreements and non-prosecution agreements to compel
corporations to self-report federal securities law violations.
The SEC hopes to obtain evidence earlier from people close
to misdeeds and develop more robust investigations.
Companiesand investorsmust consider the benefits
and drawbacks to these agreements.
BY LORI PIZZANI
his past May, Tenaris, the Luxembourg-head-
quartered manufacturer of steel tubes and
provider of other services to the worlds energy
industries, became the first-ever corporation to
reach a deferred-prosecution agreement with the U.S. SEC
under a new cooperative enforcement regime. Tenaris had
discovered an internal bribery scheme that included
undisclosed payments of commissions to agents hired to
help the firm win contract bids with an agency of the gov-
ernment in Uzbekistan.
Under the terms, Tenaris agreed (1) to produce all
non-privileged information, documents, and materials no
matter the location, (2) to use best efforts to secure full
and truthful cooperation from current and former direc-
tors, officers, employees, and agents responding to regula-
tors inquiries, and (3) to have personnel testify at trials or
proceedings over a two-year period.
The company paid US$5.4 million in disgorgement
and interest to the SEC and agreed to enhance policies
and procedures, strengthen compliance, implement due-
diligence requirements, and notify the SEC of subsequent
infractions.
The SECs new enforcement regime was first an-
nounced in January 2010 and borrows heavily from the
U.S. Department of Justices long-standing prosecutorial
structure. Thats not surprising. Robert Khuzami, the
SECs director of the Division of Enforcement who was ap-
pointed in February 2009, previously spent 11 years as a
federal prosecutor with the U.S. Attorneys Office in New
York City, including three years as chief of the units Secu-
rities and Commodities Fraud Task Force.
Investigating from the Inside Out
The SECs new cooperative enforcement platform encour-
ages both companies and individuals to offer greater coop-
eration to the U.S. securities industrys top regulator, which
engages in in-depth investigations and imposes enforce-
ment sanctions for federal securities lawviolations.
The ultimate goal? To build stronger investigations
and obtain evidence earlier, says Lorin Reisner, former
deputy director of enforcement at the SEC who left in ear-
ly January 2012. The purpose of cooperation agreements
is to help us bring stronger cases and obtain information
and evidence earlier from those with direct knowledge of
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unlawful conduct. That model has proven effective in the
Department of Justice context.
In return for that cooperation, the SEC has promised
to consider a lighter regulatory hand in the form of offer-
ing companies (and their fully cooperative personnel) the
possibility of reduced sanctions, deferred-prosecution
agreements, and/or outright non-prosecution agreements.
That is a significant departure from the SECs customary
full-blown enforcement actions, which carry hefty fines
and penalties, harsh sanctions, and reputational harm.
When we launched this initiative, we had no game
plan as to when the first deferred-prosecution agreement or
non-prosecution agreement would be used. We take these
investigations as they come, Reisner says. Weve been
very pleased with the results of our 33 cooperation agree-
ments to date, which involve many different types of cases.
I think this has greatly enhanced our enforcement efforts.
Not every infraction will be eligible for deferred prose-
cution. The SEC will fully assess the seriousness and per-
vasiveness of the misconduct and whether the case was an
isolated incident, whether the misconduct involved a com-
panys senior personnel, whether there was full and com-
plete self-reporting to the SEC, whether the company sub-
sequently engaged in exemplary conduct, and whether it
quickly took full and appropriate remedial actions. Reisner
adds that the model was designed to allow those less cul-
pable to benefit from providing information concerning
those who engaged in more culpable conduct.
Test Cases
In the case of Tenaris, the SEC found that fromApril 2006 to
May 2007 regional sales personnel had bribed government
officials in Uzbekistan to gain access to confidential con-
tract bids fromcompetitors. According to the SEC, the com-
pany used this information to revise its own bids and win
government contracts to the tune of US$5 million in profits.
But in March 2009 a third party revealed those illegal
payments, which violated the Foreign Corrupt Practices
Act. The audit committee of Tenaris board hired a law firm
to investigate the matter. In June 2009, those payments
were voluntarily brought to the attention of both the SEC
and the Department of Justice, which later, and in conjunc-
tion with the SECs May 2011 profit disgorgement man-
date, levied its own US$3.5 million criminal penalty and
established its own non-prosecution agreement with
Tenaris. In uncovering the bribes, Tenaris quickly ordered
Enforced Cooperation
Will the SECs new enforcement regime
yield better results?
T
Standards
IN PRACTICE
Countering Market Abuse (EMEA Voice)
CFA Magazine (July/August 2011)
(www.cfapubs.org)
The Other CEO (Standards in Practice)
CFA Magazine (May/June 2011)
(www.cfapubs.org)
an internal review of the compliance system and beefed up
its anti-corruption policies and practices by strengthening
its code of conduct, business conduct policy, and process
for retaining and paying agents.
Immediate self-reporting, comprehensive internal in-
vestigation, procedures enhancement, and cooperation
with the SEC all led to the regulators decision to grant the
deferred-prosecution agreement. The SEC, however, has
been stingy with deferred and non-prosecution agreements.
Only two have been implemented since the programs start,
and none of the names of the corporations entering into
cooperation agreements have been publicized.
While Tenaris was the first to hatch a deferred-prose-
cution agreement with the SEC, Carters, the childrens
clothing manufacturer based in Atlanta, was the very first
company to test the SECs cooperative policy. A fewmonths
before Tenaris, in December 2010, Carters became the first
to reach a full non-prosecution agreement with the SEC.
The SEC agreed not to prosecute Carters in return for a list
of concessions and full cooperation.
The agreement and investigation focused on the mis-
conduct of a former Carters executive vice president of
sales who was found to have engaged in financial fraud and
insider trading from 2004 through 2009. The executive
manipulated the amount of discounts the firm granted one
large department store that sold Carters clothing. Those
special accommodations were then erroneously mischar-
acterized by Carters accounting personnel. The same exec-
utive also exercised his stock options for a profit during
this period while financial conditions were being overstat-
ed. Carters discovered the misconduct in 2009 and subse-
quently restated several years of financial statements.
In announcing the non-prosecution agreement with
Carters, the SEC cited the relatively isolated nature of
the unlawful conduct and praised the companys prompt
and complete self-reporting of the misconduct, thorough
internal investigation, and extensive cooperation with
investigators.
No Huge Implications?
In the Carters case, the company got out in front of the
issue early on and fired the people maybe even before the
issue came to light, says Scott Krasik, CFA, senior research
analyst with BB&T Capital Markets in New York City.
Carters did everything it should have done. There were
no huge implications.
Since then, Krasik says, he has fielded investors ques-
tions regarding the companys credibility, but concerns were
dispelled. Once investors understand the level and scope
of whats covered (in the non-prosecution agreement), as
long as it isnt fraud which could come back to affect man-
agement in the future, investors move on, he says.
Such agreements can be beneficial to companies.
But there are drawbacks.
A company will enter into a deferred-prosecution or
non-prosecution agreement, pay a fine, be recognized for
its cooperation, and its stock price will often go up, says
Jacqueline Wolff, partner with the law firm of Manatt,
Phelps & Phillips in New York City. But the case does not
just go away. Under a deferred-prosecution agreement, the
SEC can bring the identical charges that it agreed not to
prosecute if the company breaches the agreement during
the two- or three-year term. In other words, she says, If
youre bad, they can prosecute later. She also notes that a
companys insurance policy would generally not cover the
cost of a penalty or disgorgement.
Questions and concerns have recently surfaced, in-
cluding whether the SECs new regime will translate into
watered-down investigations, given that insiders are help-
ing investigators connect the dots.
I dont think the investigations (into Carters or
Tenaris) were any less vigorous, says Ian Roffman, partner
in the Boston office of law firm Nutter McClennen & Fish
and a former SEC prosecutor. The SEC was finding the
right balance between crediting good behavior and not let-
ting bad behavior get a full pass.
Just because the SEC said it will give companies a
break doesnt mean a flood of companies will come forward.
If the SEC shows sensitivity toward trying to encourage
companies to come forward, then it will be good, says Lisa
Noller, partner in the Chicago office of Foley & Lardner.
But there is a risk. If the SEC isnt transparent in its
actions or uses a heavy hand, it wont compel companies to
come forward, warns Sam Winer, partner in the Washing-
ton, DC, office of Foley & Lardner.
Theres motivation on both sides, but cooperation
agreements are not for every case, says Keith Bishop, part-
ner in the Irvine, California office of the law firm Allen
Matkins. When theres an investigation into a corporation,
thats a pretty dark cloud that is following you around. You
just want it to go away as soon as possible, says Bishop.
Companies must weigh the pros and cons, however, before
deciding on an agreement. I think youll see a lot more
self-reporting by companies and see more investigations
but not all will result in deferred or non-prosecution agree-
ments, he predicts.
Companies will have to decide whether they want to
buy peace early on, says Robert Ray, partner with Pryor
Cashmans litigation group in New York City. Are the in-
centives great enough and is the downside risk low enough
to encourage companies to come in early, get this going,
and secure the benefits?
Lori Pizzani is an independent financial journalist based in
Brewster, New York.
After a decade of outperformance,
have inflation-indexed bonds
reached the tipping point?
BY ED MCCARTHY
TIPSy
T
he past year was another good one for Treas-
ury Inflation-Protected Securities (TIPS). The
Barclays Capital U.S. Government Inflation-
Linked Bond Index, which includes TIPS
with one or more years remaining to maturity
with a total outstanding issue size of US$500
million or more, was up 14.65 percent (year to date)
through 4 November. Longer-term bonds with maturities
over 10 and 15 years were up 25 percent and 26 percent,
respectively, for the same period (see Table 1).
Most of the gains came in the first half of the year
(although the eurozone crisis moved prices higher in late
fall), but the performance was no fluke. Figure 1 compares
returns from TIPS and nominal intermediate-term Treasur-
ies with inflation for the 19982011 period and illustrates
TIPS outperformance for four of the past five years.
This market generally has produced some pretty
strong returns in recent years, says John Hollyer, a princi-
pal with the Vanguard Group and co-manager of the Van-
guard Inflation-Protected Securities Fund in Valley Forge,
Pennsylvania. The general theme has been that interest
rates have been falling a lot, and the nice thing about TIPS
is that they have a pretty long average life, or duration, and
they are Treasury quality, so some of the credit issues that
have emerged in the past fewyears havent affected their val-
ue at all. So falling rates and high quality have caused bonds
with high quality and long duration to performreally well.
TIPS and Inflation
TIPS short-term returns are volatile and may underper-
form the trailing inflation rate. Thats because TIPS returns
are determined by the realized rate of trailing inflation
(i.e., inflation adjustments to a bonds principal) and the
markets expectations of future inflation. In the short
term, declining or rising interest rates will cause TIPS
prices to move substantially, and so you could be in a ris-
ing rate environment and have TIPS produce a negative
total return over the course of 12 months, Hollyer notes.
Thats true with any long-term bond investment.
TIPS investors frequently focus on the breakeven
inflation (BEI) rate as an indicator of anticipated inflation
and a TIPS pricing guide.
1
The BEI is the difference be-
tween the nominal Treasury yield and the comparable ma-
turity TIPS yield. For example, in early November 2011
Bloomberg.com showed the 15 August 2011 10-year Treas-
ury at a 2.03 percent yield and the 15 July 2011 TIPS bond
at 0.10 for a BEI of 2.13 percent. (Bloomberg tracks the
U.S. 10-year BEI under the U.S. 10-year breakeven rate
[USGGBE10:IND].) The rule of thumb for evaluating TIPS
prices compares the investors anticipated inflation rate with
the BEI. An investor who believes inflation will be higher
than the BEI will buy TIPS on the expectation that TIPS will
outperform comparable-maturity Treasuries. When the BEI
is greater than the investors expected inflation rate, TIPS
are considered overpriced and forecasted to underperform
on a total-return basis (from that investors perspective).
The BEI can be volatile, as the second half of 2008
showed. As concerns over tight monetary policy and a pos-
sible global depression spread, 10-year Treasury yields fell
to just above 2 percent, roughly the same level as 10-year
TIPS. On 1 July, the BEI was 2.55; by December 26 it had
fallen to 0.10. By June 2009, the BEI had moved back
above 2 percent. That volatility persists: the BEI dropped
from 2.65 percent in early April 2011 to 1.7 percent in late
September before bouncing back to 2.13 percent in early
November.
1 For more details on the BEI, see Daniel C. Dektar, ABCs of TIPs,
CFA Institute Conference Proceedings (2005).
TABLE 1
TIPS 2011 RETURNS
(year to date through 4 November)
Index Return
U.S. government 14.65%
13 years 3.54
35 years 8.09
57 years 11.44
710 years 14.95
10+ years 25.18
15+ years 26.61
Source: Based on Barclays Capital data,
cited with permission.
Source: Based on data fromVanguard, Barclays Capital Live, and the U.S. Bureau of Labor Statistics.
Note: Annual year-end returns are represented by the Barclays Capital U.S. Intermediate Treasury
Index for nominal intermediate Treasuries and by the Barclays Capital U.S. Treasury Inflation-
Protected Securities Index for TIPS. Inflation is represented by year-end over year-end results for
the Consumer Price Index for All Urban Consumers (CPI-U).
FIGURE 1
TIPS AND INFLATION
20%
15%
10%
5%
0%
5%
1999 2009 2007 2005 2003 2001
Sept
2011
Nominal Intermediate Treasuries
TIPS
Inflation
Despite the short-term volatility in the BEI, TIPS ap-
pear to provide inflation protection over the long term. Re-
searchers have found that holding TIPS for shorter periods
is not an effective method for hedging against short-term
fluctuations in inflation.
2
Longer-term investors do receive the expected benefits
because buying new issues and holding to maturity locks
in a risk-free real rate of return. Changes in the inflation
rate based on the U.S. CPI-U are highly correlated with
inflation rates based on other price indices over long peri-
ods, conclude the researchers So, TIPS provide effective
protection against unanticipated changes in the average
inflation rate over fairly long horizons. If TIPS had been
available during the 1970s and 1980s, they would have
been a very effective means of locking in a real rate of re-
turn. In contrast, long-term nominal Treasury issues pro-
duced unexpectedly erratic rates of return.
Going Negative
The falling interest rates that have increased prices of TIPS
and other bonds to premium levels have also pushed short-
er-term TIPS yields into negative territory. As of early No-
vember 2011, the five-year TIPS yielded 1.12 percent and
the 10-years yield was 0.10 percent. Dan Dektar, chief in-
vestment officer with Smith Breeden Associates in Durham,
North Carolina, points to the Federal Reserve as driving the
low rates. The Fed is holding real rates
negative in order to transfer wealth
from savers to borrowers, he says.
Thats one way of looking at it, and
another is they want to make sure that
deflation doesnt take hold in the U.S.
economy. The only tool that they really
have to be able to do that is to take the
real yield on short-termrates negative.
Some advisers and bond fund man-
agers believe that TIPS are still attrac-
tive despite the negative yields. Holly-
er cites a TIPS bond maturing on 15
April 2013 with a 0.625 coupon as an
example. Although the bonds price in
late October was US$102, producing a
yield of 0.84 percent, he believes the
investment is rational. By paying a
US$102 price for that bond, youre
paying 2 percentage points above par,
and youre only going to get par at ma-
turity, he says. Youre only going to
get over the course of two years 0.625
(interest) x 2 for two years, so youre
going to get 1.25 percent back. But the
investor who buys that bond is expecting a positive total
return because hes also going to get whatever inflation
happens over that two-year time frame.
Other investors and advisers claim that TIPS are over-
priced. Russ Koesterich, CFA, iShares global chief invest-
ment strategist in Jersey City, New Jersey, believes that
investors who are buying TIPS with negative yields are
expressing an excessively pessimistic economic view. He
argues that these negative-yield investors are accepting sig-
nificant duration risk and locking up their money for a
period with zero real return. Now, to my mind, this only
makes sense under one scenario, he says. It only makes
sense if you believe the U.S. is about to enter a period of
Japanese-style deflation. Therefore, the breakeven numbers
on the TIPSin other words, the implied inflation rate
are way too high, and were actually going into a deflation-
ary period.
Littman Gregory Asset Management in Larkspur, Cali-
fornia, recently decided to sell TIPS from their conserva-
tive tax-exempt portfolios. In early October, Jack Chee, a
senior research analyst with the firm, published an article
on the firms AdvisorIntelligence.com website explaining
the decision. In short, the firms estimated returns for TIPS
have fallen significantly below the average total return (in-
come plus price change) of 7.1 percent from their intro-
duction through July 2011.
EXHIBIT 1
TIPS PERFORMANCE UNDER DIFFERENT SCENARIOS
Real Economic Growth
Inflation Low High
High Easy Fed
Oil shock
Stagflation
Positive for safer currencies
Negative for financial assets
(including equities)
Best TIPS scenario
Low General economic weakness
Economic or geopolitical event
Debt deflation
Positive for government bonds
Negative for commodities
TIPS Performance Mixed
Low Economic Activity
Source: Based on data from Daniel Dektar and Smith Breeden Associates.
36
Strong economic growth
Weak dollar/foreign
capital withdrawal
Positive for cyclicals
Positive for commodities
Negative for government bonds
TIPS Performance Mixed
Aggressive, effective Fed
Lower oil prices
Productivity boom
Positive for real estate
Worst TIPS Scenario
High Economic Activity
C F A MA G A Z I N E / J A N F E B 2 0 1 2
2 Michelle L. Barnes et al., A TIPS Scorecard: Are
They Accomplishing Their Objectives? Financial
Analysts Journal (September/October 2010).
TIPS protect against inflation but still share the inter-
est rate risk of conventional bonds (among other similar
risks). And the firm anticipates higher interest rates. Chees
analysis:
When interest rates rise, bond prices fall, and vice
versa. From 1997 to July 2011, interest rates trend-
ed lower, declining from close to 6 percent to 2
percent, serving as a tailwind to bond prices. But,
over the next five years our expectation is that in-
terest rates will rise from current levels of less than
2 percent to levels between 4 percent and 8 per-
cent, depending on the scenario, and that there
will also be a rise in real rates, though the two rates
will not move uniformly. So, while we generally as-
sume that inflation will persist over our investment
horizon such that the principal value of TIPS will
adjust higher, these income gains will be offset by
principal losses in the form of lower TIPS prices
when real rates rise.
3
TIPS and the Economy
Despite their premium prices, Dektar maintains that TIPS
can still play a role in portfolios because they can perform
well in an otherwise adverse macro scenario. He sees two
diametrically opposed schools of thought in the world.
One is that economies are heading further into a debt de-
flation cycle. Thats what the central bankers and policy-
makers are fighting against in Europe as we speak and the
Federal Reserve as well, he says. So, theres a good case
to be made for significant deflation. But, as much fuel as
theyre pouring on the fire here, certainly long-term infla-
tion risk is there and thats one of the possible escape
routes from the debt problems were having. Its not clear
which way were going.
If investors are worried about inflation, they need to
distinguish between whether its going to be in a high-
growth or low-growth scenario, according to Dektar. TIPS
will be the best performing asset in a low-growth, higher-
inflation environment, and there isnt much else in that
sector that will do well. When growth is low and inflation
is high, TIPS are the best, as shown in Exhibit 1. In the
high-growth, high-inflation scenario, commodities, equi-
ties, and real estate, for example, will perform well.
TIPS in the Portfolio
Hollyer believes TIPS can play several different roles in a
portfolio. The first is inflation insurance (i.e., an asset that
should be responsive to unexpected changes in inflation).
When inflation is as low as it is today, he notes, TIPS are
sensitive to unexpected increases in inflation. The second
role would be as a diversifier in a portfolio. Because of
their inflation-index nature, they dont move exactly in
lockstep with other bonds, especially when inflation ex-
pectations are changing, says Hollyer. Any asset that has
a reasonable expected return but potentially somewhat
lower correlation can be a diversification benefit in a port-
folio. So I think those would be the two primary objectives
of TIPS in a portfolio.
Mark Willoughby, CFA, a principal with Modera
Wealth Management in Westwood, New Jersey, says his
firm follows a strategic asset allocation approach and TIPS
are a core holding for clients. Modera uses TIPS mutual
funds, and Willoughby estimates that the typical portfolio
has a TIPS allocation of 3 percent to 5 percent. This defen-
sive strategy fits well with the firms approach. As an asset
allocation shop, we think theres a good chance that infla-
tion will pick up at some point but we have no idea by
how much and when, says Willoughby. When we allo-
cate to TIPS, were trying to put a protection for our clients
in their portfolio against unanticipated inflation. Were
concerned about unanticipated higher levels of inflation,
and we want to have some protection in our clients portfo-
lios for that eventuality if it ever occursbecause when
you buy TIPS, theres a breakeven inflation point.
Dektar points to another strategy with TIPS. Smith
Breedens portfolios can hold them with a short Treasury
position that Dektar says essentially positions them for
higher or lower inflation. When you talk to TIPS traders,
they talk about holding them on a real-yield basis, which is
unhedged, or holding them on a breakeven inflation basis,
which is fully hedged with Treasuries or in lieu of Treasur-
ies, he says. Then what you get for your capital gain or
loss is the differential between the Treasury yield and the
TIPS yield.
The variety of TIPS investment options allows for ad-
ditional strategies in addition to direct long and short posi-
tions. Investors concerned with a near-term spike in infla-
tion should consider short-term TIPS or PIMCOs 15
Year U.S. TIPS Index Fund (symbol STPZ), according to
Lawrence Weinman, a financial adviser in Los Angeles,
California, who described several strategies in a SeekingAl-
pha.com article.
4
Laddering TIPS maturities via exchange-
traded funds is another option with STPZ on the short end,
the iShares Barclays TIPS Bond Fund (TIP) for intermedi-
ate coverage, and the PIMCO 15+ Year U.S. TIPS Index
Fund (LTPZ) for the long end. To lock in the breakeven
rate, Weinman suggests purchasing both the 10-year TIPS
and the iPath U.S. Treasury 10-year Bear ETN (DTYS).
With this strategy, he writes, if nominal Treasuries yield
increases, the hedge will increase in value to offset changes
in the TIPS value if those yields rise simultaneously.
Ed McCarthy is a freelance financial writer in Pascoag,
Rhode Island.
3 Jack Chee, TIPS Asset Class Review, AdvisorIntellingence.com (7 October 2011).
Reprinted with permission.
4 Lawrence Weinman, Yes, You Should Buy TIPS; Heres How and When,
SeekingAlpha.com (25 February 2011).
S
TANDING UP FOR THE RIGHT CALL, doing the
job the way its supposed to be donethats what
drives Mike Mayo, CFA. A veteran analyst with a
reputation as a maverick, Mayo was named by Fortune
magazine as one of 8 Who Saw the Crisis Coming and
testified before the Financial Crisis Inquiry Commission
in 2010 on the causes of the financial crisis. Now manag-
ing director with Crdit Agricole Securities (which pro-
vides services in the U.S. for CLSA, a global boutique
brokerage firm), Mayo spoke with CFA Magazine about
analyst independence, the events leading up to his 1999
banking sector downgrade, and his subsequent termination
by the firm that employed him as well as how to improve
capitalism.
How has your view of ethics evolved?
I got my CFA charter in 1991. At the time, I found the ethics
component more annoying than anything. In some ways, it
almost reminded me of the Ten Commandments. I felt like
it was a matter of checking the box more than something I
would actually apply.
During the extreme stock market bullishness of the late
1990s, there were almost no sell ratings. I wanted to down-
grade the bank group and specific banks to a sell rating.
That was a huge professional and personal risk. The CFA
Institute Code of Ethics and Standards of Profes sional Con-
duct helped give me the backbone to make the most signifi-
cant professional call of my life in May 1999, when I down-
graded the bank group and put sell ratings on banks, in the
midst of what is likely to have been the most bullish period
of our professional careers.
What specific conflicts were you facing?
There were competing loyalties. One loyalty was to the
companies I covered. Some of these companies were quite
nice to me. I went on the Gulfstream jet of Bank One with
the Bank One CEO who in 1992 was voted Banker of the
Year by American Banker. It wasnt lost on me that compa-
nies had given me information and access.
A second loyalty was to my firm. Credit Suisse was
getting many investment banking deals done. They allowed
me to invite my wife and investors to fancy dinners on the
highest floors with celebrity chefs of the New York City
scene. And my bosswho had hired mehad given me a
shot I could never have gotten several years earlier.
I had loyalty to my family. Wouldnt not rocking the boat
be the best way for me to provide for my family? So, when I
decided to downgrade bank stocks to sell ratings in the late
1990s, I knew doing so could be perceived as violating loyalty
to the companies that I covered, to the firm where I worked,
and to my family, notwithstanding my desire to call it straight
for the investor.
It was one of the hardest decisions in my life because
everyone in the room is telling you to do it one way, and
you are thinking about doing something different. That
is not a move to be taken lightly. In fact, one day, I was
actually going to make the downgrade and I chickened out.
I backed out.
How did you make the decision?
Ultimately, I realized that I was either supporting the CFA
Institute missioneither I had a purpose in what I was
doing, a meaning in helping to make a better systemor I
was neglecting my duties and just trying to make as much
money as possible. If I neglected the duties, then I wasnt
really seeing the job as adding value to the world. Theres
soul searching at a time like this. Do I matter? Does my job
matter? There is no question about what the Code and
Standardsspecifically Standard III: Loyaltyhave to say
about situations such as mine. If I have a choice between
loyalty to my company, loyalty to my firm, and loyalty to the
investor, the Standards of Practice Handbook doesnt mince
words. Client interests are paramount.
Either I would do the job in the way that is described
in the Standards of Practice Handbook, or the CFA charter is
completely irrelevant. If you just go by the book, my call
was pretty easy and straightforward. In fact, when I told my
wife, she said, Well thats your jobyou say buy, you say
sell. Whats the big deal? She didnt get it as far as the steps
I was taking. But the reality was that nobody used sell ratings.
The morning I made the downgrade, Joe Kernen of
CNBC said, Whos Mike Mayo, and do we know whether
he was turned down for a car loan? I went on CNBC in the
afternoon, and the question was asked of me, Do I trust
that there wont be a big backlash against me? My answer
was, I trust that the banks will do the right thing and allow
me to do the job the way it is supposed to be done. In the
MISSION
In his new book Exile on Wall Street,
analyst Mike Mayo, CFA, argues for integrity
BY JONATHAN BARNES ONA
end, I made it until the merger of Credit Suisse and Donald-
son, Lufkin & Jenrette in 2000.
What happened next?
I made this big call, and then I got fired as part of the merger.
Prudential Securities wanted to make some noise about be-
ing a true independent research firm and they hired me to
help lead the way. I was featured in commercials that played
during the Kentucky Derby and the NBA finals. Immediate-
ly after the tech bubble crashed, there was a lot more atten-
tion to the need for sell ratings. There were others before
me and others after me. But I would say at that period of
time, I gave it renewed momentum.
What wouldyour career be like if youhadnt takenastand?
I dont think you would be talking to me right now. I could
have lived a comfortable life. If I had given myself an out
and not downgraded the group in 1999, chances are you
would see me today with a bunch of ratings, hold or above.
I would say, Well, my holds are really sells and my out-
performs are really holds and my buys are really buys or
something like that.
Even today, I think that is how the majority of analysts
operate. Most investors kind of get it anyway, fortunately or
unfortunately. But on the other hand, they dont always get
it. Hold ratings are a way to hedge as far as what you really
think. Bottom line is, if I didnt make that May 1999 call,
then I would have simply been like the
majority and blended in.
What could make it easier
for analysts now?
One is simply the culture of a firm. At
my current firm, there is a culture that
encourages independent research. In
fact, we dont even have hold ratings.
We have buy, outperform, underper-
form, and sell. There is no ability to
simply say hold. Talk about a culture
encouraging independent research
that says quite a lot.
Having more CFA charterholders is
always a good thing. In time, I would
like to see more CFA charterholder-only
firms.
Why cant there be CFA charter-
holder-only firms where every senior
analyst is a CFA charterholder? It is
time to bring the CFA designation up to the next level. The
first CFA exam was in 1963, the year I was born. So the
CFA Program is growing up. When the CFA Program turns
50, can we start thinking about CFA charterholder-only firms?
In your book, you write about a better version of
capitalism. What does that mean to you?
It means having improved transparency. The role of account-
ing is to capture reality in numbers, and the goal of financial
analysis is to take those numbers and recreate reality. If the
numbers arent right and if the accountants arent getting it
right, then the financial analysts cant get it right either. Part
of the solution is what I call ABC. A stands for accounting
and, frankly, auditing too. We need some combination of
auditor rotation or auditor accountability (a person who
signs their name to an auditing report) and more information
than the passfail approach in place now.
The B stands for bankruptcy. Let firms fail when they
should fail. Lets not go the route of the zombie companies
in Japan. If banks overextend themselves, the government
shouldnt step in and prop them up. Allow capitalism to
work. There is a survival-of-the-fittest element in our version
of capitalism, and to support underperforming banks or
companies is a gross resource misallocation.
The C stands for clout reducing the clout of the
large banks and other corporations. We need to give power
back to the shareholders as opposed to the sometimes en-
trenched managers and boards. Shareholders should have
more avenues to speak up, and a company should be more
apt to listenbecause in my experience looking at some of
the largest banks, that has been anything but the case.
How can this be done practically?
The U.S. SEC could make it easier for shareholders to have
a say on a range of topics. The Public Company Accounting
Oversight Board is looking at changes in auditing to give
more clarity in auditing statements. Regulation should en-
sure that the banks have less leverage
and better transparency. But dont micro-
manage them either. Give the banks
rules, and then allow them to function.
Its important to have a tone from
the topnot just for brokerage firms
but really from the top of our country
that personal responsibility and ethics
matter. Some combination of the chair-
man of the Federal Reserve, the secretary
of the Treasury, and other leaders should
set a tone to encourage ethical behavior
based on transparency, long-term orien-
tation, and accountability. Moral persua-
sion can go a long way.
Everybody has an incentive to pur-
sue their self-interest and make as much
money as possible, but not when there is
misleading information or people are
cutting corners in their professional re-
sponsibilities.
What do you think of the current banking environment?
Who knows what will happen by the end of 2011, but we
are seeing two themes. One we are calling Japan lite.
Nobody is saying that it will take 20 years for the U.S. to
recover from the current situation, but to some degree, the
U.S. is in the third year of what has been a 20-year cycle in
Japan. The question is, how much longer?
For the banking industry, this is likely to be the worst
revenue-growth year since 1938. It is simply a function of
Ultimately, I realized
that I was either
supporting the CFA
Institute mission
either I had a purpose
in what I was doing, a
meaning in helping to
make a better system
or I was neglecting my
duties and just trying
to make as much
money as possible.
having overshot the loan growth in the past decade, and now
you are likely to undershoot at the same time that growth is
less. It is simply a matter of fewer loans, lower margins,
lower capital market fees, and some additional regulatory
costs. It does not have to be the end of the world. Slow
growth can be okay, as long as the companies recognize their
limitations.
The second theme is crisis-lite, meaning that when
Europe sneezes, the U.S. can catch cold. That can certainly
have an impact on capital market revenues, which includes
trading, investment banking, and stock market-sensitive
revenues. It can also cause a big risk-off trade and encourage
investors to pull back on risk as well as companies and con-
sumers and overall retrenchment. I am defining the current
period as both Japan lite and crisis-lite.
Do you have banks that you favor now?
No bank is immune to the pressures that I am talking about.
I dont know of one bank that ever thought that the 10-year
bond would be anywhere close to 2 percent. Even if it goes
to 3 percent, that is still lower than people had expected,
which further depresses revenues.
Is there still the pressure of backlash in your job?
Ive established a habit of changing ratings on stocks regard-
less of the pressures, but there are still pressures on Wall
Street analysts. I am still aghast and amazed. I cannot believe
that this still happens after everything that has gone wrong,
from the analysts scandals to the banking crisis. We have
had enoughthe real estate crisis in the early 1990s, the
tech bubble, the blowups of Enron and WorldCom, and the
housing crisis.
Has being a Wall Street outsider helped you?
No question that being a Wall Street outsider has forced me
to do better work and not to rely on management statements
as much. Ive had to dig a little harder
and kick a few more tires for the research.
You write that the crisis didnt occur
because of something that banks
did it was the natural consequence
of the way banks are, even today.
The main idea is that the crisis didnt
stem from a single action that banks
took or even a set of actions. It wasnt a
one-time occurrence. It was basically
what you would expect to happen with a financial system
set up the way ours is. And the basic structure of our system,
with all the flawed incentives and lack of market conse-
quence, is still in place.
How can the system be re-incentivized?
At the top of the list is compensation. In many cases, execu-
tive compensation still isnt based on long-term incentives.
Legitimate incentives, as well as stronger clawbacks (espe-
cially for CEOs and top executives) are needed. They should
have more deferred compensation.
Compensation at the SEC could also be re-incentivized.
The SEC staff that performed poorly during this crisis should
be fired. The SEC should hire back half as many but pay them
twice as much to reduce the incentive for them to move from
the public to private sector. For regulators, clawbacks should
be based on the success of the entities they regulate. The
number of regulators that specifically examine large banks
should be increased.
At the rating agencies and accounting firms, ways should
be found so that accountants and rating agencies are more
accountable to investors as opposed to the companies they
rate. This change may involve a new payment scheme be-
cause the purpose is to benefit investors.
How would you like your book to be received?
I would like to say that, as a result of this book, positive
change developed in the financial systemauditing and
accounting rules were improved, bankruptcy was more
accepted, and clout of big companies was moved in favor of
shareholders. To the extent that we get some wins, we can
think about effecting more change.
By writing Exile on Wall Street, Im trying to bring aware-
ness to the issues in plain English. I wrote this book for
everybodys mother. Not only do I want CFA charterholders
to read the book, but I want them to give it to their mother
and say, This is what we are up against. This is what we deal
with, and this is how Wall Street has gone astray. The issue
isnt that capitalism is bad but that we havent had capitalism
functioning the way it should.
What kind of a role would you like to play?
Actually, somebody else asked me this recently. Do I intend
to use this as a stepping stone to something else, like Andrew
Ross Sorkin? Or do I intend for this to enhance my job?
Id like this to allow me to do my job better as an analyst, to
allow me to make statements about companies without fac-
ing a potential backlash in all sorts of
subtle ways.
Theres a phrase in Judaism, tikkun
olam, which means repairing the world.
It relates to the ultimate question of
what am I doing. What am I supposed to
be doing here? CFA Institute helps to
make the financial world better and the
goal is to actually make the world better;
therefore, I should go ahead and do the
job the best that I can.
It just comes down to having meaning in my job. I feel
that money is an enormous motivator, but I think that misses
the point sometimes. The search for meaning is an even
greater motivator. Meaning for me is to have a sense that
my job somehow connects to improving the world where I
live.
Jonathan Barnes is a freelance journalist and author of the
novel Reunion.
The issue isnt that
capitalism is bad but
that we havent had
capitalism functioning
the way it should.
What is your
measure of value?
Now that investment performance measurement has its own professional designation,
the answer is simple: the Certicate in Investment Performance Measurement (CIPM
).
The CIPM program offers the nance industrys only designation dedicated to the specialized
eld of investment performance evaluation and presentation. The two-level program, driven
by a rigorous analysis of practicing professionals around the world, has at its core three
topics:
s Ethical and professional standards
s Performance measurement, attribution, and appraisal
s The GIPS
standards
Exams are held twice per year, making it possible to complete the program in 12 months.
Visit www.cfainstitute.org/cipm for details and to register.
Jed Schneider, CIPM
Senior Vice President, Verication Services
The Spaulding Group, Somerset, NJ, USA
Because of flawed financial memories, confirmation bias,
and other behavioral factors, investors may not be able
to learn the right lessons from the global financial crisis
BY MAHA KHAN PHILLIPS
FINANCIAL MEMORY IS NOTORIOUSLY SHORT.
The world of finance hails the invention of the wheel over
and over again, often in a slightly more unstable version,
observed the late economist John Kenneth Galbraith in
A Short History of Financial Euphoria. More than 17 years
after the books publication, Galbraiths comments have
never been more applicable to the world of finance. Markets
and investors seem to be suffering from a collective case
of financial amnesia.
People have forgotten whatever they did learn, if they
learned anything at all, says James Montier, a member of
the asset allocation committee at Boston-based fund man-
ager GMO and author of several books on behavioral fi-
nance. It is amazing how short-term memories are and
how unwilling people are to learn from their mistakes. As
a behavioralist, it constantly amuses and disappoints me.
The causes of Montiers frustration are easy to see. In
the aftermath of the worst recession since the Great De-
pression, one which has left most of the developed world
in dire fiscal straits, it is difficult to imagine why banks
would still be complacent about leverage. But complacent
they are.
Although some bank capital has been raised, substan-
tial additional capital may be needed to support the recov-
ery of credit and sustain economic growth under the antic-
ipated new Basel III capital adequacy standards, according
to the International Monetary Funds (IMF) most recent
Global Financial Stability Report. The IMF has been giv-
ing out the same warning since 2008 and still finds lever-
age too high.
The emperor has no clothes on, says Montier. Its
just that people dont really want to listen. You can rant
and rave all you want but you never know what will trig-
ger a collective awakening.
Banks are leveraged 20 to 1 and are mostly investing
in government bonds and mortgages, despite fears of an-
other bubble in the banking sector. Eric Sprott, the Cana-
dian money manager who predicted in 2008 that banking
stocks would plummet, recently argued that U.S. savers
will eventually withdraw funds from banks that remain
overleveraged.
For the past three years, investment banks have talked
a lot about the lessons learned and the importance of risk
professionals. In some cases, however, risk management
has clearly taken a backseat or the processes have simply
failed.
The most glaring example came in September 2011
when trader Kweku Adoboli was arrested for alleged fraud,
and Swiss bank UBS was forced to admit that it had failed
to detect unauthorized trading of index futures on the S&P
500, DAX, and Euro Stoxx 50 during the previous three
months. With losses amounting to US$2.3 billion, UBS
chief executive Oswald Grber claimed such abuses cannot
be prevented when someone acts with criminal energy.
(Grber later resigned.)
The Fundamental Things Apply
Why does the financial services industry have such diffi-
culty heeding the lessons of the recent past? If the devel-
oped world were to enter into a double-dip recession,
nobody could argue that they didnt see it coming.
Joachim Klement, chief investment officer at financial
consultancy Wellershoff & Partners in Zurich, believes
human flaws in financial memory are to blame. Speaking at
the 2011 CFA Institute Annual Conference in Edinburgh,
Scotland, Klement argued that memory plays tricks on
people.
1
We can be conditioned to think in a certain way,
which affects how we perceive the markets.
For example, in the late 1990s, many investors were
conditioned to equate the term dot-com with a profitable
investment. In 1999, the company Computer Literacy
changed its name to fatbrain.com, and its stock went up
33 percent in one day. Similarly, between 2004 and 2007,
companies that added the word oil or petroleum to
their name saw their stock price rally by 8 percent on aver-
age. During the 200210 period, 90 companies in the U.S.,
Europe, and Australia added the word China to their
name. In the four months around the name change, the
stocks of these companies rallied 324 percent on average.
Seven flaws distort financial memory, according to
Klement. Three involve our ability to forget information
(transience, absent mindedness, and blocking), and three
concern false memories (misattribution, suggestibility, and
biases). The final flaw, persistence, is a term used to ex-
plain traumatic memories that are difficult to erase. These
defects may lead to flawed decisions or repeated invest-
ment mistakes.
But experience is another critical variable. Lack of
experience of investors is the biggest part of why the crisis
happened and why lessons werent learnt, going all the way
back to the 1960s, says Klement. Its because there is a
natural replacement of investors. At some point, the old
guys retire and the new guys havent learnt from the past.
He cites research conducted by Robin Greenwood
at Harvard Business School and Stefan Nagel at Stanford
University. In their 2007 paper Inexperienced Investors
1 To view the webcast featuring Klement, go to www.cfainstitute.org
and enter the flaws of our financial memory in the search bar.
You Must Remember This
and Bubbles, Greenwood and Nagel argue that inexperi-
enced investors play a role in the formation of asset price
bubbles. Looking at the performance of equity managers
just before and after the technology, media, and telecom-
munications (TMT) bubble of 2001, they discovered that
younger managers (those under the age of 30) outper-
formed the market in the run up to the crash. In contrast,
older managers (older than 45) fared better after the bub-
ble burst and underperformed previously (see Table 1).
At the peak of the bubble, mutual funds run by younger
managers were more heavily invested in technology stocks
relative to their style benchmarks. Younger managers also
exhibited trend-chasing behavior.
You can go back to the year 2000 and then subtract,
says Klement. If a fund manager in the year 2000 was 30
years old, then his or her entire investment experience oc-
curred in the 1980s and 1990s. Someone who was 50 years
old, however, was more likely to have experienced the
1970shigh inflation and the energy bubble.
Klement draws two conclusions: If I was running an
investment company, one of the things I would really look
out for is having a good mix of young and older people.
You need young people because they have new ideas and
are the risk takers. You also need older people who wont
buy into the most expensive sentence in Wall Street: This
time its different.
Klement believes the industry would be well served
by keeping investment diaries that record manager actions
(buying or selling of shares, etc.), the rationale behind
each decision, and the possible risks attached with the de-
cision. This is something that I still recommend to fund
managers, he adds. Investment diaries help with errors
of cognition but also of omission.
Klement dismisses concerns that diaries are too time
consuming. I have the time. It doesnt take long, actually,
for my short-term trading ideas, he says. Another sugges-
tion is to use a checklist, just as pilots use checklists before
every flight to make sure they havent missed any safety
aspects. Having a framework can prevent managers from
forgetting an important step.
A Miss Is Just a Mis(interpretation)
Others see the fundamental cause of flawed financial mem-
ories as being a different phenomenon that requires differ-
ent solutions. Meir Statman, the Glenn Klimek professor
of finance at the Leavey School of Business at Santa Clara
University, believes the problem is not financial amnesia
but misremembering situations. For example, people are
quick to draw analogies between past episodes, believing
them to be the same as what they are currently going
through. The problem goes back to the saying that history
does not repeat itself but it rhymes, explains Statman.
It is very convenient for us to think that episodes are the
same. We fall into the trap of making confirmation errors.
With confirmation bias, investors look for evidence
that confirms their perceptions and overlook evidence that
disconfirms them. People dont forget the past; they misin-
terpret it. Hindsight can be a misleading thing. It is an in-
sidious cognitive error, says Statman. Are we in a bubble
right now? Are prices now higher than what is the intrinsic
value of the stocks? I dont know. I will only know in three
years time. But in three years time, it will be really tempt-
ing to say, I knew this all along.
He believes that investment professionals tend to be
clinicians: They would rather believe that three experi-
ences that are lodged in their memory are the most impor-
tant, and they form a world view based on that. Profession-
als should know from systematic studies how difficult it
is to beat the market. Yet they just walk around believing
it is easy to do because theyve had three prior successes.
Montier disagrees. Bubbles may have different details,
but they have the same themes, he says. The reason we
didnt spot this last bubble is because we are overly opti-
mistic as a species. We dont stop to think that things look
vaguely familiar. Consider the 2008 crisis. These [collat-
eralized debt obligations] were exactly the same structures
wed seen back in the late 1980s in the junk-bond boom;
its just that they were called collateralized bond obliga-
tions back then. Few people managed to spot the general
similarities.
As Time Goes By
Market structure is a factor. Neil Dwayne, European chief
investment officer for Allianz Global Investors, believes
that investors have stopped investing for the long term.
Instead, with markets experiencing heightened volatility,
possibly driven in part by high-frequency traders, investors
rent stocks. Rather than buying stocks and holding
them, investors buy and sell rapidly. This is renting rather
than investing, and it is causing financial amnesia. It has
become more extreme in the 25 years since Ive been in
this business, he says.
As recently as 25 years ago, according to Dwayne,
the fact that U.K. telephone company British Telecom saw
its share price rise by 5 percent in a day would have been
headline news. Now, the big stocks are moving 10 percent,
he says. Some of these moves are, frankly, ridiculous.
TABLE 1
FUND MANAGER PERFORMANCE
All performance data in %
Age of Outperformance Outperformance
Fund January 1998 April 2000
Manager March 2000 December 2002
25 30 8.16 8.64
31 35 3.6 3.84
36 45 1.68 0.84
46 55 1.32 0.36
56 65 1.56 3.24
66 90 1.32 4.68
Source: Robin Greenwood and Stefan Nagel,
Inexperienced Investors and Bubbles, Working Paper (2007).
Another chief investment officer, Bob Browne at
Northern Trust in Chicago, makes a related point about
market structure with regard to the speed in which infor-
mation is processed and disseminated. Browne draws an
analogy to the invention of the wheelbarrow. First invented
in ancient Greece 2,400 years ago, the device soon van-
ished from Europe and was reinvented in China during the
Han dynasty in the second century. The wheelbarrow sub-
sequently disappeared for a thousand years and wasnt seen
again until around the year 1170 in Europe. This slow
historical process is almost unimaginable today, explains
Browne, because good information is immediately dissem-
inated and acted upon.
The focus on new information can distort the invest-
ment decision-making process and lead to short-termism.
Investors are probably spending 70 percent or 80 percent
of their time focusing on whats happened in the last 30
days and what will happen in the future 30 days, says
Browne. Thats an irrelevant time horizon. The challenge
is to figure out what information has value and what can
be disregarded.
Hearts Full of Passion
The perceived opportunity costs of getting a decision
wrong also complicate matters. Colin McLean, FSIP, points
out that in asset bubble cycles, managers can lose out by
both joining in and staying too late in a market or by not
joining in at all and missing the upside. Thus, managers
are more likely to follow the consensus view.
A case in point would be Tony Dye, one of the U.K.s
best-known fund managers in the 1990s. Dye, who was
chief investment officer at asset management firm Phillips
& Drew (which was subsequently subsumed into UBS),
made the case that markets were too expensive as early as
1995. By 1996, he was moving large amounts of client
money into cash and out of equities. With the subsequent
equities boom, Dye came under immense pressure. The
firm hemorrhaged assets and underperformed, and Dye
was fired before events proved him right. His story was an
exceptiona fund manager who stuck to his guns for
years despite the pressure he was under.
A more common attitude was articulated by Charles
Prince, the former Citigroup chief executive. Commenting
on the leveraged buyout market, he famously remarked,
As long as the music is playing youve got to get up and
dance.
Rick di Mascio, chief executive of Inalytics, the Lon-
don-based performance measurement firm, finds this kind
of mindset ludicrous: People suppress their common sense
in the need to make a profit. Youve got traders looking
purely at their compensation and boards who just turned
a blind eye to risks that institutions were taking because
they all wanted to be a part of the game. It really is a greed
and herd mentality.
David Tuckett, a leading psychoanalyst and visiting
professor at University College London, offers a different
take: The basic starting point would be to say that the
nature of finance is that you cannot know what is going to
happen in the future. That brings radical uncertainty. This
engages with your emotions. Individuals have two states
of mind, according to Tuckett, who is also a pioneer in the
field of emotional finance. They can be primarily integrat-
ed or primarily divided. With an integrated state of mind,
an individual may have many different feelings but he or
she is aware that they have the feelings. A divided person
will examine only those feelings that make him or her
comfortable.
Many investors, particularly professional investors,
say they try to keep their feelings out of investing. But a
better approach might be to realize that they have feelings,
says Tuckett. He believes the biggest financial problems
occur when people are not able to feel anxious about what
they are doing.
What I would say to people is that you need to be par-
ticularly careful to investigate things that you dont want to
think about, explains Tuckett. If you sense within yourself
any kind of feeling of not wanting to examine something,
then thats exactly what you should start thinking about.
Tuckett cites the example of George Soros, who fa-
mously explained that he knew he needed to re-examine
his portfolio when he had a backache because it meant
something wasnt right.
Its Still the Same Old Story
So where does all this leave the market? Regulators cannot
exactly legislate for faulty memories. McLean believes that
market participants should be required to study financial
history. Even the regulators should be reading more histo-
ry books, he says.
Alan Brown, ASIP, chief investment officer of Schroder
Investment Management in London, wants to go deeper:
It wouldnt even hurt to have this on the school curricu-
lum either. Everyone is being asked to make their own
futures, with the development of defined-benefit schemes.
I remember when my eldest son came to me for advice.
He was given an ungenerous pension plan [at work], and
neither they nor the Independent Financial Advisor (IFA)
gave him the information he really needed, which was that
6 percent would never fund a proper pension fund. I
thought that was immoral.
Amin Rajan, chief executive of the Centre for Research
in Employment and Technology in Europe (CREATE) in
London, argues that behavioral biases should be taught in
addition to traditional financial history. We teach [students]
about the stock market and bonds and shares, but we dont
teach them about how people make mistakes, he says.
And unless investors can learn to unlearn mistake-
prone behaviors, the financial wheel will continue to be
reinvented.
Maha Khan Phillips is a financial journalist based in London
and author of the novel Beautiful from This Angle.
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W
ith 19 years of investment and financial ex-
perience in East Africa, Rene Blasky, CFA,
clearly knows the region. As the founder
and managing director of Vista Capital Limit-
ed, a financial consulting firm based in Nairobi, Kenya, Blasky
provides advisory services and has at times helped link in-
vestors to private equity. She also is chair of the East African
Society of Investment Professionals, which hopes to become
the next CFA member society in Africa. In 2006, she was a con-
sultant for the Kenyan Capital Markets Authority in a survey on
investors perceptions of the Kenyan markets. In this interview
with CFA Magazine, Blasky discusses the challenges and op-
portunities of investing in East Africa and future prospects for
growth and returns.
What are investors perceptions of East Africa?
People ask me, What is it like in Kenya? I ask them to
envision living in California in the 1800s. You must have
an entrepreneurial pioneering spirit. There are tremendous
opportunities, but there are also a lot of areas you need to
look out forin terms of what could go wrong. Your risk
management needs to be very strong, and you need to have
a very long-term outlook.
If youre a local investor or have been in the area a long
time, its much like investing anywhereyou know where
the opportunities are, the players, the required procedures,
Spirit
Rene Blasky, CFA,
on investment prospects
for East Africa
BY JONATHAN BARNES
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APIONEERING
and you know the local politics. However, for a foreign
investor coming into the East African market for the first
time, it can be an interesting experience.
What should foreign investors be aware of?
If you are a direct investor, there are a lot of procedures
and licensing. The East African governments are trying to
make the process more investor friendly in terms of reduc-
ing the number of licenses and the time frame. But it can
still take a long time to close a deal, particularly if you are
working with the government as an investment partner. I
am working with a foreign investment group that is trying
to put a deal together in Kigali, Rwanda. The general part-
ner had been very frustrated that after a year [the deal]
hadnt closed, and I was shocked that she thought that it
would have. Deals in this region can take two to three years
to negotiate and close when governments are involved.
What is the Kenyan business culture like?
You have a different protocol than in more developed mar-
kets. It is much more formal here in terms of introducing
yourself and getting to know someone. When you talk to
somebody on the phone, you dont start off immediately
with what you want to talk about. You ask them how they
are, how their family is, and how work is going. Eventual-
ly, you can get around to what you want. It is more like
Japan. Business here is much more centered on relation-
ships than in the U.S. In the U.S., you meet somebody, you
shake hands, and you get down to business pretty quickly.
Not here. Its about the person first.
What are some of the operational risks?
You have issues with electrical power and with telephones.
You have issues with licensing and taxes. It is just not as
straightforward as in other markets. For instance, power in
my office goes off at least once a weekfor a full day. Sup-
posedly, its going off for maintenance, but its been like
this for the past six months. So you have to always have a
backup plan in order to continue operating.
Sometimes it can be frustrating. One client had to
deliver a document to a third party on deadline, and the
courier service got into a motorcycle accident. As a result,
they didnt meet the deadline. Traffic here is horrific and a
huge challenge. To get to a clients office only 15 kilome-
ters away could take me an hour and a half, depending on
what time of day I leave my office.
How big of a story is the Nairobi Securities Exchange
(NSE) demutualization?
Most financial people want to get it done. Its an important
step, as the markets have been stymied by being mutual-
ized. Its going to provide a lot more governance to the
market. The stock market in Nairobi has always been a
boys club, but that is starting to change. The Capital Mar-
kets Authority (CMA) has begun to implement risk-based
supervisory rules to help with governance within the stock-
broker and investment banking community. Theyve taken
away licenses recently from three or four firms because of
abuse of client funds or governance issues.
There was a notice in the paper the other day from a
stockbroker that had let 11 staff go in an investigation of
KSh10 million stolen from a client account. A public an-
nouncement like that has never happened before. The
broker would have kept it quiet. I take my hat off to them.
The brokers have come a long way, and I look forward to
even further improvements.
What else is changing?
There are some big players coming into the market. We
have Moscow-based Renaissance Capital in the market,
and I believe HSBC is looking at coming in as well. I think
J.P. Morgan is looking around. That speaks volumes. These
firms are not going to come in to play a small role. They
are going to come in to do major things. The FTSE is
working with the NSE to build indices. And Bloomberg is
coming in. The markets are going to be much more com-
petitive, and I hope the commissions will come down.
More and more, the East African region is acting as
one market. There was talk of a common currencyI
dont see that [happening] for some time. But the common
market is really a game changer for attracting foreign in-
vestment. You are effectively dealing with an entire region,
not just five separate countries. Kenya has about 40 mil-
lion people; Tanzania, more than 43 million; and Uganda,
about 30 million people. Rwanda and Burundi combine for
another 20 million. Instead of targeting individual coun-
tries, you can target the region as a wholethe likes of at
least 130 million people. Thats the type of market that can
attract a manufacturing or consumer goods company, or
even a financial services company.
How large is consumer demand?
When I first got here 19 years ago, there was a very, very
small middle class. Now the middle class is very active.
When you go to the big shopping malls, you would never
know that anybody is having an economic crisis in the
world. It is packed.
Amazingly, Im very positive long term
for the whole region. In the short
term, we are in a very uncertain period
because of political risk and economic
challenges.
There are Apple stores here, and you have iPhones.
Blackberry is very popular. There are close to 20 million
mobile phones. You see a lot of BMWs, Mercedes, Land
Rovers, and Range Rovers. It is a pretty mobile society.
I believe there is a Marriott hotel coming in and also a
Radisson. I saw statistics the other day that internet usage
in Africa has grown almost 2,500 percent since 2000 (com-
pared with 400 percent in the rest of the world). We are
coming from a lower base, sure, but the growth is huge.
How would you rate the political risks?
Very high, I amafraid, and I dont think its declining in the
near future. We are still paying the price for the violence
following the last general election of 2007 in Kenya. The
economy was effectively shut down for two months. We
had very high security risks. A lot of people were
shutting down their businesses trying to safeguard their
belongings. When I was at a clients office, we would get
phone calls saying, Send your employees home because
things are heating up.
It was quite bad for a whileriots and demonstra-
tions in the streets. People were killed and a lot of people
were displaced. And some of those victims are still dis-
placed, living in tents basically. They havent been relocat-
ed. With the new elections closing in, its not necessarily
going as smoothly as I would like to see. Some of the
things that caused the political violence in the last election
have yet to be resolved.
Could the situation repeat itself?
It could repeat itself. I have spoken to a lot of Kenyans,
particularly younger Kenyans in Nairobi, to get a feeling
about what is going to happen in the upcoming election.
They dont think there will be violence. But in Nairobi, you
have a more politically sophisticated population. It is in
the rural areas where you have more tribal affiliations and
tribal tensions. A lot of the population is still living below
the poverty line. They have nothing to lose. They are the
ones who are potentially going to think, Lets go for it. We
have everything to gain and nothing to lose.
The next election is supposed to be in August 2012,
but it may be pushed to 2013 as they havent worked out
all the modalities of implementing the new constitution.
This uncertainty is hard on business, because a lot of in-
vestment decisions (particularly direct investment deci-
sions) arent made until after elections. People are a little
hesitant to make a business decisions before an election,
because if you have new parliamentarians and a new cabi-
net, things can change.
Do you encounter a lot of corruption?
Corruption can be encountered in dealing with policemen
all the way through to different government departments.
Im not sure if corruption is actually worse than before or
if we are just hearing about it more because there is more
freedom of the press.
The government is aware of corruption. They know it
is harmful for the country, but it is going to take some time
because it is part of the culture of tribal affiliations. In the
1970s, the governor of the Central Bank of Kenya effective-
ly said it was OK for government employees to operate
their own businesses on the side. That way, the govern-
ment didnt have to pay them as much of a salary. Because
of that, you had a lot of government employees setting up
logistics companies and transportation services to sell their
services/products to the government. I think that started
the whole thing.
If you knew what policemen here were earning as a
wage, you would certainly understand why they are trying
to take bribes on a daily basis. They are just not paid a
living wage. They cant send their kids to school, and they
cant pay their rent.
How does corruption affect your work?
When youre dealing with the private sector, you dont face
much corruption. When youre dealing with the exchanges,
you dont have corruption. It is more when you are dealing
with big government projectsroad contracts, power con-
tracts, and telecommunications. Part of our traffic problem
is because the roads arent built correctly. Some body got
money instead of buying bitumen. I dont know what the
specs are, but lets say that instead of building a six-inch
foundation, they built only a three-inch foundation and
the missing three inches is in somebodys pocket.
The government, however, is reducing the amount of
licensing required in an attempt to reduce corruption and
bureaucracy. If you dont need a license and you dont need
to deal with all of the bureaucracy, there are fewer possibil-
ities of corruption.
How are professional standards in the financial industry?
For the most part, Kenya has pretty high standards. It is
improving all of the time. Previously, some risk manage-
ment issues were lacking, but again, the regulatory bodies
are beginning to implement risk-based supervision. I think
the CFA Program has done a lot to increase professional
standards in the region. We now have between 500 and
600 candidates registered for the exams every year. The
exam takes up a whole conference center.
How many charterholders work in the region?
Right now, I believe we have 35 charterholders in Kenya
and another 510 in other East African countries. To start a
CFA member society, we need 50 regular members. We
have enough now and just need to make sure they become
members of the East African Society of Investment Profes-
sionals so we can make a formal application.
In the past, the biggest challenge to increasing our
CFA Institute member numbers has been that Kenyans got
their charter and then left the country. They wanted to go
to developed marketssuch as New York, London, South
Africa, and Dubai to gain experience. That was good, be-
cause they gained a different perspective, but we wanted
them to come home afterward. Since 2008, the financial
crisis actually has benefited us in some ways because a lot
of people are coming home.
What other investments are availableoutside the NSE?
There are mutual funds. We call them collective invest-
ment schemes or unit trusts. I dont knowthe value of assets
under management, but we have about 45 unit trusts oper-
ated by 12 different service providers. Its not as popular
as I had hoped it would be. I think its partly because the
front-load is still too highbetween 5 percent and 6 per-
cent for an equity fund. In the downward market we are
facing now, that is just not viable.
Also, a number of private equity funds are coming into
play. We have foreigners coming in for private equity as
well as locals. The president of Kenya is calling for pension
funds to play a larger role in the funding of infrastructure.
The Retirement Benefits Authority currently regulates the
percentage a pension fund can allocate to private equity or
alternative investments. We dont have any publicprivate
partnership types of investment from the pension funds
So where does the money go?
A lot of it is going into government debt. New regulations
for real estate investment trusts are expected shortly. This
is highly awaited by the whole industry. The pension plans
are really looking forward to the real estate investment
trusts (REITs) because it will provide them with a property
exposureand a liquid one.
The government issued another 30-year infrastructure
bond. They are also issuing a diaspora bond to try to get the
Kenyans who are living overseas to invest back into their
country. It didnt go as well as they had hoped, though. It
was undersubscribed. I think the Kenyan diaspora have less
to invest as they are sending more home to their families
for basic upkeep with increasing food and electricity prices.
There are more opportunities outside the NSE than on
it. If you want liquidity and a dividend yield, you go to the
stock exchange. If you want long-term growth and you are
a risk-taking, venture-capitalist type, then you go private
equity.
Whats the state of the Kenyan shilling?
Our currency has depreciated against the U.S. dollar by
about 24 percent since the beginning of 2011. Inflation is
running around 18 percent [annually]. So life is getting
hard. Costs are really increasing, and most of it is because
the middle class wants imported goods. Commodity food
prices are skyrocketing. Electricity is going up because 80
percent of our power is hydropower and we are in a drought.
The reservoirs are low, and the power company is running
diesel generators.
The government claims a lot of the banks are holding
hard currency and not turning it into Kenyan shillings,
which is really putting pressure on the shilling. And with
the inflation, even government securities yielding 1214
percent can give a negative real return.
So what is your outlook?
Amazingly, Im very positive long term for the whole
region. You have a very young population. You have a well-
trained, English-speaking, highly educated population.
There are massive growth opportunities in transport and
infrastructure, health care, education, IT, telecommunica-
tions, tourism, and the financial markets.
In the short term, we are in a very uncertain period
because of political risk and economic challenges. The new
constitution is still in the infant stages. Provincial govern-
ments are being introduced effectively for the first time, so
there are some teething problems. But overall, I think the
long term looks fabulous. Where you have problems to
solve, you have investment opportunities!
Jonathan Barnes is a freelance journalist and author of the
novel Reunion.
1 For more on the NSE and East Africa investing, see the CFA Magazine interview
with Peter Mwangi, CFA (July/August 2011).
Where you have problems to solve,
you have investment opportunities!
yet. But I think this is a huge opportunity for pension
funds because they can match their long-term assets to
their long-term liabilities.
The NSE has stated it wants to grow to 100 listed
companies by 2015.
Thats been the goal for years, decades it seems. The listed
numbers have ranged between 52 and 56 companies for
years. Every CEO of the NSE has had the goal of increas-
ing listings, but there are challenges to being publicly
listed. One of them is a tax issue. A lot of these family-run
companies or even larger, private companies have not nec-
essarily declared all of their revenue. As a result, they cant
value their company properly. They want a company to
have the highest value for their shareholders, but the fi-
nancials dont support it.
One of the things that the government is considering
is a tax amnesty. But until that issue gets resolved, I think
[NSE CEO] Peter Mwangi, CFA, has a challenge on his
hands.
1
The NSE is trying to do a small and medium en-
terprises (SMEs) exchange, but it also just goes back to
one of our biggest problems, which is liquidity. You have
all of these investorsthe pension funds in particular
have contributions coming in every single monthand
they have got to figure out where to put that money. Typi-
cally speaking, the equity proportion of the asset alloca-
tion for a Kenyan pension fund can be between 25 percent
and 45 percent. Thats low when you consider the average
age of the pension member is probably in the low 40s and
has another 20 years in the work force.
CFA Institute
BRIEFS
Richard A. Allen, CFA
LACONIA, NEW HAMPSHIRE
William C. Allen, CFA
CENTENNIAL, COLORADO
Scott Robert Antill, CFA
SHAKER HEIGHTS, OHIO
Michael H. Biggs, CFA
PLACERVILLE, CALIFORNIA
Benoit Carra, CFA
QUEBEC CITY
William G. Christman, CFA
WEST CALDWELL, NEW JERSEY
Volunteer with the DRC
If you have a strong interest in helping
to uphold ethical conduct in the invest-
ment profession, are a CFA charter-
holder with no pending professional
conduct issues, have a fair and impar-
tial temperament, and have knowledge
of or a desire to learn more about the
CFA Institute disciplinary process, the
Disciplinary Review Committee (DRC)
would like to hear from you.
The DRC, a committee of CFA Insti-
tute member volunteers who help eval-
uate and decide disciplinary cases,
is accepting nominations for potential
new members to begin serving in Sep-
tember 2012. DRC members are a
central component of the Professional
Conduct Program, providing valuable
peer input to the disciplinary review
process for members and candidates
facing alleged violations of the Code of
Ethics and Standards of Professional
Conduct, including the rules and regu-
lations of the CFA Program.
For further details about the
Professional Conduct Program, please
visit the Ethics and Standards sec-
tion of www.cfainstitute.org and select
Professional Conduct Program. To
request a DRC nomination application,
please e-mail DRC staff liaison Julia
Bellis at julia.bellis@cfainstitute.org.
15 Years of Service
Robert Johnson, CFA, former CFA Institute senior man-
aging director for the Americas region, left CFA Institute
in October 2011 after more than 15 years of service.
Johnson joined CFA Institute in September 1996 as vice
president responsible for the CFA Program curriculum
development process; he was promoted to senior vice
president in December 1998. Since then, Johnson has
served as senior managing director for CFA Institute and
has been responsible for several areas, including educa-
tion, financial market advocacy, the professional conduct
program, and development of the organizations Americas strategy. He served
as the executive director of the Research Foundation of CFA Institute. He also
served on the advisory boards of the Journal of Portfolio Management and the
Journal of Wealth Management and has been published in several finance and
economic journals, including the Journal of Financial Economics, Journal of
Finance, Financial Analysts Journal, and Journal of Portfolio Management.
Bob Johnson has made many contributions throughout his 15 years of
service to the organization, including significant enhancements to the CFA Pro-
gram, the introduction of the CIPM Program for performance measurement
professionals, and the launch of our Latin American strategy, said John Rogers,
CFA, president and CEO of CFA Institute. All of us at CFA Institute thank
him for these contributions and are grateful for his legacy.
Departure from the Board of Governors
Mark J.P. Anson, CFA, left his post with the CFA Institute Board of Governors as
of 31 December 2011. Anson did not fulfill the remainder of his second three-year
term due to time demands of his business activities as managing partner and
chief investment officer of Oak Hill Investments. The vacated Board of Governors
seat will be filled following the organizations annual election in May 2012.
J. Parker Hall III, CFA
WINNETKA, ILLINOIS
David B. Healy, CFA
SIERRA VISTA, ARIZONA
Norman M. Johnson, CFA
NORTHFIELD, ILLINOIS
Richard D. Jennings, CFA
WILSON, WYOMING
Michael A.J. Meuse, CFA
ONTARIO, CANADA
Bernard J. R. Mignon
THE HAGUE, NETHERLANDS
Timothy W. Mikullitz, CFA
NEW YORK CITY
Laurie L. Mills, CFA
ONTARIO, CANADA
Stephen J. Mottus, CFA
PIKESVILLE, MARYLAND
William A. Pincoe, CFA
NORTH CANTON, OHIO
Robert R. Roback, Sr., CFA
BALLSTON SPA, NEW YORK
Teo Corinne B.G., CFA
SINGAPORE
Patrick James Tomalin, CFA
TORONTO
In Memoriam
CFA Institute Moves with the Times
BY ASHVIN VIBHAKAR, CFA
The Asia-Pacific region represents more than 27
percent of the worlds GDP, according to recent
Economist Intelligence Unit (EIU) data. China is
forecast to account for 33 percent of the regional
subtotal, and India is expected to have a double-digit
growth rate in the next five years. The region includes 60
percent of the worlds population, and approximately 48
percent of the regions population is under 30 years of age.
Of notable interest are Pakistan, the
Philippines, and Malaysia, where youth
percentages will be at 65 percent, 59
percent, and 55 percent of the coun-
tries total populations, respectively;
these countries are estimated to have
the highest percentage of youth in the
region by 2015. With the right eco-
nomic policies, the relatively youthful
population in these countries can lead
to more sustainable economic growth.
Across the region, the average annual growth rate of
both CFA Institute members and candidates was 15 per-
cent from 2001 to 2011. Currently, the region holds 43.3
percent of global candidates; China and India account for
more than 40,000 candidates. The CFA Program is offered
only in English, which may create a challenge for individ-
uals whose first language is not English, but this obstacle
does not stop candidates in the region from striving to
attain the highly acclaimed CFA designation. Furthermore,
new and seasoned charterholders in the region are quick
to point out the benefits of earning the charterindustry
recognition, respect, and career development as they
continue their efforts to uphold the highest ethical stan-
dards in the industry.
CFA Institute and its members recognize the need to
educate and develop more stewards to face challenges in
the worlds investment markets, especially within the Asia-
Pacific region. We see professional excellence and ethics
as the foundation for both regional and global economic
sustainability. For this reason, CFA Institute continues to
invest in initiatives that promote understanding of the orga-
nizations mission through educational outreach, advocacy,
and industry and society relations.
With professional excellence in mind, CFA Institute
will host its first Asia-Pacific Investment Conference in
Hong Kong in March 2012. The conference will focus on
providing a platform for industry experts across the region
to come together, connect, and learn from CFA charter-
holders and each other. The conference aims to place CFA
Institute at the forefront of the minds of influential leaders
across the region and will pave the way for the CFA
Institute Annual Conference to be held in Singapore in
May 2013.
CFA Institute also advocates for strong ethics and
professionalism in the region through collaboration with
influential industry leaders. For example, the National
Institute of Securities Markets (NISM), established by the
Securities and Exchange Board of India, and the local CFA
member society, the Indian Association of Investment Pro -
fessionals (IAIP), will hold the second India Investment
Management Conference on 13 January 2012.
Furthering our outreach beyond the industry and
toward the growing number of young adults in the region,
the CFA Institute Research Challenge has been growing in
popularity. Last year, more than 600 students from 149
universities participated. This year, more than 156 univer-
sities from 18 countries have enrolled (30 of these univer-
sities are CFA Program Partners). Local rounds of this
years Research Challenge are already under way, and the
regional final is scheduled for March 2012 in Hong Kong.
The winning team will compete in the global final in
April in New York City.
As the markets move, the role of CFA Institute contin-
ues to evolve. Throughout the Asia-Pacific region, CFA
Institute staff and volunteers are working in areas such as
the Global Investment Performance Standards (GIPS), pro-
fessional standards, market integrity, and industry relations
to enhance the regions understanding of how the CFA
Institute mission can benefit the regional and global invest-
ment industry.
Ashvin Vibhakar, CFA, is the CFA Institute managing director
for the Asia-Pacific region.
T
Asia-Pacic
FOCUS
Global Advertising Initiatives
Advertising campaigns in China, India, and France were
launched in December 2011 to promote the CFA Program
and to increase awareness of the CFA designation among
young professionals. We currently have three campaigns
in the market that are continuations of our FY2011 adver-
tising efforts. The Global Employer and Asset Manager
Code of Professional Conduct campaigns are both global,
digital-only campaigns;the Private Wealth Management
campaign runs in North America and has both print and
online components. To find out more about these cam-
paigns, go to www.cfainstitute.org, select Pressroom
under the About tab, and go to Advertising Initiatives.
CFA Institute Scholarships: Awareness and Access
CFA Institute
BRIEFS
BY RAHUL KESHAP
CFA Institute has awarded CFA Program scholarships to
candidates for many years. In our most recent fiscal year,
we awarded more than 3,800 scholarships to university
students, finance professors, employees of regulators, and
worthy recipients selected by our global network of mem-
ber societies. Over the years, these
scholarships have provided recipients
with a substantial discount on the price
of registration for the CFA Program.
Despite the lasting impact of the schol-
arships for those who use them to be-
come CFA charterholders, many years
had passed since CFA Institute had re-
viewed its scholarship strategy. At the
request of the CFA Institute Board of
Governors and our senior manage-
ment, over the last year CFA Institute has reviewed all of
its existing scholarship categories and the rationale for
each of them to confirm a clear strategy for scholarships.
Beyond reviewing the strategic plan, the internal discus-
sion spurred excitement to expand the reach and effective-
ness of our scholarships, and Im delighted to share our
plans with you.
Our mission exhorts us to lead the investment profes-
sion globally by setting the highest standards of ethics,
education, and professional excellence. Scholarships con-
tribute to the mission by promoting more widespread
awareness of CFA Institute certificate and designation pro-
grams and by providing access to those programs for peo-
ple who could not otherwise afford their full price. As a
result of our strategic review, we have crystallized these
dual objectives of awareness and access as the overarching
justifications for offering scholarships.
The objective of awareness directs us to provide
scholarships to those key influencers who are well posi-
tioned to spread knowledge of our programs through
word of mouth, such as the finance faculty of universities,
government industry regulators, and perhaps even jour-
nalists who report on the industry. By encouraging more
of these influencers to earn the CFA charter, the industry
as a whole benefits, and the people they touch may them-
selves learn about the benefits of the CFA Program. The
objective of access dictates that we should make our pro-
grams more broadly available to individuals who are un-
able to afford the full price. By improving opportunity for
people to register for the CFA Program regardless of their
ability to pay, we demonstrate our good corporate citizen-
ship and expand our reach to those who may be strug-
gling to enter the industry but have a great deal of talent
to contribute.
For awareness scholarships, we plan to make changes
to reach key influencers more effectively and measure our
results more accurately. University finance professors will
continue to be a core focus for the scholarships, with all
full-time finance faculty members who wish to sit for the
CFA or CIPM exams receiving a scholarship. We will con-
tinue to work with our university relations team to im-
prove the connection between academic institutions and
CFA Institute scholarships by providing additional schol-
arships for university students and instituting guidelines
for promoting those scholarships within the universities.
Finally, we also plan to expand our regulator outreach by
entering into more relationships with selected industry
bodies around the world.
In order to promote CFA Program access to those
with financial need, we will be transitioning to a new
scholarship program that continues to involve our mem-
ber societies and leverages their local presence and knowl-
edge. At the same time, we will implement a uniform
global application process that simplifies the scholarship
search for prospective candidates. Society scholarships for
2012 examinations will remain as they are. Beginning with
the June 2013 CFA examination, we will transition to the
new access scholarship program. Obtaining a scholarship
will take some advance planning, much like financial aid
applications for students attending a university. Beginning
in mid-January, applicants for 2013 scholarships will be
able to go to our website and apply. In June 2012, we will
share the applications with our member societies, and
well seek their guidance in distributing up to 2,500 access
scholarships for the 2013 calendar year. Successful appli-
cants will learn of their scholarships in September and be
able to register for the CFA Program with plenty of time
to begin studying. They will each be expected to pay only
US$250, almost $800 less than the price of registration
and enrollment for a new candidate but still enough for
them to feel invested in the experience.
As a result of the newly articulated scholarship strate-
gy, CFA Institute will be expanding its overall scholarship
numbers from 3,800 in 2011 to more than 5,000 in 2013.
Along the way, well be focused on making those scholar-
ships more effective at achieving our dual objectives of
awareness and access. Well also be looking for more ideas
to improve the programs, and we welcome your ques-
tions, comments, and suggestions. And dont forget to
spread the word about the new online application for ac-
cess scholarships, coming soon to www.cfainstitute.org for
2013 exams! For more information about CFA Institute
scholarships, go to www.cfainstitute.org/scholarships.
Rahul Keshap is head of education special projects at CFA
Institute.
BY USMAN HAYAT, CFA
ducation and information technology are natural
friends. The two help fuel and feed each other.
Both are prominently featured in the CFA Insti-
tute strategic objectives and help to further our
mission of leading the investment profession globally.
To increase educational opportunities for our members,
we use a variety of tools, including producing podcasts,
organizing audio webinars, and engaging members through
social media. Recently we added another tool to our port-
foliostreaming.
Streaming an educational event enables viewers to
watch it online as if they were present at the venue. In to-
days world, where there is an abundance of free on-demand
content, which can quickly become obsolete, streaming
offers significant benefits. Most importantly, it widens ac-
cess to educational content, which otherwise may be limit-
ed to a small group of individuals. Streaming also makes
the viewers feel that they are part of a community of other
interested professionals from around the globe and enables
them to use such interactive features such as addressing
questions to the speakerall of which are not available in
recorded multimedia.
Streaming is particularly attractive to CFA Institute
given the global nature of our membership and frequent
educational events that we hold in different parts of the
world. Recently, we streamed two sessions from the fourth
annual CFA Institute European Investment Conference in
Paris. Viewers frommore than 22 countries joined us online
to watch Simon Johnson from Massachusetts Institute of
Technology (MIT) and Wolfgang Munchau from the Finan-
cial Times share their views on the financial crisis.
CFA Institute has also worked collaboratively with
societies in the Europe, Middle East, and Africa (EMEA)
region to increase access to their educational events. In
2011, we streamed a number of events hosted by the CFA
Society of the UK, with the pilot stream attracting more
than 100 viewers.
Member societies in EMEA vary in size and resources.
While it is possible for some larger societies to organize
many educational events, it is difficult for smaller societies
to do the same. Streaming an event hosted by a large socie-
ty like CFA Society of the UK, therefore, enables members
of other societies to view the event wherever they are. We
are also experiencing strong support for streaming from
some smaller societies.
Interestingly, some of the reasons which make stream-
ing of live events attractive to CFA Institute also apply to
some of our societies. For example, a societys membership
may be spread across different cities and streaming can
help avoid the need to hold the event in each city or require
Streams of Professional Education
E
members to undertake significant travel. Streaming is also
beneficial for hosting events that are over-subscribed, al-
lowing those who are unable to secure a spot access to the
speaker and the event.
The economics of streaming are also attractive. While
the cost of technology varies, depending on the hardware
and level of professional support needed, it is possible to
acquire streaming capability with relatively low investment.
The technology is meant to be mobile and it is possible to
set up at a venue within a few hours. The advantages and
cost efficiency of streaming have resulted in some societies
using this technological tool. For instance, after receiving
basic training from the EMEA multimedia producer in
June 2011, CFA Spain has now started streaming its own
events.
Given the large number of high quality educational
events held by CFA Institute and regional societies, we
hope to build steady streams of education and an online
community of regular viewers. You can view recordings of
some of our recent streams at www.livestream.com/CFAI.
If you would like to stay up to date on future streams from
EMEA and share your views, follow us on Facebook or
Twitter (@CFAemea).
Usman Hayat, CFA, is director of Islamic finance and
ESG investing.
EMEA
VOICE
Streaming is particularly attractive
to CFA Institute given the global nature
of our membership.
Sustainability @ CFA Institute
BY USMAN HAYAT, CFA, AND STEVE BOLTON
ow is CFA Institute educating investment pro-
fessionals on environmental, social, and corpo-
rate governance (ESG) considerationssuch
as carbon emissions, community relations, and
executive compensationthat define sustainability in in-
vesting? And is CFA Institute also pursuing a sustainability
agenda that considers things such as energy consumption,
environmentally responsible products, and physical waste
management? The answers to these questions begin with
the CFA Program. CFA Program candidates are introduced
to ESG considerations in Level I in the context of individ-
ual investors, and one reading is entirely devoted to corpo-
rate governance issues. Similarly, candidates learn about
risks posed by ESG issues in Level II and about socially
responsible investing in Level III.
If ESG issues are your area of specializa-
tion, you will probably find the amount of
ESG content in the CFA Program relatively
limited. The proportion of ESG content, like
that of any other topic, depends on the prac-
tice of the investment profession. CFA Insti-
tute regularly surveys investment professionals
around the world to determine the knowledge,
skills, and abilities that are relevant to the
practice. The findings of the CFA Program
practice analysis determine the body of knowl-
edge that forms the basis of the CFA Program
(i.e., the proportion of ESG content will likely
increase when the practice analysis suggests that it should).
The ESG learning opportunities that CFA Institute
offers for continuing professional development of invest-
ment professionals are wider and deeper than the content in
the CFA Programcurriculum. You can find detailed publica-
tions like Environmental, Social, and Governance Factors
at Listed Companies and The Social Responsibility of the
Investment Profession on the CFA Institute website
1
and
more than 40 pieces of multimedia content in our ESG se-
ries.
2
The CFA Institute website also includes content pub-
lished by others, such as the November 2010 J.P. Morgan
report on Impact Investments: An Emerging Asset Class.
3
CFA Institute frequently has sessions on ESG issues at
its conferences, and CFA Institute member societies hold
events specific to ESG investing. In September 2011, CFA
Institute worked with member societies in Switzerland,
Austria, and Germany to organize a traveling conference
devoted to social and environmental considerations in the
investment process.
CFA Institute is also pursuing sustainability as an or-
ganization. To formalize those efforts, we established a sus-
tainability task force of employee volunteers in 2009 that
explored and began implementing more sustainable ways of
accomplishing work and delivering products and services.
CFA Institute took a significant step forward in 2011
by initiating the sustainability program through which we
are charting organizational goals and strategies, developing
metrics to measure success, and mobilizing internal re-
sources. The various measures we are implementing include
changing the default setting on office printers to two-sided
printing and pursuing Leadership in Energy and Environ-
mental Design (LEED) certification as a green building
for our new operations headquarters in Charlottesville,
Virginia. There is keen interest in sustainability among
employees, who have already generated 25 sustainability-
related ideas as part of our internal innovation process.
If you would like to get involved in ESG education,
familiarize yourself with existing CFA Institute ESG educa-
tional content.
4
Members are welcome to initiate or join
any ESG-related discussion in the practice analysis.
5
You
can also contact your local member society if you are inter-
ested in a live event on ESG issues. Finally, if you come
across ESGeducational content that you would like to share
with investment professionals, please let us know so that
we can consider adding it to the CFA Institute website.
Usman Hayat, CFA, is director of Islamic finance and ESG
investing, and Steve Bolton is the sustainability program man-
ager at CFA Institute.
H
CFA Institute
BRIEFS
1 Go to www.cfainstitute.org, and enter the article title in the search bar at
the top of the page.
2 Go to www.cfawebcasts.org, select Series under Browse, and choose
Environmental, Social, and Corporate Governance (ESG) Investing.
3 Go to www.cfainstitute.org, and enter Impact Investments: An Emerging
Asset Class in the search bar at the top of the page.
4 Go to feeds.feedburner.com/cfa_esg_fbf to subscribe to the ESG-related
content feed.
5 Go to www.cfainstitute.org, select Course of Study under the CFA
Program tab, and go to Learn more about practice analysis under the
practice analysis section.
How Do You Know
When Youre Done?
BY RALPH WANGER, CFA
once knew a psychiatrist who belonged to the psychi-
atric sect founded by Heinz Kohut and who asked me
to read one of Dr. Kohuts works. I opened the book to
the first chapter and was surprised by the title: Termi-
nation of the Analysis. The first sentence of the book stat-
ed, The question whether at the point of terminating an
analysis the analytic process has been completed, or termi-
nation has been premature, confronts the analyst in a vari-
ety of circumstances.
This raised a couple of questions in my mind. The
first, which may have already occurred to you, was How
am I going to get through a book that is written in such
a dense and technical style? The second question was
Why do you start with the finish?
Dr. Kohut went on and on about this subject but final-
ly stated the end was when the patient was functionally
reliable. The problem of terminating analysis is equally
germane to us as financial analysts. If you are looking at a
company for the first time, you may find that reading all
the company releases, U.S. SEC filings, and some other
analyst reports provide a massive data dump, but how do
you get a coherent story out of all that stuff? What are
some practical ways to proceed?
In psychoanalysis, the doctor is paid by the hour and
so has no financial interest in terminating the analysis.
You, however, have many companies to follow and have
to do your work in a time-efficient manner. There will be
times when youre told to work on the company because
of some new product that the research director read about
that might not have been fully reflected in the stock price,
a negative story in the press, or a dramatic move in the
stock price (probably down). In the last case, you really
must cobble up some sort of response today or tomorrowat
the latest. The company does not require a lengthy program
of analysisthe stock is already in crisis. Your opinion
does not have to be exhaustively researched, but your buy
sell recommendation has to be clear andabove all fast.
Say, for example, that the stock just dropped 15 per-
cent. You have to figure out what is likely to have caused
the drop and whether that information is true or relevant,
and whether the stock has overreacted. These are not easy
judgments to make. I have met portfolio managers who
will tell you that if they dont own the crashing stock, the
sudden drop may be a buying opportunity, but if the stock
is already in the portfolio, then that company undoubtedly
I
has a fundamental problem and you should get out fast.
Some academics may argue that this asymmetrical line of
argument violates the capital asset pricing model. But sell-
side analysts know Murphys Law, so you should simply
drop a company that has cratered. Anyway, terminate the
analysis as fast as you can.
But the base case is a normal first-time analytic project
on a company in an industry you follow. How do you pro-
ceed? You can build spreadsheets and a dividend discount
model as part of your process, and these tools are excellent
guides to valuation. But these numeric tools provide noth-
ing but numbers, and it is hard to get people to act on
numbers alone. In practice, I have found that quantitative
valuation models are less accurate than qualitative ones. I
suggest you work toward a Reason to Own for the stock.
The Reason to Own should consist of two short sen-
tences, one about the company and the other about the
stock. The reasons should be falsifiable. For instance,
good management is a hard criterion to disprove. Better
would be EBITDA margins will go to 14 percent by the
end of 2013. That will be true or false. If it is true, you
should have made good money on the stock. If it is false,
that will be a strong argument to get out. In either case, by
the end of 2013, the Reason to Own will have expired,
and you must invent a new one.
If you have found a Reason to Own and you have
done enough work to convince yourself that the reason is
sound, then you are done and may terminate the analysis.
Ralph Wanger, CFA, is a trustee of Columbia Acorn Trust and
an adviser at Wanger Investment Management.
Chapter 10
I
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R
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M
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Point Counterpoint
DISAGREE: The RMB will emerge as an international reserve
currency only when it is fully convertible. This develop-
ment is at least a decade away. Economic growth is one of
the main tools for achieving the political objectives of
Chinese leadership (in particular maintaining power). The
agricultural sector was partially relieved of public-sector
direction in the 1980s and public industries were first lib-
eralized in the late 1980s and then privatized in the 1990s,
but financial reform stopped in the mid-2000s. Massive
efforts to avoid a downturn included a historic stimulus in
2009 and 2010, which might have created a major debt
bubble. A bubble burst would be hugely damaging eco-
nomically and politically for the governing party. Increased
public spending has been financed by borrowing from
government-controlled banks, placing a burden on the
financial systemboth the official one and the shadow
system. If the RMB were made fully convertible, not only
would the exchange rate become more volatile (hurting
exporters and destroying jobs) but also the risk of capital
departing the country might increase. Currently, financial
companies in China enjoy an oligopoly that would be in
clear danger if capital flight were possible. Given the nega-
tive real interest that depositors currently receive, this risk
is very real. If the official figures regarding the strength of
the financial system are accurate, making the RMB fully
convertible would not pose a threat to the financial
system. But if the financial system is much more fragile
than has been publicly disclosed and includes massive
amounts of hidden bad debt related to government-spon-
sored infrastructure projects over the past three years,
the danger of full convertibility will be enormouswith
no obvious benefits from political leaders point of view.
Daniel Pasini, CFA, is chief investment officer for equities
investing at ACPI Investments in London and a member
of the CFA Society of the UK.
AGREE: Although the RMB doesnt have full convertibility
yet, a lot of eastern Asian economies already have a high
level of acceptance for it. People in these regions are in
general comfortable with owning RMB and consider it a
very stable currency that will maintain its value. Currently,
about 35 percent of Chinas foreign trades are bilateral
trades with other Asian economies, and there are signs
that major Asian economies are moving toward accepting
each others currency instead of the U.S. dollar as a settle-
ment currency. At the recent Asian Development Banks
annual meeting in Hanoi, Vietnam, the finance ministers
of China, Japan, and South Korea agreed to consider
settling trades in their own currencies. From a policy per-
spective, the fact that the Chinese government is aiming
to turn its economy from export driven to domestic-
consumption driven increases the motivation to drive
the RMB internationalization process. The government
already made Hong Kong a very active offshore RMB
center and recently took the first step of opening the
domestic bond market. Full convertibility is important,
but I dont see it as a prerequisite for the RMB to start the
process toward attaining reserve-currency status.
Wei Shao, CFA, is assistant portfolio manager at Atherton
Lane Advisers in Menlo Park, California, and a member of
the CFA Society of San Francisco.
DISAGREE: The RMB will join the global array of traded
currencies, but the notion of a single reserve currency no
longer works and will be abandoned. Instead, the Interna -
tional Monetary Fund and others will soon establish a
currency basket to provide assurance that the political
perils and fiscal irresponsibility of one nation (or currency
bloc) will no longer threaten to disrupt the orderly pricing
of global commodities. A currency basket will also reduce
world dependence on a few giant financial institutions.
J. Gregg Buckalew, CFA, is chief investment officer at
FiduciaryVest in Atlanta and a member of the CFA Society
of Atlanta.
AGREE: China is determined to increase trade settled in
RMB (currently only 7 percent). Undoubtedly, the amount
of RMB in circulation outside of China will increase as a
result. Just 12 months after the opening of the offshore
deliverable RMB market in Hong Kong (that is, CNH),
the size of the RMB pool has increased almost tenfold to
RMB600 billion. The process is forcing more liberalization
and market-oriented reform of the currency regime. The
whole movement is also in line with the Chinese govern-
ments goal of making the RMB fully convertible by 2015.
Patrick Law, CFA, is head of greater China trading at
Barclays Capital in Hong Kong and a member of the Hong
Kong Society of Financial Analysts.
DISAGREE: For the currency of a leading world economy
to become a reserve currency seems natural, but it is
unlikely to happen with the RMB. Opening the currency
market would cause Chinese authorities to lose the most
important tool for assuring competitiveness globally and
maintaining social stability. For Chinese leaders, domestic
social problems rank far ahead of full international recog-
nition; they cannot risk a steep appreciation of their cur-
rency, which would sink exports and depress growth in
China, thus driving unemployment up and exacerbating
social costs and disparities.
Dragos Cabat, CFA, is managing partner at Financial View
Consulting in Bucharest, Romania, and is vice president of
CFA Romania.
Agree or Disagree: The Chinese renminbi (RMB) will emerge
as an international reserve currency sooner rather than later.
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Allocation Seminar
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Designing new investment solutions through the use of dynamic beta
management, risk budgeting and dynamic core-satellite allocation
Discovering new risk management techniques
Optimising regulatory constraints using new LDI approaches
Information and registration:
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Lionel Martellini, PhD
Scientic Director,
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Dr. Martellini was an excellent presenter and entertained all input

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Michael Hall, CFA
Senior Vice President, Fidelity Security Life, USA
Past participant
I found the theoretical content to be very intriguing and at the same time
offering great practical opportunities. Professor Martellinis considerable
research expertise is matched by his teaching expertise and obvious enthusiasm.
Toby Tobleman, CFA
Principal In Charge, Rudd and Wisdom Inc., USA
Past participant
A must for all portfolio managers and client advisors working on either asset
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Director, Bank of America and Senior Portfolio Manager, Columbia Management, USA
Past participant
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CFA Magazine Jan - Feb

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January/February 2012

How Wall Street has gone astray

Dr. Martellini was an excellent presenter and entertained all input

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