Tag Archive for: CFA

Strong words from editor of Financial Analysts Journal

“…I hereby consign the shibboleth of ‘uncorrelated return’ to the scrap heap of asset allocation lingo, where it shall be available only to unscrupulous sellers, credulous buyers, and unschooled investment analysts.”

— Richard M. Ennis, executive editor, Financial Analysts Journal

These strong words from Ennis appeared in in his “Editor’s Corner” entitled “The Uncorrelated Return Myth,Financial Analysts Journal (Nov./Dec. 2009). 

Ennis asserts that “The notion of the existence of ‘uncorrelated return’ assets with handsome risk premiums flies in the face of financial theory and conflicts with empirical evidence.” 

When he says “financial theory,” Ennis is referring to the capital asset pricing model, which accords positive risk premiums to market-correlated assets. He also says that evidence shows that so-called uncorrelated assets such as real estate, hedge funds, and private equity are actually highly correlated with the stock market.

What do YOU think about this topic?

Private equity job hunting tips from four professionals

Don’t bring me a resume. Bring me a deal,” said Daniel Meader, founder and managing partner, Trinity Advisory Group. Meader offered his advice during the Q&A following “The State of Private Equity: Opportunity through Crisis,” a sold out presentation to the Boston Security Analysts Society on November 5.

Other advice from panelists:

  • In New England, the best job prospects are in venture. The corporate growth and buyout styles of private equity are stagnant locally, said Martin Grasso, CEO, Pearl Street Capital Group.
  • It’s good to have consulting experience as well as investment expertise, according to Scott Stewart, MS in Investment Management Faculty Director, Boston University School of Management.
  • Get operating experience in turning around a distressed company, suggested Norman Rice, partner, ConsensusCapital Group.

Do you have more tips for private equity job hunters? Please add them in the comments.

Fixed income viewpoints from CFA Institute conference

Here are opinions on currency and CDOs that grabbed my attention at the CFA Institute’s Fixed Income conference last week.

If YOU were at the conference, I’d be interested to learn what surprised or intrigued you. 

“The New Currency World Order”
Ron Liesching of Mountain Pacific Group, LLC

The U.S. dollar cannot be replaced as the world’s reserve currency, but its role will be profoundly altered.

It’s time for investors to consider
*  Hedging their U.S. dollar risk
*  Active currency management
*  Active long commodity allocation
*  Long commodity currencies
*  Strategically long emerging market currencies
*  Global is the new core

“The Pricing of Investment-Grade Credit Risk during the Financial Crisis” 
Joshua Coval, Harvard Business School

There’s evidence that ratings agencies bent their standards to bestow too many AAA ratings.  They rated 75.5% of CDOs’ capital structure as AAA, when the rating agency model allowed 63.4%, according to “Did Subjectivity Play a Role in CDO Credit Ratings?” by John Griffin and Dragon Tang. Thanks, Prof. Coval, for sending me the link to Griffin and Tang’s article!

The collapse of structured products will impact the economic recovery to the extent that cheap credit is less available. The U.S. consumer had been the engine of U.S. GDP growth thanks to cheap credit.

Related posts:
* Dan Fuss: Bond investors have learned from experience…not

Dan Fuss: Bond investors have learned from experience…not

In some ways, famed bond investor Dan Fuss is pleased by how far the bond market has come during the last year. October and November 2008 made for a “horrific experience” he said. Since then, bonds have made an incredible recovery. However, their rebound has also brought back some of the behavior that fed their problems, said Fuss to the Fixed Income Management 2009 conference of the CFA Institute on October 1. Fuss is vice chairman of Loomis, Sayles & Company and co-manager of a number of institutional separate accounts for the firm’s fixed income group.

Fixed income’s bleak months in 2008, when it was difficult to get bids for even the highest quality investments left an impact on Fuss. On paper, October and November offered a fantastic buying opportunity. He spoke of a “50-year opportunity in bonds”  in November 2008. Unfortunately, instead bond funds struggled last autumn to sell in response to mutual fund redemptions.

As a result, now Fuss pays more attention to liquidity of his investments, even if it means that “I’m fighting the last war.” Compared to 18 months ago, “I’ll give up something to buy something more liquid,” he said.

Until a few months ago, Fuss thought he wouldn’t see a repetition of the risky behavior that he illustrated with his fable of Colossal Corporation, the world’s largest maker of “colossals,” a product Fuss made up for the purpose of his story. Colossal Corp. began by dabbling in hedging the price of ore and the Australian dollar, and then went heavily into the carry trade. Eventually, it got burned by the credit crunch and decided to give up its speculative ways.

For awhile Fuss thought that the Colossal Corporations of the world had learned the lesson that they should stick to their business rather than speculating in financial markets. “I thought that was all history,” he said. However, over the last three to four months, he observed that “By God, this thing is starting to replay…. The people who skate on thin ice when they shouldn’t are starting to skate on thin ice again.”

Speculation is reviving because of the steep yield curve, said Fuss. There is an enormous incentive to go out the yield curve to pick up yield. He discussed a risky new product that made its debut in Japan in March 2009. The Japanese product is being copied by others. “I can’t believe this is happening,” said Fuss.

Recently, traders at Loomis Sayles told Fuss that he should act quickly if he’d like to get in on a B- credit that would pay a special dividend. “I thought it was a joke,” said Fuss. But it was not.

What does GIPS verification mean?

I’m an amateur when it comes to understanding investment performance standards. So I was surprised when a speaker at the CFA Institute’s GIPS (global investment performance standards) conference speaker said verification does NOT verify that firm’s composite numbers are correct or that firm is compliant. Huh?

As I understand it, verification simply means the firm has the right processes to be compliant and to calculate performance accurately.

If you’ve got questions about this topic, I suggest you mosey on over to the Investment Performance Guy’s blog, which includes a post on “Verification verifies compliance…not!” Blogger David Spaulding, president of The Spaulding Group, Inc., looks like a valuable resource for your GIPS and performance questions. Back in March 2009, I enjoyed writing “Fixed income attribution falls short” about his talk to the Boston Security Analysts Society.

Related posts:
SEC’s update to CFA Institute’s GIPS conference
A quant’s guide to detecting a future “Madoff”
Top 5 tips for investment performance advertising

A quant’s guide to detecting a future "Madoff"

Worried about getting taken in by an investment management Ponzi scheme?

With the SEC ratcheting up its fraud detection efforts, it’s less likely that you’ll get scammed, based on what I heard at the CFA Institute’s GIPS conference last week. But the conference also introduced me to a quantitative method for detecting fraud in “The Importance of Risk and Attribution in the Post-Madoff Era” by Dan diBartolomeo, president and founder of Northfield Information Services.

The solution boils down to identifying investment returns that aren’t economically feasible. The effective information coefficient is an important tool for that, said diBartolomeo. 

A personal commitment to preventing future Madoff-style fraud 
DiBartolomeo wants to make people more aware of–and attentive to–risk.  He’s so committed that every year he hires a pickpocket to attend his annual client conference and warns his clients that “Keith the thief” will be targeting their wallets, watches, and other possessions. Despite the warning, each year, diBartolomeo has to return a pile of stolen goods. Keith succeeds because he’s good at distracting people–and Bernie Madoff was good at this, too, said diBartolomeo.

Speaking of Madoff, diBartolomeo’s firm was involved in the efforts of Harry Markopolos to uncover the secret to Madoff’s steady investment returns. At the time, diBartolomeo only knew that he was analyzing the returns of Manager B. But within a few hours, analysis revealed that Manager B’s returns “were either fictitious or had arisen from a strategy other than what was being represented to investors, wherein returns were probably being enhanced by illegal means.” You can read more of the details of this analysis in a March 2009 FactSet podcast with diBartolomeo. 

How to uncover a fraud 
“Do these returns make sense?” That’s an essential question for those who perform due diligence on potential investments, according to diBartolomeo. Returns-based methods aren’t adequate for analyzing this question, he said. Instead, one needs “a risk-based measure of investment performance that can detect manager skill(or lack thereof) quickly.”

The information ratio is one place to start, but it has flaws. The information ratio has nothing to do with making money for investors,” said diBartolomeo. For example, the information ratio would look great for a manager with alpha of 1 basis point and a tracking error of zero, but the manager’s clients wouldn’t benefit much. He also pointed out that “the statistical significance of a ratio is hard to calculate.”

The effective information coefficient (EIC) could be the answer to this problem. For more details on the EIC, read “Measuring Investment Skill Using the Effective Information Coefficient,” which appeared in The Journal of Performance Measurement (Fall 2008). 

I wonder what Madoff’s EIC was. I don’t know if diBartolomeo got an opportunity to calculate it.

Oct. 31 update: diBartolomeo’s talk is now available as a podcast from the CFA Institute.

Top 5 tips for investment performance advertising

Knowing the rules for advertising your investment performance is your key to staying out of trouble with the regulators.

Here are some of the tips I gathered from “Performance Advertising 101: Regulatory Do’s and Don’ts” presented on Sept. 23 at the CFA Institute’s GIPS conference by Rajan Chari of Deloitte & Touche, who focused on GIPS issues, and Steven W. Stone of Morgan, Lewis Bockius, who focused on SEC issues. 

1. Don’t think that you’re not subject to advertising rules because you’re not buying a newspaper or magazine ad. Advertising is broadly defined. It’s “basically, any written communication addressed to more than one person (or used more than once) that offers investment advisory services with regard to securities,” according to the speakers’ slides. Advertising includes client materials. It may also refer to anything that you distribute in unchanged form to 10 or more people. 

2. Make the necessary disclosures about performance. Consult with experts who are knowledgeable about your disclosure requirements. 

3. Tread carefully in performance advertising areas of particular concern to the SEC. For example, projecting returns may be viewed as promissory. Back testing is easily manipulated. To avoid the appearance of cherry picking, top stock picks must be balanced with worst stock picks. 

4. Keep a log of the people to whom you send advertising materials. I’ll bet that many people aren’t doing this. But it’s essential for making things right if you discover that inappropriate materials have been distributed. 

5. Take your audience’s sophistication into account when you choose the materials you send them. The regulators give you more leeway in materials aimed at sophisticated investors.

Despite the fact that “Performance Advertising 101: Regulatory Do’s and Don’ts” was presented at the CFA Institute’s GIPS conference, GIPS didn’t get much attention compared to the SEC.  That’s because investment managers always have to pay attention to SEC rules, whereas “GIPS advertising rules are only applicable if you choose to claim [GIPS] compliance in an advertisement.” You can read the GIPS Advertising Guidelines, on pages 33-37 of the Global Investment Performance Standards.

Happy advertising!

Sept. 27 addition from Rajan Chari
Thanks to the generosity of Rajan Chari, here are two links to give you more information on advertising standards.

SEC’s update to CFA Institute’s GIPS conference

One of the SEC latest initiatives resonates with the experience of Lucile Corkery, Associate Regional Director for Examinations, Boston Regional Office, U.S. Securities and Exchange Commission. That’s enhancing the licensing, education, and oversight of back office personnel. Corkery and her colleague, Melissa Clough, senior staff accountant, discussed a list of SEC initiatives on the first day of the CFA Institute’s GIPS (Global Investment Performance Standards) two-day conference in Boston on September 22. Both speakers gave the standard SEC disclaimer that their statements were strictly their personal opinions. 

Lesson from the back office 
Prior to joining the SEC, Corkery worked in an industry back office where she knew an aggressive registered rep who made her suspicious.

One day the rep came in with his cousin the lawyer and conservatorship papers for aunt, who had to be alive for the this purpose. Just one week later, the rep came in a death certificate for the aunt dated prior to his coming in with the conservatorship papers.

When Corkery challenged the rep, he said “I’ll give you whatever you want. What does it take?”

It’s no wonder that Corkery believes the licensing, education, and oversight initiative for back office personnel is “long overdue.” 

SEC initiatives 
Other SEC initiatives discussed by Corkery and Clough included:

  • Investor Advisory Committee
  • Proposed amendments to custody rules, including annual surprise exam and added controls when custody is provided by a related person
  • Revamping handling of complaints and tips
  • Advocating for a whistle blowing program
  • Conducting risk-based examinations of financial services firms
  • Establishing a new division of Risk Strategy and Financial Innovation, announced on Sept. 16
  • Enhancing examiners’ knowledge of fraud detection techniques and recruiting staff with specialized skills
  • Seeking resources to hire more examiners
  • Integrating broker-dealer and investment advisor examinations  

Job opening in Boston–posting closes this ThursdayThere’s an opening in the SEC’s Boston office for a senior specialized examiner, according to Corkery.

Act fast, if you’re interested. The posting closes on Thursday, Sept. 24. I think that means that Thursday is the last day you can apply. 

Posts from last year’s GIPS conference:


Thank you, Maine CFA Society!

The Maine CFA Society got into the spirit of my Sept. 17 presentation on “How to Write Investment Commentary People Will Read.” They skewered me for using an unnecessary adverb in a sample sentence.

That’s the enthusiasm I enjoy when I teach CFA charterholders to write more concise, compelling investment commentary.

Statistics to calm nervous investors: Research on dollar cost averaging

Are you–or your clients–nervous about buying stocks? You may find comfort in statistics from “(Re)Entering the Market: The Costs and Benefits of Dollar Cost Averaging” by Gregory D. Singer, director of research, and Ted Mann, analyst in Bernstein Global Wealth Management’s New York office. Their article appeared in the CFA Institute’s Private Wealth Management e-newsletter (August 2009).

The bottom line, according to the authors’ research

…if you have a sum of money to invest for the long term, entering the market all at once will usually prove to be a better strategy than dollar cost averaging. The odds that you will reap greater wealth in the end are in your favor. But dollar cost averaging is reasonable insurance against the risk of investing in a falling market.

The authors highlight the downside of dollar cost averaging. “If the market rises while we are ‘averaging in,’ we miss out on potential gains. And those forgone gains could be substantial.”

As evidence, they present average 12-month rolling returns for the U.S. stock market from 1926 to November 2008 for three strategies of investing a lump sum.

  • Invest All at Once: 12%
  • Dollar Cost Averaging: 8%
  • Hold Cash: 4%

I find these numbers tremendously reassuring, even though past performance is no guarantee of future results. The case for investing all at once is even stronger following 12 months of a down market, with returns of 15%, 10%, and 3% respectively.

However, dollar cost averaging does preserve wealth during the bottom 20% of markets. In this bottom quintile, it “resulted in an average of 11.6 percent more wealth than investing all at once.”  So it sounds like a great strategy for declining markets. The hitch? No one can reliably predict when those markets will occur.

Over the long run, investing all at once should outperform dollar cost averaging and holding cash.

The authors concede that investing entire lump sums immediately isn’t for everyone. Their research suggests that the potential benefits from dollar cost averaging fall after the first six months. Moreover, “Beyond 18 months, averaging in doesn’t make financial sense (unless it’s part of a program like payroll deduction, where the money becomes available only over time).”

What do YOU think? When would you recommend investing lump sums all at once vs. dollar cost averaging?