May/June 2015
The Member Magazine for Investment Professionals
CONTINENTAL LIFT: AFRICA’S GROWTH CAREER ADVICE FOR GLOBAL PROFESSIONALS A WINNING TACTIC FOR VOLATILITY?
Can eurozone managers stay on top of rising complexity?
May/June 2015
COVER STORY 26 Definite Uncertainty How are eurozone portfolio managers adapting to a low-yield environment, deflation fears, shifting monetary policies, and volatile fund flows? By Nathan Jaye, CFA 31 Continental Lift Africa’s long-term investment story is about growth momentum on a vast scale 26 By Chris Wright 36 Growing Pains for Sukuk Two experts discuss opportunities and challenges for the increasingly popular Islamic financial security By Nathan Jaye, CFA 31
“WHAT I’VE BEEN HEARING FROM SUKUK TRADERS IS THAT SUKUK ARE INCREASINGLY BEHAVING THE WAY CONVENTIONAL 36 BONDS BEHAVE.... IT’S CERTAINLY A SIGN THAT THE MARKET HAS BECOME MORE LIQUID AND MORE NORMALIZED.” 37 COVER ILLUSTRATION Alex Nabaum Why become an independent Advisor on Interactive Brokers’ platform?
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May/June 2015 Vol. 26, No. 3 CFA INSTITUTE PRESIDENT AND CEO ASSISTANT EDITOR Paul Smith, CFA Michele Armentrout
CFA Institute Magazine (ISSN 1543-1398, CPM 400314-55) is published bimonthly—in MANAGING EDITOR GRAPHIC DESIGN January, March, May, July, September, and November—by CFA Institute. Periodicals Roger Mitchell Communication Design, Inc. postage paid at Charlottesville, VA, and additional mailing offices. POSTMASTER: [email protected] [email protected] Send address changes to CFA Institute Magazine, 915 East High Street, Charlot- tesville, VA 22902. ONLINE PRODUCTION COORDINATOR CIRCULATION COORDINATOR Statements of fact and opinion are the responsibility of the authors alone and Kara Hite Jennette Townsend [email protected] do not imply an endorsement by CFA Institute. ADVERTISING MANAGER Copyright 2015 by CFA Institute. All rights reserved. Materials may not be Tom Sours ® reproduced or translated without written permission. CFA , Chartered Financial [email protected] Analyst®, the CFA Institute logo, Claritas®, GIPS®, and CIPM® are just a few of the trademarks owned by CFA Institute. See www.cfainstitute.org for a complete list. Annual subscription rate for CFA Institute members is US$40, which is included EDITORIAL ADVISORY TEAM in the membership dues. Annual nonmember subscription rate is US$50. Shanta Acharya Kate Lander, CFA Bashir Ahmed, CFA Casey Lim, CFA THE AMERICAS EUROPE, MIDDLE EAST & AFRICA Jim Allen, CFA Michael Liu, CFA 915 East High Street 131 Finsbury Pavement, 7th Floor Jonathan Boersma, CFA Bob Luck, CFA Charlottesville, VA 22902 London EC2A 1NT Jarrod Castle, CFA Farhan Mahmood, CFA USA United Kingdom Michael Cheung, CFA Dennis McLeavey, CFA Phone: (800) 247-8132 or Phone: +44 (20) 7330-9500 Josephine Chu, CFA Sudip Mukherjee, CFA +1 (434) 951-5499 Franki Chung, CFA Jerry Pinto, CFA ASIA–PACIFIC Darrin DeCosta, CFA Linda Rittenhouse 477 Madison Avenue, 21st floor 23/F, Man Yee Building Nick Dinkha, CFA Craig Ruff, CFA New York, NY 10022 68 Des Voeux Road Jerry Donohue, CFA Christina Haemmerli Schlegel, CFA USA Central, Hong Kong Alison Durkin, CFA David Shen, CFA Phone: +1 (212) 754-8012 Phone: +852 2868-2700 Kenneth Eisen, CFA Arjuna Sittampalam, ASIP William Espey, CFA Larry Swartz, CFA BRUSSELS Julie Hammond, CFA Jacky Tsang, CFA NCI LOCARTIS European Parliament Burnett Hansen, CFA Gary Turkel, CFA Square de Meeûs 38/40 M. Mahboob Hossain, CFA Raymond Wai Pong Yuen, CFA 1000 Brussels (Belgium) Vahan Janjigian, CFA James Wesley Ware, CFA Phone: +32 (02) 401-6828 Andreas Kohler, CFA Jean Wills Aaron Lai, CFA
4 CFA Institute Magazine May/June 2015 IN SUMMARY
How to Galvanize a Jellyfish
“I suppose it takes a shock to make a Castle posing as the lady’s maid for Peters’ daughter. Ashe fellow see exactly what he amounts to.” and Joan soon realize that they are both after the same —P.G. Wodehouse, Something New thing: the lucrative reward that Peters is offering for the scarab. Rather than turning rivals, they join forces, agree- When Joan Valentine and Ashe Marson ing to split the reward. But the duo must overcome “novel meet, their similarities are not what strike challenges,” to borrow words used to describe the situation sparks. Both are witty and attractive. Both under Europe’s new rules on payment for research (Market are young Americans living on their own in Integrity, 42). London and trying to eke out a living with Fortunately for Joan and Ashe, they benefit from the “hack work.” But Ashe regards himself clueless inattention of Lord Emsworth, who is the anti- as a failure stuck in a rut, whereas Joan, Peters in terms of personality. Emsworth is equipped “with who has kept exploring new situations, rebukes him for his a mind so admirably constructed for withstanding the dis- lack of enterprising spirit. “Be an adventurer,” she tells him. agreeableness of life that if an unpleasant thought entered Joan would admire the many CFA Institute members it, it passed out again a moment later.” Such a tempera- who venture forth on international career paths, where one ment might be inconceivable to many eurozone fund man- key to success is “the ability to be reflective and open to agers who are presently dealing with so much “disagree- the possibilities that exist” (“Cultural Travelers,” 20). Being ableness,” including low yields, volatile fund flows, defla- open to new possibilities was also a characteristic that dis- tion fears, and more. Surveys of managers by Fitch Ratings tinguished the long career of Irving Kahn, CFA, as William show the level of concern about key risks has reached “an Ortel explains (Viewpoint, 15). And another accomplished all-time high,” according to Alastair Sewell, CFA (“Definite investment professional is ready to “unload some advice” Uncertainty,” 26). based on his adventures in investing (Chapter 10, 48). Yet a dose of Emsworth’s detachment may be helpful When Joan unloads her advice on Ashe, he marvels at in the right measure. Overreaction and underreaction are her inspiring words. “You would galvanize a jellyfish,” he both errors. “If we can accept that a significant amount of tells her. Resolving to try new things, he soon finds himself what actually happens is outside our control,” writes Vin- employed as a thief. Technically, his official title is “valet,” not cent McCarthy, CFA, “we can better design portfolios that “thief.” His employer, Wall Street tycoon J. Preston Peters, are more adaptive to the circumstances of the environment hires Ashe to get back an ancient Egyptian scarab, which that prevails” (“A Winning Tactic,” 12). he believes was stolen by Lord Emsworth. There are two Haste usually makes things worse, as Joan and Ashe complications. First, Lord Emsworth, a befuddled fellow, learn through a series of farcical escapades. The lesson even believes the scarab was given to him as a gift. Second, applies for hiring practices at wealth management firms. Peters’ daughter is engaged to Lord Emsworth’s son. The An executive at one firm admits, “Where we’ve messed up social maneuvering quickly becomes as tricky as trying to is when we rushed the process” (Private Client Corner, 24). find unrealized losses hidden in a bank’s “other compre- Rushing to conclusions is more likely to happen in response hensive income” statement (“Bank Risk and Solvency,” 43). to negative information. Good news is often “the bit of the Peters visits Lord Emsworth at his home, Blandings narrative people miss,” as Paul Clark, CFA, points out about Castle, and brings Ashe along as his valet. The young man’s investment prospects for Africa (“Continental Lift,” 31). Plot- real job is to recover the scarab from their host’s personal ting the correct narrative for any investment story is a log- museum. From Ashe’s point of view, Peters’ relentless pur- ical function of capturing all the relevant information, or suit of the scarab makes him seem like “a sort of machine.” at least that’s the way a data analyst looks at the problem. But this very attribute is what enabled Peters to achieve his “We apply that to a knowledge network, propagate the sen- fortune. Most capable investment professionals probably timent, and calculate a systemic mood,” says one expert in share similar traits, such as persistence, a proactive mind- semantic analysis (Portfolio Performance, 18). set, and strategic outlook. Thus, CFA Institute President and The “systemic mood” of Blandings Castle has been turned CEO Paul Smith, CFA, writes of “spearheading opportuni- inside-out and upside-down by the end of Something New. ties that highlight the high standards and quality work of But Ashe, who goes from drifting jellyfish to confident man our dynamic global community” (In Focus, 6). On a related of action, would agree with the semantic analyst about the theme, Vidhu Shekhar, CFA, CFA Institute’s country head importance of “reasoning around heuristics.” As he tells for India, explains that CFA Institute’s impact in India “will Joan, “It’s not so much what has happened as what it rep- come from our ability to act as a catalyst” (APAC Focus, 8). resents that matters.” The catalyst for a plot twist in Something New comes from Roger Mitchell, Managing Editor ([email protected])
Painting by Claire Grace Claire Painting by a surprising source. Joan Valentine arrives at Blandings
May/June 2015 CFA Institute Magazine 5 CFA INSTITUTE NEWS IN FOCUS
Shining a Spotlight on Our Global Community
By Paul Smith, CFA
There is a growing clamor from soci- tool. It is our intent that widespread industry endorsement of ety and a realization within the indus- the Statement of Investor Rights will increase awareness of try that investors need to be protected Putting Investors First Month and help further our mission. from advisers who are more interested The practice of putting investors first is a business imper- in their own bottom lines. US President ative. Today, a firm’s value proposition and culture must Barack Obama recently called for more include ethical standards that place investors’ interests regulations on financial advisers, citing above those of the firm. It’s part of building a lasting busi- the White House Council of Economic ness model and differentiating the firm’s reputation from Advisers report showing that conflicts its competitors. And it’s the most essential element of pro- of interest cost middle-class families an fessionalism, a prerequisite to becoming a trusted invest- average of 1% per year in lower returns on retirement sav- ment firm. This responsibility is especially true for members ings, amounting to a national total of about $17 billion. In who work in the wealth advisory business (about 30% of our Australia, Commonwealth Bank’s chairman is being grilled global membership) but applies universally. We need to be over conflicts of interest and the use of sales targets as incen- bold in our policy prescriptions and active in our engage- tives. The EU’s ethics code has set tougher rules for EU com- ment on this front. missioners accepting gifts, setting the stage for them to act Putting Investors First is at the core of all that we do and objectively and impartially in the community interest and stand for. When investor interests come first, we advance for the public good. The push for more regulation contin- market integrity, protect investors from harm, and help them ues, and the investment industry must take responsibility to meet their financial goals. Our clients’ lives depend on for putting investors first. what we do, whether it’s helping them prepare for a secure At CFA Institute, our commitment is to build the invest- retirement, send their children to college, or purchase a ment profession and lead it for the benefit of society and home. Any way you sort it, our work launches the next gen- investors. The stakes are high, and our community has a eration so they can do better than we have. unique opportunity to impact change by channeling resources I can’t think of a better reason to step out in our commu- to those who can take responsibility, be courageous, and nities and remind our stakeholders of the value our mem- better our profession. The best way we can demonstrate bers bring to society. our commitment is to work in close partnership with our Paul Smith, CFA, is president and CEO of CFA Institute. member societies. This means spearheading opportunities that highlight the high standards and quality work of our dynamic global community and producing resources that Putting Investors First: our societies want and can deliver locally. Online Resources for Support This May, our society leaders and members worldwide are raising awareness in their local communities and advo- Putting Investors First, a CFA society-driven initiative to cating for investor interests. Together, we will shine a spot- promote the Future of Finance, has a new dedicated page light on our global work to place investors’ interests first on the Society Center. Updated weekly, the site currently and rebuild investor confidence in our industry. Last year, features the following resources for CFA Societies: 41% of member societies across 58 cities led efforts for the • Tools for the 12 May 2015 Live broadcast inaugural Putting Investors First Month. These activities • Ideas Guide for Putting Investors First activities, demonstrate member excellence, build brand awareness, including a summary of 2014 society events and allow us to practice thought leadership at the national and local levels. I encourage you to tell our story and exer- • Ad templates cise a bolder voice in your community. • Web banners The CFA Institute team has created tools to inspire the • Press releases and general promotional tools industry to improve investor access to better information, • Member outreach event resources, including advice, and service. One of these tools is the Statement of proclamations Investor Rights, a list of 10 rights that any investor should expect from financial service providers. During this Putting Society members can share their Putting Investors First Investors First Month, we will empower investment profes- plans by emailing [email protected] sionals with the Statement of Investor Rights and timely web and social media content to encourage endorsement of the
6 CFA Institute Magazine May/June 2015 CFA INSTITUTE NEWS EMEA VOICE
Growing Our Profession in the Middle East
By Nitin Mehta, CFA
Even while political turmoil in many parts of the Middle East continues, the CFA CFA Institute Members in the Middle East Institute mission based on ethics, educa- tion, and professionalism enjoys grow- 2,000 ing adoption in the region. We now have
more than 1,500 CFA Institute members, 1,500 about 5,000 candidates for the CFA Pro- gram, and 8 CFA societies serving their 1,000 local investment communities. Although the recent sharp drop in oil prices may provide headwinds for economic growth and wealth accu- 500 mulation for some of the larger markets in the region, the secular forces of economic development, the expanding role 0 of capital markets, and the growing professionalisation of 2000 2005 2010 2015 the financial industry will likely drive even higher demand for our values and offerings. This past February, I joined Aaron Low, CFA, chair of the THIS IMPACT IS EXACTLY WHAT BENJAMIN CFA Institute Board of Governors, for a tour of some of the markets in the Middle East. Our visit began in the United GRAHAM HAD HOPED FOR WHEN HE Arab Emirates, with a focus on Dubai and Abu Dhabi, fol- FIRST CONCEIVED OF A QUALIFICATION lowed by Kuwait and Saudi Arabia. Everywhere we went, the respect for CFA charterholders and the CFA Institute FOR INVESTMENT PROFESSIONALS. brand was evident. Employers, major investors, regulators, policymakers, and universities shared with us their desire to help build the investment profession in their local markets. Along the way, we met with several regulators to help As part of the regional tour, we also attended the sixth us better understand the progress of their reform agenda. CFA Institute Middle East Investment Conference in Kuwait, We learned of ambitious plans to further develop the finan- hosted by CFA Society Kuwait. The conference was con- cial sector and thus improve the efficiency of intermedia- vened under the patronage of His Excellency Anas K. Al- tion between corporations and investors, including banks. Saleh, Kuwait’s minister of finance, who also provided very What was apparent was a markedly greater emphasis on candid and forthright comments to open the proceedings. market-based solutions and a desire to grow the capital mar- In his remarks to the delegates, he mentioned that all grad- kets as a source of funds for new enterprises. Revisions to uate employees of the Kuwait Investment Authority, which corporate governance codes, more aggressive enforcement manages the country’s sovereign wealth fund, are encour- of rules and laws, and significant investments in techno- aged and supported to complete the CFA Program. When logical infrastructure at exchanges and other nodal points candidates pass the exams, they receive a promotion and in the value chain have all become part of the armoury for higher pay. This impact is exactly what Benjamin Graham competition among the regional financial centres. had hoped for when he first conceived of a qualification for At the same time, we discussed with the regulators some investment professionals. May all employers be so enlight- of the concerns expressed by our members practising in the ened one day! region, including the challenge to market integrity posed by More than 200 delegates from the region (and beyond) a disclosure-averse culture, the treatment of related-party attended the conference to hear speakers from around the transactions, and the fear of market fraud. world, including economist Nouriel Roubini. Topics cover- To make that voice heard more clearly, we held a work- ing geopolitics, demographics, and the changing energy shop in Kuwait and invited investment professionals who vol- landscape were designed to provoke thought and help gen- unteered to advocate our values in their local markets in the erate new investment ideas. The enthusiasm for learning region. CFA Institute staff shared their expertise and high- and the sense of professional community were palpable. It lighted access to the substantial resources we have assem- augurs well for the future of this vibrant and varied region. bled to support local efforts to raise professional standards Nitin Mehta, CFA, is managing director of EMEA for CFA Institute. and protect investors.
May/June 2015 CFA Institute Magazine 7 CFA INSTITUTE NEWS APAC FOCUS
Expanding the Global Presence of CFA Institute NEW CHINA AND INDIA OFFICES WILL IMPROVE SUPPORT
Early this year, CFA Institute opened new offices in Beijing and Mumbai to help our member societies grow and expand their resources and activities for our members and candidates. The teams in these offices will provide on- the-ground support to societies and work with them to deepen our relationships with employ- ers, government institutions, regulators, the academic community, and other stakeholders in order to advance our mission in these key markets. The establishment of these offices has been a strategic priority for CFA Institute over the past two years. “This important milestone in the history of CFA Institute underscores our commitment to the Asia-Pacific region and to the global investment profession,” said Paul Smith, CFA, president and CEO of CFA Institute. “The new offices in Beijing and Mumbai demonstrate the organization’s focus on broadening its global footprint and CFA Institute staff, members, and volunteers celebrated the opening of the strengthening its position as a leading steward of the global office in Mumbai. Cutting the ribbon were (from left) Vidhu Shekhar, CFA (CFA Institute India country head); Paul Smith, CFA (CFA Institute president and CEO); financial markets. This expansion is part of our promise to Ashvin Vibhakar, CFA (CFA Institute senior advisor and executive sponsor of deliver service and value to our members and candidates in Future of Finance); and Jayesh Gandhi, CFA, (India society president). their localities and to provide them with relevant support to succeed in the investment industry in a region of major “THIS EXPANSION IS PART OF OUR importance for us.” PROMISE TO DELIVER SERVICE AND VALUE About half of CFA Program candidates come from the Asia-Pacific region, with China and India as the significant TO OUR MEMBERS AND CANDIDATES IN growth markets. Currently, there are 1,400 CFA charter- THEIR LOCALITIES AND TO PROVIDE THEM holders in India and more than 3,000 in China. Demand for highly qualified financial professionals and best-practices WITH RELEVANT SUPPORT TO SUCCEED IN knowledge in China and India has been growing. China has THE INVESTMENT INDUSTRY IN A REGION fast-tracked financial reforms and the development of finan- cial centers and free-trade zones. In India, expectations are OF MAJOR IMPORTANCE FOR US.” high that the reformist government of Prime Minister Nar- endra Modi will accelerate investments and reforms to put the economy back on a track of double-digit growth. leading centers of finance and investment that subsequent “We continue to see significant growth in candidates generations of charterholders will be proud to belong to.” from both countries, but we need to improve the number “On a personal level, I’m committed to visiting China and of members and charterholders to remain relevant in help- India at least four times a year,” said Smith, who, as newly ing improve the development of these important financial appointed president and CEO, continues to hold the posi- markets,” said Aaron Low, CFA, chair of the CFA Institute tion as managing director of Asia Pacific for CFA Institute. Board of Governors. “Our charter pending numbers need “My commitment is to support our society and volunteer to transition to professional memberships. By building up group heads in the work that they do to develop their per- our societies, we want to convince aspiring practitioners in sonal and society brands. I believe this to be crucial to the China and India that building our profession for the benefit task of raising brand awareness in country and to having of society is a task that they should want to engage in with greater impact on our local communities. I’m looking for- us. By committing resources to the long-term engagement ward to helping Jayesh Gandhi in Mumbai, David Xie in with our professional members, we demonstrate our abso- Beijing, and Tiger Chen in Shanghai in this regard on my lute focus on this mission. In doing so, we will help build visits to their locations.”
8 CFA Institute Magazine May/June 2015 MEET THE NEW COUNTRY HEADS Leading efforts in India and China will be the respective IAIP VOLUNTEERS HAVE DONE A country heads: Vidhu Shekhar, CFA, in India and L.J. Jia FANTASTIC JOB OF RAISING THE PROFILE in China. To explain their roles and priorities, they recently spoke to CFA Institute Magazine in separate, brief interviews. OF CFA CHARTERHOLDERS IN INDIA.
VIDHU SHEKHAR, CFA India Country Head value to our members by engaging with employers, indus- try practitioners, regulators, and government institutions. What are your priorities in your new role? What do you see as the main opportunities/challenges? We have five priorities in India: (1) With large numbers of CFA Program candidates from China Support our India society (Indian every year, it’s critical to provide our society with the Association of Investment Profes- resources it needs to support our candidates and future mem- sionals, or IAIP) to deliver member bers. One important area will be employment opportuni- value to all our members. (2) Build ties, which we will address by deepening our relationships strong institutional partnerships with local employers so that they see the value of hiring CFA in India. In that process, we hope Vidhu Shekhar, CFA charterholders and supporting staff to pursue the charter. to build support for CFA Institute Another key area is industry relations. We need to engage and the CFA charter in India. (3) Achieve the potential of with key stakeholders to contribute meaningfully to the our programs in India and increase adoption of our codes development of a financial services industry in China that and standards. (4) Improve our messaging and communi- will flourish well into the future and in which our charter- cation in the Indian market through appropriate market- holders can thrive. Lastly, China is a fast-evolving market, ing and branding initiatives. (5) Significantly step up our and numerous opportunities and challenges will arise. We engagement with the industry, regulators, and policymak- need to be in step with new developments in the industry. ers in order to improve financial market integrity and effi- ciency in India. MOST IMPORTANTLY, BEING HERE IN What do you see as the main opportunities/challenges? CHINA MEANS WE HAVE EYES AND Our main challenge, as well as opportunity, lies in making EARS ON THE GROUND AND CAN BETTER use of a small but focused India staff to successfully lever- age the strengths of our member base as well as CFA Insti- RESPOND TO THEIR NEEDS. tute resources to the fullest. The impact will come from our ability to act as a catalyst and marshal our resources in much more effective ways.
How will local presence benefit societies? Compared with our candidate numbers, we still have a very small member base in India. IAIP volunteers have done a fantastic job of raising the profile of CFA charterholders in India. With on-the-ground presence in India, we hope to step up and sustain our initiatives in a way that supple- ments and complements the efforts of volunteers.
L.J. JIA China Country Head
What are your priorities in your new role? We have three main priorities in China: (1) Mobilize resources L.J. Jia to support the growth and development of CFA Society Bei- jing, volunteer groups, and emerging societies. We have How will local presence benefit societies? very active volunteers in major cities, and we do expect We will have the benefit of a closer working relationship some of them to form new societies in the next few years. A with CFA Society Beijing and our volunteer groups across network of societies across China will enable us to make a China, allowing us to collaborate with them on high-impact greater impact toward our mission. (2) Build the CFA brand initiatives. Most importantly, being here in China means we in China, sharpening the articulation of our value propo- have eyes and ears on the ground and can better respond sition through our educational programs, codes and stan- to their needs. dards, and thought leadership. (3) Find opportunities to add
May/June 2015 CFA Institute Magazine 9 CFA INSTITUTE NEWS
Keeping Pace with Change PRACTICE ANALYSIS ENSURES THAT CFA CURRICULUM STAYS CURRENT, RELEVANT
By Andrew Tanzer, CFA
The global investment management profession is evolving These panels are convened in all three CFA Institute rapidly. To ensure that the CFA Program reflects this con- geographic regions (Americas; Asia Pacific; Europe, Middle stant change, CFA Institute has developed a continual pro- East, and Africa) to discuss the practice of investment man- cess of global practice analysis. CFA charterholders play agement in each region. During the past year, panels have a critical role in this process. Over the years, the practice been convened on ESG investing, the structured product analysis process has been adapted to keep up with the pace market, fixed-income portfolio management, equity port- of change. folio management, and asset allocation. Before discussing how practice analysis is implemented, it Historically, these panels were composed solely of CFA helps to define the term “practice analysis” and understand charterholders. In recent years, however, CFA Institute has some of its objectives. The Standards for Educational and been “widening the funnel” to include non-charterholders Psychological Testing state that a practice analysis study— so as to ensure that the CFA Program reflects a broad per- a compilation and confirmation of the knowledge and skills spective of approaches to investment practice. As a result required for competent professional practice—is the basis of this wider approach, the practice analysis now includes for establishing the content validity of credentialing exami- investment firms, university faculty, securities regulators, nations. In short, practice analysis ensures that educational and policymakers. programs, such as the CFA Program, are relevant to invest- ment professionals and that the curricula and exams remain THIS CONTINUOUS PROCESS OF IDENTI- the “gold standard” credential for investment professionals. FYING THE MOST CRITICAL KNOWLEDGE Each year, with oversight by the Educational Advisory Committee (EAC), CFA Institute conducts rigorous practice AREAS FOR INVESTMENT PROFESSIONALS analysis studies globally to determine the knowledge, skills, IS VITAL TO STAYING CURRENT WITH AN and abilities (KSAs) as well as the level of understanding INDUSTRY OF EVER-CHANGING DEMANDS. required for a CFA candidate to practice currently. Based on the results of these studies, the Candidate Body of Knowl- edge (CBOK) is modified, which informs the development Based on the regional panels’ consensus of the critical of the CFA Program curriculum. knowledge areas and competencies required for new CFA For instance, in recent years, based on practice analysis charterholders, CFA Institute members are surveyed to assess studies, the CFA Program’s fixed-income curriculum was the proposed revisions to the CBOK. Through these annual rewritten to reflect advances in the industry since the global surveys, members provide guidance regarding the impor- financial crisis, particularly the increasing sophistication of tance and extent of understanding for the CBOK. the credit analysis process. Similarly, the behavioral finance In the final step, the EAC reviews results of the practice curriculum was completely rewritten to focus on the impli- analysis process to evaluate them and determine whether cations for institutional and private wealth investment prac- the committee supports the proposed changes to the CBOK. titioners. Such modifications are made only after the high- The cycle for this rigorous process is one (fiscal) year, and quality global practice analysis process triggers change in it typically takes at least a year for the results of the prac- the CBOK, which is the foundation of the CFA Program. tice analysis process to enter the CFA Program curriculum. Although this framework is of fundamental importance This continuous process of identifying the most critical for the practice analysis process, the next phase—implemen- knowledge areas for investment professionals is vital to stay- tation—is also critical. The first stage focuses on the Global ing current with an industry of ever-changing demands. By Body of Investment Knowledge (GBIK) and identifies topics guiding the development of the CFA curriculum and exam that are currently being debated by practitioners and aca- specifications, practice analysis helps to ensure that the CFA demics that should be considered for inclusion in the CBOK. charter remains the gold standard in the investment pro- The transition from GBIK to CBOK occurs when a topic is fession. The move in recent years to make the process more considered generally accepted and used regularly in practice. global and include a wider range of perspectives (includ- The next stage incorporates employers and subject matter ing non-member/non-charterholder experts) has enhanced experts to provide input as to the current state of investment and strengthened the program. practice. Employers and subject matter experts engage in Andrew Tanzer, CFA, is a senior research analyst and investment writer panels to ascertain skills needed by investment profession- in the investment strategy group of Gerstein Fisher. als at their firms and to identify competency gaps that exist.
10 CFA Institute Magazine May/June 2015 Claritas Program for Certified Public Accountants CFA Institute received approval from the two exams: the NASBA CPE exam and the deep knowledge of accounting with a National Association of State Boards of Claritas Investment Certificate exam. clear understanding of the investment Accountancy (NASBA) to offer the Clar- “CFA Institute sees recognition from management industry that they can build itas® Program to US certified public NASBA as an important step in support- on throughout their careers.” accountants (CPAs) for meeting their ing CPAs across the United States,” said You can explore Claritas Program mandatory continuing education require- Rahul Keshap, head, program manage- benefits, sample chapters, timelines, ments. To earn the Claritas Investment ment, at CFA Institute. “The Claritas fees, and more at www.cfainstitute.org/ Certificate and be awarded 36.5 NASBA Investment Certificate enables account- nasbacpe as well as details on the CPE credits, CPA candidates must pass ing professionals to supplement their NASBA CPE program.
IN MEMORIAM
Irving Kahn, CFA: Investment Industry Pioneer Michael R. Anderegg, CFA Irving Kahn, CFA, one of the first 284 candidates to take complex subject and boil it Livermore, California the CFA exam, died on 24 February in Manhattan at age down to something simple Marco Schaub, CFA 109. Kahn received CFA charter number 240 in Septem- and make you understand Meilen, Switzerland ber 1963 and was the last living member of the first class it,” he said. Kahn’s admira- of charterholders. tion for teaching extended Brett Albert Stein, CFA The centenarian worked as a successful money manager to his personal as well as his Corte Madera, California who used lessons from the Great Depression as well as his professional life. He was a co- mentorship with Benjamin Graham, the forefather of secu- founder and president of the rity analysis and the CFA Program, to lead his firm, Kahn New York City Job and Career Center, which opened in the Brothers Group, Inc., into the 21st century. early 1970s to teach vocational skills to high-school students. Last year, at 108, Kahn was still working three days a Kahn met Graham in 1928 and, to Kahn’s delight, soon week, commuting from his Upper East Side apartment to his became his teaching assistant. Kahn went on to work on midtown office where he collaborated with his son, Thomas Graham’s book Intelligent Investor and sought out potential Kahn, CFA, the firm’s investments for Ben’s partnership, Graham-Newman. Kahn’s president, and grand- first trade came a year later in June 1929 when he sold son Andrew, a vice short 50 shares of Magma Copper, betting his entire savings president and research of $300 that the price would fall. When the stock market analyst. crashed four months later, his investment tripled in value. “Irving had the rare Following his beginning on Wall Street, Kahn worked gift of knowing what for several investment firms, including Loeb Rhodes, Wert- he wanted to do from heim and Company, and JR Williston. Later in his career, a young age and per- he made partner at Abraham and Company, which merged severed as the field of into Lehman Brothers in 1975. Around that time, Kahn’s investment manage- sons Alan and Tom were finishing college, so in 1978, Kahn ment emerged and Brothers and Company was launched. Irving served as co- became a respected founder and chairman of the company until his death. profession,” said Paul Smith, CFA, president and CEO of Born in Manhattan on 19 December 1905, Kahn grad- CFA Institute. “His passion for investing shone through in uated from DeWitt Clinton High School. He attended City everything he did. We owe him a great deal of gratitude College for two years before dropping out to go into busi- because he helped to demonstrate that investing should be ness. As Kahn explained in a 2006 CFA Institute Magazine moved from the back office to the executive suite.” profile, “I attended City College of New York, but there Irving Kahn was a founding member of both the New were no courses in security analysis—it didn’t exist at the York Society of Security Analysts (NYSSA) and the Finan- time—so I left.” cial Analysts Journal (FAJ), which was published initially by Kahn met his wife, Ruth Perl, at Columbia University in NYSSA and later by CFA Institute. He assisted his mentor, one of Ben Graham’s first security analysis classes. They Ben Graham, and Graham’s co-author, David Dodd, in the married in 1931 and raised three sons (Donald, Alan, and research for their seminal 1934 book Security Analysis. Thomas) in Belle Harbor, in the Queens section of New York. In a 2012 video interview taped by CFA Institute to cel- Ruth passed away in 1996. Their oldest son, Donald, became ebrate the 50th anniversary of the CFA Program, Kahn a math professor at the University of Minnesota and prede- recalled his legendary mentor, Graham. “As a teacher, ceased his father by one month. Irving Kahn is survived by Ben was so successful because he had the ability to take a seven grandchildren and eight great-grandchildren.
May/June 2015 CFA Institute Magazine 11 VIEWPOINT
A Winning Tactic TO COPE WITH MORE VOLATILE MARKETS, TAKE A LESSON FROM FOOTBALL MANAGERS
By Vincent McCarthy, CFA
So far in 2015, the financial markets prevalent in the short term, both on the best model that comes to mind is from can aptly be characterised by increased upside and the downside. a sporting context: football (or soccer, volatility, in terms of both the average Yet, to see volatility and risk as one to most Americans). level of volatility and the greater fre- and the same would be a mistake. Vol- In preparation for every football quency of higher volatility. atility is merely a measure of the fluc- match, a manager sets out his team In the first week tuation in the price of a financial secu- and tactics to win the match, his game of trading alone, rity, which is simply a reflection of the plan. As good as that game plan may the EuroStoxx 50 collective behaviour of market partici- be, no manager can legislate for how Index, made up pants at a point in time. Risk cannot be the game will actually evolve. One mis- of 50 blue-chip quantified by a single statistic, as much timed tackle here or one poor pass there eurozone equities, as financial practitioners try. can change the game. A poor refereeing moved by +/– 3% In the active management world, decision—what economists might call an or more on three increased volatility can actually create “exogenous factor”—can put the best- occasions. In the opportunities for active managers to laid plans out the window. Still, the best whole of 2014, it outperform. Research by Standard & managers set out their team to be able to happened only four Poor’s has shown that during periods of adapt to anything that comes at them. times! The much-quoted CBOE Volatility high dispersion—measured as the aver- The financial ecosystem in which we Index (VIX), a key measure of market age difference between the return of operate is no different. We do not live expectations of near-term volatility, oth- an index and the return of each of the in a static world. Even the most sophis- erwise known as the “fear index,” aver- index’s components—there is a wider ticated economic and financial models aged 14.17 in 2014. In January 2015, it spread of active manager returns. In have their limitations. We are all part closed above 15 every day, with an aver- other words, increased dispersion sep- of the very world we try to model, and age above 19. arates the wheat from the chaff. despite the assumptions of many of the This increased volatility points to As I think about how best to design models we use, we are not always ratio- a market that is finding it more diffi- a more robust investment strategy to nal. As investors, if we can accept that cult to appraise the consequences of deal with the prospect of increased vol- a significant amount of what actually the political posturing between Greece atility becoming the new normal, the happens is outside our control, we can and the eurozone, divergent monetary policy across the world’s major central banks, the recent oil price collapse, a lower global growth environment, and (most concerning) the risk of Europe becoming mired in deflation. Editor’s[ Note: For more on how eurozone man- agers are coping with these trends, see “Definite Uncertainty” on page 26, an in-depth interview with Alastair Sewell, CFA, who tracks managers in his role at Fitch Ratings.] Periods of market volatility, such as we have seen recently, are usually challenging for investors. The head- line world we live in exacerbates that feeling of fear—hyperbole sells! Vola- tility, however, is a natural occurrence in financial markets, and the irrational nature of market participants is what causes financial markets to be so vola-
tile. This irrationality tends to be most Cook Timothy by Illustrations
12 CFA Institute Magazine May/June 2015 better design portfolios that are more WE ARE LIKELY TO SEE THE DIVERGENCE THEME adaptive to the circumstances of the PLAY OUT MORE ACROSS ASSET CLASS RETURNS, environment that prevails. From the lows of 2009, the world’s WARRANTING A MORE DYNAMIC APPROACH TO ASSET major central banks have helped orches- ALLOCATION THAT INCORPORATES TACTICAL DECISIONS. trate a situation whereby any reason- able strategic asset allocation deliv- ered exceptional returns. But as we In the current environment, there is On that note, I’ll leave you with a get deeper into this bull market and as a temptation for investors to move into quote from the self-proclaimed “spe- central banks begin to move in oppo- more esoteric strategies in the search cial one,” Chelsea FC manager Jose site directions, we are likely to see the for return or “alternative” sources of Mourinho. “In this moment our team divergence theme play out more across return. Although it can make sense for are able to adapt to everything,” he told asset class returns, warranting a more investment managers to have an uncon- the London Evening Standard in October dynamic approach to asset allocation strained investment opportunity set in 2014. “What the game gives us, we can that incorporates tactical decisions. terms of implementing ideas, investors cope with. We are not the kind of team Of course, the vantage from which should not compromise on transpar- that play only the same way, think the to assess this changing environment ency with undue levels of complexity. same things. We can play in a different is firm specific, based on available The simple adage “understand what way and adapt to different situations.” resources, which will dictate how well you invest in” still holds. Vincent McCarthy, CFA, is a senior investment positioned one is to make tactical asset Ultimately, the objective of adding consultant at Invesco in Dublin, Ireland. allocation calls. For most investors, I a dynamic allocation to portfolios is believe a prudent approach is to allo- to complement the existing strategic KEEP GOING cate capital to an investment manager asset allocation, making portfolios more with a strong track record of dynami- robust in an increasingly uncertain and For more on how eurozone managers cally allocating across and within asset volatile environment. Whether in life, in particular are coping with uncer- tainty and volatility, see the feature classes, allowing the manager sufficient football, business, or investing, the abil- article “Definite Uncertainty” on page flexibility around the allocation param- ity to adapt to a changing environment 26 of this issue. eters and the use of portfolio insurance. is at the very heart of our survival.
May/June 2015 CFA Institute Magazine 13 WHY BUY A SINGLE STOCK WHEN YOU CAN INVEST IN THE ENTIRE SECTOR? Technology Sector SPDR ETF Top Ten Holdings* XLK - TECHNOLOGY Company Name Symbol Weight 1 Apple AAPL 16.13% 2 Microsoft MSFT 9.54% 3 Verizon Communications VZ 4.86% 4 AT&T T 4.34% 5 Facebook FB 4.06% 6 Google A GOOGL 3.77% 7 Google C GOOG 3.73% 8 Intel INTC 3.73% 9 Intl Business Machines IBM 3.68% 10 Oracle ORCL 3.64% * Components and weightings as of 12/31/14. Please see website for daily updates. Holdings subject to change.
Potential benefits of adding Sector SPDR ETFs to your portfolio include: Time For A • Undiluted exposure to a specific sector of the S&P 500 Stock Alternative • The all-day tradability of stocks • The diversification of mutual funds • Total transparency • Liquidity Visit www.sectorspdrs.com or call 1-866-SECTOR-ETF
Consumer Discretionary - XLY Consumer Staples - XLP Energy - XLE Financial - XLF Health Care - XLV Industrial - XLI Materials - XLB Technology - XLK Utilities - XLU An investor should consider investment objectives, risks, charges and expenses carefully before investing. To obtain a prospectus, which contains this and other information, call 1-866-SECTOR-ETF or visit www.sectorspdrs.com. Read the prospectus carefully before investing. The S&P 500, SPDRs®, and Select Sector SPDRs® are registered trademarks of Standard & Poor’s Financial Services LLC. and have been licensed for use. The stocks included in each Select Sector Index were selected by the compilation agent. Their composition and weighting can be expected to differ to that in any similar indexes that are published by S&P. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. The index is heavily weighted toward stocks with large market capitalizations and represents approximately two-thirds of the total market value of all domestic common stocks. Investors cannot invest directly in an index. The S&P 500 Index figures do not reflect any fees, expenses or taxes. Ordinary brokerage commissions apply. ETFs are considered transparent because their portfolio holdings are disclosed daily. Liquidity is characterized by a high level of trading activity. Select Sector SPDRs are subject to risks similar to those of stocks, including those regarding short-selling and margin account maintenance. All ETFs are subject to risk, including possible loss of principal. Funds focusing on a single sector generally experience greater volatility. Diversification does not eliminate the risk of experiencing investment losses. ALPS Portfolio Solutions Distributor, Inc., a registered broker-dealer, is distributor for the Select Sector SPDR Trust. WHY BUY A SINGLE STOCK VIEWPOINT WHEN YOU CAN INVEST IN Why We Honor Irving Kahn, CFA
THE ENTIRE SECTOR? By William C.G. Ortel Technology Sector SPDR ETF In February, a young man passed away Top Ten Holdings* to whom CFA Institute owes a lot. He was 109. His name was Irving Kahn, AT 109 YEARS OLD, HE STILL XLK - TECHNOLOGY CFA. I never had the pleasure of meet- LOVED THE STUFF THAT WE Company Name Symbol Weight ing him, but I do have the honor of writ- 1 Apple AAPL 16.13% ing about what his example means. [Edi- PROFESSIONAL INVESTORS 2 Microsoft MSFT 9.54% tor’s Note: For more on Kahn’s passing, DO DAY IN AND DAY OUT. see “In Memoriam” on page 11.] 3 Verizon Communications VZ 4.86% Why do we choose to honor this 4 AT&T T 4.34% man? Perhaps it’s because as a teach- 5 Facebook FB 4.06% ing assistant to Benjamin Graham, he 6 Google A GOOGL 3.77% watched and guided the creation of the 2. HE DIDN’T KEEP HIS KNOWLEDGE TO HIM- SELF. When Irving got to Wall Street, 7 Google C GOOG 3.73% investment profession from the very beginning. Or perhaps it’s because he “analyst” was not a job title. Analysts 8 Intel INTC 3.73% belonged to the first class of CFA char- were called statisticians. We owe the 9 Intl Business Machines IBM 3.68% terholders, a group of people who set in existence of the investment manage- 10 Oracle ORCL 3.64% motion a social movement that helped ment profession in large part to the * Components and weightings as of 12/31/14. professionalize the world of investing. work of Irving and his mentor Benjamin Please see website for daily updates. Holdings subject to change. Irving Kahn, CFA He was among the founders of the New Graham, who would trek up from Wall York Society of Security Analysts, one Street to Columbia Business School after of our largest societies, as well as the can retain his enthusiasm. But I also work to teach others how to properly Financial Analysts Journal. honor him because there is much to analyze companies. Many people would Or maybe it’s because, at 109 years learn from his example. In particular, have just turned in year after year of old, he still loved the stuff that we pro- I think he did three things that every stellar performance and allowed their fessional investors do day in and day out. professional investor should emulate. investors to believe they were magicians instead of passing on their knowledge. Kahn was still working when he passed 1. HE READ DIFFERENT NEWS SOURCES. One away, even though he had more than of the more intriguing stories about 3. HE KEPT LEARNING. There are very few earned his retirement and could have Irving is that he was actually respon- widely respected investors who don’t moved somewhere with a better climate sible for the expansion of the Financial spend most of their time engaged in than New York City and lived a life of Times to the United States. In the early their primary job: learning new stuff. leisure. I guess he just loved this game. 1950s, he would (at great expense) pro- Kahn could have decided after 30 (or The investment industry is consid- cure copies of the pink paper because he 40, 50, 60, or even 70) years of expe- Potential benefits of adding Sector SPDR ETFs to your portfolio include: Time For A ered boring by the uninitiated. We are was fascinated with European compa- rience that he had all the knowledge unrepentant geeks. We print out annual he needed and fallen into the trap of • Undiluted exposure to a specific sector of the S&P 500 Stock Alternative nies. When he later traveled to London, reports and read them in alphabetical he met with the FT to convince them to trying to force markets to fit his well- • The all-day tradability of stocks order. Our nicknames for things—the begin publishing in the United States. constructed beliefs rather than updat- • The diversification of mutual funds Swissie, crack spreads, 2s10s—make lit- They laughed at him. By the time he ing them. Instead, he kept learning. erally no sense to other people. When • Total transparency was profiled for CFA Institute Magazine I imagine that the career ahead of our contemporaries are profiled in the in 2006, they had been hand-delivering me will be different in many ways from • Liquidity Visit www.sectorspdrs.com media, they often come off as mor- a weekend Financial Times to him for the one that Kahn had. At the very least, or call 1-866-SECTOR-ETF ally bankrupt. This characterization more than 40 years as a way of saying I’ll never have the same difficulty get- is so common that it’s discussed as a “thank you” and “we’re sorry.” ting a hold of the Financial Times. But I Consumer Discretionary - XLY Consumer Staples - XLP Energy - XLE Financial - XLF Health Care - XLV Industrial - XLI Materials - XLB Technology - XLK Utilities - XLU TV trope. (See the “Morally Bankrupt hope I can mimic his example in these An investor should consider investment objectives, risks, charges and expenses carefully before investing. To obtain a prospectus, which contains this and other information, call Banker” entry at tvtropes.org.) KEEP GOING three important ways. 1-866-SECTOR-ETF or visit www.sectorspdrs.com. Read the prospectus carefully before investing. So, when I see a distinguished inves- William C.G. Ortel is a content manager at CFA The S&P 500, SPDRs®, and Select Sector SPDRs® are registered trademarks of Standard & Poor’s Financial Services LLC. and have been licensed for use. The stocks included in each Select Sector Index tor quietly grinding out alpha because he were selected by the compilation agent. Their composition and weighting can be expected to differ to that in any similar indexes that are published by S&P. The S&P 500 Index is an unmanaged index of 500 “Behind the Scenes, Ahead of His Time: Institute, where he focuses on global macro common stocks that is generally considered representative of the U.S. stock market. The index is heavily weighted toward stocks with large market capitalizations and represents approximately two-thirds likes it, I find it inspiring. And hearing Irving Kahn Discovers True Value in a Life trends, value investing, technology, and the of the total market value of all domestic common stocks. Investors cannot invest directly in an index. The S&P 500 Index figures do not reflect any fees, expenses or taxes. Ordinary brokerage commissions about someone else who likes it makes Well Lived,” CFA Institute Magazine (Janu- future of the investment profession. This arti- apply. ETFs are considered transparent because their portfolio holdings are disclosed daily. Liquidity is characterized by a high level of trading activity. ary/February 2006) [www.cfapubs.org] cle was originally posted on Enterprising Inves- me feel like a little bit less of a nerd. tor (blogs.cfainstitute.org/investor). Select Sector SPDRs are subject to risks similar to those of stocks, including those regarding short-selling and margin account maintenance. All ETFs are subject to risk, including possible loss of principal. In part, I honor him because I hope I Funds focusing on a single sector generally experience greater volatility. Diversification does not eliminate the risk of experiencing investment losses.
ALPS Portfolio Solutions Distributor, Inc., a registered broker-dealer, is distributor for the Select Sector SPDR Trust. May/June 2015 CFA Institute Magazine 15 GEOPOLITICS FOR INVESTORS
Pippa Malmgren
Find out why geopolitical issues have a profound effect on investment strategies and results.
For more information or to download a free copy, visit www.cfainstitute.org/geopolitics.
© 2015 CFA Institute
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May the Sorts Be with You NEWS ANALYTICS MAY HELP INVESTORS SIFT THROUGH DATA TO FIND SIGNALS
By Rhea Wessel
More and more investors are tracking and analyzing news the text, often including a relevance or probability score for flows and text sentiments in large, unstructured datasets the different entities. It then aggregates this data over the and mining data in a split second for investment-relevant whole news flow and gives users an indication of whether information. Often, the goal is to incorporate findings into certain companies or terms are trending positive or negative. trading strategies and algorithms, to back-test investment Some tools score news sentiment and present it as a time theses, or to improve risk-monitoring activities. series, measure the volume of media coverage, or capture Finding information of interest in large, textual databases deviations in media coverage that can be telling for inves- is becoming easier as semantic analytic technologies mature. tors. Other tools define and track entity relationships in Tools already abound to help companies monitor the sentiment massive textual datasets. toward their brands by evalu- The focus of news analytics tools is no longer on speed ating “big data” repositories, or reducing latency, according to Armando Gonzalez, pres- Applying news analytics such as customer comments. ident and CEO of RavenPack, a provider of news analytics for investing is still a rela- Text and news analyt- for quantitative finance applications. “It’s about develop- tively new field, and many ics for investing is a newer ing sustainable alpha or verifiable risk management strat- approaches are still at the niche application, and many egies from unstructured data,” he says. “Can users reliably experimental stage. are now experimenting with extract a durable signal from the vast amount of news and KEY POINTS investment use cases. As they social content out there that lives for hours, days, weeks, Use of semantic analysis do, the need to quantify and and ideally months?” has expanded from equity incorporate unstructured investing to fixed income, data into investing equations SIGNAL VERSUS NOISE commodities, FX, trade continues to grow, along with Getting a reliable signal from not-so-reliable text sources is timing, and other areas. the volume of textual data: indeed a big challenge, particularly with such data sources Distinguishing reliable About 2.5 billion gigabytes as Twitter feeds, which have been known to include mar- signals from noise remains of data were generated every ket-moving information but which data scientists gener- a key challenge for machine day in 2012, according to ally classify as “noisy.” Even for less-noisy data, such as a learning. IBM, and by some estimates, news feed from an established financial news agency, reli- 75% of data are unstructured. able signals can still be a problem. According to one pro- Data sources that drive vider of semantic analytic tools, approximately 30%–40% tools for investors are diverse of all news contains redundant information, and only 1 in and depend on the vendor of the analytics. Some vendors allow 500 news items is market moving, such as profit warnings, users to hand-pick data and custom aggregate it. A few exam- takeover announcements, or CEO changes. ples of data sources for text analytics are news feeds, select The technology problem adds another layer of com- blogs, social media data, RSS (rich site summary) feeds, cus- plexity. If a system offers sentiment analysis and relies on tomer relationship management (CRM) data, and audio and machine-learning techniques, simplistic dictionaries or sim- TV news transcripts, such as CNBC’s Squawk Box transcripts. plistic data used to train the machine could lead to results News analytics have been used for years in equity invest- with low accuracy. ing, but now, investors are applying these tools in global According to Gary Kazantsev, who heads the R&D machine macro strategies and foreign exchange (FX) trading as well learning group at Bloomberg, other problems include author as in commodities and fixed-income investing. Early adopt- bias, the fact that expectations are often already priced in ers include quantitative hedge funds in the United States at the time of a negative or positive announcement, and the and United Kingdom. Machine learning capabilities are get- linguistic challenge of news item that can be interpreted as ting better at interpreting and almost understanding what negative (such as an earnings report) but does not have any news may mean, although many pitfalls still exist. negative language that can be picked up by computers. In a Most news analytics tools use sentiment analysis algo- web video about Bloomberg’s work in this field, Kazantsev rithms that work with a simple scoring mechanism. Using nat- joked about computers’ awkward interpretations of human ural language processing, the algorithm counts the number language. “Sentiment analysis does not a trading strategy of positive words and the number of negative words in a text make,” he said. Despite the potential risks, users are increas- and then assesses which company name appears most in the ingly interested in developing their own investment strate- text. The algorithm assigns a positive or negative score to gies that incorporate sentiment analysis.
18 CFA Institute Magazine May/June 2015 NEWS-ADJUSTED INVESTING movements, where momentum will lag in value or growth, Consider a real-world example of how a news analytics tool or other fundamental factors are slower at detecting it. News can be used. Baader Bank, an investment bank in Germany is going to be a more timely factor in an alpha strategy, so it that manages 700,000 financial instruments, uses a news ana- tends to be a more powerful signal in the short term, com- lytics tool from Clueda AG called “clueda.trader” to improve pared to some other traditional factors.” the pricing of stocks for which it is a market maker. Baader Users also rely on sentiment analysis for portfolio opti- Bank receives alerts from its Clueda system that are based mization and the timing of trades. Users incorporate anal- on real-time processing of news to identify potential events ysis of news sentiments to better predict the volatility of a or trending sentiments that might affect a stock price. security based on the intuitive understanding that there is Clueda is a spinoff of the Institute of Bioinformatics and a strong relationship between negative news and volatil- Systems Biology at the HelmholtzZentrum, a research center ity. When the news flow is headed in a negative direction, in Munich. It provides investors with semantic analytic tools investors can readjust their portfolios for lower volatility to and offers products for manual trading (in which data are optimize the portfolio. presented in an intuitive user interface) and for algorith- Analyzing news volumes in this way could improve the mic trading (with output in application programming inter- returns in FX carry trading, according to a paper written face, or API, format). by Saeed Amen, a managing director and a cofounder of Interestingly, Baader Bank recently increased its stake Thalesians Ltd. in London who also publishes quant strat- in Clueda from 18.2% to 60%. This move may be a sign of egy notes and consults and conducts research for clients, confidence in the technology based on direct experience. including RavenPack. According to Michael Schramm, the former head of financial “When you have high news volumes, it coincides with analytics at Clueda and now a consultant there, using news higher volatility,” says Amen. “And when there’s higher vol- analytics to reduce the amount of irrelevant information atility, people tend to be risk averse. They will pull back in the news flow helped Baader improve its trading profit. from risky investments, including FX carry trades.” Thus, Other investors use data from news analytics to indicate, an investor might use a strategy of reducing exposure to through backtesting, how stocks may react to particular FX carry when news volume was high. Similarly, an under- events, basing the indication on millions of data observa- standing of the sentiment of the news flow may help inves- tions. For example, the global financial services firm Mac- tors better time when to enter or exit an investment posi- quarie uses RavenPack data to map stock reactions to the tion to get the best prices on a trade. news in event studies. From Macquarie’s point of view, focus- ing on the events that matter is crucial because hard news THE RANGE OF CAPABILITIES has greater impact than soft news and “unscheduled” news Some companies are working to gain a more fine-grained causes greater shocks than “scheduled” news. understanding of text by applying grammar and semantic rules to identify patterns and entity relationships that can ALPHA, OPTIMIZATION, AND TIMING be useful to investors. By analyzing complex subject/pred- Another application for investors is using news analytics to icate/object sequences contained in such sources as news design and test alpha-generating strategies. feeds, investors can detect specific entities and events and Investors using so-called alpha testing software, such as define their relationships. FactSet, can incorporate sentiment data by “mapping it” to To get a more precise analysis, the relationships among securities data, with the goal of understanding the effect of entities must be defined and these entities must be extracted. their news-based strategies on a certain set of stocks during Computers can then perform “relation extraction” on large a particular investment horizon. According to Gonzalez, datasets (e.g., all tweets) to form a relationship network. RavenPack’s research shows that over time, positive-senti- “Automated reasoning based on that network can bring valu- ment stocks tend to outperform negative-sentiment stocks. able insights and context since relationships across sources Investors can also construct a portfolio and rank it for and time horizons are reflected,” he said. sentiment or media attention, programming an algorithm to Clueda’s research is focused on cognitive computing, go long on a certain percentage of the shares ranked high- according to Schramm. “Sentiment is used as a heuristic, est for positive sentiment and to short those ranked with as an approximation for the real content,” he says. “After we higher negative sentiment. extract the entity relations out of an article, we can detect Another approach is using senti- the main theme and if it is posi- ment indicators as a filter to exist- KEEP GOING tive or negative for the company. ing signals or factors already in an We apply that to a knowledge net- alpha model. “What you’re look- “Memes Are Analytical Weapons of Mass Destruc- work, propagate the sentiment, and ing for is something that helps you tion,” Enterprising Investor (6 January 2014) calculate a systemic mood. Then [blogs.cfainstitute.org/investor] explain price movements and ulti- we try to create reasoning around mately predict them in times when “Aye, Robot: Can machine learning replace human the heuristics.” analysts and investment roles?” CFA Institute other factors don’t,” says Gonza- Magazine (July/August 2013) [www.cfapubs.org] Rhea Wessel is a business and financial lez. “Our data can be extremely writer based in Frankfurt. useful in picking up short-term
May/June 2015 CFA Institute Magazine 19 PROFESSIONAL PRACTICE CAREER CONNECTION
Cultural Travelers GLOBAL CAREERS CROSS BOUNDARIES GREATER THAN GEOGRAPHY
By Liana Cafolla
When it comes to navigating the often slippery paths of “As a CFA charterholder, you’re told if you see a prob- other cultures, CFA charterholders Alex Proimos, Shirley lem to raise it,” he says. “It’s something I still struggle with Low, and Olaf Stier have learned many lessons about how to today. You need to adapt to individual personalities and adapt during their various career moves around the world. standards of business behavior as much as adapting to coun- Soon after finishing his studies in applied finance and tries and cultures.” business and finance law in his hometown of Sydney, Aus- Proimos advises others who are moving to a new culture tralia, Proimos, CFA, decided to venture abroad. Over the to tread carefully in their first days in a new office. next several years, he moved first to Argentina (his first time “The safest route is to observe,” he says. “Try and under- living outside of Sydney) and stand the relationships. It’s very easy to be over-enthusias- then to Peru, Haiti, the Neth- tic, and you might step on someone’s toes.” That can make Cultural misunderstand- erlands, and now the US. for a disastrous start, he adds. ings can have implications On the whole, his interna- Proimos’s experiences and advice are supported by global for professional financial tional experiences have left research on the best ways to successfully adapt to a new behavior. him with a very positive view work culture. of human nature. “What I’ve Communication skills are vitally important but that may KEY POINTS Developing the skill of lis- noticed is the average person not necessitate learning the local language, says Bertha Du- tening is a key for suc- is very generous,” he says. Babcock, associate professor in the department of English cessful business “In most places, people are and communication at City University of Hong Kong. “The communication. kindhearted and willing to importance of learning the local language varies according Understanding cultural help you.” to country, nature of the job, and the working language in dimensions can help But Proimos, who has a particular company,” says Du-Babcock, whose research people interpret behavioral always traveled alone, has focuses on first- and second-language business communi- tendencies. also had some hard-won cation behavior between cultures. learning experiences during Although learning a language at a professional level may his travels. Culturally, he take several years, understanding—as opposed to speaking— found the Argentines warm, friendly, and hospitable, and the language can bring huge benefits and a faster return. their behavior even familiar, perhaps because of their US- “Learning to understand even if you cannot speak pre- style education. Many of them also spoke some English. vents one from being excluded, and listening ability pre- In Peru, however, the language situation was different. cedes speaking ability,” Du-Babcock says. “Listening is an “The issue with language was hardest in Peru because of underdeveloped skill that can be the key to success.” working full-time in Spanish where people hardly spoke Eng- Shirley Low, CFA, faced a double language challenge lish, and their accent was different from Argentines,” he recalls. when she moved from Singapore to Switzerland with Credit Undaunted, Proimos set about the challenge of learn- Suisse about 10 years ago. She quickly had to master not ing Spanish at the age of 28 and now speaks it with pro- one but two new languages: French in Geneva (her first fessional proficiency. city of residence) and German when she moved to Zurich. Working as the chief financial officer of a waste manage- “The first couple of years working overseas are tough, full ment company at the time, Proimos also found the Peru- of good and bad surprises and challenges,” she says. “They vian business environment very different. He often had can also be frustrating, especially if one does not speak the problems getting responses to his professional inquiries. language and therefore is totally dependent on colleagues “As soon as I asked questions about finances, there were to help with translation at work.” roadblocks,” he said. In contrast, Olaf Stier, CFA, found that moving in the Perhaps not surprisingly, one virtue Proimos learned opposite direction—from his native Germany to Singapore— to value from his time in South America was patience. “I was a breeze. Language was never a problem, and cultural learned to try and really slow down—a life skill, really, to differences have been stimulating rather than stressful, be more patient,” he says. according to Stier, who is head of treasury (Asia) at Com- Communication styles vary widely across cultures, he merzbank in Singapore. found. While in the Netherlands and Argentina, he found “This is a global city, and as in most places in the world, it very normal to speak out when he saw anything wrong, if people are open-minded and respectful to each other, but that was not the case in Peru. misunderstandings are tolerated,” he says. “In fact, cultural
20 CFA Institute Magazine May/June 2015 differences will be enriching for all sides. I like leading and listening as a skill that helps achieve cross-cultural under- motivating people from different cultural backgrounds in standing. Empathetic listening is the most effective method, a global organization.” according to her, and it can be understood by referring to Low, who is now head of APAC and managing director the Chinese character for listening—ting—which has three at STOXX Ltd., found adapting to different cultural behav- parts: the ear (to hear what is being actually said), the eyes ior more complex. In her experience, Europeans gener- (to read body language, tone, and emotional state), and the ally placed less emphasis on building a relationship before heart (to understand or empathize). trying to close a deal. Tuleja also uses cultural dimensions—the country norms “In Europe, relationships take a back seat compared to the of a given culture—in her training to help people understand right product and the right pricing,” she explained. “There- the different behavioral tendencies in other cultures. Some fore, it takes longer to close business in Asia, as it takes a dimensions may be particularly useful as starting points while to develop a relationship with the client.” for CFA charterholders who are planning to move abroad. Finding that the Swiss were more direct communica- For example, high-context communication, common in tors than she was accustomed to in Asia also took some Asian cultures, assumes that a large degree of shared values getting used to. and understanding exists between the parties so that cer- “Asians, in general, are less direct and more subtle when tain things are understood without needing to be explic- it comes to giving negative feedback,” says Low. “We have itly said. Additionally, behavior, such as body language, is our indirect way to address conflicts, and this has to do with important. This contrasts with low-context communication, our culture of ‘saving face’ for the other party. After work- common in Western cultures, in which facts, information, ing in Switzerland for a while, I have realized that direct- and the spoken word take priority. ness can also be a virtue and is maybe more efficient as the “For a CFA charterholder, this would mean that a client feedback is crystal clear to all parties. However, this can be [from a high-context culture] may not explicitly tell you that painful if you do not understand the culture.” he is upset; the way it might be handled is that he doesn’t Cultural misunderstandings can have implications for pro- return phone calls or emails and you might hear it through fessional financial behavior, according to Elizabeth Tuleja, the grapevine,” says Tuleja. associate teaching professor of management at the Univer- Another dimension is direct communication, in which sity of Notre Dame and an expert coach and speaker on you say what you mean without disguising the message. intercultural communication and global leadership. This contrasts with indirect communication, which features “When communicating with people who are different implicit messages and conflict avoidance. “For a CFA char- from you, it is important to make sure that you are on the terholder, this would mean listening for what is not said,” same frame of reference—a concept or term that you under- explained Tuleja. stand may not be understood in the same way by some- A third dimension contrasts hierarchy, in which status is one else,” she says. “For example, the IFRS—International important, with equality, in which all parties are presumed Financial Reporting Standards—have been designed to rep- to have the same social status. resent a ‘global language’ of sorts so that accountants can The three dimensions can be helpful starting points interpret company assets in comparable terms across bor- for building knowledge about a culture, but Tuleja warns ders. However, what accountants are finding is that busi- against stereotyping. ness colleagues from other parts of the world are inter- “You should never assume that just because someone is preting basic concepts, such as assets and liabilities, differ- from China, they’re going to be more indirect or collectiv- ently. It is critical to remember that you can’t just assume istic, because we are all individuals, and we have our own that either rules or a person’s interpretation of the rule is unique cultural preferences when it comes to communicat- going to be the same.” ing,” she says. Tuleja suggests starting to develop an awareness of cul- Whatever the challenges of working in different cul- tural differences prior to departure by studying the new tures, CFA charterholders are unanimous about the rich- culture, reflecting on or internalizing the differences, and ness of the benefits. then practicing them. “Always be ready to take the plunge,” advises Low. “Work- “The best thing that a person can do who is getting ing in a new cultural environment always adds to one’s expe- ready for an assignment abroad is rience and helps one grow person- to open their mind and their atti- KEEP GOING ally and professionally.” tude and start learning as much as Liana Cafolla is a journalist based in Hong they can,” she says. “But it’s not just “Career Conversations: Uncovering Behavioral Kong. the learning, it’s the ability to be Styles,” Enterprising Investor (14 October 2014) [blogs.cfainstitute.org/investor] reflective and open to the possibil- ities that exist. We need to have a “Cultural Diversity and Networking,” CFA Institute webcast (26 August 2013) [www.cfainstitute.org] global mindset and try to see things from somebody else’s perspective.” “Found in Translation,” CFA Institute Magazine (July/August 2013) [www.cfapubs.org] Like Du-Babcock, Tuleja empha- sizes the primary importance of
May/June 2015 CFA Institute Magazine 21 COMPLIANCE IS ABOUT MORE THAN CHECKING A BOX It’s about serving client interests
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Honest_Accountable_Profession8.5x5.5_2.indd 3 10/8/14 12:58 PM “A finance industry that puts investors first? That will change the world.” COMPLIANCE Kenechukwu E. Anadu, CFA Financial Services IS ABOUT Market Specialist MORE THAN CHECKING A BOX It’s about serving client interests
CFA Institute is a global community of more than 120,000 investment professionals working to build an investment industry where investors’ interests come first, financial markets function at their best, and economies grow. THE The Global Investment Performance Standards FUTURE (GIPS®) and Asset Manager Code of Professional Conduct™ are ethical principles to help your firm promote full disclosure and put client interests first. OF FINANCE STARTS Learn more at www.gipsstandards.org and www.cfainstitute.org/assetcode. WITH YOU
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Future of Finance House Ad_Ken.indd 1 9/11/2014 11:28:19 AM Honest_Accountable_Profession8.5x5.5_2.indd 3 10/8/14 12:58 PM PROFESSIONAL PRACTICE PRIVATE CLIENT CORNER
The Searchers BETTER SEARCH METHODS CAN IMPROVE HIRING OUTCOMES
By Ed McCarthy
You cringe inwardly as your newest staff member barges best way to approach them? What does the interview process into your office with another complaint. Despite solid cre- entail? “Once you’ve got them targeted and you’ve got a pool, dentials and strong pre-hire interviews, he has proven dif- then you’ve got to have a structured interview assessment selec- ficult to manage and is damaging morale among other tion process and talk about what are the tools you’re going employees. You realize the time has come to speak to your to use,” she says. “It’s not just a ‘wing it when they show up.’” partners about letting him go and restarting the job search. Most wealth managers’ organizational charts have very FINDING THE RIGHT PEOPLE little padding. Each position fills a necessary role, and Multiple sources cite tight job markets, although a position’s every employee’s contribu- required skill level, the firm’s location, and other factors influ- tion matters. Consequently, ence the search. Sabrina Lowell, chief operating officer with Employer searches to it’s important to make good Mosaic Financial Partners in San Francisco, has had good fill positions require hiring decisions the first results working with recruiters when seeking support staff. substantial resources, and time around and to avoid In her experience, the key is finding a recruiter who under- wealth managers often the hire-fire-hire cycle, but stands the firm’s requirements and has a broad network. have little margin for error. some firms lack a method- The relationship saves Lowell considerable time because the KEY POINTS ical approach to hiring. “I recruiter screens applicants. On one assignment, the recruiter Many firms lack methodical find a lot of times that firms vetted 80 applicants before suggesting 5 for Lowell to inter- approaches to hiring. don’t even have simple things view. Online job networks can also bring in qualified oper- Search consultants and like job descriptions in place ations and administrative job candidates, says Matt Cooper, online job boards, such for their employees,” says president for private client services with Beacon Pointe Advi- as CFA Institute’s JobLine, Matt Matrisian, senior vice sors in Newport Beach, California. “I would say we attract can help identify qualified president of practice man- more operations-type staff through the social media online candidates. agement and strategic ini- approach—LinkedIn specifically—and our websites.” tiatives with AssetMark in For professional staff positions, industry job boards, Concord, California. such as CFA Institute’s JobLine and those provided by the Financial Planning Association and the National Associa- A LONGER-TERM PERSPECTIVE tion of Personal Financial Advisors, can help identify can- A successful job search requires adequate lead time, and didates. Cooper takes advantage of his firm’s location, some firms constantly evaluate prospective hires to keep which is home to numerous investment and wealth man- their pipeline full. According to Roger Pine, CFA, partner agement firms. Almost without exception, the firm’s profes- with Briaud Financial Advisors in College Station, Texas, sional hires have a personal connection to Beacon Pointe. his firm’s past approach to hiring was reactive; when the Either the firm’s staff knows the candidate directly, or they firm had an opening, it would start the job search. Now, he are friends of friends. Of course, a firm’s location can deter says, the firm takes a longer view by maintaining relation- some candidates. David Strege, CFA, senior financial plan- ships with university career centers and professional orga- ner with Syverson Strege and Company, says finding entry- nizations, among other sources. level professionals willing to relocate to his office in West Linda Mack, president of executive search firm Mack Inter- Des Moines, Iowa, remains a challenge. national LLC in Chicago, emphasizes the need for a recruit- Managing the job search internally takes considerable time. ing strategy and process that will help identify ideal candi- For firms lacking the resources and expertise to do the job dates. It’s essential to have “a clearly defined position profile” properly, outsourcing professional staff searches to consul- that specifies “the responsibilities, accountabilities, personal tants is an option. Mack’s firm specializes in higher-level pro- characteristics, and attributes required for success” before fessional positions with organizations that serve ultra-high- seeking candidates, she says. That profile should be based net-worth clients. Other search firms work with less-experi- on consensus within the firm; otherwise, those making the enced professionals. Caleb Brown, cofounder of New Planner selection can have different versions of the ideal candidate. Recruiting in Athens, Georgia, connects financial planning Once the job is clearly defined, the firm needs a planned and wealth management firms with qualified entry-level recruiting strategy that specifies “dates and deliverables” in candidates. Before presenting candidates to firms, the com- the hiring sequence, according to Mack. Among the questions pany uses a six-stage screening process that indicates how to answer: Where will the firm find candidates? What is the well the candidate will fare on the job. That saves the hiring
24 CFA Institute Magazine May/June 2015 advisers time, according to Brown, and allows them to con- him to test different skills in one environment. Tested skills centrate on other aspects of the process. “They don’t have cover basic math functions, formula building and format- to worry about: Is this person qualified, and can they do the ting skill, and researching and entering data into a work- job?” he says. “They can focus more on the philosophies, the book. “It allows us to build a test that covers a lot of differ- culture, the work, the work style, a lot of these bigger-pic- ent aspects of what we’re looking for,” he says. ture [attributes], the sort of intangibles that I’ve found have Sources cite several different personality profiling ser- a bigger impact on [a candidate] being a good long-term fit.” vices as being helpful. Pine uses a service from Leadership Alliance and says its personality-attributes profile helps his INTERNSHIPS’ VALUE firm manage new hires more effectively. Strege works with Internships can benefit both firms and students. Strege hires the Omnia Group for behavioral assessments and believes interns from Drake University, which is a member of the the assessment results have been a reliable indicator. “It CFA Institute’s University Recognition Program. In Strege’s seemed like every time we went against its recommenda- experience, interns hired post-graduation generally have tions, we suffered,” he says. worked out very well. Cooper’s firm also runs an extensive Several advisers report using the ProScan system from internship program. “It’s a regular class during the summer, Professional DynaMetric Programs (PDP). Lowell says her which would be predominantly for college kids, where they company profiles employees who have been successful in a actually sit in a learning environment and then are allocated position to build a ProScan profile for that job. Subsequent to different areas of the firm to work with the staff and pro- potential hires are measured against that metric. fessionals here,” he says. “And then we’ll also bring people in who are working on their graduate degrees.” FIRMS THAT ARE MAKING THEMSELVES Another value of internships is that former interns can VISIBLE FOR CLIENTS WILL ALSO MAKE become a firm’s promoters, even if they take jobs elsewhere. Pine cites his experience with an intern from Rice Univer- THEMSELVES VERY VISIBLE FOR THE sity in Houston. The internship was a success, but the stu- NEXT GENERATION OF TALENT. dent did not return to the firm after graduating. However, she recommended the company highly to another student, whom Pine later hired. Measuring financial analysis or portfolio management skills presents a different challenge, unless a new staff IMPROVING THE ODDS member is coming from a position that built a track record, Hiring is a two-way street, Brown points out, and qualified according to Matrisian. One possible testing option is to have applicants are likely to receive multiple offers. Advisory firms candidates work through a case study that requires the skills can enhance their attractiveness by leveraging the same tech- needed for the job. “I think that you can, however, give them niques that help them attract new clients. These techniques individual portfolios and ask them to analyze those port- include maintaining a high profile by being active in profes- folios, look at those portfolios, and assess whether there is sional and community organizations and generating thought- overlap between the portfolios,” he says. “What’s the risk leadership publications. “Firms that are making themselves makeup of the individual portfolios that I’ve given you? Tell visible for clients will also make themselves very visible for me in what markets these portfolios would be strong and the next generation of talent,” he says. “So, it’s almost like how would they perform in different stress tests. Giving you get a two for one.” That approach has worked for Beacon them different scenarios in terms of their portfolios and to Pointe, says Cooper. Many of the firm’s managers and staff be able to do some analytics around the portfolios I think serve on not-for-profit boards, and the firm has numerous would be helpful, as well as some of that case-study work.” institutional clients. The endowments and foundations they Testing is prevalent but still optional, of course. Cooper work with help spread the word to potential new hires. reports that Beacon Pointe doesn’t use third-party assess- ments and tests. “We haven’t used any form of personality SKILLS TESTING AND SCREENING tests or skills tests prior to hiring,” he says. “We do want There’s always a risk that a less-than-ideal candidate can everybody to have at least a four-year degree, so that would puff up his résumé and bluff his way through the inter- speak to some cognitive skills, if you will. But we’re really views. Firms frequently run criminal background checks relying on getting as many inputs from people in the firm, and pull credit reports on potential so we want that person to talk to as hires to reduce that risk. Assuming KEEP GOING many people as possible within the that those reports don’t raise any firm, and we take everybody’s opin- red flags, skills tests and personal- CFA Institute JobLine (www.cfainstitute.org) ion seriously as we’re evaluating the ity profiles can provide additional CFA Institute University Recognition Program candidate. That’s worked extremely insights about candidates. (www.cfainstitute.org) well. Where we’ve messed up is Pine gives applicants a Microsoft “Is Finance a Noble Profession? A Summary of when we rush the process.” Excel skills test. His firm uses the the Online Forum,” Enterprising Investor (5 March Ed McCarthy is a freelance financial writer program extensively in its work, 2015) [blogs.cfainstitute.org/investor] in Pascoag, Rhode Island. and the program’s flexibility allows
May/June 2015 CFA Institute Magazine 25 Trying to ride out low yields, deflation fears, monetary turmoil, and more, eurozone managers can count on one thing for sure:
DEFINITE UNCERTAINTY By Nathan Jaye, CFA
Negative interest rates, deflation fears, falling oil prices—how are fund managers reacting to the latest investment condi- tions? To get answers, Fitch Ratings Fund and Asset Man- ager Rating Group surveys approximately 800 funds and 80 managers globally. Heading up this Fitch group for Europe, Middle East, Africa, and Asia Pacific is Alastair Sewell, CFA. In this interview with CFA Institute Magazine, Sewell dis- cusses how asset management funds in these regions (and primarily in the eurozone) are dealing with an unusually complex environment. Critical challenges include coping with negative interest rates, navigating increasing market volatility, adapting risk management policies, and gauging the impact of quantitative easing (QE) from the European Central Bank (ECB). In addition to these difficulties, Sewell
also warns of the need to prepare for “surprises.” Nabaum Alex by Illustration
26 CFA Institute Magazine May/June 2015 How large is your survey for Europe, Middle East, What actions might managers Africa, and Asia Pacific? take in response to deflation? We had 77 respondents, the bulk of whom were buy-side It depends on the asset class in bond department heads, portfolio managers, or heads of question. One of the questions for fixed-income research. an asset manager is the allocation of its assets. So asset managers How is the interest rate environment affecting managers? with high levels of exposure to the Most managers were expecting interest rates to increase, but regions subject to deflation will be now consensus is more that rates will stay low for longer. less well positioned in relative terms I think the challenge, however, is for managers to identify than [managers] with exposure to the magnitude and timing of interest rate movements when regions that are, broadly speak- they do arrive. Related to that is the differential in terms Alastair Sewell, CFA ing, growing. That speaks to man- of those movements—by that, I mean the timing and mag- agers with a global presence being nitude of a US move versus a move in other jurisdictions. advantaged in that situation over those with a very specific That’s an area where we could see some surprises. regional presence. Specifically, those with high exposure to We think that the most important bet taken by asset allo- assets in the eurozone will naturally be most at risk in a euro- cators in this environment will be over the timing and mag- zone deflation scenario. You may also see investor hoard- nitude of Fed and ECB policy action. The consequences of ing behavior, which is a symptom of deflation. The question that are the emergence of re-correlation of asset class returns then is, Where are those assets stored? and higher asset class volatility when interest rates start to move. We think managers may be more tempted to allocate How will managers deal with negative interest rates? risk budgets to options strategies to manage downside risk. We have negative interest rates already in euros (on the ECB deposit facility) and most notably in Swiss francs. The What effect might rising US rates have on managers? reality of negative rates is upon us, particularly at the short The specific effect on managers will be driven by their overall end of the fixed-income curve. The fund area that comes to asset allocation. Managers with allocations to sectors more mind here is money market funds, specifically Swiss franc- sensitive to rate policy will be more exposed. The interest- and euro-denominated money market funds. A money market ing point here is probably the effect on emerging markets in fund is structurally limited in terms of the assets it can buy. particular—and their relationship to US rate policy. To the It can only buy short-maturity instruments. As a conse- extent that you as an asset manager have exposure to the more quence, it is likely to be only a matter of time before euro DEFINITE interest-rate-sensitive segments, the more sensitive your over- and Swiss franc money market funds begin incurring neg- all business will be to interest rate movements. But equally, ative nominal yields. given the potential for closely correlated asset class returns This will be a very interesting point. On the one hand, and greater volatility in asset classes as we get either move- bank deposits out to a year (for the higher-quality banks) ments or divergence in interest rate policy, managers could are routinely paying negative yields at the moment. On the be negatively affected across asset classes, hence managers’ other hand, money market fund yields will likely drop into focus on risk budgeting and risk management strategies. negative territory soon. For an investor accustomed to using money market funds, the alternatives are equally unattract- What about fears of deflation? How are managers ive—at least in terms of yields. Nonetheless, should money considering or reacting to this? market funds incur a negative yield, it may elicit a behavioral Our investor survey contains our very latest insights from response from investors whereby they pull their cash out investors. The asset managers in our survey are buy-side of money funds and seek alternatives. We don’t think there managers with combined fixed-income assets under man- are many comparable alternatives out there that would be agement of about €8.2 trillion. We asked the question, How able to offer a positive yield given the prevailing rate envi- serious is the risk of inflation or deflation, respectively, over ronment. The consequence of that is we would anticipate the next 12 months? And 65% of respondents indicated that seeing some asset flow volatility—as investors pull money deflation was a high risk over the next 12 months—an all- out of these funds only to then re-subscribe when they real- time high for our survey. ize alternatives are no more attractive. That’s an interesting finding in its own right—that asset managers are clearly concerned and consider deflation risk What’s the longer-term consequence of negative rates? as a high risk. Even more interesting is that this reading Part of the puzzle for money market funds is that regula- is actually at an all-time high. We’ve never seen a reading tory reforms are under way. In the autumn of 2017, reform for this question reach this level before. It shows that defla- will come into force in the US, and reform is being actively tion is very high on the minds of asset managers. We also debated in Europe. In fact, money market fund reform in noticed that the response rate for deflation being a high Europe [was scheduled to go] to a plenary vote of the Euro- risk has been picking up subsequent to the announcement pean Parliament in April 2015. The combination of a low- or of the ECB QE program. negative-yield environment plus reform means that investors
May/June 2015 CFA Institute Magazine 27 and fund managers are reconsidering their products. Man- would have little impact on the deflationary trends. In gen- agers are reconsidering their product ranges, and investors eral terms, the managers in our sample were positive on are reconsidering the way they use this sort of fund. the impact on capital markets from QE, but they didn’t feel We would expect to see a proliferation of new funds that it would necessarily abate deflationary pressure. Interest- are targeted at meeting the liquidity and investment needs ingly enough, though, roughly a third thought it would be of institutional investors, funds which offer a varied set of positive for capital markets and also would help abate defla- risk profiles. Essentially, these would be funds that take more tionary pressures. Overall, managers had a very positive risk—be that duration risk or credit risk (but only margin- view—I guess that means “risk on”—but views differed on ally more)—in order to generate an incrementally greater the extent to which it would abate deflation. yield. On the investor side, we would expect this change to correspond with greater segmentation of cash—so greater What about market stability and government cash forecasting, greater segmentation of that cash, turning intervention factors? cash management into more of an investment-style func- Start with central bank actions. In our survey, when we tion than has been seen historically. asked a question about what sort of risk central bank actions pose over the next 12 months, respondents were split down What effect does slower growth in the eurozone have the middle. Roughly half thought that central bank actions on the managers you survey? posed a high risk over the next 12 months. An approxi- Deflation is one thing; very low growth is a different thing. mately equal amount thought they posed a low risk. I guess In a low-growth environment, it’s not actually all that bad that means that managers are undecided on this point and for credit as the default rates tend to remain low. Of course, don’t have a strong view either way. There is a lack of con- in the deflation scenario, the cost of debt burden increases sensus on the magnitude of impact of central bank actions. in real terms, and that can become a credit negative. From Similarly, when we asked about the impact of eurozone our survey results, the risks that are top of mind in the Euro- sovereign debt and the problems associated with that, the pean credit market over the next 12 months are geopoliti- response was fairly evenly split. Again, there’s a lack of con- cal risks, and this finding is consistent with the survey we sensus. Lastly, we asked about the risk of a prolonged reces- did in the third quarter of 2014. Next [on the list] of man- sion and again saw a fairly even split down the middle. I ager’s concerns was adverse developments in one or more think what this tells you is that there’s a divergence of opin- emerging markets. ion on the severity of these macro factors as well as on the likely magnitude of the impact of these factors. Which markets are you referring to specifically? Events in Eastern Europe, Ukraine, and Russia have an influ- How closely are managers watching the financial ence on managers’ decisions. In some ways, it depends on situation in Greece? the asset manager, so those managers with exposure to those In practical terms, as a result of the various actions taken regions will be particularly concerned. Russian equities lost over the past few years, private sector exposure to Greece is around 50% in 2014. Clearly, that was very negative for any very low compared with sovereign or super-sovereign expo- investor with exposure to Russian equities, although in rel- sure to Greece now. I think, from an asset manager’s perspec- ative terms, some funds managed to outperform the index tive, all eyes would be on contagion effects and the extent and some funds underperformed. Russia and Ukraine are to which other major economies are or are not affected. the key regions identified by investors. What surprises could managers see in the How have declining oil prices affected managers? next 12 months? The rapid fall in the oil price in 2014 (a fall from around Last year in European equities, for example, there were epi- US$100 to US$50 per barrel for West Texas Intermediate) sodes of periodic drawdowns in equity performance. The has had a mixed impact on asset managers. In the past, challenge for fund managers was navigating those multi- decreasing oil prices have broadly supported economic ple drawdowns. So, in terms of navigating volatility, if you growth, [but this time,] the fall in price has (again, broadly look at the volatility of volatility (the VVIX Index), you can speaking) negatively affected oil producers (among others), see that it’s been on a broadly increasing trend since April be they sovereigns or corporate entities. It all boils down to 2014, which shows increasing volatility in the market. The the exposure that the fund manager has. If [the exposure] trend, which is also characterized by periods of relatively is to sectors that have benefited from the fall in oil prices, low volatility followed by sudden spikes, is likely to con- then this will have supported performance, but those funds tinue in 2015 because of divergences between central bank with a structural exposure to oil price–sensitive sectors or policy and geopolitical uncertainties. geographies will have suffered in most cases. That means fund managers will need to be prepared to navigate these inflection points and to navigate episodes of Are managers confident about QE from the ECB? How periodic volatility, which in some ways speaks to risk man- are they positioning themselves? agement strategies, to the use of options-based or other strat- Of asset managers we’ve surveyed, two-thirds thought that egies to provide some level of downside protection. That QE by the ECB would be positive for capital markets but obviously comes at a cost, which can affect performances as
28 CFA Institute Magazine May/June 2015 well. From a fund manager’s perspective, given the nature index credit default swap (CDS) positions might be used to of the environment we’re in, it means being prepared to be manage downside risk. surprised with these spikes of volatility. Are managers expecting an environment of Where are managers putting their money now? increasing change? We track some flow data in and out of mutual funds. These One of the questions we ask in our investor surveys is whether are flows rather than the market effects, so it’s actually credit spreads are correctly valuing risk in different areas. investors allocating money to different sectors or strate- We ask that for investment-grade, high-yield, and emerg- gies rather than the market effect on those. What I would ing market risk. The takeaway from this is, Do managers highlight in particular is that in 2014, global bond funds think the market is right in terms of the risk level implied (funds which invest primarily in government bonds glob- from spreads in the different areas? ally) attracted inflows on the order of €80 billion. That was Across these sectors, we didn’t see a very strong response one of the strongest areas of inflows. US equities attracted to any of these questions, unlike the concern about defla- €130 billion, so US equities were very popular as well. The tion rates we mentioned earlier. In investment grade, about least-attractive segment in the fixed-income space was high- 40% of respondents thought that spreads were overvaluing yield US-dollar bond funds. Those had outflows of approx- investment grade and about 40% thought that the spreads imately €25 billion in 2014, according to data from Lipper were correctly valuing investment grade. So, there was a for investment management. lack of consensus. Another segment that suffered in 2014 was emerg- In high yield, the strongest response was that spreads ing market bond funds, which had aggregate outflows of are correctly valuing risk—40% of managers thought they around €11 billion. Most of that outflow was from local were correctly valued, as opposed to 30% thinking they were currency funds (which lost €9.5 billion–€10 billion euros). equally overvalued and undervalued. Similarly, in emerging Hard currency funds actually recorded inflows to the tune markets, 47% of respondents thought that spreads were cor- of around €1 billion. rectly valuing risk, 34% thought they were overvaluing, and 20% thought they were undervaluing. So, while the strongest How do the 2014 numbers relate to past years? response in high yield and emerging markets was for a cor- The year was also very strong for US equity fund flows. rect valuation of risk, the response was neither universal nor There were inflows of €95 billion into US equity funds in particularly strong—again suggesting a lack of consensus. 2013. That followed four years of outflows from the asset class, so in 2013, the rebound in sentiment for US equities What are managers’ biggest challenges right now? manifested itself in fund flows. US high-yield [bond funds] The biggest challenge for managers is operating in a low- had very strong inflows for multiple years. The last full year yield environment and preparing for the potential conse- when we had outflows from US high-yield bond funds was quences of a change in the yield environment. Here I would 2005. In fact, in 2012, inflows to US high-yield bond funds really highlight money market funds as the area in which were about €60 billion, and 2014 was the first full-year out- the low-yield environment is most critical, given that money flow from these funds. market funds in particular are a scale business and that, Similarly, in emerging market bond funds (local currency), absent scale, they are not profitable for asset managers to there were inflows into these funds from 2005 through 2012. provide. The number one challenge is operating in the low- They were pretty much flat in 2013 and then suffered about yield environment. The number two challenge is preparing €9 billion–€10 billion of outflow in 2014. On the hard-cur- for surprises, such as anticipating the timing and magni- rency side, there were outflows last year of about €7 bil- tude of policy decisions and any divergence between policy lion–€8 billion and very strong inflows in 2012. So, overall, decisions in terms of timing or magnitude. really quite a strong reversal of opinion occurred on US-dol- As a consequence of these two, another challenge will lar high-yield bond funds in 2014 compared with prior years. be managing investor expectations and managing investor appetite. Managing investor outcomes in terms of meeting Regarding risk budgeting measures, what are return requirements while managing the volatility of returns managers doing? speaks to risk management strategies, be they option based Managers are balancing the costs and benefits of option- or CDS based or other approaches. Equally challenging, based (or other) risk management strategies. In particular, as an asset management business, is having a sufficiently in the multi-asset funds space, given the challenge facing broad and diverse product range to mitigate the impact of managers in terms of navigating inflection points in the outflows in certain areas and to capitalize on the benefit of volatility environment, we think that allocating risk budget inflows in those other areas in demand. As we saw from the to options-based strategies to manage downside risk will fund flows, there are strong differences in demand between become increasingly popular. In equities, managers could different fund sectors, and there are strong changes in the use options-based strategies, or if a fund isn’t able to use way that money is flowing. options, the manager might selectively neutralize expo- Nathan Jaye, CFA, is a speaker on intelligence and a member of CFA sure to some sectors and increase active share in other Society San Francisco. sectors for an index fund. In fixed income, single-name or
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CONTINENTAL By Chris Wright Africa’s long-term investment story is growth momentum on a vast scale
In recent years, Africa has become the darling of fron- chief global economist at Renaissance Capital tier investors in both debt and equity. African sovereigns, and lead author of The Fastest Billion: The Story many of them debut issuers, have raised money in local Behind Africa’s Economic Revolution. Oil represents 90% of Nigerian exports and and international debt markets at ever-tighter pricing. 70% of its government revenues. When the oil The boom in commodity prices, and in particular China’s price halves, the challenges for Nigeria’s finances demand for commodities, has brought economic growth are considerable. “One variable where we really across the continent. The whole story has been under- see pressure building up is the currency,” says Oliver Masetti, a Deutsche Bank economist spe- pinned by exceptional demographics. cializing in sub-Saharan Africa. The Central But the saga quickly gets more complicated. Bank of Nigeria has been fighting a consider- The continent is now afflicted with a wide range able battle on this front, effectively devaluing of headwinds, although every African state is the naira twice. The first move was an outright affected differently. The plunging oil price has devaluation alongside a hike in interest rates had a profound negative effect on Africa’s oil in November 2014. Then in February 2015, the exporters, and the drop in other commodity central bank scrapped its twice-weekly official prices has affected many others. At the same FX auctions and instead channeled all foreign time, a slowdown in Chinese growth and the demand through the interbank foreign exchange increasing sophistication of US shale capabil- market. It also made a commitment to intervene ity have badly cut demand for the raw materi- at the end of each trading day at a rate of 198 als Africa produces. After many years of capi- to the dollar—close to its weakest level ever. tal inflows into African securities, an uncertain In addition, Nigeria has faced political turbu- global picture—whether geopolitically around lence. In a delayed election, a reform candidate, Russia and ISIS (Islamic State of Iraq and Syria) Muhammadu Buhari, won the vote for president or economically around the EU—is prompting in late March. “The political uncertainty adds some of that money to retreat to safe havens. to the pressure from falling oil prices, posing This phenomenon may well increase when the problems for the currency,” says Masetti. For- US starts normalizing interest rates, as it inev- eign exchange reserves are declining and are itably must do. And on top of these problems, already 20% down over the last year. Conse- West Africa has had to contend with Ebola. quently, Masetti points out, “The central bank Should investors avoid African securities, or is running out of firepower.” should they have confidence that African sover- Making Nigeria’s situation tougher still is eigns and companies can navigate these chal- the US shale-oil boom, which means the US is lenges? Is a good entry point close at hand? no longer importing Nigerian oil. Nigeria’s oil industry isn’t efficient enough to produce more STARK REALITIES oil to compensate for lost revenue. “Oil produc- No country demonstrates the challenges Africa ers have to take the price the global market gives faces more starkly than Nigeria, which accounts them: There is nothing they can do about it but for such a large part of investable Africa. “The increase production,” says Angus Downie, econ- crash in oil prices is not negative for all of Africa, omist at Ecobank, the Togo-headquartered pan- but when Nigeria [represents] one in six Afri- African bank. “But in countries like Nigeria, it cans and one in five in GDP terms, what hap- is very difficult to increase production rapidly. pens to Nigeria is going to be taken as symbolic They’re producing around 1.9 million [barrels of the continent,” says Charles Robertson, CFA, per day] when their capacity is 2.4 million.”
May/June 2015 CFA Institute Magazine 31 OFFSETTING ADVANTAGES? How worried should investors be about such difficult cases? There is a precedent to consider. In the 1970s, oil prices rose considerably and boosted the economies of many coun- tries in sub-Saharan Africa, including Nigeria. “Nigeria built a new capital, Abuja, on the back of that,” says Rob- ertson. “It built an industrial base too, though it was sadly more sophisticated than the country’s human capital could use.” What happened was widespread raising of capital. This outcome, Robertson points out, “boosted growth but allowed countries to fuel a massive debt binge that left sub- Saharan Africa bankrupt in the 1980s when commodity prices collapsed.” Although the scenario today might look worryingly famil- iar, Robertson says there are considerable differences this
© JOE PENNEY/Reuters/Corbis JOE © time. “Firstly, sub-Saharan Africa has not gone on such a Serving one of the largest investable markets in Africa, the Nigerian Stock Exchange borrowing binge. Nigerian external debt to GDP is in single is an important financial hub on the continent, but the country’s economic prob- digits. We’ve seen one and sometimes two bond issues out lems, including the crash in oil prices and the devaluing currency, are typical of headwinds faced across Africa. “What happens to Nigeria is going to be taken of a number of countries—Ethiopia, Kenya, Rwanda—in as symbolic of the continent,” says economist Charles Robertson, CFA. recent years, but most countries have not borrowed exces- sively.” The absence of a crushing debt burden will make Nigeria’s situation isn’t all bad. A declining currency lower commodity prices easier to bear. actually helps the country on the fiscal side because oil is “Secondly, human capital is vastly improved compared traded in dollars. If the oil price halves and the currency to the 1970s,” says Robertson. In 1975, fewer than 9% of does too, the net effect in local currency terms is equal. “By children in sub-Saharan Africa (ex-South Africa) had gone propping up the local currency value of oil sales, a weaker through secondary school. By 2005, the figure had already exchange rate helps to cushion the impact of lower prices climbed above 30%. “That is the difference,” he says. “Our on the budget. But the effect is small compared to the mas- work suggests that 25%–30% is the key metric you want sive drop in oil prices,” says Masetti. Lower oil prices also to go over to avoid being destined for poverty in 20 years’ should reduce the costs Nigeria has to pay in subsidies, but time. The bulk of African countries are over that line, at again, it’s not enough to mitigate the overall negative effect. which point you can get your own domestic growth driven After all, the currency hurts Nigeria on its imports, and the by the ingenuity of your own people.” country imports a great deal of its food supply, which can’t A third difference is the availability and range of for- simply be stopped. eign investment sources today. Sub-Saharan Africa Nigeria isn’t the only African country that suffers in had almost no foreign direct investment in the 1970s. an environment with a low oil price. Another example is During the past four years in Kenya alone, Pfizer, Price- Angola, where oil also accounts for about 90% of exports. waterhouseCoopers, IBM, Google, Nokia, Procter & “In Angola, the current account is likely to turn negative in 2015 for the first time since 2009, and in a major way,” says Claire Schaffnit-Chatterjee, another economist focus- ing on sub-Saharan Africa for Deutsche Bank. Other highly exposed countries include Gabon, Democratic Republic of the Congo, and Sudan (all three with oil accounting for around 80% of exports) as well as Cameroon (50%). “There are some positive things about Angola,” says Schaffnit-Chatterjee. “One is that the government tends to respond promptly to the fall in oil prices, having learned from the previous crisis in 2008–09. They tend to have fairly conservative assumptions in the budget, and FX reserves are substantial.” Indeed, the country has deployed US$5 billion of those reserves to its newly established sovereign wealth fund, which may catalyze further investment. Angola has already begun diversifying its economy, with its non-oil
sector growing significantly faster than its oil sector in recent Alamba/AP/Corbis Sunday © years. Perhaps for these reasons, Angola’s currency has not As shown by a Google billboard in Lagos, Nigeria, global corporations are aware declined anywhere near as much as Nigeria’s. Despite such of the potential provided by Africa’s expanding middle class. During the past four years in Kenya alone, Google and other major companies, including Pfizer, advantages, Angola’s growth, public finances, and spending PricewaterhouseCoopers, IBM, Nokia, Procter & Gamble, Barclays, and Standard will all be badly affected by plunging oil prices. Chartered, have all either set up regional hubs or bulked up local operations.
32 CFA Institute Magazine May/June 2015 Gamble, Barclays, and Standard Chartered have all either Indeed, the two are linked: Fading Chinese demand is one set up regional hubs or bulked up local operations. Along- of the main reasons commodity prices are falling. For exam- side direct investment, the movements of foreign portfo- ple, declining copper prices harm Zambia, drops in gold or lio flows have been well documented. “There was no fron- platinum hit South Africa, aluminum declines hurt Mozam- tier investment in the 1970s,” says Robertson. “Today, it’s bique, and weak iron ore prices hit Sierra Leone. But dif- US$25 billion and rising.” ferent commodities have behaved in different ways. “When Exporters hurt by the declining oil price, such as Nigeria, you look at soft commodity prices—cocoa, tea, grains, palm are only one side of the coin. On the other side, oil import- oil—most still seem to be holding up,” says Downie. “It’s ers gain from a low oil price. “The net oil importers—and not a completely homogenous story of all prices rising and that’s most of Africa—benefit tremendously from the fall in falling together.” the oil price,” says Downie. Oil accounts for more than 20% Trade links are another variable among African states. of imports in Kenya, Côte d’Ivoire, Tanzania, and Senegal Some countries, such as Tunisia and Ghana, are oriented and more than 10% in Rwanda, South Africa, and Uganda. toward Europe and are damaged by the slowdown there. In North Africa, Egypt and Tunisia benefit enormously. Others—such as Angola, Zambia, Ethiopia, the Demo- Some countries are more complicated to assess. Ghana, cratic Republic of the Congo (or DRC), the Republic of the for example, is both an exporter (of crude) and an importer Congo, and Zimbabwe—have accepted a great deal of Chi- (of refined oil) because it lacks refineries. Some African nese involvement in infrastructure, energy, and sometimes countries, such as Mozambique and Tanzania, import oil banking. “The first impact of the Chinese slowdown comes today but are likely to be exporters in the future because of through the trade channel,” says Downie. “A lot of the invest- the discovery of significant oil reserves. In general, however, ment that comes into Africa from China is for exploitation there are more importers than exporters. “If you look at the of natural resources, primarily oil and minerals, and the continent as a whole, more than 50% of [African countries] slowdown in China is immediately going to reduce demand by GDP are oil importers,” says Paul Clark, CFA, African for those commodities that Chinese firms are investing in.” Equities Specialist at Ashburton Investments in South Africa, In many cases, the Chinese have gone heavily into infra- who runs an Africa fund for the FirstRand Group. Of the structure (roads, bridges, ports, telecommunications) and investable markets Clark looks at, he says Nigeria is the only have set up manufacturing entrepôts. Not all areas will be one to be negatively affected. affected by a Chinese slowdown in the same way. Any Chi- “Net importers are theoretically in a very good position nese investment supplying local markets (and, therefore, the because they should see lower oil prices translate to lower vibrant African consumer) should have no reason to leave. fuel prices for the private sector and even the government,” Schaffnit-Chatterjee sees a potential positive in the links says Downie. But the benefit is not automatic. “What we’re to China. She argues that costs of production are rising in seeing in many countries is that the drop in the crude price China and remain much lower in Africa, which could cause has not translated to a drop in fuel prices or not to the same multinationals to look to Africa for production. Ethiopia’s magnitude,” adds Downie. “Governments are trying to textile industry is one example. recoup some of the windfall from this drop in crude prices Regardless of problems, the overall trend of economic to rebalance or reinflate their fiscal positions, meaning the progress looms larger. “The fall in commodity prices in gen- consumers haven’t benefited as much as they could have eral is not supportive of growth in Africa,” says Clark. “But done.” Even so, if a country uses that windfall correctly on it doesn’t detract massively from the growth that is going to the fiscal side, its finances will come out in better shape. happen through the underlying development of these econo- Some countries stand to benefit more than others. “Defi- mies as productivity gains are made, infrastructure improves, nitely the landlocked countries—Zambia, Malawi, Rwanda— institutions are strengthened, governance is improved, and because they have the high added cost of fuel transporta- policies become better. Those are all trends that have been tion,” says Downie. Generally, any African country that pro- seen quite strongly in the early part of this century.” Clark vides fuel subsidies (and most of them do) will benefit if it recalls a McKinsey study that found that barely a quarter can take this as an opportunity to change its policy. “This is of Africa’s growth from 2002 to 2007 came from resources. the time for governments to reduce and ultimately remove “Seventy percent of the growth was from other things,” he subsidies, so as to provide a more sustainable framework says. In his view, higher commodity prices support growth for government spending next year and onwards,” says but are not necessary to sustain it. Downie. “Subsidies create great distortions, and if we can get governments away from providing them, their fiscal MOMENTUM operations become easier to manage.” Removing subsidies Africa still has stirring fundamentals. “The growth story is politically sensitive, of course, and has to be managed is not over,” says Schaffnit-Chatterjee. “This is the second- carefully. Still, subsidy reform is at least under discussion fastest-growing region in the world, and the growth drivers in some countries, notably in Ghana (which will need to do remain: infrastructure, booming services, and agriculture.” so in order to negotiate its economic reform package with Agriculture? It’s not often considered an investment play the IMF), Kenya, and Morocco. in emerging markets, but circumstances in Africa provide Other African states will suffer from declines in non- for a different scenario. “Normally, as an economy develops, oil commodity prices and from slowing Chinese growth. agriculture shrinks,” explains Schaffnit-Chatterjee. “But in
May/June 2015 CFA Institute Magazine 33 sub-Saharan Africa, the agricultural revolution has not yet is a new road, something that is being improved. It’s more taken place. So much employment and so many people— interesting that money is being spent, rather than those big over 60% of the population—are dependent upon it. It is the numbers that Africa’s got an infrastructure spending back- key sector to rely upon to alleviate poverty.” Sub-Saharan log of a gazillion dollars.” Africa has vast amounts of uncultivated land, half the total land available globally. “And there is huge scope to increase THREAT OF CAPITAL FLIGHT yields in Africa, given the low use of fertilizers, irrigation, The next challenge Africa faces is the potential normaliza- and high-quality seeds,” continues Schaffnit-Chatterjee. “We tion of interest rates in the US and other developed coun- know what needs to be done. It just requires investment and tries. This change is expected to be accompanied by capital political will.” Plus, demand is growing fast. She points out flight from emerging and frontier markets, including Africa. that food markets in sub-Saharan Africa are set to reach To a degree, one could argue this threat is old news. “We US$1 trillion by 2030, with urban food markets increasing have already been seeing it for quite a few months now,” fourfold by then, growing in tandem with the increases in says Downie, noting that the market has been pricing-in population and income and the growth of the middle class. an interest rate rise since the first quarter of 2014. Argu- “For sub-Saharan economies at large, it makes no sense to ably, the outflows people fear, caused by foreign investors have this potential and still import so much food. In lots who have bought into local equity and fixed-income mar- of countries, exporters of oil or minerals, it makes sense to kets, have already happened. Particularly with the fall in oil diversify the economy by boosting agriculture.” prices and in a global environment of general risk aversion, Others see opportunities beyond agriculture. Paul Clark’s nervous capital has probably already left. “We expect to see fund is roughly one-third exposed to Egypt, particularly more outflows, but the majority have taken place already,” through cement or other companies linked to housing and says Downie. That’s notwithstanding specific events, such as infrastructure spending. He also likes similar themes in the Nigerian election, which tend to have their own impact East Africa, such as the infrastructure requirements of a on capital flight. new transport and oil corridor from the port of Lamu in African sovereigns have become familiar sights in the Kenya to Uganda. Another key trend is regionalization, with international debt capital markets in recent years, a trend Kenyan firms in particular seeking to expand to West Africa. that can be expected to decrease in this new environment. Citing the example of a telecom company in Morocco that “There will be less issuance, but I don’t expect to see huge is expanding into West Africa, Clark says, “You are going to capital outflows,” says Schaffnit-Chatterjee. Nor is there see some powerhouses develop on the continent.” Ease of any concern about the ability to repay existing debt. Gha- doing business is steadily improving in the continent’s big- na’s level of indebtedness may be worrisome, but the coun- gest economies, and democracy is increasing. These trends try is something of an outlier. help regionalizing businesses, such as banks. Other situations are more hopeful. For some countries, “In 20 years’ time, we will still be talking about the most of the bonds themselves will not be due for redemption fact that there’s not enough infrastructure in Africa,” says anytime soon. For example, Rwanda’s bond doesn’t mature Clark. “But that doesn’t mean a ton won’t be spent on it in until 2023. “The economy should have doubled by then,” says the meantime. Everyone knows electricity production, dis- Robertson. In regard to Kenya’s dual-tranche issue matur- tribution, roads, and telecoms could all be better and are ing in 2019 and 2024, he explains, “They have got years constraining growth, but every time I go somewhere, there to grow their economy. Having borrowed at roughly 7%, I’m pretty sure they can get better than a 7% dollar return In Ethiopia’s capital, Addis Ababa, Chinese and Ethiopian laborers were working annually by improving their infrastructure.” in February 2015 to complete a metro rail line, which was part of a series of government projects intended to promote economic growth. Although the vast need for infrastructure upgrades may be a potential constraint on African MISSING THE BIGGER STORY development, some observers see it as an investment opportunity. And what of Ebola? Although the disease has caused a ter- rible situation with enormous human cost, the episode is also an example of how lurid headlines can distort the per- ception of Africa. The impact on the broader African econ- omy, even the West African economy, has been mild. “My view is that China has been more damaging to West Africa than Ebola,” says Robertson, his logic being that falling Chi- nese demand and the consequent drop in the iron ore price have derailed iron ore projects in West Africa. “Sierra Leone has been showing double-digit rates of growth thanks to iron ore projects,” he says. “The longer commodity prices are low or falling, the greater the hit to West Africa, and that has probably hurt them more economically than Ebola. Neither is good in any way, but in terms of the GDP hit, the iron ore price has been more significant.”
© TIKSA NEGERI/Reuters/Corbis © But Downie sees more to worry about in Ebola, noting “a
34 CFA Institute Magazine May/June 2015 severe economic impact because people can’t move around as freely as they used to be able to.” Citing such problems as companies suspending operations, cancelling meetings, and slowing down, he says, “If you take that as a micro- cosm of what has happened in the economy, everything has slowed down significantly and growth is going to be extremely weak.” Although some of the affected countries, notably Guinea, already appear to be on their way through the ordeal, Downie believes “the process of getting back up to a normal functioning level for companies and govern- ment will take many months.”
Clark believes the more important story is being over- THIERRY GOUEGNON/Reuters/Corbis© looked. “Things like Ebola mean the narrative doesn’t look Although cocoa was flowing successfully on this production line at Choco so good,” he says, “but the three affected countries together Ivoire’s processing plant in San-Pedro, Côte d’Ivoire, the agricultural revolution has yet to occur in much of Africa. According to Deutsche Bank economist make up only 2.2% of West Africa’s GDP and half a percent Claire Schaffnit-Chatterjee, the “huge scope to increase yields in Africa” could of Africa’s GDP. Most of Africa is Ebola-free.” Noting a ten- be a key part of the continent’s investment story. dency to see the negative in Africa, he points to the exam- ple of the 2014 coup in Burkina Faso: The more interest- 20% of the world population) and 4 billion by 2100 (mean- ing story is not that it happened but that within a week the ing 40% of the world population will be in Africa). presidents of Nigeria and Ghana were involved, speaking Robertson also sees demographics as a key element. “We to the coup leader and pushing for elections for a civilian are still in an environment from 2015 to 2020 where Africa leader. “That’s the bit of the narrative people miss,” he con- should, if you’re looking at IMF forecasts, be one of the fast- tinues. “Another example: At the moment you have three est-growing areas in the world, better than Latin Amer- countries—Nigeria, Chad, and Cameroon—talking about ica, Europe, North America, and probably MENA,” he says. dealing with Boko Haram together.” Clark believes that “That high-growth story is still likely to attract investment African states cooperating is a very positive development. and interest.” Robertson describes this as “a growth con- solidation decade: After the growth of the 2000s, this is a SEEKING POINTS OF ENTRY period when Africa does the infrastructure—the electric- If an investor is convinced that the time is still right to invest ity, roads, and ports—it needs to take growth to the next in Africa, what is the best way to do it? “It all depends on level in the 2020s. You can invest in that now or wait five appetite and time horizon,” says Schaffnit-Chatterjee. “For years, but you might not get the same entry level.” Accord- the long term, you can hardly beat sub-Saharan Africa.” ing to this perspective, whether to invest via debt or equity Despite the favorable long-term outlook, the invest- doesn’t make a huge difference. “Local currency, equity, real ment story is not likely to improve immediately. “Senti- estate, private equity—they are all ways that you can profit- ment around the continent is worse than it was,” says Clark, ably invest in this continent over the next decade,” he says. “and the equity market outlook in the near term probably Downie feels that there are “always short-term problems isn’t great. But if we look at the underlying trends and the to overcome, and it’s the investor who can take a longer- IMF forecasts for continued growth, overall Africa will con- term perspective who tends to fare better.” He talks about tinue to do well.” the growth of the middle class, which in sub-Saharan Africa Each market is different. Consider Ghana. Although the is considered to include people who may have US$3–US$5 country’s debt is likely to reach 70% of GDP, Ghana has good per day to spend. Although such an income might be seem growth prospects and a democratic track record. Every coun- scant in other regions, he points out that “you can do quite a try has some sort of tradeoff between risk and opportunity. lot with [it] in many African countries.” Moreover, he adds, “Of course, there are risks: political instability, terrorism, “The growth of consumption and aspiration is a trend we corruption,” says Schaffnit-Chatterjee. “Those will be there see continuing: The growth of this middle class helps to all the time. But the Africa growth story is not over. Inves- strengthen domestic demand, helps intra-regional demand tors with significant risk appetite and a sufficiently long time improve, and [increases] the demand for goods and services horizon can make good returns from sub-Saharan Africa.” from the rest of the world into Africa.” Continuing economic growth will require a massive Downie also points out that as the middle class devel- amount of infrastructure development. Only a quarter of the ops, economies get to a point at which, instead of importing population has access to electricity, and less than 2% of roads everything, they produce goods and services themselves. are paved (compared with 60% of roads in Asia). The lack of “Africa will probably leapfrog parts of industrialization, as infrastructure is already costing the region 2% of GDP growth it has with telephony: You don’t use landlines, as they’ve per year, according to Schaffnit-Chatterjee. There is enor- gone straight to mobiles.” mous need for investment, but Schaffnit-Chatterjee sees this In other words, development could happen faster than situation as both a hindrance and an investment opportunity. most people think. Then there is the population story. Africa’s total popula- Chris Wright is a freelance business journalist based in London. tion is expected to reach 2 billion by 2050 (accounting for
May/June 2015 CFA Institute Magazine 35 Two experts discuss opportunities and GROWING challenges for the popular PAINS FOR Islamic financial security
SukukBy Nathan Jaye, CFA Sukuk, an Islamic financial security structured to comply IBRAHIM WARDE, adjunct professor with Islamic Sharia law, has enjoyed remarkable success of international business at in recent years. With issuance of the “Islamic bond” at The Fletcher School of Law and Diplomacy, Tufts University near-record levels, the past 12 months have seen initial offerings from several non-Islamic sovereigns, including What’s your outlook for sukuk this year? the United Kingdom, South Africa, and Luxembourg. To It’s hard to say. I think the big uncertainty right get a better understanding of the latest trends, CFA Insti- now is the price of oil and the impact it will have. It could create more demand for sukuk in terms tute Magazine spoke with two experts on sukuk: Ibrahim of financing needs for certain countries. Or, in Warde, adjunct professor of international business at The the case of [an economic] downturn in certain Fletcher School of Law and Diplomacy (Tufts University) important Islamic countries, it might slow the and author of Islamic Finance in the Global Economy, and issuance of sukuk. But either way, I don’t fore- see a major drop in sukuk issuance. Salman Khan, head of Sharia office at a bank in the Coop- eration Council for the Arab States of the Gulf (formally What is the relationship between sukuk known as the Gulf Cooperation Council, or GCC). In sepa- and oil price? rate interviews, Warde and Khan discuss the opportunities Many issuers, especially outside the Islamic world, want to tap the pockets of a number of and growing pains facing a young industry, the challenges oil-producing countries. Basically, in the past of introducing interest-free lending within a dominantly few years, everybody was looking in the direc- interest-based global financial system, the mechanics of tion of the [Persian] Gulf states, where many structuring sukuk in accordance with Sharia law, reasons investors clearly favor Sharia-compliant instru- ments. Therefore, there was a sense that this for differences between theory and practice, and the role was where the money was. Certainly, the fact of standard-setting organizations (such as the Account- that issuers such as the United Kingdom or Lux- ing and Auditing Organization for Islamic Financial Insti- embourg or Hong Kong have expressed interest tutions, or AAOIFI) within the Islamic finance industry. in and issued sukuk is primarily, I would say, a function of the fact that they’re interested in financing from those parts of the world.
How close are sukuk to conventional bonds? In some ways, they’re almost identical to bonds as far as the investor is concerned—in that who- ever owns those bonds will receive some fixed remunerations. The one difference is that in
36 CFA Institute Magazine May/June 2015 the case of conventional bonds, this remuneration comes you look at the history of Islamic finance, it developed in a from interest payments, whereas in the case of sukuk, it is somewhat haphazard way. It’s only some 10 years ago or so not based on interest. that most players in Islamic finance have decided to stan- The first major sukuk issuance came out in 2002 in dardize their operations. Malaysia. The underlying assets were buildings owned by AAOIFI was created in 1990. In the early years, it didn’t the government of Malaysia. It was an ijarah sukuk, a sale play that significant a role. It’s mostly in the past decade and leaseback (SLB) operation, whereby the government of that AAOIFI has gone into overdrive trying to set up rules Malaysia sold those buildings and then leased them back. and regulations and accounting standards. The lease that was being paid by the government of Malay- There’s another body, the Islamic Financial Services Board sia constituted the remuneration of those sukuk. (IFSB), which is based in Malaysia and is equally influen- tial. This body consists of the central banks of those coun- Sukuk are always backed by assets, correct? tries that have Islamic banks, in addition to other partici- That’s the essential part—these investments should be based pants in Islamic finance. The job of these organizations is on real physical assets and on the actual income generated by to come up with standard rules so that at least there is a those assets. The other essential feature of the sukuk is that common understanding of what those products are about. they give the owners of the sukuk a claim on those under- As a result, every time there is a new issuance of sukuk, lying assets, meaning that in case of default, the owners of there is a lot of give and take among the various players those sukuk actually have a claim on physical assets. and within the institution that is issuing the sukuk. There are still a few gray areas, but by and large, there’s a gen- How does that work in practice? eral acceptance of the basic principles of sukuk. In practice, it’s quite complicated. Sukuk Many, many law firms are cur- Is there an actual regulatory framework? rently involved in figuring these There is a commitment on the part of those governments things out. There have been a few and firms to follow the rulings. The original function of cases of failed sukuk, and it became AAOIFI was to issue accounting and auditing standards. obvious that it was not clear how Initially, the rulings of AAOIFI were obligatory in Bahrain to execute the claim on assets. In and optional elsewhere. Year after year, more countries have one instance, there was a risk of asked their Islamic institutions to follow the AAOIFI norm. default for the Nakheel sukuk— As to the IFSB, it happens in an indirect way—the mem- actually the largest sukuk ever— bers of IFSB are the central banks and other regulators Ibrahim Warde issued by Dubai World (a major gov- of Islamic institutions. In their rulings and then in their ernment-owned conglomerate). In 2009, Dubai announced circulars, [these agencies] pretty much implement the rul- a standstill whereby for six months it would not be paying ings of the IFSB. its debts. At that point, serious consideration was finally put into trying to figure out what [the claim on assets] would Western entities are now issuing sukuk as well. mean in practice. There’s a basic distinction between so-called sovereign sukuk, which are governments issuing sukuk, and so-called Do Sharia standard-setting bodies and the industry corporate sukuk, which are mostly companies that need to see eye to eye? raise financing. There are always differences. Every time there’s a new issue, For a number of years, there had been expressions of there are endless debates, both among the religious schol- interest on the part of various Western governments to issue ars and (probably more commonly) among the secular spe- sukuk. The one that was much awaited was the UK sukuk of cialists who work in conjunction with the Sharia scholars. June 2014. Although the amount was small, around £200 At the time of the Nakheel sukuk, it appeared that a million, it was still quite significant symbolically. number of things had not been sorted out properly—for example, whether foreigners could actually own the prime real estate that Dubai World had pledged. Another issue at WHAT I’VE BEEN HEARING FROM SUKUK the time was that some of that real estate was more like vir- TRADERS IS THAT SUKUK ARE INCREAS- tual land—in that [the property is literally] still underwater. The question of the readiness for distribution of such lands to INGLY BEHAVING THE WAY CONVENTIONAL the sukuk holder came up. Again, these kinds of issues went BONDS BEHAVE.... IT’S CERTAINLY A beyond the religious principle, which was being followed. SIGN THAT THE MARKET HAS BECOME How much influence does AAOIFI have on sukuk? MORE LIQUID AND MORE NORMALIZED. AAOIFI has quite a bit of influence, but it’s not the only one. In the realm of Islamic finance, there are a number of inter- national bodies whose job it is to harmonize and standard- ize the rules, which is a welcome development, because if
May/June 2015 CFA Institute Magazine 37 What direction will sukuk take in the future? Do you have a background in Sharia law? One of the big gaps in Islamic finance was having a sec- For someone working on the Sharia side, it is not only Sharia ondary market, and it’s very difficult to have a secondary law that is relevant but also having a good understanding of market because, normally under Islamic finance, you cannot economics, banking, and finance—as is understanding how sell debt. Here again, there are always some exceptions. In products and financial arrangements work in practice. Per- Malaysia, where some sale of debt is allowed, the broad sonally, I’ve done a research fellowship in Islamic finance principle of not allowing a debt to be sold meant that new and economics from the Oxford Centre for Islamic Studies. I instruments had to be devised that would have a second- also have a doctorate in economics from Oxford University. ary market. By structuring sukuk as leasing instruments as The question is often asked, opposed to debt instruments, the religious objections to a What are the standard qualifica- secondary market disappeared. tions in the industry? One of the Initially, investors who had bought those sukuk wanted things that isn’t well known about to keep them. There are few similar instruments out there, Islamic finance is that many things and as a result, the strategy was one of buying those sukuk are not streamlined—the concept to hold them—not to resell them. This [attitude] has started of standards and standard qualifi- to change over time. Right now, there’s a fairly active sec- cations is pretty flexible. I certainly ondary market in sukuk. What I’ve been hearing from sukuk do not claim in any way to be a traders is that sukuk are increasingly behaving the way scholar. The Sharia scholars have conventional bonds behave, in that they tend to respond a different kind of qualification— to changes in interest rates in many of the same ways. It’s Salman Khan they usually have attended a reli- certainly a sign that the market has become more liquid gious school (called a madrassa) or and more normalized. hold a degree in some form of Islamic studies (e.g., Islamic law or Islamic jurisprudence) in a university—which typ- What types of structural innovations might come about? ically has no connection with what goes on in the finan- Every time I talk with Islamic institutions, I hear that they’re cial world. Few of them have any formal qualifications in in the process of thinking through some new breakthroughs. finance or economics. There are 14 theoretical forms of sukuk, and yet most sukuk tend to be of one of two types. One is the ijarah sukuk, the What’s your day-to-day experience of sukuk? leasing-based sukuk that I mentioned. Another one is the The Islamic finance industry has a certain theoretical basis— mudaraba sukuk, which is based on a venture capital logic. a raison d’etre—why it came into being in the first place. In Another form of creating sukuk based on physical under- theory, it is supposed to provide a much better alternative lying assets could be commodities. The way in which you to the existing conventional banking industry, which the would devise this sukuk can vary tremendously in terms of theory says has features such as exploitation and lumping of the type of commodities that would underlie the contract. risk onto the customer, along with unfairness and injustice. In reality, however, Islamic financial products (sukuk and How common are sukuk backed by intangibles? other products) are largely copied and pasted from existing Increasingly, Islamic finance is trying to cover certain types commercial banking products. In a step-by-step procedure of intangibles as long as they do have substantial economic of what you might call synthetic engineering, individual value. In other words, the main objection of Islamic finance aspects of those contracts are brought in line with Sharia to conventional finance is that there were too many instru- ethical requirements. ments where the economic content was very hard to figure out—especially in terms of things like derivatives and the What are examples of differences in theory and practice? like. Now, increasingly, in Islamic finance, there are attempts The basic Sharia justification of an ijarah [sale and lease at figuring out how intangibles could actually be looked at as back, SLB] structure is that at the outset—when the financed having some economic value. It’s not a matter that is necessar- party sells the asset to the sukuk holders—the ownership ily easy to resolve, but it is at least being seriously considered. should naturally transfer to the sukuk holders. One of the problems is that pretty much all ijarah sukuk structures SALMAN KHAN, head of Sharia office at a leading Islamic Bank IN A STEP-BY-STEP PROCEDURE In what role do you work with sukuk? OF WHAT YOU MIGHT CALL SYNTHETIC I work in the Sharia division of an Islamic bank in Dubai. ENGINEERING, INDIVIDUAL ASPECTS OF Part of my responsibility is to perform Sharia review for all sorts of transactions, which include sukuk and syndicated [ISLAMIC FINANCIAL PRODUCTS] finance transactions. For example, there are legal documents ARE BROUGHT IN LINE WITH SHARIA that oversee sukuk transactions. I read them cover to cover and word by word to make sure all of the contents agree ETHICAL REQUIREMENTS. with my bank’s Sharia resolutions and mandate.
38 CFA Institute Magazine May/June 2015 come with a legally binding promise or undertaking, given THERE IS NO STREAMLINED AND UNIFIED at the outset by the sukuk holders to the lessee which sold the asset in the first place, not to sell that asset to any other SET OF SHARIA STANDARDS. INSTEAD, third party. EVERY BANK HAS ITS OWN SHARIA BOARD, This [promise] (in the view of many people) undermines significantly the reality and the soundness of that sale. It WHICH PRODUCES ITS OWN REGULATIONS. becomes questionable because in a true sale, once I buy the item, I can sell it to anyone I want—I have ownership. How- ever, if I say I’m buying it but I only have the right to sell manner prohibited by AAOIFI (plus lots of sukuk transac- it back to you (i.e., the party from whom I bought it), then tions are structured using this prohibited structure). All of the question arises as to whether it is a real sale or just a this is done very openly despite the very clear and unam- loan backed by a lien or a mortgage on an underlying asset. biguous prohibition by AAOIFI. The Islamic Fiqh Academy In addition, the financed party also gives an “Undertaking (IFA) in Saudi Arabia (which also issues resolutions and is to Purchase” (PU) the asset back from the sukuk holders at well recognized after AAOIFI as a kind of a central body) has a formula-based price. This formula-based price, under all also very openly issued a resolution prohibiting tawarruq. circumstances, insures the sukuk holders from any possi- Still, tawarruq is used in huge quantities in Saudi Arabia bility of a loss. If there is any fluctuation in the price of the itself, not just in liquidity management functions but also asset owned by the sukuk holders during the ijarah term, in a very wide range of financing products. The clue that the risk of such fluctuations will nevertheless be deflected explains this clear contradiction is that neither AAOIFI nor back on to the financed party via this formula-based price, the IFA have any penal authority—neither does any other since this price ensures that in all situations, the financed body. Therefore, it’s like having a highway with a 120-kilo- party will repurchase the asset in case of default or early meter-per-hour speed limit but no speed cameras. settlement (or even if the sukuk runs to full term) at exactly the original price at which the financed party sold it to the Which standards inform your day-to-day work? sukuk holders. So, a PU neatly ensures a 100% principal My role is to judge and review the documents based on the protection. AAOIFI Sharia standards as well as the Sharia resolutions In simple words, the natural risk sharing that is so cru- passed by the Sharia board of my bank. There is no stream- cial to all genuine Sharia ethical transactions seems to be lined and unified set of Sharia standards. Instead, every bank totally absent from this structure. The sukuk holders will has its own Sharia board, which produces its own regula- always earn full profit, while the financed party (since it is tions. There is a concept in Sharia law that every Islamic committed to buy the asset back at the original price and to scholar can have his own view on anything. That is called always have to “service its outstanding”) will always have a fatwa, or a religious pronouncement. the full risk on its head. AAOIFI’s fatwa represents its consensus opinion, but the gentlemen sitting on the Sharia board of my bank (or any Are Sharia standards strict in interpretation? other bank) could have a different view. When their opinion They may be regarded as somewhat strict on some counts differs from AAOIFI, then they will issue a fatwa or a judg- but not in others. The standards themselves must be looked ment that is different from AAOIFI, which means that we at in conjunction with how well they are applied, respected, have to somehow combine the religious judgments and pro- or followed. The reality on the ground is that if you look at nouncements of AAOIFI with the ones that our board issues. the range of structures which are practically and regularly used—and if you look at the flexibility upon flexibility given What does the future hold for sukuk? in structuring—you will see that there isn’t much strictness. There will be greater and greater flexibility in terms of structuring. In Malaysia at the moment, there are certain How much influence does AAOIFI have? concepts which are not accepted in other jurisdictions (like AAOIFI, which is the closest thing to a central body [for the Middle East), such as sale of debt, prohibited buyback Sharia finance], makes pronouncements regarding the (also called bai inah), and certain notions of sale of rights. Sharia compliance of various products and commercial In Malaysia, basically, there are very few red zones. This arrangements. So far, it has nearly 50 Sharia standards is not a disrespectful statement but rather a very simple and and a number of accounting standards as well. Of partic- objective observation. All of these concepts, which at the ular note, Sharia Standard No. 30—Monetization relates moment are not accepted as being the basis for a product or to a structure called tawarruq, which is very, very com- sukuk structure in the Middle East, have always been per- monly used—tens of billions [of dollars] daily in terms of mitted in Malaysia. It is still a very young industry where the liquidity management and treasury functions of Islamic no set of standards truly holds sway. banks and windows, as well as normal retail and corporate Nathan Jaye, CFA, is a speaker on intelligence and member of CFA Soci- finance products. ety San Francisco. AAOIFI clearly says that tawarruq, when used the way it is organized by banks, is not Sharia compliant. Yet virtu- ally every Islamic bank in the world uses tawarruq in the
May/June 2015 CFA Institute Magazine 39 2015 FINANCIAL ANALYSTS SEMINAR Celebrating 60 Years
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© 2015 CFA Institute ETHICS AND STANDARDS MARKET INTEGRITY AND ADVOCACY
Reform Fiduciary Duty—Now!
By Kurt N. Schacht, JD, CFA
With the recent announcement that the investment advice” while permitting different business US Department of Labor would amend models and service levels. That approach would provide the definition of “fiduciary” under the ample room in the investment profession for both a sales- Employee Retirement Income Security person model (i.e., broker/dealer) and the fiduciary adviser Act, the hotly contested debate over a model, which requires a professional to act with prudence, uniform fiduciary duty for providing per- loyalty, and care. Quite simply, the tipping point on duty of sonalized investment advice is heating care is whether you hold yourself out as a financial adviser up once again. The Department of Labor and are offering advice to guide personal investment choices. is expected to require many individuals Making this distinction is not rocket science. who provide financial advice to put the Participants in the policy debate have quibbled for decades interests of their clients first when advising retirement plan about the way forward, and now we have statistics that participants and IRA account holders. Not surprisingly, in quantify the cost of this quibbling to the average investor. the aftermath of the Labor Department announcement, the According to a new report released by the Council of Eco- question of which investment service providers owe a fidu- nomic Advisers, an estimated $1.7 trillion of IRA assets are ciary duty (and when they owe it) has fueled commentary invested in products that “generally provide payments that from industry insiders and politicians alike. generate conflicts of interest.” The report estimates that the Although the Labor Department proposal has taken center aggregate annual cost of conflicted advice is about $17 bil- stage, the US SEC was given a mandate under the Dodd– lion each year. As an industry, we ought to be ashamed. Frank Act of 2010 to study the existing legal and regula- If you are selling investment products and disclose your tory standards of care and the option to issue new rules, conflicts, and you are transparent that you are not acting with the provision that any such rules accommodate a com- solely for the benefit of the customer and that you are not mission-based fee model. Although the SEC did study the the customer’s personal investment adviser, that’s fine. But matter (several times in fact), the legal complexity of the for the sake of everyone associated with finance, stop defin- issue, together with intense lobbying from those with signif- ing yourself as a personal financial adviser. You are not: You icant commercial interests, has kept the issue and the SEC are a salesperson. Unfortunately, as a result of hopelessly rummaging for a solution. Delay is almost standard operat- confused regulatory and legal interpretations, salespeople ing procedure in Washington, DC, and there are many par- have become comfortable with the belief that they can offer ticipants who love the political uncertainty of “who moves much the same service as registered investment advisers. first?” as a tactic to stop fiduciary duty dead in its tracks. Reform can be done the easy way or the hard way. The From CFA Institute’s point of view, we care less about who easy way in the United States is merely to amend and clar- fixes the problem because reform is long overdue. ify the language in the existing Investment Advisers Act of Meanwhile, investors have been blissfully ignorant. The 1940 to require anyone providing personalized investment reality is that most investors don’t understand or even care advice to register and become a genuine fiduciary under about the debate. From the average investor’s point of view, the 1940 Act—with no exceptions or convoluted regula- the difference between fiduciary duty owed by an adviser tory interpretations. The hard way is to stumble around versus a suitability standard of care owed by a salesperson for another decade, coming up with endless variations on (typically an investor’s broker) is boring, to put it frankly. If what constitutes advice (seriously?) or try to create a new only investors realized that it can mean everything in terms standard of care that somehow blends the concepts of fidu- of how they are ultimately treated and their rights in the ciary duty and a salesperson’s duty. event that something blows up with their investment sav- In our view (and under the CFA Institute Code of Ethics ings. The degree of investor inattention was confirmed in a and Standards of Professional Conduct), you are either giving 2008 study commissioned by the SEC (the RAND Report), “client-first,” unconflicted advice or you are not. Whether which found that typical retail inves- the agency leading the charge should tors were completely confused about KEEP GOING be the Department of Labor, the SEC, the titles and duties of their financial or both, let’s get on with it. And the services providers. Follow the Market Integrity Insights same goes for any market in the world. The only fair remedy is to draw clear blog: http://blogs.cfainstitute.org/ marketintegrity Kurt Schacht, JD, CFA, is managing director of distinctions for service providers on the Standards and Market Integrity at CFA Institute. two standards of care. Simply put, elim- Follow us on Twitter: @MarketIntegrity inate the fuzziness around “personal
May/June 2015 CFA Institute Magazine 41 ETHICS AND STANDARDS MARKET INTEGRITY AND ADVOCACY
The Impact of Europe’s Research Reforms
By Bob Dannhauser, CFA
New technical advice issued by the European Securities and and research. A gold-plated feature of any subsequent reg- Markets Authority (ESMA) that addresses how investment ulation in the United Kingdom would affect an important research is paid for has the potential to rock the industry investment management center. globally. Transparency around the cost of research—and “The ESMA technical advice has spurred spirited discus- more direct accounting for how it is paid for separately from sion of policy alternatives to address unbundling of pay- execution costs—will almost certainly affect the quantity ment for research and execution,” notes Rhodri Preece, and sources of research and change the competitive dynamic CFA, head of capital markets policy in EMEA for CFA Insti- for smaller investment management firms. And although tute. “In our discussions with industry stakeholders, there the new rules would apply to European firms only, invest- remains a lack of clarity over how ESMA’s advice will be ment managers with a global footprint might find it easiest interpreted and applied by member states. In drafting the to comply with the European standards rather than try to final standards, the European Commission must build con- parse research consumption procedures according to where sensus among legislators in the Parliament and Council.” the book of business resides. But even as the details are being sorted, there is little The issue is the extent to which investors understand doubt that fundamental change is inevitable. “There is still what they are paying for when it comes to trade execution the possibility that the proposed regulatory framework will and, more specifically, how bundled services (including the be amended, but as it stands, it appears that hard dollars provision of execution and investment research services) will be the only way for research in Europe to be paid for can complicate their understanding of the costs of invest- from 2017, with that cash paid directly by a firm out of its ing. The prevailing global practice is to pay for execution own resources or charged to a budget pre-agreed with the and research with commissions. From the perspective of client,” says Will Goodhart, chief executive of the CFA Soci- investment managers, transaction cost disclosure has been ety of the UK. a customary part of the routine of reporting to investors, but there has been no disaggregation of the components of BOTH THOSE WHO PRODUCE AND what is accomplished with commission spending. The proof of appropriate stewardship of client trading expenses has THOSE WHO CONSUME INVESTMENT been in the bottom-line performance of the account, reflect- ing skill in security selection, portfolio management, and RESEARCH FACE NOVEL CHALLENGES trading cost management. At least for European investment managers, those days IN THE COMING MONTHS. are ending. ESMA is recommending that investment research be priced explicitly by its producers and be paid for either (1) directly by the investment manager and absorbed as its cost of doing business or (2) from a separate account funded CFA Institute joined with the CFA Society of the UK to by the investor and subject to reporting that allows clients sponsor research by Frost Consulting to examine how the to see a budget for research and actual spending. Commis- new regime might be implemented at asset management sion-sharing arrangements (CSAs), whereby an executing firms. At the least, firms would need to develop a more broker directs a part of the commission earnings to pro- refined view of not only how they consume research but viders of investment management research, could still be also which research offers value in contributing alpha that allowed as a mechanism for paying for research, subject is commensurate with the newly declared explicit costs of to certain enhancements. But because of the requirement that research. Firms would face some tricky decisions in of an ex ante budget for research that cannot be increased allocating research costs to individual client accounts while without client agreement, the prior linkage between trade satisfying the requirement that each account have a pro- volume and research received (whereby more trading gen- spective research budget and accounting of actual spend. erates more commissions and thus more research) is alle- Clients would have more insight into how much it costs to viated, along with the inherent conflict of interest of the produce the results in their accounts, as well as how inten- bundled commission model. In a response to ESMA’s pub- sive a consumer of research their chosen investment disci- lication of this technical advice, the UK Financial Conduct pline is. It seems fair to wonder whether firms with European Authority (FCA) indicated that it interprets the advice as clients would run two systems of purchasing and consuming inconsistent with the operation of CSAs in their current research given the applicability of the new rules to only the form, because there is still some linkage between execution 28 member states in the EU—or whether it would be more
42 CFA Institute Magazine May/June 2015 efficient to adopt the new system globally. Indeed, clients in subject to objection by the European Parliament alongside other jurisdictions may be interested to learn of the avail- the Council. Member states must also craft rules for imple- ability of more information on how their assets are spent. menting the final legislation in their jurisdictions. ESMA released its advice to the European Commission Both those who produce and those who consume invest- as part of the Commission’s mandate to consider possible ment research face novel challenges in the coming months. content in delegated acts resulting from the July 2014 pas- Separating the purchase of research from the trade execu- sage of the Markets in Financial Instru- tion decision is a logical next step in ments Directive (MiFID II) and the Mar- KEEP GOING addressing some of the dysfunctions kets in Financial Instruments Regula- that conflating the two transactions tion (MiFIR). ESMA’s technical advice Get the CFA UK report, Investment has wrought—motivating, for exam- reflects its consideration of comments Research Valuation Approaches: A ple, development of the CFA Institute Framework and Guide for Investment received after the publication of its May Managers and Asset Owners: Soft Dollar Standards. But the policy 2014 consultation paper, including the http://cfa.is/1BH6O9N. objective won’t be accomplished with- comments offered by CFA Institute. The Learn more about the CFA Institute Soft out significant expense, and some of the scope of MiFID II and MiFIR is quite Dollar Standards: http://cfa.is/1FW0avl. unintended consequences for both Euro- vast, covering issues related to inves- Read the UK Financial Conduct Authority pean investment managers and smaller tor protection, market microstructure, paper on the use of dealing commission: investment management firms are well and transparency. The European Com- http://bit.ly/1w2KUwO. worth paying attention to. mission will consider ESMA’s technical Policy Perspectives: Payment for Invest- Bob Dannhauser, CFA, is head of global capital advice in adopting delegated acts that ment Research: http://cfa.is/1Gd3bK5 markets policy at CFA Institute. would take effect by 1 January 2017, The Importance of Comprehensive Income for Banks
By Vincent Papa, CFA
The global financial crisis has reinforced WHY COMPREHENSIVE INCOME MATTERS the need for enhanced investor scrutiny of The comprehensive income statement has two portions: large, complex banks. Not only are these namely, the income statement and the OCI statement. Taken financial institutions fiendishly opaque and together, these two statements reflect the wealth created complex, but a significant number of them during a reporting period, including the value added from also have the potential to pose systemic operating and investing activities as well as gains or losses risk (29 global banks have been designated from re-measurements of assets and liabilities. For pur- as so-called systemically important finan- poses of valuation, most investors would typically moni- cial institutions, or SIFIs). How financial tor and be familiar with income statement line items (net instruments are accounted for and the interest income, fee income, impairments for the bank busi- related impact on the performance reporting of large, complex ness model). Unlike the income statement, the OCI state- banks were the subjects of two recent CFA Institute publica- ment is not monitored as closely by investors, and it com- tions that highlighted several deficiencies in bank reporting prises four line items: debt and equity securities re-measure- practices, including delays in write-downs of economically ments, derivatives used to hedge anticipated transactions impaired loan assets and inadequate risk reporting. (capital acquisition commitments, future interest rate pay- While the worst economic ravages of the crisis (includ- ment/receipt fluctuations), pension obligation re-measure- ing increased credit risk and the resulting erosion in asset ments, and foreign currency translation gains or losses. quality) may be in the past, we at CFA Institute see need for a sustained focus by preparers, regulators, and standard set- A FOCUS ON OCI REPORTING FOR ters on enhancing the transparency of banks. At the same time, investors need to better monitor bank performance. BANKS IS APPROPRIATE BECAUSE To address these issues, CFA Institute recently released the THESE INSTITUTIONS HAVE LARGE report “Analyzing Bank Performance: Role of Comprehensive Income.” Analyzing eight years of bank data from 44 global CATEGORIES OF ASSETS AND LIABILITIES banks, including many SIFIs, and providing an extensive WHOSE GAINS OR LOSSES ARE review of academic evidence, this latest publication makes the case for drawing increased investor attention toward key RECORDED IN THE OCI STATEMENT. business activities (e.g., valuation changes of interest rate risk–sensitive debt instruments) that are reported through the “other comprehensive income” (OCI) statement.
May/June 2015 CFA Institute Magazine 43 ETHICS AND STANDARDS MARKET INTEGRITY AND ADVOCACY
A focus on OCI reporting for banks is appropriate because regulatory capital. But Basel III eliminates the prudential these institutions have large categories of assets and liabili- filter, and therefore, AFS re-measurements will influence ties whose gains or losses are recorded in the OCI statement. regulatory capital. The newly issued International Financial For example, “available for sale” (AFS) securities are part Reporting Standards (IFRS) financial instruments accounting of the liquidity buffers used to structurally hedge fixed-rate requirements (IFRS 9) no longer classify securities as AFS, liabilities. These securities are held by most banks, and a but this change is unlikely to neutralize the impact of secu- recent academic study showed that, on average, AFS assets rity valuation changes on regulatory capital. Under IFRS 9, account for 11% of total assets. In addition, banks often use equity and debt security re-measurements will likely be clas- derivatives that are designated as cash flow hedges for the sified as fair value through OCI and still have an impact on purposes of hedging anticipated variable interest rate and regulatory capital for banks in countries that strictly follow foreign currency transactions. Basel III requirements. As seen in Table 1, AFS re-measurements can be mate- rial. For example, in 2008 the book value of equity for Dexia RELEVANCE OF OCI BEYOND BANKS (based in Belgium) was decimated in large part because of Although our study is focused on banks, these recommen- the significant AFS unrealized losses (€11.1 billion) that dations are applicable to OCI information for insurance occurred in that year. Even so, despite massive losses and companies (for which there could be expanded use of OCI the need for a state bailout in 2008, Dexia’s regulatory capi- under proposed accounting standards updates). tal (which filters out AFS unrealized gains or losses) actually A 2011 Columbia University working paper found that portrayed a picture of a healthy bank from 2007 to 2010. valuation models for insurance companies based on book This underscores why investors should not ignore the unre- value multiples (price/book ratios, or P/Bs) where book alized losses that are reported in the OCI statement (but not value includes unrealized OCI gains or losses are more pre- through net income) when assessing bank solvency and risk. dictive than valuation models where the book value (in the P/B multiple) excludes the cumulative OCI effects. (See D. TABLE 1 Nissim, “Relative Valuation of U.S. Insurance Companies,” AFS Unrealized Losses Exceeding ROE: Notable Cases 2011 Columbia University working paper.) As a result, Company Country Year ROE AFSUGLE investors should not ignore OCI for nonfinancial compa- Dexia Belgium 2008 -57.8% -209.9% nies, as highlighted by International Accounting Standards Board Chair Hans Hoogervorst in a 2014 speech delivered Deutsche Bank Germany 2008 -12.2% -14.1% in Japan. “A very real example of the dangers of relegating Banco Sabadell Spain 2010 6.7% -10.6% unrealised losses to OCI is what happened in the first decade HSBC UK 2008 -12.2% -23.7% of this century with some big American car manufacturers Wells Fargo US 2008 2.7% -6.7% and airline companies,” he said. “Their employee benefit schemes had caused huge liabilities to build accumulated Bank of New York Mellon US 2008 2.4% -8.1% OCI. Although unrealised, these deficits were not unreal.” Note: AFSUGLE = AFS unrealized gains or losses/equity. Vincent Papa, CFA, is director of financial reporting policy at CFA Institute. Sources: Based on data from company annual reports.
Another reason investors should pay greater attention to KEEP GOING debt and equity securities classified as AFS is that they will affect the regulatory capital of banks to a greater extent than Review the report “Analyzing Bank Performance: Role of in the past. Prudential regulators, under Basel II, allowed Comprehensive Income” at www.cfapubs.org. banks to strip out AFS re-measurements when determining
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NOTICE OF DISCIPLINARY ACTION On 19 February 2015, CFA Institute imposed a Private Reprimand on a Covered Person. A Review Panel found that the Covered Person violated If you are aware of potential violations of the Code and the Code of Ethics and Standard I(D)–Misconduct of the CFA Institute Standards by a member or candidate, we encourage Code of Ethics and Standards of Professional Conduct (2010). you to contact [email protected]. Specifically, CFA Institute found that the Covered Person surreptitiously accessed a colleague’s client contact information in Members seeking guidance in applying the Code Microsoft Outlook and changed the phone numbers and email addresses of clients to prevent them from being contacted directly. and Standards to their professional activities should contact [email protected].
44 CFA Institute Magazine May/June 2015 Private Company Reporting: What Investors Need
By Rhea Wessel Impact of Private Company Accounting Standards Efforts to reduce the complexity and compliance costs of on Investor Analysis financial reporting for private companies appear poised to have a negative impact on those for whom the reports are 14% 19% 23% compiled: investors. For the first time, investors’ opinions of 4% 29% 7% these efforts have been made known, and they overwhelm- 5% 5% ingly say that the moves will make it more difficult to con- 34% duct financial analyses. 29% 28% A report published by CFA Institute showed that some 46% 82% of investors surveyed say moves for reduced require- ments, or differential standards for private companies, will 48% 44% decrease comparability, 73% foresee greater complexity, and 37% 65% say efforts will lead to a loss of decision-useful infor- 28% mation about private companies. Titled Addressing Finan- cial Reporting Complexity: Investor Perspectives, the report Decrease Comparability Reduce Create Greater Result in the Loss was released in May 2015. among Companies Compliance Complexity for of Decision-Useful (i.e., investment Costs Investors Information alternatives) INVESTORS AND COMPLEXITY Strongly Agree Agree Strongly Disagree Disagree The implications are clear, according to the report’s author, Mohini Singh, director of Financial Reporting Policy at Note: Responses to the survey question: “The creation of private company accounting standards will have the following impact on the investment analyses CFA Institute. “The report clearly shows that investors’ of investors who invest across private and public companies?” For details, see views of complexity are very different from those of cor- the full report Addressing Financial Reporting Complexity (www.cfapubs.org). porate managers,” says Singh. “Investors do not want sep- arate private company reporting. Instead, they believe REDUCING COMPLEXITY that the issue of financial reporting complexity should be Standard setters could work to reduce two key sources of addressed for all types of companies. Furthermore, they complexity: inadequate accounting standards and inade- think some sources of complexity are unavoidable, such quate communication. as those related to complex transactions. But other avoid- Problems of inadequate accounting standards include, able sources can be reduced, particularly those complexi- for example, decreased comparability because of optional- ties created by inadequate accounting standards and inad- ity and exceptions to principles. equate communication.” The optionality available in current accounting standards For years, people involved in financial reporting have can result in widely different financial statements, making it been talking about reducing reporting requirements for pri- difficult for investors to make comparisons, which is a criti- vate companies. Organizations behind the efforts, includ- cal part of the decision-making process. If standard setters ing the IASB (the International Accounting Standards increase reporting options through the creation of separate Board), which has developed separate standards for small private company standards, investors will face even more and medium-sized enterprises, and the FASB (the Finan- complexity when performing analyses. cial Accounting Standards Board), which is working on US Likewise, exceptions to principles add complexity to finan- private company standards, are responding to companies’ cial reporting. Financial reports should provide information concerns about rising compliance costs. The IASB and FASB that helps investors decide whether to invest (i.e., reports approach of developing reduced requirements, however, has need to reflect the underlying economics of transactions and a serious impact on investors’ ability to compare reports and events). Exceptions to principles suggest that there is a lack get useful information, and it could lead to higher capital of consensus on the economic substance of a transaction. costs for private companies, the study showed. Problems of communication include, for example, man- “If the FASB continues to push for differential standards,” agement that has a lack of understanding or a lack of intent says Singh, “it should develop them on a very limited basis— to disclose certain items, such as the risks and uncertain- for instance by reducing the disclosures about items that are ties faced by the business. Another problem is poor finan- recognized and measured in the financial statements or by cial statement presentation that does not allow users to link giving private companies more time to adopt new require- income statement and cash flow captions, making state- ments if they have limited resources.” ments more complex for investors to analyze. Overall, the underlying assets and liabilities of an entity According to a 2012 report published by CFA Institute do not change based on the type of entity or its legal struc- titled “Financial Reporting Disclosures: Investor Perspec- ture. Similar items should therefore be recognized and mea- tives on Transparency, Trust, and Volume,” standard setters sured similarly, according to Singh. could require improved communication to investors, including
May/June 2015 CFA Institute Magazine 45 ETHICS AND STANDARDS MARKET INTEGRITY AND ADVOCACY 2015 enhancing the style and presentation of information. Ideas of investors that current efforts by standard setters to create include an emphasis on matters of importance during a report- separate private company standards will actually increase ing period, a greater integration of information within the complexity, it’s clear that standard setters still have work to financial statements and between the financial statements and do to find a balance between the needs of companies to cut INVESTMENT management commentary, and entity-specific information. their compliance costs and the needs of investors to receive Given the investor view that it is these areas of avoidable valuable, usable information. complexity that need to be addressed, and the clear statement Rhea Wessel is a freelance journalist based in Frankfurt. MANAGEMENT Intentional Accidents WHAT IS THE DRIVING FORCE BEHIND INTERNET FINANCE IN CHINA? WORKSHOP
By Alan Lok, CFA 15–19 June 2015 Ever since Alibaba and Tencent secured commercial bank- unthinkable in the West, but it is common practice in this Harvard Business School ing licenses from the China Banking Regulatory Commission part of the world. (CBRC) in September and July 2014, respectively, the inter- Second, most of the banks with sizable balance sheets Boston, Massachusetts, United States net big boys’ entrance to the financial industry arena has in China are state owned. That includes the Bank of China Offered by CFA Institute and Harvard Business School been nothing short of spectacular. And with both companies (BOC), the Agricultural Bank of China (ABC), and the Indus- going a step further in gaining clearance from the CBRC to trial and Commercial Bank of China (ICBC). Together, these establish their consumer credit rating operations in Janu- banks make up the supporting pillars for the Shanghai and ary 2015, their presence may prove revolutionary. Already, Shenzhen stock exchanges and, to a certain extent, the Hong some in the Chinese capital markets predict the eventual Kong Stock Exchange. As such, without the inherent bless- obsolescence of traditional financial intermediaries there. ing from the Central Politburo, it is next to impossible for Indeed, internet financing in China has been touted by both Alibaba and Tencent to throw their punches directly some of its hardcore supporters to be the key move toward at these state-owned operations. For more than 45 years, The program was a useful insight into establishing a more convenient payment mechanism (and Third, Alibaba and Tencent are Chinese-owned enter- the Investment Management Workshop has played an essential role alternative investment approaches the mechanism that has the least informational asymmetry). prises. One of the best ways to tackle the inefficiency and in shaping the principles and practices of investment management available to our clients; it gave me a With the rise of internet financing, according to these sup- complacency within state-owned banks is to create exter- across the globe. This renowned program, developed by Harvard porters, traditional intermediaries (such as banks, security nal competition. But national interest still takes top pri- Business School and CFA Institute, brings together highly accom- better understanding of the broad houses, and financial exchanges) will gradually lose their ority. To strike a balance between safeguarding national plished faculty and leading executives from around the world to competitive landscape and our place relevance, leading to a great reduction in the cost of capital interests and injecting competition into the finance indus- confront the ever-changing challenges that define the investment in client portfolios. for every stakeholder within the ecosystem. (In this connec- try, encouraging home-grown enterprises, such as Alibaba management industry. tion, one should consider the investor protection issues CFA and Tencent, is the preferred solution. Institute has raised in regard to crowdfunding.) Need more convincing? Think about this. The Chinese JOHN KELLY-JONES Beneath all these seemingly grand capital market bene- government did not question Alibaba’s or Tencent’s entrance KEY TOPICS FOR 2015 Partner and Chief Operating Officer fits foreseen from internet financing, however, lurks a slow, into the consumer credit market. Why not? In fact, both the • Factors that influence investment performance Independent Franchise Partners, LLP strong, agenda-driven undercurrent: the Chinese government. CBRC and Xinhua news agency (China’s official voice of the • Compensation policies for investment firms and professionals 2012 IMW attendee • Future prospects for private equity and hedge funds A school of thought has attributed the recent success of Central Politburo) were effectively silent when all these • The search for alpha in today’s economic environment Alibaba and Tencent to loopholes within the legal framework. activities were going on in the background. Also, when Ali- • An effective investment management organization By the time regulators caught up to them, their financial busi- baba and Tencent made their initial encroachments into the Learn more and apply now at www.cfainstitute.org/execed ness operations had surpassed the point at which they could banking sector, the moves occurred during a series of bank- Questions? Contact us at [email protected] be contained. This “too big to fail” argument might sound ing reforms specifically directed to tackle the complacency plausible on the surface, but to those with a better under- and inefficiency within state-owned banks. standing of the Chinese legal, cultural, and political systems Internet financing is something truly unique to China (where nothing happens by chance), it barely holds water. and has no context in other parts of the world. Witness- First, when it comes to legal enforcement in China, the ing its evolutionary development within the Chinese capi- interests of the country and political tal markets is exciting, and continued party override everything. Regardless KEEP GOING analysis of it in the next five years will of whether the regulatory framework be instructive. is robust enough to deal with such Follow Alan Lok’s analysis of Chinese Alan Lok, CFA, is director of capital markets innovative evolution as described here, capital markets on the Market Integrity policy at CFA Institute. A version of this article Insights blog: http://blogs.cfainstitute. the Chinese government still possesses originally appeared on the CFA Institute Market org/marketintegrity Integrity Insights blog. the power to veto anything it deems FOLLOW US ON LIKE US ON FOLLOW US ON unfavorable. Such an action might be
46 CFA Institute Magazine May/June 2015 © 2015 CFA Institute
2015 IMW Ad.indd 1 3/23/15 1:35 PM 2015 INVESTMENT MANAGEMENT WORKSHOP
15–19 June 2015 Harvard Business School Boston, Massachusetts, United States Offered by CFA Institute and Harvard Business School
For more than 45 years, The program was a useful insight into the Investment Management Workshop has played an essential role alternative investment approaches in shaping the principles and practices of investment management available to our clients; it gave me a across the globe. This renowned program, developed by Harvard Business School and CFA Institute, brings together highly accom- better understanding of the broad plished faculty and leading executives from around the world to competitive landscape and our place confront the ever-changing challenges that define the investment in client portfolios. management industry.
JOHN KELLY-JONES KEY TOPICS FOR 2015 Partner and Chief Operating Officer • Factors that influence investment performance Independent Franchise Partners, LLP • Compensation policies for investment firms and professionals 2012 IMW attendee • Future prospects for private equity and hedge funds • The search for alpha in today’s economic environment • An effective investment management organization Learn more and apply now at www.cfainstitute.org/execed Questions? Contact us at [email protected]
FOLLOW US ON LIKE US ON FOLLOW US ON
© 2015 CFA Institute
2015 IMW Ad.indd 1 3/23/15 1:35 PM WARNING: The editor general has CHAPTER 10 determined that reading this column could expose you to sarcasm, irony, and other forms of humor. Investment Secrets of Upside-Down Speed-Readers
By Ralph Wanger, CFA
So, do you want to be a better analyst? Of course you do. IN MY EXPERIENCE, MEASURES When I was a new CFA charterholder, I did too. I attended a SUCH AS PRICE/EARNINGS OR PRICE/ meeting in New York City and met the president of the New York Society of Security Analysts, Orhan Sadik-Khan. (Sadik- ASSETS ARE TREACHEROUS BECAUSE Khan had a long and distinguished career as an analyst and MARKET MOVES GO MUCH FARTHER investment banker, which included serving as managing director at Paine Webber from 1986 to 2000.) During a break THAN YOU COULD HAVE IMAGINED. in the meeting, I went up to him and asked him to tell me a couple of trade secrets. He obliged and gave me two tips. The first tip was quite peculiar: “Learn to read upside- If you find out that things happening at the company are down!” He pointed out that when you are meeting with a not as rosy as you had hoped, do not let your good feelings company CFO and ask a question, the CFO will take a big about the company keep you from marking the stock “sell.” spreadsheet out of a drawer and look up the answer. But if Otherwise, you will follow the stock down, arguing that every you can speed-read upside-down, you will be able to see a new price drop makes the stock a “buy” again. Bad idea. lot of other figures on the spreadsheet too. I have been a fan of the Chicago Cubs baseball team for Well, maybe. I never got the hang of inverted eavesdrop- 70 years. They may be lovable, but I do not bet on them. ping. And today, most spreadsheets show up on a computer Rule 3: HAVE A REASON TO OWN. As an attentive reader, you are screen, so it is hard to get a look at them without being caught. probably now wondering, “Kindly old CFA charterholder, Sadik-Kahn’s second suggestion was much more valuable how do I know whether a bit of negative news is a signal to to me. He said that when you are in a one-on-one meet- go from ‘buy’ to ‘sell’ or if it is just a random fluctuation?” ing with a CEO, taking notes is not a good idea. The act of Good question. It is hard to decide. The best method I have writing everything down is going to inhibit the CEO’s free come up with so far starts when you first think a stock is flow of conversation. It is much better to keep eye contact a buy. Immediately write down two short sentences. The and maintain a lively, less formal atmosphere. The essen- first sentence should be about the compelling reason for tial second step is to write or dictate your notes as soon as future success. The second reason should tell why the stock possible. For the first hour, you have detailed memory of is likely to go up. what was said. After the second hour, your recollection gets In the lingo of the philosopher Karl Popper, each of these a little fuzzy, and after that, it deteriorates badly. ideas should be falsifiable. For example, “Beefsteak Mines has To do this right, you do need to schedule your transcrip- discovered a large deposit of rich gold ore, it will complete tion time. Too frequently, we go to meetings with crowded a mine in six months, and big profits will follow in 2016.” schedules—without 10 or 15 minutes in between for writ- That is a well-formed reason to own, because when you ing. Your boss probably does not care how many sessions look at the company three months from now, new develop- you get to but does want one really useful insight. ments may make the argument false. If building the mine is Your devoted author has now been a CFA charterholder not going well and the mine cannot open before 2020, even for a time that is depressingly close to 50 years, and I am assuming that the company doesn’t run out of money, your going to unload some advice on my readers that I hope will be argument will be false and you should bail out. But if the more useful than speed-reading spreadsheets upside-down. bad news is of a workers’ strike that will delay the project Rule 1: DON’T EMBARRASS YOUR BOSS. When a gormless youth, only one month, your reason to own will still be intact and I made a poor decision involving a work-related matter, and you will be able to buy the dip in stock price. someone told my boss. The next day was terrifying. I man- Your argument can be falsified by success. For example, aged to grovel enough to keep my job, but I learned a real assume it is now 2017. The mine is running well, and the lesson. My action embarrassed my boss. Nothing gets you stock has gone from 15 to 50. Now your argument that the fired faster than embarrassing the boss. mine would succeed in the future is false because the suc- cess happened in the past. Rule 2: DON’T BET ON THE CUBS. When you have followed Beef- In my experience, measures such as price/earnings or steak Mines for a considerable time, you will develop an price/assets are treacherous because market moves go much emotional investment in the company. You will know and farther than you could have imagined. Having a “reason to like a number of people there, and you will have improved own” works imperfectly but better than the alternatives. your own reputation by recommending its stock, if it actu- Ralph Wanger, CFA, is a trustee of Columbia Acorn Trust. ally went up.
48 CFA Institute Magazine May/June 2015 Covering the Global Economy Precision︱Speed︱Access
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