May/June 2013 - s3-ap-southeast-1. · PDF fileThe story of Edmond Dantès ends here: plunging toward oblivion. Betrayed out of jealousy, condemned by political entan- ... pursues a

Solvin

g Fin

ancial I

llite

racy

The Member Magazine for Investment Professionals

May/June 2013

CIPM® HAS EVOLVED.

Take another look at CIPM and gain the skills to drive smarter, more effective investment decisions.

Find out more at www.cfainstitute.org/programs/cipm

26 The Decision Code

Research into how brains encode memory could lead to smarter investorsBy Cynthia Harrington, CFA

COVER STORY

30 Solving Financial Illiteracy“Our objective is realistic,” says one expert on financial literacy, but can initiatives really change behaviors?By Rhea Wessel

36 Profit, Profession, and ServiceGeorge Schwartz, CFA, invests according to moral principles— and free cash flowBy Jonathan Barnes

COVER ILLUSTRATION

Jesse Lefkowitz

26

May/June 2013

41

CFA INSTITUTE NEWS

5 In Focus

The Claritas® program supports our mission to change finance for the greater goodBy John Rogers, CFA

7 EMEA Voice

To build trust, the investment industry needs more professionalismBy Nitin Mehta, CFA

9 APAC Focus

Asia’s role in shaping the Future of FinanceBy Paul Smith, CFA

30

36

2

VIEWPOINT

12 Reducing the Trust Deficit“Financial fraud cannot continue forever in an atmosphere of truth”By Helen Qiang Raleigh, CFA

13 Financial Literacy and Professional MissionEducation, not regulation, is the best way forwardBy Albert Cavazos, CFA

14 The End of Bank Secrecy?The U.S. government’s pursuit of offshore tax avoidance intensifies pressure on advisers and firmsBy Ian Comisky and Matthew Lee

16 Central Bank Policy and Portfolio ConstructionHow should portfolios be positioned for aggressive monetary policies?By Vincent McCarthy, CFA

17 Letters

PROFESSIONAL PRACTICE

18 Are loans the comeback asset class?

20 Erroneous trades and mini-flash crashes

22 Career navigation: tips from four success stories

24 How far should advisers go with outsourcing?

ETHICS AND STANDARDS

39 Market Integrity and Advocacy

• Member societies provide a bolder voice

• Investor rights and protection in Asia

• Navigating ethical gray areas

• Balancing SME financing with investors’ needs

46 Professional Conduct

3 In Summary

48 Chapter 10

Tails, You Lose

May/June 2013

14

48

12

“WHEN SENIOR MANAGERS HAVE CONTACT WITH CLIENTS, THEY UNDERSTAND WHAT CLIENTS LIKE ABOUT A FIRM AND WHAT THEY FIND CHALLENGING.”

22

May/June 2013 CFA Institute Magazine 3

Counting the Cost

“Dantès had been flung into the sea, into whose depths he was being dragged down by a cannon-ball tied to his feet.” — Alexan-dre Dumas, The Count of Monte Cristo

The story of Edmond Dantès ends here: plunging toward oblivion. Betrayed out of jealousy, condemned by political entan-glements beyond his ken, an innocent man wrongfully imprisoned without trial for 14 years and forgotten to the world, the man named Dantès dies. But the

Count of Monte Cristo rises in his place.So goes the plot of Dumas’ classic novel, in which appar-

ent endings are frequently turned inside out and transformed into beginnings. When we meet Dantès, he is already an accomplished and honorable sailor with a promising career but also an illiterate and naïve young man. Yet the injustice that leads to his utter impoverishment, stripping him of every-thing he holds dear, enriches him in ways he never could have

begins tunneling through the prison walls and makes contact with a fellow prisoner, a priest whose fate also was caught up in the shifting political tides of the French revolution, the Napoleonic period, and the Bourbon restoration. The priest offers Dantès more than friendship. He becomes his teacher.

Like Dantès, many people today, caught up in the shift-

-acy has implications for investment professionals individu-ally and collectively (“Financial Literacy and Professional Mission,” 13). CFA Institute has a role to play too. Not only has the organization sponsored an effort to promote inves-tor education, but local member societies have established

-eracy,” 30). Moreover, according to John Rogers, CFA, the new Claritas® -

services industry and society (In Focus, 5).Education certainly proves transformative for Dantès: “like

the aurora borealis which lights navigator of the northern seas on his way, [the priest] showed the young man new landscapes and horizons illuminated by fantastic lights.” The curriculum encompasses the classical liberal arts, natural sciences, mul-tiple languages, and even martial arts and swordsmanship (his tutor was a soldier before entering the priesthood). But

-science because “human knowledge is very limited.” More-over, with a little logic, the priest also helps Dantès unravel the mystery behind his imprisonment. As he explains, “You must have a very noble heart and simple mind that you had not your suspicions from the very outset.” Perhaps the way

Dantès’ brain “encoded” memories also deceived him. Just because long-term memories are formed doesn’t mean the right lessons are remembered (“The Decision Code,” 26).

Finally, the priest reveals his most precious secret: a trea-sure hidden on the isle of Monte Cristo. Like someone using foreign bank-secrecy laws to avoid taxation (“The End of Bank Secrecy?” 14), the priest has concealed its location, even though doing so led to his imprisonment. The two plan to escape and claim the fortune together. But the priest dies suddenly. When the jailers leave the body in a sack for dis-posal, Dantès sneaks through his tunnel, removes the body, and takes its place. He doesn’t know that they plan to hurl the body into the sea from the high cliff where the prison is perched. In a way, however, what appears to be a fatal blunder accords with the advice of a successful CEO who says, “You can’t plan out your whole career, but you can set the direction” (Career Connection, 22).

Dantès’ new career direction puts him on a fast track to termination. On the verge of drowning, he escapes from the burial shroud and surfaces to face a gloomy prospect: “a black and tempestuous sky … the vast expanse of dark, surging waters” (a predicament that may seem familiar to small- and medium-sized enterprises struggling for access to capital—Market Integrity, 43). Yet it is a new dawn. He

Monte Cristo, pursues a quest for vengeance.In some respects, there are surprising similarities between

the count’s time and our own. For example, another char-acter, impressed by the mysterious new count’s opulence, remarks that “our neighbor must be some stockbroker who has speculated on the fall of Spanish funds.” But in today’s

-ulations to predict the outcome of aggressive quantitative easing by central banks and build the right portfolio for the future (“Central Bank Policy and Portfolio Construction,” 16).

The count marshals all his knowledge and wealth to destroy his persecutors. My Penguin edition of the novel

Caviezel) describes it as “the quintessential novel of revenge.”

humility acquired through suffering. The count’s scheme sets in motion a frightful sequence of unintended conse-

-

Tactics, 20). He must confront his own prideful presump-tion and the fallibility of human understanding, precisely

too late does the count see that “All human wisdom is con-tained in these words: wait and hope.”

Roger Mitchell, Managing Editor ([email protected])

IN SUMMARY

4 CFA Institute Magazine May/June 2013

MASTHEAD


CFA Institute Magazine (ISSN 1543-1398, CPM 400314-55) is published bimonthly—in January, March, May, July, September, and November—by CFA Institute. Periodicals postage paid at Charlottesville, VA, and additional mailing offices. POSTMASTER: Send address changes to CFA Magazine, 560 Ray C. Hunt Drive, Charlottesville, VA 22903-2981.

Statements of fact and opinion are the responsibility of the authors alone and do not imply an endorsement by CFA Institute.

Copyright 2013 by CFA Institute. All rights reserved. Materials may not be reproduced or translated without written permission. CFA®, Chartered Financial Analyst®, and the CFA Institute logo 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$10, which is included in the membership dues. Annual nonmember subscription rate is US$50.

the americas560 Ray C. Hunt DriveCharlottesville, VA 22903-2981USAPhone: (800) 247-8132 or

+1 (434) 951-5499

477 Madison Avenue, 21st floorNew York, NY 10022 USAPhone: +1 (212) 754-8012

europe, middle east, & africa131 Finsbury Pavement, 7th FloorLondon EC2A 1NTUnited KingdomPhone: +44 (20) 7330-9500

asia–pacific23/F, Man Yee Building68 Des Voeux RoadCentral, Hong KongPhone: +852 2868-2700

BrusselsNCI LOCARTIS European ParliamentSquare de Meeûs 38/401000 Brussels (Belgium)Phone: +32 (02) 401-6828

May/June 2013 Vol. 24, No. 3

editorial advisory teamShanta AcharyaBashir Ahmed, CFAJim Allen, CFAJonathan Boersma, CFAJarrod Castle, CFAMichael Cheung, CFAJosephine Chu, CFAFranki Chung, CFADarrin DeCosta, CFANick Dinkha, CFAJerry Donohue, CFAAlison Durkin, CFAKenneth Eisen, CFAWilliam Espey, CFAJulie Hammond, CFABurnett Hansen, CFAM. Mahboob Hossain, CFAVahan Janjigian, CFAAndreas Kohler, CFAAaron Lai, CFA

Kate LanderCasey Lim, CFAMichael Liu, CFABob Luck, CFAFarhan Mahmood, CFADennis McLeavey, CFASudip MukherjeeJerry Pinto, CFALinda RittenhouseCraig Ruff, CFAChristina Haemmerli Schlegel, CFADavid Shen, CFAArjuna Sittampalam, ASIPLarry Swartz, CFAJacky Tsang, CFAGary Turkel, CFARaymond Wai Pong Yuen, CFAJames Wesley Ware, CFAJean Wills

cfa institute president & ceoJohn Rogers, [email protected]

managing editorRoger [email protected]

online production coordinatorKara Hite

advertising managerTom [email protected]

puBlisherRay [email protected]

assistant editorMichele Armentrout

graphic designCommunication Design, [email protected]

circulation coordinatorMatthew [email protected]

The authors of this book examine the rationale for investing in currency. They highlight several features of

currency returns that make currency an attractive asset class for institutional investors. Using style factors to

model currency returns provides a natural way to decompose returns into alpha and beta components. They find

that several established currency trading strategies (variants of carry, trend-following, and value strategies)

produce consistent returns that can be proxied as style or risk factors and have the nature of beta returns. Then,

using two datasets of returns of actual currency hedge funds, they find that some currency managers produce

true alpha. Finally, they find that adding to an institutional investor’s portfolio even a small amount of currency

exposure—particularly to alpha generators—can make a meaningful positive impact on the portfolio’s performance.

The Research Foundation funds, publishes, and distributes monographs, literature reviews, and

periodic papers on a variety of relevant investment topics. It traces its roots to 1965 when one of the

predecessor organizations of CFA Institute established the CFA Research Foundation in an effort to

generate research and publications relevant to the needs of investment professionals worldwide.

For more information go to: www.cfainstitute.org

Now available from The Research Foundation of CFA Institute:

A New Look at Currency InvestingMomtchil Pojarliev, CFA, and Richard M. Levich

This publication is available online for free in PDF and e-bookformat and can be purchased in paperback for US$9.95.

The Claritas Program and the Greater Good

By John Rogers, CFA

As we celebrate 50 years of the CFA Pro-gram, the launch of our new education initiative—the Claritas® Investment Cer-

-stone for CFA Institute. To follow up on an article on this initiative in the March/

-

a global, comprehensive education pro-

services outside of investment roles a clear understanding of the investment industry and their professional responsi-bilities within it. During a private employer pilot program

-

pilot partners include such industry leaders as Cognizant,

In May, registration opens to the public for the Claritas

progress. In particular, I want to emphasize how well the program aligns with our goal to restore trust and integrity in

-

engage with a bigger community, and employ a bolder voice.

-ing in different roles, and the Claritas Investment Certif-icate is designed especially for that 91%. The employer

-vided new interaction with nontraditional segments of the industry, such as legal and professional services and insur-

profession, including regulators, private investors, advis-ers, students, and the media, will want to join our cause. In fact, one of the core objectives of this new initiative is to

to lead the investment industry to higher ethical and pro-

Institute has an obligation to be a proactive voice in restor-ing trust and raising investment acumen across the industry.

In anticipation of our global launch, we celebrated region-

of the initiative, and as of press time for this issue of the

coverage in 19 countries. In addition, we saw 21,000-plus

latest educational initiative, including engaging seminars

Claritas Investment Certif-www.cfainstitute.org/programs/claritas -

sider colleagues who might be interested. Encourage them to enroll and offer to serve as their mentor.

Future of Finance project—a long-term global effort to shape a trustworthy,

-ety—recently went live, and I encourage you to visit. The hub is a dedicated part of the CFA Institute website that

-inghouse for content that is collected and shared globally.

-tent and engaging interactive communication opportunities

--

cant research-based outputs, including publications, events, media campaigns, tools, and other communications for gov-

-

and the general public. If you identify content that would be useful to share on the hub, please share it with the proj-ect team at .

The Future of Finance initiative and the Claritas Invest--

industry relies on all of us getting involved as ambassadors of ethics and best practices in order to move the needle and

As always, I would enjoy hearing your ideas and perspective.

John Rogers, CFA, is president and CEO of CFA Institute.

CFA INSTITUTE NEWSIN FOCUS


MEMEMMBERS OF CBERS OF CFFA INSA INSTTIITUTETUTE, AANDND CACANDNDIIDDAATES FTES FAAAA OR THE COR THE CFFA DESA DESIIGNGNAATTAAAA IIONON, MMUSTUST ACACTT WWTT IITHTH IINTEGRNTEGRIITYTY, CCOOMPETDDILIGENCE, RESPECT, AND IN AN ETHICAL MANNER WITH THE PUBLIC, CLIENTS, PROSPECTIVE CLIENTS, EMMPLOYEEEMPLOYEES, COLLEAGUES IN THE INVESTMENT PROFESSION, AND OTHER PARTICIPANTS IN THE GLOBAL ACAPITATT L•• PLACE THE INTEGRITY OF THE INVESTMENT PROFESSION AND THE INTERESTS OF CLIENTS ABOVE THEI OWN PR OIINTERESTS • USE REASONABLE CARE AND EXERCISE INDEPENDENT PROFESSIONAL JUDGMENT WHEN C DUON CTIINVESTMENT ANALYSIS, MAKING INVESTMENT RECOMMENDATAA IONS, TATT KING INVESTMENT ACTIONS, A NGND EN AGINOOTHER PROFESSIONAL ACTIVITIES • PRACTICE AND ENCOURAGE OTHERS TO PRACTICE IN A PROFESSIONAL L AND MMANNER THATAA WT ILL REFLECT CREDIT ON THEMSELVES AND THE PROFESSION • PROMOTE THE INTEGRI F TY O ANDTTHE RULES GOVERNING CAPITATT L MARKETS • MAINTAITT N AND IMPROVE THEIR PROFESSIONAL COMPETENCE AND SMMAINTAITT N AND IMPROVE THE COMPETENCE OF OTHER INVESTMENT PROFESSIONALS. MEMBERS OF CF SA IN TITUCCANDIDATES FAA OR THE CFA DESIGNATAA ION, MUST ACT WT ITH INTEGRITY, COMPETENCE, DILIGENCE, RESPECT, AND IEETHICAL MANNER WITH THE PUBLIC, CLIENTS, PROSPECTIVE CLIENTS, EMPLOYERS, EMPLOYEES, COLLEA UESG INIINVESTMENT PROFESSION, AND OTHER PARTICIPANTS IN THE GLOBAL CAPITATT L MARKETS • PLACE THE I GRNTE ITYIINVESTMENT PROFESSION AND THE INTERESTS OF CLIENTS ABOVE THEIR OWN PERSONAL INTERESTS • USE RES ACCARE AND EXERCISE INDEPENDENT PROFESSIONAL JUDGMENT WHEN CONDUCTING INVESTMENT ANALYSIS, S MAIINVESTMENT RECOMMENDATAA IONS, TATT KING INVESTMENT ACTIONS, AND ENGAGING IN OTHER PROFESSIONAL ACTPPRACTICE AND ENCOURAGE OTHERS TO PRACTICE IN A PROFESSIONAL AND ETHICAL MANNER THATAA WT I REFLELL R COON THEMSELVES AND THE PROFESSION • PROMOTE THE INTEGRITY OF AND UPHOLD THE RULES GOVERNING N CAPMMARKETS • MAINTAITT N AND IMPROVE THEIR PROFESSIONAL COMPETENCE AND STRIVE TO MAINTAITT N AND MIMPROVCCOMPETENCE OF OTHER INVESTMENT PROFESSIONALS. MEMBERS OF CFA INSTITUTE, AND CANDIDATES FAA OR THEODDESIGNATAA ION, MUST ACT WT ITH INTEGRITY, COMPETENCE, DILIGENCE, RESPECT, AND IN AN ETHICAL MA ER WNNE ITPPUBLIC, CLIENTS, PROSPECTIVE CLIENTS, EMPLOYERS, EMPLOYEES, COLLEAGUES IN THE INVESTM OFESSENT PROOOTHER PARTICIPANTS IN THE GLOBAL CAPITATT L MARKETS • PLACE THE INTEGRITY OF THE INVESTM FESSENT PROF IOTTHE INTERESTS OF CLIENTS ABOVE THEIR OWN PERSONAL INTERESTS • USE REASONABLE CARE A RND EXERCISE IINDEPENDENT PROFESSIONAL JUDGMENT WHEN CONDUCTING INVESTMENT ANALYSIS, MAKING INVESTM NT ENRRECOMMENDATAA IONS, TATT KING INVESTMENT ACTIONS, AND ENGAGING IN OTHER PROFESSIONAL ACTIVITIES •• PRACEENCOURAGE OTHERS TO PRACTICE IN A PROFESSIONAL AND ETHICAL MANNER THATAA WT ILL REFLECT CREDIT ON TTTHEMSELVES AND THE PROFESSION • PROMOTE THE INTEGRITY OF AND UPHOLD THE RULES GOVERNING CAC PITATT•• MAINTAITT N AND IMPROVE THEIR PROFESSIONAL COMPETENCE AND STRIVE TO MAINTAITT N AND IM E PROVE TH COMOOF OTHER INVESTMENT PROFESSIONALS. MEMBERS OF CFA INSTITUTE, AND CANDIDATES FAA OR THE CF SA DESIGNAAACT WT ITH INTEGRITY, COMPETENCE, DILIGENCE, RESPECT, AND IN AN ETHICAL MANNER WITH THE PUBLIC, CLIENPPROSPECTIVE CLIENTS, EMPLOYERS, EMPLOYEES, COLLEAGUES IN THE INVESTMENT PROFESSION, A THER ND OTPPARTICIPANTS IN THE GLOBAL CAPITATT L MARKETS • PLACE THE INTEGRITY OF THE INVESTMENT PROFESSI NON ANDIINTERESTS OF CLIENTS ABOVE THEIR OWN PERSONAL INTERESTS • USE REASONABLE CARE AND EXERCI E SE INDEPPROFESSIONAL JUDGMENT WHEN CONDUCTING INVESTMENT ANALYSIS, MAKING INVESTMENT RECOMM DEN ATAA IOIINVESTMENT ACTIONS, AND ENGAGING IN OTHER PROFESSIONAL ACTIVITIES • PRACTICE AND ENCOURA OGE THERPPRACTICE IN A PROFESSIONAL AND ETHICAL MANNER THATAA WT ILL REFLECT CREDIT ON THEMSELVES A HE PROND THPPROMOTE THE INTEGRITY OF AND UPHOLD THE RULES GOVERNING CAPITATT L MARKETS • MAINTAITT N AND IM ROVE PPPROFESSIONAL COMPETENCE AND STRIVE TO MAINTAITT N AND IMPROVE THE COMPETENCE OF OTHER I STNVES MENPPROFESSIONALS. MEMBERS OF CFA INSTITUTE, AND CANDIDATES FAA OR THE CFA DESIGNATAA ION, MUST ACT W WT ITH INCCOMPETENCE, DILIGENCE, RESPECT, AND IN AN ETHICAL MANNER WITH THE PUBLIC, CLIENTS, PROSPECTIVE V CLIEEMPLOYERS, EMPLOYEES, COLLEAGUES IN THE INVESTMENT PROFESSION, AND OTHER PARTICIPANTS I HE GLN THCCAPITATT L MARKETS • PLACE THE INTEGRITY OF THE INVESTMENT PROFESSION AND THE INTERESTS OF CLI NTSEN ATTHEIR OWN PERSONAL INTERESTS • USE REASONABLE CARE AND EXERCISE INDEPENDENT PROFESSIONAL JUDGLWWHEN CONDUCTING INVESTMENT ANALYSIS, MAKING INVESTMENT RECOMMENDATAA IONS, TATT KING INVESTMENT E ACAAND ENGAGING IN OTHER PROFESSIONAL ACTIVITIES • PRACTICE AND ENCOURAGE OTHERS TO PRACTICE INN APPROFESSIONAL AND ETHICAL MANNER THATAA WT ILL REFLECT CREDIT ON THEMSELVES AND THE PROFESSI NON • PRO

TAKE THE LEAD

Renew your CFA Institute and CFA society memberships and demonstrate your commitment to ethical leadership in investment markets.

RENEW TODAYWWW.CFAINSTITUTE.ORG/RENEW

Rebuilding Trust with Professionalism

By Nitin Mehta, CFA

the obligation of professionals to act in the public interest. Financial reforms being implemented around the world will be ineffective if they do not also fundamen-tally improve the behavioural norms of

-ment industries. Current signals indicate, however, that there is an unbalanced

emphasis on new regulations and industry structures, which

values and conduct of practitioners.-

sions have long regulated their members’ behaviour for the

focus on our mission of “leading the investment profession globally by promoting the highest standards of ethics, edu-

do has always positively contributed to society, but the time

In the past, there were few restrictions on someone who decided to practise as an accountant, a lawyer, or even a

establish standards of practise in order to protect the public. Today, most of us would only consult a doctor who has the

practice. Yet, many readily entrust their savings to profes-

-fessionalism would certainly complement new regulations and help to restore public trust in the industry.

A profession that comes with status, self-regulated auton-omy, and often rich rewards has an obligation to assure the public that it has established conditions of entry, standards of fair practice, disciplinary procedures, and continuing edu-cation for its members. CFA Institute provides such profes-sionalism. In particular, it supports members by offering

webcasts, publications, and blogs. In doing so, we can help our members stay on top of industry trends and the latest

Although conscientious employers and practitioners join

professional associations and adopt their standards, many -

tent regulation around the globe. In the United Kingdom,

of minimum education, continuing professional develop-ment, adherence to a code of ethics, and membership in an appropriate professional body. The aim is to raise profes-sional standards in the industry, clarify the different types

this new approach on investor protection and consumer trust.A positive sign is that regulators are realising the need to

--

tiative has been welcomed by retail investors in the United Kingdom, many will wonder why similar regimes do not cover practitioners in other parts of the industry. After all, many of the biggest and most egregious failures occurred

In recent decades, shifts in values have resulted in too -

of innovation and entrepreneurship and not enough cele-bration of ethics. The result has been a clear swing toward business and personal success and away from professional competence and ethical values. If this trend is not reversed and trust restored, there may not be much of a business left.

All those involved have an important role to play in

broad professionalisation and place a greater emphasis on this as a complement to and balance for regulatory and

of employment; such moves would lead to long-term com--

titioners should adopt the higher standards and obligations

professionals to ensure that these professionals are prop-

less than such coordinated action will reshape the future of

Nitin Mehta, CFA, is Managing Director of Europe, Middle East, and Africa (EMEA) at CFA Institute.

CFA INSTITUTE NEWSEMEA VOICE


THE FUTURE OF FINANCE IS HERE. We are proud to announce the launch of a dynamic new online hub designed to engage and inspire the wider investment industry on the issues affecting us all—from finding ways to increase investor protections and stabilize retirement to combatting systemic market risk.

WWW.CFAINSTITUTE.ORG/FUTUREFINANCE HOW CAN YOU HELP?

Visit the site regularly

Join in the dialogue

Share content with clients and colleagues

Submit content

SEND US YOUR [email protected]


Asia’s Role in Shaping the Future of Finance

By Paul Smith, CFA

is an advertisement by one of the region’s

-cial crisis, depositors, investors, and the

assurances seem necessary for them to

At the same time, Asia holds an emi-nent position in the post-crisis global

-

start earning middle class incomes. All these trends signify a

regional and international thought leaders gather to discuss

that ethics, sustainability, and properly functioning capital

SHAPING GLOBAL REGULATIONS TO ENSURE

MARKET EFFICIENCY

that these economies are eager to develop to become full---

of capital in Asia. There are also concerns that overregula-

-ing system is believed to rival the formal sector in size, thus

with international regulations. As the center of global eco-

-

DEVELOPING AN INCLUSIVE FINANCIAL SYSTEM

serve large customers, whereas to start or grow businesses, small customers are forced to borrow from family mem-

Poor access to reasonably priced credit hurts an impor-

-

-

will remain underdeveloped.-

cial system would be an important step in reconnecting the system to the community it is supposed to serve. For this

this space. Alibaba.com, the big e-commerce site in China,

-

nimble enough to incorporate new business models.

CFA INSTITUTE NEWSAPAC FOCUS

IMPOSING EXTERNAL REGULATIONS ON A MARKET ALREADY PARTIALLY DISTORTED BY STATE-SPONSORED CAPITALISM COULD EXACERBATE THE INEFFICIENT ALLOCATION OF CAPITAL IN ASIA.

BRIEFS

IN MEMORIAM

Andrew John Braid, CFA, ASIP

United Kingdom

Tadeusz Kozlowski, CFA

Maplewood, New Jersey

Gary J. Pappas

Pinehurst, North Carolina

Jerome B. Schmitt, CFA

Wheeling, West Virginia

STRENGTHENING ETHICS, ENSURING SUSTAINABILITY

Regulatory reform and innovative business models can

-

-

conglomerates controlled by families or state agencies also

-

-

-

-

Paul Smith, CFA, is the CFA Institute managing director for the Asia-Pacific region.

CFA INSTITUTE NEWSAPAC FOCUS


Fred Young, CFA, died on 3 February in Winnetka, Illinois. Born in 1914 in Bulls Gap, Tennessee, Young was awarded his CFA charter in 1963. He was in the CFA Pro-gram’s first class of charterholders, with registration number 211.

Young held an undergraduate degree from Maryville College in Tennessee. After earning his law degree from the University of Missouri in 1941, he enlisted in the U.S. Navy and retired many years later at the rank of commander. Following his military career, Young pursued a successful career in banking, investment planning, and motivational speaking on issues related to personal finance management. He pub-lished a book on the subject in 1979 (How to Get Rich and Stay Rich). Young enjoyed a long association with Harris Bank in Chicago. Friends and families recall fondly that Young’s “charter membership [in the CFA Program] was an achievement of great value to him.”

Claude Reny, CFA, of Montreal passed away suddenly on 2 October 2012. A longtime CFA Institute volunteer, Reny was an active member of CFA Society Toronto. He was a past chair and member of the Canadian Advocacy Council, serving the organization since 2007.

Ada Litvinov, current CAC chair, remem-bers Reny’s “strong passion for ethics and integrity in our profession, and how he was always looking for the next great idea on investor protection.” Reny also played a critical role at the CAC meetings by initiating discussions on new topics and perspectives. “During his time as the CAC chair in 2010,” says Litvinov, “Claude put a strong emphasis on teamwork and building a better CAC in order to help all of us achieve common goals.”

ASIA CAN LEAD BY INCORPORATING INTO FINANCIAL BUSINESS MODELS PROVEN INTERNATIONAL BEST PRAC-TICES IN CORPORATE, SOCIAL, AND ENVIRONMENTAL GOVERNANCE.


CHALLENGE YOUR THINKING

Renew your CFA Institute and CFA society memberships and maintain access to global and local educational resources that deliver critical insights from industry leaders.



Reducing the Trust Deficit“FINANCIAL FRAUD CANNOT CONTINUE FOREVER IN AN ATMOSPHERE OF TRUTH”

By Helen Qiang Raleigh, CFA

Today’s leadership coaches spend a great deal of time talking about qual-ities such as vision and communica-tion skills, but one important element is often missing: character develop-

being truthful—say what you mean, mean what you say, and back up what you say with action.

Unfortunately, we as a society are so consumed with being politically cor-rect that we not only stop saying what we mean and meaning what we say but also stop expecting that kind of truthful character from our leaders

not being truthful is that we as a soci-ety experience what Jon Hilsenrath has

Wall Street Journal, 27 January 2013). Trust is not only the core of a society’s

our economic system. Trust cannot be

free economy, people will voluntarily exchange goods and services only with someone they know and trust and who says what he means and means what he

been lying, they will stop trading with him. When too many such incidents happen, the economic system will fall apart. As American abolitionist leader Frederick Douglass said, “The life of a nation is secure only while the nation

Those of us in the investment indus-try have suffered a great deal of trust

-dals and systemic failures—the housing

to name only a few—brought consum-

-fessionals who are also entrepreneurs know that we are not in business to sell goods and services. What we are pro-viding is a commitment to make good on our promises.

Almost all of these scandals were perpetrated by a small group of invest-ment professionals who lacked such character traits as honesty and integ-rity. While most investment profes-sionals hold themselves to very high standards, a few bad apples with poor character made all of our reputations

“Character is like a tree and reputation

VIEWPOINT

Illu

stra

tion

by

Tim

oth

y C

ook


Financial Literacy and Professional MissionEDUCATION, NOT REGULATION, IS THE BEST WAY FORWARD

By Albert Cavazos, CFA

-

--

-

-

--

-

-

-

-

Albert Cavazos, CFA, is founder of AC Finan-cial Investment & Wealth Management in San Antonio, Texas, and a member of CFA Society San Antonio.

Illu

stra

tion

by

Tim

oth

y C

ook

-

-

-

-

-

-

-

Helen Qiang Raleigh, CFA, is chief investment officer of Red Meadow Advisors in Denver, Colo-rado, and a member of the CFA Society Colorado.


The End of Bank Secrecy?FINANCIAL INSTITUTIONS MUST UNDERSTAND HOW FATCA WILL CHANGE COMPLIANCE

By Ian Comisky and Matthew Lee

For decades, Swiss banks catered to the rich, offering numbered bank accounts and other discreet services protected by the most stringent bank-secrecy laws in the world. For the past four years, however, the U.S. government has undertaken aggressive efforts to pierce those historic laws, exposing a haven for international tax evasion that catered to wealthy Americans holding secret accounts at Swiss banks. The

-tice Department initially trained their

-

-tually received a US$104 million whis-

helped U.S. citizens hide money using secret accounts, offshore corporations, family foundations, and other mecha-nisms designed to conceal the true iden-tity of account holders. The U.S. also discovered that the sheer number of accounts held by Americans was stagger-

-ment estimated that more than 52,000

the U.S. by paying US$780 million in

the names of U.S. customers of the bank that were suspected of committing tax fraud. Under enormous diplomatic pres-sure from the U.S. government, Swiss legislators subsequently voted to weaken the country’s bank-secrecy laws, paving the way for the thousands of additional names to be turned over to U.S. author-ities. This result prompted the Justice Department to proclaim on its website

Justice Department attorneys and -

tains of information handed over by the Swiss, commenced more than 150 criminal investigations of account

holders, and eventually brought crim-inal charges against the most egre-gious tax evaders. To date, nearly 50

other Swiss banks have faced criminal

-cial advisers) who assisted account hold-ers in hiding assets offshore.

The government’s crackdown on off-shore tax avoidance and evasion shows no sign of abating. At least 10 banks in

-rently under criminal investigation for allegedly aiding and abetting tax fraud by U.S. depositors. Switzerland’s oldest bank, Wegelin & Co., was indicted in federal court in New York, had its correspondent bank account in the U.S. seized, and eventu-ally pleaded guilty

penalties in excess

is widely expected that additional for-eign banks either wi l l be of fered deferred-prosecu-tion agreements or will face criminal charges for their roles in helping Americans evade taxes and that more names from banks all over

There is nothing illegal about a U.S. taxpayer maintaining a bank account or investing in a foreign country, even in such so-called bank-secrecy countries

and Singapore. Anyone having such an account is required to report on his or her personal income tax return all

-ital gains) earned in that account and

bank account. Account holders are also

Department on 30 June of each year.

income from a foreign account can sub-

charges, including tax evasion, as well as substantial civil penalties. U.S. tax-

payers with foreign assets over certain dollar thresholds are also required to

income tax returns. Civil and criminal

the civil statute of limita-tions to assess taxes for the tax return that failed to report the foreign assets.

its deferred-prosecution agreement and the Swiss government started divulg-ing the identities of holders of secret

VIEWPOINT

Illu

stra

tion

by

Tim

oth

y C

ook


accounts, the IRS announced a special amnesty program (called the Offshore Voluntary Disclosure Program) for off-shore bank accounts. It was prompted by the recognition that not everyone with a Swiss bank account was a tax cheat. Amnesty was only available if the account holder came forward before the IRS obtained the individual’s account information; once the IRS learned of the taxpayer’s noncompliance, the voluntary disclosure program was no longer an option. Individuals who took advantage of that program were required to pay back taxes and substantial civil penal-ties but were able to avoid criminal pros-ecution. This special amnesty program (which lasted only six months) was such a huge success, with more than 15,000 individuals coming forward to confess that they had unreported bank accounts, that the IRS re-opened the program in 2011 and again in 2012. To date, more than 35,000 individuals have taken advantage of the three IRS amnesty programs for offshore accounts, gener-ating more than US$5 billion in addi-tional revenue for the U.S. Treasury.

Many more U.S. taxpayers who are believed to be holding foreign accounts in Switzerland and other countries have failed to “come in from the cold,” largely because they believe that they are pro-tected by the bank-secrecy laws of these countries (i.e., the U.S. government will never discover the existence of their accounts) or that these jurisdic-tions would never willingly give up the names of depositors. But that situation is changing. Key provisions of a con-troversial new U.S. law—the Foreign Account Tax Compliance Act (FATCA)—become effective starting in 2014.

FATCA was enacted in 2010, but its implementation was delayed to pro-

to solicit comments and publish imple-menting regulations. Final regulations were issued in early 2013. The primary focus of FATCA is to identify noncom-pliance by U.S. taxpayers using off-shore accounts. Once implemented,

which encompasses traditional banks

institutions, including hedge funds) to disclose information annually about

accounts held by U.S. individuals or foreign companies in which U.S. indi-viduals hold a substantial ownership

(FFIs) that refuse to provide such infor-mation to the U.S. will face a stringent penalty: withholding of 30% of all U.S.-source payments of interest, dividends, and the like. Effectively, FATCA forces foreign banks to cooperate if they wish to have access to U.S. capital markets and will substantially penalize banks that refuse to participate.

In an effort to facilitate the effective

the U.S. Treasury has recently released model intergovernmental agreements designed to allow countries to sign bilat-eral agreements with the U.S., rather than requiring individual FFIs in each country to enter into agreements with the U.S. government. To date, seven countries (the United Kingdom, Mexico, Denmark, Ireland, Switzerland, Spain, and Norway) have signed or initialed model agreements. In addition, the Treasury announced that it is currently negotiating with more than 50 countries and expects to conclude intergovern-mental agreements with those countries in the near future. Even countries with no other bilateral information exchange agreements with the U.S. have been dis-cussing intergovernmental agreements to ease the FATCA compliance burdens

FATCA heralds a new era with respect to offshore investing by U.S. taxpayers. The U.S. government has a powerful new tool to detect offshore tax evasion. FATCA will require that foreign banks annually disclose the names of their U.S. depositors or face

withholding on U.S. source payments. U.S. taxpayers with undeclared foreign accounts can no longer assume that they will remain undetected or pro-tected by foreign bank-secrecy laws. These taxpayers may be well advised

to consider the current voluntary dis-closure program before FATCA is fully implemented and the window of oppor-tunity for amnesty has closed.

FATCA also has dramatic and far-reaching implications for the global investment community. Foreign mutual funds, hedge funds, private equity funds, and other offshore investment vehicles are considered FFIs and must comply with FATCA’s reporting and/or withholding regime. These funds will be required to conduct due diligence on existing investors to determine whether any are U.S. persons and to implement procedures for analyzing whether new investors are U.S. persons. Offshore funds also will be required to annu-ally disclose the names of their U.S. investors or face the 30% withholding tax on U.S.-source payments of inter-est and dividends and gains from sales of U.S. securities.

-tutions and investment funds also will be required to comply with FATCA. They must conduct due diligence to deter-mine who their U.S. investors are and withhold 30% of offshore payments made to investors who are not compli-ant with the FATCA regime. In part, complying with these provisions will require due diligence to determine the

U.S. payments that are going offshore. If there is any uncertainty, the domes-

is paying the funds should exercise caution and withhold the 30% FATCA tax rather than risk a violation of the reporting regime.

Certain countries (notably Russia, China, and Brazil) have resisted imple-mentation of FATCA. Still, the U.S. gov-ernment believes that enough of the worlds’ banks will comply with FATCA to reduce international tax evasion and, in the process, increase revenues by way of withholding for the noncompli-ant. Only time will tell if the massive effort required to comply with FATCA

government.

Ian Comisky is a partner at Blank Rome LLP in Philadelphia and a former federal prosecutor. Matthew Lee is a partner at Blank Rome LLP in Philadelphia and a former U.S. Department of Justice trial attorney.

“All Along the Watchtower: New U.S. Rules Raise Compliance Barriers for Non-U.S. Firms,” CFA Institute Magazine (March/April 2013) [www.cfapubs.org]

KEEP GOING


Central Bank Policy and Portfolio Construction

By Vincent McCarthy, CFA

“All courses of action are risky, so pru-dence is not in avoiding danger (it’s impossible), but calculating risk and acting decisively”—Niccolò Machiavelli, The Prince

we have witnessed an unprecedented

central banks. The explicit goal of their intervention has been to lower borrow-ing costs and push asset prices higher

asset holders to feel wealthier and moti-

of central bank policy on the real econ-omy is a much-debated topic, risk assets have responded in an almost Pavlov-ian way, with each round of monetary stimulus pushing asset prices higher.

much more challenging environment for investors because the yields on tradi-

or reduce risk in portfolios, are now at or near record lows. Cash returns are now effectively zero or negative while the real yields on many top-tier govern-ment bonds are also negative.

Most notably, portfolio managers face a serious quandary when construct-ing lower-risk portfolios, which tend to be heavily weighted to risk-free govern-

lower risk tolerance are still seeking to generate a return similar to what they would have historically earned in cash and AAA government bonds with the same level of risk. Unfortunately, in the current low-interest-rate environment, it is simply not possible for investors to achieve a return anywhere near cur-

risk, whether in the form of credit risk, duration risk, leverage, or the inclusion of other asset classes.

-

risk-free government bond) is currently trading around 1.34%. Historically, from

government bond annual yield aver-aged 5.7%, reaching a high of 10.8%

1.2% in May 2012. Given such circum-stances, how should portfolio manag-

government bonds? One could argue that, based on mean reversion, these government bonds should now be mod-

relative to any prior period.The same question could be extended

to all asset classes because of the distort-

scale asset purchases). Although focus-ing too much on the short term can be a debilitating exercise, should portfo-lio managers and clients now re-think the long-term expected returns that are built into the portfolio construction pro-cess, given that central banks could keep rates low for another 5, 10, or even 20 years, as has been the case in Japan?

The outlook for expected returns in the long term will certainly be tied

world, economic growth remains anemic, forcing the major central banks to pursue more aggressive monetary policies in an attempt to compensate

-ulate economic growth. So far, these policies have boosted asset prices and have had mixed results for economic growth. There is no sign that central banks will diverge from their current path. We have seen already that even

the hint of a change in policy can send the markets into a tailspin. We must also consider the diminishing marginal impact of looser monetary policy as a reason why even more monetary stim-ulus will be deployed to stimulate eco-nomic growth.

Mervyn King, outgoing governor of

monetary policy to “running up an ever- He explained, “Monetary

policy works, at least in part, by pro-viding incentives to households and businesses to bring forward spending

reduces spending plans tomorrow. And when tomorrow arrives, an even larger stimulus is required to bring forward yet more spending from the future. As time passes, larger and larger doses of

-land has been one of the most aggres-sive central banks with regard to mon-

its benchmark interest rate to 0.5% and expanded its balance sheet by a

of GDP, the increase is greater than cor-responding increases in the U.S., Japan, or the eurozone. Yet the U.K. economy

-ployment remain too high. Neverthe-

-tral banks remain committed to these

for the real economy is questionable. -

etary stimulus.-

ted to keep rates near zero until unem-ployment falls to at least 6.5% and until

--

tain an easy monetary policy “as long -

ness in the eurozone economies, this

VIEWPOINT

“Asset Allocation in a Distorted Interest Rate Environment,” CFA Institute Confer-ence Proceedings Quarterly (March 2013) [www.cfapubs.org]

“Regime Change: Implications of Macro Shifts on Asset Class and Portfolio Per-formance,” CFA Institute webcast (Sep-tember 2012) [www.cfawebcasts.org]

KEEP GOING

LETTERS

FRESH THINKING IN THE INDUSTRY

With interest, I read the interview with Rob Arnott about the equity risk premium [“An Opening of Minds,” March/April]. In particular, the notion of replacing “risk free” asset with a “risk minimizing” asset is an appealing concept. Ditto

-match. It’s amazing that such a sensible approach has not caught on. Maybe it needs some good illustration and a marketing strategy!

In recent months, I have seen other pieces that also chal--

esis versus an adaptive-market hypothesis). Though prob-ably triggered by painful market experiences over the past

-ing to see some fresh thinking in the industry.

Colette Coffman, CFA New York City

THE XX FACTOR

Perhaps the most disheartening aspect of the article “Board-room Diversity in the EU” by Claire Fargeot (EMEA Voice, November/December 2012) was the fact that it was penned by

-

not given the recognition that we deserve. I too am against quotas when the free market is functioning, but since women started on the road to job equality in the 1960s, progress has

been painfully slow. One cannot honestly say that of all the potential board member candidates, only 13.7% are women

growth rate, to reach female representation of 40% would take 72 years! Besides, a simple look at the general popu-

-terholders are women. Female charterholders would make excellent board members based on their rigorous analytical training and high ethical standards. All too often I’ve seen intelligent women passed over due to the old boys’ club that still exists or because women do not brag about their accom-plishments. The men’s “accomplishments” can be so risky that they threaten the company’s viability. Whom would you rather have as a board member—thoughtful, disciplined Shelia Bair [current chair of the Systemic Risk Council and former chair of the U.S. FDIC] or all-or-nothing Jerome Kerviel [convicted on charges stemming from the 2008 rogue trading scandal at Société Générale]? Studies have shown that companies with female board members are more successful, particu-larly in the long term. One upside of the current situation is

stem from egotistical male-dominated decisions.

Jaime Jacob, CFA Denver, Colorado


process could take many years. Previ-ous attempts by the Federal Reserve to wean the U.S. economy off quantitative easing have failed. Meanwhile, the new governor of the Bank of Japan, Haruhiko Kuroda, is fully supportive of Prime Minister Shinzo Abe’s crusade to rid

to pursue much more aggressive mon-etary policy. The incoming governor of the Bank of England, Mark Carney, is likely to increase the size of the bank’s asset purchase program but also could

-geting to GDP targeting.

Pinpointing the turning point in mon-etary policy comes down to how long it will take to work off the excesses and imbalances accumulated in previous decades, and such an outcome appears to be some time away. The aggressive action of the world’s major central banks will provide a cap in any rise in yields and could even push yields lower, but over the next 10 years, investors prob-ably will not be able to achieve the

historical returns they came to expect over the previous 10 years. Likewise, it

pre-crisis levels any time soon.Moreover, central banks could be set-

-cial crisis than in 2008, with no clear indication of how they will exit the

respective balance sheets. For example, within the Federal Reserve, opinions are mixed as to how the U.S. economy will evolve and hence when and how the Fed should exit its asset purchase program. According to Charles Plosser, president of the Philadelphia Federal Reserve, “If we get it wrong, the damage might be

markets.” In other words, when the pro-verbial drug is taken away, there will be one serious comedown. I believe central banks will continue to tolerate the potential long-term side effects in their attempts to stimulate a sustainable recovery in the real economy.

With so much uncertainty in the -

lios is more important than ever. With respect to the types of portfolios that traditionally were considered lower risk (cash and government bonds), inves-tors need to be willing to accept lower returns than were achieved histori-cally. To have any prospect of achiev-ing the desired return, portfolio manag-ers and advisers need to educate their clients about adding additional asset classes that may help them achieve their return objectives.

due diligence and client education are required before following the lead of the world’s major central banks and moving up the risk curve. The worst thing to do is to chase higher-return assets without educating clients about the types of risks involved.

Vincent McCarthy, CFA, is a senior investment consultant in Dublin and a member of CFA Soci-ety Ireland.


The Comeback Asset ClassLOANS HAD A BANNER YEAR IN 2012. WHAT’S NEXT?

By Sherree DeCovny

UNDERSTANDING THE QUIRKS

PROFESSIONAL PRACTICEPORTFOLIO PERFORMANCE

Loans currently offer attractive risk-adjusted returns as well as low default and high recovery rates.

Investors in this asset class must tolerate lack of transparency, a long set-tlement cycle, paper-based processing, and irregular cash flows.

Securitized loans can fill the gap between the bank lending and corporate bond markets.

KE

Y P

OIN

TS

Julian Black


-

-

-

-

-

-

-

-

--

A COMPONENT IN GLOBAL

RECOVERY

-

-

-

-

Sherree DeCovny is a freelance journalist specializing in finance and technology.

KEEP GOING

“Mortgage Market Design,” summarized in CFA Digest (March 2013) [www.cfapubs.org]

“The Coming Crisis in Credit Availability,” summarized in CFA Digest (February 2013) [www.cfapubs.org]

“The Role of Debt in the Global Economic Downturn,” CFA Institute Conference Proceedings Quarterly (December 2012) [www.cfapubs.org]

Subscription Credit Facilities

Limited partners contribute an initial amount of capital into a pri-vate equity fund, but they also have an obligation to contribute more cash when the general partner is ready to make an invest-ment. Making capital calls on limited partners is an administra-tive hassle because it involves liaising with several individuals or entities. The fund can draw down only once: It cannot pay the money back to the limited partners and draw again. Negative carry is another potential problem; funds do not want to draw cash and then have it sit around earning nothing.

To that end, subscription credit facilities have increased in popularity. A subscription credit facility is a flexible revolving bank loan to a private equity fund, which provides cash when the general partner needs it. The bank takes security over the capital call. If the investors default on their calls, the bank can enforce against the limited partners.

“It’s a very flexible and cost-efficient way for the private equity fund to manage its working capital,” notes Julian Black, global head of structured finance at Appleby. “In addition, the bank gets a much better yield than it would get on a plain vanilla loan to a firm with the same credit quality.”

Currently, subscription credit facilities are not securitized, but there is some interest in creating a securitized market for these loans. The banks could sell the loans to a special purpose vehicle and then allow third parties to invest in it.

“Subscription credit facilities are relatively short term, so they’re not as well suited for securitization as some longer-term corporate loans, but it’s doable,” says Black. “This is a more bespoke asset class that could be put into a CLO.”

Adam Margolin


Erroneous CombustionDO ERRONEOUS TRADES CAUSE MINI-FLASH CRASH EVENTS?

By Dennis Dick, CFA

Broken Markets

SIZE PRICE EXCHANGE

300 $25.00 NSDQ

300 $25.02 NSDQ

300 $25.03 ARCA

PROFESSIONAL PRACTICETRADING TACTICS

In the era of high-fre-quency trading, erroneous trades have the potential to cause disruptive spikes or vacuums of liquidity as well as extreme price movements.

Current order-protection policies can create a disin-centive for high-frequency traders to provide liquid-ity, especially in times of market uncertainty.

Some markets already have a limit up/limit down mechanism, designed to prevent many erroneous trades from occurring, and a procedure for the U.S. market will take effect in 2014.

KE

Y P

OIN

TS


uniform guidelines for dealing with potential erroneous trades. Trades occurring on NASDAQ that are greater than the numerical threshold set in the following table may be subject to cancellation:

NUMERICAL GUIDELINES REFERENCE PRICE (regular hours)

Greater than $0.00 up to 10% and including $25.00

Greater than $25.00 up to 5% and including $50.00

Greater than $50.00 3%

Source: Based on data from NASDAQ OMX (www.nasdaqtrader.com).

For example, if a stock is trading at $20.00 but suddenly trades down to a price of $18.00, the trades that occurred at $18.00 or below may be canceled.

Exceptions to these guidelines include multi-stock events and pre-market and after-hours trading, in which the numer-ical thresholds are higher, meaning that the stock prices can move further away from the reference price without being subject to cancellation.

Other factors also come into play, according to John Zecca, senior vice president of NASDAQ OMX. “We do take other factors into consideration which could potentially produce a different outcome, particularly in situations where out-side factors might weigh in favor of canceling fewer trades than would be done using our standard break thresholds,” he says. “Some of those factors include system malfunctions or disruptions, volume and volatility for the security, news released for the security, overall market conditions, and exe-cutions inconsistent with the trading pattern in the stock.”

With all these additional factors, the decision to cancel a trade can still be somewhat arbitrary, and that raises con-cerns with some traders.

Chris Eikenberry, director of trading at JC Trading Group, gives a troubling scenario: “Let’s assume stock XYZ suddenly drops from $40 to $34 and a trader decides to take a long position at $34. The stock then rises back up to $36 and the

5 to 10 minutes, the stock proceeds to climb back over $40. Shortly after, the exchange reviews the trades and decides to cancel all trades under $36. The trader’s buy of $34 is canceled, but their sell of $36 stands. This turns their long sale at $36 into a naked short position. So instead of having

trader is now down $4 a share.”In this scenario, the trader

stepped in to buy the stock as it was falling, provided liquidity, and helped stabilize the price. But despite what appeared to be a case of traders making a prof-itable trade, the cancellation of their buy order left them with a loss. “It is unfair to the short-term trader who enters the market in good faith to have to contend with the possibility of losing money from

-able trade,” says Eikenberry.

University of Illinois at Chicago, agrees. “In the May 6th -

rebound. Some of these traders were sophisticated partici-pants hedging their overall risk, so they were only exposed to market mispricing. Canceling those trades left some of those sophisticated traders unhedged, and many of them were subject to serious losses. The clearest way to get more

that situation. But canceling trades goes the other route. I suspect it is the surest way to ensure that traders in the

sort of destructive outcome that we do not want.”Saluzzi disagrees. He believes that this problem is some-

thing the exchanges are actually doing right. “Just because

mean that you should be entitled to the money in it? Why should the guy on the other side of these trades be enti-tled to a sudden windfall? The bottom line is that there are going to be errors, and it is the exchange’s responsibility to enforce their own policies for clearly erroneous trades

errors without earning it.”Zecca believes that the process is working but that the

implementation of the “limit up/limit down” procedure for U.S. markets beginning in February 2014 will help. “We’ve recently canceled fewer trades on behalf of our member

-dardized and reliable. Once the marketwide circuit break-ers are triggered, subsequent bad trades no longer occur. In addition, we expect limit up/limit down to provide fur-ther improvement.”

Unlike the current circuit breakers, which halt the stock

limit down mechanism will prevent the trades from occur-

used in Germany, France, Italy, Japan, and the United King-dom. “Limit up/limit down should reduce the incidence of erroneous trades on exchanges by preventing the execution of certain trades which may otherwise occur far from the

prior reference price,” says Zecca.In theory, limit up/limit down

should prevent many of these erro-neous trades from occurring in the

the new limit up/limit down bands has already begun.

Dennis Dick, CFA, is a proprietary trader at Bright Trading in Detroit and a member of CFA Society Detroit.

KEEP GOING

“What to Do about High-Frequency Trading,” Financial Analysts Journal (March/April 2013) [www.cfapubs.org]

“Broken Markets: How High Frequency Trading and Predatory Practices on Wall Street Are Destroying Investor Confidence and Your Portfolio” (a review), Financial Analysts Journal (January/February 2013) [www.cfapubs.org]

“Exchange-Traded Funds, Market Structure, and the Flash Crash,” Financial Analysts Journal (July/August 2012) [www.cfapubs.org]


PROFESSIONAL PRACTICECAREER CONNECTION

Plotting a CourseHOW FOUR INVESTMENT PROFESSIONALS NAVIGATED SUCCESSFUL CAREERS

By Lori Pizzani

How have successful CFA charterholders plotted a career course and advanced to become senior executives? We asked four professionals to share their backgrounds, successful tactics, and career advice.

COMING FULL CIRCLE

Sometimes it’s what you don’t want to pursue as a career that helps determine your career path.

Today, Alex Matturri, CFA, is CEO of S&P Dow Jones Indi-ces. However, he began his professional life on a different track:

“I started out as a lawyer, but I never really practiced law because I didn’t want to be a traditional lawyer,” he says.

Instead, he was accepted into a bank training program in New Jersey, started as a security analyst, worked for

had the opportunity to move into derivatives and options trading as a way of manag-ing portfolios at Bank of New York. At the time, derivatives trading was in its infancy. He

eventually moved to Deutsche Bank as an investment strat-egist on the index team. That unit was subsequently sold to Northern Trust, where Matturri was promoted to vice president and director of global equity index management for passive strategies. He moved to Standard & Poor’s and worked his way up to have responsibility over all aspects of the company’s global index business. “I’ve come full circle back to derivatives, indices, and active managers,” he says.

Matturri’s current responsibilities are more strategic than in the past because he is tasked with running the global business. He says that he has stepped away from

became his core focus. Matturri -

ing. “The U.S. market is much more mature,” he says. “Other countries are just starting to invest, just start-ing to understand the index fund and exchange- traded funds. That makes it fun.” But he admits that he pines for the excitement of the stock market’s gyrations: “I used to stare at trading screens. I miss the buzz and excitement of that.”

pursued his CFA charter because executives at Bank of New York strongly encouraged it. “An MBA offers more practical-ity, but the CFA Program expanded my knowledge of global

His advice to other CFA charterholders who are plot-ting their own careers is to keep an open mind. “You can’t plan out your whole career, but you can set the direction,” he says. “An opportunity may not initially seem like a good choice, but it can turn out to be.” He advises people against taking a job only for the money and suggests charterhold-ers think more broadly, looking beyond jobs on Wall Street to consider corporations and pension funds.

BLENDING FLEXIBILITY AND DISCIPLINE

For Theresa Mozzocci, CFA, head of marketing and sales at Cantor Fitzgerald Investment Advisors in New York City, the turn in her career path came when she realized her weak-nesses earlier in her career: “I was a trader at the Board of

Trade. But I was a terrible trader because I hated losing money. You

She transitioned to working as an analyst at a small, niche asset

into a consultant relations job in which her focus was talking to people, something she was “really good at.” That experience led her to her current position at Cantor Fitzgerald, where she spearheads the marketing and sales function

is responsible for developing and implementing all market-ing and sales initiatives, including training and educating the internal sales force (e.g., showing them how to cross-sell and sell new products).

you need to readily adjust,” Mozzocci says. “I love the fact that I don’t know how the day will come out, but at the end of the day, you do need some discipline.” She gets paid a salary plus an annual bonus based on a mix of the growth of her group and other subjective factors.

What Mozzocci likes most is “getting out and talking to clients about products and solutions and getting the pulse of what the customer feels.” And she has had to learn how to keep rejection in perspective. “You have to have a tough skin, and I’ve learned that it’s not me personally,” she says. “It’s because of a lot of other factors that are not in control

Don’t try to plan your whole career. Rather, set the direction and create goals.

Identify and leverage personal strengths and interests, and develop a niche you can own.

Be realistic about what initiatives will add value for you.

KE

Y P

OIN

TS

Theresa Mozzocci, CFA

Alex Matturri, CFA


that I hear no. You can’t let that discourage you. You have to shrug it off.”

“One of the best things I ever did was to get my CFA char-ter,” she says. “It shows people I am not just a sales person but that I really understand the business.” Her advice to other CFA charterholders building their careers is to speak up (“Ask anything to anybody”), keep learning, stay involved, and network. She remains active in the CFA Society Chicago.

CARVING A NICHE

John Del Vecchio, CFA, wears sev-eral hats these days. He is the co-founder and co-manager of the Ranger Active Bear ETF (which

-aging member of Index Deletion

focused on the merits of forensic

analysis), and creator of the Del Vecchio Earnings Quality Index (which since 30 January 2013 has been the basis of the new Forensic Accounting ETF). He is also co-author of the 2012 book What’s Behind the Numbers? A Guide to Exposing Finan-cial Chicanery and Avoiding Huge Losses in Your Portfolio.

Del Vecchio began his career as a quantitative analyst with Federated Investors in New York City and then moved to Washington, DC, to work at The Motley Fool (for which he still does some consulting). From 2003 to 2007, he worked for famed bear investor David Tice, whose Prudent Bear Fund and a sister fund were, coincidentally, sold to Feder-ated Investors in 2008.

He struck out on his own in 2010 and is still involved in

as well as coming up with quant ideas that he can use to

short,” he says. “We take big positions to short, and when the companies don’t come around, we capitalize on them.”

What he dislikes most is dealing with investors who say they are long-term thinkers when they really focus on the short term. “It’s less like investing and more like gambling,” he says. “I wish they’d just buy the fund and then step away. But people prefer you to perform on a daily, monthly basis.”

For anyone seeking to go out on their own, Del Vecchio -

tise and, next, lining up several clients. As to launching an ETF: “Be prepared to lose money for a while, as there are lots of operating costs,” he says. He was fortunate that the

With the new Forensic Accounting ETF, however, “we are all prepared to lose money, at least initially.”

He did receive an advance from McGraw-Hill but is not expecting to make money: “The purpose of the book was to share what we knew.”

His career advice is to deter-mine who you are and what gets

you excited. Don’t be a jack of all trades and master of none. “If you have a couple of things you are passionate about, pursue those on your own and carve out a niche in a bigger corporation,” he says. Then decide if you want to stay in the corporate setting or work for yourself.

PURSUING A PASSION

In his 32-year career, Eric Propper, CFA, has had to stay on track through several mergers.

Trust, Propper initially cut his teeth working at E.F. Hutton, which was later acquired by Shearson Lehman and subse-quently by Smith Barney. After the second merger, he went to work for J. Bush and Company, which was later acquired by Riggs Bank. Next, Propper worked for Stein Roe & Farn-ham, one of three companies acquired by Invesco in the early 2000s and fused into Atlantic Trust, which remains the private asset management arm of Invesco.

His company is headquartered in Atlanta, but Propper

also receives bonuses tied to how well Atlantic Trust and Invesco have fared.

He estimates that he spends half his time with clients across the country and the other half attending to varied management duties and related meetings: “I have a litany

words, he explains, “It ’s not a 9-to-5 job; I’m on the road a lot.” But the demands haven’t dimmed his enthusiasm. “Professionally, I am in one of the greatest positions in the industry,” he adds.

“I am passionate about what I do,” he continues. “Being involved in the investment management business is highly stimulating.” An important component for him is contact with clients. “We believe senior managers are coaches and

should stay active in client relationships,” he says. “It is one of the best parts of this industry because clients trust you. When senior managers have contact with clients, they

He credits the CFA Program with giving him broad-based knowledge. “I have an MBA, but the CFA Program curric-

day basis.” Propper also believes the CFA designation offers credibility and shows that a char-terholder has what Propper con-siders the two key ingredients to success: drive and perseverance. His career advice to others is “be passionate.”

Lori Pizzani is an independent financial and business journalist based in Brews-ter, New York.

KEEP GOING

“Leading Edge” (Career Connection), CFA Institute Magazine (September/October 2012) [www.cfapubs.org]

“Variations on a Theme” (Career Connection), CFA Institute Magazine (March/April 2012) [www.cfapubs.org]

John Del Vecchio, CFA

Eric Propper, CFA


OutlandersHOW FAR SHOULD ADVISERS GO WHEN DECIDING TO OUTSOURCE?

By Ed McCarthy

MOTIVATION FOR OUTSOURCING

PROFESSIONAL PRACTICEPRIVATE CLIENT CORNER

Many of the activities involved in providing wealth management ser-vices can be outsourced to external vendors.

Although cost cutting was the initial impetus for many firms’ decision to out-source, other motivations, such as access to higher-quality services and tech-nologies, are becoming more important.

Outsourcing is not a pana-cea, and wealth manage-ment firms tend to encoun-ter trade-offs and other constraints that limit their ability to outsource.

KE

Y P

OIN

TS


The survey respondents listed “access to asset allocation models” and “access to managers we could not access on our own” as their top motivations for outsourcing. Over-

with the results of their decision. Over 60% reported that outsourcing gave them more time to spend with clients and

wider array of investment products, and institutional-level due diligence and monitoring.

Of course, not all wealth managers are outsourcing the -

ipating in the Northern Trust survey that do not outsource investment management, the primary reason given was that they consider investment research to be part of their value proposition. This response was most common among

-lion in assets under management). Pine echoes this senti-ment. “We get our research from all kinds of publications,” he says. “But the decision making, the implementation, the execution we keep in-house because we want to make sure that that’s something that we can do differently, that we can point to and say this is why we’re different, this is why you [as a client] might want to work with us.”

IDENTIFYING THE CORE, SELECTING VENDORS

The key to a successful outsourcing experience starts with identifying core functions. That’s often easier to say than

be similar can reach different decisions on their approach. Identifying core competencies starts with a business anal-ysis, notes Peter Amato, vice president of wealth manager

-guishes it from its competition. From that point, the analy-sis shifts to the activities supporting that value proposition. “What are the activities that they want to keep unique to them as their competitive advantage?” Amato asks. “That

-uating its outsourcing decisions. Instead of going straight

simple. He likes to be able to sketch the entire business on a 3×5 card. “What do we do?” is the critical question, he says. “One is [to provide] platinum-perfect customer service. Another one where we want to differentiate ourselves is on thoughtful investing. And so we’re not going to outsource any one of those things because that’s what makes us different.”

Outsourcing decisions aren’t always clear-cut, even when the

The decisions can also be subject

to constraints. Pine currently outsources the development and maintenance of the web portal his clients use to view their portfolios. He considers it part of the client experience and “desperately” wants to bring it in-house but has so far been unable to do so. “It means rebuilding the whole web-site, which my company doesn’t have the wherewithal to do,” he says. “We don’t have that expertise. [But] I’ve made the decision strategically that we’re going to have to build something, which means hiring a programmer and doing these sorts of things that, on the face of it, aren’t really

close to the client experience for us to let someone else be in charge of how it works. It’s been a real disappointment.”

Some vendors offer niche services. The website virtualso-lutionsforadvisors.com provides a directory of several such

provide more of a turnkey operation. For example, State Street offers a fully integrated wealth platform with ser-vices ranging from accounting to custody, including front-

Pinnacle Advisor Solutions is an example of a relative

unique background. The company is a division of Columbia, Maryland–based Pinnacle Advisory Group, a wealth man-

management. Pinnacle Advisor Solutions started operat-

advisors, says John Hill, Pinnacle Advisory Group’s presi-dent. The outsourced services are aimed at emerging RIA

Hill describes it as a comprehensive package that includes both asset management services and consulting on build-

CAVEATS

the right solution. In 2011, Amato co-authored a State Street report (“Next-Generation Outsourcing for Wealth Managers: Riding the Wave of Converging Business Trends”) that iden-

-ing client relationships, a risk that the wealth manager will become locked into suboptimal technology, and a decreased ability to customize services.

Firms that have highly customized processes can have

-cally in a box, but they have to be able to adapt to some level of stan-dardization to achieve the scale that we can bring to the table,” says Amato. “Otherwise, it’s not good

unique processes just for them.”

Ed McCarthy is a freelance finance writer in Pascoag, Rhode Island.

KEEP GOING

“Building a Better Investment Experience for the Client,” CFA Institute webcast (February 2013) [www.cfawebcasts.org]

“Key Trends and Issues for Financial Advisers,” CFA Institute Take 15 Series (September 2012) [www.cfawebcasts.org]


--

-

-

-

CODED AND STORED

-

-

-

-

-

--

-

-

THE BIOLOGICAL INVESTOR

THE DECISION CODE

By Cynthia Harrington, CFA

Could research into how brains encode memory lead to smarter investors?

This article is the third in a series called “The Biological Investor.” Part 1, which focused on chemical messengers and neural processes, was published in the January/February 2013 issue. Part 2 about the influence of emotions on decision making appeared in the March/April issue.

--

-

--

-

-

-

-

THE SHAPE OF MEMORY

-

-

--

-

-

-


Illus

trat

ion

by J

ames

Yan

g


-

-

GENES SHAPE EXPERIENCES, EXPERIENCES SHAPE GENES

-

-

-

-

-

-

-

-

--

-

-

--

-

-

Cynthia Harrington, CFA, is a principal at Cynthia Harrington & Associ-ates, a Los Angeles-based firm that provides executive coaching for investment professionals.


MAKE AN IMPACT


Renew your CFA Institute and CFA society memberships and remain an active part of global and local efforts to shape a stronger, more accountable investment profession.

R Y C U R B J K A N O L E S O L V I N G M C A D R Y C U R B J K A N O L O P F I N A N C I A L EB I L L I T E R A C Y S Y P E S F H K O N T B J O D B A E M J O P I L A R E T U R N K EWP C U T B Y E T Y U I O A H P F T B I Y Z X C E B N M O N B E R V O A T S E G L K A U J S G M I N B K30 CFA Institute Magazine May/June 2013

Illu

stra

tion

by

Jess

e Le

fkow

itz

Financial literacy—or the lack of it—among the general population affects every investment adviser as well as every citizen. Discussions about the problem can cause emotions to surge, given the wide variety of policy and nonpolicy prescriptions that are proposed to tackle it.

By Rhea Wessel

“Our objective is realistic,” says one expert on financial

literacy, but can initiatives really change behaviors?

Though people may spar about how to reach

a deeper understanding of money matters,

Some authorities, including the Organisa-tion for Economic Co-operation and Develop-ment (OECD), believe that a poor understand-

the U.S. subprime mortgage crisis. From this

matter that affects the stability of the entire

A perfect storm is brewing, the reasoning goes. Individuals must increasingly take charge

contribution programs and the growing chal-lenge of unfunded government retirement schemes. Financial products are ever more complex and opaque, and people have unprec-edented access to credit, which provides an incentive to consume rather than save.

-eracy on the international policy agenda, along with other slow-moving phenomena that can have drastic consequences over the long term but are easy to ignore in the short term. Deal-

-

industry believe they have a responsibility to

programs as part of efforts to rebuild the trust

Changing behavior, however, may prove even harder than providing education. Research

is no guarantee of a positive economic outcome -

cially. It’s a bit like going on a diet. You may know all about diets and how to diet success-fully, but knowing about diets and successfully going on a diet are two very different things.

to affecting behavior, according to Annamaria Lusardi, professor of accountancy at the George Washington University School of Business and academic director of the university’s Global Center for Financial Literacy. “We have found

the capacity to plan for retirement, to have a cushion of wealth, and to make decisions that are now more commonplace than before,” she says. “Financial knowledge is very, very strongly

SCOPE AND SCALE

to be measured. In an inaugural 1997 study, Jump$tart, a Washington, DC–based national coalition of organizations working to improve

-cial literacy as “the ability to use knowledge

products and concepts, as well as the basic numeracy and mathematics needed to apply

planning.No matter where the line is drawn between

acknowledge that a lack of understanding about basic concepts is not limited to low-income or undereducated consumers. Among U.S.-based investors, the 2009 National Financial Capa-bility Study showed that a majority of people with household income of more than $150,000

-cial concepts correctly, according to analysis published in a National Bureau of Economic



Research working paper released in September 2012 (“Financial Literacy, Financial Education and Economic Outcomes” by Justine C. Hastings, Brigitte C. Madrian, and William L. Skimmy-horn). Advisers to wealthy and educated people know it all too well: Having a high net worth does not necessarily translate into having a high

-tries. An international study co-authored by

-cial literacy is very low around the world, regard-

in a country. The survey also showed that women -

ters and that older people tend to have lower

generations, suggesting these groups may be vulnerable.

For Robert Holzmann, director of the RH Institute for Economic Policy Analyses in Vienna

-acy, the important point is not quantitative mea-sures of knowledge but the baseline behavior

-cial decisions on their own—because behavior

Financial Literacy Initiatives from CFA Institute Societies

The Bay Area Financial Education Foundation (BAFEF), established as a public nonprofit by members of the CFA Society San Fran-cisco, supports proven financial literacy programs in the areas of finance, investment, and entrepreneurship. Support is given through volunteers, event participation, and funding, according to Ted Jablonski, president of the foundation and a wealth man-ager in the Bay Area.

Jablonski explained that the foundation’s goal is to help people sort through the thousands of education programs available and identify the programs that have a strong track record for making the intended impact.

“The foundation board looked for scalable, proven programs in our area of interest,” says Jablonski. “Then we went through due diligence to select a list of partners.”

BAFEF selected five public and private partners for its financial literacy program, including the Wall Street Journal Classroom Edi-tion, which provides students with access to daily financial news and related study materials, and the SIFMA Foundation’s “Stock Market Game,” in which teams of students invest a hypothetical portfolio of $100,000.

“When we started our program in 2007, it was a ‘feel good’ moment and we wanted to give something back,” says Jablonski. “But after the crisis, public confidence in large institutions was really low. Now, I think it’s critical for our profession to engage in financial education and to find a place where we can offer sup-port to rebuild trust.”

PITTSBURGH

CFA Society Pittsburgh began a financial literacy project in 2011 on the initiative of Christopher Pretsch, CFA, a managing director of Staley Capital Advisers and a former board member of the society.

Pretsch, who still runs the financial literacy committee, had noticed frequently that regardless of age or education level, many

of his clients lacked basic financial savvy. In addition, he saw how easy it was for companies to mis-sell products or sell bad finan-cial products.

“One of the reasons companies get away with this is because people don’t know how to differentiate,” he says. “They don’t know how to tell a good financial product from a bad financial product. I felt there was a real need for people to learn about this stuff. I felt like CFA Institute and [CFA Society Pittsburgh], because we are unbiased and aren’t trying to sell anything, would be a good vehicle for us to get out there in front of the public and educate people.”

The committee, which now has 10 people involved, gives lec-tures on basic financial principles to youngsters, often at schools, and has a backlog of requests to do the same for adults in the Pittsburgh area.

In the opinion of Pretsch, one of the problems in the invest-ing world today is that there is too much information. “You’ve got all these websites, you’ve got CNBC all day long,” he says. “I try to remind people that CNBC’s business is not to teach you about the market or inform you. Their business is to sell commercials. All the stuff in between the commercials is just filler to keep you engaged. They have 14 hours to fill. They have to keep talking about this stuff. It makes people want to trade more than they should, to buy stocks more than they should. It pulls people in too many different directions.”

Pretsch sees over and over again how individual investors will do the exact opposite of what they should in times of market panic. “If we can educate people about hysteria and how to resist it,” he says, “it makes our jobs as advisers easier because we don’t have to deal with clients who are trying to sell stocks when they should be buying and the other way around.”

In the end, it comes down to this for Pretsch: “A better-edu-cated investor makes a better client.”


socioeconomic status or knowledge level.

education,” says Holzmann, who also advises a Russia-supported and World Bank–led research

“That makes the important question, How -

cially capable?”

-ity to (1) control or record daily spending, (2) budget or live within one’s means, (3) plan or prepare and save for future knowns and unknowns, (4) choose or select between alter-

know where to go for help. Empirical, inter-national studies are ongoing to compare these traits among people of different demograph-ics, such as high income, low income, country of residence, and so forth.

of the equation. “What comes out from the liter-

and asking people good questions about their plans and money can be more valuable than

But even with good advisory services, indi-vidual investors still must be able to under-

adviser will tell them,” says Flore-Anne Messy, -

utive secretary of INFE at the OECD in Paris.

advisers to understand the context and provide

-cial education by helping people to make good decisions and have a better understanding of what is at stake.”

FINANCIAL EDUCATION INITIATIVES

A plethora of institutions have undertaken

Government agencies, companies, nongovern-mental organizations (NGOs), and concerned individuals are using a variety of ways—some more creative than others—to make an impact.

The OECD’s International Network on Finan-cial Education (INFE) provides a policy forum

-cial education. The network, which works with

106 countries and 230 public institutions, has compiled an extensive repository of studies on the subject and holds conferences around the world as part of efforts to develop indicators

Messy works with partners to develop meth-

a population, including attitudes and behaviors. In cases where the goal is to change behavior (not simply to inform or raise awareness), the network recommends starting early with educa-tion initiatives in schools and combining those efforts with regulation and advice.

The program’s goal is to help people develop savvy, informed habits for their per-

Messy. “We know that not everyone can become, will become, or should become a sophisticated investor.”

EDUTAINMENT

experimented with “edutainment,” or behav-ior-oriented content that has a “fun factor.” One notable example is a soap opera in South Africa. The project, conducted by South Africa’s National Debt Mediation Association (NDMA) and supported with design and evaluation by

-ity themes for a soap opera called Scandal! The storylines included a woman overspending and spiraling into debt. After she confesses her situ-ation to a friend, comes clean with her husband, and gets advice from a debt counselor, the char-acter begins to take control of her spending.

Multiple plot elements, introduced over six weeks, touched on getting into debt and break-ing the debt cycle. The effect on knowledge and

WHAT COMES OUT FROM THE LITERATURE IS THAT GOOD INDEPENDENT FINANCIAL ADVICE AND ASKING PEOPLE GOOD QUESTIONS ABOUT THEIR PLANS AND MONEY CAN BE MORE VALUABLE THAN GENERIC FINANCIAL EDUCATION.


behavior was measured by, for example, moni-toring calls to the debt counseling hotline. “The results are encouraging since they show signif-

knowledge,” says Holzmann, who served as a senior adviser on the project.

Another creative approach comes from activ-ist Johnny Deas, founder of the Great Ideas Edutainment Foundation. Through a program called “Financial Literacy Music,” he uses his

--

averaging.Many experts, including Messy and Madrian,

see games as a particularly effective tool for teaching money principles because games allow

one to fail within a protected environment. The experience of failure then provides an incentive

-

entertainment as a paradigm shift away from -

cally lecture based and often is perceived as

interactive, and it links education to action by embedding offers and opportunities for real-world choices directly into the games.

The SIFMA Foundation’s “Stock Market Game,” for example, has received particularly high marks for its ability to engage players (usu-ally young people) in a real-life simulation of stock investing. It allows participants to see a direct connection between their choices and their account balances as teams invest a hypo-thetical portfolio of $100,000. The game also

compete and results are easily comparable.

Boston-based D2D calls itself an “idea lab” for developing products, services, and public poli-

moderate-income people. Funded by the Ford Foundation and the W.K. Kellogg Foundation, among others, and chaired by Peter Tufano, dean of the Saïd Business School at the University of Oxford, the organization focuses on behav-ior-affecting programs to promote saving and learning. It has led efforts to introduce “prize-linked savings” to the U.S. market—products that reward saving with chances to win cash prizes. “The idea is to link saving with suspense, fun, and possibility instead of self-denial and

executive director of D2D.Financial games are a big part of what D2D

does. It has developed a number of games to

the mass market and are available for free on

games, D2D realized that the problem was not a lack of available information. “We concluded that the problem is not on the supply side; it’s on the demand side,” says Flacke.

learning through games that have the poten-tial to teach and attract a large audience. “The

-

large; the number of people who are willing to try out something because it looks fun is much larger,” says Flacke.

D2D has pulled together a library of so-called casual games based on themes from popular culture that have wide appeal and are easy to play. One advantage of games is that learning is not passive. Instead, players practice decid-ing how much to charge to the credit card or debit card or how much to defer for retire-ment. Games also can help people overcome trepidation associated with the topic of saving and investing.

“If it’s a good game, you get engrossed in the puzzle solving. The anxiety you feel about the topic ebbs away, and there’s a window when you can help people learn both information and

are solving the puzzle,” says Flacke. In addition, the games can include a nudge to actually take action, something D2D is focused on right now.

Recently, D2D worked with Staples to help

THE IDEA IS TO LINK SAVING WITH SUSPENSE, FUN, AND POSSIBILITY INSTEAD OF SELF-DENIAL AND DEFERRED GRATIFICATION.


of its retirement plan among employees. D2D embedded into the “Bite Club”—a vampire-

allows Staples employees to go directly to the website of the Staples retirement vendor, and it customized the game for the Staples plan. “Staples did some really creative marketing that looked nothing like a traditional 401(k) enrollment kit,” says Flacke.

ideal tool, given the small cost of making elec-tronic ones available online. But he is careful to

and online tools, such as retirement or insur-ance calculators. Often, tools are presented as games, but they lack the game-play elements that make games fun.

EMPLOYER PROGRAMS

employee participation in the company’s retire-ment plan is part of a larger trend. Increasingly,

conducting campaigns, holding learning com-petitions, and making online study materials available, among other methods. According to a study titled “Personal Finance and the Rush to Competence: Financial Literacy Education in the U.S.,” commissioned by the now-defunct Fannie Mae Foundation, companies have started education programs to increase participation in (and contribution to) retirement plans, to comply with related regulations, and to avoid potential liability for investment losses. Exam-ples in the U.S. include the forestry products company Weyerhaeuser, the logistics provider UPS, and Staples.

courses. A study of the impact of a mandatory course the U.S. Army provided for enlisted sol-diers found that attending the class doubled par-ticipation in and contributions to a retirement savings plan. The army course is one of the

in the literature, according to one of the study’s co-authors, Brigitte Madrian, Aetna Professor of Public Policy and Corporate Management at the Harvard Kennedy School of Government.

literacy program well, you can have impact,” says Madrian.

FOR THE ULTIMATE BENEFIT OF SOCIETY

Some CFA Institute member societies have begun their own initiatives in their local communities, such as the outreach programs by CFA Society Pittsburgh and the Bay Area Financial Educa-tion Foundation (BAFEF), which was started by the CFA Society of San Francisco (see side-bar on page 32).

CFA Institute also reaches out to those who

the investor education effort directed by Robert Stammers, CFA. In his view, investor education can improve markets. Well-informed investors will demand transparency and make markets

But achieving large-scale transformation depends on small changes in behavior for indi-vidual people. “Financial education doesn’t mean making people become little Warren Buf-

“It’s about equipping people to be in charge of

Rhea Wessel is a freelance journalist based in Frankfurt.

CFA Institute and Investor Education

The investor education effort at CFA Institute shares information via various channels and media, including its blog Enterprising Investor (blogs.cfainstitute.org/investor). “I am passionate about financial education because when investors are well informed, they require transparency and make better investment decisions,” says Robert Stammers, CFA, director of investor education. “This leads us to a more equitable and efficient market and a chance for investors to receive a fair return.”

For more effort about investor education initiatives and offer-ings, contact [email protected].


The CFA Code of Ethics and Standards of Practice are also fundamental to Schwartz’s operating model. Although he acknowledges

anybody,” he draws a sharp distinction between a business and a profession, noting that a busi-

“the professional operating in a profession exists to serve.”

In this interview with CFA Institute Maga-zine, Schwartz, author of Good Returns: Making Money by Morally Responsible Investing, explains the nuances and opportunities for growth in morally responsible investing, its differences from socially responsible investing, and the solid fundamentals he looks for in a company.

What’s the difference between morally respon-

sible investing (MRI) and socially responsible

investing (SRI)?

There are a lot of funds that invest in so-called SRI. They tend to be more interested in environ-mental issues and pollution, or they’re interested in low-cost housing for underprivileged people or agenda equity. They screen out companies

and gambling—that sort of stuff. That’s not our focus. Our Catholic Advisory Board has asked us to be very, very focused on abortion as well as embryonic stem-cell research and pornog-raphy. One of our shareholders said, “George, it seems like you just focus on the mortal sins, not the venial sins.” That’s Catholic terminol-ogy for serious sins versus not-so-serious sins.

us in with the socially responsible funds. As a matter of fact, Morningstar groups us with SRI in their rankings. We wrote to them sev-eral times about the distinction, but they’re not interested in the distinction. Maybe to them it’s a distinction without a difference. Not to us.

Actually, there’s very little crossover, correct?

Absolutely. No question about it. We can and have invested in defense companies, such as General Dynamics and United Technologies. Some of the socially responsible funds would say, “Oh, no. We don’t want weapons. We don’t want weap-ons of mass destruction.” Or they’ll say, “We don’t want companies that make alcohol prod-ucts because alcohol is such an evil. It destroys marriages.” Anyway, again, that’s not our focus.

What screens are you employing?

We have 50,000 shareholders, most of whom are Catholic. I’d say virtually all of them are pro-life

companies that support abortion in any way:

Morally responsible investing is much smaller than its better-known cousin socially responsible investing, but it has “huge potential as an industry,” according to George Schwartz, CFA, founder of Ave Maria Mutual Funds. Estab-

the Ave Maria funds invest according to moral principles of the Catholic Church and in particular screen out com-panies involved in any way in abortion, pornography, and embryonic stem-cell research. The funds’ restrictions are set by a Catholic Advisory Board, consisting of prominent

Kudlow, and Domino’s Pizza founder Tom Monaghan. Not only did the funds have a low redemption rate among its investors during the 2008–09 period, but they have expe-rienced substantial growth since then. Today, with 50,000 shareholders and US$1 billion in assets under manage-ment, Schwartz believes his approach to morally responsi-ble investing (MRI) is “just scratching the surface.”

By Jonathan Barnes

George Schwartz, CFA, invests according

to moral principles—and free cash flow

PROFITPROFESSION

and SERVICE

the drug companies that make abortion-related drugs, the hospital companies that perform abortion, insurance com-panies that pay out for abortion—those are all screened out.

Closely related is embryonic stem-cell research. The position of the Catholic Church is that embryonic stem-cell research is very closely related to abortion, so any company involved in stem-cell research is off the table. That knocks out most of the biotech companies.

Any company that contributes corporate funds to Planned Parenthood is out of consideration. Planned Parenthood is the biggest provider of abortions in the country, maybe in the world. No matter how much money or how little money a company contributes to Planned Parenthood, we’re not going to invest in that company. It’s mostly the bigger com-panies that, I’m guessing, feel pressure from their boards or their shareholders or their employees. It’s considered the politically correct thing to do in some quarters. I’ve talked to CEOs of smaller companies who say, “Planned Parent-hood? Why would we give money to Planned Parenthood?” We think that’s great, but the bigger companies say, “Well, we get requests from various charitable organizations, and we have certain demands on our charitable giving. We’re very broad minded, and we have many different constitu-encies.” They end up giving to Planned Parenthood, so we don’t invest in them.

We also screen out companies engaged in pornography—either in the production or distribution of pornographic

that have subsidiaries or divisions engaged in pornography and the hotel companies that show pornographic movies on the TV screens in hotel rooms.

Most of the hotel companies show porn on their screens. It’s an evolving list that changes from time to time. Sometimes companies aren’t offenders, and then they become offenders.

How much of the investment universe is screened out?

Our screens exclude about 150 companies out of the Russell 3000. So it’s about 5% of companies that are off the table. Most of those companies are not great investment opportu-nities anyway. Many of them are bad companies with bad business models that have too much debt or bad manage-ment or have dissolution from stock options, so we wouldn’t want to invest in any of them.

Do you find moral companies are better investments?

Yes, they can be but not necessarily. Just because a com-pany doesn’t support abortion or pornography doesn’t make it a better company. Moral characteristics aside, we want to invest in stocks that can appreciate substantially—in gen-eral, stocks that are well managed and, as I said, have good products and have good business practices.

Valuation is the critical element in our investment deci-sion-making process. The stock has got to be cheap in rela-

book values, and so forth. That’s the critical element.

What’s your screening process?

We buy several commercially available screening services.

The biggest and the best one is SIMON. SIMON is a division of ISS, Institutional Shareholder Services. They’ve accumu-lated a vast database of which companies have made chari-table contributions and a lot of other things. It’s a very broad

what companies have contributed to Planned Parenthood or what drug companies make abortion-related drugs or almost anything we want to know.

Has that research ever been wrong?

A few years ago, one of our screening services reported that

-

never had contributed to Planned Parenthood. So we con-tinued to own that stock. The screening service had made a mistake. Nobody’s perfect.

When we buy a company, I send a personal letter to its CEO and tell them we bought the company and became a shareholder and that they did not violate, by our research, any of these core principles of the Catholic Church and if they ever do so in the future, we’re going to have to sell the stock.

What are some companies you had to sell?

Becton Dickinson was one that we sold. I believe they were making an abortion drug. And eBay and DuPont started con-tributing to Planned Parenthood, so we sold both of them.

Does MRI describe a Catholic-only investment style,

or does it apply also to other faiths?

It applies to anyone who’s faith based or has a moral com-ponent to their way of investing. There’s the Timothy Plan, a Protestant-based family of funds. They are considerably smaller than us, and they also screen out alcohol, tobacco, defense companies, and so forth. I’m sure if you asked them, they’d say they are very morally responsible, so it’s often

Amana Mutual Funds is an Islamic family of funds. The LKCM Aquinas Fund is a Catholic family of funds—consid-erably smaller than us—run by Luther King Capital Man-agement out of Texas. Thrivent Investment Management is Lutheran and substantially larger than us. They have many billions of dollars under investment. We have US$1 billion. [Editor’s note: Nicholas Kaiser, CFA, principal portfolio man-ager of Amana Mutual Funds, was featured in the May/June 2012 issue. An interview with Luther King, CFA, founder of Luther King Capital Management, appeared in November/December 2006. Both articles are available online through www.cfapubs.org.]

What has been the response from your shareholders?

I get letters and phone calls all the time from shareholders who say, “It’s so wonderful, George, that you have these funds.

People say, “Whenever I invested in these other mutual funds, I always wondered if some of the companies in that portfolio supported abortion.” I tell them, “Almost for sure, any of the other funds are invested in some companies that are engaged



in embryonic stem-cell research or support abortion in one way or another.” We’re offering a product designed for what some people might consider a narrow segment of society. Not even all Catholics are pro-life. By some measures, only 50%

people who like what they see invest with us. I think we’ve established a reputation for sticking to our knitting, doing what it is we say we’re going to do.

You’ve written that Catholics as investors tend to share

common characteristics. Can you elaborate?

Our shareholders are decidedly long-term oriented. I call them sticky shareholders. They didn’t bail out in 2008. Some did, but most of our shareholders stayed with us despite the

the bank collapse and so forth. I think our shareholders are more focused than the average mutual fund investor. We have a mixture of individual investors and institutional inves-tors. When people are putting money where their hearts are, in their moral beliefs, or at least in funds that aren’t in con-

asset growth since the bottom of the market in early 2009. Our assets have increased by 27% per year compounded—

We don’t invest in companies just because they make rosaries or because they build houses or because they’re run by a Catholic CEO. A Catholic CEO can be a crook too, or a poor manager or take on too much debt for a company. That happens a fair amount, I’d say—not just with Catho-lic CEOs but among all CEOs.

What’s your investment methodology, aside from screens?

in companies that have an enduring competitive advantage—what Warren Buffett would call an economic moat. These

-

average return on equity, return on total capital. When a

--

dend year after year, and buying back stock when it’s sell-ing below intrinsic value. We love to see that.

You’ve written of Caritas In Veritate as a moral influence

on your work. Can you explain?

I’m no scholar of papal encyclicals, but I did review Pope Benedict XVI’s 2009 encyclical Caritas In Veritate (Charity in Truth). It allowed me to more deeply explore the rela-tionship between wealth and moral purpose, which is at the heart of our morally responsible investing. Pope Bene-dict XVI warned of the dangers that may arise from those

it unbalanced growth. That’s what I’ve always preached to

because they allow you to do so many other good things. They allow you to give to charities as well as other philan-thropic organizations or provide for your family’s education and well-being. So many Catholics, especially older Catho-lics, have this view that money is the root of all evil, which

as long as you don’t make the pursuit of money your god.

What’s the growth potential for MRI?

continue to spread. There are something like 60 million Catholics in the United States. Let’s say 30 million are adults and only 20% of them are serious investors. That gives you 6 million people in the United States who are Catholic adults and serious investors. I think we’re really just scratching the surface among Catholics. Of course, there are other Chris-tians and other folks who are of a similar mindset or have similar values. They’re also potential investors for our fund. I think we have huge potential as an industry.

“Thou shall not steal” is a major moral law. In light of

corporate scandals of the past decade, have you ever

considered a screen for corruption?

-eign corporations’ practices, but I’m told that in many areas of the world, bribing people is just the way you do business. You can’t do business if you don’t bribe some government

Act and certainly a violation of Catholic principles. But how would you monitor that, and how would you measure it?

How does MRI relate to the professional ethics of CFA

Institute?

I’ll answer with a question. Do you know the difference between a business and a profession? Many people say no, they don’t know the difference. The difference is that

business can’t stay in business. The business owner has no

come to buy gas.A profession, on the other hand, does not exist primarily

-tence, but the professional operating in a profession exists to serve. Big difference. You serve as a professional, and

-growth of the profession that I serve in—and I serve our investor clients.

What is the essence of a professional? The essence of a professional is someone who puts his clients’ interests ahead of his own. That’s absolutely paramount to being a profes-sional. Being a charterholder, I take that professional code of ethics very seriously.

Jonathan Barnes is a financial journalist in the San Francisco Bay area.


Member Societies Provide a Bolder VoiceBy Kurt N. Schacht, JD, CFA

A key priority at CFA Institute involves

industry. A major part of that initiative is to continue encouraging our 138 member societies to serve as local spokesper-sons to advocate for ethics, standards, and investor-focused regulatory policy in their respective markets. Think about it—societies potentially play an integral part in CFA Institute advocacy efforts by providing an expansive global deliv-ery function and offering a local practi-

recently hosted several advocacy workshops for lead advo-cacy volunteers in each society. These regional workshops, held in Milan, Bangkok, and Newport Beach, California, gave society advocates the opportunity to strategize, dis-cuss goals, share success stories, and discuss ways to build local advocacy efforts.

As a part of the recent Europe, Middle East, and Africa (EMEA) regional society leader meetings in Milan, CFA Insti-tute sponsored its third annual one-day advocacy workshop for the region. About 50 representatives from 35 societies in the EMEA region shared ideas and learned how to work

markets. Participants expressed concerns over the loss of investor trust and a desire to improve investment adviser behavior, corporate governance practices, and oversight of

-tioners who have adopted the Asset Manager Code of Pro-fessional Conduct or promoted its adoption by investment

are gearing up to have more impact on the regulatory front and to engage with their local policymakers. In 2011, eight EMEA region societies reported undertaking outreach to pol-icymakers, and in 2012, 12 societies worked to build rela-tionships with and provide input to regulators in their local markets. Many more societies are doing industry, media, or university outreach. The recent workshop should result in even greater local outreach on behalf of our members and investors across EMEA.

to further develop their local advocacy efforts. In addition to the 17 advocacy chairs, more than 60 society presidents

in the region joined the workshop to focus on how to improve outreach to their national industry leaders, media

outlets, and policymakers. The workshop focused on build-ing capacity for regulatory outreach on local/regional issues and on industry outreach to promote the Asset Manager Code of Professional Conduct. Those societies with strong advo-cacy committees in place were able to share ideas and best practices with those who are just beginning their efforts.

As ambassadors for CFA Institute and for their own -

ing their capacity over the last two years to speak out on ethics, standards, and policy issues. In 2011, only seven of the societies in the region reported some local activities; in

--

pines have been supplemented by growing levels of activity

the delivery of this, our third regional advocacy workshop, we anticipate continued growth in the number of societies participating as local spokespersons for improving market integrity and in the level of engagement across the region.

During the Americas regional society leader meetings in Newport Beach, about 90 society leaders met to share society success stories and discuss opportunities to promote advo-cacy work. Building collaborative relationships with regula-tors, industry groups, and policymakers and the need to be proactive were cited as ways to ensure successful partner-ships. Participating societies engaged with these groups by writing comment letters in response to the Dodd-Frank Act, holding roundtables on regulatory initiatives, and having regulators attend or participate in society events.

Attendees also demonstrated their ongoing collaboration with other state-based societies on relevant advocacy issues, such as the proposal to extend Ohio’s sales-tax umbrella to cover a broad array of professional services. Breakout ses-sions included building committee and regulatory relation-ships, industry outreach, and media outreach and Global

advocacy workshop not only showcased the success of the region’s advocacy efforts but also generated a discussion on how to build on that momentum. As one advocacy chair said, “There is so much that can be done.”

If you are interested in getting involved in your local CFA

cfainstitute.org/about/locations/Pages/society_directory. Find out more about our advocacy work at www.cfainstitute.org/ethics/integrity.

Kurt N. Schacht, JD, CFA, is managing director of Standards and Financial Market Integrity at CFA Institute.

ETHICS AND STANDARDSMARKET INTEGRITY AND ADVOCACY

Follow the Market Integrity Insights blog: blogs.cfainstitute.org/marketintegrity

Follow us on Twitter: @MarketIntegrity

KEEP GOING



Protecting Investors in Asia

By Padma Venkat, CFA

While regulators are grappling with the dichotomy of regulation versus innova-tion and working to close new gaps in investor protection in the aftermath of the Lehman Brothers mini-bonds deba-cle, the industry continues to churn out products that attempt to skirt regula-tory oversight.

“A lot of products and instruments sold in China to the public are falling through the cracks,” said Anthony Neoh, former chief adviser to the China Secu-rities Regulatory Commission, at the recent Mis-selling of Financial Products: Investor Rights and Protection Forum in Hong Kong, which was co-sponsored by CFA Institute and the Institutional Investor Educational Foundation.

Neoh’s keynote address covered a wide array of topics—ranging from reg-ulating credit-rating agencies to emerg-ing trends leading to a convergence of investor protection across the globe (e.g., the U.S. Dodd–Frank Act, Basel III, and

institutions’ adhering to “Know Your Customer” and suitabil-ity standards. He predicted that China may move to a “twin peak” regulatory system composed of a market conduct reg-ulator and a prudential regulator, which is similar to the regulatory structures in the United Kingdom and Australia. He urged the rest of Asia to follow the Australian model of

-

The forum offered perspectives on how investor rights are currently enforced and how their claims are handled during a panel discussion moderated by Stuart Leckie, chairman of Stirling Finance Limited, and featuring Reuben Guttman, director of Grant & Eisenhofer, P.A., in the United

-furt; Sou Chiam, CEO of the Financial Dispute Resolution Centre, Hong Kong; and Tan Kin Lian, former CEO of NTUC Income, Singapore.

Neoh suggested that product regulation could be achieved through focus-group testing for suitability, whereas Tan rec-

-tors in a process similar to the introduction of new drugs to the market. “This responsibility cannot be left to the retail investors, who do not have the ability to analyze the prod-ucts or access to the information that is needed to make an informed judgment,” Tan stressed.

When things do go wrong, inves-tors in Asia have limited options for recourse, although they have relatively

ago. In Hong Kong, the Financial Dis-

its doors in June 2012 to promote set-tlement of disputes through mediation and, if necessary, arbitration. Although this is a welcome development for inves-tors, the FDRC has a major limitation—it only covers claims from individuals for losses up to HK$500,000. Sou Chiam, CEO of the FDRC and a speaker at the forum, said that she envisions such lim-itations being lifted to cater to a wider

is also prohibited from “naming and

future wrongdoing.Missing in many parts of Asia, includ-

ing Hong Kong, is the ability of inves-

who have bought products domiciled in the United States

that the current trend whereby most class-action lawsuits do not cover criminal liability and are settled for less than the actual losses is sending the wrong message to investors.

“Securities fraud pays,” Reus stated. “It pays because if you as a company issue stocks or bonds and you lie to your investors, out of the $1 billion or $2 billion fraud, you have to pay one-tenth back. What criminal goes into a store, robs it of $100, and when he is caught, he only gives back $10? This shows the lack of criminal enforcement.”

Moreover, the lack of class-action lawsuits deters investors

legal action is costly. That situation is in stark contrast to

Whether wider regulatory oversight, class-action suits, -

ing to Guttman, the best deterrent to wrongdoing is trans-parency. When everyone knows what happened, who did it, and what penalties are involved, potential wrongdoers

levied on banks.“What you hope in this case is that resolution is transpar-

ent, the wrongdoing is transparent, that there is a record

At a recent joint CFA Institute–Institutional Inves-

tor Educational Foundation event in Hong Kong,

Anthony Neoh, former chief adviser to the China

Securities Regulatory Commission, discussed the

development of industry regulation and investor

remedies in China and Hong Kong.


out there, and that record then drives the regulators to do something, drives the press into oversight, and puts the investment community on notice that the next time they buy a horse, they should check the horse’s teeth,” said Gutt-

The common theme among all the speakers was the need

institutions. The goal of CFA Institute, as co-sponsor of the forum, was to facilitate debate and discussion on a key topic in order to help shape an investment industry that serves the greater good.

-

associations.To access the audio podcast and video webcast of this

event, visit https://bitly.com/investorrights.

Padma Venkat, CFA, is director of Capital Markets Policy at CFA Institute.

Navigating the Gray Areas of Ethical BehaviorEthical behavior is about more than simply following the rules—it’s also about carefully considering issues and taking the appropriate path forward.

In a recent interview with CFA Institute Magazine

Development and Education at CFA Institute, discussed a new online, interactive training resource that helps prepare practitioners for the daily challenges of ethical decision making in the investment industry. Offered in webinar format, the case-

for continuing education (CE) credit.

Who is a good candidate for the online ethical

decision-making training?

This training is geared toward any investment profes-sional who wants to increase his or her awareness and appreciation for ethical issues that are a normal and pre-

before they become unmanageable or destructive. The training will help pro-fessionals become more conscious of their thoughts and actions by utilizing a decision-making framework to facili-tate analysis of ethical matters and lead to appropriate decisions and conduct.

What are the advantages of using a case-based

approach?

and circumstances that investment professionals may face

these scenarios will give participants practice applying the ethical-decision-making framework to identify, analyze, and

real-world subjects. Cases allow participants to apply theo-retical principles to actual practice.

What are the benefits for the training participants

and their firms?

fundamental ethical principles applicable to investment pro-fessionals and how to make those principles a key factor in everyday decision making and action. Trust is a critical element in the investment services arena. Clients highly value investment professionals they can trust, and invest-ment professionals, in turn, can gain client trust by demon-strating honesty, integrity, and ethical behavior. By taking such steps as adopting a vigorous code of ethics—such as the CFA Institute Asset Manager Code of Professional Con-

duct—and training personnel on eth-ical decision making, firms demon-strate to clients their commitment to these values and enhance their repu-tation among investors.

For more information on ethics training, visit www.cfainstitute.org/decisions or e-mail [email protected].

KEEP GOING

Jon Stokes

A recent joint CFA Institute–Institutional Investor Educational Foundation

event in Hong Kong featured a panel discussion on the rights and protection

of Asian investors. Pictured left to right: Moderator Stuart Leckie, chairman of

Stirling Finance Limited, Hong Kong; Sou Chiam, CEO of the Financial Dispute

Resolution Centre, Hong Kong; Reuben Guttman, director of Grant & Eisenhofer,

P.A., Washington, DC; Alexander Reus, founding partner of DRRT, Frankfurt; and

Tan Kin Lian, founder and director of Tan Kin Lian & Associates and former CEO

of NTUC Income, Singapore.

VISIT CFAINSTITUTE.ORG/CLARITAS TO LEARN MORE



SME Financing and Investors’ Needs

By Claire Fargeot and James Allen, CFA

-

hard as the credit crunch dried up traditional sources of funding. Now, policymakers on both sides of the Atlantic

-nomic growth—to shake off the economic malaise that has

exchanges in Europe and reduced regulatory and report-

But as policymakers take action to improve access to

including transparency and other protections.In a recent European Central Bank (ECB) survey, access

--

ers). According to the ECB survey, the supply of bank loans,

facing tougher capital and liquidity standards that explic-itly encourage sovereign and mortgage lending and discour-

to come. Against this backdrop, it is not surprising that pol-icymakers are focusing on the ability of equity capital mar-

Indeed, at a joint CFA Institute—Federation of European -

sioner Michel Barnier spoke on long-term investment as part of one of the last initiatives under his tenure as commis-

has been the target of major reform, and there is no ques-tion that the EU economy is in need of measures to boost economic growth and encourage more long-term sustain-able investment. These measures are expected to focus on

for innovation-led sustainable projects and activities.Although the investment industry is expected to provide

-sary to carefully consider the barriers to attracting inves-

A recent pan-European CFA Institute member poll asked respondents for their views on this issue as well as on any

encourage economic recovery. The results point to a clear

both tackling existing barriers and encouraging alterna-tive sources of funding. The survey’s results included the following:

• to access funding—such as specialized funding or pro-portionate listing and disclosure requirements—as having mixed success.

•

--

cial disclosure.

• To come up with the right mix of policy measures and incentives, a multidimensional approach is needed. Provid-

capital adequacy requirements for banks would facilitate

of European social entrepreneurship funds and mentor-ing programs, and the further development of European

-

allows smaller companies to raise capital via crowd-funding -

capital markets for long-term funding is gaining momen-tum. In many cases, however, these efforts are attempting to unwind rules adopted in response to the reporting prob-lems of many small, start-up companies in the late 1990s.

To help CFA Institute and regulators better understand

markets, CFA Institute commissioned a report on the topic: Exchanges and Their Investors: A New Look at Reporting Issues, Fraud, and Other Problems by Exchange. It considers how fre-quently companies listed on venture exchanges have report-ing problems, fraud, and other issues when compared with companies listed on more-established securities exchanges. The report’s authors—Douglas Cumming, CFA, professor

Fellow with the Tilburg Law and Economics Center at Til-burg University—reviewed reports of fraud, mis-reporting

The authors note that exchanges “are thought of as the


found was that differences in listing standards at exchanges

that are likely to negatively affect shareowner value. In par-

insiders or by external investors. (Please note that involve-

actual fraud.)

OTC Markets Group) were involved in fraud litigation cases.The authors concluded that the lower listing standards at

The authors found that the litigation of fraud cases was generally lower—much lower in some cases—in other mar-

-parity is partly a result of two primary factors. First, liti-

the lower numbers of fraud cases in Canada and the United

other mitigating factors were likely at play, as well. In par-

Venture Exchange were involved in litigated fraud cases. The authors also stated that a “large proportion” of litigated

involved illegal distributions or fraudulent manipulation of

-panies) were involved in litigated fraud cases. The authors state that a “large proportion” of litigated fraud cases in the

cases, involve illegal distributions or fraudulent manipula-tion of investor accounts (2 percent of listed companies). A possible reason for the low level of fraud at AIM-listed companies is the requirement that such companies have a nominated adviser (“NOMAD”), or a designated broker, to obtain a listing and act as a “front-line intermediary.” Even though the Neuer Markt, the shuttered junior exchange in

four fraud cases were litigated. China reported fraud liti-

In response, the authors called for greater transparency requirements for exchanges not only on the individual cases of

mis-reporting or fraud by listed com-panies, but also on aggregate data and disclosures about the number of cases brought against listed com-panies. The point is to ensure that investors are able to understand the risks associated with investing in dif-ferent markets.

afforded access to capital markets to fund their growth and development, but they should provide investors with the transparency and quality of information required for informed decisions and appropriate investor protections.

To achieve this balance, we

annually and include the auditor’s report in an annual report to share-

-

company news through normal public distribution channels. Company principals should be liable for fraudulent represen-

company announcements delivered through these channels. The shares of such companies should trade on exchanges or trading platforms dedicated to companies that take advan-tage of the limited reporting options to ensure investors are aware that such companies do not have to adhere to the same transparency and governance requirements as are required of traditionally listed companies.

The venture exchange report is available at http://bit.ly/ventureexchange.

Claire Fargeot is head of Standards and Financial Market Integrity of CFA Institute for Europe, Middle East, and Africa, and James Allen, CFA, is head of Capital Markets Policy at CFA Institute.

How successful, if at all, do you think the following initiatives have been

at gaining investment in SMEs? (pan-European CFA Institute member poll)

1 (Not at all successful) 2 3 4 5 (Very successful) Don’t know

Specialized Funding Vehicles

46% 39% 28% 14%

Specialized SME Markets Paid-for Sell-side ResearchProportionate Listing and

Disclosure Requirements

3%5%

4%

13%11%

14% 14%

23%25%

28% 28%

20%

30% 30%

24%

12%

16%

9%

4%2%

17% 17%

26%25%

Refresh your investment vision. With a powerful assembly of speak-ers and experts covering a comprehensive range of investment analysis and portfolio management topics, there is no better chance to enhance your practical skills than the 2013 Financial Analysts Seminar.

For more than five decades, analysts from all around the world have come to this intensive event in Chicago to immerse themselves in the latest investment ideas and tools.

FEATURED SPEAKERSMARC FABER Managing Director at Marc Faber Limited Editor, The Gloom Boom & Doom Report

VIKRAM MANSHARAMANI Lecturer, Yale University Author of BOOMBUSTOLOGY: Spotting Financial Bubbles before They Burst

MAUREEN O’HARA Robert W. Purcell Professor of Finance at the Johnson Graduate School of Management at Cornell University Author of Market Microstructure Theory

FEESConference Fee US$3,495 CFA Institute Member/Candidate Rate US$2,995 CIPM Member/Candidate Rate US$2,995

FINANCIAL ANALYSTS SEMINARImproving the Investment Decision-Making Process

22–25 July 2013 Chicago, Illinois United States Hosted with CFA Society Chicago

Learn more and apply now: www.cfainstitute.org/events

DISCIPLINARY NOTICES

SUMMARY SUSPENSION

On 14 February 2013, the Professional Conduct Program rescinded its Notice of Summary Suspension and reversed the Revocation of membership previously imposed on Grenville M. Gooder, Jr., CFA (U.S.), because he agreed to cooperate with the Professional Conduct Program’s investigation.

PRIVATE REPRIMAND

On 14 January 2013, the CFA Institute Designated Officer imposed a Private Reprimand on a Charter-holder Member. The Designated Officer found that the Member violated Standards I(A) – Knowledge of the Law, I(D) – Misconduct, and IV(A) – Loyalty of the CFA Institute Code of Ethics and Standards of Professional Conduct (2010).

In 2011, after an adversarial administrative hear-ing in his local jurisdiction, a governmental authority found that the Member made multiple unsolicited and unwanted sexual comments towards female coworkers, leered at his female coworkers, and made inappropriate comments about the appearance of his female coworkers, all in violation of both the policies of his employer and of local law. The Member received a formal notice of adverse action from his employer and was censured by his employer’s Board of Direc-tors for his misconduct.

On 14 January 2013, the CFA Institute Designated Officer imposed a Private Reprimand on a

Charterholder Member. The Designated Officer found that the Member violated Standards I(A) – Knowledge of the Law, IV(A) – Loyalty, V(B)(2) – Communications with Clients and Prospective Clients, V(C) – Record Retention, and VI(A) – Disclosure of Conflicts of the CFA Institute Code of Ethics and Standards of Professional Conduct (2005).

Specifically, the Designated Officer found that the Member recommended that his clients invest in a company whose shares were thinly traded. When the company failed to perform as the Member had expected, he decided to act as counterparty and repurchase his clients’ shares at their purchase price. The Member, however, lacked written discretionary authority to trade in his clients’ accounts and failed to inform them of his plan to repurchase their shares. In addition, although he initially sought his firm’s advice about the proposed transaction, he purchased the shares despite his firm’s admonishment to wait until legal and compliance personnel had considered the issue. Upon learning of the Member’s purchase, his firm conducted an investigation into his conduct and fined him $5,000, based in part on the fact that no clients were injured and that the Member had cooperated fully in the investigation and did not profit from the transaction.

On 4 February 2013, the CFA Institute Designated Offi-cer imposed a Private Reprimand on a Charterholder Member. The Designated Officer found that

the Member violated Standards I(A) – Knowledge of the Law and IV(A) – Loyalty of the CFA Institute Code of Ethics and Standards of Professional Conduct (2005).

Specifically, the Member, a portfolio manager for an SEC-registered investment advisory firm, resigned from his employer and contrary to the terms of his Non-Competition and Confidentiality Agreement, provided his new employer with his client list from his previous firm. The Member’s new employer then used the client list to solicit clients from his previous firm, also in violation of the terms of the charterholder member’s Non-Competition and Confidentiality Agreement.

On 7 February 2013, the CFA Institute Designated Officer imposed a Private Reprimand on a Charterholder Member. The Designated Officer found that the Member violated Standards I(A) – Knowledge of the Law and IV(A) – Loyalty of the CFA Institute Code of Ethics and Standards of Professional Conduct (2005).

Specifically, the Designated Officer found that the Member solicited two of his former employer’s employees prior to his resignation on behalf of a company the Member had formed. The Member used his former employer’s confidential information to assist him in estimating how much one of the employees would make if the employee went to the Member’s new company.

ETHICS AND STANDARDSPROFESSIONAL CONDUCT


Need guidance in applying the Code and Standards? Contact Standards and Financial Market Integrity at [email protected].

Aware of potential violations of the Code and Standards by a member or candidate?

Contact [email protected].

As required by the CFA Institute Bylaws, each year mem-bers self-disclose complaints, lawsuits, and other profes-sional conduct matters on their Professional Conduct State-

opened more than 250 industry cases based on self-disclo-sures. Self-disclosure is an important part of the PCP and a hallmark of CFA Institute members’ dedication to ethics. Self-disclosure is not, however, the only source of PCP cases. The program opens some cases based on its own research and discovery.

CFA Institute looks into each matter, but most do not involve conduct that violates the Code of Ethics and Stan-dards of Professional Conduct.

The number of industry cases and ultimately the number of sanctions imposed, remain a small percentage of the membership. The chart illustrates the number and range of sanctions from private reprimand to summary suspen-sion imposed since 2009.1

1 A summary suspension automatically becomes a revocation of CFA Institute membership and/or prohibition from participation in the CFA Program within 30 days unless the member/candidate requests a review.

Self-Disclosure and Disciplinary Cases

40

35

30

25

20

15

10

5

0

2009 2010 2011 2012 1Q 2013

Number of Sanctions Imposed

Summary Suspension

Prohibition from Participation in CFA Program

Revocation of Right to use the CFA Designation/Membership/CFA Program

Timed Suspension of Right to use the CFA Designation/Membership/CFA Program

Censure

Private Reprimand

INVESTMENT MANAGEMENT WORKSHOPIMW offered by CFA Institute and Harvard Business School Executive Education

8–12 July 2013 Harvard Business School Boston, MassachusettsUnited States

Since its inception in 1968, the IMW has provided a forum for more than 3,500 participants to share broad-ranging insights and investigate cutting-edge strategies for balancing risk and return.

This year’s workshop explores such topics as:• How changing macroeconomic risks affect

asset allocation• The factors that influence investment performance• Managing risk in a portfolio — and a business• Investment management products and services

in the global marketplace• Future prospects for private equity and hedge funds

• Compensation policy for investment firms and professionals

• Seeking alpha in today’s economic environment• Designing an effective investment management

organization• Liquidity management in uncertain times

Enrollment in the IMW is limited to a select group of mid-level to senior executives who have significant involvement in investment decision making and business operations.

Learn more and apply now: www.cfainstitute.org/execedQuestions? Contact us at [email protected]

CFA Institute Member/Candidate Rate: US$7,500

The registration fee includes workshop tuition, course materials, on-campus accommodations, and meals.


CHAPTER 10

Tails, You LoseWHY DO PEOPLE PLAY GAMES WITH AN INFINITELY NEGATIVE EXPECTED VALUE?

By Ralph Wanger, CFA

invented by a great mathematician to make a philosophic point.

the player has to put up an agreed-on amount of chips in return for a proba-bilistic payoff. The player gets to toss a

he wins an amount of chips as follows:

tosses tails, the game terminates and the player gets the amount of chips that was in the previous pot. (For math

-nation of the game details.)

very large payoff with a very low prob-ability, it is obvious that this is a game with large “tail risk” for the house. Expected value of the game to the house

so no rational casino should operate -

dence that this game is in fact played rather frequently by rational humans, some of whom you know.

If the price to play the game were 128

any time the player’s run of heads was seven in a row or less. If the game was set up to play rather slowly (say, one

game for the house for enough years that the promoter of the game would be retired before the scheme blew up.

thought, “One could make a successful

living for quite a number of years, and in the unlikely event that the scheme should fail before you have cashed out, you still can write an artful letter of apology to your limited partners and close the fund.

The one entity that should not spon-sor this game would be a fund with an

becomes inevitable. Therefore, govern-ment should never think of doing such

rather popular. For instance, the state of Florida has issued hurricane insur-ance for a premium that every observer knows is way too low. Everyone expects that Florida will be struck by a very destructive hurricane before long, and the state insurance fund will be insuf-

the damage claims. I suppose the politi-cians who are unlucky enough to be in charge when that dire hurricane arrives will explain that “the event could not possibly have been predicted.”

A similar scheme has been used by the federal government for issuing mortgage guarantees to the Ameri-

through FNMA (Fannie Mae) and FMAC (Freddie Mac). In 2008, 11 wazillion mortgages went bad, and it cost the government a trillion dollars or so.

Proprietary trading desks invent

year, some trader takes a big position that goes against him and costs his

-

The rationalization seems to be that successful traders have unique skills that would be unusable if their trades

were impeded by a burdensome level of compliance. The managements of these banks are happy to book the sub-

-prietary desk. Then the player tosses 10 straight heads, and it is a disaster for the desk. The trader is immediately called a “rogue trader” when a manage-ment investigation determines that all sorts of rules were broken, but this is just one more example of getting nailed by a run of bad luck that was going to occur sooner or later.

holding in Mortgage Guarantee Insur-ance. My boss asked me to do a risk analysis of that business. I soon came up with an answer. I told him, “The busi-ness has no small risks. Earnings will

there is a severe recession, at which point the company will go bankrupt.” That is precisely what occurred. For an analyst, it is very hard to put an accu-

end, but you must remember that at some time the end must come.Ralph Wanger, CFA, is a trustee of Columbia Acorn Trust.

“THE EVENT COULD NOT POSSIBLY HAVE BEEN PREDICTED.”

www.edhec.edu LILLE - NICE - PARIS - LONDON - SINGAPORE

“I DID IT”Matthew set himself an objective: to join a leading part-time programme in Risk & Investment Management.He was admitted to EDHEC. He achieved his goal.

The MSc in Risk & Investment Management is offered in a part-time format on EDHEC campuses

programme focuses on asset allocation and risk management.

Documents

May/June 2013 - s3-ap-southeast-1. · PDF fileThe story of Edmond Dantès ends here: plunging toward oblivion. Betrayed out of jealousy, condemned by political entan- ... pursues a