< The Finance Professionals' Post: April 2010

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28 posts from April 2010


New Member Benefit: Invitation to Institutional Investor Journals

Institutional Investor JournalsNYSSA has partnered with Institutional Investor Journals to offer its members a special 25% savings on subscriptions to any of its nine journals. Institutional Investor Journals offer in-depth, original, and practical research in investment management and finance. Written and edited by world-renowned practitioners and academics, the journals are extensively read and highly regarded in the industry.

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GIPS 2010: Major Changes to Global Standards Concern Investors

GIPS® (Global Investment Performance Standards) are about to undergo their second major revision since they were introduced in 1999. Because the standards are widely accepted, it’s critical for investment professionals to familiarize themselves with the changes that are in the works.

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Current Major Differences Between IFRS and US GAAP

At last year's meeting in Pittsburgh, Pennsylvania, representatives of the G-20 renewed their commitment to complete convergence in accounting standards by June 2011—less than two years away. While the group did not explicitly propose worldwide adoption of IFRS (International Financial Reporting Standards), that is the implication, because it hardly seems likely that the rest of the world will drop IFRS in favor of GAAP (US Generally Accepted Accounting Principles). The following table offers a side-by-side comparison of the two standards. 

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SEC in a Quandry over Its Push for IFRS

Illustration by Mark Andresen The seemingly unstoppable juggernaut of US IFRS (International Financial Reporting Standards) adoption has collided with the global financial crisis, one of the few barriers that may be capable of derailing the rush to a single international accounting standard. Adoption of IFRS in the US is now far from a given, and even the roadmap published by the US SEC (Securities and Exchange Commission) in November 2008 has the potential to be sidetracked or possibly abandoned now that President Obama’s administration has taken office.

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Deriving a Forward-Looking Equity Market Risk Premium

It is always better to use a forward-looking value that reflects the current market conditions. But the standard methods for calculating equity risk premiums rely on historical estimates—and therefore are backward looking. These approaches produce a type of average that may not reflect expectations of future returns at a particular moment in time (e.g., when volatility is high). This article describes a method of estimating a forward-looking equity risk premium based on prospective market multiples—in particular, the ratio of enterprise value to EBIT (earnings before interest and taxes). The example below is only an illustration, because forecasts are outdated by the time they make it to press. The numbers are based loosely on estimates from around mid-2009.

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Some Mark-to-Market Concerns about Liquidity

This article is in response to Neil O'Hara's "The Unfair Attack on Fair-Value Accounting."

In early April of 2009, FAS 157, the mark-to-market accounting statement, was amended amid great controversy. Depending on the categorization of an asset (as belonging to one of three “levels”), FAS 157 had required firms to value financial assets on a mark-to-market basis. Level three assets such as mortgage-backed securities and collateralized debt obligations were subject to this requirement, even though, unlike traded securities, they did not benefit from liquid markets. The new rule gives firms greater discretion as to how level three assets are valued, and allows them to take into consideration the illiquid market for these securities.

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The Unfair Attack on Fair-Value Accounting

Illustration by Mark Andresen The blame game for the financial crisis has no limits. In an effort to divert attention from their own culpability, bankers who took risks they did not understand and politicians who encouraged mortgage lending to people with shaky credit have pointed the finger at the accountants. Banks faced with severe losses on their structured debt portfolios and other securities pressed regulators to suspend accounting policies that oblige the banks to record these holdings at fair value, which usually means the current market price.

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The CFTC Should Sit on Their Hands

There are several things that the Commodity Futures Trading Commission (CFTC) will be considering as they convene hearings. Hopefully they will hear well-researched, and well-thought-out opinions, unlike that of Michael Masters—whose testimony was slammed equally by the left and the right, by the likes of Nobel Laureate Paul Krugman and commodity trader Jim Rogers. Among the issues that the CFTC is looking at are transparency in the markets and the position reporting limits where there are not currently any Federal guidelines. A third issue is the stratification of the COT—the commitment of traders—which characterizes how the market participants are biased in the marketplace. Ultimately, these make for good talking points, but regulation in these areas will not stamp out speculation nor insure Americans against high commodity prices.

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Developing Business Models to Address Climate Change

The writing is on the wall. The economic order that treats the consequences of manmade carbon emissions as an external cost of doing business is about to suffer an abrupt demise.

The scientific community is nearing consensus on the need to reduce carbon and other atmospheric greenhouse gases by about 80% relative to 2000 levels before the year 2050, if a global climate catastrophe is to be avoided. Policy and market makers around the world are responding with an array of cap-and-trade systems, clean-energy subsidies, and fossil-fuel taxes that will eventually embed a carbon price into the operating margins and cost of capital of practically every company on earth. The skyrocketing price of fossil fuels is only adding momentum to this unstoppable decarbonization trend.

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Calculating the Risks of Impending Water Shortages

World Water UsageWater is taking center stage alongside the emission of carbon as the preeminent environmental risk facing the planet in the twenty-first century. And, in a manner similar to its early response to carbon risk, the private sector has begun to prepare for an era of stricter regulation and rationing of what is perhaps the earth’s most precious finite resource.

The media has recently focused on water scarcity primarily from a climate-change perspective. Glacial melting—which Achim Steiner, executive director of the UNEP (United Nations Environment Programme), has called “the canary in the coal mine”—is reportedly depleting the freshwater supply of vast regions of Asia and South America. 

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An Update on Changes to Financial Statements

Michael Moran, of Goldman Sachs’s Global Markets Institute, kicked off January’s “Changes to 2009 Financial Statements” (an event sponsored by NYSSA’s Improved Corporate Reporting Committee), and he could not have given us a more timely presentation on accounting for transfers of financial assets if he had read an advance copy of the Valukas Report on Lehman Brothers. 

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Cluster Analysis as a Funds of Hedge Funds Portfolio Tool

Constructing a diversified portfolio of managers in a fund of funds requires a method for determining how the different exposures complement each other. We show how cluster analysis can be an important tool in this process, especially during a period of market turmoil. Cluster analysis complements the qualitative assessment of a manager’s style and can be used to develop a view of changing markets and manager responses to these changes.

Figure 1: Cluster Analysis Results


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Fiduciaries Can Save the Earth

Earth Day is as good occasion as any to celebrate the many positive influences sustainable investing has had on mainstream investing practices. Sustainable investing addresses the flawed assumption of traditional investment models that financial capital can be deployed endlessly without reference to the limits of the earth’s regenerative capacities. Sustainable investing is consequently creating profound shifts in the way we think about “wealth,” forcing us to question our obsession with short-term results, and stimulating research into new metrics for defining and measuring the value of our investments. But perhaps the most far-reaching impacts on the real world of investing will be felt as the principles of sustainable investing cause fiduciaries to radically rethink their responsibilities to those whose assets they hold in trust.

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What Is Your Level of Customer/Client Service?

One of the companies that has been the most successful at marketing its products and providing the highest level of customer service is the supermarket chain Stew Leonard’s (aka “the world’s largest dairy store”). Stew’s mantra is etched in stone at the entrance to each of his stores. It states, “Rule #1 – The customer is always right. Rule #2 – If the customer is ever wrong, reread rule #1.” I wonder how many of you agree that the customer is always right. How many feel that sometimes the customer should be informed that he or she is not right and the reason why?

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The Sustainability Education Gap

More than 570 asset owners and investment managers who control more than $18 trillion in global assets have signed on to the UN’s Principles for Responsible Investment (UNPRI). The magnitude of these numbers indicates that sustainable and socially responsible investing has achieved mainstream status. At the same time, the news that the UNPRI expelled five signatories for failure to issue annual reports detailing their progress in implementing the group’s sustainability guidelines suggests a lack of serious commitment to the charter’s principles. These compliance failures may also be attributable to a short supply of investment professionals with the requisite skills to meaningfully assess the complex spectrum of environmental, social, and governance risk factors that must be monitored under the PRI initiative.

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Book Review: The New World of Wireless

The New World of Wireless4G is the fourth generation of cellular wireless standards. It is viewed by Scott Snyder, author of The New Worlds of Wireless, as a disruptive technology that will change the business models of many industries. Few companies, he concludes, have yet to understand the implications.  This book is a systematic analytical guide for what the author sees as a far-reaching technological and organizational revolution. 

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Book Review: Animal Spirits

Animal SpiritsIn classic theory, homo economicus is a rational being who seeks to obtain the highest possible order for himself, who optimizes information, opportunities, and constraints. But George Akerlof and Robert Shiller, the authors of Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism (Princeton University Press, 2009), believe no such creature exists. Rationality, they say, limits the dimensions of inquiry, and isn’t the only tool we have. They argue that noneconomic methods are needed to reveal how real estate and the stock market can come to describe roller coaster drops and loop-the-loops, and, for example, how index averages could be halved in little more than a year. 

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The Corporate Restructuring Techniques of Private-Equity Firms and the Case of Crown, Cork & Seal

Casestudy-connellyThe recent success of PE (private equity) firms has attracted a great deal of media attention. PE firms restructure corporations, implementing a hands-on management style that focuses directly on increasing firm value. Popular thin king has it that PE techniques are not possible in a public firm, due to the incentives imbedded in the ownership structure. However, the techniques used by PE firms are nothing new, and they certainly can function in a public firm. As long ago as the late 1950s, Crown, Cork & Seal implemented a radical restructuring along proto-PE lines.

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The G-20 Agenda for Regulatory Reform

Meeting behind impressive security barricades in a revitalized Pittsburgh, Pennsylvania, representatives of the G-20 (Group of 20) nations announced agreements in principal on a number of fronts, including financial services regulation, stimulus efforts, global trade, reallocation of IMF (International Monetary Fund) shares, and rebalancing national economies. The group affirmed its new standing as the global economic forum of record, formally eclipsing the G-7 (Group of 7) and the G-8 (Group of 8).

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Privilege of Peerage: The Value of Professional Designations

If it seems like an increasing number of people in the investment community have an acronym or two after their names, it’s true—more people are earning professional designations and certifications than ever before. There are already too many designations to keep track of—at least 100, by some estimates—but their popularity continues to grow. It’s fair to ask whether a few letters after your name can really make a difference in your career prospects, especially in today’s tough job market. But top-level professionals across a broad spectrum of financial sectors answer that question with an unequivocal yes.

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Moving Toward a Steady-State Economy

Illustration by Mark AndresenWhen he resigned his post as a senior economist with the World Bank in January 1994, Herman Daly delivered a farewell speech to his colleagues in the style of the Dutch uncle. Prescribing “a few remedies for the Bank’s middle-aged infirmities,” he spoke of the bank’s “unrealistic vision of development as the generalization of northern overconsumption to the rapidly multiplying masses of the south.” He warned that the depletion of natural capital could no longer be left out of the economic equation. It was time, he said, to assign a monetary value to the negative environmental impacts of throughput and to factor them in as opportunity costs of production.

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Book Review: A Failure of Capitalism

A Failure of Capitalism Most call it simply “the crisis.” Richard Posner calls it a depression. When it comes to analyzing the factors behind it, he objects strongly to the addiction—common among journalists, politicians, economists, and ideologues and populists of every stripe—to finger-pointing, name-calling, and partisan sniping. At the same time, he rejects Wall Street’s claims of helpless innocence, its contention that no one could possibly have known what was coming, its grumblings of hindsight being 20–20. Posner cites economists and journalists whose foresight needed no spectacles, whose warnings covered everything from the housing bubble, to low savings rates, to deregulation, to risky new instruments. Despite some major shortcomings, A Failure of Capitalism (Harvard University Press, 2009) will be of use to anyone who’s still looking for an overview of the meltdown. And those weary of populist, partisan accounts will find Posner’s no-nonsense, jargon-free engagement with tangible issues refreshing.

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Creating a Z-Score Calculator on Your PDA

Edward I. Altman’s z-score for predicting bankruptcy, introduced in 1968, was the precursor of credit-scoring models. Its application has since expanded to measure more than the publicly traded manufacturing companies investigated in Altman’s original paper. Using the following template—based on a paper by Arnold and Earl (2006)—you will be able to create a z-score calculator for your PDA. (In this case, we used an HP iPAQ PDA with Windows Mobile). While PDAs cannot take advantage of some of the Excel capabilities available on a PC, the Windows Mobile environment is functional enough to create a z-score template.

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Book Review: The Only Guide to Alternative Investments You’ll Ever Need

The Only Guide to Alternative Investments You'll Ever NeedIn the classic approach to portfolio construction, just three types of assets suffice to fulfill all investment objectives. Common stocks produce long-run capital gains that are taxed at comparatively favorable rates, while also constituting a hedge against inflation. Bonds serve as a bulwark against recession and they come in tax-preferred varieties. Liquidity needs can be satisfied with ultra-safe money-market instruments such as Treasury bills. By utilizing these building blocks in proper proportions, individuals can position themselves as desired along the risk-versus-reward continuum.

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A New Approach to Equity Investing

FTSEFTSE has partnered with Westpeak Global Advisors to launch a new equity style index offering. The new FTSE ActiveBeta Index Series is based on research from Westpeak identifying that momentum and value—two widely used approaches to active management—are, in fact, systematic sources of returns and should therefore be viewed as additional forms of beta (or market) returns, or ‘active betas’. The research also provides evidence of the counter-cyclical nature of momentum and value returns, which implies that the combined capture of momentum and value should provide superior risk-adjusted performance compared to the capture of either momentum or value alone.

Click here to read the white paper.


Outsiders and Outperformers: Women in Fund Management

The gender gap is a wide one in the world of investment management. Women manage only 3% of the assets in the $1.9 trillion dollar hedge fund industry, and only 10% of mutual fund managers are women (NCRW 2009). While the number of female CFA® charterholders has risen in absolute numbers from 5,719 in 2000 to 15,992 in 2009, the percentage of charterholders who are women has hardly budged—from 18% to 19%—over that period, according to the CFA Institute.

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Human Collateral: How to Keep Unemployment from Sinking Your Marriage

eFinancialCareersDivorce rates during the past recession fell slightly. Experts attribute this to the fact that a) divorce is cost-prohibitive during down times, and b) tough economies bring people closer to their loved ones and core values. But there's little doubt that a lack of funds hurts matters at home.

Emma Johnson, a columnist for eFinancialCareers, examines the impact that strained finances can have on a marriage in this article


The Seven Deadly Frictions of Subprime Mortgage Credit Securitization

The securitization of mortgage loans is a complex process that involves a number of different players. Figure 1 provides an overview of the players, their responsibilities, the important frictions that exist between the players, and the mechanisms used to mitigate these frictions. An overarching friction which plagues every step in the process is asymmetric information: usually one party has more information about the asset than another. Understanding these frictions and evaluating the options for allaying them is essential to understanding how the securitization of subprime loans can go awry. (For a more extended description of some of these frictions, see “Securitisation: When It Goes Wrong …” in the September 20, 2007, Economist.)

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