The Finance Professionals' Post

How Should I Study for the CFA Exam?

"How should I study for the CFA exams?"

-Anonymous

In my previous article, “When Should I Start Studying for the CFA® Exam?”, I outlined how a candidate should prepare for the CFA Level I, II, or III exams in June and the CFA Level I exam in December.

The most important point I raised in Part I is that you should have finished reading the curriculum readings and/or your prep provider’s materials by April 15th if studying for the June exam and October 15th if studying for the December exam.

This second article will help you understand what you should be doing from April 15th until the June exam day or from October 15th until the December exam day. If you have completed the CFAI curriculum readings or the prep provider’s materials by April 15th or October 15th, it is not time to kick back and relax. In my opinion, you have only completed 50% of the work if you are a Level I candidate, 40% of the work if you are a Level II candidate, and only 30% of the work if you are a Level III candidate that is needed to be prepared for the exam.

My CFA Experience: Vy Bui

No matter how prepared we are, we all tend to be nervous and worry a lot as the CFA exam day gets closer and closer. I remember a week before the exam; I was so stressed out from thinking that I didn’t have enough time to review all the material and about all the other things that could go wrong on exam day that I ended up getting sick. Being sick is never good and especially then, because that was the time I needed my energy and focus the most.

Even though I tried to go to bed early the night before the exam, somehow I couldn’t sleep. I slept about five hours and woke up at 5:30 a.m. That morning I did some exercise, stretched my body, and had a nutritious breakfast which helped me feel fresher after a night of little sleep. Many candidates I talked to had the same sort of experience. I think it's just because we worried too much about the exam.

Regaining Investor Confidence for US-Listed Chinese Companies

A number of high profile scandals such as Longtop Financial Technologies and Sino-Forest have given Chinese companies a bad name among US investors. Portfolio managers who previously held extensive investments in US-listed Chinese equities now avoid the sector and some of the previously largest underwriters of US-listed Chinese equities have exited this market.

Between 2006 and 2010, a total of 339 Chinese companies listed on the major US stock markets, 106 on NYSE and 233 on NASDAQ. During this period of high interest in investing in Chinese companies, few anticipated the coming scandals and delistings.

My CFA Experience: Colin Mansfield

In retrospect, my CFA experience was one I wouldn’t have any other way. If asked while submerged for months in studying I certainly would have had a different answer. I experienced diverse circumstances for each of the exams; grasping Level I while a senior in college, scraping by Level II while working full time, and concentrating on Level III while unemployed. I was charged with having to overcome many challenges throughout the program which never allowed me to settle for a study routine that I found comfortable. However, I was compelled to make it all worthwhile, and passed all three exams on the first attempt. I consider this a product of rigorous study habits, motivation and some luck when it came to the actual material on each exam. I was relieved to find questions about the topics I knew well which, for many, can be the difference between success and failure.

The Wisdom of Melville

"If your banker breaks, you snap." - Herman Melville, Moby Dick

One thousand miles into the journey, about a third of the way to England, we were struck by a humpback whale, destroying our rudder and leaving us floundering on the Atlantic.

Having read Synchronicity by Leon Jaworski, and seen this Jungian idea play out in my own life, I am a firm believer in the important hidden meaning of seemingly coincidental events, whch suggests there are no coincidences. Yet for 10 years now, I’ve been unable to connect the dots between my work on the imperative to transform economic and financial systems and the unlikely circumstance for me to decide to attempt an Atlantic crossing (I’m generally a small boat sailor), to pick up the daunting Moby Dick (I generally read non-fiction), and for us then to get slammed by a great whale.

I can now thank Carla Seaquist for showing me the meaning of this coincidence. In her insightful essay “Wall Street: Brush up your Melville”, she compares Jon Corzine (and implicitly all “Captains of Wall Street”) to Captain Ahab, although her treatment of them is far gentler than one might expect in the circumstances.

Reflections on the FMA Annual Meeting

Myron Scholes Credit: Wikimedia Commons

In October, I attended the annual meeting of the Financial Management Association International in Denver. After listening to the keynote address by Nobel Laureate Myron Scholes (of Black-Scholes fame), I left the conference hall along with the crowd to attend the reception. While waiting for the elevator, I noticed a situation that was pertinent to Scholes’ presentation. Because there was no stairway leading from the conference level to the concourse, people had no choice but to take the elevators, and a small jam formed. I was sure that there would be a stairway, if only for fire-safety reasons. I searched the floor and found only a door leading to the basement. I considered how dangerous this would be in a fire emergency. Fires in the modern hotels are relatively infrequent occurrences and a hotel can stay past its useful life without any. In that case, the cost of adding an extra stairway would be entirely sunk.

Mathematical Role Models

Whether you are an aspiring risk manager, quantitative analyst, or a trader, your first order of business is to manage risk. Fundamental analysis can tell you what a company is worth or whether a sector is undervalued theoretically, but market prices and volatility have their say also. You come to find that entries and exits are important, but ultimately risk management comes down to position sizing.

From there you can purchase expensive backtesting/simulation software and a subscription to the data that you need to run through it, but unless you have been trained in what all the boxes you've checked before you click "Run" mean, you will likely have data mined and over optimized your way to hypothetical success.

At various times of my career I have used such simulation software. Admittedly, it is very helpful and still is in some ways. It is very fast in its calculations and can also run Monte Carlo simulations for you, for example. However, nothing will replace the knowledge you will get from having to learn to do it from the ground up. I have done that too. My first model was created by hand on spreadsheets: first Lotus 123 cum Excel.

Constructing a portfolio that will provide you and your clients with the best risk-adjusted returns, while suitably diversifying your holdings, is done by teams these days. Teams that have a great deal of resources and intellectual capital. You need to learn how to construct such a model in order to compete in the global marketplace that is seeming to become more and more uncertain each day, perhaps by yourself at the beginning. It may appear to be easy in theory, but it is much harder in practice. One of the best things you can do to get started in an affordable manner is to become very proficient in Excel.

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Quantitative hedge funds (Quant funds), such as AQR and Renaissance, spend enormous amounts of time, money, and effort to make sure they sift through oceans of data to find the most profitable opportunities. They also invest in the best personnel...many of whom have PhD's in Quantitative Finance or hold designations such as the CQF (Certification in Quantitative Finance). The competition is brutal, and this is before you have to fight off the high frequency traders...

Successful risk managers know the limitations of VaR, the Kelly formula, and CAPM. As Aaron Brown, Risk Manager of AQR wrote in his new book, Red Blooded Risk, "Successful risk taking is not about winning a big bet or even a long series of bets. Success comes from winning a sufficient fraction of a series of bets, where your gains and losses are multiplicative.

In order to get to the place where you can affect such trades, you need to test the data. I believe that this is best accomplished these days in an affordable manner using Excel. Thankfully, Excel has dozens of built-in mathematical functions that which can utilize advanced techniques that can give you the answers you need with the statistical significance to boot.

Without these answers, you will not have the emotional nor statistical confidence to manage the risk, nor will you have the answers to the questions that are frequently being asked in today's environment: "What happens if....?"

 

–Michael Martin

Michael Martin has been a successful trader for over 20 years. He is the creator of "Martin Kronicle," author of The Inner Voice of Trading, and instructor of the NYSSA Certificate in Commodity Trading & Trend Following.

Financial Collapse: It's Only Natural

What do the collapse of MF Global, the euro crisis, the subprime mortgage crisis, the collapse of Fannie Mae and Freddie Mac, and the 1998 collapse of Long-Term Capital Management (LTCM) all have in common?

Certainly these crises all shared the following characteristics: too much leverage, lack of transparency, inadequate regulatory oversight, agency problems of misaligned incentives, and failures of leadership at the very least. This is what we know, and we’re frustrated watching inadequate public and private sector responses to these problems.

Rethinking the Role of an Analyst

It is common to question the worth of Wall Street analysts. Whether they love a stock that drops like a rock or are late to the party for one that soars, there are plenty of naysayers. Conversely, many publications analyze recommendations and pronounce certain analysts the best of breed, often using questionable methodologies to do so.

In addition, a huge volume of academic research has focused on the work of analysts, narrowly defining it as crafting earnings estimates and making stock recommendations. All of that is in contrast to surveys of institutional money managers, which consistently show that they place little value on sell-side recommendations versus other factors.

The reality is that far too much attention is paid to an exercise in futility that doesn't really match up to the needs of investors; while stock ratings are fodder for reporting and analysis, they can conceal rather than reveal what an analyst truly brings to the table. But a larger issue is that most analysts are set up to fail.

Not So Great Expectations

Oddly enough, the day after Steve Jobs died was the first time that I had been in Silicon Valley in decades.  Finding myself with a rental car and time on my hands, I drove to Apple headquarters. The scene was very much like that for other cultural icons that have passed on: a row of TV trucks, a large pile of notes, photos, flowers, and mementos, and the flags at half staff. There were spots available in the visitor parking area adjacent to the building, and people milling around—even going into the building—but I didn’t join them.

The Lost Profession of Banking

Banking used to be a profession, not just a business. That profession is vital to the real economy, and essential at a time of profound economic system transition. It's about time we rebuild the banking profession, using public-private hybrid models when necessary, to promote banking's critical public purpose, such as rebuilding our energy infrastructure for the post-carbon era.

All this was brought home to me while listening to the presentation for a large-scale rooftop solar project at the Business-Climate conference hosted by PriceWaterhouseCoopers.

Making Rare Earth Element Disclosure Transparent and Compliant

"Getting the Most Out of other Organizations’ Practices"

When prices for rare earth metals rose sharply over the last five years, we saw junior mining companies take on rare earth projects and seek financing to explore them on the equity markets.

Such events would not normally create a compliance problem. But, in the rare earth business, there were a few new twists that made clear disclosure harder to do. One such twist was that there were just so many rare earths; another was that the term had been popularly stretched to cover other metals that were not rare earths at all. Rare earth elements are the lanthanide series (lanthanum through lutetium, elements 57-71 on that long-neglected row of the periodic table atop thorium, uranium and the Lawrence Labs synthetics), plus yttrium, which occurs with the lanthanides and shares most of their chemical characteristics.

Why the “Occupy Wall Street” Protesters Have Picked the Wrong Target

It’s easy to see why people who are angry with the current dismal economic state of the country so often mistakenly place the blame for this situation on Wall Street. After all, hasn’t it become the national symbol for greed, wealth, and corruption?

Investors Step Up Pressure for Integrated Reporting

We live in a world of rapid human population growth and consumption,  heightened resource scarcity, and the attendant stresses placed by all these factors, not to mention our "business as usual" economy on the earth's ecosystem.   Corporations must acknowledge this and can no longer afford to operate without closely monitoring, managing, and disclosing their environmental, social, and [corporate] governance (ESG) risks—any one of which can explode into a crisis with very material financial consequences. Asset managers who fail to require the companies in which they invest to step up to the plate and take on this responsibility are rightfully being viewed as shirking their own fiduciary duty. 

The Real Road to Serfdom

        The past is never dead. It is not even the past.
                    —William Faulkner (1951), Requiem for a Nun

        History is more or less bunk.
                    —Henry Ford (1916), Interview in Chicago Tribune

In June of this year, I was a presenter, discussant, and session chair at the 18th Conference of the Multinational Finance Society, held in Rome. In his keynote address, Hersh Shefrin, professor of finance at Santa Clara University and a pioneer in behavioral finance, made a desperate plea to restore historical economics to the finance and international business curricula within graduate programs. There are several arguments in favor of educating future finance professors, economic diplomats, and investment bankers in the history of economic processes: 

    • First, many practices and relationships long abandoned by developed nations still flourish in developing markets. 

    • Second, many extant laws and attitudes originated in the distant past. 

    • Finally, setting aside concepts such as quantum finance and “financial hydrogen bombs,” we find   that systemic dislocations in the financial markets have analogs in the past, for greed, fear, and gullibility have always been characteristic of our species. 

Commentary: Why We Need a Financial Transactions Tax

Speculators may do no harm as bubbles on a steady stream of enterprise. But the situation is serious when enterprise becomes the bubble on a whirlpool of speculation.

- John Maynard Keynes, Speculator and Economist

You know you’ve hit a hot button when publicly traded stock exchanges, futures brokers, and a host of bank stocks get slammed with the simple mention of a financial transactions tax ("FTT"). The market’s response is understandable – even a small transactions tax would have a significant impact on the high frequency trading and other “quant” trading strategies that now comprise an astonishing 70% of vastly bloated equity trading volume.

Commentary: The Big Choice

A $20 trillion “externality” appears to present civilization with its BIG CHOICE: economic destruction or ecological destruction, both with chilling global security implications. Here’s why, along with a practical and more hopeful alternative to “Sophie’s Choice.”

Carbon Tracker has released an illuminating report, “Unburnable Carbon—Are the world’s financial markets carrying a carbon bubble?”

The report nicely describes the potential “stranded asset risk” to resource company investors, and calls for a regulatory response on disclosure. What the report does not make explicit is the BIG CHOICE: Barring a miracle technology advance in the next decade (keep working brilliant scientists and entrepreneurs), if we want to avoid civilization-transforming and global security threatening climate change, we must absorb a global security threatening a $20 trillion write off (that’s 40 percent of global GDP) into our already stressed global economy. Even if gradually spread over a decade or more, with partial offsetting value creation in sustainable energy industries, this is an unprecedented challenge.

First the essential facts as per the report:

• The Potsdam Institute calculates that in order to reduce the risk of exceeding 2 degrees Celsius warming to a 20 percent chance (not all that comforting), the global carbon budget for 2000–2050 cannot exceed 886 GtC02. Minus emissions in the first decade of the century, this leaves a budget of 565 GtC02 over the next 40 years.
• Total “proved” fossil fuel reserves listed on public company balance sheets and State reported reserves is estimated at 2795 GtC02, nearly 5 times the remaining budget, implying 80 percent of these reserves should be left in the ground.
• Seventy four percent of these reserves are State owned (Russia, China, Saudi, Venezuela, Iran, Iraq, etc.) or owned by private companies, 26 percent are owned by the 200 largest public energy companies.

According to James Leaton at Carbon Tracker, the market value of the top 100 public oil and gas companies and the top 100 public coal companies listed in the report exceeds $7 trillion, approximately 12% of the global public equity market. Making a simple assumption¹ that State-owned companies and reserves have an equivalent market value per unit of carbon would suggest the global market value of proved fossil fuel reserves equals $27 trillion.

A real cap on carbon emissions designed to limit warming to two degrees implies sovereign states and public corporations will need to strand 80 percent of their $27 trillion of proved reserves. Rounding down, this implies a potential $20 trillion write off.²

The risk of systemic collapse of an already fragile, interconnected global economy is high if we incur a write off of this magnitude. Fossil fuel intensive economies and investors would be severely damaged, no doubt triggering a deep and prolonged recession while the losses were absorbed. Some, like Saudi Arabia where energy represents 75% of government revenues, and Venezuela (50% of government revenues) would face economic devastation leading to widespread social unrest.

Not surprisingly, the markets are ignoring this risk today as the Carbon Tracker report makes clear. Why would they do otherwise when, as Bill McKibben pointed out, the US House of Representatives recently defeated a resolution stating simply that “climate change is occurring, is caused largely by human activities, and poses significant risks for public health and welfare”? Why listen to the broad scientific consensus when we can invent a more accommodating (and remarkably partisan) physics? No surprise that this week, American Electric Power announced that it is shelving plans for its $668-million, full-scale carbon capture plant at Mountaineer in West Virginia, the nation’s most prominent effort to capture carbon dioxide from a coal-burning power plant in the United States, “until economic and policy conditions create a viable path forward.”

Rising fossil fuel stock prices coupled with no game-changing promise of carbon sequestration technologies (the present reality) implies the markets assume we blow past the 2 degree warming limit into catastrophic climate change.

Is there an alternative to the BIG CHOICE between ecological destruction and economic destruction? I think the answer is “yes,” but not with the simple happy talk of “CSR” and “growing the green economy.” A viable plan will entail real costs, unprecedented commitment, and shared sacrifice.

Costs: The seminal “Stern Review” on the economics of climate change suggests that for a range of manageable costs centered around a 1% reduction of GDP growth, greenhouse gasses can be stabilized at 500 to 550 ppm by 2050. While this modeling exercise is highly complex, it contains at least two fundamental flaws. First, it presumes 500 ppm is consistent with the 2 degree goal, when the scientific consensus, propelled by increasingly disturbing new evidence of climate change, is calling for a limit of only 350 ppm, what Bill McKibben calls “the most important number in the world.” And second, it appears to ignore the $20 trillion stranded asset write down and associated economic spillovers by assuming carbon sequestration capabilities will allow us to continue burning fossil fuels largely unabated.

I can only speculate on what portion of the $20 trillion stranded cost potential will need to be incurred. It will depend on the success of carbon sequestration technologies (unknowable), and their cost (also unknowable). But it will not be cheap. Prudence suggests we should plan to incur at least half of these costs, still a profound multi-decade economic challenge. We must also determine what combination of caps, taxes, and regulation will best manage the difficult carbon-limiting prioritization decisions among coal, various qualities of oil, and gas, and among the resource bases of sovereign states (with armies) and multinational corporations that we decide to burn, all having profound financial, political, social, and security implications.

Unprecedented commitment: At the core, our challenge and our greatest chance to mitigate the most horrendous consequences of the BIG CHOICE boils down to a capital allocation decision. We must of course invest aggressively in the “green economy” of clean technologies including carbon sequestration, energy efficiency, and alternative energy. Indeed this process has begun as documented by Ethical Market’s Green Transition Scoreboard, which now documents over $2 trillion of private sector investments in, and commitments to, the “Green Transition.” We must accelerate low technology paths such as avoided deforestation and grassland restoration³ to sequester carbon. But we must also remove subsidies and divest from the destructive fossil-fuel- based energy, transportation, and industrial agriculture systems, and from the destabilizing and counterproductive speculation of the Wall Street financial system. Only if we marshal unprecedented private and public resources to the great energy system transition can we hope to manage the BIG CHOICE.

Shared sacrifice: It’s time for true leadership around shared sacrifice. This must start with the richest half billion people, less than 10% of the human race, whose consumption and investment decisions will determine the fate of civilization. It’s time we awaken to the burden we bear. Seeking justice, our children will ask—What did you do, once you knew?

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–John Fullerton is the founder and president of the Capital Institute. He is also the principal of Level 3 Capital Advisors, LLC, an investment firm focused on high impact sustainable private investments. This article originally appeared on his blog, the Future of Finance.

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1. This assumption is somewhat flawed because the market capitalization of a resource company should and usually does exceed the present value of its “proved reserves” because as a going concern, it is expected to create incremental value beyond its current reserves. However, my assumption remains conservative because it also ignores all “unproved” reserves whose values are only partially reflected in company valuations, and ignores reserves held by all private companies and public companies not in the top 100 lists. World recoverable reserves certainly exceed by a wide margin, some argue by multiples, the current quantity of “proved reserves” on the books, meaning the total potential for stranded reserves is far greater than indicated here.

2. Yes this analysis ignores the potential of carbon sequestration technologies, but they are probably at least a decade away and uncertain. It also probably overstates the sovereign value of reserves, given the widely held belief that some governments overstate their reserves for political reasons. But it also ignores the value of many refining assets, power plants, shipping, rail, and pipeline infrastructure that will be devalued if we decide to leave fossil fuels in the ground in order to limit carbon pollution. It ignores the value of all private and smaller energy companies. It ignores the value to dependent governments of all associated production and consumption tax receipts associated with fossil fuels which have tremendous economic value. And, it only achieves an 80 percent confidence that we don’t exceed the 2 degrees warming target. Overall, we believe the $20 trillion estimate of aggregate economic exposure is reasonable.

3. See www.savoryinstitute.com.

Rare Earths in Rare Lands

THE IMPORTANCE OF RARE EARTHS

Count Otto von Bismarck was not only the most visible European politician of his generation, but also a famous wiseacre. Driving home a point on the importance of hard power, he said that “if Germany will be weak, no armies of diplomats besieging European courts will further its interests. If on the contrary, it will be strong, its diplomatic representation can be delegated to the international corporation of dentists“ (cited from memory).

Today, the People’s Republic of China packs enough hard power for its diplomats to go into dentistry. It produces 97% of the world’s rare earth elements, which are essential components in many industries. When Japanese prime minister Naoto Kan tried to whip up nationalist sentiment by denying the wartime atrocities of the Japanese military against Chinese civilians, China instituted a technical shutdown of some of its rare earth mines. Several industries in Japan including automotive immediately felt the punch. Rare earths are necessary for the magnets used in cars’ electric motors, among many other technologies.

Commodities are Different (in a "Full World")

Foreign Policy’s recent “How Goldman Sachs Created the Food Crisis” reflects the dangerous, myopic thinking all too prone to “blame Wall Street” that is a natural consequence of Wall Street’s appalling, anti-social behavior in recent years.

I am no apologist for Wall Street’s modern business practices and ethics, and certainly not for Goldman Sachs, as reflected in this blog and in my 2009 Blankfein Letters. But to confuse the historic shift underway in the commodities markets that is a result of our “full world” economy with Goldman’s or any other Wall Street speculator’s bad behavior is missing the critical point.

Robert Litterman: Who Should Hedge Tail Risk?

In a somewhat ironic turn of events, many investment banks began selling insurance against equity tail risk to institutional investors following the financial crisis. Ironic because one might expect that investment banks, with high leverage and quarterly earnings reports to worry about, would be the natural buyers of such insurance and long-horizon investors the natural sellers.

Surely, those with deep pockets and long horizons, who would be little affected by the crisis, should be selling insurance to those with short horizons and leveraged positions, who would be most highly affected.

Of course, there will always be a price low enough that a given investor would be willing to buy insurance, and there will always be a price high enough that the same investor would be willing to sell insurance. But investors who have long horizons, sufficient liquidity, and low leverage should consider carefully whether, in practice, the price at any given time is low enough that buying tail-risk insurance makes sense for them. That scenario is unlikely because long-horizon investors are not natural buyers of tail-risk insurance.

Continue reading "Who Should Hedge Tail Risk?" »

From the Arcives: Benjamin Graham on Being Right in Security Analysis

Benjamin Graham, the man widely recognized as the father of security analysis, wrote the following article in 1946. Though the market has changed dramatically since then, his approach to judging the success of an analyst’s recommendations remain just as valid today.

ON BEING RIGHT IN SECURITY ANALYSIS

The most interesting and important work of the senior ana­lyst leads up to and includes the recommendation that one or more common stocks be purchased. How can we tell whether such a recommendation has been right or wrong?

Fukushima, Mon Amour

THE RISE AND FALL AND FALL OF NUCLEAR ENERGY

Nuclear energy is generally considered an important part of any future energy mix. Yet, it is a Cinderella of American public policy: neoconservatives like it because it is “manly,”—unlike the “effeminate” renewables—and because it annoys environmentalists and has its origins in nuclear weapons research. Yet many do not believe in global warming, and are generally extremely supportive of the oil and gas lobby. Legislators from Utah, one of the most conservative states in the nation, keep the objects of civilian nuclear infrastructure out of the state with the assiduousness of the most determined treehuggers.

Tea Partisans dislike federal subsidies in general, and nuclear energy specifically, as it has heavily relied on federally funded research and development. Environmentalists, who tend to be politically liberal, like neither the nuclear industry and its wastes, nor the generous federal support nuclear energy has historically received at the expense of renewables. Finally, nuclear energy is one of the greatest sufferers of the NIMBY (not in my back yard) attitude typical of the American taxpayer. Only a few, poorly organized legislators representing nuclear industry–heavy states (Tennessee, New Mexico) tend to be supportive of nukes independently of their party colors. The net result of this conundrum is that no new reactors have been opened in the US over the past 30 years. This relegates the US utilities to older, less safe reactor designs, which show their physical wear.

“US Debt Default Would Be a Moral Disaster”

So declared JPMorgan CEO Jamie Dimon regarding the prospect of a US default on its debt, after which he received a standing ovation at the University of Colorado’s Denver School of Business.  Hmm… Let’s do a little press review—the following items quoted from recent news articles:

• JPMorgan Chase recently lost a class-action lawsuit brought upon the bank for illegally foreclosing on military members’ homes while they were on active duty. 

Commentary: The King’s Ransom

This week, Galleon hedge fund manager Raj (“King”) Rajaratnam was found guilty on all 14 counts of insider trading. The wiretap evidence incriminating “the King,” including (incredibly) tips from inside the Goldman Sachs boardroom by the former head of McKinsey, was overwhelming and created the specter of a gangster trial. The defense’s strategy suggesting it was all “public information” was insulting to common sense, even more so to market professionals, and was clearly unpersuasive to the jury.

Suggestions for Modern Security Analysts

Economics is the social science that most identifies itself with the natural sciences. There is much that can be written about this statement in light of the events that unfolded in the 2007–2008 credit crisis, but this article focuses on the consequences pertaining to the field of Security Analysis, which is an economics-based discipline.

Security Analysis seeks to value firms based on the goods and services sold to customers via the assets (tangible and intangible) and obligations (liabilities) generated to support those sales. Despite the simplicity of this exposition, and the related simplicity of cash flow-based valuation, assessing value can be extremely difficult. The difficulty stems from the well-known fact that value is subjective, and from the equally well-known fact that the future is uncertain. Subjectivity and uncertainty means that Security Analysis requires many working assumptions, which is important because modern economics is currently grounded in mathematics that accommodates only a limited number of assumptions. As a purely theoretical, science-like endeavor this may (or may not) work, but Security Analysis is a profession, and professions are concerned with decision-making in contrast to science, which is concerned with prediction.

Just One Question: Did You Calculate the Risk?

The movie Stalag 17 opens with an escape attempt from an Austrian POW camp during World War II. Two POWs, Manfredi and Johnson, are preparing to escape through a tunnel that has been secretly constructed beneath one of the camp’s latrines. As the two would-be escapees go through a last minute review of their plans with Hoffy, the barrack chief, and Price, the barrack security officer, a skeptical POW asks a key question.

BRICs versus CIVETS

The acronym BRIC—Brazil, Russia, India, and China—coined by the Goldman Sachs economist Jim O’Neill (2001) is now a widely accepted and understood term. The justification for such a grouping is clear, as the BRICs are comparable in terms of territory, population, GDP, stock markets, and sociopolitical factors (see Table 1). The acronym CIVETS—Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa—was conceived in 2009 by Robert Ward, director of global forecasting for the Economist Intelligence Unit (see Economist 2009), and popularized by Michael Geoghegan (2010), group chief executive of HSBC Holdings plc, shortly after. As the newer term makes its way into the investment lexicon, we need to ask whether these six countries merit such a grouping.

Commentary: As Goes Egypt . . .

I am no Middle East expert, and clearly there are a multitude of factors beyond a humiliated fruit cart vendor in Tunisia that have triggered the revolutions playing out on our nightly news. Certainly decades of repression and unfathomable corruption (Mubarak is thought to have in excess of $40 billion invested securely outside Egypt) are the primary drivers. But I would like to focus on food and energy. A consensus is emerging that dramatic increases in food prices are also a root cause of the revolutions in Tunisia and Egypt, as reflected by an article in Scientific American titled: “Are high food prices fueling revolution in Egypt?”

Trains of Thought: Divergent Theories about Economic Crises

The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.

–John Maynard Keynes

Goldman and Facebook: Who's Using Who?

I sure got that one wrong.

At the end of my 2009 year end letter to Lloyd Blankfein, Chairman and CEO of Goldman Sachs, the third in an exchange that took place during the depths of the financial crisis, I predicted that Goldman clients would begin to defect, either of their own volition, or because their own clients would force them to. I predicted “civil war (inside Goldman) could break out after Goldman loses the Facebook IPO for one reason alone: the Goldman Sachs brand.”

Oops.

Commentary: Carnegie’s “Gospel of Wealth” and the Gates/Buffett Giving Pledge

Andrew Carnegie’s essay titled “Gospel of Wealth” published in 1901, is the touchstone of the great American philanthropic tradition. Its central thesis warns against extreme wealth being passed on to heirs or even charitable institutions ill-equipped to administer its effective disposition. Carnegie’s position on the “duty of the man of Wealth” is quite clear:

First, to set an example of modest, unostentatious living…to provide moderately for the legitimate wants of those dependent upon him; after doing so to consider all surplus revenues which come to him simply as trust funds, which he is called upon to administer, and strictly bound as a matter of duty to administer in the manner which, in his judgment, is best calculated to produce the most beneficial results for the community – the man of wealth thus becoming the mere agent and trustee for his poorer brethren, bringing to their service his superior wisdom, experience and ability to administer, doing for them better than they would or could do for themselves.

Ideas in Equity: New Companies, New Technologies

I am not a huge fan of the changes in the Wall Street Journal. The publication has not regressed to the level predicted by the cartoonists—“Girls of Wall Street Gone Wild” with glossy centerfolds—but neither has it improved much, in Technicolor.

Yet some of its sections retain the old luster and, for the equity lovers, I review some of the companies recognized in its 2010 Technology Innovation Awards. My choice of six companies out of fifty-something prizewinners and runners-up reflects only my own preferences and my ability to understand the underlying technology, with an expertise borrowed from the days of my misspent physics youth. In particular, I exclude software and biotech companies from my list because I cannot exercise anything close to professional judgment on the advantages and shortcomings of their achievements.

Commentary: Footprints and Foreclosure

The global economy now uses 1.5 times the earth’s capacity to regenerate the natural capital we use every year, up from the 1.4 times of the prior year, according to a report of the well-respected Global Footprint Network. In their Living Planet Report 2010, released this week but based on 2007 data, the most recent available, WWF together with the Global Footprint Network and the Zoological Society of London record the most significant milestone since we crossed parity (an ecological footprint of one) back in 1975. This is not good news.

Commentary: Crackpots of the World, Unite!

The author reminds the reader that neither markets nor corporations are synonymous with “capitalism,” and one ignores the lessons of economic history at one’s own peril.

In one of his more charitable moods, Dr. Johnson noticed, “A wise Tory and a wise Whig, I believe, would agree. Their principles are the same, though their modes of thinking are different.”¹ I can half-seriously propose that the inverse is also true; namely that ignoramuses, utopians and, finally, fanatics, have remarkably similar modes of thinking though their principles and convictions are vastly different.

Commentary: The End of Investment?

I recently attended a school function and was chatting with a friend (“Pam” for the sake of this post) who is a buy side analyst at a major asset management firm, the kind that manages hundreds of billions of pension fund assets, and 401Ks.

Pam’s firm, like many mainstream asset management companies, is a signatory of the Principles for Responsible Investment (PRI). The first two Principles state:

1. We will incorporate ESG (Environmental, Social, and Governance) issues into investment analysis and decision-making processes.
2. We will be active owners and incorporate ESG issues into our ownership policies and practices.

In response to a simple “how’s work going” type of question, Pam proceeded to tell me how much the business has changed in recent years, suggesting this was in response to the financial meltdown. She told me she no longer writes in-depth research reports. “Everything is about short term trading.” Remarkably to me, she told me all the analysts now run their own portfolios and their bonus is 100% driven by performance.

Coming of Age: A Brief History of the Changing Role of the Securities Analyst

From green-eyeshade-wearing, slide-rule-toting, underpaid, inconsequential “statisticians,” to highly respected, well-paid, recognized experts on major industries and their most interesting companies—over the last half century the securities analyst has been transformed from peon to potentate. Motivated by the recognition, now universal, that analysts’ judgments move markets, change securities prices, and impact corporate strategies, the evolution of the analyst has been, albeit unevenly, a global phenomenon.

In Defense of a Quant (Part II): The Ups and Downs of the Normal Distribution

In my previous column, I mentioned that particular attacks on the deficiency of mathematical finance are centered on the alleged misuse of “simplistic” normal distribution by the quants. Nassim Taleb never fails to contrast the disdainful and primitive “Brownian” paradigm with the supposedly more sophisticated “fractal” point of view, which he attributes to Benoît Mandelbrot. I quote only two passages from the Black Swan: “I find it ludicrous to present the uncertainty principle as having anything to do with uncertainty. Why? First, this uncertainty is Gaussian.” Or another pick: “So selecting the Gaussian while invoking some general law appears to be convenient. The Gaussian is used as a default distribution for that very reason.”

Cartoon: Bull vs. Bear

Illustration by Karl Wimer.

As an impartial, nonprofit forum for the finance and banking industries NYSSA encourages discussion and debate among its member and other professionals. Commentaries, however, should be taken as the sole opinion of the author(s) and not of NYSSA. If you would like to submit a commentary to the Finance Professional's Post, send your article to the editor.

Cartoon: Stemming the Tide

Illustration by Karl Wimer.

As an impartial, nonprofit forum for the finance and banking industries NYSSA encourages discussion and debate among its member and other professionals. Commentaries, however, should be taken as the sole opinion of the author(s) and not of NYSSA. If you would like to submit a commentary to the Finance Professional's Post, send your article to the editor.

Commentary: Toward a Finance Ethic

“An ethic, ecologically, is a limitation on freedom of action in the struggle for existence. An ethic, philosophically, is a differentiation of social from anti-social conduct. These are two definitions of one thing. The thing has its origin in the tendency of interdependent individuals or groups to evolve modes of co-operation.

“The ecologist calls these symbioses. Politics and economics are advanced symbioses in which the original free-for-all competition has been replaced, in part, by co-operative mechanisms with an ethical content.

Cartoon: An Uphill Battle

Illustration by Karl Wimer.

As an impartial, nonprofit forum for the finance and banking industries NYSSA encourages discussion and debate among its member and other professionals. Commentaries, however, should be taken as the sole opinion of the author(s) and not of NYSSA. If you would like to submit a commentary to the Finance Professional's Post, send your article to the editor.

Cartoon: Credit Crisis Lineup

Illustration by Karl Wimer.

As an impartial, nonprofit forum for the finance and banking industries NYSSA encourages discussion and debate among its member and other professionals. Commentaries, however, should be taken as the sole opinion of the author(s) and not of NYSSA. If you would like to submit a commentary to the Finance Professional's Post, send your article to the editor.

In Defense of a Quant (Part I)

The public likes simple explanations, especially if they are argued with bombast. For instance, the financial crisis happened because “the young boys with PhDs in physics were conceiving a financial hydrogen bomb” (attributed to F. G. Rohatyn of Lazard Fréres). To me, it sounds like “the laws of fluid mechanics sunk the Titanic.” This is literally true, of course, but the substantive reason was much more mundane (and universal): hubris and the human propensity to throw all caution to the wind—literally and idiomatically—when big money is involved.

Commentary: From Risk to Uncertainty

Stress-test complacency will be a cause of the next financial meltdown.

Economic commentators have been increasingly using the word “uncertainty” as of late. The context has included the business climate, the stimulate vs. austerity debate, and forecasting the investment outlook across capital markets. 

Clawbacks in Play with SEC, Dodd-Frank

Act 4, Scene 1—that’s where we are in the drama over corporate clawbacks. Put on stage by SOX (Sarbanes-Oxley), the clawback drama took its latest turn with the passage of the recent financial reform legislation, which goes farther than either SOX or the SEC have moved to date.

Cartoon: A Slowly Thawing Glacier

Illustration by Karl Wimer.

As an impartial, nonprofit forum for the finance and banking industries NYSSA encourages discussion and debate among its member and other professionals. Commentaries, however, should be taken as the sole opinion of the author(s) and not of NYSSA. If you would like to submit a commentary to the Finance Professional's Post, send your article to the editor.

Commentary: Who Knows What the Stock Market Holds?

“Doubt is not a pleasant condition, but certainty is an absurd one.” –Voltaire

You have to love those who state with certainty that stocks have made their lows and a resumption of the bull rally is underway. God may favor the bold, but fools do rush in where angels fear to tread.

Who knows if various stock market indices, which have produced a wonderful bounce from the lower end of their trading ranges, will broaden out and help numerous other indices reverse their bearish Mega Trend (“death cross”) signals? Who knows if the US economy has evolved into a private sector driven sustainable path of growth and, thereby, can avoid an economic backward slide into hell? 

Cartoon: Double Dip Nightmare

Illustration by Karl Wimer.

As an impartial, nonprofit forum for the finance and banking industries NYSSA encourages discussion and debate among its member and other professionals. Commentaries, however, should be taken as the sole opinion of the author(s) and not of NYSSA. If you would like to submit a commentary to the Finance Professional's Post, send your article to the editor.

Commentary: Shareholder Activism in a Post-Lehman World

As the global economy gradually recovers from the impact of the worst global financial crisis since the 1930s, companies continue to lay off thousands of employees and financial institutions are expected to write down trillions of dollars of toxic assets. In addition, governments have spent or committed to spend exponential sums of money in order to stabilize their economies. Investors have been particularly affected by the consequences of the financial crisis, having suffered a significant reduction in the value of their investments in a number of companies. According to the World Federation of Exchanges, as of February 2009, the global equity market capitalization was estimated to have reduced by $31 trillion since the peak prior to the crisis.

Commentary: Goldman v. United States—What it Really Means

“It is not what a lawyer tells me I may do; but what humanity, reason and justice tell me I ought to do.”

I invoked these words of the statesman and philosopher Edmund Burke to close my December 31, 2009, letter to Lloyd Blankfein. They now have particular resonance. I don’t know if, as the SEC has charged, Goldman committed fraud. However, to focus on the legal technicalities of the case is to miss the larger point. At its core, Wall Street’s failure, and Goldman’s, is a failure of moral leadership that no laws or regulations can ever fully address. Goldman v. United States is the tipping point that provides society with an opportunity to fundamentally rethink the purpose of finance. That reexamination will extend far beyond round one of financial reform and will be far more transformative.