Can financial data be protected from cyber attacks? - CFA ...

Can financial

data be

protected

from cyber

attacks?

The Member Magazine for Investment Professionals

Jan/Feb 2015

•

•

•

•

•

•

• •

•

•

•

•

•

• 1

Interactive Brokersfor Institutions

1 1

cfa

stocks • options • futures • forex • bonds — on over 100 markets worldwide from one account

1 1

Jan/Feb 2015

COVER STORY

26 Once More Undo the BreachTo protect financial data, firms

must learn how to survive

cyberattacks and respond to them

more effectively because prevention

is an obsolete concept, says

cybersecurity expert Bruce Schneier.

By Nathan Jaye, CFA

32 Rulers of DarknessAre trade-at rules the best way

for regulators to shed light on

dark trading?

By Sherree DeCovny

CFA INSTITUTE NEWS

8 EMEA Voice

ESG in Investing: Highlights from EuropeBy Usman Hayat, CFA

9 APAC Focus

The ROI of Learning and DevelopmentBy Richard McGillivray

11 Miscellaneous Briefs

VIEWPOINT

13 Toward a New Framework for Private WealthTo improve performance, better structures

and investment processes are needed

By Pranay Gupta, CFA

15 The Decisive Advantage of DecisivenessOverlooked skills can help an investment

manager stand out from the crowd

By Jason Voss, CFACOVER ILLUSTRATION

Kelly Alder

11

12

13

26

AlphaSense is a registered service mark of AlphaSense, Inc. | www.alpha-sense.com

AlphaSense is , including some of the world’s largest investment rms and anks, managing over $3 trillion in AUM.

AlphaSense is a game changer for research. Everyone will need it.

Portfolio ManagerNew York

“I spent a week building a report that this tool built in a minute.

Research AnalystSan Francisco

“

ith one search, AlphaSense helps you nd key information uried in roker research, S lings, call and event transcripts, IR presentations and your own proprietary content.

With AlphaSense, you can:

Keyword search millions of documents and use uni ue lters to hone results

Search across all public companies worldwide and know exactly who said what

Get email alerts every time a company mentions “X” (any keyword or theme)

Upload your own content – AlphaSense will index it and make it searcha le

Annotate content, take notes and access your intel on the companies and themes you track – even at a meeting or on the road

AlphaSense helps you nd what others miss on pu lic companies worldwide

The New Search Engine for Analysts

Request a free trial today. Visit www.alpha-sense.com or call 212.203.2799

Introducing AlphaSense

No More R -F AlphaSense eliminates the need to search documents one at a time.

LEARN MORE.FactSet.com/advise

Data and Analytics to Advise with Confidence You can’t predict what’s going to happen in the future, but you can use the right tools to determine the best asset allocation strategy. Incorporate custom capital market assumptions and simulate portfolio performance of various asset allocation strategies so you can advise your clients on an optimal path to reach their unique goals.

PROFESSIONAL PRACTICE

18 Investing with “impaired vision”

20 A new era of investment potential for solar power?

22 How Social Security benefits boost optimization

24 Demonstrating added value

ETHICS AND STANDARDS

36 Market Integrity and Advocacy

• “An ideal platform for influencing policy”

• Beyond Bitcoin: crypto 2.0 vs. regulators

• Closing the gap for non-GAAP performance measures

• Will Hong Kong lose its special status?

40 Professional Conduct

Notices of disciplinary action

5 In Summary

Jan/Feb 2015

36

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 Institute Magazine, 915 East High Street, Charlot-tesville, VA 22902.

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

Copyright 2015 by CFA Institute. All rights reserved. Materials may not be reproduced or translated without written permission. CFA®, Chartered Financial Analyst®, the CFA Institute logo, Claritas®, GIPS®, and CIPM® are just a few of the trademarks owned by CFA Institute. See www.cfainstitute.org for a complete list.

Annual subscription rate for CFA Institute members is US$40, which is included in the membership dues. Annual nonmember subscription rate is US$50.

THE AMERICAS915 East High StreetCharlottesville, VA 22902USAPhone: (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

Jan/Feb 2015 Vol. 26, No. 1

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 Lander, CFACasey Lim, CFAMichael Liu, CFABob Luck, CFAFarhan Mahmood, CFADennis McLeavey, CFASudip Mukherjee, CFAJerry 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 AND CEODwight D. Churchill, CFA

MANAGING EDITORRoger [email protected]

ONLINE PRODUCTION COORDINATORKara Hite

ADVERTISING MANAGERTom [email protected]

ASSISTANT EDITORMichele Armentrout

GRAPHIC DESIGNCommunication Design, [email protected]

CIRCULATION COORDINATORJennette [email protected]

4 CFA Institute Magazine Jan/Feb 2015

Jan/Feb 2015 CFA Institute Magazine 5

Let There Be Light

The characters of Charles Dickens’ classic yuletide tale A Christmas Carol are so vivid and familiar that they seem like old acquaintances, from the miserly Ebenezer Scrooge

-ures lurks in the shadows. It is the darkness.

This darkness is more than the absence of illumination. It seems to be a mysterious presence that slithers into every scene and coils itself around any source of light. Along the street at night, a multitude of candles are “like ruddy smears upon the palpable brown air.” Even when a lamp is held up to the dark, the “scanty light” is constricted.

People instinctively distrust any lack of visibility. This is -

parency” in a variety of forms has become a common refrain. Terms such as “dark pools” and “dark trading” have an omi-nous sound. For more substantial reasons, concerned reg-ulators have begun to peer into the dark and develop poli-cies (“Rulers of Darkness,” 32). They are also trying to shed light on shadowy crypto-currencies (“Beyond Bitcoin,” 37).

But Scrooge prefers poor visibility. “Darkness is cheap, and Scrooge liked it,” writes Dickens. Scrooge has a point.

-sive, and likely to burn the house down. Modern methods demand vast electric grids. To lower his electric bill, maybe

a modern Scrooge would invest in trends with potential to make solar power inexpensive and practical (“Solar Flair,” 20). The Scrooge in the story certainly believes in the advan-tages of impaired property, for he lives in “a gloomy suite of rooms, in a lowering pile of building up a yard, where it has so little business to be” (“Impaired Vision,” 18).

Scrooge not only makes his residence in an isolated, fore-boding place but also double-locks himself inside two sets of doors. Like modern computer networks, however, the system is easily penetrated by “hackers”—a ghost and three Christ-

-vention is futile against virtual intruders. The trick is to “fail gracefully” through resilient adaptation, says cybersecurity expert Bruce Schneier (“Once More Undo the Breach,” 26).

Graceful failure for Scrooge means going through a pain-ful process of enlightenment about his inner darkness. With the help of three spirits, he sees his former life carrying him “through the lonely darkness over an unknown abyss.” When his black heart is illuminated by compassion like “a

-

Roger Mitchell, Managing Editor ([email protected])

IN SUMMARY

Literature Review

ISLAMIC FINANCE: ETHICS, CONCEPTS, PRACTICE

Usman Hayat, CFAAdeel Malik, PhD

This review will clarify misconceptions and serve as a rich and nuanced introduction to

© 2014 CFA Institute

For more information or to download a free copy, visit www.cfainstitute.org/islamic_finance.

25 YearsB. Holland Timmins, CFA CFA Society AustinBruce H. Criel, CFACharles N. Rother, CFA CFA Society Orange CountyEdgar Albert Norton Jr., CFAJames J. Kerrigan, CFA CFA Society Dallas/

Ft. Worth

20 YearsJohn J. Baczewski The Boston Security

Analysts Society, Inc.Stephen P. Barnes, CFA CFA Society PhoenixChristopher P. Bloomstran, CFA CFA Society St. LouisGayle H. Buff, CFA The Boston Security

Analysts Society, Inc.William J. Cashin Jr., CFA CFA Society PhiladelphiaThomas J. Connelly, CFA CFA Society PhoenixWilliam J. Dezellem, CFA CFA Society PortlandMario Eichenberger, CFAArthur Finkelberg, CFA CFA Society MississippiMatthew D. Gelfand, CFA CFA Society Washington, DCWalter Bruce Harley, CFA CFA Society LouisvilleWalter V. Haslett Jr., CFA The New York Society of

Security Analysts, Inc.Mark F. Jasayko, CFA The Hong Kong Society of

Financial Analysts LimitedJohn E. Johnson, CFAAmit S. Khandwala The New York Society of

Security Analysts, Inc., Yvonne M. Kopecky, CFA CFA Society San FranciscoDaniel Lehrer, CFA The New York Society of

Security Analysts, Inc.Scott L. Miller, CFA CFA Society Dallas/

Ft. WorthDaryl S. Moe, CFA CFA Society MadisonNiels-Ulrik Mousten, CFA CFA Society DenmarkTod Andrew Nestor, CFA CFA Society PittsburghKent Layne Oots, CFA CFA Society ArkansasJohn D. Quackenbush, CFA CFA Society ChicagoSteven Philip Ralston, CFAPascal Michael Romano, CFA CFA Society IndianapolisNicolas A. Saade Jr.John F. Wisentaner, CFA CFA Society West Michigan

These members continue to inspire us with their commitment to never cease enriching their skills and expanding their knowledge. Their lifelong dedication to embrace new perspectives, challenge their assumptions, and stay up to speed with our ever-changing profession is helping to shape a stronger investment industry.

THE PATH OF INVESTMENT EXCELLENCE IS A LIFELONG PURSUIT

©20

14 C

FA In

stit

ute

15 YearsCraig D. Allen, CFA CFA Society San DiegoJoseph A. Anglin, CFA CFA Society ColoradoFrancois E. Aubert CFA Society SwitzerlandMichael D. Axel, CFALaurent A. Bachmann, CFA CFA Society SwitzerlandMark W. Bodie, CFA The New York Society of

Security Analysts, Inc. Pui Wah Regina Chan, CFA CFA Society TorontoDon M. Chance, CFAAlina Chiew, CFADouglas Sherman Cronk, CFA CFA Society OkanaganRobert James Denoo CFA Society ChicagoBeverly A. Durston CFA Society SydneyAlain Eckmann, CFA CFA Society SwitzerlandJoseph D. Eskridge Jr., CFATheo Evangelakos, CFA CFA MontrealChristian Faitz, CFA CFA Society GermanyMichael P. Fogarty, CFA CFA Society Kansas CityMichael K. Frommelt, CFA CFA Society LiechtensteinJean-Pierre Galichon The New York Society of

Security Analysts, Inc.Gary E. Gordon, CFA CFA Society BaltimoreJohn F. Gualy, CFA CFA Society HoustonSteven Philip Habegger, CFAMatthew John Haertzen, CFA CFA Society PhoenixCraig Hicklin Harrel, CFA CFA Society HoustonWarren Huang, CFAAndrew J. Hutton, CFA CFA Society United KingdomFuminori Imura, CFAShirin Ismail, CFAPaul Timothy Kaspar, CFA CFA Society MinnesotaMark J. Kavaloski CFA Society Los AngelesJason Kiss, CFA CFA Society San FranciscoHendrik A. Klein Haneveld, CFAHenry Chi-Yin Lam, CFA The Hong Kong Society of

Financial Analysts LimitedDirk E. Laschanzky, CFA CFA Society IowaMattias Ledunger, CFA CFA Society SwitzerlandDerrick Hong-Peng Lee, CFANelson Cheong Wing Lee, CFA The Hong Kong Society of

Financial Analysts LimitedSean Anthony Lynch, CFA CFA Society NebraskaThomas P. Madsen, CFA CFA Society ChicagoZenon Andrzej MarciniakWilliam Gordon McBean, CFA CFA Society Orange CountyJ.R. Melikian, CFA CFA Society JacksonvilleDaren E. Miller, CFA CFA Society CalgaryGeorge L. Montgomery, CFA CFA Society PhiladelphiaRonald L. Moy, CFAConor Savio Muldoon, CFA CFA Society Los AngelesRaymond L.H. Murphy III, CFA The Boston Security

Analysts Society, Inc.Alan F. Niederer, CFA CFA Society Switzerland

Ana Dolores Novaes, CFA CFA Society BrazilDaniel Doyce Payne, CFA CFA Society JacksonvilleRobert Matthew Peets, CFA CFA Society VancouverCraig P. Prall, CFA CFA Society Atlantic CanadaPaul William Reisz, CFA CFA Society Los AngelesMario Ruiz, CFA CFA Society OttawaPierre Saint-Laurent, CFA CFA MontrealRoelof M. Salomons, CFA CFA Society NetherlandsRobert A. Seiler, CFA CFA Society SwitzerlandWilliam A. Shahriari, CFA CFA Society Tampa BayJohn Simmons, CFA CFA Society ChicagoRaymond J. Slatter, CFAKaj Mikael Somerkoski, CFAKanna Sriskanthan, CFA CFA Society StamfordCraig B. Stanford, CFA CFA Society CalgarySuzanne D. Stepan, CFA CFA Society West MichiganRehaz N.M. Subdar, CFA CFA Society TorontoPaul Victor Temperton, CFA, CIPM CFA Society United KingdomIsabelle Juillard Thompsen, CFA CFA Society United KingdomMatthew Irvin Walter, CFA CFA Society South CarolinaWataru Watanabe, CFARichard J. Wayman, CFA CFA Society ColumbusKevin J. Williams, CFA CFA Society HawaiiDaniel A. Xystus, CFA The Hong Kong Society of

Financial Analysts LimitedClay H. Young, CFA CFA Society North CarolinaE. A. Tony Zaremba, CFA CFA Society CalgaryJoseph M. Zuiker, CFA CFA Society Bermuda

Join us in applauding the energy, effort,

and perseverance of these members in

achieving these Continuing Education

milestones in 2013.

CFA INSTITUTE NEWSEMEA VOICE

ESG in Investing: Highlights from Europe

By Usman Hayat, CFA

When a large company, such as British Petroleum, Lonmin, or GlaxoSmithKline, makes headlines for the wrong reasons, the underlying cause is often linked to envi-ronmental, social, or governance (ESG) factors. Examples of ESG issues include cli-mate change, environmental degradation, water stress, human rights, employee rela-tions, corruption, and executive compen-sation. Fortunately, ESG issues in invest-

ing are not all negative. Within the past year, a host of pos-itive developments have occurred in the wider ESG space.

GROWTH OF GREEN BONDS

The era of green bonds has come, claims a 2014 report by the Climate Bonds Initiative, which estimates that the green bonds market “stood at $35.8bn outstanding on 10 June 2014, with issuance in 2013 ($11bn) and 2014 ($18.3bn) accounting for over 80% of the total outstanding.” The report describes these as bonds “where the use of proceeds is for climate or environmental projects and they are labelled as ‘Green’” and attributes their growth to rising interest in ESG issues. A major concern about green bonds is whether they are merely a strategic re-branding of what would otherwise have been conventional bonds. In 2014, 13 commercial and investment banks, along with the IFC and the World Bank, launched a set of voluntary guidelines to bring clarity to the processes involved in issuing and managing such bonds. For the long-term sustainability of the green bond segment,

EXCLUSIONARY SCREENING

Different methodologies are used by investors to consider ESG issues in investing, but the oldest methodology—exclu-sionary screening—is the most widely used. Exclusionary screening means not investing in companies because what they do is against the investor’s values. According to the 2014 European Sustainable and Responsible Investment Study published by Eurosif, exclusionary screening covers “about 41% (€7 trillion) of European total professionally managed assets.” Thus, exclusionary screening accounts

-ing may come as a surprise to those who argue for moving away from exclusionary screening to ESG integration or those who consider ESG issues strictly as economic risks

FOSSIL FUEL DIVESTMENT

That climate change may have a “serious, pervasive and irreversible” impact on human society and nature is at the

heart of the fossil fuel divestment campaign. Many inves-tors have pledged to withdraw from fossil fuel investments

series of small moral victories for the campaigners, such as

impact? Some observers believe that the divestment cam-paign relating to apartheid in South Africa shows that such

discourse. Others are cautioning investors that some fossil

on investors.

IMPACT INVESTING

beyond its size, attracting the attention of investors, entre-preneurs, politicians, and even the pope. According to the 2014 report of the Social Impact Investment Taskforce (established under the UK’s presidency of the G–8), “social impact investments are those that intentionally target spe-

-sure the achievement of both.” Capturing data and market perspectives from 125 impact investors, the 2014 impact-investment survey by the Global Impact Investing Network and J.P. Morgan Social Finance states that “shortage of high quality investment opportunities with track record” is the single most important challenge facing impact investments.

ESG EDUCATION AND CFA INSTITUTE

CFA Institute continues to offer a variety of educational opportunities regarding ESG issues in investments. In Sep-tember 2014, we launched a free e-course, ESG-100, which offers a comprehensive introduction to ESG issues in invest-ing. The course is accessible at cfa.is/ESG100. In addition, as part of a wider practice-analysis process, our curricu-lum team has conducted focus groups with ESG specialists in London, New York, Amsterdam, and Hong Kong to keep the ESG-related content in the CFA Program curriculum up to date with industry practice. The 2015 CFA Institute Annual Conference in Frankfurt this April will have more than one session dedicated to ESG issues in investing. Our member societies also continue to hold such events as the “Alpha from Sustainability” conference organized by CFA Society Netherlands in October 2014. If you are a member of CFA Institute and would like to offer your expertise in ESG issues in investing for our educational efforts, please email me at [email protected].

Usman Hayat, CFA, is director of Islamic finance and ESG at CFA Institute.


The ROI of Learning and Development

By Richard McGillivray

Measuring the return on investment of learning and devel-opment (L&D) programs has been one of the major chal-

past year, the CFA Institute institutional partnerships team -

als about this question, particularly as it relates to the appli-cation of knowledge-based curricula, such as the Claritas®

In our experience, L&D ROI is more often evaluated sub-jectively in the workplace rather than measured empiri-cally. There are many reasons for this tendency, including the challenge of isolating the impact of training as a vari-able in the performance and contribution of employees who are complex social beings working in complex social teams and workplaces. Drawing on insights gained from speaking

--

ing and learning.First, when customers know they are dealing with a com-

pany that invests in high-quality, reputable training, it gives --

company’s commitment to delivering consistent high-quality services throughout the customer journey and across geo-graphic regions. Thus, to ensure that ROI in training is effec-tive for client acquisition and retention, companies value partnering with L&D providers that are well known, reputa-ble, and supportive (in branding terms) of their businesses.

Second, employer brand is increasingly a key factor in companies’ ability to attract talent. The most talented profes-sionals favor employers known to invest in their employees, both in structured development and practical opportunity. Such professionals recognize that having worked at a top employer brand enhances their appeal to future employers, particularly because of the training investments that have been made. L&D providers that are reputable and have a

-tribute to this perception when their brands are also visible to individuals and carry their own intrinsic value.

In modern, knowledge-based workplaces, learning hap-

with which we are able to learn things because they are close to what we already know. For example, a person who under-stands the fundamentals of accounting will more quickly assimilate International Financial Reporting Standards than

and concepts. Through horizontal (broader, more general) learning, such as the knowledge-based Claritas Program,

a wide range of other possible learning can become prox-imal. In L&D terms, this effect is one of the reasons why horizontal learning is an effective and necessary founda-tion for vertical (deeper, more expert) learning.

Because so much of learning in the workplace is now social and project based, some of the most valuable com-petencies for individuals to have are those that help them quickly become more proximal to knowledge that they need. This capacity includes the ability to identify, seek out, accu-

--

spear, an independent learning strategist, researcher, and innovator, refers to this as “learning agility.”

Learning agility requires competencies that support immediate, project-based, and social learning. Three com-

to reach out to others, to contribute, to understand the context of a project in which

, which means “I used this approach in a previous project, and I think we

and (3) , which means reaching out to people within one’s organiza-

that’s needed for a particular task.We are encouraged by two key pieces of feedback in our

review of participants in our clients’ Claritas programs. First, they report that their employees have increased their

-lated into willingness among employees to contribute pro-

and its clients.Many of our clients arrange their learning support of the

Claritas curriculum in two important ways. First, learning support groups are arranged to enable individuals to form cross-organizational bonds with colleagues in other func-tional areas. Second, input is provided to learning support groups by in-house subject matter experts. These structures have enabled the movement of expertise between indi-viduals and teams, and the curriculum has provided the common professional language and mutual respect neces-sary for this exchange to happen. In doing so, these clients have succeeded in fostering competencies that are support-

L&D investment.

Richard McGillivray is director of institutional partnerships in Asia Pacific at CFA Institute.

CFA INSTITUTE NEWSAPAC FOCUS


Research Foundation

Aliber Ad

Congratulations to the

newest CFA charterholders

Your CFA designation sets you apart—focused on investment knowledge, committed to integrity. Employers around the world turn to CFA charterholders for the value they bring to clients and for the highest standards of excellence they bring to the industry.

Meet the new charterholders at cfainstitute.org/newclass.

ARE THE FUTURE OF FINANCE

©2014 CFA Institute. CFA®, CFA Institute® and Chartered Financial Analyst® are registered trademarks of CFA Institute in many countries around the world.


Charterholders Ride for PeaceBy Michele Armentrout

When Ahmed Olayinka Sule, CFA, and Uchenna Ndu, CFA, -

working event, they quickly made the connection that they were fellow Nigerians who grew up in two distinctly dif-

Igbo ethnic group, and Sule, in western Nigeria, from the Yoruba ethnic group.

“Nigeria encompasses over 100 different ethnicities, and unfortunately, in many parts of Africa, members of these

Sule said.As their friendship

grew stronger and they began to discuss trib-alism issues in Africa, they often wondered what they could do to impact change in the region for the greater good. (The pair are equally pas-

and tennis, but their exchanges on world matters and social

activism often dominated.) It was during one of these dis-cussions that the investment professionals came up with a novel idea for promoting solidarity and cooperation among

The friends embarked on their journey on 22 August 2014 and raised £535.33 (US$837) for the AET to help children

access education and training.

“It was a great feeling arriving in Paris on 24 August and knowing we achieved our goal without any punctures, bike problems, or accidents,” Ndu said. “And what a wonderful way to get away from technology and clear the head while taking in the beautiful French and English countryside.”

Overall, the trip renewed their faith in the human spirit.“In the course of our ride, we were generously helped

by many people, some of whom donated to our cause when

-phones while others helped with directions when we got off track,” Sule said.

If you are interested in donating to Ndu and Sule’s cause, including upcoming bicycle rides that they are currently planning, contact [email protected] for details.

Michele Armentrout is a communications specialist at CFA Institute.

IN MEMORIAM

Michael O’Loughlin Burpee

Bermuda

Pascale Nadine Canova-Aeberli, CFA

Feusisberg, Switzerland

G. Raymond Chang, CFA

Toronto

Anne B. Dewey, CFA

San Carlos, California

Michael Scott Fuller, CFA

Richmond, Virginia

Anne M. Grichuhin

Bainbridge Island, Washington

Robert H. Harper, CFA

Chicago

Nathan L. Hutson, CFA

Dallas, Texas

Emiel Roland Mahler

South Melbourne, Australia

Mark Rowland, CFA

Atlanta

Christopher Michael Shawe, CFA

London

Samuel H. Talley, CFA

Fairfax, Virginia

Joseph M. Wikler, CFA

Silver Spring, Maryland

Jayne S. Wong, CFA

Lafayette, California

Uchenna Ndu, CFA, continues the 500-kilometer bike ride on Day 2 under sunny

skies, rested and ready to ride to his next destination. Ndu and his fellow

cyclist, Ahmed Sule, CFA, departed from the London Eye on 22 August 2014.

Ahmed Sule, CFA, pauses for a break in the

French countryside en route to Beauvais, a

historic cathedral city in the Northern French

region of Picardy.

CFA INSTITUTE NEWS

CFA INSTITUTE NEWS

Society Leadership Conference

Focuses on Partnerships

The 23rd annual CFA Institute Society Leadership Conference was held in London at Park Plaza West-minster Bridge in September, with more than 350 delegates attending the three-day event that fea-tured seminars, panel discussions, and educational opportunities focusing on the theme “Shaping our Future Together.”

William McGinnis, CFA, of CFA Society Milwaukee, and Sharon Criswell, CFA,

of CFA Society Austin, take advantage of a networking opportunity following

a work session on “Partnership and the Bigger Community.” Both profes-

sionals were awarded a Volunteer of the Year Award for their respective

society engagement.

Maria Barabash and

Elena Matviychuk of

CFA Society Ukraine

celebrate their Most

Outstanding Society

Excellence Award with

Ray DeAngelo, senior

advisor at CFA Insti-

tute, who presented

the award to the

energetic duo.

CFA Institute Board of Governor Member Colin McLean, FSIP, addresses

the audience during a panel discussion with delegates as CFA Institute

CEO Dwight Churchill, CFA, looks on.

CFA Institute Holds Annual Global Policy Summit

In mid-November, CFA Institute hosted a Global Policy Summit in Char-lottesville, Virginia. The event brought together approximately 120 CFA Institute volunteers, society leaders, and staff members from around the world to dis-cuss industry issues and strategies for gener-ating more member and society engagement in advocacy worldwide.

Members of five CFA Institute policy councils—the Corporate Disclosure Policy Council, the Capital Markets Policy Council, the GIPS® Executive Committee, the Standards of Practice Council, and the Asset Manager Code Advisory Committee—were on hand for the two-day event, as were volun-teers from CFA Institute societies who are actively advocating for ethics and CFA Institute standards and policy positions in their local markets.

Ph

oto

by

Mic

hae

l Bai

ley

In the “Ethical Behavior vs. Regulation: Solving the Lack

of Trust” debate (left to right) Samuel Jones Jr., CFA,

member of the Standards of Practice Council, argued the

importance of ethics while Christopher Addy, CFA, chair of

the Capital Markets Policy Council (CMPC) and fellow CMPC

member Bruce Tomlinson, CFA, discussed the merits of

industry regulation.


Volunteer with the DRC

If you have an interest in helping to uphold ethical conduct in the investment profes-sion, are a CFA charterholder with no pend-ing professional conduct issues, have a fair and impartial temperament, and have knowledge of or a desire to learn more about the CFA Institute disciplinary process, the Disciplinary Review Committee (DRC) would like to hear from you.

The DRC, a committee of CFA Institute member volunteers who decide disciplin-ary cases, is accepting nominations. Email DRC Administrator Ange Hansen at [email protected] to request an application. Application deadline is 28 February.

For details, visit the “Integrity and Stan-dards” section of www.cfainstitute.org and select “Professional Conduct Program.”


VIEWPOINT

Toward a New Framework for Private WealthTO IMPROVE PERFORMANCE, BETTER INVESTMENT PROCESSES ARE NEEDED

By Pranay Gupta, CFA

Institutional investment management has evolved over the years to become a more transparent product indus-try. Competitive pressures have led to

-cesses, better risk management, lower fees, and greater alignment of inter-est between the asset owner and the asset manager. But private wealth man-agement has been driven historically by the need for privacy, legal struc-tures to protect ownership, and inter-generational transfer of assets. In this framework, the client had a relation-ship with the individual banker rather than with the banking institution. The result was a less effective investment structure for client assets because both the client and the banking institution did not consider management of the assets as a prime objective.

As the legal environment has evolved, the situation for private wealth has also

privacy is no longer possible, (2) global legal structures are more readily avail-able in a cost-effective manner, and (3) strength of institutions has become a bigger factor for a banking relationship. Consequently, the value of the invest-ment proposition for private wealth assets has come into focus. For client

-cient investment proposition, changes will be necessary in the private wealth investment industry. What changes are needed, and what would be the chal-lenges of making such changes? This article outlines possible solutions.

THE INVESTMENT PROBLEM

The requirements of a private client are exactly the same as for any kind

-

real return with a constraint on the

would seem that this requirement can be tackled in exactly the same way as a

traditional institutional plan sponsor’s portfolio problem. But eight key differ-ences make the private wealth invest-

and implement.

(1) A TRUE ABSOLUTE-RETURN REQUIREMENT. Private wealth portfolios come with a constraint on maximum use of hedge funds, implying that the requirement of absolute return has to be met by a solu-tion in which one is long market risk in all asset classes at all times. This is

Institutional asset management sidesteps the abso-lute-return long-market investment problem in three di f ferent ways. First, for long-only products, the solu-tion is having a long market index as a benchmark. Second, for abso-lute-return prod-ucts, the approach is to use the ability to short. Third, for multi-asset prod-ucts, a hybrid of asset class market indexes is used as the benchmark. Plan sponsors do the same by creating a “policy portfolio,” which they use to transform the absolute-return problem of the plan into a relative-return prob-lem to be followed by the managers.

In the private wealth world, however, because discretionary mandates give full control of the investment process to the asset manager, the difference in risk exposure between long-only invest-ments and an absolute-return require-ment falls within direct responsibility of the manager and cannot be sidestepped to a policy portfolio or a hybrid bench-mark. This constraint imposes a true absolute-return investment problem,

the institutional investment manage-ment problem.

(2) CUSTOMIZATION. Institutional invest--

work in which assets are invested in multiple commingled fund structures (internal or external). Private wealth is distinguished by the fact that every

preferences to be incorporated into the portfolio, resulting in limits on invest-ments, liquidity, leverage, single stock holdings, home bias, intergenerational

large number of accounts in private wealth, the customization requirement is a problem for large-scale implemen-tation. Even though the manager may have a single market view, all accounts are different and each one needs a dif-ferent portfolio.

(3) ACCOUNT SIZE. The investment pro-cess in an institutional product can be created for a single portfolio size, at any given time, be it a large or small asset base. In the private wealth setting, however, there can be accounts of dra-matically different sizes that need to be managed at the same time. Accord-ingly, the investment process needs to be simultaneously applicable and Ill

ust

rati

on b

y Ti

mo

thy

Co

ok


VIEWPOINT

relevant to very large and very small account sizes.

(4) DEFINED TIME HORIZON. In institutions, although intra-horizon drawdowns are painful, the agency structure serves to delink any emotional attachment to the assets, thereby decreasing behavioral biases in investment decisions. Because private wealth is very much an emo-tional attachment for the owner, the tolerance for intra-horizon drawdowns

-itive impact on the possibilities of the portfolio that are feasible or optimal for private wealth clients.

(5) LIMITATION ON DERIVATIVES. The seg-regated legal structure of institutional assets affords their use as collateral for non-delta-one derivative investments. In the private client world, trying to make such an arrangement for every single client account is cumbersome and limits the types of instruments that can be used to gain or hedge exposure in a private client portfolio.

(6) COST OF MANAGEMENT. The business model of private wealth relies on sourc-ing revenue from multiple points of

the total account, transaction fees for every trade or investment, wider bid–ask spreads, and a management and performance fee for investment prod-ucts. Because of the multiple levels of fees, private wealth assets must clear a higher hurdle than institutional assets (which don’t have these costs) to deliver a similar net-of-fees return.

(7) DIRECT STOCK HOLDING. Private clients have a bias in favor of direct holding of stocks rather than investment in funds. Although this bias is mostly emotional, a rational argument can be made for it. Directly holding a stock is appropri-ate if the objective is an absolute return (and a drawdown is acceptable), rather than holding a stock inside a fund (for which the objective is market-relative performance).

(8) THE BUSINESS MODEL. Private wealth has always had a service-oriented business model in which a critical

component is to include services from other parts of the bank in the asset structure. This kind of arrangement can take the form of using internally man-aged funds from the bank’s own asset management division or using “favored” external managers. Both approaches lead to incurring higher trading and implementation costs. In institutional asset management, the economic inter-ests of the client and asset manager are aligned toward minimizing fric-tional costs, but in private wealth man-agement, these interests diametrically oppose each other because higher imple-mentation costs are direct revenue for the asset manager. Furthermore, the fact that private wealth is a service business means that the relationship manager for the client is more central to all portfolio decisions than is the portfolio manager.

Given these eight structural differ-ences, a standard institutional invest-ment process cannot be directly imported to solve a private wealth problem.

INCUMBENT INVESTMENT

FRAMEWORKS

The traditional investment solution for private wealth assets was based on the concept of a 60/40 balanced portfolio, with some variations. The risk level of the portfolio could be varied to cater to the asset owner’s risk aversion, allow-ing for conservative and aggressive portfolio solutions. Based on this con-ventional framework, four investment approaches have been tried in private wealth. First, in decentralized portfolio management, each relationship team manages its portfolios independently. This approach dilutes investment uni-formity but brings the portfolio closer to the client. Second, in a core–satel-lite portfolio structure, every account invests in a single, core investment product that is internally managed. The remainder (or “satellite”) of an account is managed on an basis. A third approach is the core packaged set of internal funds, in which a core set of in-house investment products is used for all accounts but the account itself is

left to be managed by the relationship manager on an advisory or discretion-ary basis. Finally, with the standardized house view, a single investment view is recommended and implemented with different degrees of rigidity, depend-ing on the account mandate.

All four models fail to tackle the structural problems described earlier in this article. Moreover, they have the

-sion on the percentage of equity expo-sure in the portfolio, driven by a single investment process, dictates the success or failure of the portfolio. Given that market timing cannot be done sustain-ably, the portfolio is therefore always prone to failure at some point.

ALTERNATIVE INVESTMENT

FRAMEWORKS

three alternative frameworks offer the potential to address many of the chal-lenges in private wealth.

(1) A PRIVATE WEALTH MANAGER PLATFORM. Consider a private wealth platform in which professional fund managers make their full portfolio holdings avail-able on a live basis. Through the plat-form, clients would have the ability to invest in any of the funds or directly in the underlying assets of any fund. The fees should be the same, so the man-

as to the implementation choice. The client’s portfolio could be rebalanced according to the client’s choice or the bank’s advice (depending on the man-date), and the client could choose to

taken into account. Although portfolio holding replication would not be feasi-

funds and illiquid funds, this structure would solve a number of critical issues. It would allow full client customiza-tion, facilitate direct stock holding,

taken by a professional fund manager (yet leave the implementation control with the relationship manager), allow a single investment platform for advisory


The Decisive Advantage of DecisivenessOVERLOOKED SKILLS CAN HELP AN INVESTMENT MANAGER STAND OUT FROM THE CROWD

By Jason Voss, CFA

Some of the skills most investment man-agers look for are obvious. You proba-bly recognize these skills as necessary because they permeate the mythology of the investment business. Yet many of the critical skills needed for a suc-cessful investment management career are not taught in business schools, dis-cussed in the business press, or under-

Having hired research analyst interns, research analysts, a portfolio manager, and even my own successor when I retired from investment man-agement in 2005, I have gained a fair amount of knowledge about which skills separate you as an investment manager. Distinctive skills include such attributes as creativity and intuition, which were

If you would like to separate your-self from the crowd of highly motivated and highly intelligent candidates, try adding these to your arsenal of skills. In the second part of the series, I will

decisiveness, absolute versus relative decision making, and forthrightness.

DECISIVENESS

The difference between a research ana-lyst and a portfolio manager is that an analyst aims a gun but the burden of

on the manager. This difference under-scores not only the grave stresses that can come with responsibility but also the need for decisiveness in investment management.

I have worked with analysts whose experience in the investment business was greater than mine as a portfolio manager. Even so, when I would ask these analysts for their opinion about a business and a prospective investment in that business—“Would you buy at the current price?”—they would answer the question with loads more data. While

This article is adapted from an ongoing series of posts being published on the Enterprising Investor blog. To date, installments in the Skills That Separate You as an Investment Manager series have addressed the following topics: introspection (April), creativity (May), intuition (June), decisiveness (July), absolute versus relative decision making (August), forthrightness (September), discernment (October), and scaling (November). All posts in the series are available at blogs.cfainstitute.org/investor.

and discretionary clients, and reduce the bias toward in-house funds. This structure is already present in institu-tional asset management for large cus-tomized managed accounts (as well as in the alternatives world), where it facilitates greater transparency and better risk management. There seem

-

wealth asset management.

(2) A GROUP OF THEMATIC PORTFOLIOS. First-generation wealth creators often have

dynamics that are better articulated as trends or themes rather than as equity–bond allocation decisions or stock selec-tions. With this kind of client in mind, what if a private bank’s investment team were to create and manage trans-parent security portfolios that capital-

an advisory mandate, the client could choose the theme that seems likely to play out and allocate (and rebalance) assets accordingly. In a discretionary mandate, the bank portfolio manag-ers could take the allocation decision as well. This approach would offer three advantages. First, equity–bond allocation decisions would be taken at

multiple times and for differing reasons

client’s views would be incorporated while the investment team’s expertise still would be used. Finally (and most importantly), an implicit time horizon would be created for each theme, lead-ing to more realistic risk–reward trade-offs for the client.

(3)ALLOCATING TO CLIENT OBJECTIVES. Institutional allocation frameworks often begin with asset class alloca-tion (an approach also followed in pri-vate wealth), but several plan sponsors have a liability-driven investment (LDI) approach. Although the LDI framework cannot be explicitly followed in private wealth because there may be no spe-

by allocating to client objectives rather than to asset classes. Such objectives could include liquidity, yield to matu-rity, growth, short-term asset selec-tion, illiquidity premium, active allo-cation, and stable shareholding. Each

investment horizon and an inclina-tion as to the equity–bond decision. Again, although this framework may not solve all the problems of private wealth management, it could help align

the expectations of the client with the realities of the portfolio and allow the implementation of client objectives while retaining account control with the relationship manager, supported by the investment strength of the invest-ment manager.

PRACTICAL SOLUTIONS

Investment processes followed by pri-vate wealth need to improve to deliver better performance and risk manage-ment but must do so in a manner that does not compromise customization and service quality. I have proposed some potential solutions that would satisfy

private clients for their assets and also would enable the formation of portfo-lios with the institutional strength of investment decision making. Because these frameworks would be minimally disruptive to organizational structures, I believe these approaches are potential options for private banks to consider.

Pranay Gupta, CFA, has more than 20 years of experience in asset management. He is a member of the CFA Institute Research Founda-tion’s Board of Trustees and a visiting research fellow at the Centre for Asset Management Research and Investment at the National Uni-versity of Singapore.


VIEWPOINT

this response was sometimes helpful, it was, I think, an example of that most

paralysis. Their lack of decisiveness was shrouded in a cloak of data.

Analysis paralysis happens for several reasons. For starters, most analysts and portfolio managers have yet to realize or come to grips with one of the great les-

things that have occurred in the past, but investment results unfold in the future.

-sions are always leaps of faith. No fact can make a decision for you. First, you must come to grips with this reality.

Second, I have found that underneath the carefully constructed veneer of ana-lytical rigor that many analysts wear is a person out of touch with his or her emo-tional state. One way to overcome this problem is by using meditation because it can provide valuable insights into one’s emotional state and the underly-ing causes of emotional states.

Third, if you catch yourself in anal-ysis paralysis, try making decisions of less consequence under uncertainty as practice. Start with very small deci-sions and work your way up. For exam-ple, start by being deliberate and con-scious about what apples to buy at the grocery store and eventually advance to decisions with much higher stakes.

When I retired from money man-agement, I had the unique privilege of hiring my successor. He and I shared an

acquainted with the many choices I had made during my tenure as well as with my models. As you might expect, he asked numerous questions about my pro-cess, my relationships, and my choices.

All of the questions were of the knowledge-seeking sort until one day he asked me a very different type of

green earth are you doing that when you could be doing thisbig smile, and my successor immedi-ately apologized, saying, “I’m sorry, that was out of line.” I replied, “Quite the contrary, this is the moment I have been waiting for, and the fund is

now yours.” The transition was sealed -

ing and able to question my judgment.With that simple act of decisiveness,

the responsibility was his and I was able to quietly retire a couple of weeks later.

ABSOLUTE VS. RELATIVE

DECISION MAKING

A lack of decisiveness can be cured by the careful application of a medita-tion practice that leads to greater intu-itive insights. Your outward appear-ance becomes one of a person making “snap decisions” of the sort that Daniel Kahneman calls System 1 decisions. But inwardly, the architecture is entirely different. It is not prefrontal cortex vs.

waves vs. beta brain waves. In this way, your attunement to the environment around you allows you to make absolute decisions rather than relative ones—not always, mind you, but in cases

and the facts do not determine your answer.

Put another way, you do not need to reference data, other experiences, or consult others when making your decisions. Instead, you are able to make decisions because you have developed direct perception of the truth. This abil-

-ization of “the calculus,” which then took two years to describe mathemat-ically. The mathematical proof was for all of the rest of us, as Newton

.Of all the skills I have enumerated

in this series, this one is rarest. I have seen only a handful of people capable of making decisions of this quality. To be clear, I am not talking about the

-sion gun willy-nilly to take on the out-ward appearance of decisiveness. No, I am talking about the person that rou-tinely makes absolute decisions whose

-ably smart.

In the state of absolute decision making, judgment is purer and free of prejudices and the decision maker is seeing things others cannot see. We have all witnessed athletes “in the

zone” who make decisions absolutely that result in brilliant outcomes. Scien-tists like to poke holes in the hot-hand fallacy by looking at more extended sample sizes, but they do not take into account the self-reports of the athletes themselves who say that they are “in the zone.” Instead, scientists assume a constant state of mind in the athlete across the entire sample.

in dangerous situations also report sim-ilar experiences. Many of these types of heightened “in the zone” experi-ences are described in the book On

by Dave Grossman and Lauren Chris-tensen. Through meditation, people can develop the ability to tap this deep state of mental awareness in which people report seeing the spin of bullets caused

at them. Most importantly, in the state of heightened awareness, many report doing extraordinary things to avoid the

Times such as 9 March 2009, when the

are an example of when the ability to decide absolutely (from heightened awareness), rather than relatively, is critical to long-term outperformance.

of meditation for making decisions, I am not aware of another way to develop this skill set. On the other hand, self-con-fessed meditator Ray Dalio of Bridge-water Associates has said that any alpha he has ever generated is attributable to his meditation practice.

In my discussion of creativity in the November/December issue of CFA Insti-

(also available on the blog), I mentioned

my purchase of AES Corporation (AES). What I did not state then was that I pur-chased the majority of the shares on a day in which my trader at Lehman Brothers warned me against buying because it was a day when most of the market feared the company was going bankrupt. In fact, the trader pleaded with me, “Are you sure you want to buy more? You are the only bidder today!”


Behavioral economics folks will tell you that I only remember this story because it worked out for me in the end, that I have buried the pain of other failed “guesses” deep within my subcon-scious mind. But I keep an investment thesis for every business I do analysis on, including those that I do not buy. Further, at least quarterly, I review my decisions, even those I do not purchase and hence have no opportunity to sell. My records show that this instance was one of only a few times I ever acted in this way during my career. It was an absolute decision. AES had released appallingly bad news and appeared likely to go bankrupt, so the decision was not made relative to fundamentals.

My other decisions of this kind were purchases of Bank of America and Gen-eral Electric and a sale of Kmart. These decisions also turned out to be “cor-rect” decisions as evaluated by future market success or failure.

FORTHRIGHTNESS

You may have mastered all other skills necessary for successful investment management, but knowing and com-municating that you know something are entirely different skill sets. Trans-lating the insights of the right brain into language—a more linear form—takes tremendous skill. With this skill, investment professionals are able to

speak the truth of what they think and know in such a way that the often abstruse thought processes of invest-ment analysis are made clear for listeners, such as portfo-lio managers, chief invest-

of directors. Forthright-ness differs from honesty in that it insists that invest-ment managers speak the truth as they see it and vol-unteer their opinions with-out heavily filtering the message. When you consis-tently take this approach, decisions become easier to make because people seem to have an innate sense of the truth of your statements.

If you want to be more forthright and for your

words to ring with truth, try working with the following mental framework. Words are typically perceived as authen-

imagination, thought, word, and deed.

• is the “aha!” or “eureka!” quality that comes with true discovery.

• is inspiration combined with knowledge and experiences to

this as creativity.

• is the creation of architec-ture meant to make the initial inspi-ration and commensurate imagina-tion a structured reality.

• (as in “I give you my word”) is a meaningful commitment and responsibility to make real the orig-inal inspiration.

• is doing the hard work to make an originally intangible idea a tan-gible reality.

working together seamlessly, then mag-ical things can happen for investment managers. Such things include chang-ing the asset allocation of a portfolio, creating an ideal set of questions with which to pepper an intransigent busi-ness management so you get to the truth of a situation, developing a new way

of looking at all businesses that leads to new analytical insights, or divining what to write to your shareholders in your semiannual report so it conveys your true regret at a bad decision but doing so in such a way that you get to keep your job and restore trust.

As a part of the original job candi-

of my master’s thesis, in which I con-cluded that active managers outperform passive managers (contrary to popular opinion) so long as you use downside measures of risk and not measures of volatility in calculating Sharpe and Treynor ratios. During a subsequent in-person interview for that research analyst job, my interviewer turned to me and said, “You know, I think your thesis is a load of bull!”

I took a deep breath to dissipate my emotions and to center on some inspi-ration. Namely, I did not feel that my

inspired insight. Knowing what I knew

managers), I could not imagine that he had read the thesis. I then remembered

interview, he was on a conference call with a company and that he was then busy checking emails for a while, keep-ing our interview at bay. This was the “thought” stage of forthrightness. I also committed myself to challenge him on whether or not he read the thesis (the word phase) and then replied (deed phase), “I don’t think you read it all the way through, because it actually advo-cates strongly for the power of active management.”

Normally, the advice given to inter-view candidates is to be a shrinking violet and not to challenge the inter-viewer. In this case, however, my words resulted in the interviewer blushing and then saying, “Well, you are right. Why don’t you tell me what your thesis is about?” I eventually received a job offer, which I accepted. This is the nature of

abstruse layers of conversational and intellectual confusion.

Jason Voss, CFA, a former mutual fund manager, is a content director at CFA Institute.

Illu

stra

tion

by

Tim

oth

y C

ook


PROFESSIONAL PRACTICEPORTFOLIO PERFORMANCE

Impaired VisionINVESTORS IN IMPAIRED REAL ESTATE SEE A SILK PURSE INSTEAD OF A SOW’S EAR

By Sherree Decovny

As an alternative investment, impaired real estate isn’t a

opportunities. Moreover, investors can now participate in structured transactions than could potentially achieve high returns over a short time period.

Real estate is impaired when its fair value is less than the carrying value recorded on the owner’s balance sheet. Impairment can be caused by factors such as environmental or physical damage, weak rental demand, low occupancy rates,

pressure to offer concessions to tenants, a high number of leases due to expire, bank-ruptcy, and legal matters.

There is no scarcity of impaired properties, accord-ing to Brent Anderson, CEO at International Risk Group (IRG) in Littleton, Colorado. But investing in impaired real estate requires specialized technical, legal, financial, real estate, and risk man-agement expertise. Ander-son estimates that about 13% of the US commercial and industrial real estate market has some form of impair-ment, but only a small por-tion of properties will trans-

with investors to rehabilitate and sell them. Ultimately, value is created by taking a site that has perceived (and to some extent real) problems and returning it to productive reuse.

“Like all real estate, it’s got to have fundamental value, and a number of these properties have the wrong attributes for any potential redevelopment,” Anderson says. “They may

or their former use is not conducive to being repurposed for a future use.”

THE DRIVERS

The US real estate market is in recovery, but investment in impaired real estate is not driven by economic conditions. In good times and bad, there are typically good purchase

it comes to exiting the deal. That being said, other factors currently support the market for these properties.

One is reshoring activity in the US, particularly from the Far East. Companies that want to come to the US need a

transactions are driven by foreign companies that want to exit the US market and need to sell an impaired property.

Another factor is the desire to invest in green and sus-tainable projects and to address land scarcity. Impaired real estate may be reused in different ways. An environmental issue on the land can be cleaned up, the buildings on the property can be left in their existing state, and the property can be sold or leased. As an alternative, the buildings can be rehabilitated, sold, or leased, or they can be torn down. Some properties have excess land that can be developed. One advantage is that it is often possible to use the exist-ing infrastructure, including roads and sewer and power lines, to support the site instead of building from scratch.

Demographics also play a role, especially in the residential sector. According to a 2013 survey conducted by the Urban

-ment in the Digital Age,” 39% of respondents (all US residents) born during the 1980s and early 1990s said that they were city people. Furthermore, 14% live either downtown or near downtown, 34% live in a city neighborhood outside of down-town, and 13% live in a dense, older suburb. The demand is

locations, but the current owner can’t execute because they can’t solve an impairment issue,” says Adam Margolin, man-aging partner at Structured Finance Solutions in Denver, Colorado. “By dealing with the impairments, you can turn an unattractive, vacant piece of property into something useful as well as a revenue producer for the municipality. That in itself is of great value.”

THE RISK

The deal structures almost always involve multiple types of documents and relationships with an array of parties,

uncertainty and transaction costs. In addition to the tradi-tional buyer, seller, equity investor, and lender documents that go along with any transaction, documents must be sub-mitted to federal and state regulatory agencies. Depending on the deal, specialized insurance contracts and bonding documents may be necessary to protect against unknown environmental risks.

A lack of understanding of the market vernacular pre-vents some investors from identifying and taking advan-tage of good opportunities. Often, they are scared away by the term “impairment” because they conjure up images of polluted sites, costly cleanup jobs, and legal complications.

Investment in impaired real estate is being driven by reshoring, green/sustain-ability project activity, and demographic trends.

Cost overruns and extensions are key risks; environmental risk can be mitigated through specialized insurance and bonding contracts.

Impairment analysis, fair value determination, and tax implications are critical to the investment decision.

KE

Y P

OIN

TS


The perceived risk may differ from the reality. Impair-ments can be relatively minor. Certain risks are associated with every real estate deal. For example, building supply costs could increase, or the municipality or governmental entity may change its standards and building codes. Cost overrun risk in an impaired real estate transaction is typ-ically managed through due diligence and underwriting.

“The potential outcomes need to be measured in the con-text of the greater transaction. If half the cost of a transac-tion is environmental-related issues and you miss that by 100%, your deal is in serious trouble,” says Anderson. “If you have 10% of your cost involved in that and you miss by 100%, you’re going to be unhappy but you’re not going to be dead.”

In addition, the deal could take longer than expected, which is known as extension risk. Yet the potential high return associated with impaired real estate transactions may give them a distinct advantage over more traditional transactions.

“If the transaction takes longer than expected, cost over-runs will affect the IRR [internal rate of return],” Margo-lin explains. “But when you have higher IRRs and higher returns, you have much more latitude to deal with that kind of volatility.”

THE OPPORTUNITY

Not all investors are natural players in the impaired real estate market. Individual transactions tend to require an equity cap-ital investment ranging from $3 million to $20 million. Thus, they attract smaller institutions, real estate funds, foreign

-tion, density, zoning, credit enhancements, and risk in valu-ing real estate and that can execute quickly. These investors recognize that the market is tight

traditional property assets.Spreads in impaired real estate

transactions are as high as 1800–2000 bps over US Treasuries, Mar-golin points out. In comparison, the

real estate mezzanine transactions are currently about 800–1200 bps over Treasuries. Two of IRG’s recent deals have turned over and paid off in less than a year, yielding a triple-digit IRR. Generally, the company underwrites to a three-year holding period and aims to achieve a return of 20–22%, depending on the particular deal parameters.

It is possible to enhance the credit rating on a portfolio of impaired property assets using securitization and insur-ance. For example, the fact that the properties in the port-folio may be rehabilitated and monetized in different ways makes it more challenging to securitize impaired assets than commercial properties in commercial mortgaged-backed securities, for example.

to look at the characteristics of the property and due dili-gence work that has already been done to understand the risks and estimated returns. “There’s a certain amount of judgment involved in the impairment analysis and fair value determination, and there are various valuation approaches,”

Hughes Goodman in Tysons, Virginia. “One needs to know how the real estate that has been impaired is being used by its current owner to better understand the inputs taken into consideration in determining the level of that impairment.”

The fair value of the asset is judged based on its current use. The cost approach looks at the cost of both the land and the reconstruction of the assets on it. The relative sales value approach compares the impaired real estate to the selling price of similar assets in the market. The income approach, which is probably the most judgmental, looks at the income generated from the real estate asset over time.

It is also important to look at the tax implications, notes

estate practice. Real estate professionals may want to make an impaired real estate investment for future appreciation and use some tax losses up front. But Gilman warns against phantom income scenarios, in which the asset is generat-

the income. That income could be offset against other loss-making assets. Additionally, if the investor expects to make

and a day, the time needed to qualify as long-term capital gains. It might be worth paying the tax on phantom income

capital gains rates on the appreciation.

this asset class is not for everyone.“The most useful investment partner is one who is not

just looking to create value on a piece of paper but truly cre-ating some value on the ground,” says Anderson. “It’s someone who believes it’s possible to make a silk purse from a sow’s ear.”

Sherree DeCovny is a freelance journal-ist specializing in finance and technology.

“Bricks and Clicks,” CFA Institute Magazine (July/August 2014) [www.cfapubs.org]

“Cultivating Returns,” CFA Institute Magazine (September/October 2012) [www.cfapubs.org]

KEEP GOING

NOT ALL INVESTORS ARE NATURAL PLAYERS IN THE IMPAIRED REAL ESTATE MARKET. INDIVIDUAL TRANSACTIONS TEND TO REQUIRE AN EQUITY CAPITAL INVESTMENT RANGING FROM $3 MILLION TO $20 MILLION. THUS, THEY ATTRACT SMALLER INSTITUTIONS, REAL ESTATE FUNDS, FOREIGN INVESTORS, AND FAMILY OFFICES.


PROFESSIONAL PRACTICEANALYST AGENDA

Solar FlairIS SOLAR POWER ENTERING A NEW ERA OF INVESTMENT POTENTIAL?

By John Rubino

of cost cutting and innovation (largely fueled by subsidies from governments trying to move beyond fossil fuels), gen-erating electricity from sunshine is economically viable. And as solar power’s cost continues to fall, solar appears ready not only to participate in tomorrow’s global energy market

but also to lead it.According to a 26 October

2014 report by Deutsche Bank analyst Vishal Shah, solar is at grid parity (the point at which rooftop solar panels provide electricity as cheaply as the local utility under cur-rent subsidy regimes) in 10 US states. Over the next two years, says Shah, “solar has the potential to reach grid parity in 12 additional states. In those markets, we expect installed [solar] capacity growth of ~400%–500% within 3–4 years.”

And the US isn’t even the main growth story. China (because its energy needs and pollution problems are both immense) and Japan

(because its commitment to nuclear power culminated in the Fukushima disaster) are poised to lead the world in solar installations through the balance of the decade.

Extrapolating today’s near-parabolic trend out to 2050, the International Energy Agency now predicts that solar’s share in the global electricity market will rise from the current 1% to 26%, making it the world’s single largest energy source.

Three developments have been key for solar’s sudden

changing customer behavior. First, as to costs, solar power keeps getting cheaper. “In recent years, the main focus has been on reducing costs,” says Treasa Ni Chonghaile, port-folio manager with Bethesda, Maryland–based Calvert Global Alternative Energy Fund. “They’re using less silver in solar cells, for instance, and developing better invert-ers [which convert DC current from solar arrays into AC current that can power appliances].” She predicts that the likely result will be a further 10% drop in solar panel pro-duction costs in 2015.

Even bigger savings are being realized in “balance-of-system costs,” such as installation, says Edward Guinness,

portfolio manager of London-based Guinness Atkinson’s Alternative Energy Fund. “A few years ago, the modules were more than half the total cost of a system, let’s say $4 per watt [of generating capacity] for the module and $8 for the installed system. Now the module is $0.60 and in Europe the installation costs another $0.60–$1.00. Best prac-

lowering the cost of capital. System installers, such as Solar-City and Vivint, offer to build and maintain solar arrays on homeowners’ rooftops in return for lease or loan payments that are typically less than current utility bills. The installer then sells these income streams to securitizers who bundle them—just like mortgages or credit card balances—into asset-backed bonds and sell them to institutional investors.

Meanwhile, “yieldcos” have emerged that own solar farms

approach is similar to the model used by real estate invest-ment trusts (REITs) for commercial property or by master limited partnerships (MLPs) for gas pipelines. “Yieldcos are driving the cost of capital down and creating a visible benchmark for other sources of capital to come in at attrac-tive prices,” says Guinness.

Finally, customers are noticing the past declines in module costs. “This is an ocean liner beginning to respond to the price points for modules that have already been reached,” says Guinness. “Many countries are waking up to the poten-tial of solar, and [as they expand their installed base] much fat is being taking out of the non-module piece. The differ-ence between the cost of installation in China and Germany versus the US or the Middle East is huge.” So, increasing demand begets economies of scale and lower prices, which ramps up demand even further.

Add it all up, and “the cost of producing electricity with solar will continue to decline while the cost of other energy sources goes up. I’m hopeful that we’ll see grid parity in a majority of markets by the end of the decade,” says Chonghaile.

SPEED BUMPS AND COMPLICATIONS

Soaring demand, although far better than the alternative, does not market nirvana make. There are always potential com-

MARGIN COMPRESSION. Falling prices and fast growth are great for generating sales but can be problematic for earnings. “Many of the [solar panel makers] that were used to higher margins are having to absorb lower markups and narrower margins,” says Pavel Molchanov, energy analyst with Tampa, Florida, brokerage house Raymond James & Associates.

The International Energy Agency has predicted that solar energy’s share of the global electricity market will rise from 1% currently to 26% by 2050.

To benefit from this trend, investors will have to avoid a variety of pitfalls, from margin compres-sion to shifting government policies.

Despite difficulties, “this is a story that will become more rather than less com-pelling over time,” predicts one analyst.

KE

Y P

OIN

TS


Installers tend to book the costs of customer acquisition and system construction up front and accrue the result-ing revenues over time. SolarCity, for instance, generated 20% higher revenues year over year in 2014’s third quar-ter but saw its operating expenses rise by 119%, produc-ing a substantial loss.

Chonghaile. “The strongest panel makers will be those that eke out the most power from every panel and participate in the fastest-growing markets.”

Chinese panel makers boast the industry’s lowest pro-duction costs. And given their home country’s solar ambi-tions, they’re positioned perfectly. “A lot of China’s tier-1 manufacturers are at full utilization and can’t keep up with local demand,” says Chonghaile.

CONSOLIDATION. Most parts of the solar ecosystem are highly fragmented and thus ripe for a wave of M&A as stronger

to roll up (or over) weaker competitors, notes Chonghaile.Ditto for the installer market, where “the companies with

the necessary scale to facilitate tax equity funds, asset-backed securities, and economies of scale in a post-ITC [investment tax credit] environment gain market share,” observes Shah.

CAPACITY CONSTRAINTS. “The Chinese government is acting like an OPEC, not allowing its solar companies to build new manufacturing capacity unless it comes with mean-

adding new plants, the Chinese companies are upgrad-ing and improving what they’ve got.” Other things being

risks turning glut into shortage, temporarily constraining sales growth.

UNPREDICTABLE REGULATIONS AND SUBSIDIES. Despite the approach of grid parity, this is still a market in which subsidies and trade barriers play huge and occasionally decisive roles. The US recently imposed antidumping duties on Chinese solar modules, and Japan is rumored to be considering cuts in its perhaps overgenerous subsidy regime. And the US Solar Investment Tax Credit, which shaves 30% from the upfront price of a solar array, is due to expire in 2016, effectively raising the cost of solar power by nearly a third.

So, even as solar panels become commodities and bal-ance-of-system best practices become the norm, geogra-phy still matters. The companies headquartered in markets where demand is growing fastest or subsidies are most gen-erous will continue to have big advantages.

FLUCTUATING FOSSIL FUEL PRICES. In late 2014, the price of oil plunged by nearly 20%, which spooked the energy market in general and con-tributed to a painful correction in solar equities. Not to worry, says

price of electricity. The econom-ics of solar have zero connection

to oil in North America and Europe and only a very tenu-ous one in Japan.”

Coal is a different story and could, by declining in price, delay solar grid parity in many markets. But fossil fuel price volatility also works in solar’s favor because sunshine is always free and solar panel long-term costs are well under-stood. As a result, solar farms “are very stable, predictable assets,” says Guinness. So, even where solar is a bit more expensive than coal, solar power’s predictability could make it attractive on a risk-adjusted basis.

In any event, as solar becomes ubiquitous, it will begin

markets, displacing fossil fuels and limiting their pricing power. “Solar puts a ceiling on where electricity prices should be able to go,” says Guinness.

THE STORAGE SPEED BUMP. Solar appears to be guaranteed a great few years. After that initial period, however, “a hurdle pops up,” says Molchanov. Because solar is an “intermittent” source of electricity that works only when the sun is shin-

problem might limit solar’s long-term growth prospects.“This point is a ways away in markets like the US, where

solar has a less than 1% share. But in Germany, where it’s 8%, [potential grid destabilization] is a big deal,” says Mol-chanov. “By the end of the decade, there will be many coun-tries where solar is above 10% of the electricity mix, and at that point, it will be vital for the industry to develop cost-effective storage solutions.”

Consequently, one key to mainstreaming renewables is a battery capable of storing excess power during the day and then feeding it to the grid at night, effectively convert-ing intermittent technologies like solar and wind into much more attractive “baseline” power sources.

“Right now, the emerging battery market is dominated by big, familiar names,” says Chonghaile. “Samsung and Panasonic are each developing battery types, some focus-ing more on the automobile market and some on renew-ables themselves. Siemens has a battery that can be used for wind power. Johnson Matthey in the UK is buying up various battery tech companies. They’re each making big strides.”

LONG LEGS

Nothing is guaranteed of course, but if the right pieces—including cheap capital, continued cost reduction, favorable government policies, and viable storage solutions—fall into place, solar’s current momentum appears to have very long legs indeed. “This is a story that will become more rather

than less compelling over time,” says Guinness.

John Rubino, a former financial analyst, is author of The Money Bubble.“Global Energy: The Private Equity Opportunity

of the Century,” summarized in CFA Digest (October 2014) [www.cfapubs.org]

“The Global Impact of the U.S. Shale Energy Boom,” CFA Institute Take 15 Series (17 April 2013) [www.cfainstitute.org]

KEEP GOING


PROFESSIONAL PRACTICEPRIVATE CLIENT CORNER

The Accidental Optimization BoosterSOCIAL SECURITY BENEFITS CAN HAVE SURPRISING VALUE FOR WEALTHY CLIENTS

By Ed McCarthy

--

tainly sensible for most retirees to maximize what they can earn from the system, but does it matter to the very wealthy?

Consider the example of one such client who easily

Charles Bennett Sachs, CFA, with Private Wealth Counsel in Miami, Florida, learned that the client had decided to start his Social Security

(without consulting Sachs), he asked why. The client cer-tainly didn’t need the extra income, and wasn’t he con-cerned that early claiming probably wasn’t the optimal decision?

That’s when Sachs learned that his client viewed the

an extra thousand dollars or so that “popped” into his account each month, and he

enjoyed “blowing it.” That attitude didn’t completely sur-prise Sachs, who notes that at some point the extra monthly

Security is just a complete non-issue,” he says. “It doesn’t make or break or change one iota one way or the other.”

Sachs doesn’t tell clients to waste the money, but he does

may help clients in other ways. Wealthy clients have usu-ally been good earners and savers. Their attitudes toward money can lead them to delay activities and continue saving,

-lems arise. Consequently, he often must push them to enjoy life and do things sooner rather than later. Claiming Social

-tus. “They get that extra $1,000, $1,500 in at age 62, [and] maybe they’re going to build that up for a great travel fund,” he says. “Maybe they’re going to go and enjoy things.”

IT MATTERS FOR MOST

As Sachs points out, at some income level the retirement

-lent of pocket change to the recipient. But according to the other advisers interviewed for this article, that attitude is uncommon among their wealthy clients. Helen Huntley, with

-

between $1 million and $4 million. In her experience, the extra income from optimization matters to that cohort. “If you’re talking about somebody who is [mega] wealthy, then it probably doesn’t make any difference,” she says. “But for typical people who are hoping to spend a good bit of money, like a couple hundred thousand a year, you’re talking about more than 10% of that amount coming from Social Security. So, I don’t see that that would be considered negligible.”

The numbers support that attitude because the potential cumulative lifetime difference between optimal and subop-timal claiming strategies can be substantial, says William Reichenstein, CFA, at Baylor University in Waco, Texas. “So, I don’t care if you have a billion dollars, you’ve got an asset out there that, if you work it right, can be worth $200,000 more instead of less,” he says. “It ought to be something that everybody is interested in.”

Some retirees also have emotional reasons for pursuing optimization strategies. Harli Palme, CFA, with Parsec Finan-

older clients, no matter how wealthy, have experienced 14 years of investment market volatility. As a result, they’re still a “little gun shy” and want their money to last in an unknown future. Her experience has been that retired clients actively seek to maximize guaranteed incomes like Social Security because they know that investment results are variable.

A sense of fair play is another frequently cited reason, as some wealthy taxpayers believe they have paid more than enough to the government and want a payback. Jim Dew, president of Dew Wealth Management in Scottsdale, Ari-zona, says that among his retired clients, there is a strong feeling that “they put money into this program and they want to get their fair share out.” Clients are pleased to learn about optimization strategies.

There’s also an element of pleasant surprise at receiving money from a system that many boomers assumed would be bankrupt by now. Dew notes that in the late 1970s and early 1980s, advisers and clients often deliberately omit-

-jected income sources on that assumption, particularly for baby boomers. Subsequent changes to the program have extended its projected lifespan, however, and the bene-

-cial asset as well.

Although Social Securi-ty’s retirement benefits are only a small fraction of wealthy retirees’ incomes, most advisers report cli-ents are interested in bene-fit optimization.

In some cases, an optimized strategy can provide a mar-ried couple over $200,000 more in lifetime benefits compared with a subopti-mal strategy.

Research shows that most retirees, including most sin-gles, benefit from delay-ing the start of their Social Security retirement benefit.

KE

Y P

OIN

TS


PLANNING STRATEGIES

-late large amounts in tax-deferred retirement plans. Once the clients reach age 70½, required minimum distributions

-cial, has found that it’s often advantageous for those clients

withdrawals from their retirement plans before RMDs are required. The delayed start opens up optimization strategies, and when combined with other techniques, such as Roth IRA

“By doing that [conversion] and combining it with deferred Social Security,” he says, “you’re not only growing your Social Security at 8% a year but you’re also going ahead and tax-

will have to eventually come out of your IRA or 401(k).”Securing a higher guaranteed income for retired clients

reduces the required rate of return from the portfolio as well, according to Johnson. Some clients respond to that change by reducing their portfolios’ volatility. Others, such as those investing for a legacy, may feel more comfortable taking on more risk in search of higher returns because their required rate of return is lower.

EARMARKS

a couple that arranged to donate their optimized retire--

tractual gift, but the charity was pleased with the arrange-ment because it provides a reliable monthly contribution.

In another case Dew handled, clients who owned a busi--

bined estates were worth about $20 million. They wanted liquidity in the estate to help their heirs with estate taxes and to avoid being forced to sell the business. The clients were also interested in helping a grandchild pay for college.

Both spouses were high earners and willing to delay col-

be over $6,000. They agreed to earmark $4,000 of their

insurance policy that is owned by an irrevocable life insurance trust.

plans to use the remaining $2,000 per month to help with their grand-son’s college room and board.

Johnson also cites a case in which the higher income resulting

-ents’ estate plans. In this instance, the clients decided to invest the

additional income in a Roth IRA that named a three-year-

contributions can grow to a substantial amount.

RUNNING THE NUMBERS

The analytics behind claiming schemes are complicated, which is why many retirees opt for simple approaches, such as the breakeven calculation. Despite the complexity, there are several key factors advisers and retirees, particularly married couples, should consider, says Reichenstein, a co-developer of the Social Security Solutions software. These include the ratio of the spouses’ two primary insurance amounts (PIAs), their relative ages, and the life expectancy of the high-PIA spouse and low-PIA spouse.

-

--

ees, including most singles. Sita Nataraj Slavov and John B. -

ing the impact of mortality, program rules, and interest rates.

changes have made delayed claiming more advantageous

They conclude that with real rates close to zero, most households, including those with higher-than-average mor-

“At real interest rates closer to their historical average, delay is not actuarially advantageous for single individuals with

married couples, primary earners with above-average mor-tality can gain from delay by passing on a higher survivor

Optimization strategies must evaluate multiple claiming strategies over potential starting dates between ages 62 to 70 for both married couples and single retirees. The permu-tations quickly create a very bushy decision tree. Reichen-stein says that he once calculated there were over 70,000 claiming strategies available to a couple with an age dif-ference of four years.

The advisers cited in this article use different tools for the

in-house spreadsheets or use free or low-cost web-based tools. Another option is to use one of the growing number

of commercial planning programs, such as Reichenstein’s Social Secu-rity Solutions. Although the tools being used vary, the general con-

-ent, wealthy clients are interested in and appreciative of efforts to

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

John B. Shoven and Sita Nataraj Slavov, “When Does It Pay to Delay Social Security? The Impact of Mortality, Interest Rates, and Program Rules,” NBER Working Paper No. 18210 (July 2012): www.nber.org/papers/w18210.

John B. Shoven and Sita Nataraj Slavov, “Recent Changes in the Gains from Delaying Social Secu-rity,” NBER Working Paper No. 19730 (August 2013): www.nber.org/papers/w19370.

KEEP GOING


PROFESSIONAL PRACTICEPRIVATE CLIENT CORNER

What Have You Done for Me Lately?DEMONSTRATING ADDED VALUE TO CLIENTS IS A CONSTANT CHALLENGE

By Ed McCarthy

by emerging low-cost advisory services and robo-advisers. One frequently cited reason for the perceived lack of a threat is that those business models can’t match the breadth and depth of services that wealth managers provide.

But what if clients fail to grasp just how much work a wealth manager does for them? Consider what the

-lio with relatively low turn-over, periodic performance reports, occasional emails and phone calls, and a hand-ful of in-person meetings for scheduled reviews or special circumstances.

The adviser knows that the client-facing activities are only the tip of the iceberg and that a great deal more ana-lytic and support work takes place, but clients aren’t nec-essarily aware of that back-ground work. “I don’t think many of them have any sense for everything else that’s going on behind the scenes,”

says John K. Mell III, CFA, wealth manager at Wetherby Asset Management in New York City. Ironically, the ones

new clients because those clients are most likely to recall introductory in-depth presentations on what Mell calls the “non-client-facing work.”

Rectifying that lack of understanding is the adviser’s responsibility, not the client’s, according to Greg Friedman, founder and CEO at Private Ocean in San Rafael, California.

“The rest of the time they probably think you’re at the beach or you charge too much or it’s not that hard [to be a wealth manager],” he says. “So whose fault is it that the client doesn’t know what you’re doing?”

WHY IT MATTERS

The need to demonstrate added value for professional ser-vices isn’t immediately obvious when people seem satis-

doctor was doing enough to merit your business and justify

his fees? But unlike investment advisers, doctors aren’t always competing directly with other doctors for patients. The wealth management environment is very competitive,

value-add,” says Friedman.The need to explain the added value can result from inter-

its fee schedule several years ago. The services didn’t change. -

pricing its services. As a result of the change, some clients began questioning their fees and Wetherby responded in several instances by providing more detailed tracking of the work performed for the client. “We’d try to keep an activity list, high-level things that we were working on for them, things that had been accomplished, and a running list of all of the things that we were working on,” he says. One challenge was to monitor the work done for a client while avoiding excessive tracking. The goal, Mell explains, was to “demonstrate all of the non-investment, non-client-fac-

-ning side or even on the investment side.”

STARTING EARLY

Determining how much detail about supporting work to

presented also matters. Clients probably won’t appreciate a self-aggrandizing presentation. “Nobody wants to hear, ‘I’ve been wonderful, aren’t you happy with that?’” says Charlotte Beyer, retired founder of the Institute for Private Investors and author of .

Beyer believes that the discussion about added value should start with prospective clients as part of the busi-ness development cycle. During that stage, the parties can

tolerance in an attempt to reach mutual agreement on the relationship before it is formalized. Going through those steps is a natural way for the adviser to show the client how much work goes into the relationship and client services.

Gavin Management Group in Toronto follows this approach by providing clients with a service agreement that lists all the

-ing to Matt Bacchiochi, CFA, portfolio manager at Gavin,

-ents all the services it will deliver and how it will be paid

-ers walk through each item in the agreement to discuss the

Clients are often unaware of the work wealth managers do on their behalf.

When clients are uninformed about advisers’ services, the lack of knowledge can reduce the value they place on the advisory relationship.

Giving clients a compre-hensive picture of pro-vided services can raise their appreciation of the value added by their advis-ers, but advisers should avoid the appearance of self-promotion.

KE

Y P

OIN

TS


LLBH Private Wealth Management in Westport, Connecti-cut, also begins explaining its value-add to new clients. Accord-

spends numerous hours learning about the client’s situation and goals. Staff members then meet with the clients to show what they are going to work on in the applicable areas. The

the goals that they’ve given us and we’ve worked out together, and we check them off as we go,” says Pratt-Heaney. “Every time we meet with them we present this book, which is a compilation of everything that we’re working on.”

OPENING UP THE BOX

Advisers use a variety of methods to show clients what they do behind the scenes. The goal, says Friedman, is to “open up the box” and give clients a look behind the scenes. In some cases, he has used his client relationship management soft-

can run more than 40 pages for a year, and when he brings it to the client meeting, it makes an impression. “Now that is a really powerful message with visual cues and the whole bit, where they’re just like, ‘Wow, I had no idea,’” he says.

Client meeting agendas, particularly for annual review

work. Besides reviewing completed projects, the agenda can introduce new projects and ideas. It’s about “planting the seeds” for ideas and then building the timeline to accom-plish each project. When clients see an idea move from con-cept to completion, Mel explains, “they know all the back-

to reach the endpoint.

on advisers’ efforts. Bacchiochi cites the example of clients using Gavin’s real estate purchase advisory service. Many

wish to buy a home, their involvement with the transaction often ends after they view a property and agree to buy it. From that point, Gavin’s staff takes over and completes the deal. “That gives us an opportunity to say we dealt with the real estate agent on this, we arranged the general insurance for this, we talked to the title company for this,” he says. “That allows us to show them some value in that context.”

Clients can underestimate what’s involved with manag-ing their portfolios. For example, Thomas Balcom, founder of 1650 Wealth Management in Lauderdale-by-the-Sea, Flor-ida, uses customized structured notes in clients’ portfolios. The investment process involves soliciting bids from 6–10 differ-ent banks before deciding where to invest clients’ funds. But clients initially don’t realize that they can’t directly access notes with simi-lar terms—that accessibility is a

commentary to review its activities

involving structured notes and other research work it pro-vides in managing clients’ portfolios.

STEPS NOT TAKEN

not taken in managing their wealth. Private Ocean reviews possible tax-related trades in each client’s account at year-

still important to share that result with the client. “We will notify the client and say we looked at this on your behalf and determined that this strategy wouldn’t work,” he says. “That’s an extra burden. It’s an extra activity, but it’s also a communication saying we thought of you, we looked at this for you, we put energy into it and decided it wasn’t the right strategy for you.”

Mell sometimes takes a similar approach. In some cases, a time-consuming analysis for the client can lead to an active decision to do nothing. If clients aren’t informed about that work, they won’t value it. For example, client meetings often focus on investment portfolios and the dis-cussion covers current status, possible changes, and steps not taken. “We do have to highlight both the things that are going to cause action and the things that may actually cause inaction, which is still an active decision and is kind of hard to always demonstrate,” he says.

THE PAYOFF

Without exception, the sources interviewed for this article report that clients’ perception of an adviser’s added value

This knowledge boosts satisfaction, retention, and referrals. Admittedly, there is a risk that the “wow” factor diminishes over time as the service baseline moves higher. The “what have you done for me lately?” attitude can emerge, and advis-ers must work to overcome this diminution. “We have to con-

-ing things that we have or haven’t talked with our clients about in a little while,” says Mell. “Even things on the to-do list that have been accomplished two-and-a-half years ago,

three years ago, maybe it’s an oppor-tunity to revisit them. Has anything changed? Is there a different set of factors that would make us behave differently or give a different recom-mendation? We have to constantly demonstrate our value.”

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

“Investment Professionals and Fiduciary Duties,” Research Foundation Literature Reviews (September 2014) [www.cfapubs.org]

“Putting Investors First: Positioning Wealth Management Firms to Understand the Client Base of the Future,” CFA Institute Webcast (September 2014) [www.cfainstitute.org]

KEEP GOING

A TIME-CONSUMING ANALYSIS FOR THE CLIENT CAN LEAD TO AN ACTIVE DECISION TO DO NOTHING. IF CLIENTS AREN’T INFORMED ABOUT THAT WORK, THEY WON’T VALUE IT.

THE BREACH

To protect financial data,

firms must become more

resilient and learn how

to respond to attacks

“because they’re not going

away,” says cybersecurity

expert Bruce Schneier

ONCE MORE

UNDO

By Nathan Jaye, CFA

Are organizations taking the threat to

cybersecurity too lightly?

Many are. Some of it is not understanding the contours of the threat, but a lot of it is a funda-mental psychological bias. We tend to be risk seeking when it comes to losses, which means that we are likely to take the chance that we won’t be attacked—rather than spend to pre-

from the point of view of the person in charge of network security at an organization. If he

underspends, he saves the company 10% of his budget and he’s a hero. If he’s unlucky and his company gets whacked, he can always get another job elsewhere.

Recently, we’ve seen the phrase “too big to

secure.” What do you make of it?

It’s less the size and more the complexity. Com-plexity is the worst enemy of security, and com-plex systems are much harder to secure. Spe-

-plex systems are much harder to secure, and that describes computers, networks, and pretty much all technological systems.

Are larger firms naturally more complex?

Not really. They can be more complex, but they don’t have to be. What matters is how they’re organized, how different parts of them can affect each other and society as a whole, and so on. They might be more fragile because of what they do and the role they play in our econ-omy, but that’s a different question.

How can organizations move toward

simplicity?

Think resilience. If nonlinear, tightly coupled complex systems are more dangerous and inse-cure, then the solution is to move toward more linear and loosely coupled systems. This might mean simplifying procedures or reducing depen-dencies or adding ways for a subsystem to fail

After the online breach of JPMorgan Chase, cybersecurity

exactly is cybersecurity (and cybervulnerability)? What can or cannot be done to make sensitive information more secure? A leading computer security and privacy expert, Bruce Schneier is one of the world’s most recognizable voices on cybersecurity, author of the popular security blog , board member of the Electronic Frontier Foundation, and CTO of Co3 Systems. His new book,

, will be published in Feb-ruary. In a straight-shooting interview with

, Schneier discusses detecting and dealing with breaches of client data, the possibility of an attack on

answers when questions of security arise.



gracefully without taking the rest of the system down with it.

A good example of a loosely coupled system is the air traf-

-plex, but individual failures don’t cause catastrophic failures else-where. Even when a malicious insider deliberately took out

Chicago, all the planes landed

disruptions, but they were isolated in both time and space.A counterexample might be the national power grid a

decade ago. In 2004, a single failure resulted in the entire Northeast of the United States and southeastern Canada losing power. That’s because the system was so tightly cou-pled. In the decade since then, the power grid was rede-signed to be more resilient to failure. Companies need to learn from these examples and make their computer net-works more resilient.

The US Treasury Department has spoken of bolstering

fortifications around outside vendors to financial

institutions, including law firms and marketing firms.

Are those really the weak points? Will this be effective?

Those are certainly some of the weak points, and perhaps the Treasury Department has some detailed information to indicate that those points need shoring up. As to whether it will be effective or not, that requires a lot more detailed information about the systems than I have.

You’ve written that a motivated, funded, and skilled

hacker will always get in. So, what can be done?

Again, think resilience. Security is a combination of preven-tion, detection, and response. All three are required, and none of them are perfect. As long as we recognize that—and build our systems with that in mind—we’ll be OK.

This is no different from security in any other realm. A motivated, funded, and skilled burglar will always be able to get into your house. A motivated, funded, and skilled murderer will always be able to kill you. These are realities that we’ve lived with for thousands of years, and they’re not going to change soon.

What is changing in IT security is response. The 1990s -

walls and antivirus systems. The early 2000s were the decade of detection, with intrusion detection systems and managed security monitoring. This is the decade of response. We’re all going to have to get better about IT incident response because there will always be successful intrusions.

What about smaller financial firms that lack

the resources to secure their systems?

Lots of companies won’t have the resources to secure their own networks, and they’re going to have to get used to outsourcing. This isn’t

anything new. We’re already outsourcing our data to the cloud, and a lot of our applications to network providers. We’re already outsourcing mission-critical corporate respon-sibilities, like HR, payroll, and legal. IT security is going to look more like that.

The trick here is to know what can be outsourced and what can’t be. A company might be able to outsource the more technical aspects, but it’ll always need to have an inci-dent-response team in house because so many aspects of incident response are nontechnical.

My own company, Co3 Systems, builds coordination software for incident response. It’s built for a technical IR

from legal, PR, corporate, and so on to be part of any inci-dent response. And the system is scalable, so both large companies, like JPMorgan, and much smaller companies

Are there security best practices that can be used?

-oped some pretty robust best practices. The problem is that IT security is a constantly moving target, and what were best practices two years ago might not be the best things to do any longer. Too often, “best practices” are little more

Bruce Schneier

Illu

stra

tion

by

Kelly

Ald

er

Ph

oto

by

Geo

ffre

y S

ton

e


than a liability dodge, allowing companies to basically say, “We didn’t know what to do, but we’re doing what every-one else is doing, so please don’t sue us.”

What about security risk assessments or checklists?

There are lots of security risk assessments and checklists out there. While they’re valuable and have their place in any defensive system, they’re naturally limited. So many of the most successful attackers out there do things that aren’t on the checklist.

One of my worries is the tendency of the media to sim-plify IT security. It’s not a matter of “six things you must do today to secure your network” or “the seven habits of highly effective network security professionals.” In security, the devil is in the details, and those details matter a lot.

What is your book Data and Goliath about?

Fundamentally, it’s a book about surveillance and what to do about it. I tackle both government and corporate sur-veillance—the NSA and the FBI as well as Google and Face-book. I describe the types of surveillance that’s going on, mostly on the internet but off it as well. I talk about the harms of this surveillance, on a variety of different levels. And I give solutions—for governments, for corporations,

book, and I wrote it for a general audience. I’m hoping it goes mainstream.

What could someone working in security at a financial

services organization learn from your book?

On the surface, the book isn’t aimed at security profession--

ferent from someone with a different job.” But when you

think about it, people who work in IT security spend their time defending their employers’ data from attackers of all kinds. Understanding how those attacks work—who is after your data, what they do with it once they get it, and the policy debate that will underpin how we protect it—is vital to crafting good defenses. So, I hope that people who work in IT security will come away with a better under-

-cal society we all live in.

For example, we’re seeing a lot of government espionage against nongovernment targets. The Chinese government spends a lot of time attacking US corporate networks. Stux-

other networks around the world. And so on. Increasingly often, innocent corporate networks are collateral damage of these continual nation-state offensive actions in cyberspace.

Financial services firms getting caught in the crossfire—

is that the dominant theme?

It’s not the dominant theme, but it’s an important theme. Decades ago, government and corporate networks were sep-arate. Foreign and domestic networks were separate. Mil-itary and civilian networks were separate. Today, they’re all one thing.

How do organizations know whether they have been

breached?

Sometimes, it’s obvious—the attackers did something to make themselves visible, or the organization mysteriously had $100,000 transferred to a bank account in Eastern Europe. Other times, the organization never knows. In many

during an audit of some sort.

Recent Data Breaches of Financial Organizations

YEAR COMPANY RECORDS LOST DETAILS

2014 JPMorgan Chase 76 million Beginning in June 2014, hackers stole names, addresses, phone numbers, and emails of account holders from the United States’ largest bank. Hackers compromised more than 90 of the bank’s servers, obtaining highest-level administrative privileges.

2014 Korea Credit Bureau 20 million An employee of the Korea Credit Bureau (KCB) was accused of selling customers’ names, social security numbers, and credit card numbers to phone-marketing companies.

2014 European Central Bank unknown Personal information was stolen from servers of the European Central Bank (ECB), which received an anonymous call requesting money in exchange for the stolen data.

2013 NASDAQ unknown NASDAQ OMX Group’s community forum website was breached, compromising email usernames and passwords.

2013 Citigroup 150,000 Personal information of bankruptcy consumers was exposed after the company failed to properly redact online court records.

2013 7-Eleven, JC Penney, Hannaford, Heartland, JetBlue, Dow Jones, Euronet, Visa Jordan, Global Payment, Diners Singapore, and Ingenicard

160 million Cybercriminals stole 160 million credit and debit card numbers and targeted more than 800,000 bank accounts over an eight-year period.

2012 Iranian banks 3 million A software manager hacked 3 million bank accounts in at least 22 different banks after his report to the banks’ CEOs detailing vulnerabilities was ignored.

Source: www.informationisbeautiful.net.


This is part of what makes incident response interest-ing. The response begins after the incident occurs, but it could be immediately after or it could be months after. If the organization is good, response happens while the inci-dent is going on and the attackers are kicked out of the net-work in real time.

Have you thought about the possibility of a breach of

the financial markets themselves?

There’s always the possibility of a breach of any network. -

kets themselves, though. That system is complex enough that the breach will be a particular piece of the system that runs the market.

Regarding the JPMorgan breach, have you speculated

on the motivation?

I haven’t seen the details, so I don’t know. Motivations

ones. Some attacks are random—the attackers want a big pile of credit card numbers and they don’t care where they get them. Others are targeted—the attackers want some

unusual to have no idea what the motivations of a partic-ular attacker are.

What’s your advice on passwords?

I wrote an article on passwords on my blog that summa-rizes my advice. Basically, choosing a password that is (1) easy to remember and (2) hard for a computer to break is very, very hard.

Do we need a certain mindset for good security?

a certain way of thinking about the world in terms of how

some people naturally think this way. They can’t walk into a -

lift. They can’t use an online service without noticing all the ways they could cheat. They might not do any of those things, but they’re continually thinking about them. I wrote an article on this topic in 2008.

I can always train people in the technical aspects of this security system or that security system, but it’s much harder to train the security mindset.

What’s your insight on the future of security and

vulnerabilities?

I expect the future to look a lot like the past. While the details of IT security and vulnerabilities change all the time, at a macro level nothing has changed in a long time. The attacks and defenses we’re seeing today are just extensions of what we’ve been seeing for years.

The main thing I see changing in the near term is how we approach response. I do believe that this decade will see qualitative changes in how organizations deal with incident response.

Is there room for ephemeral data in organizations?

It’s an odd question. Ephemeral data—data that is erased and not stored—has been the norm for most of human his-tory. Keeping data was the exception, and sometimes it was

everything doesn’t mean that we should. The best way to secure data is to erase it. If Target Corporation or Home Depot didn’t save all that customer data, they wouldn’t have been the victims of such massive data thefts.

Could financial firms begin to implement policies for

ephemeral data?

invented centuries ago, most of the data they’ve invented has been ephemeral. It’s only recently, as the cost of data storage has become so cheap, that they’re saving everything

At this point, I think it is essential for organizations to look at the data they’re saving and decide if they really need to save it or not. Saving data brings with it risks—costs much greater than the price of storage—and organi-zations need to understand those risks.

If you were building security for an organization from

the ground up, how would you begin?

I would hire someone who knew how to build a security organization from the ground up and then tell him to do it. Building a security organization is hard and not something I would take lightly. It also isn’t my expertise, and I under-

I can’t just pick it up as I go.One of the most important things is to understand that a

security organization isn’t going to be world class from day one. There’s a maturity path that any security organization needs to walk, and that takes time. It also takes money and a senior management team that understands its importance.

Do we need more open discussion of security issues?

There is a lot of open discussion already. Do we need more of it? I don’t know. There is a lot of it going on. I need to be

could solve something.

Is cybersecurity getting more attention than before?

I think so, yes. It’s getting more attention in the corporate world, as major attacks are being written about more in

JUST BECAUSE IT’S EASY TO SAVE EVERYTHING DOESN’T MEAN THAT WE SHOULD. THE BEST WAY TO SECURE DATA IS TO ERASE IT.


the press. It’s getting more attention nationally, as Edward Snowden’s NSA documents are being published and dis-cussed. And it’s getting more attention internationally, as we learn about the cyberattacks coming from countries like Russia and China. The FBI is now complaining about security and trying to convince companies like Apple to make their systems less secure. I think we’re on the verge of some major public policy decisions about cybersecurity on a variety of different fronts.

There’s a view that hacking is only going to get worse.

Do you agree?

I don’t think it’s going to get worse, but I don’t think it’s going to get better either. Right now, attack is easier than defense. It’s not just the complexity of modern computer and internet systems—fundamentally, it’s easier to break into one of these systems than it is to prevent others from doing so. This is why I focused my company on incident response and why I talk so much about resilience. We need to be able to survive attacks, because they’re not going away.

Could defense become easier again at some point?

history—it shifts every 100 years or so. Before gunpow-der, the superweapon of the day was the knight. In armor

-arms were invented, that changed. Even the most untrained peasant infantryman could take out a knight. Gunpowder

changed everything about medieval warfare—not just the

castles were useless in the face of cannon.

offense. By the time World War I rolled around, technol-ogy again favored the defense. Trench warfare was hell on attackers. It wasn’t until Germany invented blitzkrieg

to counteract trenches and give the advantage back to the

future of warfare isn’t going to look like the past.

Is there a similar history of technology, regarding attack

and defense?

Of course. You can see it in policing—technologies that enable criminals to commit crimes versus technologies that enable the police to solve crimes. You can’t really see it in IT yet because all the technologies are too new. These are 50- to 100-year cycles. But sometime in the future, proba-bly not in our lifetimes, the pendulum will shift and defense on the internet will be easier than attack.

Until then, we need to improve our ability to respond to attacks and beef up our resilience in the face of attacks.

Nathan Jaye, CFA, is a member of CFA Society San Francisco.

© 2014 CFA Institute

THE NEW ECONOMICS OF LIQUIDITY AND FINANCIAL FRICTIONS

David Adler

“This book provides a new understanding and approach to asset pricing, risk measurement and management, central banking policy, and the overall working of today’s economy,

For more information or to download a free copy, visit www.cfainstitute.org/liquidity.

FEATURED SPEAKERS INCLUDE

Ronald M. Florance, Jr., CFA

PRESIDENTRMF Consulting

Clare Flynn Levy

FOUNDER AND CEOEssentia Analytics

POST-CONFERENCE WORKSHOP

Tax-Efficient Monetization of Concentrated Wealth

Designed to give advisers the knowledge they need to create and play a key role in overseeing their clients’ concentrated wealth.

WEALTH MANAGEMENT2015

Strategies for Private Clients4–5 March 2015 Sheraton New Orleans HotelNew Orleans, Louisiana, United States

Hosted with CFA Society Louisiana

The 2015 CFA Institute Wealth Management Conference offers an engaging spectrum of practitioner tools, educational sessions, and discussions on the latest issues facing private wealth management.

New sessions in 2015 focus on investment strategies that resonate with millennials, cyber risk fundamentals, and practical applications of behavioral finance.

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

Hannah Shaw Grove

PRINCIPALHSGrove LLC

Patrick O’Shaugnessy, CFA

PRINCIPAL AND PORTFOLIO MANAGERO’Shaughnessy Asset Management


As regulators focus

on dark trading,

will trade-at rules

help markets?

DARKNESSOF

By Sherree DeCovny

Controversial changes often have humble beginnings. In 2001, the US moved to minimum ticks of a penny from sixteenths of $1. Now, the SEC is planning a pilot test to see if the tick size should be widened to a nickel in cer-tain small-cap, less actively traded stocks. The tick pilot will examine the change’s effect on liquidity, execution

-cantly perhaps, the pilot also includes a “trade-at rule” so the SEC can study activity in dark pools.

The roots of the tick pilot have their origin in the Jumpstart Our Business Startups (JOBS) Act, which was passed by Congress in 2012 and was designed to encourage funding of small businesses by easing certain securities regula-tions. Also, the Small Cap Liquidity Reform Act (which passed the House in February 2014 but has not been passed by the Senate) proposes to allow companies with stock prices exceeding $1.00 and revenues of less than $750 million to choose a tick size of $0.05 or $0.10.

The Financial Industry Regulatory Author-ity (FINRA) and the exchanges have already provided their input to the SEC, and the pilot program is now available for public comment.

-ing companies to have a market capitalization below $5 billion. The share price must have a closing price of at least $2 on the last day of the measurement period and at least $1.50 on

every US trading day during the measurement period. Moreover, the consolidated average daily volume during the measurement period has to be below 1 million shares, and the volume-weighted average price has to be at least $2.

The idea of having a pilot test before imple-menting a rule has mixed implications for market participants. Although the prospect of making system changes to accommodate the pilot may

if one of the test groups shows positive results.

TEST GROUP 3

Pilot securities will be placed into three test

will also be a control group. Securities in Test Group 3 will be subject to a trade-at rule. This rule prohibits any trading center from executing a trade at the national best bid or offer (NBBO) unless the trading center was displaying that price at the time it received the incoming order.

The past decade brought a proliferation of dark pools and broker internalization engines. Dark pools account for about 20% of total market volume, although they accounted for as much as 40.4% on 10 June 2014, according to data com-piled by Bloomberg. The SEC has grown con-cerned about this trend because of dark pools’ potential to hinder price discovery.

Proponents of the trade-at rule maintain it would discourage dark trading and internaliza-tion activity because orders would have to be


competition in the open market. Moreover, in theory, market participants might price more aggressively and quote in larger size, which would lower spreads and increase liquidity.

The tick pilot is designed with 13 exceptions to the trade-at rule. There are exceptions for block size orders, retail inves-tor orders with at least a $0.005 price improvement, inter-market sweep orders, negotiated trades, and more. Also, the

if it is displaying a quotation at a price equal to the NBBO.It is debatable whether these exceptions will help or hurt

the pilot. Some observers believe they are restrictive and could make the trade-at rule cumbersome to implement.

“If you give an exception for retail or institutional order

-lyst at TABB Group. “That’s a big challenge.”

SKEPTICISM ABOUNDS

Critics maintain that generally, the tick pilot is a poor exer-cise in logic because wider spreads are unlikely to lead to more research and trading in small-cap stocks and will not create jobs. In addition, they question the criteria for par-ticipation. After all, a company with $5 billion in market cap is not so small.

They argue the same disconnect exists for the trade-at

high, costs are low, spreads are tight, and orders are exe-

wholesale brokers, and clients arguably could be getting

critics cannot see how the trade-at rule would yield tangi-

“From the top of the book, we get about 4.5 times what’s displayed on average for our retail clients at a price that’s better than the marketplace over 90% of the time,” says Paul Jiganti, managing director and head of investor advo-cacy at TD Ameritrade. “It’s tough for us to look at the trade-at rule and say we’re going to get much better than that.”

Some are afraid the requirement to route orders to exchanges likely will result in higher access fees, which would be passed to customers in the form of higher com-missions. Some institutional investors are concerned about information leakage.

doesn’t leave room for is the different ways retail and insti-tutional investors execute their trades.”

INTERCONNECTED ISSUES

The industry has been debating several hot issues, including

access fees, quote protection, and market complexity. These are all interconnected, and right or wrong, they are being wrapped into the discussion about the tick pilot.

In the maker-taker model, resting orders get a rebate upon execution, the order that crosses the spread pays a fee, and

the exchange keeps the difference. Proponents of maker-taker note that it is a way for exchanges to attract displayed liquid-ity. Critics say the model should be banned because brokers do not pass the rebates on to customers. Brokers have an incentive to route an investor’s order to an exchange, where

responsibilities. In addition, according to critics, the maker-

The Modern Markets Initiative, which represents HFT

taker model could force more volume to the dark. But with a trade-at rule, much of the dark volume could shift back to lit exchanges.

Regulation National Market System (Reg NMS), which took effect in 2007, set the maximum exchange access fee at 30 cents per 100 shares (i.e., 30 mils). Many market par-

fact, NASDAQ OMX recently announced an experiment start-ing in February 2015 that will involve 14 stocks. Broker/dealers and market makers will be charged $0.07 per hun-dred shares, and the rebates will be reduced to $0.06 per 100 shares.

“We’ve been advocating for a smarter access fee that is closer to zero—10 mils or 5 mils—on the very active stocks. Then you don’t have the perceived distortions in that end of the market,” says Jiganti. “That solution makes much more sense than banning maker-taker because I think you would do damage to liquidity in quite a few stocks

CFA Institute policy work on trade-at rules is only one part of a larger advocacy

effort to address market structure issues globally. Rhodri Preece, CFA, head

of capital markets policy for the Europe, Middle East, and Africa (EMEA) region

at CFA Institute, recently participated in a panel discussion on high-frequency

trading at the European Capital Markets Institute’s Annual Conference in Brussels.

He also argues that these issues are best left to the indus-try to solve on its own, without barriers in its way. Any rule change should be done by segmenting the market. The indus-

all approach, as evidenced by the tick pilot, and segmenta-tion would work here as well. But skeptics counter that the industry has no incentive to change on its own.

LEARNING FROM OTHERS

Canada and Australia implemented trade-at rules in 2012 and 2013, respectively, and market participants want to gain insight from their experiences. Yet any comparisons of market structures across geographies must be done with caution because each market has unique characteristics. The success or failure of a rule in Australia or Canada does not ensure the same outcome in the US.

For starters, Canada’s trade-at rule was broader in scope, applying to all dark pools and dark trading. In contrast, the SEC does not intend for the trade-at component of the tick pilot to be applicable to the broader market. The test is to see whether it would improve trading in small-cap stocks by consol-idating liquidity and facilitating price discovery on exchanges.

Canada’s rules for order-execution permit full broker pref-erencing. A broker can jump to the front of the order book to execute a trade against a standing order if the incoming trade is against a standing order from the same broker. But

preferencing (which has not been proposed in the US) could introduce a new layer of complexity and concern for fairness.

Canada already disallowed internalization without price improvement. But as Jiganti points out, the price improvement measured in dollars for retail clients “fell off the cliff,” drop-ping 70% overnight when Canada instituted its dark rules.

Unlike Canada, the US has off-exchange retail whole-

interlisted stocks has been migrating from Canada to the US to take advantage of higher-quality execution.

Also notable is that Australia’s trade-at rule required trades to be below block size and exempt from pretrade transparency requirements to provide one full tick of price improvement.

A recent study commissioned by CFA Institute found no -

ment discouraged lit liquidity or increased the propensity of market participants to post lit liquidity in Australia or Canada. (For more on the report, “Regulatory Efforts to Reduce Dark Trading in Canada and Australia,” see the sidebar on this page.) In both countries, the minimum price improvement regulation increased spreads. Average trade sizes in dark

-cantly in Australia. Finally, the trade-at rules do not appear to have succeeded in encouraging the posting of lit liquid-ity or increasing overall liquidity.

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

Are Trade-At Rules Effective Policy Tools?

CFA Institute recently commissioned a study of the effects of the trade-at rules in Canada and Australia. The resulting report, “Regulatory Efforts to Reduce Dark Trading in Canada and Australia: How Have They Worked?,” is available on the CFA Institute website (http://cfa.is/1vzUhNg).

The researchers (Sean Foley of the University of Sydney and Tālis J. Putniņš of the University of Technology Sydney and Stockholm School of Economics in Riga) looked at the 250 and 200 most actively traded stocks on the Canadian TSX Composite Index and the Australian ASX 200 Index, respectively. In both countries, dark trades below block size had to have at least one full tick of price improvement (half a tick if the spread was one tick or less). Foley and Putniņš reached the following conclusions:

• Dark trading with insignificant price improvement does not discourage lit liquidity.

• Liquidity metrics in both countries found that minimum price-improvement regulation is associated with an increase in spreads.

• Market participants are not more likely to post lit liquidity.

• Average trade sizes in dark markets were unchanged in Canada and decreased significantly in Australia.

• The regulations reduced the amount of dark trading, ensured that dark trades provide meaningful price improve-ment, and reduced the amount of internalization in the dark.

• The trade-at rules apparently have not succeeded in encouraging the posting of lit liquidity and increasing overall liquidity.

Some aspects of market structure could affect the imple-mentation of a trade-at rule in the US, as the report points out. Dark orders do not have to provide price improvement to interact with lit orders. The price-improvement increments are $0.005. Broker/dealers are exempt from Rule 612 of Reg NMS. This rule prohibits market participants from displaying, ranking, or accepting quotations, orders, or indications in increments smaller than $0.01 (or $0.0001 for stocks priced less than $1.00 per share). Additionally, ATSs that match customer orders are exempt from requirements concerning fair access, capacity, integrity, and security that are imposed on other platforms.

In a policy brief based on the report, CFA Institute offers four recommendations. First, all trading venues should operate under similar rules regarding conflicts of interest with custom-ers. Second, trading venues should disallow internalization without meaningful price improvement of at least one tick (or a partial tick for securities priced below one primary currency unit). Third, the recommendations call for regulators to con-tinue monitoring the growth in dark trading volume and to take appropriate steps if dark trading volume reaches a “mean-ingful” magnitude. Finally, the policy brief states, “regulators and trading venues should improve reporting and disclosure around the operations of dark trading facilities.”


Supporters:


Swimming in the Deep EndWHO SHOULD QUALIFY FOR THE POOL OF “ACCREDITED INVESTORS”?

By Kurt N. Schacht, JD, CFA

To say that the evolving digital age has been a game changer for investment mar-kets would be an understatement. From the rise of crypto-currencies, such as Bit-coin (see related article on page 37), to crowdfunding, we’re seeing a new breed of investor and a host of regulatory chal-lenges as we head into largely uncharted

ensure investors are protected?For example, take the US Securities

and Exchange Commission’s (SEC’s) reas--

individuals earning $200,000 (or $300,000 jointly with a spouse) over a two-year period or those with personal net worth exceeding $1 million, excluding primary residence. The review, which is required under the Dodd–Frank Act,

-ous review since their enactment more than 30 years ago.

In a recent interview with the , I noted that capital raised via the private investment markets now rivals their public counterparts. Given the age of these accred-itation rules and the fact that more than 9 million house-holds now meet the accredited investor standard, a checkup is long overdue. As I noted, with this new focus on private

-ticated is “pretty long-in-the-tooth” and clearly needs review.

The SEC’s Investor Advisory Committee (IAC), which CFA

that the SEC should consider modifying in regard to indi-

income and net worth have traditionally been the measure, -

cial sophistication would include evaluating professional

knowledge rather than income alone.In the event that the SEC ultimately should decide to

IAC has encouraged other approaches, such as limiting investments in private offerings to a percentage of assets or income. Much like the crowdfunding rules, this potentially helps protect investors without unnecessarily shrink-ing the pool of accredited investors. As the IAC’s recommendation states, “The

risks associated with investing in private offerings are greatly affected by how heavily the individual invests in such offer-ings. For example, an individual with $200,000 in income who invests $5,000 in a private offering is unlikely to suffer

said if that individual invests $50,000 or $100,000.”The opportunity to serve as a representative on front-

line advisory groups, such as the IAC and similar groups around the globe, provides CFA Institute with an ideal plat-

of building an investment industry where investors’ inter-

change, in terms of technological advances and evolving investor appetites, we anticipate that this policy debate as well as others will present ample opportunities to promote members’ interests and carry out our mission.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: http://blogs.cfainstitute.org/marketintegrity

Follow us on Twitter: @MarketIntegrity

KEEP GOING

While attending the CFA Institute Board of Governors meeting in Istanbul this

past October, Kurt Schacht, CFA (pictured second from left), managing director

of Standards and Financial Market Integrity at CFA Institute, participated in

a CNBC panel discussion about ethical standards and the future of finance

that included Ertunc Tumen, CFA (pictured on the far right), president of CFA

Society Istanbul.


Beyond BitcoinCRYPTO-CURRENCIES ARE ONLY THE BEGINNING

By Sviatoslav Rosov, PhD

The protocol underlying Bitcoin (also known as the crypto--

able than its well-known crypto-currency application may imply. This fact is becoming increasingly evident.

Crypto-currencies are virtual payment systems that do not rely on a central authority to generate currency supply or to verify, track, and record transactions. Instead, crypto-currencies rely on a distributed ledger to determine, verify, and track ownership of monetary units without the need for

merely as digital records with a tiered structure of clear-ing institutions culminating in the central bank. The tech-nology behind the crypto-ledger enables the bypassing of this centralized clearing structure to record the ownership

The umbrella term for technologies and applications based on the Bitcoin crypto-ledger protocol is second-generation (or “crypto 2.0”) technologies. The majority of development in this sphere is occurring outside the Bitcoin ecosystem, which is now too large to be a proving ground for untested innovations. There are many examples of these second-generation “smart contracts” or “smart properties” that enable any application involving property rights to be traded using the Bitcoin crypto-ledger principle.

The most obvious alternative use of a crypto-coin is that of a token, sometimes known as a “colored coin.” A token is

as real estate, art, or a commodity. An innovative application of crypto 2.0 technology involves smart contracts. For exam-ple, a homeowner and a tradesman agree that the home-owner will deposit the payment into an escrow account that will be released when both parties agree that the trades-

-ple sees software developers fund a new product by issu-ing appcoins that are necessary to access and use the soft-ware or app.

REGULATORY HEADACHES

The creation of tokens or colored coins via initial coin offer-ings or crowdsales has been greatly facilitated by the rise of decentralized exchanges that increasingly allow users to quickly and easily create and trade their own crypto-coins representing either a virtual currency or some other asset. Crypto 2.0 is causing headaches for regulators, who are already struggling to devise policies for crypto-curren-cies, such as Bitcoin. The initial coin offerings/crowdsales

look a lot like traditional securities offerings but with one -

tions to protect investors from fraud.

In the United States, the Securities and Exchange Com-mission (SEC) is increasingly concerned with these possibly unregulated securities issues. Most providers of the software used to perform crowdsales argue they are simply provid-ing tools that can be used for any number of activities—legitimate or otherwise. Crypto 2.0 businesses that actu-ally conduct crowdsales also stress that their issued coins are not marketed as securities, meaning they fall outside the SEC’s jurisdiction. As with the more general phenom-enon of crowdfunding, crypto-coin offerings are currently a case of “investor beware.”

The New York Department of Financial Services is also discovering the complications of crypto 2.0 and is scaling back regulatory proposals for creating a “BitLicense” for Bitcoin companies as the range and variety of potential crypto-ledger businesses threaten to become unmanageable. Initially, the BitLicense was a set of proposals focused on anti-money laundering and know-your-customer regulation

crypto 2.0 businesses with coins representing non-currency value (e.g., tokens) or existing only to drive other, primary functions (e.g., appcoins) has sent regulators back to the drawing board. Bitcoins, as it turns out, were only the tip of the crypto-iceberg.

Sviatoslav Rosov, PhD, is an analyst in the capital markets policy group at CFA Institute.

THESE CRYPTO-CURRENCY OFFERINGS

LOOK A LOT LIKE TRADITIONAL

SECURITIES OFFERINGS BUT WITH ONE

EXCEPTION: THE LATTER ARE STRICTLY

REGULATED IN MOST JURISDICTIONS TO

PROTECT INVESTORS FROM FRAUD.

Cast your vote for your favorite Financial Analysts Journal article in 2014 in the Graham and Dodd Readers’ Choice Award: http://bit.ly/FAJRCA2014.

FINANCIALANALYSTSJOURNAL

FAJ


Reconsidering Non-GAAP Performance Measures

By Mohini Singh, ACA

Financial statements prepared in accordance with gener-ally accepted accounting principles (GAAP) provide inves-

analysis. Companies often supplement GAAP information with other measures, referred to as non-GAAP or alternative performance measures, to provide users with information they believe will put them in a better position to understand

-

measure is a measure of a company’s historical or future

includes or excludes amounts from the most directly com-parable GAAP measure. Such information is often included

-

The use of non-GAAP measures can be problematic for a variety of reasons, such as when non-GAAP measures are described in terms that are neither included in accounting

-

application also results in noncomparable information about the company over time. Furthermore, the lack of standard-

of comparable information across companies—comparability that is essential for investment analysis. In some cases, these measures cannot be easily derived from or reconciled back

be used by companies to obscure GAAP results or to pres-ent an overly optimistic picture of a company’s performance.

Given the aforementioned issues with the use of non-GAAP measures, some suggest eliminating such measures. CFA Institute has expressed concerns over the consistency

but does not expect these measures to disappear. Given this reality, what investors want is the ability to deconstruct, understand, and validate them over time and make com-parisons between companies with more disaggregated and audited information.

To this end, the European Securities and Markets Authority (ESMA) and the International Organization of Securities Commissions have issued papers that set out principles for issuers to follow with respect to their presentation of

prescribed by GAAP. The major con-cerns about non-GAAP measures deal

and presenting them as well as prominence of presentation for GAAP and non-GAAP measures.

DEFINITION AND EXPLANATION

Each non-GAAP measure presented and its components -

measure.RECONCILIATION. Issuers should provide a reconciliation

from the non-GAAP measure to the most relevant GAAP

explanation of the adjustments. The ESMA paper stresses

subject to audit and gives users additional assurance of the consistency and the reliability of the amounts presented.

DISCLOSURE. Disclosure explaining the context of any non-GAAP measure is essential so users can understand what information the measure is meant to provide. Accordingly, issuers should disclose the reason for presenting the non-

may be useful to investors and for what purposes manage-ment uses the measure.

PRESENTATION

For any non-GAAP measure presented, issuers should pro-vide the measure for comparative periods. Furthermore, the non-GAAP measures presented should remain consis-tent from period to period. If that is not the case, an issuer

-

a measure is no longer used, the issuer should explain why.

PROMINENCE OF PRESENTATION

When a non-GAAP measure is presented, the most relevant GAAP measure should be included with equal or greater prominence so as not to confuse or obscure the presenta-tion of the GAAP measures.

Mohini Singh, ACA, is director of financial report-ing policy at CFA Institute.

Consultation Paper: ESMA Guidelines on Alternative Performance Measures: (http://bit.ly/1qqY5VE)

IOSCO Proposed Statement on Non-GAAP Financial Measures (http://bit.ly/1xaiEb6)

KEEP GOING

ETHICS AND STANDARDSMARKET INTEGRITY AND ADVOCACY


Whither Hong Kong?RECENT PROTESTS RAISE KEY QUESTIONS ABOUT THE CITY’S FUTURE

By Tony Tan, DBA, CFA

Hong Kong has been counting the cost of the disruptions caused by recent anti-government protests. UBS estimated that one month of disruptions to the retail sector could translate to a 10 bp reduction in real GDP growth for 2014. Over the long term, however, the bigger worry lies in the protests’ impact on the future of Hong Kong. Currently, the city enjoys special privileges on two fronts. First, polit-ically, Hong Kong has a high degree of autonomy under the “one-country, two-system” principle. Second, economically, Hong Kong is a test bed for Chinese reforms. For example,

settlement center, a critical step toward the international-ization of the Chinese currency. Most recently, the stock exchanges of Hong Kong and Shanghai agreed to link up (via the Shanghai–Hong Kong Stock Connect program) to allow greater foreign investor participation in the A-share market and to let Chinese investors own Hong Kong stocks.

With so much at stake, it is hard to imagine the pro-tests not impinging on this relationship. Conspicuously,

after it failed to receive approval from regulators. Hong Kong Chief Executive C.Y. Leung (the city’s top leader) has said that public “cooperation” was needed in order to push the program forward. Although the program was imple-mented after a relatively short delay, the setback implies the extent of Chinese control over Hong Kong’s market and calls into question other pending cross-border initiatives, among them the proposed mutual fund recognition scheme, which is expected to be a game changer for the asset man-agement industry. The episode has raised important ques-

just another city in China as it becomes more closely inte-grated with the mainland?

Indeed, over the past few years, Hong Kong has been eclipsed by mainland cities in a number of areas. Shang-hai’s stock exchange has exceeded Hong Kong’s in terms of market capitalization, and Shanghai’s port has surpassed Hong Kong’s in terms of container volume. Hong Kong has also slipped from being the wealthiest city in China, and

centers as rivals of Hong Kong.But what distinguishes Hong Kong from these cities are

common characteristics of Western capitalist economies—rule of law, free markets, and freedom of expression—fea-tures that the Communist government has been hard pressed to replicate in the mainland. These Western legacies afford

business with China from their base in Hong Kong because -

statements in its IPO document, a Hong Kong court seized its

assets as reparation for investors. This robust legal system is partly why Hong Kong is the largest source of overseas direct investments in the mainland.

But the protests have exposed the vulnerability of the city’s vaunted pillars. In August, China’s legislature handed down an interpretation of the provisions on universal suf-frage in Hong Kong’s mini-constitution, sparking the pro-tests. Some legal experts argued that the legislature’s action undermined the rule of law (the principle that no one is above the law and that the law applies equally to all). The expulsion of a Hong Kong lawmaker from a mainland gov-ernment advisory council after he called for the resigna-tion of the city’s leader also sent a worrying message on dissent. In addition, the reported pres-

-ments against the protests.

International investors could take their cue and decide to seek more stable jurisdictions from which to conduct their businesses. With 4,000 foreign regional headquar-

them responsible for business in the mainland, an exodus of these companies would be disastrous for Hong Kong and would hurt China too.

Preserving Hong Kong’s core characteristics is to China’s -

ized and until the mainland has the standards and legal safety nets that the international investment community requires, its capital markets will not be able to function at their fullest and Chinese companies with global ambitions will still need Hong Kong. (Incidentally, the Chinese Com-munist Party’s plenum in September emphasized the “social-ist rule of law with Chinese characteristics” by announcing reforms to its judicial system—among them, making courts more independent.)

who want to preserve its pillars may weaken as the voices of those eager to bend them rise. In politically turbulent times, it’s critical for Hong Kong to focus on safeguarding the keys to its success in order to ensure its future.

Tony Tan, DBA, CFA, is head of Standards and Financial Market Integrity in the Asia-Pacific region at CFA Institute.

PRESERVING HONG KONG’S

CORE CHARACTERISTICS

IS TO CHINA’S ADVANTAGE.

DISCIPLINARY NOTICES

ETHICS AND STANDARDSPROFESSIONAL CONDUCT

SUMMARY SUSPENSION

On 2 September 2014, CFA Institute imposed a Summary Suspension on Erwin T. Speckert (Canada/Switzerland), a charterholder member, automatically suspending his membership and right to use the CFA designation. Because he did not request a review, the summary suspension became a Revocation on 2 October 2014.

In June 2014, the Swiss Financial Market Supervisory Authority (FINMA) barred Speckert from, among other things, carrying out any activity that is legally related to the financial markets and requires a permit and from engaging in professional activity as a securities broker. FINMA’s bar was issued in connection with proceedings against three Swiss firms of which Speckert served as a director. FINMA found that the firms were improperly engaged in accepting investor subscriptions on behalf of clients without the proper licenses.

On 15 September 2014, CFA Institute imposed a Summary Suspension on Stephen Hinch (Thailand), a member, automatically suspending his membership. Hinch was suspended for his failure to cooperate with a Professional Conduct Program investigation of an industry-related matter. Because he did not request a review, the Summary Suspension became a Revocation on 16 October 2014.

TIMED SUSPENSION

Effective 19 October 2014, CFA Institute imposed a Five-Year Suspension of membership and the right to use the CFA designation on Michael R. Cooper (Canada), a charterholder member. A Hearing Panel found that Cooper violated Standards I(B)–Independence and Objectivity, I(C)–Misrepresentation, III(D)–Performance Presentation, and VI(A)–Disclosure of Conflicts of the CFA Institute Code of Ethics and Standards of Professional Conduct (2010).

Cooper was the owner of Cooper Financial Research (also known as CR Financial Research, Inc.), which prepared and published research reports on the internet (at CFMonitor.com). Three small gold-mining companies paid Cooper and his firm to prepare and publish favorable research reports and YouTube videos about them on the internet.

Cooper secretly entered into written agreements with two of the companies that required that he compromise his independence and objectivity by promising to use his best efforts to serve and promote the companies’ interests whenever he wrote about them. One of the two companies explicitly required that Cooper obtain its advance approval of anything he might want to publish about it. In exchange for his flattering research coverage, the companies each compensated Cooper with $5,000 monthly payments and undisclosed stock options, which represented a direct stake in his ongoing ability to successfully promote them. Cooper had a similar, oral agreement with the third company, which also paid him $5,000 per month (but no options) as compensation for his research reports and videos, which were always highly favorable.

The Hearing Panel found that Cooper did not disclose to potential investors that he had entered into these promotional agreements with the three companies and that his compensation was

contingent on promoting their interests. Cooper’s repeated failures to disclose these conflicts of interest were egregious. Only after receiving the Professional Conduct Program’s Statement of Allegations outlining his apparent violations of the CFA Institute Standards did Cooper finally begin to disclose his contractual obligations to favorably promote the three companies. But even then, he continued to fail to disclose the volumes, exercise prices, and expiration dates of the stock options he received as payment.

Finally, Cooper failed to make reasonable efforts to ensure that a video presentation he placed on YouTube touting his investment performance on behalf of investors was fair, accurate, and complete, and he made misleading statements in two videos suggesting to investors that he had a staff of CFA charterholders who assisted him in preparing his reports. Although Cooper had at times employed several different people to help him prepare his research reports and videos, he was the only person at the firm who was ever a CFA charterholder.

Effective 24 September 2014, CFA Institute imposed a Two-Year Suspension of membership in CFA Institute and of the right to use the CFA designation on James S. Zoldy, Jr. (US), a charterholder member. A Hearing Panel found that Zoldy violated the CFA Institute Code of Ethics and Standards of Professional Conduct I(A)–Knowledge of the Law, I(C)–Misrepresentation, and I(D)–Misconduct (2005).

Zoldy is chairman, treasurer, and part owner of Halsey Associates Inc. (Halsey), a registered investment adviser in New Haven, Connecticut. In August 2008, Zoldy learned that a portfolio manager at the firm was misrepresenting his investment performance results in the quarterly letters he sent to his clients. Upon further investigation, it was determined that these misrepresentations had occurred in hundreds of client letters over a period of approximately three years.

When confronted, the portfolio manager vehemently denied the allegations, but on the following day, he admitted that he had lied and that he had misrepresented his performance results to his clients. While under review, the portfolio manager also was caught deleting copies of his communications with clients from the firm’s computer system. The portfolio manager pleaded with Zoldy to keep his job because a termination would jeopardize his career and ability to support his family, but the decision was made to terminate his employment.

In connection with the termination, Zoldy signed a Memorandum of Understanding on behalf of Halsey in which he agreed that, so long as the portfolio manager did not disparage the firm or its employees, it would not report his misconduct and resulting termination to the proper regulatory authorities. Several weeks later, with Zoldy’s knowledge and approval, Halsey submitted a Form U5 (Uniform Termination Notice for Securities Industry Registration) report to FINRA, the US Securities and Exchange Commission, and the Connecticut Department of Banking that he knew falsely and misleadingly stated that the portfolio manager had not been discharged for cause or while under suspicion of violating investment-related laws, rules, or standards of industry conduct.

Approximately six months later, an outside consultant working for one of Halsey’s clients learned from Halsey that the portfolio manager had been terminated because he was found to have engaged in misrepresentations to clients and that his misconduct had not been reported to the regulatory authorities. Only then, after strong encouragement from the client’s outside consultant, did Zoldy make Halsey correct the false and misleading Form U5 filed previously and notify the proper regulatory authorities of the portfolio manager’s termination for cause, misrepresentations of investment performance results to his clients, and deletions of firm records.

CENSURE

Effective 10 September 2014, CFA Institute imposed a Censure on Rene A. Pochop (US), a lapsed regular member. A Hearing Panel found that Pochop violated Standards III(A)–Loyalty, Prudence, and Care (to Clients), III(E)–Preservation of Confidentiality, and IV(A)–Loyalty (to Employer) of the CFA Institute Code of Ethics and Standards of Professional Conduct (2005).

Specifically, upon her termination in June 2006, Pochop removed a large volume of confidential client information belonging to her employer, including names and contact information, account types, and personal investment histories and performance results. She then used that confidential and proprietary client information to conduct a competing business.

By misappropriating the clients’ confidential information without their prior knowledge and permission, Pochop failed to exercise prudent judgment and placed her own personal, financial, and business interests ahead of the clients’ privacy interests. Pochop’s unauthorized removal and use of her employer’s confidential and proprietary client information also violated the terms of an agreement she had signed to become a co-owner of the firm and her duty of loyalty, which included the obligation to follow her employer’s policies and procedures and keep the firm’s client information strictly confidential.

Finally, Pochop did not disclose in her annual 2008 and 2009 Professional Conduct Statements that she was the subject of allegations of misappropriation of client information in a counterclaim filed by her former employer in connection with her lawsuit for wrongful termination. Although not cited as a violation of the Code and Standards, Pochop’s failures to report significantly delayed the commencement of the Professional Conduct Program’s investigation and were taken into consideration in determining an appropriate sanction.

RESIGNATION

Effective 22 August 2014, Douglas Furster Drennan (US), a charterholder member, Permanently Resigned his membership in CFA Institute and in any member societies and his right to use the CFA designation in the course of an investigation of an industry-related matter by the Professional Conduct Program.


Proud to be aGLOBAL PLATINUM SPONSOR

of CFA Institute

2014–2015

Research Challenge

Would you like additional review for FREE?Sign up to receive a CFA Program practice question delivered straight to your inbox every day until the June 2015 CFA exam.

Free

DayDayQuestionQuestion

of theSign up today to receive your daily email.

www.schweser.com/cfa-questions

The Global Leader in CFA® Exam Prep Helping Candidates Earn the Following Designations and Certificates: CFA® | FRM® | CAIA® | Claritas®

www.schweser.com/cfa-RC2015 | 877.599.2664 (U.S.) | +1 608.779.8327 (Int’l.)

Follows CFA Institute Prep Provider Guidelines. Required Disclaimer: CFA Institute does not endorse, promote, or warrant the accuracy or quality of the products or services offered by Kaplan Schweser. CFA Institute, CFA®, and Chartered Financial Analyst® are trademarks owned by CFA Institute. ©2014 Kaplan, Inc. All Rights Reserved.

MRKT-16336

An investor should consider investment objectives, risks, charges and expenses carefully before investing. To obtain a prospectus, which contains this and other information, call 1-866-SECTOR-ETF or visit www.sectorspdrs.com. Read the prospectus carefully before investing.

The S&P 500, SPDRs®, and Select Sector SPDRs® is a registered trademark of Standard & Poor’s Financial Services LLC. and have been licensed for use. The stocks included in each Select Sector Index were selected by the compilation agent. Their composition and weighting can be expected to differ to that in any similar indexes that are published by S&P. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. The index is heavily weighted toward stocks with large market capitalizations and represents approximately two-thirds of the total market value of all domestic common stocks. Investors cannot invest directly in an index. The S&P 500 Index figures do not reflect any fees, expenses or taxes. Ordinary brokerage commissions apply. ETFs are considered transparent because their portfolio holdings are disclosed daily. Liquidity is characterized by a high level of trading activity.

Select Sector SPDRs are subject to risks similar to those of stocks, including those regarding short-selling and margin account maintenance. All ETFs are subject to risk, including possible loss of principal. Funds focusing on a single sector generally experience greater volatility. Diversification does not eliminate the risk of experiencing investment losses.

ALPS Portfolio Solutions Distributor, Inc., a registered broker-dealer, is distributor for the Select Sector SPDR Trust.

Potential benefits of adding Sector SPDR ETFs to your portfolio include:

• Undiluted exposure to a specific sector of the S&P 500

• The all-day tradability of stocks

• The diversification of mutual funds

• Total transparency

• Liquidity Visit www.sectorspdrs.com or call 1-866-SECTOR-ETF

Time For A Stock Alternative

Financial Sector SPDR ETF

1 Berkshire Hathaway B BRK.b 9.02%

2 Wells Fargo WFC 8.61%

3 JP Morgan Chase JPM 7.53%

4 Bank of America BAC 5.96%

5 Citigroup C 5.44%

6 American Express AXP 2.77%

7 US Bancorp USB 2.65%

8 American Intl Group AIG 2.60%

9 Goldman Sachs GS 2.57%

10 Metlife MET 2.08%

Company Name Symbol Weight

XLF - FINANCIAL

* Components and weightings as of 11/30/14. Please see website for daily updates. Holdings subject to change.

Top Ten Holdings*

Consumer Discretionary - XLY Consumer Staples - XLP Energy - XLE Financial - XLF Health Care - XLV Industrial - XLI Materials - XLB Technology - XLK Utilities - XLU

WHY BUY A SINGLE STOCK WHEN YOU CAN INVEST IN

THE ENTIRE SECTOR?

Can financial data be protected from cyber attacks? - CFA ...

Documents

Transcript of Can financial data be protected from cyber attacks? - CFA ...