CFA Institute

Mergers and acquisitions (M&A) are no longer just about sealing the deal — they’re about unlocking real, long-term value. Yet, with 70% to 90% of M&A deals failing, a flawed due diligence process is often to blame. In today’s evolving market, firms must move beyond risk assessment and embrace value-driven due diligence — a holistic approach that evaluates not just financials, but operational resilience, technological capabilities, and cultural fit. According to the latest data published by PitchBook, global M&A activity experienced strong growth in 2024, driven by more favorable macroeconomic conditions and stabilizing valuations. In North America, deal value exceeded $2 trillion across 17,509 deals, reflecting a 16.4% year-over-year (YoY) increase in value and a 9.8% rise in deal count. Although the market has slowed, corporate firms continue forging ahead with strategic acquisitions, owing this resilience to a lesser reliance on debt income. Whether corporate- or private equity (PE)-driven, successful M&A hinges on one thing: An accurate valuation arrived at through a strong due diligence process that uncovers detailed insights into a target company’s strengths, weaknesses, and growth potential. This process has expanded far beyond traditional risk assessment to become a more comprehensive, value-driven approach that considers operational, technological, and leadership capabilities. The Shift Toward Value Creation in M&A Due Diligence Accenture’s latest research reveals a critical shift in how firms approach due diligence. Traditionally, the focus was on identifying risks and mitigating or eliminating them. Now, forward-thinking firms are using the due diligence phase to create a detailed value-creation plan that begins pre-deal and extends well into post-deal integration. Accenture’s research proves this shift is essential, as 83% of private equity leaders believe their current due diligence practices need substantial improvement, particularly in how they align with broader investment ideas. Holistic M&A due diligence helps firms evaluate more than just financials—it includes reviewing operational capabilities, assessing leadership top-down, and analyzing the present and near-future technology landscape. For instance, generative AI and predictive analytics offer increased speed to this process so firms can uncover deeper insights in less time. How Comprehensive Due Diligence Mitigates Risks in M&A Transactions Comprehensive due diligence in M&A provides a snapshot of a company’s current state and a roadmap for future success. It ensures that both the purchaser and the seller fully understand the deal’s strengths, liabilities, and overall feasibility. This approach is essential, as 44% of leaders cite a lack of quality third-party data as the greatest barrier to effectively carrying out M&A due diligence. Due diligence in M&A mitigates risks by: Allowing a thorough examination of operational capabilities, tech infrastructure, and leadership preparedness, Identifying potential cultural clashes that could hinder post-deal integration, and Leveraging advanced technologies like AI and analytics to scrutinize large datasets, accelerating insights that otherwise would take months to uncover. Case Study: Implications of Over- or Undervaluing Assets It’s been proven time and again that a lack of due diligence leads to an M&A failure rate of between 70% and 90%. That’s staggering. Why don’t more blended companies make the cut? Most often, the company or brand isn’t promoted in a way that illustrates unity between the companies. Sometimes, it’s not clear why two seemingly unrelated businesses would be joining forces. Etablishing a clear and unified vision from the beginning is paramount. Not getting the transaction right can lead to significant losses of assets, personnel, and shareholders and, in some cases, even lead to bankruptcy. The Most Expensive M&A Failure in History The 2000 merger of America Online (AOL) and Time Warner, valued at $165 billion, eventually ended in separation in 2009 due to misaligned goals, cultural differences, and an overestimation of the synergies between the two companies. The AOL-Time Warner failure exemplifies the need for a deeper, more integrated approach to due diligence, including assessing financial performance and cultural, technological, and operational readiness for seamless post-deal integration. M&A Due Diligence Challenges Due diligence in M&A isn’t easy. Here are some of the most frequent challenges experienced and how they can be resolved: Challenge #1: Poor communication How to mitigate: •            Define clear channels of communication. •            Establish roles and correlate responsibilities. •            Send frequent updates. •            Encourage open dialogue. Challenge #2: Too much data How to mitigate:  Use a secure data integration platform that allows stakeholders to store, share, and access relevant documents. Challenge #3: Not enough experience How to mitigate:  Hire professionals with the necessary experience including financial advisors, accountants familiar with corporate accounting and taxation, and solid M&A lawyers. Challenge #4: Not knowing what you don’t know How to mitigate:  Establish a due diligence checklist for a structured approach and reminders to maintain close oversight. Challenge #5: Not enough time/Short deadlines How to mitigate:  Ensure tasks are prioritized, resources are allocated efficiently, and timelines are established that are realistic. Challenge #6: Differences in cultural norms and approaches How to mitigate: Undertake culture assessments as early as possible. This due diligence creates open lines of communication and helps all parties develop ways to bridge gaps and promote alignment. Leveraging Technology in Due Diligence As Accenture emphasizes, technology is reshaping the due diligence landscape. Generative AI and machine learning allow firms to: •            Automate routine tasks like document gathering and analysis, •            Accelerate data processing, reducing the time spent on manual due diligence by up to 30%, •            Provide deeper insights into financial performance, operational risks, and leadership capabilities, and •            Continuously monitor market conditions and update diligence processes in real-time, ensuring firms remain agile in today’s fast-paced deal environments. PE firms that adopt these technologies can screen more deals, extract better insights, and ultimately make smarter investment decisions. Accenture’s survey found that 62% of PE leaders expect generative AI to transform their deal processes, and many are already increasing their investments in AI solutions. The Future of M&A Is Due Diligence The days of due diligence as a box-checking exercise are over. Today’s M&A landscape requires a more holistic, value-focused approach, where technology plays a critical role in uncovering insights and driving post-deal success. Firms embracing this evolution — leveraging AI, integrating comprehensive data sources, and aligning leadership strategies — will be better positioned to maximize value and minimize risks. Accurate and reliable

In a year marked by renewed volatility and shifting economic expectations, even the most familiar investment principles are worth revisiting. Behavioral finance concepts like loss aversion and goal framing may seem basic, but they remain essential tools for understanding how clients will actually behave, especially under stress. Financial advisors recognize that “know your client” is more than a regulatory requirement. It means understanding not just time horizons and return targets, but the emotional narratives behind the numbers. Two clients might share the same objective — say, retiring at 60 — but respond very differently when markets turn. One sees opportunity, the other sees risk. The difference lies in why they’re investing. That “why” matters. Investment objectives are often treated as planning inputs, but they also reveal deeper psychological patterns: how much risk a client is willing to take, how they interpret uncertainty, and what emotional outcomes they hope to avoid. Tapping into that context can help advisors deliver better guidance, especially when market conditions test client discipline. This is where a powerful distinction comes into play: the difference between Builders and Avoiders. Builder vs. Avoiders Most client goals fall into one of two broad categories, each reflecting a distinct emotional orientation and behavioral tendency: Builders (Aspirational, Goal-Oriented) These clients are focused on opportunity and growth. Common goals include: “I want to retire early.” “I want to build a passive income stream.” “I want to grow capital so I have freedom in how I work.” Typical behavioral traits of builders: Stay invested during market volatility Reframe downturns as buying opportunities View risk as necessary to achieve goals Avoiders (Fear-Driven, Loss-Oriented) These clients are focused on minimizing risk or avoiding worst-case scenarios. Common goals include: “I don’t want to run out of money in retirement.” “I want to avoid being caught off guard.” “I don’t want to depend on the state pension.” Typical behavioral traits: Prone to panic selling Often invest too conservatively May reduce contributions after early success Reframing Goals for Long-term Discipline Advisors can go beyond surface-level planning by exploring the emotional context behind a client’s objectives. When goals are rooted in fear, even minor setbacks can trigger outsized stress responses. But when goals are reframed around positive aspirations, clients are more likely to stay the course. For example, shifting the goal from “I don’t want to outlive my money” to “I want to live independently and with dignity” helps move the focus from avoidance to aspiration, supporting more confident and disciplined investing. How Advisors Can Apply This Insight Here are three questions to ask when evaluating client goals: Why does this goal matter to the client? Is the motivation based in fear or aspiration? How might this influence decisions during periods of stress? By identifying a client’s emotional orientation, advisors can: Provide more personalized risk guidance. Strengthen communication and trust. Encourage more consistent investing behavior. The Bottom Line Investment goals are more than technical inputs — they’re emotional signposts. Whether shaped by fear or aspiration, these goals influence how clients experience risk, respond to market stress, and define success. For advisors, the real opportunity lies in understanding not just what clients want, but why. Consider two clients: Sarah, a 45-year-old executive focused on financial independence, and Tom, a 52-year-old contractor worried about running out of money. They both describe a moderate risk tolerance and choose similar portfolios. But when markets fall, Sarah stays the course, while Tom wants to pull out. The difference isn’t their asset allocation. It’s their motivation. One is building toward a goal; the other is trying to avoid a fear. By identifying a client as a Builder or an Avoider and adjusting your communication and planning approach accordingly, you can help them navigate uncertainty with greater clarity and confidence. Because successful investing isn’t just about numbers. It’s about aligning strategy with the stories people believe about their future. source

The rise of revenue-sharing tokens is redefining the crypto landscape, bridging the gap between speculative trading and tangible value. By directly linking token holder returns to project growth, these innovative mechanisms are not only attracting investors but also reshaping decentralized finance (DeFi). As pioneers like Aerodrome, Raydium, and Bananagun showcase the potential of aligning incentives, the stage is set for a new era in crypto investment — one where sustainable growth meets progressive regulatory adaptation. In this evolving ecosystem, the opportunity for fundamental investors has never been more promising. Over the past few years, given the existential business risk brought upon by Securities and Exchange Commission (SEC) enforcement actions, the vast majority of DeFi applications chose to pause all value accrual discussions indefinitely. This decision, while logical under the circumstances of the time, was massively detrimental to the industry. Many DeFi tokens without any direct tie to the success and growth of the underlying business were deemed to be useless and underperformed the market. The election of Donald Trump and the expected regulatory easing for the crypto industry has flipped this dynamic on its head. DeFi protocols now expect that popular value accrual mechanisms will carry far less associated risk. Reluctant DeFi projects are also being forced to reckon with the benefits these mechanisms have had for the projects brave enough to implement them. In this post, I highlight three applications that have taken different approaches to deliver economic value back to their token holders. All three have been very successful, seeing huge gains in both the amount of people using their products and their tokens’ prices. The success of these projects offers examples of possible methods more reluctant DeFi protocols could implement under a more progressive regulatory framework. Aerodrome Aerodrome is the dominant decentralized exchange on Coinbase’s Ethereum Layer 2 (L2), Base. In crypto markets, governance has been challenged by participants prioritizing short-term gains over the long-term health of the business. Aerodrome addresses this with a system in which token holders are incentivized to be long-term active participants in the network. To have maximum impact on governance matters, holders must lock their tokens for a long duration, providing them with greater voting power. With this voting power and continued participation in governance, this group of token holders are entitled to 100% of the revenue the exchange generates from trading fees and bribes. This design solves the problem of creating long-term alignment between token holders and the project. Aerodrome’s design provides the most control to the most committed holders. To give you an idea of how impactful those revenue distributions can be, in Q4 2024 the application generated $100.7M of revenue, for an annualized run rate of > $400M. This type of design also creates a virtuous cycle for the business, where as volume and revenues increase, token dividend yields spike to access these yields, market participants need to purchase and then lock their tokens, effectively reducing supply in circulation and benefitting all token holders. This design and the secular growth of DeFi on Base have made Aerodrome one of the biggest winners in DeFi this year, with its native token AERO up ~13x since the token launched in February 2024. Creating long-term buy-in amongst holders and giving them direct exposure to the success of the application no doubt has played a major part in the success of Aerodrome in 2024. Raydium Raydium, a decentralized exchange built on Solana, was among the first DeFi applications to achieve success on Solana after its launch in early 2021. Over the last two years, as Solana has recovered from the fallout surrounding the collapse of FTX, Raydium has cemented its position as a top decentralized exchange. To share economics with its token holders, Raydium implements a buyback program, instead of directly paying out fee revenue. Through this system, 12% of all fees earned by the protocol are used to purchase RAY tokens in the open market. This creates systematic demand for the token that is directly tied to increased usage of the application. In 2024, as meme coin trading on Solana exploded, so did trading volume on Raydium, which in December was up more than 13x YoY. Volume growth begets fee growth, and in December Raydium crossed 45M RAY tokens repurchased through the buyback program. This amount represents more than 10% of all RAY tokens and circulation and has created ~$360M in buy pressure for the token at current prices. This type of buyback program has the benefit of being more conservative from a regulatory risk perspective, since no fees are being paid out, and creates a direct tie-in between the growth of the application’s fundamentals and demand for the token. This design element differentiates Raydium and its token from its competitors on Solana, many of which are issuing tokens to incentivize usage, resulting in high inflation rates. Raydium is a great example of how a value accrual mechanism can significantly improve the investment case for a token. Raydium’s token delivered a +289% return in 2024. Bananagun Bananagun provides sophisticated trading tools to its users and allows them to execute these complex strategies via chat on the popular social media platform Telegram. Bananagun charges a fee ranging from 50-100 bps based on the type of trade being executed. While the application could have kept all these revenues to pay expenses and salaries, Bananagun developers instead directed 40% of all fees to token holders through direct dividend payments. To restrict access to this program to long-term investors, Bananagun decided that users should be required to purchase and stake a minimum of 50 tokens (~$3,000 at the time of writing) to be eligible to receive rewards. Once those tokens are acquired and locked, users receive programmatic payments in the project’s native token (BANANA) or ETH at the end of every epoch. Currently, these dividends provide an annual yield of 19% to holders, making a Bananagun a bona fide income-producing asset. Much like Raydium’s buyback, these dividends fluctuate with the total fees earned by the

“If exchanging money [interest-paying reserves] for short-term debt has no effect, it follows inescapably that giving banks more money is exactly the same as giving them short-term debt. All that quantitative easing (QE) does is to restructure the maturity of US government debt in private hands.” — John H. Cochrane, Senior Fellow, Hoover Institution, Stanford University “Keynesian, New Keynesian, and [Milton] Friedman’s quantity theories predict that pegging the interest rate at zero leads to unstable inflation or spiraling deflation. The quantity theory of money predicts that massive quantitative easing results in large inflation. None of these outcomes happened [after the global financial crisis]. Inflation was positive, low, and stable.” — Thomas S. Coleman, Bryan J. Oliver, and Laurence B. Siegel, Puzzles of Inflation, Money, and Debt The fiscal theory of the price level (FTPL) lays out a new model for understanding inflation. John H. Cochrane and Thomas S. Coleman discussed the FTPL’s logical framework and how it explained past inflation episodes in the first installment of this series. In the second, they considered what sort of countermeasures the FTPL might prescribe for addressing the current inflation episode, among others. Here, they take our investigation into the nature of the FTPL a few steps deeper. In particular, they address the disconnect between how many finance academics and finance practitioners view the inflation phenomenon in general and quantitative easing’s (QE’s) effect on it in particular. They also consider whether QE contributed to the pandemic-era bull market in equities and to inflation in asset prices across the board. Below is a condensed and edited transcript of the third installment of our conversation. John H. Cochrane: Quantitative easing is one area where academics and professionals differ loudly. Wall Street wisdom is that QE is immensely powerful and is stoking financial bubbles. Academics say, “I take your $100 bills, I give you back 10 $10 bills. Who cares?” Thomas S. Coleman: If you look at the Federal Reserve’s balance sheet, reserves exploded on the liability side, but on the asset side, bonds — either Treasuries or mortgages — offset it. And so the Federal Reserve was taking the bonds with one hand and giving people the dollar bills with the other. But it was kind of a wash. Olivier Fines, CFA: The S&P 500 rose 650% from 2009 through January 2020. Clearly, this outpaced the economy. Has inflation occurred in financial assets? Because there’s only so much toothpaste I can use as a consumer. The excess liquidity went to the financial markets. We asked our members, and a great majority thought that stimulus actually benefited the investor class because that money had to go somewhere and it went into equity markets. Cochrane: The price-to-dividend ratio from the dividend discount model is 1/ (r – g). That’s a good place to start thinking about stock prices. So, higher prices come when there are either expectations of better earnings growth [g] ahead or when the discount rate, the rate of return, the required return [r], declines. In turn, the required return consists of the long-term real risk-free rate plus the risk premium. So, why are price-to-earnings ratios so high? The first place to look is long-term real interest rates: They are absurdly low and declined steadily from the 1980s until right now. They’re still incredibly low. Why is the stock market going down? The number one reason is we all see that we’re going into a period of higher interest rates. So, let’s track stock price to earnings and think about the level of real interest rates there. In fact, up until recently, quantitatively, the puzzle is that stocks were too low. The price-to-earnings ratio relative to long-term real interest rates tracked beautifully till about 2000. And then long-term real interest rates kept going down and the price-to-earnings ratio didn’t keep going up. If you’re in Europe, where long-term real interest rates are negative, price-to-earnings ratios should be even larger. As you decompose the price-to-earnings ratio, you need a higher risk premium to compensate for that lower real interest rate. Stocks may not offer great returns, but they are a heck of a lot better than long-term bonds. So, it’s not even clear that risky assets are particularly high. Why are stocks going down? I think we see long-term real interest rates going up. And it’s perfectly reasonable to think the risk premium may be rising. We’re heading into riskier times. Coleman: There’s also growth. If you look at the United States versus Europe, there might be differences in expected growth in that as well. Cochrane: That’s a good point. We do see some tailing down of growth as well, and Europe’s growth has been terrible since the financial crisis. So, right now value stocks are doing great, and growth stocks are doing terribly. Tech stocks are doing terribly as well. Where the dividends are pushed out way into the future, if those dividends are discounted more as we go into higher real interest rates, then value stocks, which have high current earnings, do well amid higher discount rates. Rhodri Preece, CFA: Many practitioners believe that through large-scale purchases of government bonds, QE has pushed down yields and diverted flows into equities and other risk assets as investors search for higher expected returns. It also created the expectation that the central bank will underwrite the financial markets, the so-called Fed put. And this has led to a tidal wave of rising asset prices across a number of markets in the post-2008 period. Not much discernment among or within asset classes — just generally prices have gone up. Many practitioners attribute this largely to the central banks and their QE programs. You said earlier that academics don’t see it that way. Could you unpack that and explain the discrepancy? Cochrane: So, let’s define the terms a little bit. QE is when a central bank buys a large amount of, let’s say, Treasury debt and issues in return interest-paying reserves, which are overnight government debt. So, an academic looks at that

As the second quarter of 2025 approaches, the global economy advances with a mixture of resilience and unease. Though inflation is easing and growth has tentatively resumed, 2025 is unfolding beneath the weight of mounting geopolitical risks and structural divergences. Still, the outlook remains in flux. With recent tariffs and trade frictions just beginning to take effect, their long-term impact on global markets is far from clear. Economic Fundamentals While the United States continues to display surprising economic strength, Europe struggles to find momentum, and China confronts a new slowdown. At the same time, trade frictions, sanctions, and military conflicts threaten to reshape global flows of capital, goods, and influence. The International Monetary Fund (IMF) forecasts global growth at 3.3% in 2025 — steady compared to last year but below pre-pandemic trends (IMF). The United States remains the standout, with 2.7% growth projected after a 2.8% expansion in 2024, driven by robust consumer spending and capital investment (IMF). In contrast, the euro area is forecast to grow by just 1.0%, with Germany teetering near recession and France and Italy showing limited recovery. China, after reaching its 5% target last year, is slowing again: its 2025 growth is expected to decelerate to 4.5%, facing property market fragility, aging demographics, and a renewed wave of US tariffs (Reuters). India continues to expand rapidly at around 6% to 7%, while other emerging markets such as Mexico and Eastern Europe are feeling the effects of weaker global trade demand (Reuters). On inflation, a clear turning point has arrived. In the United States, consumer prices have eased to 2.8% year-on-year as of February — the lowest in more than two years (BLS). The euro zone has also seen relief, with inflation at 2.4%, nearing the European Central Bank’s target (Reuters). In China, however, inflation has slipped below 1%, raising deflationary concerns amid subdued consumer demand. The IMF anticipates global headline inflation to fall to 4.2% in 2025 (IMF). Policy Divergence and Rising Trade Frictions Monetary policy responses remain fragmented. The US Federal Reserve has kept its policy rate at 4.25% to 4.50%, signaling it is in “no rush” to cut rates despite market expectations and political pressure. Chair Jerome Powell warned that fresh import tariffs and industrial policies from Washington are raising “unusually elevated” uncertainty and could simultaneously push inflation up and dampen growth (Reuters). In Frankfurt, the European Central Bank (ECB) cut its deposit rate to 2.5% in early March, citing stagnating output. ECB President Christine Lagarde emphasized the fragility of the situation, highlighting the risks posed by a looming trade war with the United States and surging defense expenditures (Reuters). In contrast, China’s central bank has begun modest easing, including a 10 basis point cut and additional liquidity to support growth amid rising capital outflows (Reuters). In early April, the Trump administration imposed new tariffs, including a 10% global tariff and up to 50% duties on 57 countries (Holland & Knight). The average tariff on Chinese products has increased to 54%, which has resulted in an increase in trade tensions. The EU and China are preparing retaliation, while Canada and Mexico have secured partial exemptions under USMCA. The economic allies are divided, and the markets are wary, which is causing concerns about a prolonged global trade war due to these protectionist measures. Central bank policy and global economic stability are both put to the test by the circumstances. (​Gibson Dunn) Markets Navigate Turbulence The US stock market has experienced significant volatility in response to recent tariff announcements. Following the April 2 declaration of new tariffs, major indices such as the S&P 500, Dow Jones Industrial Average, and Nasdaq Composite saw substantial declines. The S&P 500 fell more than 10% in two days, marking its worst performance since World War II. (​Reuters) In a subsequent policy reversal, President Trump announced a 90-day pause on certain tariffs, leading to a temporary market rebound. The S&P 500 surged 9.5% on April 9, 2025, its largest single-day gain since 2008 (​Reuters). However, this relief was short-lived as concerns over escalating trade tensions, particularly with China, continued to unsettle investors. The S&P 500 and Nasdaq Composite dropped by 4.6% and 5.4%, respectively, on April 10. (​Reuters) Volatility remains elevated. The VIX index, Wall Street’s “fear gauge,” has climbed back to levels not seen since 2023, reflecting nervousness about policy missteps and geopolitical escalation. Many firms have delayed capital expenditures, citing unclear outlooks on tariffs and regulation. In Europe, bank and energy stocks have underperformed, reflecting both fiscal pressures and the threat of new windfall taxes related to defense spending and energy price volatility. The meteoric increase in gold prices has been one of the most remarkable financial developments of early 2025. Gold has reached record levels as a result of the increasing geopolitical uncertainty and the apprehension of investors regarding inflationary pressures from tariffs. Spot gold reached an all-time high of $3,167.57 per ounce on April 3. It has increased by approximately 15% since the beginning of the year, and as of April 10 it was still above $3,100. (​Mint) Despite volatility, credit markets remain orderly. Corporate bond spreads have widened modestly, but most indicators suggest that investors are not pricing in a deep recession. Emerging markets have underperformed, especially those tied to global trade flows and sensitive to dollar strength. One notable exception: commodity-exporting nations, particularly in the Gulf and parts of Africa, have benefited from elevated resource prices and investor rotation into perceived value markets. As the IMF notes, global financial conditions have tightened, but not dramatically. Central banks in advanced economies, including the Bank of England, are choosing to hold steady for now, while signaling vigilance. Policymakers remain deeply aware that a single escalation — be it in trade, energy, or conflict — could quickly shift the macroeconomic trajectory. Conclusion: What This Means for Analysts and Investors For financial analysts and investors, 2025 demands careful attention to more than just fundamentals. While inflation is cooling and growth persists in pockets, escalating trade frictions and geopolitical uncertainty are reshaping risk in real time. Traditional models may underweight the impact of policy shocks, especially around tariffs and capital flows. As macro conditions grow more fragile, understanding cross-border dynamics — and adjusting forecasts and allocations

The invention of market cap-weighted indices has been beneficial for the average investor by providing a simple and efficient way to gain exposure to equity markets. However, hidden beneath the surface of some market cap-weighted indices lies levels of concentration rarely observed in history. In this post, we examine how elevated concentration levels have historically impacted returns, valuations, and long-term investor outcomes — and why today’s market dynamics may be setting the stage for a familiar ending. The US stock market has reached its highest concentration level in more than 50 years, with the top 10 stocks comprising a weighting of 36%. Several problems may arise when a few companies dominate the market. The concentration in the top 10 stocks necessitates that performance will be heavily influenced by these handful of companies. Strong performance from these stocks can drive the entire market higher, while any significant declines may disproportionately drag the market down. This dynamic can sometimes mask the performance of the remaining 490 stocks, leading to a skewed perception of overall market health. While there is always an urge to proclaim, “this time is different,” market history tells us that while the plot may change, the story often ends the same. In this post, we utilize the top 500 US stocks, weighted by market cap (Top 500), to examine how the top 10 stocks have historically performed based on levels of concentration and valuations, and why market participants may be unprepared for the aftermath of current events. A stock’s placement in the top 10 may be short-lived and volatile or it may last for decades (Figure 1). The 1970s and 1980s were dominated by industrial giants and energy companies. IBM and Exxon Mobil spent multiple decades in the top 10. The 1980s and 1990s also saw a few pharmaceutical and telecommunications stocks enter and exit the top 10. Even tobacco producer Altria made a brief appearance in the top 10. By 1999, the rise of technology/growth companies was in full swing as the weight to the top 10 stocks rose to multi-decade highs. The 1998 to 2000 Technology/Growth Bubble was the last great cycle of market concentration prior to our current extreme levels. The 2000s saw a decade of strong performance by value names as several energy and financial companies rose to the top 10. This came to a crashing halt during the 2008 financial crisis. The 2010s to present saw a resurgence of technology or technology-related companies that increased the level of market concentration beyond that of the late 1990s and early 2000s. Figure 1: Largest Stocks Change Frequently Decade to Decade. Represents the top 10 largest stocks based on market cap from the 500 largest US stocks. Source: Compustat. Calculation: Hartford Equity Modeling Platform. Market Cap Weight vs. Earnings Contribution The weight of the top 10 stocks is currently 37% and has increased at a far higher rate than their earnings contribution, which currently stands at only 28%. This has created a large gap between their earnings contribution and weight (Figure 2). The current gap between the market cap weight and the earnings weight is one of the widest since 1970. There have been two other occasions of a gap close to this magnitude. In August of 2020, a gap appeared as the largest stocks led the way after the Covid bear market, ahead of the expected earnings that were projected following the “stay at home” shift in spending. In this case the weight to the top 10 remained steady as the market continued to rally and earnings contributions caught up. In 2000, the weight to the top 10 also remained steady and earnings contributions caught up, but in this instance company earnings had collapsed, and the market lost 49%. It is impossible to predict how the current gap will be resolved, but the recent gap formed due to the weight of the top 10 going parabolic while their earnings contribution has remained steady. It would take a herculean effort for earnings contribution to catch up, but it is possible. Figure 2: Weight to Top 10 Has Increased While Earnings Contribution Has Been Steady. Date Range: 12/31/1964 to 12/31/2024. Represents the top 10 stocks based on market cap from the largest 500 US stocks. Source: Compustat. Calculation: Hartford Equity Modeling Platform. Is it possible for today’s top 10 stocks to maintain their market leadership? Figure 3 is a hypothetical illustration of the growth of each stock in the top 10 if their past 10-year return is extrapolated forward. If the last 10-years repeats itself, the top 10 would increase to a weight of 73%. It may be sufficient to say that the current performance trajectory of the top 10 stocks is unsustainable. Figure 3: Current Trajectory of Top 10 is Unsustainable. Top 500 based on the 500 largest US stocks. Chart uses current weights and past 10-year returns and applies them for 50 years into the future. Past performance does not guarantee future results. Source: Compustat. Calculation: Hartford Equity Modeling Platform. Now that it has been established that the top 10 have reached extreme levels of concentration, we will consider whether concentration has influenced forward returns. We divided the Top 500 US stocks into the top 10 and Bottom 490. Both were equal-weighted and rebalanced monthly. Next, we used the weights in Figure 2 and combined them with the forward five-year return differential between the Top 10 Equal Weight and Bottom 490 Equal Weight. For the entire analysis, the Bottom 490 Equal Weight outperformed the Top 10 Equal Weight in 69% of rolling five-year periods. When we divided our observations equally into thirds, the highest levels of concentration still led to Bottom 490 Equal Weight outperformance. The third of the time the market was most concentrated, the top 10’s weight ranged from 23% to 39%. The Bottom 490 Equal Weight’s forward five-year return outperformed after 88% of those periods (Figure 4). In the middle third of concentration levels, the Bottom 490 Equal Weight outperformed 80% of

Hedge funds have become an integral part of institutional portfolio management. They constitute some 7% of public pension assets and 18% of large endowment assets. But are hedge funds beneficial for most institutional investors? To answer that question, I considered performance after fees and compatibility with institutional investors’ long-term investment goals. I found that hedge funds have been alpha-negative and beta-light since the global financial crisis (GFC). Moreover, by allocating to a diversified pool of hedge funds, many institutions have been unwittingly reducing their equity holdings. So, while my answer is no, hedge funds are not beneficial for most institutional investors, I propose a targeted approach that may justify a small allocation. And I cite new research that leaves the merit of hedge fund investing open to debate among scholars. Performance After Fees Hedge fund managers typically charge 2% of assets under management (AUM) plus 20% of profits. According to Ben-David et al. (2023), hedge funds’ “2-and-20” fee structure adds up to more than “2-and-20.” Ben-David and his co-authors estimate that the effective incentive rate is 50%, which is 2.5 times greater than the nominal 20% figure. The authors say, “This happens because about sixty percent of the gains on which incentive fees are earned are eventually offset by losses.” They calculate a 3.44% average annual cost of AUM for the hedge fund industry between 1995 and 2016. This is a heavy burden for what are essentially portfolios of publicly traded securities. How have the funds fared? Hedge funds were star performers prior to the GFC, but then things changed. Cliff Asness shows how hedge funds ran out of gas. Maybe it was because hedge fund assets increased tenfold between 2000 and 2007. Maybe it was because of the accounting rule change regarding the valuation of partnership assets that took effect in 2008. And, possibly, increased regulatory oversight from the 2010 Dodd–Frank reforms “…chilled some profitable hedge fund trading….” In any event, diversified hedge fund investing appears to have underperformed in modern (post-GFC) times. For the 15 years ending June 30, 2023, the HFR Fund-Weighted Composite Index had an annualized return of 4.0%. This compares to a 4.5% return for a blend of public market indexes with matching market exposures and similar risk, namely, 52% stocks and 48% Treasury bills. By this measure, the hedge fund composite underperformed by 0.5% per year. The recent scholarly literature on hedge fund performance is mixed, however. Sullivan (2021) reports that hedge fund alpha began declining after the GFC. Bollen et al. (2021) reach a similar conclusion. On the other hand, a more recent paper by Barth et al. (2023) indicates that a newly emergent subset of hedge funds — those not included in vendor databases – has produced returns superior to those that do participate in the databases. The reason for this is not entirely clear. Nevertheless, the revelation of the existence of these heretofore-overlooked funds suggests that they warrant further study and leaves the merit of hedge fund investing open to debate among scholars. Hedge Fund Impact on Alpha In our work, we focus on how alternative asset classes such as hedge funds have affected the alpha garnered by the institutional investor portfolios we study. This approach is concrete and pragmatic. We calculate the alphas of a large sample of pension funds. Then, we determine the sensitivity of alpha production among the funds to small changes in the percentage allocation to the asset class. Here, we are observing the return impact of each fund’s allocation to hedge funds and the performance impact of those hedge funds on the institutions’ bottom line. There is nothing nebulous or hypothetical about the procedure. Our dataset of institutional funds comprises 54 US public pension funds. Using returns-based style analysis, we devised a benchmark for each of them and calculated their alpha over the 13 years ended 30 June 2021. The range of alphas is -3.9% to +0.8 per year, or a little less than five percentage points. For each pension fund, we obtained the average allocation to hedge funds over the study period from the Public Plans Data resource of the Center for Retirement Research at Boston College. While some pension funds in the database allocated 0% to hedge funds, the average allocation was 7.3% and the maximum average allocation was 24.4%. Exhibit 1 illustrates the result of regressing the alphas on the respective hedge fund allocation percentages. The slope coefficient of -0.0759 has a t-statistic of -3.3, indicating a statistically significant relationship. We can interpret the slope coefficient as follows: A decrease of 7.6 bps in total pension fund alpha is associated with each percentage point increase in the hedge fund allocation percentage. The average allocation to hedge funds for the full 54-fund sample is 7.3% during the period under study. This translates to an alpha reduction of 0.55% per year at the total fund level for public funds in aggregate (0.073 x -7.6). That is a big hit for an asset class the constitutes less than 10% of AUM, as is the case for public pension funds in aggregate. Exhibit 1. The Relationship Between Pension Fund Alpha and Hedge Fund Allocation (2009 to 2021) Summing up so far: Hedge funds are diversified portfolios of publicly traded securities. A recent estimate of their cost to investors is 3.4% of AUM annually, which is a heavy burden. Using HFR data, we estimated that hedge funds underperformed a benchmark with matching market exposures and risk by 0.5% per year since the GFC. The scholarly literature on hedge fund performance is mixed. Our evaluation of the impact of hedge fund investing on the performance of public pension funds since the GFC indicates that an average allocation of about 7% of assets has cost the funds, in aggregate, roughly 50 bps of alpha a year. Taken as a whole, these results challenge the wisdom of investing in hedge funds — at least in diversified fashion — as a source of value added. Hedge Funds Are Not Stock Surrogates

The evolving landscape of the non-U.S. cannabis industry mirrors the early growth stages seen in the United States, which we outlined in our preceding article in this series. As recreational cannabis markets emerge, the consumer base expands from daily enthusiasts, who might even cultivate their own cannabis, to a wider demographic. In the U.S., younger individuals from diverse backgrounds are choosing cannabis over alcohol for a fun Saturday night, while older demographics are discovering its benefits for pain relief and the management of various health conditions. These trends in market maturity indicate what might be expected in regions such as Europe, Latin America, Africa, Oceania, and Asia over the next decade. Governments play a crucial role as gatekeepers in this development, and regulatory reforms toward cannabis access vary significantly across the globe. A World Tour of Cannabis Regulations In Europe, expected regulatory reforms and growing acceptance of both medical and recreational cannabis use are contributing to a robust growth in the cannabis sector. The European market is becoming increasingly sophisticated, with a regulatory focus on consistency and compliance. We believe the European cannabis industry is on the cusp of significant transformation, driven by a wave of regulatory developments. Countries like Germany, Malta, and Luxembourg are at various stages of legalizing or expanding legal access to cannabis, indicating a wider trend toward liberalization across the continent. Germany is currently debating the establishment of a regulated market for adult-use cannabis, which could set a precedent for other European Union countries. Additionally, the EU’s evolving position on CBD — recognizing it as a novel food — provides a legal framework that could boost the CBD market’s growth. These regulatory changes, along with increasing public support for cannabis legalization, are poised to drive substantial growth and innovation in Europe’s cannabis industry over the next decade. With several EU countries already having legalized cannabis in some form, the region shows potential for significant market expansion, particularly as regulations evolve and export opportunities increase. Latin America has been at the forefront of cannabis regulatory reform, with countries like Uruguay and Colombia leading the way in legalization for medical and adult use. In the coming years, Mexico may fully legalize cannabis, which would significantly impact the regional market, and potentially create one of the world’s largest legal cannabis markets. Brazil’s expanding medical cannabis program and Argentina’s recent regulations allow home cultivation and pharmacy sales for medical use. This illustrates the broader trend towards liberalization in Latin America. These developments, combined with the region’s favorable climate for cannabis cultivation, are expected to attract significant international investment and increase Latin America’s prominence in the global cannabis market. Interest is growing in African cannabis cultivation for both local consumption and export is growing. While regulatory and infrastructural challenges hamper the market’s full potential, Africa’s cannabis industry is poised for growth, supported by regulatory advancements in countries like South Africa, Lesotho, and Zimbabwe, which have made strides in legalizing and regulating cannabis for medicinal and industrial purposes. A landmark court ruling in South Africa in 2018 decriminalized private cannabis use, but there has been significant confusion around the rules, which exposes a need for regulatory adjustments. South Africa’s efforts to establish a legal framework for commercial cultivation and trade nevertheless underscore the region’s potential. Lesotho became a pioneer in Africa by granting licenses for medical cannabis cultivation in 2017. It was also the first country to export legal cannabis. This legacy, along with the country’s ideal growing climate, is increasingly attracting foreign investment. As more African nations reevaluate their cannabis laws to tap into the economic benefits, the continent could become a key player in the global cannabis supply chain. Oceania has been a leader in medicinal cannabis. Australia’s progressive medical cannabis laws and recent proposals for further liberalization, including potential pathways to recreational legalization, highlight the country’s growing market. Although New Zealand did not pass a law for recreational cannabis in a recent referendum, the country continues to expand its medical cannabis program. These regulatory developments, along with ongoing research and international trade opportunities, position Oceania for significant growth and innovation in cannabis cultivation, production, and distribution. Asia presents a complex regulatory landscape for cannabis, with countries like Thailand attempting stuttering steps towards liberalization by legalizing cannabis and removing its narcotics designation. The introduction of medical cannabis clinics and dispensaries marks Thailand’s ambition to lead in Asia’s cannabis market. However, more recently, Thailand’s new prime minister, Srettha Thavisin, has said that his government will “rectify” its cannabis policy and limit its use to medical purposes. Thailand is also considering instituting a monetary penalty on recreational users. Meanwhile, countries like South Korea and Japan are cautiously expanding access to medical cannabis and CBD products, respectively. Alas, strict drug laws across the region remain a major barrier to development. Over the 10-year horizon, as social attitudes evolve and the economic potential of cannabis becomes increasingly recognized, regulatory reforms in select Asian countries could unlock substantial growth opportunities in the cannabis sector there. The International Growth Outlook Knowing all of this, which part of the world should a curious cannabis investor focus on? Below, we project annual growth rates for different regions based on current trends, legislative reforms, theological advancements, demographics, shifts in social attitudes, and industry reports up to April 2023. Projected Annual Growth Rates Region 1-Year Growth Rate 5-Year Growth Rate 10-Year Growth Rate Europe 9% – 13% 21% – 25% 19% – 23% Latin America 8% – 11% 19% – 23% 23% – 27% Africa 7% – 9% 15% – 20% 20% – 24% Oceania 10% – 15% 23% – 27% 21% – 25% Asia 5% – 10% 13% – 17% 18% – 22% Europe and Oceania emerge as leaders in short-term market growth potential, driven by progressive legalization movements and advanced regulatory frameworks. Latin America, Oceana, and Africa are identified as promising markets with substantial longer-term growth prospects, contingent on overcoming existing regulatory and infrastructural challenges. Asia’s complex regulatory environment produces a cautious growth outlook, albeit with notable

This is the final post in my three-part series on performance measurement for private market funds and the difficulties of using the internal rate of return (IRR) measure as equivalent to a rate of return on investments. In Part I, I discussed the rise of global assets under management (AUM) in private market funds and how this trend may have been driven by a perception of superior returns compared to traditional investments. As I illustrated, a root cause for this belief is the generalized use of IRR to infer rates of return, which is problematic. In Part II, I discussed in more detail how IRR works and why it should not be misconstrued as an equivalent measure to infer investment rates of return. In this post, I will review existing corrective measures for IRR, which present their own challenges, and propose a fix: NAV-to-NAV IRR. Existing IRR Corrections The most common correction is the modified IRR (see Phalippou 2008 for a comprehensive discussion).[1] For example, Franzoni et al. (2012) use MIRR to study the determinants of the return of individual LBO investments.[2] With an MIRR, you need to choose a financing and re-investment rate. Both rates can be set to 8%, the usual hurdle rate, or to a stock market index. If intermediary cash flows are not large and the investment is held for a relatively short period of time, MIRR is fine. Thus, in a context like that of Franzoni et al. (2012), using MIRR is natural and results are insensitive to the exact reinvestment rate assumption. However, in some of the cases I reviewed previously, the holding period is long. The longest one was the 48-year track record of KKR. Over such a long period, MIRR converges to whichever reinvestment rate has been chosen, which is unappealing. MIRR is just like a net present value (NPV) calculation. You need to choose discount rates, which is effectively the same as choosing financing and reinvestment rates. With IRR, you do not need to choose the discount rate. Just like any derivative of NPV, such as the Kaplan-Schoar Public Market Equivalent, the only conclusion that can be drawn is on relative performance. That is, if one uses an MIRR, NPV or PME, all that can be concluded is whether the benchmark has been beaten or not, but not the magnitude (alpha). We do not know how large any under- or over-performance is. In the above example, what we calculated was an MIRR because we assumed a financing rate and a reinvestment rate and computed the rate of return ror. Proposing a Simple, Albeit Imperfect, Fix: NAV-to-NAV IRR My analysis so far in this series (see Part I and Part II) shows that the issue comes from early cash flows, which are high either by design (survivorship bias) or by active manipulation (exit winners quickly, use of subscription credit lines). Intuitively, a solution is a measure that takes out these early cash flows. One option is then to require any private capital firm to report its past five-, 10-, 15-, and 20-year returns (aggregated at the level of a strategy, the whole firm, and by funds); and to forbid any use of since inception IRR. Thus, any fund or firm that is less than five years old cannot display an IRR, only a multiple. The IRR would be reported as non-meaningful.   The measure just described is called an NAV-to-NAV IRR because it takes the aggregate NAV at the beginning of the time period, treat it as an investment, record all the intermediary cash flows that occurred, treat the aggregate NAV at the end of the time period as a final distribution, and then compute the IRR on the time-series.[3] Alternative names include “horizon pooled return,” perhaps to avoid the word IRR. This measure is quite common in presentations of aggregate private capital performance. NAV-to-NAV IRRs would be a major improvement. In a previous post, we saw that when KKR publishes a “past twenty years” IRR, their figure is around 12%. A 12% IRR is realistic because the reinvestment assumption is realistic. That 12% also squares up with its multiple. According to Preqin data, KKR’s net of fees multiple is about 1.6, which is what an investment earning 12% per annum would generate after four years, and four years is the average holding period of private equity investments. Similarly, when Yale stopped reporting its since inception IRR, and switched to past 20 years IRR, its performance was 11.5% — a far cry from the 30% that led to the endowment  being hailed an Investment Model. CalPERS, which did not experience abnormally high cash flows early on in its private equity investment program, also has a since-inception IRR of 11%. Thus, Yale and CalPERS have had similar returns in private capital. The past 20-, 15-, 10-, and five-years horizon IRRs would probably show this picture explicitly and more accurately. Exhibit 11 shows the horizon IRRs reported by Cambridge Associates. The first two rows could be what is mandated, except for the short-term figures. A one-quarter, or even past three-years return in private markets is not meaningful because it is mostly based on the NAVs. Reported returns for private equity (only funds classified as leveraged buy-out and growth) are 18%, 16%, 16%, 15%, and 13% at 5-, 10-, 15-, 20- and 25-years horizon. These figures are reasonable. The limits of NAV-to-NAV IRRs The proposed solution effectively boils down to cutting the initial years. As the window moves every year, the measure cannot be gamed because the early cash flows one year no longer are the early cash flows two or three years down the line. There are two main drawbacks, however. The first drawback is that some data is thrown away. If a fund did well between 1995 and 1999, this will not be recognized in the 2024 report because we include up to 25 years. However, these far-away results may not be relevant to judge a track record. A related issue is that

When constructing an investment menu for a defined contribution retirement plan, the focus is often on selecting the right investment managers and products. The goal is to choose options that best align with the retirement plan committee’s investment philosophy and are most suitable for the organization’s workforce. While these decisions are important, we believe it is equally important to select the right investment vehicles to fulfill that strategy. That is, the most appropriate mutual fund share class or collective investment trust (CIT) tier. In this post, we review various investment vehicle types, discuss how vehicle choice can impact fees and performance, and outline key criteria to consider when analyzing the reasonableness of the fee structure for a given defined contribution plan. Key Terminology First, it is critical to establish key terminology for this discussion. While this list is not exhaustive, it covers many of the relevant terms used when evaluating investment menu share class decisions and overall fee structures. The Current Landscape The Employee Retirement Income Security Act of 1974 (ERISA) requires retirement plan fiduciaries to act prudently and solely in the interest of the plan’s participants and beneficiaries. As such, the Department of Labor’s (DOL) fee guidance to plan sponsors has emphasized the responsibility of plan sponsors to monitor plan expenses, including assessing the reasonableness of total compensation paid to service providers, identifying potential conflicts of interest, and making the required disclosures to participants. To help plan sponsors evaluate fee reasonableness, the DOL’s guidance on section 408(b)(2) of ERISA requires service providers like recordkeepers and advisors, to disclose total compensation received by the service provider, their affiliates, or subcontractors. Despite this guidance and the benefit of required disclosures, some fee arrangements — such as those involving revenue sharing — can be difficult for plan sponsors to analyze, let alone participants. Not surprisingly, several organizations have found themselves in fee-related lawsuits over the last decade. In our practice, we see most plan sponsors moving away from revenue sharing and other opaque fee arrangements. Aside from concerns about fee-related litigation, many plan sponsors value the clarity provided to plan participants when offering only zero-revenue share classes in their plan lineups. Participants can easily ascertain recordkeeper fees and be assured the mutual fund expense ratio is used only for the mutual fund provider’s expenses. The Plan Sponsor Council of America’s (PSCA’s) 66th Annual Survey reported that only 35% of plans surveyed include revenue-sharing funds within their investment lineups, meaningfully lower than in prior years. In our role as plan advisor, we have helped many plan sponsors reduce plan fees and increase fee transparency by moving to zero-revenue share classes. We expect this trend to continue in the coming years. Share Class Choice Impacts Fees and Investment Performance From a fee perspective, the difference between revenue-sharing and zero-revenue share classes is illustrated in Figure 1. In the example, the revenue-sharing share class (R3) of a popular target date fund is compared with the zero-revenue share class (R6). The values are normalized from an approximately $30 million plan with roughly $20 million invested in the target-date funds. In this example, there is approximately $125,000 of revenue sharing generated by the R3 share class (as estimated by comparing the modeled investment fees of the R6 share class to the modeled investment fees of the R3 share class). Figure 1. Share Class Difference Illustration Notably, in this example, the difference in manager fees between the two share classes is typically used to compensate the recordkeeper and/or advisor — either in part or in whole. In the R3 share class scenario, it is likely the $125,000 difference between the R3 and R6 share classes (representing distribution fees) would be used to pay part or all the recordkeeper and/or advisor fees. Conversely, in the R6 share class scenario, the advisor and/or recordkeeper fees would need to be paid by the plan or by the plan sponsor directly. In both cases, a plan sponsor would need to determine what is a reasonable level of fees for an advisor and a recordkeeper based on plan size and participant count as well as services included. In addition, in the case of revenue sharing, plan sponsors must ensure anything above the “reasonable” fee level is credited back to participants or used to pay other plan expenses. To make this fee reasonableness determination, a plan sponsor must calculate the amount of fees going to vendors and compare that figure to industry benchmarks for plans of similar size, receiving similar services, on an annual basis. This can place a significant burden on plan sponsors and, in our experience, is not often reliably completed. Following this approach, many plan sponsors discover their fees are out of line with industry benchmarks and can achieve cost savings by moving to zero-revenue share class structures. From an investment performance standpoint, fees have an impact on investment performance. The higher the fees, the less money available to compound and grow in each participant’s investment portfolio. In Figure 2, we illustrate the differences in performance between the R3 and R6 share classes of the same target-date fund as Table 1. As a reminder, they both hold the same investment portfolios: the only material difference is the expense ratio. Comparing the performance of a $10,000 investment over a 10-year period, an investor in the R6 share class would end with approximately $1,000 more than an investor in the R3 share class. Larger investments or longer periods of time would magnify this effect, resulting in even greater differences in outcomes. Figure 2. Investment Performance Illustration Estimate is hypothetical and assumes an initial investment of $10,000 is invested for 10 years in the R3 share class and the R6 share class of the same target date fund in the same vintage and utilizes historical 10-year annualized return as of 12/31/2023. In the absence of revenue sharing, a plan that charges fees to participants would allocate the advisor and/or recordkeeper fees to participants’ accounts, which would appear as a separate line item on their