CFA Institute

The United States is a consumption-driven economy. But over the last half century, the US consumer has been weakening in the face of social and economic pressures. In recent years, the US Federal Reserve’s easy money policies along with fiscal stimulus have boosted consumption, but with inflation’s resurgence post-pandemic, such measures have run their course and consumer spending has resumed its long-term trend of declining growth. This will likely lead to recession. What’s the alternative? A US iteration of Japanification in which the Fed, the federal government, or some combination thereof artificially keep the US consumer afloat. A Consumer-Driven Economy Just how consumer-driven is the US economy? Personal consumption expenditures (PCE) constitute two thirds of total GDP, while gross exports account for only about 10%. The US economy is inward-focused and does not rely much on external income. As such, the consumer’s central role has only become more central over the last 50 years. As a share of US GDP, PCE has grown from 59% in 1968 to 68% in 2022, while net exports have fallen and gone into deficit over the same time period, from 0.1% in 1968 to -3.3% in 2022. This export deficit tracks consumption, indicating that it too is now consumer driven. PCE as a Percentage of US GDP Sources: Chart data culled from US Census Bureau, BEA, BLS, FRED, BIS With a Weakening Consumer But the US consumer is facing steady and increasing headwinds. While PCE has increased as a share of GDP, both nominal and real PCE growth has slowed over the last half century. Nominal PCE growth declined from 9.9% in 1968 to 3.5% in 2019, and real PCE growth from 5.7% in 1968 to 2.7% in 2022. This indicates that the US consumer’s economic influence is diminishing. Net PCE (Left Axis) vs. US Net Exports (Right Axis), Both in US Billions Dovish monetary policy and government stimulus have fueled PCE growth since 2000. These policies went into overdrive amid the COVID-19 pandemic, leading to a sharp jump in nominal PCE growth and a spike in inflation. But those policies cannot be sustained in the face of higher interest rates. Nominal YoY PCE vs. Real YoY PCE What Is Ailing the US Consumer? 1. Slower Income Growth PCE growth has been accompanied by expanding household debt, especially after 1968, and the US consumer is increasingly debt dependent. Household debt now accounts for more of nominal PCE, rising from 73% in 1976 to a peak of 141.5% amid the Great Recession in 2008. As of 2022, it stood at 109%. Debt is growing as a share of PCE, and thus the US consumer is more levered with less capacity to spend. YoY Household Debt vs. Nominal YoY PCE 2. Weakness in Other Economic Drivers PCE has risen as a proportion of GDP even as it has expanded at a slower rate. This implies that the pace of growth of other components of GDP — net exports and capital expenditure (CapEx), for example — has been declining even faster. Moreover, as PCE has taken up an ever greater share of GDP, US wages have not kept pace. PCE/GDP (Left Axis) vs. YoY Employee Compensation (Right Axis) 3. Rising Inequality In a consumption-driven economy, increasing inequality reduces the resources available to a greater and greater proportion of the population and, consequently, reduces overall consumption. According to US Census Bureau estimates, US inequality has risen over the last 50-plus years, with the country’s GINI inequality index increasing from 0.394 in 1970 to 0.488 in 2022. The income of the top 10% of US households has jumped from 213% to 290% of the median household income over the same period. As wealth is concentrated among a smaller and smaller cohort, the purchasing power of the majority diminishes. Mean Household Income Growth by Quintile 4. Demographic Challenges The rate of US population growth has been on a fairly consistent downward trend since the 1960s. This means the population is aging and will have a lower share of young people to drive consumption. Both nominal and real PCE growth have tracked lower population growth during the last 50 years. Nominal YoY PCE Growth (Left Axis) vs. Nominal YoY Population Growth (Right Axis) (%) So, What Are the Implications? Taken together, these factors point to four key developments: 1. Slowing Real PCE Growth Real PCE growth has fallen back to pre-pandemic levels following the COVID-19 bump. To be sure, health care, online services, travel, and auto sales, among other sectors, are defying the trend, but they are the exceptions. Real YoY PCE Growth Percentage (%) 2. A Shifting Debt Burden Following the global financial crisis (GFC) and again during the pandemic, the federal government increased its debt burden to prop up the struggling consumer and keep the economy running. Thus, the debt burden propelling economic growth shifted from the consumer to the public sector, and PCE growth started tracking total debt more than household debt. Nominal PCE YoY vs Total Debt YoY But this phase of increased government spending has come to an end in the face of higher interest rates. Currently, debt growth is falling in all non-financial sectors — government, households, and corporates — as is PCE growth. Meanwhile, delinquency rates on consumer loans have increased, returning to their pre-COVID levels. The COVID-bump in government stimulus has run its course, and the consumer is once again swimming against the current. Consumer Loan Delinquency Rates (%) 3. Falling Inflation When consumption growth slows, demand-side inflation does as well. Supply-side factors drove the recent surge in inflation, which peaked in 2022. As these factors have dissipated and consumer demand has weakened, so too has inflation. YoY Inflation vs. Real YoY PCE Growth by Quarter (%) Real YoY PCE (Left Axis) vs. YoY Inflation (Right Axis) On a larger level, the relationship between CPI and real PCE has undergone a major shift beginning in 1980. During the previous 30 years, CPI and PCE growth tended to move in opposite directions. Consumer

Taking nonfinancial information into account when conducting financial analyses is not entirely new to professional investors and analysts. But the demand for information beyond revenue, earnings, and other conventional accounting measures has increased significantly in recent years. This year, investors with over $130 trillion in assets asked more than 15,000 companies worldwide to specifically disclose environmental information so that they could evaluate how it impacted their investments. Companies now report more nonfinancial environmental, social, and governance (ESG)-related data than ever before. Indeed, an analysis of 50 Fortune 100 companies by White & Case LLP found that all 50 had included environmental disclosures in the 2022 reports they filed with the US Securities and Exchange Commission (SEC). When a company discloses nonfinancial information in its Form 10-K annual report or other specific SEC filings, it becomes subject to the SEC filing review process. Based on our survey of the related academic literature, here is what investors should know about the SEC filing review process and how it may affect ESG-related disclosures. The SEC Filing Review Process The SEC Division of Corporation Finance handles the filing review process as an important element of its day-to-day responsibilities. The SEC selectively reviews companies’ filings made under the Securities Act of 1933 and the Securities Exchange Act of 1934 to check for compliance with applicable accounting and disclosure requirements. The goal is to ensure that companies provide investors with material information to make informed investment decisions. Under the Sarbanes–Oxley Act of 2002, the SEC must review all companies at least once every three years. To manage this workload, the SEC strategically schedules the filing reviews throughout the year. Many of the largest companies by market capitalization have at least some aspects of their filings reviewed annually, while smaller companies may only have their filings reviewed once every three years. When the SEC staff believe companies can enhance their disclosures, they issue a comment letter to the company and request a response within 10 business days. The general public can access these comment and response letters to understand the SEC’s concerns and how the companies sought to address them. No Guarantee That (ESG) Disclosures Are Complete and Accurate The SEC filing review process has some important limitations — at least two of which create frequent misunderstandings. First, the SEC discloses only those filing reviews that resulted in at least one comment. It does not disclose which filings it reviewed without comment. Thus, the public generally will not know whether the SEC reviewed a filing without comment except through cumbersome Freedom of Information Act (FOIA) requests. Second, the SEC may review an entire filing cover-to-cover or just certain parts of specific filings, but it does not disclose the scope of its review to the public. What do these limitations mean for ESG-related disclosures? The SEC typically begins filing reviews with the annual report. But companies file considerable ESG-related information in their DEF 14A proxy statements, which the SEC may or may not review. In fact, DEF 14A filings have received comment letters less than one-third as often as 10-K annual reports. In addition, if ESG-related disclosures are outside an SEC filing altogether — in a sustainability report on the company’s website, for example — the SEC may have no responsibility to review those disclosures. So, stakeholders should not assume that “no news is good news.” There may be no record of an SEC comment letter related to ESG disclosures because the SEC did not review the disclosures. And even if it did review some ESG-related information, the SEC states that this does not guarantee the disclosures were complete or accurate. Securities law does not require that companies disclose their material ESG matters. That it does is a “myth” or “misunderstanding,” as then-SEC Commissioner Allison Herren Lee explained in a May 2021 speech. Where Will the SEC Be Most Effective? Our analysis of the literature suggests that the SEC is better at enforcing compliance with bright-line accounting and disclosure rules but is less likely to issue a comment letter when disclosures rely heavily on a company’s professional judgment. Given the subjective nature of many ESG-related disclosures and the lack of a generally accepted reporting framework, it is not clear from a compliance-monitoring perspective how rigorous SEC oversight of ESG disclosures can be. Instead, academic research suggests that the public dissemination of SEC comments and company responses could help companies reach consensus and converge on disclosure norms. This will ultimately take time and thus may not keep pace with the rising demand for ESG-related information. More ESG-Related Comment Letters to Come It is no surprise that CFA Institute, BlackRock, and other investment professionals have applauded the SEC’s push to require climate-related information in companies’ registration statements and annual reports. As a result, we expect the SEC will increasingly comment on ESG-related disclosures to ensure compliance with the related requirements. The message is clear: This reporting area may not be entirely new, but it is evolving rapidly, and it is up to all of us to keep up. If you liked this post, don’t forget to subscribe to the Enterprising Investor. All posts are the opinion of the author(s). As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer. Image credit: ©Getty Images / qingwa Professional Learning for CFA Institute Members CFA Institute members are empowered to self-determine and self-report professional learning (PL) credits earned, including content on Enterprising Investor. Members can record credits easily using their online PL tracker. source

Since their emergence in the 1970s, defined contribution (DC) plans in the United States have evolved. One notable change has been a shift in how they develop investment lineups for participant-directed DC plans. Plan sponsors are progressing from simply using commonly held investment beliefs to creating a structure that intentionally considers the characteristics and needs of their unique group of participants. In this article, I outline the process for creating such a structure from an asset class perspective. A key component to thoughtful DC plan investment design is crafting a diversified investment structure before selecting specific investment vehicles. Regulatory Foundation & Guidance for Investment Menu Structure The Employee Retirement Income Security Act of 1974 (ERISA) mandates that plan fiduciaries act prudently and diversify the plan’s investments to minimize the risk of large losses. By providing a greater degree of asset class diversification, plan sponsors can enable more opportunities for participants who self-direct their retirement account to mitigate investment risk. For DC plans subject to ERISA, there are several prescriptive requirements, along with a principles-based standard of care (duty of loyalty and duty of care) that plan fiduciaries must follow when building a plan’s investment structure. Even for plans not subject to ERISA, many plan sponsors consider the guidelines set forth under ERISA as best practice and choose to implement them. Generally, ERISA section 404(c) provides DC plan fiduciaries protection from the liability for participant investment choices if they offer a minimum of three diversified investment options that bear materially different risk and return characteristics, such as equity, fixed income, and cash equivalents. In practice, it is quite rare for an investment structure to be limited to just three investment options. This is because many investment fiduciaries believe that offering a larger, diversified opportunity set is beneficial for participants. Under the Pension Protection Act of 2006, certain pre-diversified investment options, such as Target Date Funds (TDFs), are considered qualified default investment alternatives (QDIA), which provides a safe harbor to mitigate fiduciary risk. The US Department of Labor (DOL) provides guidance for the selection of TDFs as well as periodic reviews of continued suitability. The DOL guidance is best practice and plan sponsors should leverage it when evaluating TDF usage in their plan’s investment structure. Plan sponsors should establish a structured process that first identifies a TDF philosophy and then reviews participant demographic data, including retirees, to review and ultimately select an appropriate TDF suite. The same participant data review is also useful when assessing a plan’s core investment structure. Beyond ERISA requirements and optional safe harbor provisions, DC plans’ named investment fiduciaries and their 3(21) investment advisors and 3(38) investment managers have wide-ranging investment structure flexibility if decisions are made in the best interest of participants and beneficiaries. Such flexibility allows for an array of suitable investment options, which can be overwhelming for plan sponsors. Crafting a Robust Investment Structure While the variability of DC plan participant groups’ needs and characteristics precludes a set formula of a “right” or “wrong” investment lineup design process, plan sponsors should maintain a prudent and documented selection process to satisfy their fiduciary responsibilities under ERISA. A comprehensive design process is multi-step, demands engagement by a plan sponsor’s retirement plan committee, and is best led by a qualified retirement plan advisor who is committed to facilitating committee conversations and preparing demographic and fund utilization reviews, among other duties. A Sample Process in Seven Steps 1. Identify a purpose & objectives statement Identify the company’s philosophy about the DC plan’s primary purpose and objectives. Sample statements and their potential impact on investment structure: Purpose: It is important that our DC plan reflect the company’s goal to promote a culture of “retirement environment.” This would manifest as: long employee tenure, employees who commonly retire from our company, and retirees who find it attractive to retain their DC plan accounts in the employer’s plan throughout retirement. Potential impact: The purpose statement might suggest that plan asset classes and TDFs support a retiree’s need to diversify fixed income allocations, because fixed income typically becomes a larger portion of an investor’s portfolio near throughout retirement. Purpose: It is important that our DC plan further the company’s goal of supporting employees as they save and invest for retirement. We observe that our company has a long history of employing mostly early-career persons, and based on past experience, we expect high employee turnover that results in few, if any, retirements from the company. When retirements occur, we observe that accounts are removed from the DC plan shortly thereafter. Potential impact: The purpose statement might merit the inclusion of multiple equity asset classes and core or core plus fixed income because, for the non-TDF investor segment, this design would provide for adequate equity diversification, while minimizing the need to allocate to separate fixed income sub-asset classes. It also might lend itself to a TDF designed for high equity allocations early in its glide path and low-to-moderate equity allocations (relative to the TDF universe average) near the target retirement age. 2. What percent of participants are enrolled in managed account services and/or self-directed brokerage accounts? Participant enrollment in a managed account service is typically low enough that it does not influence the plan’s overall investment structure, aside from ensuring the service’s minimum required asset classes are included. But if the managed account service serves as the plan’s QDIA, and retention in the QDIA is high, identify the asset classes the managed account provider will use and not use. Perform a cost-benefit analysis of including asset classes beyond those required by the managed service provider. 3. Develop a participant group profile to understand the plan’s investors. A DC plan’s participant group profile should be based on demographics and investor type. Since each plan’s participant group has diverse demographic characteristics, don’t rely on participant group averages for information such as age, compensation, education level, and company tenure. Analyzing averages often fails to reflect the breadth of a plan’s unique participant group, as well as any concentrated

Should retail investors have access to the full spectrum of alternative assets? This question inspires spirited debate among investment professionals and regulators. Illiquidity is often cited as a reason to restrict access to private credit, private equity, venture capital, real estate, and hedge funds. But the assumption that more liquid assets are inherently safer is misguided. Retail investors — especially Generation Zs who are new to investing — are trading speculative investments like binary options and cryptocurrencies on public platforms. Though liquid, these assets are complex and risky — and certainly no “safer” — than those available in the private markets. Investment restrictions based solely on liquidity unnecessarily penalize “mass affluent” retail investors, and we will illustrate how. Behavioral Finance Insights: The Illusion of Control Traditional finance holds that the more illiquid the investment, the higher the premium an investor should demand. It also advocates that the smaller the portfolio size and the lower the income availability, the larger the allocation to liquid assets should be. But reality is more complex. Indeed, investors with “adequate” income levels are still investing overwhelmingly in public markets. Many investors, regardless of their financial literacy, believe they can time the market. They trade public equity daily, aiming to “buy low and sell high.” They lose money with almost absolute certainty. Market timing is an illusion. No one can time markets consistently and over a long period. Yet, retail investors are trading in liquid markets, despite evidence that they’d be better off with passive exposure. In 2021, Richard Thaler attributed the surge in day trading to “boredom” and to a general decrease in fees. “People like free, so the combination of free commissions and boredom got a lot of them interested in investing, especially at the individual stock level,” he noted. “After all, just buying mutual funds, or even worse, index funds is so boring. There is no entertainment value in buying a global index fund.” Sports betting provides entertainment value that carries similar risks. Incidentally, Thaler also argued that most day traders believe they are better than the others and are certain they can beat the market. This is a dangerous delusion. These “armchair traders” are pitted against institutional investors who have access to sophisticated infrastructure and information — the equivalent of a Sunday runner trying to beat Usain Bolt. While an argument could be successfully made that lower-income and unsophisticated investors should steer clear of day trading and illiquid products, those investors with “adequate” levels of wealth should give alternative investments a look. Private market investments traditionally offer long-term opportunities from which investors cannot exit on a whim. The prevailing argument is that the lack of liquidity in the private markets is per se an issue for all retail investors. But what if, in line with behavioral finance findings, liquidity constraints could instead insulate investors from making subpar decisions? Illiquidity Premium: Friend or Foe? Let’s assume that liquidity constitutes a material additional risk driver for investments in private markets. If this was the case, then there would be evidence that investors are rewarded for taking illiquidity risk. And there is. In a 2022 study, Barclays suggested that there is an average liquidity premium of 2% to 4% for buyout funds and 3% to 5% for riskier early-stage VC funds. In a recent article published on CAIA Association’s blog, author Steve Nesbitt of Cliffwater claims a 4.8% premium for private equity over public markets between 2000 and 2023. These studies suggest investors are indeed rewarded for their illiquidity risk. But if this illiquidity premium exists, should there not be a free market for any investor to access these opportunities and benefit from this premium? Not so fast. Notable performance numbers do not, per se, support the case for extending access to every investor. But they at least beckon the financial community to ask the question given our fiduciary obligations.   If we assume the highest illiquidity premium from the two studies cited (5%), does liquidity pose a threat so big to investor risk-return profiles that access to private markets should be limited? Would these premiums erode if the floodgates were opened to the mass market? In pondering these questions, our sense is that when it comes to private markets, there are many other factors that need to be considered by investment professionals, investors, and regulators. First, not all alts are created equal. They carry various risk-reward profiles and do not follow a one-size-fits-all approach. This fact alone indicates the need for fine tuning by regulators. Second, even mass-market investors have different investment objectives, beyond just absolute performance. Diversification and value-alignment are just two examples. That is why the question of whether an investor should add private market assets to the portfolio should be tied to the investor’s risk-return profile. Liquidity Constraints and Accreditation To be clear, investor screening systems that protect weaker individuals are a good thing. But it is worth asking why regulators believe liquidity is a primary discriminant when deciding what products unaccredited (unsophisticated, less wealthy) investors can access. The Securities and Exchange Commission (SEC), the European Union (EU), and the UK’s Financial Conduct Authority (FCA) take different approaches regarding access to less-liquid products. All the approaches are based on a combination of wealth and education. It seems inconsistent that non-accredited investors may access products such as crypto or binary options trading exchanges simply because these products are liquid. Do regulators believe that because it is relatively easy to find buyers, an unsophisticated investor is necessarily protected?  Options are complex instruments traditionally used by institutional investors to reach specific portfolio goals. On the other hand, platforms selling binary options or contract for differences (CFDs) are akin to casinos, where payout is “all or nothing.” How is it that these investments do not require accreditation? Lifting Barriers to Access: An Example The European Union took an innovative approach in regulating more liquid private market investments in 2015 with Regulation 2015/760, which introduced the European Long-Term Investment Fund (ELTIF). At first, ELTIF struggled

The Ownership Dividend: The Coming Paradigm Shift in the U.S. Stock Market. 2024. Daniel Peris. Routledge — Taylor & Francis Group. Could the next opportunity in the stock market be with dividend stocks? According to Daniel Peris, the answer is “yes,” and after reading his insightful book, The Ownership Dividend: The Coming Paradigm Shift in the U.S. Stock Market, readers may find it hard to disagree with him. Peris is a senior portfolio manager at Federated Hermes, having joined the firm in 2002. His focus has been dividend-paying stocks, and he is considered one of the leading authorities on the subject. Previously, Peris authored several books on investing, including two about dividends: The Strategic Dividend Investor (McGraw Hill, 2011) and The Dividend Imperative (McGraw Hill, 2013). Both books remain valuable for any investment professional because they challenge one’s assumptions about how well companies use their cash. In The Ownership Dividend, Peris writes that there is soon to be a realignment in the stock market that could create “profitable opportunities for those who are prepared.” The shift will be from investors preferring a price-based relationship with their investments over a cash-based one. After four decades of an “anything goes” environment, where investors were dependent on the ever-changing price of a stock, Peris believes the tide has begun to turn. Investors will demand that more companies share their profits via dividends. Predicting a realignment in the stock market is bold and could easily be dismissed; however, Peris makes a great case for why dividends should be given a lot more attention than they currently receive. Peris carefully explains how the past four decades of declining interest rates have led investors to focus on the price growth of shares, rather than the income they provide. His argument is well crafted, and he challenges the generally accepted notion that large, successful companies do not need to share their earnings with shareholders by paying dividends. By recounting the role that dividends historically played in the stock market, Peris takes readers through an account of how dividends encouraged investment and how they have been diminished by the misapplication of the work of Franco Modigliani and Merton Miller, whose Dividend Irrelevance Theory has been misused as an argument for companies not to pay a dividend at all. The Dividend Irrelevance Theory states that the dividend policy of a company has no effect on its stock price or capital structure. The value of a company is determined by its earnings and investment decisions, not the dividend it pays. Thus, investors are indifferent as to whether they receive a dividend or a capital gain. As Peris points out, however, this theory is often misunderstood. Created in 1961, the theory assumes that most companies would be free cash flow negative, because they operated in capital-intensive industries and would need external capital to fund their growth plans and to pay dividends. While that may have been the case in the 1960s, Peris estimates that this situation applies to only 10% of the stocks in today’s S&P 500 Index. The current S&P 500 is made up primarily of service companies that are free cash flow positive and have sufficient cash flow to fund their growth and also pay a dividend. Peris provides countless reasons for the role that dividends play as an investment tool, but his review of stock buyback programs should be read by every investor. He is ahead of his time and unafraid to point out that perhaps the emperor has no clothes. While many on Wall Street applaud stock buyback programs as a tool to boost earnings per share, Peris exposes the reality that too often a significant portion of what is “bought back” is used for employee stock option plans. Investors would be well served to understand how stock buyback programs are often diluted by stock compensation plans. In fiscal year 2023, Microsoft repurchased $17.6 billion of its common stock and issued $9.6 billion in stock-based compensation. Microsoft is hardly an outlier; the past 40 years have seen dramatic growth not only in stock buyback programs but also in employee stock option plans. Over the course of 10 chapters, Peris makes a compelling case for the importance of dividends. His book is written for practitioners, not academics, which makes the book approachable and absent of any pretense. While his target audience may not be professors, it would be a useful book for anyone teaching a course on investing, which should include the idea that on Wall Street, there is never just one way to value an investment. The fact that investing in dividend-paying stocks is out of fashion on Wall Street is well accepted; even Peris acknowledges that fact. But what if Wall Street is getting it wrong? What if Peris is right that dividends will soon become much more important? As Peris sees it, the fall in popularity of dividend investing can be attributed to three factors: the decline in interest rates over the past four decades, the change in the securities tax code in 1982 that enabled share buybacks, and the rise of Silicon Valley. These three factors caused the stock market to shift from a cash-based return system (where dividends mattered) to one that is driven by near-term price movements. However, these factors have potentially run their course. According to Peris, “The 40-year decline in interest rates has come to an end.” Over time, he maintains, the market will revert to where investors will expect a cash return on their investments. Each factor is thoroughly explored by Peris, but his review of the relationship between interest rates and the cost of capital is especially timely. As interest rates fell from their highs in the early 1980s, companies had little difficulty raising capital. The recent rise in interest rates could make it more difficult. It was not long ago that investors were faced with money market funds and CDs having negative real rates of return, leaving them few options in which to invest for current

Finding suitable peers for financial analysis is a vexing task that requires careful consideration of firms’ underlying economics, accounting choices, and financial statement presentation. But without comparable financial statement information, peer benchmarking may yield less meaningful and even misleading insights that negatively impact earnings forecasts. In a recent study published in The Accounting Review, we developed a methodology to identify comparable firms for benchmarking and analyzed its implications for analyst outcomes and valuation with multiples. In this post, we will highlight the salient details, some of which may surprise you. There are different ways to define peer firms, such as industry membership, stock index membership, closeness in market capitalization, and similarity in value drivers (e.g., P/E ratio, return-on-invested capital, and growth). As an alternative to traditional classifications, researchers have tested new ways to identify peer firms, such as investors’ co-search, intensity of firms’ filings with the SEC’s EDGAR, and stock information on Yahoo! Finance. These widely utilized methods fail to directly address a crucial aspect of firm benchmarking: the availability of key financial statement information for peer firms. When several financial statement line items are missing for a peer firm, analysts struggle to derive meaningful inferences from the comparative to the focal firm’s financial statements. Our financial statement benchmarking (FSB) measure aims to fill this gap. The data and code are freely available on our website. Capturing the Degree of Overlap Between Financial Statement Items Built on the Jaccard similarity coefficient, pairwise FSB captures the degree of overlap in financial statement items reported by two firms, with scores ranging from 0 (no overlap) to 1 (full overlap). The higher the FSB score, the greater the benchmarking information available to external users. For instance, if the focal firm has reported 270 items, 200 of which overlap with 220 items reported by the peer firm, the FSB score is 0.69 (200 / (270 + 220 – 200). To put this into context, the average score for analyst-chosen peers in our sample is 0.68. Assuming that FSB is a helpful metric in capturing the similarity of two firms’ underlying economics and accounting choices, we expect it to be positively correlated with analysts’ choices of peer firms. Our sample of analyst-chosen peers comes from a Review of Accounting Studies article, “Analysts’ choice of peer companies.” By manually screening more than 2,500 sell-side equity analysts’ reports, the authors extracted data on comparable peer firms selected for the focal firm in each report. In our study, for each analyst-chosen peer firm, we selected a matching firm in the same industry that was not chosen but which had a similar size and valuation multiple. The results show that analysts tend to choose peer firms that are more comparable to a focal firm from a financial statement benchmarking perspective. When FSB is higher by one-standard-deviation, the likelihood of being selected as a peer firm by an analyst increases by 13%. Higher FSBs Increase Accuracy of Earnings Forecasts Does choosing peers with higher FSBs have positive implications for analyst performance? We find that when the average FSB of the set of analyst-chosen peer firms is one-standard-deviation higher, the accuracy of analysts’ earnings forecasts increases by about 23%. When selecting peer firms, look for firms that have more similar financial statements to the focal firm, even if that means searching outside the focal firm’s main industry. In fact, only 40% of the analyst-chosen peer firms operate in the same product market as the focal firm. Which companies do you think would be good peer firms to choose when analyzing Colgate-Palmolive? Morningstar lists Procter & Gamble and Unilever as top peers for the company. Despite being listed on a US stock exchange, Unilever has a modest 0.69 FSB score with Colgate-Palmolive. This is likely because the company uses International Financial Reporting Standards to prepare its financial statements. Using different accounting standards reduces comparability due to differences in the recognition and presentation rules. In contrast, P&G and Colgate-Palmolive have a higher FSB score of 0.77, suggesting a greater comparability than Unilever and Colgate-Palmolive. In contrast to Morningstar’s approach, Google Finance creates a list of peer firms based on investors’ co-search activity. Notably, among the peer firms Google Finance lists for Colgate-Palmolive is Coca-Cola. Although this observation may seem unintuitive at first blush, our methodology suggests that, from a financial statement benchmarking perspective, Coca-Cola would be an excellent fit in this case because its FSB score with Colgate-Palmolive is well above the average at 0.82. This may explain why investors extensively co-search the financial information of the two companies. Validation and Testing After validating and testing the pairwise FSB metric, we aggregated data across all industry peers of the focal firm to understand how easy it is to benchmark a firm’s financial statements overall. This process yielded a large panel of firm-level FSB data. Also, to enrich our methodology, we decomposed FSB at the financial statement level, generating separate FSB scores for the income statement, balance sheet, and statement of cash flows. While analysts’ consensus earnings and net debt forecasts are more accurate when firm-level FSB is high (i.e., it is easy to benchmark and understand a firm’s financial statements), income statement and balance sheet benchmarking play different roles in those outcomes. We find that the Income statement FSB score predicts the accuracy of earnings forecasts but not net debt forecasts. In contrast, balance sheet FSB score predicts the accuracy of net debt forecasts, but not earnings forecasts. In economic terms, a one-standard-deviation increase in income statement (balance sheet) FSB is associated with a 17.3% (12.1%) more accurate consensus earnings (net debt) forecasts. These findings highlight that benchmarking benefits depend on the context of the analysis.  For the Investor: Industry, Industry-Size, or FSB Peers Beyond positive analyst outcomes, a key question for investors is whether choosing peer firms based on FSB improves valuation with comparables. To this end, we compared the predictive ability of the valuation multiples formed using FSB-based peers to those of the models employing traditional methods for peer firm

In the realm of finance, cognitive biases profoundly influence investor decision-making. Among these biases, confirmation bias remains particularly pervasive. Confirmation bias is the inclination to favor information that aligns with pre-existing beliefs while discounting contradictory evidence. Confirmation bias is exacerbated by echo chambers on social media platforms, where algorithm-driven content personalization creates an environment that reinforces investors’ views. Platforms such as X (formerly Twitter) and Reddit are especially prone to these dynamics, particularly among younger, retail investors, significantly shaping market perceptions. This blog post explores the mechanisms through which confirmation bias and echo chambers influence investor behavior on these platforms and proposes strategies for mitigating their impact. The Role of Social Media: X and Reddit X and Reddit have emerged as crucial sources of financial information for retail investors. While these platforms provide real-time updates and foster community insights, they also serve as fertile ground for reinforcing confirmation bias. X: The platform’s algorithm curates user feeds based on interaction history. For investors, this means that following specific finfluencers often results in an information bubble dominated by like-minded content. This is a key point made in the Research and Policy Center’s report, “The Finfluencer Appeal: Investing in the Age of Social Media.” An investor with a bullish outlook on tech stocks, for instance, is likely to receive a feed saturated with optimistic analyses, discouraging exposure to more skeptical viewpoints. This reinforcement of one-sided perspectives amplifies confirmation bias, leading to unbalanced decision-making. Reddit: Finance-oriented subreddits like r/WallStreetBets exemplify how echo chambers operate. These communities are prone to groupthink, where popular sentiments are upvoted while dissenting views are suppressed. This effect was particularly evident during the GameStop and AMC short squeezes in 2021, where the echo chamber dynamics led investors to disregard financial fundamentals and make emotional investment decisions. Many retail investors who bought GameStop or AMC at peak prices faced severe financial losses as the stocks subsequently collapsed. Impact on Financial Decision-Making The interplay between confirmation bias and echo chambers has driven significant financial phenomena in recent years. A recent example also revolves around GameStop — the flash rally of 2024. This recent event was sparked by the re-emergence of Keith Gill (Roaring Kitty) on Reddit and X after a three-year hiatus. Gill’s return prompted a sudden surge in GameStop’s stock price, which rose by more than 70% in a single day, reaching a peak of nearly $31 before plummeting by over 50% within just a few days. This led to significant losses for many retail investors who bought in at elevated levels, reminiscent of the speculative mania of 2021. Similarly, in the cryptocurrency market, platforms like X and Reddit have fueled speculative hype, particularly during bull runs. Many investors bought into projects like Cardano (ADA) without fully understanding the associated risks. Cardano experienced a sharp decline, dropping more than 40% from its 2024 peak, highlighting the volatility and uncertainty surrounding even well-known projects. Despite its ambitious promises of creating a scalable and sustainable blockchain ecosystem, Cardano’s progress has often been ambiguous, leading to skepticism about its real-world utility. The hype-driven environment, coupled with confirmation bias, led many investors to disregard warning signs, resulting in substantial losses during market corrections. Mitigation Strategies Although confirmation bias and echo chambers are pervasive, platforms like X and Reddit still provide substantial value for staying informed. X offers rapid access to breaking news and expert opinions, while Reddit allows for in-depth discussions and diverse community insights. To fully benefit from these resources without falling victim to biases, investors must adopt strategies to mitigate the risks of engaging with these platforms. Here are some strategies that can assist: Follow Diverse Perspectives: On X, consciously follow accounts that present differing opinions. If your perspective is typically bullish, include skeptics and contrarian voices in your feed to broaden the scope of content and challenge your views. Diversify Reddit Communities: Rather than relying on a single subreddit, explore a range of finance-oriented communities with varying viewpoints. Engaging with diverse perspectives helps prevent the pitfalls of group thinking and encourages a more nuanced understanding of market dynamics. Seek Non-Social Media Sources: To mitigate the effects of social media echo chambers, supplement your information sources with trusted financial news outlets, peer-reviewed academic papers, and market research reports. These sources provide more rigorously vetted information that is not influenced by the algorithms that curate social media content. Challenge Personal Beliefs: Regularly adopt a devil’s advocate approach toward your own investment ideas. For every positive argument, deliberately seek out and evaluate counterarguments, weighing evidence on both sides before deciding. It may even be worth engaging in discussion and actively asking trusted experts in your network or in online communities to challenge your investment thesis. Key Takeaway In an era where information is abundant yet algorithmically filtered to align with individual preferences, it is imperative for investors to recognize and actively counteract confirmation bias. Platforms like X and Reddit can offer valuable insights, yet they also distort an investor’s perception of financial realities, creating significant risk to their financial well-being. By deliberately seeking diverse viewpoints and critically assessing their own beliefs, investors can foster a more balanced and informed decision-making process. Maintaining intellectual flexibility in finance is not merely beneficial; it is essential for navigating complex and rapidly evolving markets. Let us commit to stepping outside the confines of the echo chamber and cultivating a broader, more informed perspective. source

Despite a brief return to normalcy in 2022, equity factor strategies have experienced performance challenges relative to cap-weighted indexes since the COVID-19-induced market crash of 2020. While there are many explanations for these challenges, our focus here is on another question: Is it possible to retain the benefits and economically sound basis of a factor approach to equity investing while more closely aligning a factor portfolio’s performance with a cap-weighted benchmark? Before we answer that, let us briefly review the drawbacks of cap-weighted indexes. In cap-weighted indexes, companies with higher market caps receive a higher weighting in the index. Smaller companies, on the other hand, which presumably have the most room to grow, receive a lower weighting. The risk inherent in investing in cap-weighted index strategies is threefold. One, they may experience losses as companies with the largest weights “mean revert” to lower price levels. Second, by underweighting smaller companies, cap-weighted strategies may prevent investors from meaningfully benefiting from companies with the most growth potential. Finally, cap-weighted index strategies are relatively concentrated in a small subset of the largest stocks. This lack of diversification runs against a cornerstone of modern investing and leaves investors vulnerable to significant downside risk if one or more of the largest companies in the index experience large drawdowns. In contrast, a properly constructed equity factor strategy will be driven by risk factors that have been shown to reward investors over the longer term. These factors — Value, Momentum, Size, Profitability, Investment, and Low Volatility — have been empirically validated over several decades by various researchers and possess a clear and intuitive economic rationale. Multi-factor portfolios that have exposure to all six factors are typically more diversified and lower volatility investment vehicles compared with cap-weighted indexes and the products that emulate their behavior. While the latter characteristics have served factor portfolios well, as we have seen, in some market environments, equity factor portfolios may underperform cap-weighted strategies. The question is: Is there a way to retain the benefits of factor investing while staying more aligned with the performance of cap-weighted indexes? What Is to Be Done? As we show below, a binary choice between factor investing and cap-weighted-like performance is not necessary. While tilting towards cap-weighted benchmarks in a wholesale manner will likely not benefit investors in the long run, there is a middle way: continue investing in a factor strategy but apply tracking error constraints to reduce the performance gap between cap-weighted and “unconstrained” factor portfolios over a given period. As our analysis demonstrates, applying the latter adjustments to a factor portfolio has both pros and cons, both in the short and long term. How Do Tracking Error Constrained Factor Portfolios Behave? The chart below shows the recent performance differences between a standard six factor portfolio –where each factor has equal weight — and tracking error (TE) constrained variants of it. When we apply TE constraints, the table indicates the performance gap between the factor portfolios and the cap-weighted index shrinks considerably. The cost that these portfolios pay, however, is around 100 basis points (bps) of additional volatility and a deterioration of downside protection, as measured by maximum drawdown. Factor Portfolios with Tracking Error Constraints,31 December 2022 to 30 June 2023 CapWeighted Six FactorEqual Weight Six FactorEqual Weight1% TE Target Six FactorEqual Weight2% TE Target Return 17.13% 6.04% 14.70% 12.38% Volatility 14.44% 13.10% 14.05% 13.72% SharpeRatio 1.01 0.27 0.87 0.72 Max. Drawdown 7.43% 7.90% 7.51% 7.61% RelativeReturn – -11.09% -2.43% -4.75% TrackingError – 4.65% 0.98% 1.95% InformationRatio – n/r n/r n/r Max. Relative Drawdown – 10.04% 2.19% 4.29% The sector composition of the TE-controlled portfolios in the following table shows that the strong underexposure to the Technology sector falls significantly relative to the standard multi-factor portfolio. This may not come as much of a surprise. After all, larger technology companies have been one of the primary drivers of the outperformance of cap-weighted vehicles relative to equity factor strategies. Sector Allocations as of 30 June 2023 Cap Weight-ed Six FactorEqual Weight Six FactorEqual Weight1% TE Target Six FactorEqual Weight2% TE Target AbsoluteWeight Relative Weight Absolute Weight Relative Weight Absolute Weight Relative Weight Energy 4.7% 6.3% 2.0% 5.3% 0.6% 5.9% 1.2% BasicMaterials 2.3% 2.6% 0.3% 2.4% 0.0% 2.4% 0.1% Industrials 8.8% 7.4% -1.4% 8.3% -0.4% 7.9% -0.9% Cyclical Consumer 12.4% 11.7% -1.0% 12.0% -0.3% 11.7% -0.7% Non-Cyclical Consumer 6.5% 11.2% 5.1% 7.4% 0.9% 8.3% 1.8% Financials 12.7% 13.1% 1.5% 12.9% 0.2% 13.1% 0.4% HealthCare 14.2% 17.7% 4.2% 14.8% 0.6% 15.4% 1.2% Tech 34.5% 21.5% -15.7% 31.7% -2.8% 28.9% -5.7% Telecoms 1.1% 2.0% 0.9% 1.3% 0.2% 1.6% 0.4% Utilities 2.7% 6.6% 4.1% 3.8% 1.0% 4.8% 2.1% Over a longer measurement horizon, the following chart demonstrates that controlling for TE detracts from long-term risk-adjusted performance by increasing volatility and reducing returns. The information ratios and the probability of outperforming the cap-weighted index over various horizons also deteriorate slightly. Long-Term Risk Adjusted Performance,30 June 1971 to 31 December 2022 Cap Weighted Six FactorEqual Weight StandardPortfolio Standard PortfolioTE 1% Standard PortfolioTE 2% AnnualReturns 10.22% 13.10% 10.95% 11.63% AnnualVolatility 17.33% 15.53% 16.82% 16.38% Sharpe Ratio 0.33 0.55 0.38 0.43 Max.Drawdown 55.5% 50.9% 54.0% 53.5% AnnualRelativeReturns – 2.88% 0.72% 1.41% AnnualTrackingError – 4.20% 1.14% 2.21% InformationRatio – 0.69 0.63 0.64 Max. RelativeDrawdown – 20.1% 5.8% 10.7% OutperformanceProbability(One Year) – 66.89% 67.71% 67.38% OutperformanceProbability(Three Years) – 79.42% 75.81% 75.30% OutperformanceProbability(Five Years) – 86.94% 84.62% 84.44% Conclusion Tracking error risk control is an effective way to manage the out-of-sample tracking error of multi-factor indices, and it can also help reduce sector deviations of multi-factor indices. We don’t have to throw out the baby with the bathwater. However, over the long term, aligning a factor portfolio’s performance with a cap-weighted index may be detrimental to both absolute and risk-adjusted returns. Moreover, simple cap-weighted approaches to equity investing lack the economic and conceptual foundations to justify their use. While they may outperform in certain market environments, they do not possess the formula for superior long-term risk-adjusted performance. If you liked this post, don’t forget to subscribe

The following is based on “Redefining the Optimal Retirement Income Strategy,” from the Financial Analysts Journal. Financial planning tools largely assume retirement spending is relatively predictable, that it increases annually with inflation regardless of an investment portfolio’s performance. In reality, retirees typically have some ability to adapt spending and adjust portfolio withdrawals to prolong the life of their portfolios, especially if those portfolios are on a declining trajectory. Our latest research on perceptions around retirement spending flexibility provides evidence that households can adjust their spending and that adjustments are likely to be less cataclysmic than success rates and other common financial-planning-outcomes metrics imply. This suggests that spending flexibility needs to be better incorporated into the tools and outcomes metrics that financial advisers use to advise clients. Flexible and Essential Expenses Investors are often flexible on their financial goals. For example, a household’s retirement liability differs from a defined benefit (DB) plan’s liability. While DB plans have legally mandated, or “hard,” liabilities, retirees typically have significant control over their expenses, which could be perceived as “soft” to some extent. This is important when applying different institutional constructs, such as liability-driven investing (LDI), to households. Most financial planning tools today still rely on the static modeling assumptions outlined in William P. Bengen’s original research. This results in the commonly cited “4% Rule,” where spending is assumed to change only due to inflation throughout retirement and does not vary based on portfolio performance or other factors. While the continued use of these static models may primarily be a function of their computational convenience, it could also be due to a lack of understanding around the nature of retirement liability, or the extent to which a retiree is actually comfortable adjusting spending as conditions dictate. In a recent survey of 1,500 defined contribution (DC) retirement plan participants between the ages of 50 and 70, we explored investor perceptions of spending flexibility and found that respondents were much more capable of cutting back on different expenditures in retirement than the conventional models suggest. The sample was balanced by age and ethnicity to be representative of the target audience in the general population. Ability to Cut Back on Various Spending Groups in Retirement Spending Group 0% — Not Willing to Cut Back Reduce by 1% to 24% Reduce by 25% to 50% Reduce by 50% or More Food (At Home) 29% 42% 21% 7% Food (Away from Home) 12% 41% 25% 20% Housing 31% 29% 22% 12% Vehicles/Transportation 13% 46% 26% 13% Vacations/Entertainment 14% 36% 25% 20% Utilities 31% 45% 16% 8% Health Care 43% 30% 17% 8% Clothing 6% 44% 25% 22% Insurance 32% 40% 19% 8% Charity 18% 31% 12% 19% Source: PGIM DC Solutions as of 5 October 2021 According to traditional static spending models, 100% of retirees would be unwilling to cut back on any of the listed expenditures. In reality, though, respondents demonstrate a relatively significant ability to adjust spending, with notable variations across both expenditure type and households. For example, while 43% of respondents wouldn’t be willing to cut back on health care at all, only 6% would say the same about clothing. In contrast, certain households are more willing to cut back on health care expenditures than vacations. A spending cut’s potential cost may not be as severe as traditional models imply. For example, models generally treat the entire retirement spending goal as essential: Even small shortfalls are considered “failures” when the probability of success is the outcomes metric. But when we asked respondents how a 20% drop in spending would affect their lifestyle, most said they could tolerate it without having to make severe adjustments. Impact of a 20% Spending Drop on Retirement Lifestyle Little or No Effect 9% Few Changes, Nothing Dramatic 31% Some Changes, But Can Be Accommodated 45% Substantial Changes and Considerable Sacrifices 13% Devastating, Would Fundamentally Change Lifestyle 2% Source: PGIM DC Solutions as of 5 October 2021 For example, only 15% said a 20% spending drop would create “substantial changes” or be “devastating” to their retirement lifestyle, while 40% said it would have “little or no effect” or necessitate “few changes.” Retirees appear to be far more sanguine on a potential reduction in spending than traditional models would suggest. The clear ability to cut spending as demonstrated in the first chart, and the relatively small implied potential impact on retiree satisfaction, or utility, in the second, at least for a relatively small change in spending, has important implications when projecting retirement income goals. While understanding each retiree’s spending goal at the more granular expenditure level is important, so too is having a sense of what amount of spending is “essential” (i.e., “needs”) and “flexible (i.e., “wants”) when mapping out assets to fund retirement liabilities. The following chart provides some context on what percentage of the total retirement income goal constitutes “needs.” Distribution of Responses: The Composition of a Retirement Goal That Is a “Need” (Essential) Source: PGIM DC Solutions as of 5 October 2021 While the average respondent says that approximately 65% of retiree spending is essential, there is notable variation: The standard deviation is 15%. Spending flexibility is critical when considering the investment portfolio’s role in funding retirement spending. Virtually all Americans receive some form of private or public pension benefit that provides a minimum level of guaranteed lifetime income and can fund essential expenses. In contrast, the portfolio could be used to fund more flexible expenses, which are a very different liability than is implied by static spending models that suggest the entire liability is essential. Conclusions Overall, our research demonstrates that retirement spending is far more flexible than implied by most financial planning tools. Retirees have both the ability and the willingness to adjust spending over time. That’s why incorporating spending flexibility can have significant implications on a variety of retirement-related decisions, such as required savings level (generally lower) and asset allocations (generally more aggressive portfolios may be acceptable, and certain asset classes become more attractive). For more from David Blanchett,

With its riveting victory over France in the World Cup finals and the heroics of its all-time great team captain Lionel Messi, Argentina has good reason to celebrate. But as the post-World Cup glow subsides, the country faces significant and deep-seated economic and financial challenges. Inflation reached an annualized rate of 92.4% for the period ending 30 November 2022, placing added pressure on a population already hard hit by years of stagflation and anemic economic growth. Moreover, after three decades of deficit spending, concerns about the solvency of Argentina’s public debt remain ever present. Indeed, the current prices of credit default swaps (CDS) indicate a 60% chance of default by 2024, according to Cbonds data. Argentina has not always endured such dire economic conditions. In fact, it was the 10th richest country in the world per capita in the early 20th century. To be “as rich as an Argentine” was a common aspiration. So what explains Argentina’s fall from the economic heights, how can it recover, and what lessons does it offer other emerging market economies? Argentina’ economic golden age from 1860 to 1930 owed much to its agricultural breadbasket, the Pampas, and the bounty of wheat, corn, wine, and beef it produced. Foreign investment from Germany, France, and the United Kingdom flowed in, and high wages attracted immigrants from Italy, Spain, and elsewhere. From 1860 to 1899, Argentina’s real GDP advanced at an astonishing clip of 7.7%. per year. During the first two decades of the 1900s, Argentina’s economy outperformed both Canada’s and Australia’s. Making a bet on Argentina’s future, Harrods even opened its first overseas location in the capital of Buenos Aires. With the Great Depression, however, Argentina’s decades of economic expansion came to a halt. Though the pain was global and other nations suffered similar economic declines, Argentina has yet to return to a trajectory of sustained economic growth. Inflationary Shock and the Maradona Era Where did Argentina stray from its development path? As the Great Depression led to a collapse in Argentina’s exports, widespread populist discontent destabilized the government. Over the next 50 years, populist regimes alternated with military dictatorships. Scarred by the export shocks of the Great Depression, Argentina’s economy turned inward. Rather than grow international trade, the country’s leaders embraced a misguided economic philosophy of self-sufficiency. Formulated by the economist Raul Prebisch, this approach sought to protect the development of domestic industries through import tariffs, subsidies, and even the nationalization of certain sectors of the economy. Following a coup d’etat in 1976, the new military junta began to reverse some of these protectionist policies and open up the economy to more international trade. But economic liberalization and the junta’s interests did not always coincide, and amid the country’s deteriorating finances, the initial results were mixed, so these efforts were soon dialed back. In 1978 meanwhile, Argentina hosted the World Cup, and the national team captured it first championship. Though the tournament had its share of controversy — state intervention was not limited to the Argentine economy — the victory constituted a bright moment in an otherwise dark era for the country. An ongoing challenge in this era stemmed from tax revenue, or the lack of it. Shortfalls grew especially severe in the midst of the Falklands War in the early 1980s and like many governments before it, Argentina’s rulers printed more and more money to finance the conflict, setting off rampant inflation and debasing the currency. By the end of the war, the annualized inflation rate was running at 82% per year. Argentina Inflation Rate (%), 1978 to 1984Annual Change on Consumer Price Index High inflation was a worldwide phenomenon in the 1980s, and Argentina was hardly alone in its struggles. As economists explored heterodox shocks to control rising prices and following a return to democratic government in 1983, Argentina’s leaders implemented the Austral Plan two years later. This replaced the traditional Argentinian peso with a new currency, the austral. (Though critics described the austral as effectively a peso with three zeros chopped off.) The Austral Plan also included wage freezes and tariff reductions. Initially, the program reduced inflation to a more modest yearly rate of 50% or so. In 1986, the country’s GDP grew at a respectable annualized 6.1%, and, behind the legendary Diego Maradona, Argentina captured its second World Cup. But the hoped-for recovery proved illusory as what became known as Argentina’s lost decade dragged on and economic growth continued to sputter. Massive fiscal deficits led the government to increase its money printing and inflation ramped up to unprecedented levels. In July 1989, it was running at 200% per month and ended the year at an annual hyperinflationary rate of nearly 5,000%. Argentina Inflation Rate (%), 1984 to 1990Annual Change on Consumer Price Index The Reform Era When Carlos Menem took office in December 1989, public expenses and the fiscal deficit added up to about 36% and 7.6% of GDP for the year, respectively. Menem lifted price controls, removed barriers to cross-border capital flows and international trade, simplified the tax code, and privatized several state companies. But his most fateful decision was converting the austral back to the peso and pegging it to the US dollar. This marked the beginning of what became known as the “convertibility regime,” which lasted into the early 2000s. The fixed-exchange rate regime, or currency board, was not a new concept, and many other countries have pursued similar arrangements. But when nations peg their currency to a foreign one, they effectively forfeit their ability to conduct independent monetary policy. If the US economy grew more rapidly than its Argentinian counterpart, Argentina’s central bank had to print more money to keep up with the fixed rate of exchange. This drove domestic inflation higher as the peso supply outpaced domestic production. In effect, the currency board was in thrall to US monetary policy. Still, the fixed-exchange rate regime initially showed promise. Inflation ran over 2,000% in 1990 but declined to only 1.6% in 1995. The Argentine government also