CFA Institute

FTX is simultaneously the biggest fraud and the culmination of the largest banking crisis in the history of the crypto industry. But the FTX debacle has very little to do with crypto itself: It is merely another episode in global finance’s long history of such catastrophes. Despite extensive regulation and central bank activity, traditional finance is littered with shocks, panics, bank runs, and other disasters of which FTX is just the latest iteration. But unlike traditional finance, crypto offers a pathway to a sounder financial system. If crypto is going to deliver on this, the principles of decentralization, immutability, and verifiability need to be adopted by more centralized institutions. Financial Crises Are Symptoms of the Opaque Fractional Reserve Banking System Fraud is as old as humanity, and banking crises are as old as banking itself. But the ubiquity of such excesses has increased ever since banks evolved from depository institutions that held client deposits on reserve to fractional reserve banks. Fractional reserve banks only keep a small share of client deposits on hand. Hungry for returns, they prioritize profits over client safety, leveraging up their balance sheets by investing client capital in longer-duration, less-liquid, and less-credit-worthy assets. This dramatically boosts the sector’s profitability, but it makes banks susceptible to runs and insolvency.* If clients seek to redeem their deposits en masse, the banks won’t have the necessary capital available to meet the demand. The FTX collapse is an outgrowth of this system. FTX CEO Sam Bankman-Fried allegedly bailed out his own trading firm, Alameda Research, with FTX client capital, effectively turning FTX into a fractional reserve bank and executing the typical financial fraud. Regulation and Monetary Policy Don’t Fit with Crypto Traditional finance attempts to counteract the inevitable excesses of fractional reserve banking with regulation and monetary policy. Neither of these are likely to work effectively in crypto. Let me explain. The FTX scandal highlights crypto’s ongoing regulatory arbitrage potential. Bitcoin, Ethereum, and other crypto-assets are decentralized, internet-based financial technologies. They facilitate the movement of capital among various parties throughout the globe, no matter their jurisdiction. Exchanges are easy to set up in more far-flung jurisdictions as a means of evading restrictions and growing market share away from the hawkish eyes of developed market regulators. In fact, this is exactly the path FTX pursued, opting to conduct its operations in the Bahamas. Perversely, the stricter developed market regulators become in the wake of the FTX collapse, the greater the incentive among crypto operators to migrate to more permissive jurisdictions. Enron, Barings Bank, and Theranos all demonstrate that complex banking regulations solve neither banking crises nor frauds. In fact, FTX’s Bankman-Fried cultivated close relationships with US regulators in Congress and the SEC in recent years. He was hiding in plain sight, and regulators didn’t see a thing. Thoughtful crypto regulations may help rein in crypto intermediaries in the future, but history shows regulation is no silver bullet. Central banking does lower the risk of bank runs in traditional financial markets. A central bank’s status as lender of last resort reduces the incentive to flee insolvent institutions. But with crypto, monetary policy is both undesirable and not especially applicable. Effective monetary policy requires supply elasticity. The US Federal Reserve can manipulate the US money supply, but nobody can just print bitcoin.** An inelastic supply of the primary assets is a major constraint to any lender of last resort. Moreover, recent events demonstrate why central bank bailouts are both pernicious and undesirable. FTX itself effectively acted as a lender of last resort in the crypto space in May and June: It bailed out troubled centralized lenders BlockFi and Voyager, as well as its trading arm, Alameda. But these actions only hid the underlying risk in these institutions and led to a larger crisis down the road. Binance, crypto’s largest exchange, looked like it might step in as FTX teetered on the edge, but wisely stayed on the sidelines. Healthy Economies Reveal Failures. They Don’t Hide Them. Bad business practices, poor risk taking, overly leveraged companies, and outright frauds need to be uncovered and put out of business. That is how a healthy, functioning economy works. Central banks can help conceal these challenges in the short-term and delay the final reckoning, but that creates economic inefficiency and damages productivity over the long term. So, where does crypto go from here? Apply the Principles of Verifiability and Transparency to Centralized Finance Like any nascent technology, bitcoin is volatile, but it is robust. Bitcoin and Ethereum continue to process transactions and smart contracts, delivering financial freedom to underserved people around the world. They provide these services without the need for regulators and central banks. Centralized institutions like FTX have failed to live up to the principles that make bitcoin, Ethereum, and other cryptoassets valuable: transparency, openness, decentralization, etc. To take this industry to the next level, crypto advocates need to impose these principles on centralized financial institutions. Crypto intermediaries like FTX cannot be allowed to succumb to the age-old shenanigans of traditional finance. Self-custody of assets and decentralized exchanges are two great solutions because they don’t expose users to the vagaries of centralized custodians and their penchant for fractional reserve banking. Proof of reserves can also make centralized institutions more transparent. After all, centralized intermediaries aren’t going away. Not everyone has the wherewithal to fully transition into crypto’s decentralized universe. Traditional financial institutions need to integrate crypto’s first principles into their operations. A simple on-chain proof of reserves that allows the public to view company assets and liabilities would be a good first step. It wouldn’t prevent all malfeasance, but it would dramatically reduce risks by fostering accountability, openness, and transparency. Regulators wouldn’t be required to audit exchange balance sheets. Instead, crypto can automate the audits through code and on-chain transparency. That information could be disseminated in real-time and be available to everyone. Crypto Isn’t Going Anywhere Bitcoin has declined 78% since its October 2021 peak. It also fell 92% in 2010 and 2011, 85%

Introduction  A global black swan event — COVID-19 — followed by record inflation and the sharpest upward interest rate trajectory in three decades has bedeviled markets over the last three years. Moreover, the financial markets have undergone structural shifts that call into question the effectiveness of traditional portfolio construction techniques. No one can predict the future, but the next phase of the market cycle will not look like that of the last decade, when investors enjoyed the longest bull run in US history. So, investors should consider adjusting how they build their portfolios. Here we examine alternative portfolio construction methods that supplement the traditional 60/40 stock/bond portfolio with allocations to alternatives, or alts. These include private equity/venture capital; hedge funds; and real assets, including private real estate, commodities/natural resources, and intellectual property. We explore the theoretical basis for going beyond the 60/40 portfolio and consider the present and future market conditions that could make alternative portfolio allocations useful to institutional and individual investors alike. The State of the 60/40 Portfolio  The year 2022 was historically bad for the average 60/40 portfolio, which fell by 16%. So why stick with it? Because, for most of the last century, bonds’ low or negative correlation to stocks protected portfolios from stock market volatility. Unfortunately, this relationship tends to fall apart amid high inflation. During “quasi-stagflationary” periods, stocks and bonds often exhibit higher correlations. Their correlations have tended to be negative or minimal — below 20%, for example — since 1998, when the five-year inflation CAGR generally fell below 3%, according to Blackstone. The current higher, 3%-plus inflation regime has pushed the stock-bond correlation to more than 60%, a level reminiscent of the 1970 to 1998 era. This has contributed to the traditional 60/40 portfolio’s third-worst annual return since 1950. Public equities have recovered somewhat in 2023. Through the end of the third quarter, the 60/40 portfolio delivered a 7% rate of return. Still, the public markets have been volatile: The S&P 500 ended September down more than 7% from its July highs, with more volatility expected. While the stock market has performed well lately, seven major tech stocks account for much of the gains and price-earning ratios are high. Simply put, a rising rate environment impedes growth, potentially devalues bonds (and stocks), and injects uncertainty into the market. With renewed geopolitical tensions and ongoing public health threats, sentiment-based swings in stock values may be inevitable, and while future US Federal Reserve moves are unknowable, inflation may remain a fixture and constitute a headwind to dividend stocks and bond yields for some time to come. So volatility will probably be the rule rather than the exception in the months and years ahead. Year-over-year (YoY) CPI inflation has fallen in recent months amid one of the most aggressive rate hike cycles ever. But the path to the Fed’s 2% annual inflation target remains fraught. While the Fed did recently signal possible rate cuts in 2024, nothing is guaranteed and a “higher for longer” policy is still possible if inflation persists. The stock-bond correlation has continued to hover around 60% since the start of the year. The 60/40 portfolio showed considerable diversification benefits in recent years and generated enviable returns through the pandemic. But the current moment requires a paradigm shift. Investors must consider different portfolio compositions if they want to drive risk-adjusted returns, decrease cross-asset correlations, increase appreciation potential, and diversify into alternative income sources. Infusing Alternatives (Alts) into a Portfolio The rationale for changing or optimizing portfolio allocations rests on Harry Markowitz’s modern portfolio theory (MPT). Bundling assets with low correlations can help maximize returns given the specific risk/return characteristics of the assets themselves. In MPT, pairing a risk-free asset with a “market portfolio” to create optimal portfolios should maximize anticipated returns for various levels of anticipated risk (downside variance). These allocation decisions, in turn, improve the “efficient frontier,” or the opportunity set that realizes the highest expected returns at the lowest volatility or standard deviation.  There are many ways to optimize a portfolio. The “Endowment Model” pioneered by the late David Swensen at Yale University is a prime example in the alternatives spaces. The perpetual nature of endowments and their smaller liquidity needs make their increased exposure to alts, which tend to be less liquid than publicly traded stocks, intuitive. Some endowments have alts allocations of more than 50%. Swensen believed in a strong equity focus but felt the bond portion of a portfolio should provide yield while also offsetting the volatility contributed by the portfolio’s stock component. Under Swensen, the Yale Endowment did not invest in corporate bonds because of their inherent principal-agent conflict — company management has to drive value for both stock- and bondholders — and because they display a minimal premium relative to government bonds after factoring in defaults. Swensen also avoided non-US bonds because, despite potentially similar/offsetting returns, the associated currency risk and uncertain performance in volatile times did not align with his long-term investment goals. As he explains in Pioneering Portfolio Management, equity generates superior long-term returns, a well-diversified portfolio requires investing in non-publicly traded/private/illiquid securities, active managers can extract alpha in less-efficient markets, and patient investors with longer horizons have a relative advantage. During his 25 years managing the Yale Endowment, Swensen achieved a 12.5% annualized return and outperformed the S&P 500 by 280 basis points (bps). So, what is it about alternatives portfolios? Alts are generally less correlated to public stock and bond investments. Private equity and hedge funds, for example, may correlate with public equities, but MPT holds that adding less correlated assets may improve a portfolio’s overall risk/return profile. Alts tend to be more illiquid, perhaps because they trade less frequently than their public counterparts or because they lack liquid prices. Valuations for alts are often based on periodic private valuations. For privately owned real estate, valuations depend on appraisals, so changes in value may have a lag and, in turn, smooth returns/volatility. The alts-trading markets may not be as efficient as

In this Research Foundation book, edited by  Alfonso Ricciardelli, CFA, and Philip Clements, CFA, practitioners introduce the key features of the alternative credit asset class. They spotlight leading transactions to evaluate those features and their implications for investors. They also discuss the market’s anticipated continued growth and potential evolution. Net zero requires transformational changes and significant investment, Roger Urwin, FSIP, asserts. This guide aids industry leaders in implementing net-zero investing. Based on interviews with more than 20 industry leaders, it offers practical guidance that stresses the importance of mindset shifts and highlights strategies for success. In this report, Serena Espeute and Rhodri G. Preece, CFA, examine how young investors use content from financial influencers on social media platforms, such as YouTube, TikTok, and Instagram, to gather information and make investment decisions. Access to powerful LLMs like ChatGPT is reshaping roles in the investment profession. In this report, Brian Pisaneschi, CFA, discusses how to ethically build investment models in the open-source community. He defines alternative data and presents an ESG investing case study. Winnie Mak and Andres Vinelli explore actions investors, asset managers, corporations, and policymakers may consider to improve the disclosure of transition plans, provide clarity on transition activities, and mitigate risks associated with transition finance. Innovations such as smart beta exchange-traded funds (ETFs) and direct indexing go beyond traditional capitalization-weighted strategies and incorporate varying levels of active management. In this paper,  Jordan Doyle  and Genevieve Hayman offer an updated framework for active management to capture the full range of index-based strategies and to support informed investment decision making. Climate-related data are critical to assessing and managing the financial risks and opportunities posed by climate change, yet the data are often inconsistent and unreliable. This paper by Andres Vinelli, Deborah Kidd, CFA, and Tyler Gellasch, discusses how regulations to enhance transparency are evolving and suggests how investors can make effective use of the data available to them. Private markets have ballooned since the Great Financial Crisis. While advocates hail their efficiency, critics call for more regulation, Stephen Deane, CFA, writes. This report illuminates how private markets function and uses the results from a CFA Institute global survey to inform recommendations for investors and policymakers. The cost of capital is the expected rate of return that the market requires to attract funds to an investment and is one of the most important concepts in finance, write James P. Harrington, Carla Nunes, CFA, and Anas Aboulamer. This paper provides a good understanding of this, which is essential for making global investment decisions. CFA Institute Research and Policy Center convened net-zero thought leaders and investment luminaries to break down the big ideas around achieving net zero. These Voices of Influence provide practical guidance for investors, asset managers, investment professionals, and regulators. More than 50 authors from the United States, Europe, and Asia collaborated on 16 research projects that we are delivering on a staggered publishing schedule. If you liked this post, don’t forget to subscribe to the Enterprising Investor. All posts are the opinion of the author. 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 / Ascent / PKS Media Inc. 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

Reminiscences of a Bond Operator: A Guide to Investing in Corporate Debt. 2024. Mark A. Rieder. Independently published. New and seasoned corporate bond investors will be delighted to get acquainted with Mark Rieder’s conversational narrative and clear presentation of complex analytical ideas in Reminiscences of a Bond Operator. When asked about the top reference work in bond investing, I refer my colleagues and students to Frank J. Fabozzi’s The Handbook of Fixed Income Securities.[1] As comprehensive a magnum opus as Fabozzi’s book is, Rieder’s book, released in 2024, adds value as a highly technical guide enhanced by personal insight into analyzing corporate bonds and private credit, as well as structuring and managing a debt portfolio. Rieder maintains that anyone can assemble a corporate bond portfolio, but only a skilled investor can consistently select the correct bonds to generate alpha without incurring significant losses. After reading this book and having 30 years of experience in analyzing individual corporate bonds and managing fixed-income portfolios, I can say that I learned fresh methods of analyzing individual issues and structuring total portfolios that will immediately influence my investing activities. Mark Rieder is not a household name to analysts and portfolio managers the way Frank Fabozzi is. Still, his book deserves a place in the universe of corporate bond practical guides as issuers come and go and the world of credit changes, such as it did with the explosion in private credit after the 2008 Financial Crisis. He has a rich background in the analysis and management of fixed income, from his early days at Deloitte & Touche and Goldman Sachs to his tenure as Managing Director and Lead Corporate Bond Portfolio Manager at GIC, the sovereign wealth fund of the Government of Singapore. In 2023, he founded La Mar Assets, a global multi-strategy credit manager. Based on his long tenure through the Financial Crisis and beyond, he confidently speaks from a deep experience in the trenches of corporate credit. Keep in mind that Reminiscences is not a primer in corporate fixed-income investing, yet it begins with an Overview of the Financial Markets (Part I). Subsequent parts of the book consist of The Research Process (Part II), Portfolio Management (Part III), Advanced Topics in Portfolio Management (Part IV), and lastly, Lessons Learned and Concluding Thoughts (Part V). As rudimentary as the Overview may seem in its description, it provokes much useful thinking about the size and performance of the bond market, the largest issuer — the United States — and its growing financing needs, the demand for corporate debt in a zero-interest rate policy (ZIRP) environment, and the refinancing of such low-interest debt. The point of the book is summarized on page 40: “Savvy investors adjust their portfolios by increasing credit exposure when spread and yields are wider, then reduce exposure when spread and yields tighten.” If only bond investing were so simple. That is why the author provides in-depth exercises and case studies in the heart of the book. Within The Research Process (Part II), I found that Chapter 9: Analyzing Company Cash Flows and Chapter 10: Rieder’s Matrix keeps analysis on track for one purpose: minimizing unknown information about the potential investment to make the best-informed decision at the time the trade is executed. Within Portfolio Management (Part III), Chapter 13: The Difference Between Coupon, Yield, and Bond Returns provides sound insight into selecting issues based on moves in benchmark rates and credit spreads. It addresses hybrid securities at length, raising a topic that rarely enters discussions of fixed-income instruments. Rieder encourages investors to consider hybrids for higher yields, acknowledging all their risks compared to alternatives in the fixed-income market. The following chapters (within Portfolio Management) are explicitly geared toward institutional investors: Chapter 17: The Rise of Credit Trading Widgets and Chapter 18: Private Credit Opportunities and Challenges. The latter explores an asset class that potentially creates situations with no limits on leverage. Rieder raises many important questions related to private credit’s surge over the past decade: • Does private credit have a lower default profile than public debt? • Will defaults increase as interest rates climb? • Can companies that utilize private credit restructure ad infinitum? • Could there be systemic risk stemming from the rush of life insurers into private credit? • Are there any liquidity concerns? The author suggests that the evolution of private credit markets will lead to a significant convergence between liquid and private credit. More than a decade of rapid growth in private credit issuance and investment could be explored in a future book on this issue. Advanced Topics (Part IV) applies to investors and analysts in all asset classes. It addresses topics such as financial engineering, bankruptcy, reorganization, and, my favorite, credit portfolio risk management. It also deals with a subject many of us have experienced but rarely gets mentioned: inheriting a portfolio. I do have one criticism of this comprehensive book. An index should have been included. Despite the author’s inclusion of extensive notes and my bookmarking of numerous pages, I frequently found myself searching for specific topics and individuals referenced. To conclude, Reminiscences is an attractive guide to corporate bonds that is professionally focused but accessible to analysts and portfolio managers of all experience levels. It also serves as a launching point for deeper analysis of fixed-income topics that could be affected by increased market volatility. 1.  Frank J. Fabozzi, et al., The Handbook of Fixed Income Securities, 9th ed, (McGraw Hill, 2021). source

The most-read blogs published on Enterprising Investor between April 1 and June 30 captured a profession in motion, grappling with disruption, uncertainty, and legacy. While the topics varied, several themes emerged: AI and the analyst’s edge: Investment professionals are thinking seriously about how to work with, rather than be replaced by, AI. Q2’s top reads explored bias, prompting, model performance, and what it means to stay competitive in an AI-driven world. Rethinking portfolio construction: From stretched market concentration to small-cap rotation and Bayesian frameworks, readers dug into smarter ways to diversify and position portfolios amid regime shifts. Learning from the long view: History, macro forces, and global politics loomed large in Q2 content. Readers looked to the past, not for nostalgia, but for data-driven insight into future risks and returns. 1. Vices, Virtues, and a Little Humor: 30 Quotes from Financial History Mark J. Higgins, CFA, CFP, and Rachel Kloepfer deliver a sharp, unsentimental reminder that financial folly is nothing new. These quotes from centuries past expose the recurring misjudgments, overconfidence, and occasional brilliance that continue to shape markets today. 2. Market Concentration and Lost Decades With the top 10 US stocks now representing more than a third of market cap, Bill Pauley, CFA, Kevin Bales, CFA, and Adam Schreiber, CFA, CAIA, explore what history tells us about such extremes. Elevated concentration and stretched valuations have often preceded long periods of underperformance, underscoring the need for a more intentional approach to diversification. 3. Small Caps vs. Large Caps: The Cycle That’s About to Turn Daniel Fang, CFA, CAIA, draws on market cycle history, rate-driven migration dynamics, and relative valuations to make the case for a small-cap comeback after more than a decade of underperformance. 4. How Tariffs and Geopolitics Are Shaping the 2025 Global Economic Outlook Kanan Mammadov examines how inflation, economic divergence, and a surge in protectionist policy are reshaping global markets in 2025. With trade tensions escalating and market volatility rising, he argues that investors must adjust forecasts and strategies to account for cross-border risks and policy shocks. 5. Two Enduring Legacies, One Oracle’s Exit, and “Buffett’s Alpha” This post reflects on Warren Buffett’s retirement and how the award-winning Financial Analysts Journal article “Buffett’s Alpha” helps explain his long-term success. I weave together the legacy of a legendary investor with the 80-year history of the Journal, reminding readers that outperformance may be rare, but it’s not necessarily mysterious. 6. AI Bias by Design: What the Claude Prompt Leak Reveals for Investment Professionals This forensic look at a leaked Claude system prompt reveals how embedded instructions can distort financial analysis by reinforcing bias, overstating fluency, and simulating reasoning. Dan Philps, PhD, CFA, and Ram Gopal argue that without explicit safeguards, investment professionals risk mistaking AI-generated coherence for insight and inheriting flawed assumptions at scale. 7. Tariffs and Returns: Lessons from 150 Years of Market History Drawing on one of the most comprehensive long-term datasets available, Guido Baltussen, PhD, Joshua Dekker, Michael Hunstad, PhD, Bart van Vliet, CFA, and Milan Vidojevic, PhD, explore how tariffs have historically influenced growth, volatility, and asset class performance. Their analysis reveals that while protectionism often raises macro risks, equity style factors, especially low volatility, have consistently provided resilience across high-tariff regimes. 8. Outperformed by AI: Time to Replace Your Analyst? In a head-to-head test, top AI models outperformed human analysts in generating detailed SWOT analyses — especially when guided by advanced prompting. Michael Schopf, CFA, argues that the future of investment research belongs to those who can combine model selection, prompt engineering, and human judgment into a competitive edge. 9. AI in Investment Management: 5 Lessons From the Front Lines Markus Schuller, Michelle Sisto, PhD, Wojtek Wojaczek, PhD, Franz Mohr, Patrick J. Wierckx, CFA, and Jurgen Janssens outline five key lessons on how AI is reshaping investment workflows. From boosting early-career productivity to raising ethical and regulatory concerns, this post emphasizes the need for critical thinking, explainability, and intentional integration to unlock AI’s value responsibly. 10. Bayesian Edge Investing: A Framework for Smarter Portfolio Allocation Sandeep Srinivas, CFA, introduces a dynamic, evidence-updating framework that helps investors calibrate conviction, detect mispricing, and allocate capital more intentionally.Rooted in Bayesian reasoning, the approach reframes rationality as adaptive judgment — where clarity, not certainty, gives investors a lasting edge. Looking Ahead These were the most-read blogs published on Enterprising Investor between April 1 and June 30, a quarter that reflected a profession balancing innovation with insight. Whether wrestling with the implications of AI or revisiting the lessons of financial history, our readers show deep curiosity and a continued hunger for rigor. source

“In investing, only some roads lead to Rome – others just take you in circles” Investing in consumer products requires distinguishing between passing fads and sustainable market leaders. Some companies succeed through affordability and mass-market appeal, while others thrive on exclusivity and pricing power. The key question for investors is not just which products will dominate, but why. Is the company’s success rooted in functional utility, emotional appeal, or a mix of both? By classifying products into commodity, luxury, or hybrid models, investors can identify durable competitive advantages. Is it the right time for a commodity product to achieve mass adoption? How do companies sustain value? Can a commodity business develop pricing power? Are luxury brands as resilient as they seem? Answering these questions can guide smarter investment decisions. Paths to Value: Commodity vs. Luxury Consumer products typically solve two distinct sets of needs: Functional: Addresses practical concerns such as cost, convenience, and efficiency. Here, success hinges on mass adoption and economies of scale. Emotional: Caters to status, identity, and exclusivity that transcend a product’s basic function. These business command premium pricing through strong branding and controlled scarcity. Some companies, however, blur the lines, creating a hybrid strategy that integrates affordability with aspirational branding — the final goal for all paths is to create and protect value and stay relevant. Framework to Analyze Commoditized Offerings Commodity businesses thrive by addressing practical needs, and they scale through utility. This is reflected in the S-curve of commodity businesses, moving through three key phases: Slow Build: The product is niche due to high costs or lack of infrastructure. Accelerated Growth: A tipping point, often driven by falling costs or technological leaps, fuels mass adoption. Maturity: Growth slows as competition intensifies, forcing companies to innovate or consolidate. Investor Takeaway: Each phase bears unique valuation implications. In the early stages, excitement can fuel high multiples, while in maturity, valuations moderate materially as the brand’s durability is tested.   Functional Success: Clean Energy’s Exponential Rise Solar Energy: In 1977, solar cells cost $77 per watt. By 2024, that figure plummeted to $0.11 per watt, enabling mass adoption. Companies like First Solar and Enphase Energy capitalized on this shift, delivering substantial long-term returns for investors. Similarly, in Electric Vehicles (EVs), Tesla began with the high-end Roadster. It soon recognized the broader opportunity in more affordable models. As battery prices declined, Tesla scaled up the Model-3 and Model Y, pioneering an industry now teeming with contenders like BYD.This pivot from niche to mass market underscores how effective cost reductions can transform a once-premium product into a widespread commodity. Investor Takeaway: Watch for cost inflection points in commodity industries — when affordability crosses a critical threshold, adoption and valuations surge. Fading into Irrelevance Orkut dominated early social media in markets like Brazil and India, yet stagnation spelled its downfall. Limited updates, poor mobile user interface, and minimal corporate backing let Facebook iterate faster and deliver a superior user experience. By missing its chance at a mass-adoption S-curve, Orkut ultimately faded into irrelevance. Investor Takeaway: In rapidly evolving industries, consistent innovation is paramount. Even an early lead can vanish without ongoing product development and strategic investment. Framework to Analyze Aspirational Brands Hermès Birkin bags, Macallan Scotch, and Bugatti automobiles show how heritage, craftsmanship, and exclusivity create formidable brand moats. These offerings aren’t just products; they are experiences, tied to storied legacies or handcrafted production methods that resonate with affluent consumers seeking status. By limiting production, each brand amplifies its allure. From Birkin waitlists to single-malt maturation or limited-run hypercars, scarcity becomes part of the value proposition. Three pillars drive luxury success: Aspirational Branding: Strong storytelling, craftsmanship, and heritage. Exclusivity & Scarcity: Limited production ensures high perceived value. Ownership Experience: The brand extends beyond the product. Investor Takeaway: In luxury, controlling distribution and upholding exclusivity is critical. Maintaining tight brand narrative and scarcity is essential to preserving pricing power. Investors often pay a premium for companies that leverage brand loyalty to sustain high margins. Yet even legendary names risk dilution if they expand recklessly. Contrarian View: Are Luxury Brands More Vulnerable Than We Think? Pierre Cardin rose to fame in the 1960s with avant-garde designs but pursued an aggressive licensing model across a vast product range. Although lucrative initially, this approach eroded the label’s exclusivity. Over time, Pierre Cardin’s name became synonymous with discount-level offerings – illustrating how a luxury aura can dissolve when overexposed. Is Gucci encountering a similar challenge? Its focus on trend-driven, accessible products may have diluted its luxury image, especially as consumer preferences shift towards timeless and understated luxury. Investor Takeaway: Exclusivity hinges on strategic brand guardianship. Investors should be wary of luxury brands expanding aggressively to maximize short-term profits, as it may undermine long-term brand equity. The Hybrid Approach: Bridging Functionality and Status. Several brands have successfully combined commodity functionality with premium positioning, transforming everyday products into lifestyle statements. For instance, Voss Water elevated plain bottled water into a symbol of luxury through sleek design, selective distribution, and a narrative emphasizing Nordic purity. Dyson reimagined household appliances like vacuums and fans, turning them into premium products through innovative engineering and design. Similarly, Stanley, originally known for rugged outdoor gear, evolved into a lifestyle brand with its Quencher Tumbler. The tumbler gained viral popularity on social media due to its sleek design, vibrant colors, and robust functionality. These brands address practical needs while offering a sense of sophistication. Investor Takeaway: Hybrid brands elevate basic products into lifestyle essentials through compelling storytelling and strong consumer relationships. However, as they scale, these brands often face valuation volatility due to execution risks. Investors must assess growth strategies and market positioning to ensure that expansion efforts do not compromise the brand’s core value proposition. Why Brand Equity Matters According to Kantar, strong brands balance three mental connections — knowledge, feelings, and experience — to stand out meaningfully, remain different, and stay top-of-mind. This alignment correlates with tangible financial rewards: Kantar’s chosen brand portfolio significantly outperformed major equity benchmarks since 2006.

For more insights on the equity risk premium from Rob Arnott, Cliff Asness, Mary Ida Compton, Elroy Dimson, William N. Goetzmann, Roger G. Ibbotson, Antti Ilmanen, Martin Leibowitz, Rajnish Mehra, Thomas Philips, and Jeremy Siegel, check out Revisiting the Equity Risk Premium, from CFA Institute Research Foundation. “There’s one aspect of MMT that I have some sympathy for: the notion that what we spend money on is far more important than how we finance it.” — Cliff Asness Amid resurgent and persistent inflation, much of the bloom, such as it was, is off the modern monetary theory (MMT) rose. The US Federal Reserve raised interest rates by 75 basis points (bps) on 21 September in what is just the latest step in its tightening cycle. In the face of the CPI numbers for August, which showed inflation at 8.3%, further rate hikes are hardly off the table. These developments couldn’t have been anticipated in October 2021, when the Equity Risk Premium Forum discussion was held; nevertheless, the perspectives on MMT and many other topics, shared by Rob Arnott, Cliff Asness, Mary Ida Compton, William N. Goetzmann, Roger G. Ibbotson, Antti Ilmanen, Martin Leibowitz, Rajnish Mehra, Jeremy Siegel, and Laurence B. Siegel, are still relevant. Their assessment of MMT was ambivalent at best. Arnott declared that far from having the redistributive effect envisioned by its proponents, MMT policies simply make the rich richer. From there, panelists reflected on their 10-year predictions from the 2011 forum for the realized equity risk premium (ERP). All their forecasts vastly underestimated the actual figure. Before concluding the forum, they returned to the nature of the ERP and whether it is an actual “risk” premium. Ibbotson suggests that “One possibility would be that stocks are perceived as being much riskier than they are,” while Jeremy Siegel theorizes that “It could be the Tversky–Kahneman loss aversion explanation. . . . People react asymmetrically to losses versus gains.” Below is a lightly edited transcript of the final installment of their discussion. Roger G. Ibbotson: Does anybody here have an opinion, a positive opinion, about MMT? It seems to have taken over the government and the Fed really. Does anybody think there’s something positive to that? Rob Arnott: We at Research Affiliates have a draft paper that Chris Brightman wrote a year ago, and he hasn’t published it because he was worried about upsetting clients in the middle of the COVID pandemic. The paper shows that there’s a direct link between deficits and corporate profits. That is to say, a trillion dollars of deficit spending goes hand in hand with a trillion dollars of incremental corporate profits over the next four years. This relationship has a theoretical basis that would take too long to get into right now. In any event, the implication is that if you pursue MMT, you’re going to be enriching the people who you’re ostensibly looking to “milk” with the intent of enriching the poor and the working class. Laurence Siegel: I think most of us knew that. We just couldn’t prove it. I’d love to read Chris’s paper. Cliff Asness: That’s the verdict on quantitative easing for 10 years now. Let me say something about MMT. There’s one aspect of MMT that I have some sympathy for: the notion that what we spend money on is far more important than how we finance it. The one good point in MMT, which they don’t stress enough, is this: If the government did much less and charged zero tax rates, so that there was a big deficit, the libertarian in me would think that’s a good world. And if the government spent a ton of money and fully financed it with taxes, I might think that’s a bad world. I think MMT does make that distinction. I just then make every policy choice opposite from them. Arnott: The level of taxation is not the taxes we pay. It’s the money that we spend. Because whatever is spent is either coming out of tax revenues or pulled out of the capital markets through running deficits and increasing the debt. The money is being pulled out of the private sector in both cases. So, spending sets the true tax rate and is what’s disturbing about a $3- to $5-trillion deficit. Remembrance of Forecasts Past Rajnish Mehra: Larry, after the last forum in 2011, you sent an e-mail with everybody’s forecast for the equity premium. L. Siegel: It was an e-mail with all the forecasts from 2001, so we could compare our then-current (2011) forecasts with the old ones (2001). I don’t have a record of the forecasts from 2011. Sorry. But I do remember that Brett Hammond gave a talk at the Q Group in 2011 where he said that all the 2011 forecasts were very close to 4%. Ibbotson: I missed the last forum because of a snowstorm, but I think markets exceeded almost everybody’s expectations. L. Siegel: They sure did. Ibbotson: So, it doesn’t matter what we said. Whatever the forecasts were, the market did better. The person who had the highest estimate, won. Jeremy Siegel: And, by the way, I would say that bonds did much better than everyone predicted. Stocks and bonds both exceeded expectations over the last 10 years. Martin Leibowitz: My recollection — I could be wrong, and you’ll correct me on this, Larry — was that the numbers ranged from a 0% risk premium up to around 6%, with an average of 3.5% to 4%. It’s very interesting how those forecasts correlate with a lot of the numbers we’ve been bouncing around today, with very different types of explanations for how we got there. L. Siegel: Marty, those were the forecasts in the 2001 forum, the first one. In the 2011 forum, the estimates were all very close to 4%. Looking at the 2001 (20 years ago) forecasts, the lowest was Rob’s, and it was zero. But these were not 20-year forecasts; they were 10-year forecasts. The highest forecast was that of Ivo Welch, but the highest forecast from among

The first time I met Dr. Daniel M. Zimet, he told me the story of his best-ever handball match. His story changed my life, and it can empower investment leaders to improve the trajectory of their organizations. It goes like this… By the time the 1997 three-wall Nationals came around, Zimet had already lost eight times to his nemesis Kendall Lewis, a ranked professional handballer. “If you were to see us side-by-side, the results wouldn’t surprise you. Kendall was built like an NFL tight end. I’m scrawny and scrappy,” Zimet said. This fateful match started at five on a Saturday afternoon. The first game went the same way as many others between the two players. Zimet ground out bread-and-butter points while Kendall made spectacular shots. But unexpectedly, Zimet eked out a 21-20 victory in game one after an hour of play. Lewis found his rhythm in the second game and prevailed 21-7, sending the match into a tiebreaker.  As it started to get dark, the venue’s lights came on and the players passed the second hour of grueling play. The crowd swelled. The fans became so boisterous that the event director stopped matches in the adjacent courts. Those fans added to the ones already watching this incredible match. Beer was flying in the stands. Kendall served for the fourth time to win the match point. Trying something new, he hit an overhand serve. Zimet’s return was weak and short, a perfect opportunity for Lewis to hit a low-kill shot. More than 20 years later, as we sat in his office, Zimet recalled what happened next like it was yesterday: “I reached deep into my depleted well of strength and sprinted as fast as I could to the front of the court, where Kendall’s match-ending shot seemed to fall in slow motion. At full sprint and stretch, I caught up to the ball an inch from the ground and hit the perfect shot — a flat kill. I rolled over on the concrete to break my speed. On my knees, I squeezed both hands into fists and screamed at the top of my lungs. The crowd’s roar was so overpowering that I couldn’t hear my voice.” His voice trembled as he retold this story. I could swear his eyes grew watery. But what happened next is a bit strange. He told me the rest of the story nonchalantly. “He was down 9–10 and failed to score on his next serve. Then, Kendall served an ace.” “Wait, you lost?” I asked. “How was that your ‘best moment’? What about all your wins?” I couldn’t understand how a world-class athlete could be elated by defeat. But Zimet then explained his rationale: “Measurable goals can impede self-motivation. Those who focus on mastery — rather than on the scoreboard — are the biggest winners in the long run. That time, I played to the absolute best of my abilities.” This match changed Zimet. From then on, he knew he belonged amongst the best in the game. “Every victory stands on that match’s shoulders,” he told me. “That match, that point, and that loss solidified my quality as a player, a competitor, and a person, making it the most important moment of my career as an athlete.” Of course, he loves to win, but Zimet – a sports psychologist — defines success in terms only a sports psychologist could. He focused on mastery over ego, the importance of relationships and community (“The crowd’s roar was so overpowering that I couldn’t hear my voice”), the meaning of sport as a meritocracy, and the importance of engagement and flow. To him, all these concepts came together that day on the court. His theory became an epiphany for me. I asked myself: What if leaders could develop a similar mindset and apply it to their organizations? Zimet’s story was the spark that started the project that became my forthcoming book, The Psychology of Leadership, available for pre-orders. It put me on a path of discovery. I spent four years investigating new ways to apply psychology to leadership. I plowed through hundreds of books and articles in scientific psychology. What I learned has been life-changing and worth sharing with the world.  I will be discussing these concepts at CFA Institute Live 2025 in Chicago in May. In next week’s post, I will discuss the hidden trap sabotaging your decisions. source

“You cannot anticipate exactly how these risks or dangers are going to play out. . . . But we should be pretty assertive in insisting that we need certain principles, including enough capital buffers — that is, equity unencumbered by any kind of contingent debt or anything like that — that can really withstand shocks in the core of our financial system.” — Simon Johnson, Co-Chair, CFA Institute Systemic Risk Council (SRC) The effects of potential crises and dislocations on the global financial system and on systemic risk, in particular, can’t all be forecast in advance. The best we can do is prepare for a range of systemic risks and ensure that markets have the right infrastructure and regulatory frameworks in place to weather the storms.  In the case of the war in Ukraine and other geopolitical conflicts, that means understanding the consequences of sanctions, embargos, and potential tariffs and countering the spillover effects on energy, food, and other commodities markets. For financial institutions, that means enough liquidity to withstand unanticipated shocks. For stablecoins, cryptoassets, and other newer markets, it means having the regulatory oversight, authority, and mechanisms in place to protect investors. Simon Johnson, former IMF chief economist and co-chair of the CFA Institute Systemic Risk Council (SRC), thinks about issues like these every day. He sat down to talk about systemic risk and the many pressing challenges affecting global economies and the global financial system with SRC executive director Kurt Schacht, CFA, at the Alpha Summit GLOBAL by CFA Institute in May 2022. War in Ukraine What implications does the ongoing war in Ukraine have on systemic risk? “We are watching this very carefully,” Johnson said. “[You] have the Russians who are trying to drive up gas prices in Europe. They’ve actually been very successful in that. They’re trying to disturb and unbalance the global oil market — a bit more mixed results on that, but they’re definitely still having a go. And all of those things, of course, feed into inflation, particularly headline inflation. Food prices have been impacted, energy prices absolutely impacted.” Will the conflict threaten the solvency of financial institutions? “That is the question of the day and every day right now,” Johnson said. “The key is capital. How much equity do we have in the financial system as buffers against losses? That was the problem globally in 2008 and was a big recurring problem in Europe after 2010.” But there’s good news. The reforms instituted in the aftermath of the global financial crisis (GFC) in the United States and Europe were more effective than many people, Johnson among them, might have anticipated. “So banks are better prepared for unexpected shocks,” he said. “And unexpected shocks — well, we just had two big ones in the last two years basically.” “This is a big stress test,” Johnson continued. “COVID was a real stress test. Let’s agree on that. But COVID actually played out in some ways better and easier. There was a pretty unified and well-organized government response for a while on the economic dimensions at least. Now we’re dealing with something much more complicated, I would suggest, and likely more difficult.” Johnson has written extensively on how to respond to Russia’s invasion of Ukraine, whether in the form of sanctions, the oil embargo, tariffs, or other actions. He worries about Russia shutting down the grain and agriculture trade in the region. “This is another way they are malevolently putting pressure on the world,” he said. “And I think we need better coordinated, I would propose G7-led, responses to that economic issue, which is a massive overlay with national security considerations.” Climate Change as Systemic Risk What role if any should central banks play in addressing climate change risk? According to Johnson, there’s now a consensus in both industrial countries and emerging markets that climate change could impact the financial system either directly or indirectly through its economic impact. “I think that’s actually already decided,” he said. “I think central banks want to go there.” The question is how. “There is some ongoing debate about exactly what central banks should do — what instruments they have, what’s the appropriate scope for action. Is it a proactive thing directly to do with financing energy, or is it more about capital buffer and how do we calibrate that?” he said. “That’s a very active, somewhat technical discussion that doesn’t always come out clearly in the public context.” Johnson emphasized that part of the role of the SRC is to get involved and make sure its members understand the issues, that they are talking to the officials, and really engaging with them on those kind of technical but critical details. Johnson believes both the physical risks of climate change and the energy transition risks in reaching net zero are interconnected and systemic. “I think in the US military there’s a saying along the lines of ‘Plans are worthless, but planning is everything.’ I think that same thing goes for systemic risk,” Johnson said. “Because markets are going to go up, markets are going to go down. Financial institutions are going to fail. The questions are, Does that affect the core of the financing of your economy? Does it have spillover effects into energy prices, for example? Does that affect, in some destabilizing way, the macro economy? Those are the issues we have to keep at every day.” Stablecoins, Crypto Assets, and CBDCs The SRC has been outspoken about the need for regulatory action around “stablecoins” and issued a letter to the US Treasury and members of the Financial Stability Oversight Council (FSOC) in February 2022 urging action to “address the risks to U.S. financial stability posed by unregulated stablecoins.” The SRC recommended that FSOC designate stablecoins as systemically important payment, clearing, and settlement activities and asked FSOC member agencies to use their existing authorities to oversee and regulate stablecoin markets. Johnson pointed out that having some markets for assets that go up and go down is not by itself inherently systemic. But in the SRC’s view, if the public

“As we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say, we know there are some things we do not know. But there are also unknown unknowns — the ones we don’t know we don’t know.”   US Secretary of Defense Donald Rumsfeld during a Pentagon briefing We assume professional experts know a lot about their areas of knowledge whether in national security, investing, medicine, or other fields. But, as Rumsfeld’s comment highlights, “metaknowledge,” or awareness of the limits of your knowledge, is just as important as knowing what you know. Do professional experts have an edge over non-experts by having higher levels of metaknowledge? A new study sought to answer that question by conducting research with experts in the fields of climate science, psychological statistics, and investment. The researchers concluded that experts did tend to have higher metaknowledge than non-experts. For example, they were less overconfident overall but had more conviction in their correct answers than non-experts. However, experts were also more likely to exhibit greater confidence in their wrong answers compared to non-experts. Previous studies found cognitive biases among finance and medicine experts. For example, economists display overconfidence in their theories, despite a long history of incorrect forecasts. While touting the importance of decision analysis in general, investment professionals often fail to do so in practice. Yet, many maintain strong conviction in their sub-optimal conclusions. Alas, years of experience does not seem to ameliorate these tendencies. Medical professionals have exhibited similar patterns. In one study, physicians’ confidence in a diagnosis remained at 70%, even when they correctly diagnosed difficult cases only 5.8% of the time. Just as misjudgements can harm a medical patient, sub-optimal decision analysis can harm a client’s investment returns. Given the durability of certain cognitive biases, how can advisors de-risk decision-making by raising their metaknowledge? One way to do this is by leveraging individual investing talents within a structured team environment. This gives an organizational edge. Organizational edge is not merely about the sum of individual talents but also how these talents are structured, integrated, and leveraged. A well-designed organization optimizes team dynamics, encourages effective communication, and fosters a culture that supports decision-making aligned with its strategic objectives. Having the right environment and processes in place can amplify individual capabilities which are as essential to success as are market strategies. Bigger is not always better when it comes to investment teams. Having a large research investment team does not guarantee good decision making or sound judgement. In fact, it can add unnecessary complexity and inefficiencies into the investment process. Flatter organizations tend to do better. This may be due to more simplified structures. Leveraging the insights of research analysts alongside those of portfolio managers is the mark of skilled leadership and a supportive environment. Teams with diversity in education, experience, skills, and knowledge can add value to an organization through shared goals and open communication. Studies show that gender-balanced investment teams may have an increased potential to achieve superior risk-adjusted returns. A recent report by the CFA Institute Research and Policy Center offers a framework for improving gender diversity in the investment industry. Key Takeaway Confidence is a necessary but insufficient factor in long-term investing success. Raising the metaknowledge quotient of the investment team can help protect against the surprises that lurk in left-tail events and remain unknown, until they’re known. source