CFA Institute

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

Earlier this year, the head of the US Department of Justice’s anti-trust unit vowed to crack down on the buyout sector’s aggressive deal-making practices. What that implied wasn’t entirely clear. As long as it remained a cottage industry, private equity (PE) was always lightly regulated. Even after the late 1980s junk bond mania demonstrated PE’s potential to wreak economic havoc, rudimentary reporting guidelines, weak accounting standards, and lax legislation all but endorsed PE’s capacity for incomparable value creation. The Gilded Age of Private Markets The SEC attributes the private markets’ phenomenal expansion to a comparatively casual regulatory framework relative to that of the public markets. Perhaps the industry’s small size and lack of systemic risk justified such leniency. At the peak of the 2007 credit bubble, the top traditional asset managers handled about $70 trillion in global assets while private capital firms only managed $3 trillion. But the landscape is changing fast. Every year from 2010 to 2020, in the United States private markets raised more capital than the public markets did. Last year, private capital firms had almost $10 trillion in assets under management (AUM). The growth rate is impressive, and so is the sector’s influence on the economy and equity markets through buyouts, take-privates, IPOs, and other corporate activity. Last year, private capital firms sponsored 38% of global M&A deals. In any given year, PE- and venture capital (VC)-backed IPOs may represent between 20% and over 50% of all public listings on national stock exchanges. But as the industry expands further, the risks will accumulate. Efficient markets require an unfettered flow of timely and accurate information as well as complete transaction transparency. These characteristics typically apply to the public equity and bond markets, but not to private capital. Tepid Attempt at Regulation The only real government effort to impose detailed disclosure requirements on PE firms occurred in the United Kingdom as the global financial crisis (GFC) unfolded. Amid sweeping job cuts at PE-owned businesses, trade union pressure combined with public outcry led to Treasury Select Committee hearings. In response, the British Private Equity & Venture Capital Association (BVCA) organized a commission to develop a code of practice to encourage more transparency. The commission recommended a set of voluntary disclosures, not serious regulation that would hold fund managers accountable. In the end, many of the PE practitioners expected to follow the so-called Walker Guidelines never reported on the performance and economic impact of their investee companies. Fifteen years later, all that remains of the initiative is a rather toothless reporting group run by the BVCA. This lack of detailed reporting requirements helped persuade BlackRock, Fidelity, and other traditional asset managers to launch alternative investment activities in private markets. The Reformation of Private Markets Yet, given recent developments, stricter supervision is warranted. In the first two years of the COVID-19 pandemic, for instance, almost half of LP investors, including those responsible for running retirement plans, allocated capital to PE fund managers whom they had never met in person. Even sophisticated institutions were cutting corners to secure their share of annual allocation. Such practices raise an obvious question: Who protects the clients and ensures that conflicts of interest are adequately dealt with? Of all the sector’s shortcomings, political capture may be the most perverse. This is hardly a new issue. The emergence of “access capitalism” was flagged almost 30 years ago. But the general trend towards influence-peddling has intensified. With so much firepower, alternative asset managers have secured the services of former presidents and prime ministers, among other policymakers. For all the criticism of the accountancy profession, a supervisory body does provide oversight and can sanction firms and practitioners alike. Audit regulation was strengthened in the wake of the telecom and dotcom crash of the early 2000s. In the UK, since the GFC, the Financial Reporting Council has fined accountancy firms for botched audits. And the UK government plans to strengthen the supervisory framework by granting new powers to a soon-to-be-created Audit, Reporting and Governance Authority. By contrast, thanks to their access and influence, private capital investors face very little scrutiny despite managing the population’s savings and retirement funds. So what should the regulatory priorities be? A Possible Regulatory Agenda Five areas in particular warrant comprehensive reform: 1. Information Accuracy and Disclosure Valuations can be subject to extensive finessing and manipulation. Academic research shows that PE operators inflate fund values, particularly when trying to raise money. Loose mark-to-market rules have turned the valuation exercise into a form of legerdemain that enables PE portfolio companies to demonstrate less performance volatility than their listed peers. But by failing to reflect fair market value, alternative asset managers simply adopt a mark-to-myth approach. Today, the most tempting ground for potential accounts manipulation is in private markets. Naturally, this has repercussions on the equity markets when inflated asset valuations are used as proxies ahead of anticipated IPOs, as the WeWork saga and last year’s SPAC-sponsored listings demonstrate. The integrity of performance reporting is another concern. Private capital firms can restrict the dissemination of data related to their activities and underlying portfolios. Indeed, one of the advantages of being controlling shareholders is the ability to withhold information. Warren Buffett raised the issue of performance disclosure at Berkshire Hathaway’s Annual General Meeting (AGM) on 4 May 2019: “We have seen a number of proposals from private equity funds, where the returns are really not calculated in a manner [that] I would regard as honest . . . If I were running a pension fund, I would be very careful about what was being offered to me.” Even if LP investors might be partly responsible for such shenanigans, proper reporting is paramount if they are to make informed decisions. One way to bridge the data gap and move towards an industry-wide governance framework would be for PE practitioners to adopt the Global Investment Performance Standards (GIPS) already used by many asset managers. 2. Fees. Efforts to end excessive rent extraction may provide the acid test for the sector.

Economists and market participants have introduced increasingly sophisticated models over the past half-century to explain the ups and downs of the equity markets. With some adjustments to corporate earnings measures and risk-free rates, these methods describe market movements quite well. But there is a simpler way to account for how equities behave. What if we de-emphasize their financial nature and think of them as high-end consumer goods — luxury watches, for example — whose prices are determined by the forces of supply and demand? Equities occupy an elevated position in Abraham Maslow’s hierarchy of human needs. Simply put, we buy stocks only after we have seen to our shelter, food, transportation, education, and other more immediate concerns. The higher our income, the freer we are to invest in equities, and vice versa. Based on this perspective, income inequality becomes a hidden driver of equity prices. In a very equal society, equities are less in demand. Why? Because the need for shelter and consumer goods trumps the need to own stocks. Imagine 20 households each have annual incomes of $50,000 while a single household has $1,000,000. According to our research, the latter household’s demand for equities is nearly 20 times that of the other 20 households combined. While traditional finance’s equity performance models still work, there is an alternative explanation for the 40-year secular bull market based on 19th century laws of supply and demand. On the demand side, rising income inequality mechanically drives equity demand up and with it, returns. On the supply side, net share issuance has been anemic ever since the Securities and Exchange Commission (SEC) legalized share buybacks in 1982. Classical economics explains what happens when demand for a good rises faster than its supply: The real price of the good must increase. Thus, the secular bull market that started in 1982 has been the direct consequence of strong demand growth fueled by ballooning income inequality, among other factors, combined with supply that has not kept up. The S&P 500’s real price return during the 1982 to 2021 bull run was 6.9% per year, according to our analysis. That’s 6.2 percentage points better than the 0.7% generated annually between 1913 and 1982. What explains that difference? Of the excess return, we find that 2.4 percentage points stems from a sea change of sorts. Income equality was on the rise in the late 1970s and early 1980s, but then the tide turned and increasing income inequality has since become the norm. Another 1.4 percentage points of the excess price return results from the supply squeeze caused by the 1982 SEC’s decision on share buybacks. The rest is due to growing equity allocations, lower inflation, and lower interest rates, among various other factors. So what if the world had been different? Had income inequality trends not reversed or the SEC not permitted buybacks, the S&P 500’s real price in 2021 would have been starkly different. We express these dynamics by focusing on the real price evolution of a $10,000 investment made throughout 1982 in the S&P 500 and realized throughout 2021. Outcome of a $10k Investment Made in 1982 and Realized in 2021 (Average Real S&P 500 Price Index in 1982: 317) Buybacks as Is Assumption Inequality as Is Negative InequalityTrend Stoppedin 1982 Negative InequalityTrend Continuedsince 1982 Dividends Fully Reinvested $315k $193k $133k Dividends Not Reinvested $134k $81k $56k Average Real S&P 500 Price (in 2021 Dollars) 4,261 2,581 1,764 Sources: Cowles Commission, S&P, Oliver Wyman Buybacks as Before 1982 Assumption Inequality as Is Negative InequalityTrend Stoppedin 1982 Negative InequalityTrend Continuedsince 1982 Dividends FullyReinvested $315k $193k $133k Dividends NotReinvested $81k $49k $33k Average RealS&P 500 Price(in 2021 Dollars) 2559 1540 1047 Sources: Cowles Commission, S&P, Oliver Wyman The market would have risen in all scenarios. But there is a major difference between the S&P 500’s 230% increase in the most bearish scenario and its 1240% actual increase. So, while income inequality is not the be-all and end-all of stock market performance, it is a critical factor that was previously hidden from view. What does this mean for the secular bull market’s future viability? To be sure, cyclical headwinds will play a role at times, as they have over the past year or so. But rising income inequality will continue to propel equity markets unless and until the ballot box decides otherwise. 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 / Zorica Nastasic 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

The debate over the inclusion of private investments in 401(k) plans is a hot topic in the investment community. With more than $8 trillion in assets and a growing asset base the US defined contribution (DC) market is a significant, largely untapped market for privates. The research paper “Why Defined Contribution Plans Need Private Investments[i]” — a 2019 collaboration between the Defined Contribution Alternatives Association (DCALTA) and the Institute for Private Capital (IPC) — provides an analysis of the potential benefits of including private equity and venture capital in DC plans, with the clear conclusion reflected in the paper’s title. A balanced view should consider the objectives of the study’s sponsors.  Specifically: DCALTA’s mission statement calls for “advocacy on the benefits of including hedge funds, private equity, and other alternative investments within a defined contribution framework.”   Consistent with the organization’s mission, the 2019 study’s bold conclusions include: Investing in private funds “always increases average portfolio returns” when publicly traded stocks are replaced with private equity (referred to as “buyout” in the study) and venture capital investments.  The study states that “…despite the wide dispersion of returns in private funds, the ability to diversify by investing in multiple funds is sufficient to have nearly guaranteed superior returns historically.” The message: If you play the game right, private investments always win. A careful reading of the research should ring alarm bells for the prudent investor or fiduciary: 1. It implies that any outperformance of private investments vs. public markets justifies investment. 2. The study uses mean returns, which improves scenario results, when median results are more appropriate. 3. It assumes that the tiny VC market in the 1990s could have accommodated impossibly large investments in the simulation’s early years. 4.  Assumes that the overall size of the venture capital market was equal to the buyout market, when in fact it is much smaller. 5. The cost assumptions for indexing traditional stocks and bonds are relatively high. There are lower-cost options available in the market.   6. The paper’s findings are based on hypothetical returns, while a recent real-world study indicated that the median fund of funds’ return has trailed the S&P 500. The Devil’s in the Details The paper compares the historical returns (from 1987 to 2017) of a traditional 60/40 stock/bond portfolio to simulated portfolios in which a chunk of the publicly traded stock allocation is replaced with randomly selected venture capital and/or buyout funds. To compare results with public markets, the paper uses public market equivalents (PME) — a methodology for assessing the performance of private equity relative to a public equity benchmark — as a key measure. For example, the median PME of 1.06 for private equity means the typical buyout fund return was 6% better (over its entire life, not annualized) than returns from a similar investment pattern in the S&P 500. Is that good?  I think the late David Swensen, esteemed head of the Yale endowment, would have said no.  He wrote: “The high leverage inherent in buyout transaction and the corporate immaturity intrinsic to venture investments cause investors to experience greater fundamental risk and expect materially higher investment returns.”[ii] The authors’ conclusions seem to suggest that even a 1.01x PME is worth the trouble. The prudent investor would disagree.   Mean Public Market Equivalent (PME) Return Median Public Market Equivalent (PME) Return Private Equity (aka Buyout) 1.12 1.06 Venture Capital (VC) 1.18 0.86 Source: “Why Defined Contribution Plans Need Private Investments.” In Fact, You Aren’t Invited to the Party Despite median VC performance that trailed public markets[iii], mean returns were juiced by a small number of killer VC funds that Acme 401(k) Plan can’t (and couldn’t) access.  For simulation purposes, everyone was invited. In practice, there was a velvet rope — even for large, institutional investors. This is no secret. The research acknowledges it: “Top VC funds are also difficult for most investors to access because of excess demand for these funds and the tendency for VC general partners to limit the size of their funds.” Temporal Anomalies and Retroactive Re-Weightings In 1987, the DC market in the US was worth $525 billion.[iv]  A 10% target allocation in venture capital, which the simulation assumes, would therefore require a $52.5 billion investment.  Unhelpfully, total venture capital raised for the five years from 1987 to 1991 was $31 billion.[v]  Marty McFly’s 401(k) plan could have reaped the spoils of the halcyon years. Not all of us have a time-traveling DeLorean. The simulation also relies on equal allocationsbeing made to both VC and buyout funds, despite the capitalization of the (higher returning) VC funds being much smaller than the buyout market. The simulation massively over-weights the smaller, better performing (based on the mean result) VC funds. Is this what they mean when they say VC investment leads to great innovation? Finally, the 60/40 Vanguard index funds used for most of the period of the paper, (VTSMX and VBMFX) have annual expense ratios of 14 and 15 basis points, respectively, when much lower-cost options have been available from Vanguard and others for years.  It’s Cheap if You Ignore the Costs The study’s key scenario calls for plans to invest in 10 funds per year. Most institutional investors in private markets invest in less than three per year. To get to the desired 10+ funds, the plans would likely need to invest in funds of funds. In the unsimulated world, that costs more money. The paper’s assumed added costs of up to 0.5% per annum for privates compares with real world fund of funds costs of ~2%.[vi]  In addition, the paper’s claim that returns were virtually guaranteed to perform better than a 60/40 portfolio appears to not reflect any additional costs associated with private investments A more constructive approach would be to analyze the actual performance of funds-of-funds. Helpfully, academics already have. One study[vii] shows that more than half of the funds of funds underperformed the S&P based on PME. The paper’s authors note: “Our results also have policy implications regarding

After working with private clients for 27 years, I’ve done many non-traditional things beyond offering them investment advice. I’ve gone for runs; attended funerals, bar mitzvahs, and concerts; and even referred one client to a top-flight pro-sports surgeon when he dislocated his shoulder. This year, I mailed holiday cards to every client. It featured a photo of my husband and me with our gigantic Bernese Mountain dog, Grace, all wearing our Santa hats — well, Grace refused to wear hers. A few days later I received this note from one of my long-time clients: Barbara, Thank you for the wonderful card. I feel I need to meet the one “member of the family” that I have never had the privilege of looking in the eye. May 2023 be a super year for you & Duncan. All best, (His name) This was the first time I’ve had a client request a meeting with my dog! And of course, I set it up immediately. Grace and I had a great visit with this lovely couple, and we talked about topics that had absolutely nothing to do with their investment portfolio. Grace was thrilled that they offered her some rippled potato chips and lots of belly rubs. What a fun way to start the New Year! Here are seven more surprising ways to bond with clients: Maria Pia Leon, Director Client Services, Forbes Family Trust, Miami “A couple of years ago, a long-time client asked me to help him with a very different task: putting up and restoring a 1960 Rolls Royce. It was the car he had used in his wedding, and over time, it had deteriorated. I have always loved classic cars, and I always had the crazy idea of working on a 1978 Porsche 911, so this request was not so much out of my realm. “The project took us three years; then while he was visiting last summer, we finally went for a ride in the car. Just the look on his face showed me that those three years of reviewing catalogs, auctions, and color palettes were so worthwhile. This entrepreneur embraced his passion and helped a family tradition continue. As a trusted adviser, I see my role as helping to sustain the wealth for generations, and for me, this includes a car with meaning if it is part of a family story. I am pleased this car will be used for weddings and special occasions of future generations.” Blair duQuesnay, CFA, Lead Advisor, Preserve, Ritholtz Wealth Management, New Orleans “Last fall I was planning on travelling to Southern California for an event, so I decided to reach out to several clients in the area to arrange meetings. I had never met one of my newer clients in person: We started working together at the beginning of the pandemic, so we had only met virtually. She is a single retired woman who lives alone in Northern San Diego County, which is quite a long drive — 30 minutes or so — from where I was staying. I told her I would look for a local hotel and we could have dinner together. She said, ‘Why don’t you just stay with me?’ “Now maybe this might seem a bit weird, but I said ‘Sure,’ and we ended up having a very relaxed time getting to know each other. She gave me a tour of her beautiful property and garden, we went to a not-fancy local place for dinner, and later we watched Netflix on her couch together . . . just like friends. The next morning, I drove back to LA with pomegranates and passion fruit from her garden. My daughter really loved the passion fruit!” Kathrine Madsen, Senior Investment Advisor HNWI/UHNWI, Private Banking Elite, Danske Bank, Copenhagen “When I started out in this business 15 years ago at age 28, fresh out of Copenhagen Business School, I was very self-conscious and always wondering if I was good enough to do this job. Over the years, I have realized that you can memorize P/E ratios but that won’t make you trustworthy. Either you have a trusting relationship with your clients or you don’t. Trust has to come naturally. I like to give my clients a sense of who I am in real life, not just the corporate Kathrine. “During the pandemic, one of my wealthiest clients and I deepened our bond: We both had a lot of time on our hands. On occasion she would send me LinkedIn profiles of men she deemed to be good potential for me to date. Then I shared with her that I had taken on a hugely challenging project of renovating my kitchen all by myself. She said ‘Oh how cool are you? Send me some pictures!’ “I have an integrated dishwasher, and it was a tough job getting it to fit properly. The plate had to perfectly match to the top drawer of my kitchen table. I was so excited that I aced it on the first attempt! I filmed a video of this successful situation and texted it to my client. At age 28, I would never ever have expected that I would do something this odd, texting a video of my dishwasher to a major client. It is interesting how these types of relationships start and how they evolve.” Guillaume Drouin Garneau, CIM, Portfolio Manager, RBC Dominion Securities, Montreal “In addition to being an investment adviser, I’m a passionate cyclist, in pursuit of adventure, pushing my physical and mental boundaries to new levels. I’m also the co-owner of Le Club Espresso Bar, an online retailer of premium cycling brands and a unique space offering an espresso bar and a boutique under the same roof. Our mission is simple: To gather and grow the cycling community, provide a selection of high-quality cycling brands, and to expand the third wave of coffee, a movement to produce high-quality coffee. “A few of my clients are very interested in coffee, and one asked me

Some of the most powerful tools in today’s investment playbook started as academic arguments. But they didn’t reshape practice until they moved off the page and into the hands of portfolio managers, risk teams, and product designers. Harry Markowitz’s efficient frontier, Bill Sharpe’s capital asset pricing model (CAPM), Eugene Fama and Kenneth French’s style factors, and Edward Qian’s risk parity framework all began as journal arguments. Their ideas now sit inside portfolio guidelines, ETF rulebooks, and risk dashboards worldwide. The leap from theory to real-world relevance is what gives high-quality research its staying power. As CFA Institute Research and Policy Center celebrates the 80th Anniversary of the Financial Analysts Journal and 60th Anniversary of the Research Foundation, it is an opportune time for investment professionals to reflect on the impact of practitioner-relevant research on the industry’s evolution. Uncovering practitioner-relevant insight is at the core of the Hillsdale Investment Management–CFA Society Toronto Research Award, which is accepting submissions for 2025. Any academic or practitioner can submit their research for consideration, regardless of their geographic location. Consideration is given to any original, unpublished work that sheds light on Canada’s capital markets and helps investors allocate capital more intelligently. Topic areas include public and private markets governance, sustainability, and market microstructure. The deadline is fast approaching (June 27). Past winners include a six-factor model tailored to Canadian equities that helps portfolio managers navigate the “factor zoo,” a study quantifying when currency hedging adds value to international equity funds, and an analysis of how complex instrument allowances affect mutual fund performance and risk. Scholarship only changes behavior when it solves a concrete problem and arrives in a form investors can apply. Market context makes that harder. A factor model that works in one region might falter in another due to differences in  industries, regulations, and investor behavior. That is why competitions like the Hillsdale Award — focused on market-specific research — help innovative ideas travel faster and land with greater impact. Research in Action: 3 Hillsdale Award-Winning Papers Navigating Canada’s Factor Zoo (2024) introduced a six-factor model built on three decades of data of Canadian equity returns, giving portfolio managers a clear, evidence-based shortlist for factor investing. Using CFMRC-TSX and COMPUSTAT files for July 1991 to December 2022, the authors measured 17 widely cited style factors across 11 academic frameworks and ran redundancy, spanning, and anomaly-pricing tests. Classic HML and UMD signals added little once profitability, investment, and mispricing variables were included. The data pointed to six variables (market, size, monthly-updated value, return-on-equity, expected growth, and post-earnings-announcement drift) that explained Canadian returns more consistently than any legacy model. This  result trimmed the “factor zoo” to a manageable practitioner toolkit for screening, attribution, and product design. It identifies where global multifactor products may be mis-aligned with local risk premia. Currency Hedging and Tracking Error (2023) provided evidence that actively hedging foreign exchange exposure with currency forwards can lift international equity fund performance. It gave managers evidence-based guidance on when FX hedging pays. The study matched 55,000 forward contracts to 1,279 US-registered international equity funds (2004-2019) and sorted users into “exposure managers,” “occasional users,” and “non-users.” Systematic hedgers cut benchmark-relative volatility by about one percentage point and outperformed unhedged peers by roughly 120 basis points (bps) per year, benefits that were largest during FX-volatile quarters. Forward books tilted toward currencies with favorable carry and momentum profiles, indicating that a disciplined overlay can function both as a risk-control and a modest return engine. Counter-factual tests suggested non-users left 40 to 60 bps of annual performance on the table. The paper supplies CIOs with quantitative thresholds for when the cost of forwards is likely to be rewarded and a template for linking hedge ratios to currency-factor signals. Complex Instrument Allowance at Mutual Funds (2020) revealed evidence that letting mutual funds use leverage, derivatives, and other complex instruments erodes returns and increases downside risk, signaling to fund boards and regulators that fewer restrictions can hurt investors. Analzsing SEC N-SAR filings for 4,793 US domestic equity funds (2000-2015), the authors built an “allowance score” for leverage, derivatives, and illiquid-asset permissions, then linked those permissions to daily performance and risk. Funds with the broadest latitude under-performed more constrained peers by 1.3 percentage points of four-factor alpha a year and carried higher market beta and downside semivariance, particularly in bear markets. Derivative authorizations showed the strongest negative relation to risk-adjusted returns, while better board oversight and larger fund size mitigated the drag. The findings give trustees and regulators a data-backed caution: expanding a fund’s toolbox without commensurate monitoring can lead to higher volatility and lower investor welfare. (See all past winning research papers) Why This Matters to the Wider Investment Community Sharper Tools: The winning paper often surfaces updated factor libraries, hedging templates, or governance checklists that teams can A/B test in live portfolios. Diversity of Thought: A global author pool examining a mid-size market helps reduce home bias and brings fresh ideas across borders. Faster Uptake: Because the award sits inside a professional body, useful findings reach practitioners, directly compressing the time from research to real-world application. Award Details The Judges: Every submission is judged by a panel of CFA charterholders. This means only research with clear, test-ready insights and practical relevance survive the review process. The Award:  The award, which comes with a $10,000 (CAD) prize, helps empower winning researchers to continue ground-breaking research through flexible funding they can redirect to additional research funding, conference travel, or their next projects, without strings attached. High Visibility with Investment Professionals: The winning paper and authors gain visibility among more than 11,500 CFA charterholders  in Canada and the broader global CFA Institute community. Publication can lead to stronger citation momentum and, more importantly, faster adoption in practice. The winning paper is unveiled at CFA Society Toronto’s Annual Investment Dinner, promoted through Society press channels, and published in The Analyst, CFA Society Toronto’s quarterly magazine. How to Submit Submission deadline: 27 June 2025, 23:59 ET Eligibility: Open to global researchers; submissions must focus on

The “Mercer CFA Institute Global Pension Index 2023” takes the top spot. The CFA Institute Research and Policy Center (RPC) focuses on four forward-looking research themes to drive content engagement, action, and outcomes. These themes are Capital Markets (Strengthening the Structural Resiliency of Capital Markets); Technology (Understanding the Latest Developments in Data Analytics, Technology, and Automation); Industry Future (Providing New Insights into the Future of the Profession); and Sustainability (Advancing the Industry’s Thinking on Sustainability Challenges). Below are the most popular top five articles of 2023 published under the Capital Markets theme in the RPC since its inception. The theme underscores a commitment to the dynamic relationship among asset managers, asset owners, and individual investors/savers through the capital markets, given the backdrop of trends in the regulatory and policy environment. 1. “Mercer CFA Institute Global Pension Index 2023” This report delivers the world’s most comprehensive comparison of 47 retirement income systems, representing 64% of the global population, and suggests ways to improve the efficacy of each pension system studied. 2. “Cryptoassets: Beyond the Hype” Based on interviews of investment professionals and crypto experts, this report, by Stephen Deane, CFA, and Olivier Fines, CFA, goes beyond the hype to understand the state of crypto investing and the implications for investors and policymakers. 3. “CFA Institute Global Survey on Central Bank Digital Currencies” Stephen Deane, CFA, and Olivier Fines, CFA, gauge demand for central bank digital currencies (CBDCs) by examining the attitudes of a significant segment of potential CBDC end-users. Their data is derived from a CFA Institute global membership survey. 4. Revisiting the Equity Risk Premium Held once a decade since 2001, the Equity Risk Premium Forum gathers leading investment minds to discuss new equity risk premium (ERP) research and key trends. The 2021 consensus was lower expected returns in the future. The publication, edited by Laurence B. Siegel and Paul McCaffrey, includes contributor updates by Clifford Asness and Jeremy Siegel, among others, from 2023. 5. Valuation of Cryptoassets: A Guide for Investment Professionals The valuation of bitcoin, Ethereum, and other cryptoassets is a challenge for the investment industry. Urav Soni and Rhodri Preece, CFA, review the tools available to value cryptoassets, and in doing so, aim to help practitioners better understand the dynamics of cryptoassets. If you liked this post, don’t forget to subscribe to Enterprising Investor and the CFA Institute Research and Policy Center. 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 / Galeanu Mihai 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

The M&A Failure Trap: Why Most Mergers and Acquisitions Fail and How the Few Succeed. 2024. Baruch Lev and Feng Gu. Wiley. At an early-1980s presentation by a leading investment bank to a business school alumni group, the bank’s CEO was confronted during the Q&A session about the high failure rate of corporate mergers and acquisitions (M&A), from which Wall Street derives a significant chunk of its revenues. The CEO responded by pointing out that companies’ internal projects — their investments aimed at building businesses from scratch rather than buying them — also fail at a high rate. He did not mention the perverse incentive whereby divestments made in the wake of failed acquisitions generate additional fees for bankers. Neither did he cite any data on comparative success ratios of internal and external corporate growth initiatives. Thanks to Baruch Lev, professor emeritus of Accounting and Finance at the New York University Stern School of Business, and Feng Gu, chair and professor of Accounting and Law at the School of Management, University at Buffalo, we now have an authoritative measure of the M&A failure rate. Lev and Gu define failure in terms of post-acquisition sales and gross margin trends, stock performance, and goodwill write-offs. Based on a sample of 40,000 transactions over 40 years, they find that 70% to 75% of M&A deals fail. That is twice the 36% failure rate for internal projects reported by project management application service provider Wrike, Inc. As if these figures were not sufficiently dismaying, Lev and Gu report in The M&A Failure Trap that the failure rate is on the upswing. Acquisition premiums have risen, and average goodwill write-offs have gotten larger. Moreover, conglomerate acquisitions — purchases of companies unrelated to the acquirer’s core business—have made a strong comeback. This comeback has occurred despite the de-conglomeration of most of the widely diversified corporate giants of the 1960s — after their shares traded at discounts to focused companies’ stocks and management failed to produce the synergies they claimed would emerge from their frenetic dealmaking. Lev and Gu further note that the usage frequency of “synergy” in corporate merger announcements tripled between the 2000s and 2010s. Investors will find this book an invaluable resource. In addition to being called upon to vote on major M&A proposed transactions, shareholders sometimes suffer horrendous losses due to ill-conceived and poorly executed acquisitions. Based on rigorous statistical analysis of their huge sample of deals, the authors identify 43 different factors that enhance or detract from the probability of success. For example, the larger the deal size, the higher the percentage of the payment for the acquisition that is made in the acquirer’s stock, and the higher the S&P 500’s return in the year preceding the transaction, the greater the probability of failure. Lev and Gu condense their analysis into a 10-factor model that is practical for investors to employ in assessing the merits of a prospective merger. The authors leaven their abundant quantitative detail with colorful prose. They supplement their quantitative findings with case studies of both successful and unsuccessful M&A. Such prominent deals as Hewlett Packard/Autonomy, AOL/Time Warner, and Google/YouTube are examined for clues that can predict the fates of future transactions. Lev and Gu do not shrink from identifying culprits as they explore the underlying causes of the high M&A failure rate. These include (in their phrase) “commission-hungry investment bankers.” They also point to overconfident CEOs and boards of directors who, despite substantial evidence to the contrary, imagine that a transformational acquisition can pull a company’s profitability and stock performance out of the doldrums. CEOs receive extra compensation for completing such transactions but are not penalized if the transactions fail. Flawed incentives for CEOs also help explain the above-mentioned resurgence of conglomerate acquisitions. Spreading a corporation’s operations across a wide range of unrelated businesses provides no genuine benefit to shareholders, who can diversify on their own by holding stocks of companies in many different industries. In contrast, the manager of a single-line-of-business company has no hedge against an industry downturn that will adversely affect CEO compensation. Spreading risk by transforming the company into a conglomerate makes strategic sense for the CEO, who has a more direct say than shareholders in the matter. In addition to describing this sort of agency cost and presenting extensive evidence that corporations should strongly consider internal investment as an alternative to acquisitions, especially considering the buy-rather-than-build route’s frequently formidable integration challenges, the authors address accounting issues that are pertinent to M&A, such as the subjectivity of the fair value estimates required for calculating goodwill. This discussion draws on Lev and Gu’s expertise in financial reporting, as displayed in their pathbreaking The End of Accounting and the Path Forward for Investors and Managers (2016), reviewed here in June 2017. They also write about the disturbing phenomenon of acquisitions made with the intention of terminating a successful competitor’s operations. It in no way diminishes The M&A Failure Trap’s overall excellence that it includes a couple of mistaken quotation attributions. Publishers ought to instruct their editors to make use of Quote Investigator®. Had this book’s editors checked that indispensable website, they would have learned that there is no reliable evidence that P. T. Barnum ever said, “There’s a sucker born every minute.” That is an example of an anonymous saying being put in the mouth of a famous person, as happens with many aphorisms. Similarly, in the case of “It’s difficult to make predictions, especially about the future,” which Lev and Gu (along with many other writers) attribute to the physicist Niels Bohr, Quote Investigator concludes that the author of the “comical proverb” is unknown. Bohr died in 1962, and no published linkage of his name to the witticism prior to 1971 has been found. Notwithstanding these very minor editorial shortcomings, The M&A Failure Trap must be judged a rousing success. Massive M&A deals make headlines but too rarely make money for stockholders. “Fondly do we hope, fervently do we pray” (yes, Abraham Lincoln did

The UN Framework on Climate Change (UNFCC) is set to convene the 27th annual Conference of the Parties, commonly known as COP27, in Sharm el-Sheikh, Egypt, next week. The goal is to assess global progress in addressing and mitigating the impacts of climate change, and myriad voices will seek to influence the dialogue. The global asset owner community will lend a strong and influential set of voices to the proceedings. This group, comprised of pension funds, sovereign wealth funds, foundations, and endowments, is increasingly engaged and outspoken around environmental, social, and governance (ESG) issues. And the top 100 asset owners control $23.5 trillion in assets as of 2020, according to Willis Towers Watson, so they stand a good chance of being heard. The Voice of the Asset Owner Roger Urwin of Willis Towers Watson’s Thinking Ahead Institute believes asset owners have critical roles to play in the global climate change debate. “Their allocations, ownership muscle and trickle-down influence will be important in opening the door to net zero pathways,” he said. “The [2021] Glasgow COP summit has highlighted how asset owners can work together as part of a wider collaboration framework to produce better long-term outcomes for the whole system.” As a group, asset owners take ESG and climate change very seriously. In fact, according to our first Morningstar Voice of the Asset Owner Survey, fielded in August, 85% of asset owners believe ESG is “very” or “fairly” material to investment policy, with 70% saying it has become more material in the past five years. Our survey sought to understand asset owners’ opinions and attitudes on investment policies, current investment trends, the impact of regulatory change, key stakeholders and influencers, and, importantly, the role that ESG plays in investment decisions. The findings are instructive as COP27 approaches and we consider how asset owners can bring their influence to bear on this important topic. Surveyed asset owners are pushing for constructive change around ESG and climate on multiple fronts. For example, most respondents felt that ESG ratings, indexes, data, and tools have become either “a lot” or “somewhat” better in the past five years. But they expect continued improvement to be initiated by governments, rating agencies, standard-setting bodies, service providers, and markets. In other words, asset owners are looking for an array of key participants across the ESG ecosystem to drive change. When it comes to implementing ESG policies, about 40% of the asset owners surveyed use external asset managers, presumably outsourcing important elements of their investment policies, such as proxy voting. More than two-thirds say stewardship is a “somewhat” or “very” significant part of their ESG program, including both direct and collaborative engagement. Asset owners generally view regulation of ESG as beneficial for addressing greenwashing through greater transparency, more enforcement, and better regulation. In addition, nearly three-quarters expressed support for regulations intended to achieve specific sustainability objectives. Words into Action While advancing public debate on ESG is important, asset owners have proven time and again that actions speak louder than words. They have been instrumental in developing ESG practices over the past several decades, often filling the void created by the absence of effective public policy, engaging on their own and collaboratively through initiatives like Climate Action 100+. Asset owners were among the first investors to request disclosure on company sustainability issues, signaling that ESG matters for their investment decisions. They have used their influence to engage with companies on such environmental issues as carbon emissions, waste management, and pollution as well as social issues encompassing management and board diversity, fair labor practices and treatment of indigenous peoples, and corporate governance best practices. COP26 led to the creation of the Glasgow Financial Alliance for Net Zero (GFANZ), an umbrella organization made up of separate alliances for asset owners, asset managers, banking, insurance, consultants, and financial service providers.* Realizing GFANZ’s promise will depend on financing from the large asset owners that expressed a favorable stance on regulation targeting specific objectives like “net zero by 2050” in our survey. The agenda at COP27 will emphasize financing the transition to a low-carbon economy. Commitments by banks to reduce financed emissions have become a contentious topic in the United States where companies and asset managers are already under scrutiny from politicians for their support of ESG investing. With reports that banks are balking at their commitments in this area, asset owners are pushing back. This illustrates the challenges of managing for net zero amid energy market volatility, geopolitical turmoil, and political polarization, but it is consistent with our survey findings that energy management and greenhouse gas emissions are the most material ESG issues for asset owners. Tackling a “Wicked Problem” The Conference of the Parties, or COP, has been coming together for over a quarter century to assess global progress in countering climate change. These ambitious proceedings aim to secure voluntary national commitments on carbon reductions and financing as well as follow-through and progress reports. They reflect the challenge of collective action in the face of an inherently complex and difficult-to-solve “wicked problem” like climate change, which features tensions between the developing and developed worlds about burdens, costs, and equity. It is a problem that requires influential, steady, and honest voices to drive the debate forward through words as well as actions. The global asset owner community is one of these important voices. If you liked this post, don’t forget to subscribe to the Enterprising Investor. * For full disclosure, Morningstar Inc. is committed to be net zero by 2050 and actively participates in the Indexes and Research & Data workstreams of the Net Zero Financial Service Providers Alliance (NZFSPA). All posts are the opinion of the author and of the speakers quoted or discussed. 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/ioanna_alexa Professional Learning for CFA Institute Members CFA Institute members are empowered to self-determine and self-report professional learning (PL) credits

Readers clicked most on “Applying Economics — Not Gut Feel — to ESG” by Alex Edmans in 2023. The CFA Institute Research and Policy Center (RPC) focuses on four forward-looking research themes to drive content engagement, action, and outcomes. These themes are Capital Markets (Strengthening the Structural Resiliency of Capital Markets); Technology (Understanding the Latest Developments in Data Analytics, Technology, and Automation); Industry Future (Providing New Insights into the Future of the Profession); and Sustainability (Advancing the Industry’s Thinking on Sustainable Investing). The theme Advancing the Industry’s Thinking on Sustainable Investing covers an array of sustainable investing topics, including biodiversity, human capital, climate risk, net zero commitment issues, and environmental, social, and governance (ESG) investment approaches and performance data. CFA Institute research provides investment professionals with tools and resources for understanding, measuring, and managing sustainability-related risks and opportunities; meeting client demands; and complying with regulatory requirements. 1. “Applying Economics — Not Gut Feel — to ESG” Interest in ESG issues is at an all-time high. However, academic research is still relatively nascent, often leading us to apply gut feel on the grounds that ESG is too urgent to wait for peer-reviewed research. For the Financial Analysts Journal, Alex Edmans highlights how the insights of mainstream economics can be applied to ESG, once we realize that ESG is no different from other investments with long-term financial and social returns.  2. “An Exploration of Greenwashing Risks in Investment Fund Disclosures: An Investor Perspective” Nicole Gehrig and Alex Moreno examine investment funds’ disclosures related to ESG information through the lens of investors to understand the nature of disclosure issues that could give rise to a perception of greenwashing. 3. “Definitions for Responsible Investment” This guidance developed by CFA Institute Global, Sustainable Investment Alliance, and Principles for Responsible Investment (PRI), provides five key definitions for responsible investment terms: screening; ESG; thematic investing; stewardship; and impact investing. 4. “Green Parity and the Decarbonization of Corporate Bond Portfolios” Based on an investment universe for the 2017 to 2021 period, this study by Mario Bajo and Emilio Rodriguez for the Financial Analysts Journal examines different strategies that corporate bond investors can apply to achieve decarbonization goals. The authors find that a “Green Parity” strategy yields the best performance. 5. “Guidance for Integrating ESG Information into Equity Analysis and Research Reports” This guide to integrating ESG information draws from a number of CFA Institute publications to present a framework for identifying ESG information, assessing the materiality of ESG information, integrating ESG information into analysis and valuation, and presenting ESG information in research reports. If you liked this post, don’t forget to subscribe to Enterprising Investor and the CFA Institute Research and Policy Center. 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 / franckreporter 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