CFA Institute

The number of environmental, social, and governance (ESG) benchmarks and indexes demanded by the asset management community has grown at an unprecedented rate over the past two years. That’s according to our latest survey of Index Industry Association (IIA) members. Unpacking these high-level numbers, ESG indexes have expanded beyond more traditional areas of integration into new asset classes and strategies. The IIA queries our membership each fall in our annual benchmark survey to understand where the index industry’s growth is coming from. Last fall, the IIA found the number of ESG indexes increased 85% over the last two years. In response, we conducted additional surveys of the global asset manager community in 2021 and 2022 to confirm that index providers are meeting the ESG needs of the investment community, assessing the impact, and monitoring potential impediments to growth. That’s what makes the results of our most recent ESG Global Asset Manager Survey so interesting. Conducted earlier this year, the survey queried 300 investment fund companies across Europe and the United States. It found that amid geopolitical conflict, rising interest rates in many countries, a 40-year high in inflation, and now recession fears, the influence of sustainable investment factors on the global market ecosystem has continued to accelerate. In fact, our survey found that ESG factors are even more important to global asset managers today than they were a year ago. A full 85% of asset managers reported that ESG has become a larger priority within their company’s overall investment strategy in the past year. Overall, Has ESG Become More or Less of a Priority within Your Company’s Overall Investment Strategy over the Past 12 Months (By Geography) To be sure, given extensive media coverage of ESG and its aggressive promotion by asset managers, these results may not be all that surprising. So, we dug deeper on our next question and asked asset managers to quantify the integration of ESG considerations into their portfolios. We wanted to understand what asset managers believe the future state of asset management will look like. Expectations around ESG portfolio percentages within the next 12 months jumped more than 13% over last year’s survey. Moreover, within 10 years, asset managers expect 64.2% of their portfolios will contain ESG elements. These double-digit percentage increases over last year’s results extend across every time horizon surveyed. Approximately What Percentage of Your Asset Management Portfolios in Your Firm Do You Expect Will Contain ESG Elements in the Future? Weighted Average 2021 Survey 2022 Survey 12 Months from Now 26.7% 40.0% 2 to 3 Years from Now 35.0% 48.2% 5 Years from Now 43.6% 57.4% 10 Years from Now 52.3% 64.2% Base: All Respondents (300) ESG integration has become so widespread that sustainable investment approaches have expanded beyond equities into other asset classes. The percentage of investors implementing ESG factors in their allocations to fixed income shot up to 76% this year, from 42% just a year ago. In fact, ESG integration in all asset classes grew year-over-year, with the most expansion in fixed income. This trend shows no signs of slowing: Over 80% of global asset managers expect the use of ESG criteria in all major asset classes to increase in the next 12 months.  What explains these results? Based on conversations with market participants, I believe better data has led to better ratings and more research and development in fixed income, which in turn has created greater impetus to incorporate sustainable investing across asset classes and portfolio holdings. In Which Asset Classes Does Your Company Currently Implement ESG Criteria? 2021 2022 Fixed Income/Bonds 42% 76% Equities/Stocks 53% 74% Commodities 37% 47% Base: All Respondents (300) That conclusion isn’t purely anecdotal: More than 9 out of 10 survey respondents agreed that environmental impact, social sustainability, and corporate governance tracking tools, metrics, and services were either highly or fairly effective. That’s up significantly from 66% in 2021. Of course, given concerns about greenwashing and disparate data across the E, S, and G, this result seems optimistic. To date, environmental data is more quantifiable and directly measurable than social and governance data. Within “E” ratings, agencies can standardize how emissions are measured across various jurisdictions, for example. By contrast, privacy issues make some social data difficult if not impossible to collect. More fundamentally, not every country or culture, let alone individual, agrees on what the specific social priorities ought to be. But the survey responses do indicate something of a paradox: Fund managers are giving broadly equal weight to the E, S, and G components even as their attitudinal comments suggest that environmental concerns are more top of mind at this stage of ESG development. In fact, 78% of respondents said that “environmental criteria should always be given priority over social and governance criteria.” Which of the Following Best Describes How Each of the Elements of ESG Are Incorporated into Portfolios? Even in a year of economic and geopolitical challenges, global asset managers believe demand for ESG investing will accelerate and expand further into more asset classes. This raises a number of questions: Will there be enough data to support rising demand for ESG-oriented indexes and tools? Will a global consensus develop on more than just the “E” in ESG? That is, will sufficient insights be developed on social and governance criteria? These are issues we will be sure to monitor in our discussions with global asset managers in the coming years. This is the sixth installment of a series from the Index Industry Association (IIA). The IIA is celebrating its 10th anniversary in 2022. For more information, visit the IIA website at www.indexindustry.org. 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/enjoynz Professional Learning for CFA Institute Members CFA Institute members are empowered to self-determine and self-report professional learning (PL) credits

In golf, a hole-in-one is a remarkable feat. The odds? Roughly one in 850,000 from a distance of 150 yards – practically a statistical anomaly. Yet, the 2023 LPGA tour recorded 20 such occurrences. How can this be? Simple: a low probability doesn’t necessarily translate to low frequency. Hold on to that thought for a moment. Now, let’s switch gears. Imagine two coin-toss games. In the first, the coin is fair, offering an equal chance of winning or losing. In the second, the coin is flawed: there’s a 60% chance of losing and only a 40% chance of winning. Both games, however, offer an expected return of 25%. At first glance, most would claim that the flawed coin presents a higher risk. But consider this carefully. Both games are equally risky if we don’t know the outcome in advance –particularly when playing only once. The next flip could easily defy probability. Therefore, risk isn’t merely about the odds of winning. It’s about the severity of loss when things go wrong. Let’s add a new layer. Suppose the fair coin offers a 150% return on a win but a 100% loss on failure. The flawed coin, meanwhile, offers a 135% return on success but only a 50% loss on failure. Both scenarios result in an expected return of around 25%, but the flawed coin lets you live to play again — a crucial factor in investing. In investing, risk is not defined by probability or expected return. True risk is the likelihood of permanent capital loss when the odds turn against you. Risk, therefore, should always be viewed in absolute terms, not relative to return. Simply put, as a minority equity investor, there is no return level worth the risk of a permanent loss of capital. Since the future is unpredictable, avoiding extreme payoffs is paramount. Rational investing doesn’t involve betting on binary outcomes, no matter how enticing the potential upside. While this sounds simple, in practice, it’s far more nuanced. Theory to Practice Consider a chemical company that has just completed a major capex cycle, funded primarily through significant debt. The management is optimistic that new capacity will triple cash flows, allowing the company to quickly repay its debt and become net cash-positive in two years. Additionally, the stock is trading at a deep discount relative to peers and its historical average. Tempting, right? But the prudent investor focuses not on the potential upside but on the bankruptcy risk inherent in a commoditized, cyclical industry, especially one vulnerable to Chinese dumping. Now consider another example. A branded consumer company with a historically strong cash-generating legacy business. Recently, the company has taken on debt to expand into new related products. If the new product flops, the company’s core portfolio will still generate enough cash flow to pay down debt. It would be a painful setback, but far less catastrophic. For a long-term investor, this investment might still result in a profitable outcome. In both cases, the difference isn’t in the probability of success but in the severity of failure. The focus should always be on managing risk. Returns will follow naturally through the power of compounding. Empirical Evidence: Leverage and Long-Term Returns To reemphasize this principle, let’s turn to a more practical illustration. I analyzed the performance of US stocks over the past 10 years by creating two market-cap-weighted indices. The only distinguishing factor? The first index includes companies with net debt to equity below 30%. The second index comprises companies with net debt to equity above 70%.Index 1. The results speak for themselves. The low-leverage index outperformed the high-leverage index by 103% over the decade and surpassed the broader S&P 500 by 23%. Repeating similar exercise for emerging markets (EM) highlights similar trends, albeit in a narrower range. The low-leverage index outperformed the high-leverage index by 12% over the decade and surpassed the broader MSCI EM by 6%. These outcomes underscore a simple truth: companies with lower leverage — less risk of bankruptcy — are better equipped to weather downturns and compound returns over the long term. Key Takeaway Investing isn’t about chasing improbable victories or betting on binary outcomes with alluring upsides. It’s about safeguarding your capital from permanent loss and allowing it to grow steadily over time. By focusing on companies with strong balance sheets and low leverage, we minimize the severity of potential failures. This prudent approach enables us to weather market downturns and capitalize on the natural power of compounding returns. Remember, managing risk isn’t just a defensive strategy. It’s the cornerstone of sustainable, long-term investing success. source

Profitability metrics are often the main focus in the search for high-quality stocks. But Profitability is not a defensive factor and may expose investors to a company’s aggressive profit-chasing, among other unintended risks. So, how can such risks be mitigated? By incorporating an additional quality dimension that we classify as Conservatism. By combining Profitability and Conservatism, we can reduce a portfolio’s downside risk and enhance its risk-adjusted returns over the long run. Profitability Isn’t “Defensive” Profitability and Quality are often used interchangeably. That’s understandable. Several influential academic studies, including Eugene F. Fama and Kenneth R. French’s five-factor model, feature Profitability as an equity factor. Outside of academia, however, Quality has a broader definition that extends beyond simple Profitability. Thematically, Quality is a “defensive equity factor” that should provide downside protection during bear markets. This raises the question: Does Profitability offer similar downside protection? To answer this, we examined the historical performance of various factor strategies using several conventional industry Profitability metrics. These include Fama and French’s Profit, Return on Equity (ROE), Return on Invested Capital (ROIC), and Return on Assets (ROA). We sorted and ranked all stocks within the Russell 1000 universe according to their Profitability scores and then constructed factor-mimicking portfolios by taking the first quintile of stocks with the highest scores and weighting them equally. We rebalanced the factor strategies on a monthly basis and calculated their performance from January 1979 to June 2022.  Historical Performance of the Profitability Factor   Fama–French Profit ROE ROIC ROA Russell 1000 Annualized Return 14.2% 14.2% 14.0% 13.4% 10.1% Annualized Volatility 17.2% 17.4% 17.1% 17.3% 15.3% Sharpe Ratio 0.58 0.58 0.57 0.53 0.39 Maximum Drawdown –53.6% –55.3% –53.0% –61.6% –51.1% Upside Capture Ratio 1.12 1.14 1.12 1.08 – Downside Capture Ratio 1.03 1.05 1.03 1.02 – Source: Northern Trust Quant Research, FactSet, Russell 1000, January 1979 to June 2022 Our analysis shows all four Profitability strategies generated positive excess returns relative to the Russell 1000. But they all experienced higher maximum drawdowns than the benchmark and had a downside capture ratio over 1. As such, the Profitability strategies failed to provide downside protection.  The Case for Conservatism These results demonstrate that the profit-centric view of Quality can lead to higher downside risk. Why? Because the overemphasis on Profitability encourages firms to take on excessive leverage and conduct empire-building activities, among other profit-chasing pursuits. A profitable but highly levered firm may have greater default or bankruptcy risk when financial stress increases amid economic crises.  Minimizing such risks requires a multi-dimensional approach that incorporates Conservatism into the Quality design. We look for firms with high levels of profitability that also exhibit greater financial conservatism. That means lower leverage, stronger balance sheets, more conservative asset growth, etc.  To illustrate the process, we examined the performance of various Profitability and Conservatism metrics during the Global Financial Crisis in 2008 and the COVID-19 crisis in 2020. The following chart shows the annualized return spreads between equally weighted top and bottom quintile factor-mimicking portfolios during the market crashes. We found that Profitability metrics generated negative return spreads. For instance, ROE, ROIC, and ROA had return spreads of –25% to –37% during the recent COVID crisis. By contrast, all Conservatism metrics had positive return spreads during both stress events. Profitability vs. Conservatism during Crises Note: Prudent Capex Growth prefers low CAPEX growth over high CAPEX growth.Source: Northern Trust Quant Research, FactSet, Russell 1000 Next, we demonstrated the defensive characteristic of Conservatism with scatter plots and fitted polynomial curves for both Profitability and Profitability Plus Conservatism. The fitted curves illustrate that the convexity of Profitability improved from –0.11 to +0.04 when it was combined with Conservatism. The positive convexity, or smile effect, is the defensive feature that drives the factor’s outperformance in both up and down markets. Convexity of Factor Returns Note: Profitability is based on composite metrics of ROA, ROE, ROIC, and Profit. Conservatism is based on composite metrics of CAPEX growth, Leverage, and Cash Holdings.Source: Northern Trust Quant Research, FactSet, Russell 1000 Finally, we updated the first chart by adding our Profitability Plus Conservatism portfolio. We found that the composite factor offered much better downside protection and risk-adjusted returns than the more simplistic Profitability metrics. The Profitability Plus Conservatism portfolio had a lower maximum drawdown and higher risk-adjusted returns. The Profitability Plus Conservatism Factor   Fama–FrenchProfit ROE ROIC ROA Comp-ositeProfit-ability1 Profit-ability +Conserv-atism2 Russell1000 AnnualizedReturn 14.2% 14.2% 14.0% 13.4% 14.1% 15.0% 10.1% AnnualizedVolatility 17.2% 17.4% 17.1% 17.3% 16.9% 16.6% 15.3% SharpeRatio 0.58 0.58 0.57 0.53 0.58 0.65 0.39 MaximumDrawdown –53.6% –55.3% –53.0% –61.6% –51.8% –49.0% –51.1% UpsideCaptureRatio 1.12 1.14 1.12 1.08 1.10 1.13 – DownsideCaptureRatio 1.03 1.05 1.03 1.02 1.01 0.99 – 1. Composite profitability consists of equally weighted Fama–French Profit, ROE, ROIC, and ROA; 2. Profitability with Conservatism consists of equally weighted profitability metrics and conservatism metrics.Source: Northern Trust Quant Research, FactSet  Conclusion Academic literature may treat Profitability and Quality as synonyms, but our research shows they are far from analogous. High-Profitability stocks can suffer from excessive leverage, aggressive business models, and so on. When crises come, they may not provide much of a safety net. But Conservatism can add that extra dimension to Quality, one that can potentially deliver higher risk-adjusted returns. Further Reading Fama, Eugene F., and Kenneth R. French. “The Cross-Section of Expected Stock Returns.” The Journal of Finance. Novy-Marx, Robert. “The Other Side of Value: The Gross Profitability Premium.” Journal of Financial Economics. Hsu, Jason, Vitali Kalesnik, and Engin Kose. “What Is Quality?” Financial Analysts Journal. 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/ photonaj 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

Your Essential Guide to Sustainable Investing. 2022. Larry E. Swedroe and Samuel C. Adams. Harriman House. The establishment of the United Nations-backed Principles for Responsible Investment (PRI) in 2006 marked a turning point for investors. The PRI united signatories under a framework that was consistent with the neoclassical underpinnings of traditional finance — the pursuit of the best risk-adjusted returns — while making explicit how environmental, social, and governance (ESG) issues should be included in the analysis and valuation of securities and in subsequent engagement with management and the voting of proxies. While the practices of responsible investment (RI), socially responsible investment (SRI), and morals-based screening had been long intertwined without clear definition, by implicitly limiting the consideration of ESG issues to those that are financially material to shareholders the PRI set a boundary that in turn helped define the other sustainable finance practices. For most investors (universal owners such as pension funds may be slightly different) the overlap between RI and SRI ends when shareholder and stakeholder interests are no longer aligned. The primary benefits of the PRI’s framework have been as a catalyst for the incorporation of material ESG issues into investment practices, and as a signpost for the limits to which investors would naturally consider ESG issues. Beyond these limits stakeholders need to seek other avenues for change such as regulatory or legal reform, or changes to consumer behavior. Despite the PRI’s helpful framework, “sustainable investment” has less clarity today. Both media representation and asset manager marketing materials conflate the shareholder and stakeholder approaches with morals-based screening and impact investing, leaving us once again in need of guidance. Investment professionals and authors Larry Swedroe and Samuel Adams step into this quagmire of mixed messaging with a helpful and timely tome. Their first chapter tackles the central issue head on — “there are dozens of forms of sustainable investing” — and promptly (in the same sentence!) offers a framework that forms the outline for their guide — “we can categorize most of them into three general categories: ESG, SRI, and impact.” The book is well-organized, well-paced, well-articulated, and welcome; a good starting point for those seeking to understand the history and current practices of sustainable investing, and for those seeking practical guidance, including (for US investors) specific investment examples. The book recommendation comes with two important qualifications, however, which are discussed at the end of the review. First the strengths; Swedroe and Adams cover the “what,” “how,” and “who” of sustainable investing in the book’s first 30 pages. The “what” chapter includes summaries of SRI, impact investing, and ESG investing and includes examples of each strategy — a vegan climate ETF; a farmland REIT; and an ESG-aware ETF — which both professional and retail investors will find helpful. The “how” chapter explains the nuanced differences among: Negative/exclusionary screening Positive/best-in-class screening Norms-based screening ESG integration Sustainability-themed investing Impact/community investing Corporate engagement and shareholder action The “who” chapter covers: Sovereign wealth funds Pension plans College and university endowments Faith-based investors Family offices and foundations Financial advisors and wealth managers Individual investors Institutional asset managers Investor coalitions (including the PRI). This chapter provides insight into the methods and challenges of each investor type such as, “Endowments can find it challenging to invest sustainably because of their unique set of stakeholders.” Following their concise introduction Swedroe and Adams explore in depth “why” investors choose to invest sustainably and “what” they hope to accomplish. They note that sustainable investors “seek to promote a better world, through the societal return achieved by improving outcomes for both people and the planet.” The three returns to sustainable investing — financial, societal, and personal — are reviewed, leaving readers well equipped (after a short chapter that expands on the history of sustainable investing) to consider in depth the performance and impact of sustainable investing. Both chapters are comprehensive — combined, they account for about half of the book’s content — and have a strong academic tilt not present until this point. Investment professionals will find the two chapters particularly helpful, but retail investors may be challenged by the sheer volume of the literature review. It is also in these two chapters that the authors’ use of multiple frameworks (RI and SRI in particular) begins to creak under the strain of shifting perspectives. Noting that decades of data supported the factor research that refined the capital asset pricing model (CAPM), the authors caution that researchers’ current efforts to identify ESG factors are limited by the short time span of ESG data. They also note a divergence in both ratings and ratings methodologies by the major ESG ratings agencies, and it is here that the creaking is first heard. As with the issuer size and price-to-book ratios used in the original factor research, academics seeking to identify an ESG “factor” rely on standardized inputs for their research, including the ratings from ESG ratings providers. The same ESG ratings also help asset managers develop (and market) their negative or positive screens for investment funds, ratings, and screens that resonate with an investing public to align their moral or social goals with their investment holdings. However the divergence in ratings is much less relevant to active managers who integrate the ESG information into their valuation models. Researchers and investors use ESG ratings for their “headline scores,” while analysts use the 50-plus page reports as an input so that material ESG issues can be incorporated into a security’s valuation. That the utility of ESG ratings is dependent upon an end user’s perspective is emblematic of the current tangle in sustainable finance and highlights the benefit of a consistent framework — ideally the “financial materiality” framework promulgated by the PRI. As founding Sustainalytics CEO Michael Jantzi opined at a responsible investment conference I attended, the marketplace should ultimately determine which rating methodology is preferred by end users. The authors next review performance implications for ESG factors — sin stocks and screening, carbon intensity and risk, best-in-class — and cover impact, equity, and

As an investment professional, I know how easy it is to get caught between two extremes: chasing financial independence to retire early or staying in the industry far longer than we should — trading time for titles, bonuses, and perceived security. I’ve seen both paths lead to regret. That’s why I believe the real goal isn’t early retirement or late retirement — it’s meaningful retirement. There’s a magic window when we still have health, time, and financial freedom. The key is knowing when to step into it — and making sure you’ve built more than just wealth along the way. Work is often stressful, especially in banking and finance. So it’s no surprise that some professionals dream of leaving behind the daily grind as soon as they can. Lying on a beach and never having to reply to another work email seem enticing, especially when you have toxic colleagues and unreasonable bosses to deal with. However, after retiring, when the stress disappears, the golf course starts to feel repetitive, and spa days lose their magic. You begin to wonder: Is this it? Even though I have achieved my financial freedom, I’ve never quite subscribed to the FIRE movement because I know having money alone is not enough for a fulfilling retirement. If you spend much of your prime years solely focused on wealth accumulation, and neglect your relationships, interests, and your identity outside of work, you may find yourself having no purpose and no network post-retirement. Retiring at Retirement Age At the other end of the spectrum are those who wait too long to retire — setting ever-higher goals, afraid to leave the security or status of their careers. A LinkedIn poll I conducted showed that more than one-third of 2030 respondents believe they need at least $10 million to retire. Do we really need this much to retire? In banking and finance where the salary is good, it’s easy to stay in a job that you are no longer passionate about, just to keep clipping the coupon. In doing so, you may be missing out on the magical stage of your life. The Three Stages of Life Life can be divided in three stages: Stage 1: YouthYou have time and health, but not much money (unless you have a trust fund). Stage 2: Mid-LifeYou have money and health, but very little time — career and family consume most of it. Stage 3: Old AgeYou have time and money (hopefully), but health begins to deteriorate. But there’s a magical stage between Stage 2 and 3 where you have all three: time, health and money. Some people extend Stage 2 for too long, chasing promotions, accumulating wealth, and missing this precious window to live fully and intentionally. I left banking in 2017 to get into this magical stage where I have freedom to do what I like, and with whom I like. To make the most of this magical phase, and to ensure your retirement is meaningful, not just comfortable, you first need to build three forms of capital: financial capital, human capital, and social capital. Financial Capital This is the most obvious form of retirement readiness. You need enough money to support your lifestyle, healthcare, and travel plans. During my banking years, I lived below my means. I didn’t buy the Ferrari. I didn’t dine often at Michelin-starred restaurants. I wore a Timex instead of a Rolex. When I left UBS and returned from Hong Kong to Singapore, I bought the cheapest car I’ve ever owned. At first, I wondered: “Would people look down on me now that I no longer have the MD title or a luxury car?” I was overthinking. No one cared. What people did care about was how I transitioned — from banker to lecturer and writer with a large following on LinkedIn. Wealth doesn’t need to be displayed. Let your actions and impact speak for themselves. For my personal investment, I’ve shifted from properties and stocks into bonds and ETFs to reduce risk. Human Capital This refers to your skills, knowledge, and interests — the things that give you a sense of identity and purpose beyond your job title. Throughout my career, I invested in myself. I took courses that sparked my curiosity — not just finance, but graphic design and portrait photography. I incorporated those passions into my work, even offering to be the photographer at client events. I loved teaching, so I volunteered to conduct internal training for departments like credit, compliance, and legal, even though it wasn’t part of my KPIs. In the evenings, I taught finance as an adjunct associate professor at a top university in Asia. While still in banking, I started writing about career development on LinkedIn. Today, these skills and interests serve me well. I collaborate with major brands on sponsored content and events and continue to find fulfillment in the work I choose. Social Capital This is the trust and goodwill you’ve accumulated over the years by treating others with respect and helping them. You’ll need plenty of it after you quit your day job. When I published my book Small Actions, former banking colleagues supported me by buying multiple copies for their juniors. Some recommended me for speaking gigs; others regularly engaged with my LinkedIn posts. What many people don’t realize is a full-time job offers daily networking opportunities: you meet new colleagues and clients. After you retire, your social circle can shrink quickly. You tend to meet the same few friends, and you stop gaining new perspectives. When I was still a banker, I made a point to expand my network beyond the office. Today, I interact with many young professionals from diverse industries who keep me updated and relevant. While you are at your day job, invest in others: buy lunch and coffee, mentor junior colleagues, and support your friends’ projects. Don’t Just Accumulate Wealth, Accumulate Life Too Whether you retire early, late, or somewhere in between, to retire well, you need more than a number. You need financial, human, and social capital. Until you’ve built

There is an old adage on Wall Street: To succeed as an equity fund manager, follow interest rates and the bond markets. We decided to put that theory to the test: So, how do we determine whether active equity fund managers are following the bond markets? There is no perfect answer, but the proxy we apply here is the performance of in-family bond funds. Our theory is that the expertise required to produce outperforming bond funds would spill over and help generate above average returns for in-family active equity funds. For instance, if an asset management firm’s active bond managers did poorly over the past five years, we would anticipate their counterparts in active equity to underperform as well. With this premise in mind, we pulled the performance of all US dollar-denominated funds over the past five years and then matched each actively managed equity fund to their fund family and compared its performance to that of the average in-family fixed-income mutual fund. Our Bottom Bond Fund Performers category designates the lowest performance quartile over the five years under review, and the Top Bond Fund Performers those funds in the top 25%. We tested our theory across actively managed emerging market, value, growth, small-cap, large-cap, and international equity funds. In general, our results were inconclusive. For instance, the average five-year return of emerging market equity funds in families with top-quartile bond managers was –1.22% per year, while the average return of those in a family with bottom-quartile bond managers was –1.12%. The –0.10 percentage point difference is hardly significant and demonstrates that bond fund performance does not predict equity fund performance in this category. Top Bond FundPerformers(Same Fund Family) Bottom BondFund Performers(Same Fund Family) Difference Emerging Market Equity –1.22% –1.12% –0.10% Value Equity 8.44% 8.56% –0.12% Growth Equity 9.28% 9.25% 0.03% Small-Cap Equity 6.38% 6.89% –0.51% Large-Cap Equity 7.33% 7.19% 0.14% International Equity 1.02% 0.87% 0.15% The only two sub-asset classes with results that might support our theory are large-cap and international equities. In the former, strong in-family bond fund performance is associated with 0.14 percentage points of equity fund outperformance per year compared to those in the bottom quartile. All in all, our results do not indicate that a fund family’s success with bond funds translates to the equity side of the ledger. Of course, our in-family proxy may not be the best gauge of which equity fund managers pay the most attention to interest rates and the bond markets. To be sure, only a truly novel set of data could accurately identify that cohort. 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 / dszc 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

Investors betting on a near-term plunge in interest rates may be mistaking political theater for monetary policy reality. President Donald Trump’s renewed pressure on Federal Reserve Chair Jerome Powell has stirred speculation in the bond and futures markets. But history — and Powell’s own posture — suggest that such expectations are misplaced. Past confrontations between presidents and Fed chairs rarely produce immediate policy shifts. The lesson: wagers on dramatic rate cuts rest more on wishful thinking than sound economic reasoning. Trump’s variety of moral suasion might strike investors as unconventional. “I call him every name in the book trying to get him to do something,” he said of Powell. But history offers several instructive examples of how presidents have tried — and mostly failed — to sway Fed chairs. In 1965, for example, President Lyndon Johnson had harsh words for William McChesney Martin, who had just pushed through a rate hike: “You’ve got me in a position where you can run a rapier into me and you’ve done it. You took advantage of me and I just want you to know that’s a despicable thing to do.” Johnson feared the higher rates would undermine his domestic spending programs and his escalation of the Vietnam War. Yet despite the pressure, Martin stood firm — and did not reverse the rate hike — illustrating how even intense presidential demands often fail to move the Fed. Why Powell Won’t Play Politics So far, Powell has stood his ground in the face of the president’s verbal assaults. “Everyone that I know,” he has said, “is forecasting a meaningful increase in inflation in coming months from tariffs because someone has to pay for the tariffs.”  There are two important reasons to doubt that the Powell will soon change tracks on interest rate management. For one thing, he has little to gain and much to lose by deviating from the stance he believes is best supported by current economic data. Nothing suggests that Powell regards the Federal Reserve chairmanship as a steppingstone to higher office and might therefore be motivated to play politics. Two of Powell’s predecessors — G. William Miller and Janet Yellen — did go on to serve as Secretary of the Treasury after leading the Federal Reserve. But their paths offer little reason to believe Powell would view that role as a likely reward. Miller was appointed to both posts by the same president, Jimmy Carter, so his move wasn’t the result of cross-party political calculation. Yellen, meanwhile, was initially appointed Fed Chair by Barack Obama, then passed over for reappointment by Trump, and later tapped for the Treasury role by President Joe Biden — Obama’s former vice president. In contrast, Powell was appointed to lead the Fed by Trump himself, but has since faced public criticism and even threats of dismissal from the former president. While Trump has shown a willingness to include former rivals in his cabinet, it’s hard to imagine Powell earning such favor. At best, he might hope Trump refrains from trying to fire him before his term expires in 2026 — a step of questionable legality. In that light, we can suppose that Powell is concerned with safeguarding his legacy.  He probably does not want to be remembered, as Arthur Burns sadly is, for submitting to political pressure and consequently failing to keep a lid on inflation. Misguided monetary policy also tarnished the reputation of Eugene Meyer. His much later successor Ben Bernanke concurred with economists Milton Friedman and Anna Schwartz in concluding that the Fed’s contractionary policy during Meyer’s tenure helped transform the economic downturn that began in 1929 into the Great Depression. The Limits of One Vote The second argument against betting bigtime on an imminent interest rate plummet is that even if Trump’s tactics improbably succeed in changing Powell’s mind, they would change only one vote out of 12 on the Federal Open Market Committee. The FOMC’s decision at its June 17 to 18 meeting to leave the target Fed funds rate at 4.25% to 4.50%, was unanimous. Furthermore, seven of the 19 officials who are eligible for the 12 voting positions predicted there will be no rate cuts for the remainder of 2025, up from four in March. History Suggests the Fed Won’t Fold Surely, you might say, the FOMC would never go against its chair if he altered his position on rates? If that were to happen it would not be unprecedented. In June 1978, Miller was in the minority as the full FOMC voted to raise rates. Investors who cling to hopes of a substantial drop in interest rates in the near future may have been heartened by recent statements by Federal Reserve officials Christopher Waller and Michelle Bowman. They said the Fed could begin lowering interest rates as soon as July. Note, however, that Waller specifically ruled out an immediate, sharp rate reduction, instead saying the FOMC should “start slow.”  Powell also rejected Trump’s stated rationale for demanding a reduction in interest rates, correctly pointing out that ensuring “cheap financing for the US government” is not part of the Fed’s legislative mandate. After Waller and Bowman’s remarks, Powell reaffirmed his previous stance, telling the House Financial Services Committee, “For the time being, we are well positioned to learn more about the likely course of the economy before considering any adjustments to our policy stance.” The futures market’s estimate of the probability of a quarter-point rate cut at the July 30 FOMC meeting rose from 8% just before Waller’s comment to 19% as of June 27. Still, the kind of steep, immediate rate cut Trump has called for remains a longshot. Hope Is Not a Strategy In summary, given Jerome Powell’s characteristically deliberate approach to monetary policy, his current stance on interest rates, and his likely focus on legacy during his final year as Fed Chair, there is little reason to expect presidential pressure — however forceful — to prompt a dramatic pivot. Tempting as a big market payday might seem,

Russia’s invasion of Ukraine has had ramifications throughout the global investment community. There are the obvious repercussions: the rising volatility in the equity and commodities markets as well as spiking inflation. But there are also more subtle effects: The war has forced investment professionals to navigate complex gray areas where their choices might be legal from a regulatory standpoint but questionable from an ethical perspective.  The Russia–Ukraine War is not the first conflict to affect the financial industry in these ways, but it has changed the reality on the ground for practitioners. The investment community needs to recognize this and act accordingly. The threat of such conflicts and their consequences raise important questions that we as a community must address. Codes of professional standards like the CFA Institute Code of Ethics and Standards of Professional Conduct guide people facing real-world ethical dilemmas. Such dilemmas are like highway junctions with the particular code of conduct serving as a roadmap that tells us which lane to take. But a map is useful only as long as it accurately reflects reality. When reality changes, the map must be adjusted. Otherwise, those who take the wrong lane might encounter a more complex intersection further down the road. Should portfolio managers hold stock in companies that play some role in military aggression even when it’s perfectly legal to do so? Should an adviser cut ties with a client who is directly or indirectly involved in such conflicts? Where should the lines be drawn? War-related issues are hardly unique to the investment profession, so the answers to these questions should be guided by general moral norms and principles. But there are few phenomena that do as much damage to capital markets or society as a whole. War not only poses risks to the investment industry’s profitability but also to its reputation and credibility. Financial professionals or institutions that assist a government waging war to upend the rules-based world order can hardly bolster the public’s confidence in the financial markets or the investment profession. We need to be mindful of such risks. The Russian invasion of Ukraine has demonstrated that war has dramatic ripple effects that extend far beyond the front line and are hard if not impossible to model. What seemed rock solid can fall apart in a matter of days. Prior to the war, Russian equities traded on foreign exchanges. Many had “buy” ratings from major investment houses. Soon after the Russian attack, they were all worthless. Wealthy clients with established relationships found their accounts blocked. Lucrative deals had to be scrapped and businesses liquidated. At one point, the market was left to wonder whether agent banks would wire through coupon payments from the Russian government to its creditors. A year ago, such concerns would have raised more than a few eyebrows. The conflict has changed the investment landscape at such a sheer scale and with such speed that the rules must be adjusted to stay relevant. The question is: What should these new rules look like? Now is the time to begin that discussion. Should there be explicit rules requiring investors and institutions to dissociate themselves from war-related activities in certain circumstances? What about an exclusionary screening approach? It is never easy to find a common denominator on complicated and divisive ethical questions. Indeed, there are no perfect solutions to these dilemmas, but that doesn’t mean solutions aren’t possible. The investment industry could promote an environmental, social, and governance (ESG)-like approach when it comes to military conflict. This could take the form of guidance on best practices or disclosures around war-related information to current and potential clients. These might include a list of portfolio companies that do business in the aggressor country or a divestment strategy detailing how securities from such firms will be excluded in the future. There are no doubt other potential solutions that will emerge in the course of these conversations. The Russia–Ukraine conflict has demonstrated that the consequences of major wars are impossible to anticipate and too big to ignore. Which is why the investment community needs to come together to develop common standards to apply when such conflicts break out but with the ultimate goal of preventing them from breaking out in the first place. Let’s start the discussion. 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 courtesy of GoToVan, licensed under the Creative Commons Attribution 2.0 Generic license. Cropped. 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

“Ultimately, there’s one investment that supersedes all others: Invest in yourself. Nobody can take away what you’ve got in yourself, and everybody has potential they haven’t used yet.” — Warren Buffett Last year, I interviewed 52 remarkable people for my research paper “Smart Women and Men: How They Invest in Themselves,” which was released on 8 March 2023. Below are 10 stories told by people from various locations and cultures in response to the question: How do you invest in yourself? I’ve found that regarding the know your client (KYC) concept, few queries are more revealing. Donovan Bailey, CEO, Bailey Inc., Five-Time Olympic and World Champion Sprinter, Toronto “How do I invest in myself? Well, for context, my athletic career . . . is well documented. I am the first man in history to simultaneously be the world champion, Olympic champion, and world record holder for the 100 meters. I am a two-time Olympic gold champion, three-time world champion, and two-time world record holder. I am also the only person to be twice inducted into Canada’s Sports Hall of Fame. How did I accomplish all of that? My No. 1 priority is to invest in my body. “When I started out as a professional athlete, I spent over 60% of my earnings investing in my body: I had to buy the best food (I had to eat six meals a day!), the best physio, whatever it took to achieve my goal of becoming the greatest athlete on the planet. At age 54, I’m no longer competing, but I make sure to get regular exercise, eat high quality food, and sleep well. As you get older, it is important to find a structure that works for you.” Anna Jonsson, Head of Institutional Clients and Distribution, Storebrand, Stockholm “There are so many ways that you can invest in yourself — the key is that you need to find the time to pursue whatever that looks like for you. Make sure it happens. I don’t feel bad about finding the right balance for me. I choose to spend less time hanging out with friends because I have lots of socializing via my work events, and I make daily exercise my priority. I tell my five-year-old daughter that I’m a better mom when I run. You can’t have everything, but you can have a lot.” Christophe Bristiel, Sales Director, Château La Nerthe, Châteauneuf-du-Pape, France “After graduate school in business, I worked for many years, mostly for Citibank in New York, Frankfurt, and London. Although this was an exciting career, I believe the single most important ‘investment’ I have [made] was to leave the banking/trading world in late 2004 and get my Certified Sommelier degree at the Université du Vin in Suze-la-Rousse, which is only about 30 kilometers north of Châteauneuf du Pape. Châteauneuf du Pape is the oldest appellation in France, as it was established as a separate AOC [appellation d’origine contrôlée] in 1936, and I am proud to say that Château La Nerthe has been certified in organic farming since 1998, and I am happy to follow in my father’s footsteps as sales director.” Anita Kunz, Artist and Illustrator, Toronto “My career has been my most important investment in myself. I live in Canada now, but for over 20 years I lived in London and New York, contributing to magazines and working for design firms, book publishers, and advertising agencies all around the world. I’ve produced cover art for many magazines including Rolling Stone, The New Yorker, Sports Illustrated, Time, Newsweek, The Atlantic Monthly, and The New York Times Magazine. I have also illustrated more than 50 book jacket covers. “I like to invest in others: I want to give back. Ontario College of Art was remiss in telling students it is one thing to be an artist, but it is quite a different thing to be running a small business. Once a month, I teach in various cities around the world: I have a lot of useful information, and I don’t want the students to make the same mistakes that I did. It took me years to learn how to say no and how to ask for more money.” Harjot Singh, Global Chief Strategy Officer, McCann, London “How do I invest in myself? In three broad categories. First, I like and honor my physical comforts: a home that is soothing, sensorially comforting, and visually pleasing. I wait patiently till I can invest in what I know and believe is the most comfortable and beautiful, such as my handcrafted Hästens bed with horsehair. I waited several years till I could buy it. Second, I respect what fuels my body — both in the physical form in terms of what goes in my body but also what is the best emotional diet that I can consume. I seek out enrichment via art, music, spiritual learning, literature, and theater. Third, I am very selective about the people around me, and I invest in my relationships. I enjoy giving and sharing — to witness and enable good things [for] good people.” Laura Maia de Castro, Journalist, São Paulo “The number one way that I invest in myself is through meeting people and making connections. As a journalist, I spend a lot of time listening to stories and hearing different perspectives: It’s a great way to open my mind. I always have to pitch story ideas, so whether I am waiting on the street for an Uber or sitting in the waiting room at my doctor’s office, I listen to people, and this adds another layer to my existence. I have a lot of stories saved in my repertoire. I am a compulsive interviewer, and just the other day, I asked my statistician colleague at the bank to try to explain to me exactly what she does. I also asked the interns, ‘Why is there such hype around a certain meme?’ I am curious about everyone’s jobs and stories, and this is good for me both professionally and

Pim van Vliet, PhD, is the author of High Returns from Low Risk: A Remarkable Stock Market Paradox, with Jan de Koning. The low-volatility premium may be the most compelling anomaly in financial markets: Less risky securities outperform their riskier counterparts over the long term. Empirical tests of the capital asset pricing model (CAPM) first documented this counterintuitive phenomenon more than a half century ago. It emerged not in a search for alpha but rather as an unwelcome reality, an unintended consequence of theory testing, and remains poorly understood to this day. This makes the defensive low-volatility factor unique and sets it apart from other factors. Since the low volatility factor defies a risk-based explanation, academics who believe in efficient markets have trouble accepting it. Indeed, Eugene Fama and Kenneth French left low volatility out of their three-factor and five-factor models.  Practitioners, by contrast, often struggle to capitalize on the factor because of the high risk associated with it relative to its benchmarks and because of leverage constraints and potential career risks. Such complexities and hurdles make low volatility a special animal within the expanding “factor zoo.” Yet the low-volatility factor is both resilient and robust. Here, by applying the principle that the simplest explanation is usually the most accurate — Occam’s razor — we make the case for low volatility. The graphic below shows how low volatility interacts with other factors. Even after seven cuts or slices, the factor still performs. If it keeps its alpha after so many slices, its simplicity must be key to its significance. The Starting Point: CAPM Using US market data from July 1940 to December 2023, we measure the volatility factor much like a Fama and French style factor, by taking a long position on low-volatility stocks and a short one on their high-volatility counterparts. Over this period, the low volatility premium (VOL) equals 6.4% with a beta that by construction is very close to zero. The CAPM alpha is 6.3% per annum with a t-stat of 5.3, far above the critical levels Campbell Harvey recommended to minimize the risk of finding “fake factors.” Low-Volatility Premium (VOL) Controlled for Other Factors, July 1940 to December 2023 Sources: The Kenneth R. French Data Library and Paradox Investing The First Slice, 2FM (Rates): Two Factors, Equities and Bonds When the CAPM was unveiled, Richard Roll’s critique was that bonds and other assets should be included in the market portfolio. Since low-volatility stocks resemble bond-like stocks, this higher rate-sensitivity could be an explanation. Still, a two-factor regression that includes both equities and bonds lowers VOL’s alpha by only 0.3%. Second Slice, FF 3FM: Fama-French Three-Factor Model One explanation of the low-volatility factor is that value is often defensive. While the relationship is time varying, on average volatility loads positively on value and negatively on size. The classic three-factor Fama–French regression, which includes both the value and size factors, reduces VOL’s alpha by 1.1%. Third Slice, 4FM (Inv): Three-Factor Model Plus Investment Fama and French augmented their three-factor model with two more factors — investment and profitability — in 2015. We find the investment factor accounts for about 0.5% of VOL’s alpha. This makes intuitive sense since conservative, low-investment firms tend to exhibit less volatility.  Fourth Slice, 4FM (Prof): Three-Factor Model Plus Profitability Of these two new factors, profitability has a much stronger relationship to volatility and accounts for 1.2% of VOL’s alpha. We find that unprofitable firms tend to be very volatile even as their profitable peers do not always demonstrate the opposite. Thus, the short leg drives most of this result.  Fifth Slice, FF 5FM: Fama-French Five-Factor Model Combined, these five factors bring VOL’s alpha down by 0.9%. This indicates that investment and profitability are different dimensions of the quality factor that interact with value and size.  Sixth Slice, 6FM (Mom): Five-Factor Model Plus Momentum The most dynamic factor, momentum, generates high gross returns but requires considerable turnover, which erodes net returns. This is why Fama and French did not include it in their five-factor model. When we add momentum, the VOL premium does not rise or fall. Seventh Slice, 7FM: The Kitchen Sink In our final, all-inclusive “kitchen sink” regression, VOL’s alpha declines by 0.2% and is still standing at a statistically significant 2.1%.  All this demonstrates low volatility’s overall robustness. The factor’s outperformance survives critiques from all different angles. By applying Occam’s razor to the factor zoo and slicing low volatility every which way, the strategy still stands out as the premier factor. If it takes five or six factors to explain it, low volatility may not be that bad after all. To take it one step further, by integrating value, quality, and momentum into a “Conservative Formula,” we create an enhanced low-volatility strategy that beats VOL along with all the other factors. The following figure shows how the Conservative Minus Speculative (CMS) portfolio fares after each of our previous cuts. The alpha starts at 13.3% and only falls to 8.2% after all seven slices. Enhanced Volatility Premium (CMS) Controlled for Other Factors, July 1940 to December 2023 Sources: The Kenneth R. French Data Library and Paradox Investing Amid low demand for defensive investing during the recent tech-driven market rally, the case for low-volatility investing may be stronger than ever. In a market that often overlooks it and a world where the obvious is often overcrowded and overvalued, the low-volatility anomaly stands as a testament to the power of contrarian thinking. Sometimes, the less-trodden path offers the better journey. As we look ahead, the question remains: Will the market eventually catch up to this hidden gem, or will low volatility continue to be the market’s best-kept secret? For more from Pim van Vliet, PhD, don’t miss High Returns from Low Risk: A Remarkable Stock Market Paradox, with Jan de Koning. 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