CFA Institute

“My basic point here is that neither the Financial Analysts as a whole nor the investment funds as a whole can expect to ‘beat the market,’ because in a significant sense they (or you) are the market . . . the greater the overall influence of Financial Analysts on investment and speculative decisions the less becomes the mathematical possibility of the overall results being better than the market’s.” — Benjamin Graham An enduring principle of financial history is that past solutions often plant the seeds of future problems. Among the least-expected examples of this phenomena were the passage of the Securities Act of 1933 and the Securities Exchange Act of 1934. These acts mandated extensive financial disclosures by publicly traded companies and outlawed market manipulation and insider trading. Prior to their passage, Wall Street stock operators routinely profited by cheating markets rather than outsmarting them. To be clear, these regulations were desperately needed to clean up US securities markets. After they were passed, skillful securities analysis, rather than market manipulation and insider trading, was largely the only way to beat the market. Of course, truly above-the-mean securities analysis was and remains exceedingly rare. But that hasn’t kept capital from flooding into actively managed mutual funds — even after the first index funds launched in the 1970s. Under pressure to differentiate their products, fund managers introduced a slew of investment strategies covering various asset classes and sub-asset classes. Increased complexity, specialization, and robust marketing budgets convinced the public that professional managers could add value to their investment portfolios beyond what they could otherwise obtain by investing in a diversified portfolio of stocks. Few paid attention when the SEC noted that the average professionally managed portfolio underperformed broad indexes before fees in an exhaustive 1940 study. For more than 80 years, the fact that few active managers add value has been validated by numerous research papers published by government agencies, including the SEC, and such Nobel laureates as William Sharpe and Eugene Fama, as well as the experience of Warren Buffett, David Swensen, Charles Ellis, and other highly regarded practitioners. Despite a preponderance of evidence, many investors continue to reject the undeniable truth that very few are capable of consistently outperforming an inexpensive index fund. Outside a small and shrinking group of extraordinarily talented investors, active management is a waste of money and time. The Extraordinary Wisdom of the Crowd So, why is the active management delusion so persistent? One theory is that it stems from a general lack of understanding as to why active strategies are doomed to failure in most cases. The primary reason — but certainly not the only one — is summed up by the “wisdom of crowds,” a mathematical concept Francis Galton first introduced in 1907. Galton described how hundreds of people at a livestock fair tried to guess the weight of an ox. The average of the 787 submissions was 1,198 pounds, which missed the ox’s actual weight by only 9 pounds, and was more accurate than 90% of the individual guesses. So, 9 out of 10 participants underperformed the market. Galton’s contest was not an anomaly. The wisdom of crowds demonstrates that creating a better-than-average estimate of an uncertain value becomes more difficult as the number of estimates increases. This applies to weight-guessing contests, GDP growth forecasts, asset class return assumptions, stock price estimates, etc. If participants have access to the same information, the total estimates above the actual amount tend to cancel out those below it, and the average comes remarkably close to the real number. The results of a contest at Riverdale High School in Portland, Oregon, illustrated below, demonstrate this principle. Participants tried to guess the number of jellybeans in a jar. Their average guess was 1,180, which wasn’t far from the actual total of 1,283. But out of 71 guesses, only 3 students (fewer than 5%) beat the average. Anders Nielsen came closest with 1,296. Average Participant Guess by Number of Participants The Seed of the Active Management Delusion Speculators prior to 1934 understood the wisdom of crowds intuitively, which is one reason why they relied so heavily on insider trading and market manipulation. Even in the late 1800s, market efficiency was a formidable obstacle to outperformance. The famed stock operator Daniel Drew captured this sentiment when he reportedly commented, “To speckilate [sic] in Wall Street when you are no longer an insider, is like buying cows by candlelight.” The Great Depression-era securities acts improved market integrity in the United States, but they also sowed the seed of the active management delusion. As companies were forced to release troves of financial information that few could interpret, markets became temporarily inefficient. Those like Benjamin Graham who understood how to sift through and apply this new data had a competitive advantage. But as more investment professionals emulated Graham’s methods and more trained financial analysts brought their skills to bear, the market became more efficient and the potential for outperformance more remote. In fact, Graham accelerated this process by publishing his techniques and strategies and thus weakened his competitive advantage. His book Security Analysis even became a bestseller. After a time, Graham concluded that beating the market was no longer a viable goal for the vast majority of financial analysts. That did not mean that he had lost faith in their value; he just knew with mathematical certainty that outperformance was too tall an order for most. Despite his indisputable logic, his warning was largely ignored. By the 1960s, too many investment firms and investment professionals had staked their businesses and livelihoods on beating the market. Letting Go of the Fear of Obsolescence The flawed belief that we can beat the market persists to this day. What’s worse, it has spread to institutional consulting and other sectors. Many firms base their entire value proposition on their manager selection skills and asset allocation strategies. Yet these are subject to the same constraints as Galton’s weight-guessing contest. For example, average estimates of asset class return

The wealth management landscape is undergoing a seismic shift as single- and multi-family offices grow in scale, sophistication, and influence. No longer just vehicles for wealth preservation, these entities are now dynamic investment powerhouses, managing diverse portfolios, integrating cutting-edge technologies, and embracing sustainable investing. For investment professionals, this evolution presents a unique opportunity: the chance to hone and leverage their expertise in a space that prioritizes long-term strategy, client-centric solutions, and innovative financial approaches. As family offices continue to expand, those who understand their complexities will be well-positioned to lead the next era of wealth management. Single-family offices are the fastest-growing segment in wealth management. According to Deloitte, the number of single-family offices worldwide surged by 31% to 8,030 in 2023, up from 6,130 in 2019, with projections that there will be 10,720 single-family offices by 2030. Alongside this expansion, assets under management are expected to grow to $5.4 trillion by 2030. For CFA charterholders in particular, this evolution represents a pivotal moment to leverage their expertise and play an instrumental role in the family office space. Transforming the Role of Family Offices Once primarily focused on wealth preservation, family offices have evolved into dynamic organizations that manage diverse portfolios, support intergenerational wealth transfer, and embrace innovative investment strategies. Single-family offices, often structured like private hedge funds, cater to ultra-high-net-worth families with bespoke financial services. Multi-family offices, meanwhile, serve multiple families, offering wealth management, tax optimization, estate planning, and more. The transformation of single- and multi-family offices to dynamic organizations aligns seamlessly with the core competencies of CFA charterholders. Long-term planning, client-centric approaches, and alternative investments are in high demand. Furthermore, as seasoned wealth managers retire, multi-family offices are acquiring their books of business, presenting leadership opportunities for those seeking to expand their client base and assume leadership roles. Strategic Planning for Intergenerational Wealth Family offices increasingly focus on managing wealth transitions between generations. To excel in this space, investment professionals must complement their technical expertise with interpersonal and strategic skills including: Understanding family dynamics: This requires navigating complex relationships and mitigating conflicts to maintain harmony during wealth planning. Environmental, social, and governance (ESG) and impact investing expertise: Younger generations prioritize investments aligned with their values, driving demand for sustainable investing strategies. Global ESG assets are projected to exceed $40 trillion by 2030, presenting an unparalleled opportunity for investment professionals to specialize and set themselves apart. Legacy and succession planning skills: This requires designing and implementing comprehensive strategies that ensure seamless wealth transitions while honoring the family’s long-term goals. Digital Assets: A Unique Niche Cryptocurrency is emerging as a significant asset class for family offices, driven by a desire to engage younger generations and diversify portfolios. Given their ability to hold illiquid assets for extended periods of time, family offices are uniquely positioned to capitalize on the long-term potential of digital assets. Investment professionals who acquire expertise in blockchain technologies, regulatory frameworks, and risk management can carve out a niche as advisors in this rapidly growing market. Understanding crypto’s broader implications — from portfolio diversification to fostering intergenerational engagement — further enhances a practitioner’s value proposition. Leveraging Wealth Tech Technology is reshaping how family offices operate, with innovations ranging from AI-driven investment platforms to advanced compliance tools. Mastering wealth tech is critical to improving operational efficiency and delivering personalized client experiences. Staying ahead in this domain requires: A deep understanding of how technology enhances client lifecycle management Insights into integrating digital tools into family office practices, from streamlining workflows to optimizing portfolio reporting Practitioners who embrace these advancements can position themselves as forward-thinking professionals who elevate both the efficiency and sophistication of family office operations. The Multifamily Office Advantage Multi-family offices offer a wealth of opportunities to refine skills and broaden impact. With a diverse client base, multi-family offices expose investment professionals to a wide array of financial scenarios, enabling them to: Develop expertise in alternative investments, tax optimization, and cross-border wealth management. These are in-demand skills in today’s global economy. Expand their roles beyond investment management into areas such as philanthropic advising, succession planning, and family governance. Lead initiatives to attract and retain high-net-worth clients, demonstrating their strategic and leadership capabilities. For those seeking dynamic and exciting careers, the multi-family office sector offers tremendous opportunities. Future-Proofing Your Career As family offices continue to evolve, investment professionals who adapt to their unique demands will find significant opportunities for growth and leadership. The future of wealth management lies in a holistic approach — one that blends technical expertise with strategic foresight, relationship management, and adaptability to emerging trends like sustainable investing, digital assets, and wealth technology. CFA charterholders are uniquely positioned to capitalize on these trends. But any investment professionals who embrace this transformation will not only enhance their careers but also play a pivotal role in shaping the next generation of family office success. source

The brief descriptions below are of my three favorites among the book reviews published in 2024 in Enterprising Investor. Throughout the year, our Review Team members generously share their expertise and experience in bringing to CFA charterholders’ attention books that offer insights, concepts, and techniques that are useful to them in their work. The three books that I highlight here stand out for their applicability to practical issues confronting investment decision-makers. I have derived tremendous benefits from serving as Book Review Editor since 1989, initially for the Financial Analysts Journal and since for Enterprising Investor. Writing some of the reviews myself, while working with team members on others, has been a valuable component of my lifelong learning. In addition, I have found it rewarding to help fellow charterholders enhance the knowledge and skills necessary to perform at the highest level. The M&A Failure Trap: Why Most Mergers and Acquisitions Fail and How the Few Succeed. Baruch Lev and Feng Gu. The 70%-75% M&A failure rate found by the authors cries out for exactly their brand of rigorous quantification of the factors that produce success or its opposite. Especially valuable is their exploration of the managerial incentives that continue to lead to doomed deals. Lev and Gu manage to make their heavily data-driven analysis highly readable, with colorful prose and engaging stories of both winning and losing transactions. The Ownership Dividend: The Coming Paradigm Shift in the U.S. Stock Market. Daniel Peris. It is important for practitioners to read works that challenge conventional wisdom and The Ownership Dividend certainly fits the bill. Peris’s strongly supported, alternative narrative is that the deemphasis of dividends over the last few decades was a function of specific historical circumstances, with the pendulum now set to swing back toward a more traditional focus on current income. I find particularly interesting his contention that Modigliani and Miller’s dividend Irrelevance theory is period-bound rather than generalizable to all eras. Markets in Chaos: A History of Market Crises Around the World. Brendan Hughes. Notwithstanding Hegel’s aphorism, commonly rendered as, “We learn from history that we do not learn from history,” investment professionals truly can up their game by studying past market cycles. Hughes reaches as far back as the eighteenth century in his examination of financial crises. He brings their lessons to bear, however, on investment decisions involving such weighty contemporary issues as technological challenges to incumbent financial institutions and the obstacles facing the United States in attempting to rectify its fiscal imbalances. 2025 Sneak Preview In 2025, watch for a review of Buffett’s Early Investments: A New Investigation into the Decade When Warren Buffett Earned His Best Returns, by Brett Gardner. The energy and creativity that went into the Oracle of Omaha’s initial triumphs offer guidance and inspiration to opportunity seekers more than a half century on. Also be on the lookout over the coming year for Enterprising Investor’s take on The Making of Modern Corporate Finance: A History of the Ideas and How They Help Build the Wealth of Nations, by Donald H. Chew, Jr. The theories discussed in this book are staples of the CFA curriculum, but Chew brings out an additional, vitally important dimension — the vast impact that ideas have had on financial practice and through that medium on global economic performance. After reading this book, practitioners will not merely regard the corporate finance pathbreakers as illustrious figures in textbooks but feel on a first-name basis with them. If you liked this post, don’t forget to subscribe to the Enterprising Investor. All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer. Image credit: ©Getty Images / Ascent / PKS Media Inc. Professional Learning for CFA Institute Members CFA Institute members are empowered to self-determine and self-report professional learning (PL) credits earned, including content on Enterprising Investor. Members can record credits easily using their online PL tracker. source

Shocks, Crises, and False Alarms: How to Assess True Macroeconomic Risk. 2024. Philipp Carlsson-Szlezak and Paul Swartz. Harvard Business Review Press. Good macroeconomic predictions and risk assessments are not easy to make, so maybe the problem should be reframed not as an effort in prediction but as a process of learning to develop better macro judgment. Macroeconomic investment research is generally focused on the short run and tied to market behavior. It can be classified into three approaches to analysis: a quant school that links data to precise forecasts, a narrative school that talks through stories to provide macro awareness, and a hybrid school with narrative surrounded by supporting data. With clear evidence that most macro forecasts are problematic, these approaches can be unsatisfying. Shocks, Crises, and False Alarms presents a new way of thinking about and framing macro risks that is refreshing. Co-authors Philipp Carlsson-Szlezak and Paul Swartz, respectively global chief economist and senior economist at Boston Consulting Group, are not at all part of the quant numbers school, so anyone looking for a better way to make precise forecasts will be disappointed. Similarly, the authors do not fall into the pure narrative or hybrid schools, which focus on current stories or historical comparisons. Carlsson-Szlezak and Swartz attempt instead to develop for the general management audience a useful framework that gives readers a clear focus on what is meaningful for identifying critical macro shocks. For investment professionals, reading how consulting economists frame these questions provides an alternative perspective to recalibrate macro thinking. This contrasts with Wall Street economists, who are driven by the latest macro data announcement shocks on the stock and bond markets. Carlsson-Szlezak and Swartz reframe good macro analysis as a process for developing better judgment about the economic environment and not specific forecasts. Get the big picture and direction right, and you have likely solved the problem. The authors’ key focus on navigating shocks and crises is based on understanding the economic operating system and three foundations: 1. Employ judgment and do not focus on a specific forecasting school or model framework. 2. Think of macro awareness as a debate, not a question to be definitively answered through specific output. To assess true macro risk, the reader must be aware that no master model exists because no single framework or model can explain the varied phenomena that managers face. A healthy skepticism regarding theory is necessary, along with a willingness to practice economic eclecticism and focus on the broad picture and trends. 3. Macro risk assessments should not be focused on the usual doom-mongering. There are, of course, critical concerns and risks, but there is also a resilience in modern economies that is often missed by focusing only on downside risk. After setting this initial framework, the authors assess risks in three core areas: the real economy, the financial setting, and the global environment. The real economic discussion can be broken into three parts: an assessment of the business cycle, the drivers of long-term growth, and issues associated with technology and productivity. Fundamentally, no real symmetry exists in the business cycle. A fast and steep economic decline will tell us nothing about the recovery. Managers should therefore look at the specifics of demand and what may drive the cyclical moves on the supply side, without trying to force their conclusions into a cyclical framework. Thinking about long-term growth can be conceived as a move back to basics. Growth is driven and constrained by the key inputs of labor and capital, along with productivity. Whether the discussion centers on the United States or any emerging market country, a basic labor/capital growth model is a logical and useful starting point. Finally, a focus on technology and its impact is critical for any meaningful growth discussion. A shock from technology, the impact of productivity changes, and the consequences from labor and capital growth can be both promising and perilous for an economy, so following these dynamics is a useful exercise if you want to predict the future. The financial economy must be viewed within a framework of policy stimulus that assesses both the willingness and the ability of policymakers to act. Capabilities must match policy desires. Carlsson-Szlezak and Swartz argue that viewing the macro environment only as a doom-monger will result in missed opportunities. Nevertheless, there are current financial risks that will weigh on the likelihood of future crises. Inflation is not easy to solve because the cure may not be viewed as an acceptable risk–reward tradeoff. The risk from the overhang of high debt is not going away because there is no desire to address the problem. A stimulated macro environment through fiscal and monetary policy is likely to create market bubbles — which can have both a positive and a negative economic impact. The third core area of focus, the global economy, cannot be divorced from the analysis of a specific country. Trends in different economies tend to converge, yet they can also diverge and become more disjointed. The large convergence bubble across the globe may have ended, so we must accept a more disjointed world in the future. Trade will be affected by specific policies that are more mercantilist, so any view forward must account for disjointed behavior. Although the dollar’s possible demise has been the subject of an ongoing debate, its global dominance is unlikely to change, so global connectedness will endure. The investment professional’s response to macro risks is often to avoid them and not even try to make a macro forecast or else fall into the trap of following doomsayers. A significant portion of risk and return is associated, however, with the macro environment, and the biggest investment opportunities arise from large macro shocks and crises. Simply avoiding upside and downside risk predictions will critically affect long-term returns, so there is value in employing macro judgment as a preparation for the future. My own quantitative orientation, combined with top-down thinking in a global macro investing environment, generated a negative bias on my

The US Federal Reserve began raising the federal funds rate in March 2022. Since then, almost all asset classes have performed poorly while the correlation between fixed-income assets and equities has surged, rendering fixed income ineffective in its traditional role as a hedging tool. With the value of asset diversification diminished at least temporarily, achieving an objective and quantifiable understanding of the Federal Open Market Committee (FOMC)’s outlook has grown ever more critical. That’s where machine learning (ML) and natural language processing (NLP) come in. We applied Loughran-McDonald sentiment word lists and BERT and XLNet ML techniques for NLP to FOMC statements to see if they anticipated changes in the federal funds rate and then examined whether our results had any correlation with stock market performance. Loughran-McDonald Sentiment Word Lists Before calculating sentiment scores, we first constructed word clouds to visualize the frequency/importance of particular words in FOMC statements. Word Cloud: March 2017 FOMC Statement Word Cloud: July 2019 FOMC Statement Although the Fed increased the federal funds rate in March 2017 and decreased it in July 2019, the word clouds of the two corresponding statements look similar. That’s because FOMC statements generally contain many sentiment-free words with little bearing on the FOMC’s outlook. Thus, the word clouds failed to distinguish the signal from the noise. But quantitative analyses can offer some clarity. Loughran-McDonald sentiment word lists analyze 10-K documents, earnings call transcripts, and other texts by classifying the words into the following categories: negative, positive, uncertainty, litigious, strong modal, weak modal, and constraining. We applied this technique to FOMC statements, designating words as positive/hawkish or negative/dovish, while filtering out less-important text like dates, page numbers, voting members, and explanations of monetary policy implementation. We then calculated sentiment scores using the following formula: Sentiment Score = (Positive Words – Negative Words) / (Positive Words + Negative Words) FOMC Statements: Loughran-McDonald Sentiment Scores As the preceding chart demonstrates, the FOMC’s statements grew more positive/hawkish in March 2021 and topped out in July 2021. After softening for the subsequent 12 months, sentiment jumped again in July 2022. Though these movements may be driven in part by the recovery from the COVID-19 pandemic, they also reflect the FOMC’s growing hawkishness in the face of rising inflation over the last year or so. But the large fluctuations are also indicative of an inherent shortcoming in Loughran-McDonald analysis: The sentiment scores assess only words, not sentences. For example, in the sentence “Unemployment declined,” both words would register as negative/dovish even though, as a sentence, the statement indicates an improving labor market, which most would interpret as positive/hawkish. To address this issue, we trained the BERT and the XLNet models to analyze statements on a sentence-by-sentence basis. BERT and XLNet Bidirectional Encoder Representations from Transformers, or BERT, is a language representation model that uses a bidirectional rather than a unidirectional encoder for better fine-tuning. Indeed, with its bidirectional encoder, we find BERT outperforms OpenAI GPT, which uses a unidirectional encoder. XLNet, meanwhile, is a generalized autoregressive pretraining method that also features a bidirectional encoder but not masked-language modeling (MLM), which feeds BERT a sentence and optimizes the weights inside BERT to output the same sentence on the other side. Before we feed BERT the input sentence, however, we mask a few tokens in MLM. XLNet avoids this, which makes it something of an improved version of BERT. To train these two models, we divided the FOMC statements into training datasets, test datasets, and out-of-sample datasets. We extracted training and test datasets from February 2017 to December 2020 and out-of-sample datasets from June 2021 to July 2022. We then applied two different labeling techniques: manual and automatic. Using automatic labeling, we gave sentences a value of 1, 0, or none based on whether they indicated an increase, decrease, or no change in the federal funds rate, respectively. Using manual labeling, we categorized sentences as 1, 0, or none depending on if they were hawkish, dovish, or neutral, respectively. We then ran the following formula to generate a sentiment score: Sentiment Score = (Positive Sentences – Negative Sentences) / (Positive Sentences + Negative Sentences) Performance of AI Models BERT(Automatic Labeling) XLNet(Automatic Labeling) BERT(Manual Labeling) XLNet(Manual Labeling) Precision 86.36% 82.14% 84.62% 95.00% Recall 63.33% 76.67% 95.65% 82.61% F-Score 73.08% 79.31% 89.80% 88.37% Predicted Sentiment Score (Automatic Labeling) Predicted Sentiment Score (Manual Labeling) The two charts above demonstrate that manual labeling better captured the recent shift in the FOMC’s stance. Each statement includes hawkish (or dovish) sentences even though the FOMC ended up decreasing (or increasing) the federal funds rate. In that sense, labeling sentence by sentence trains these ML models well. Since ML and AI models tend to be black boxes, how we interpret their results is extremely important. One approach is to apply Local Interpretable Model-Agnostic Explanations (LIME). These apply a simple model to explain a much more complex model. The two figures below show how the XLNet (with manual labeling) interprets sentences from FOMC statements, reading the first sentence as positive/hawkish based on the strengthening labor market and moderately expanding economic activities and the second sentence as negative/dovish since consumer prices declined and inflation ran below 2%. The model’s judgment on both economic activity and inflationary pressure appears appropriate. LIME Results: FOMC Strong Economy Sentence LIME Results: FOMC Weak Inflationary Pressure Sentence Conclusion By extracting sentences from the statements and then evaluating their sentiment, these techniques gave us a better grasp of the FOMC’s policy perspective and have the potential to make central bank communications easier to interpret and understand in the future. But was there a connection between changes in the sentiment of FOMC statements and US stock market returns? The chart below plots the cumulative returns of the Dow Jones Industrial Average (DJIA) and NASDAQ Composite (IXIC) together with FOMC sentiment scores. We investigated correlation, tracking error, excess return, and excess volatility in order to detect regime changes of equity returns, which are measured by the vertical axis. Equity Returns and FOMC Statement Sensitivity

For the past three years, I’ve written a monthly column for Canadian MoneySaver called “Portfolio Confidential” that answers various investor questions. Some of these I receive from emails, but most come from another source: I offer readers a free 30-minute confidential Zoom chat in which I provide an independent, unbiased perspective on their financial situations with no sales pitch. In exchange, I get to use their anonymized questions in future columns. After 30 columns, I have a pretty good snapshot of the real-world issues that are front of mind among today’s investors and their advisers. I’ll share the five most common client concerns and how I addressed them in the hope that readers will find some value. To be sure, my answers are not definitive, so I would be delighted to hear your feedback as to how I could improve my responses. 1. The Allure of the “Panic Sell” “I know I shouldn’t panic right now about what is happening to my investments. I told my adviser I would invest in index funds that I would not touch for over 10 years. But isn’t this time different with the war in Ukraine causing so much uncertainty?” Stock markets tend to go up over time. The average annual total return for the US market — the S&P 500 index — is somewhere around 8% to 10% for most rolling periods over 10 years. This is why so many investors are drawn to equity markets, but not even diversification will protect you from unpredictable and extreme volatility. No one can time the market. So don’t try. Instead, consider the two things you do have control over. First, decide whether you want to commit to being a stock market investor for the long term — 10 years is a long time. Second, use a disciplined approach and invest the same amount of money on a regular basis, monthly, for example, so that you don’t let your emotions influence your investing behavior. 2. Falling in Love with a Stock “I have a portfolio of about US$1 million. Last year I bought 800 shares of Zoom for approximately US$50,000. The rest of my portfolio is down about 5%, but Zoom has zoomed and is now worth $170K, or nearly 20% of my whole stock portfolio. What should I do now?” Founded in 2011, Zoom Video Communications, Inc., is a Silicon Valley-based firm that offers video, telephone, and online chat capabilities on a peer-to-peer, cloud-based software platform. Amid the pandemic and its ubiquitous work-from-home (WFH) arrangements, Zoom captured the zeitgeist of the COVID-19 era, and its stock soared to unprecedented heights. Full disclosure: I love Zoom! I have been using it daily since the lockdown. But even though I love it as an amazing communications tool, along with millions of other people, this doesn’t mean it should constitute a fifth of our investment portfolios. One of the most common mistakes investors make is falling in love with a stock and piling a disproportionate amount of money into it. “This company is changing the world!” is among the more common rationales for doing so. But the trouble is anything can happen at any time to any company, including Zoom. So, what to do? My advice is to re-balance the position in order to maintain a sensibly diversified portfolio. Sell half right away and then half again on a pre-determined date in the near future. The goal is to pare back to the original 5% weighting in an orderly fashion so as not to be driven by emotion. As fun as it is to have 20% in a high-flying momentum stock, all stocks eventually come back down to earth. For the sake of risk management, we have to recognize that a 20% position in any one stock is a form of speculation not investing. Finally, if you just can’t bear to sell, move your Zoom position to a completely separate account and label it “speculative” — look at it as a stand-alone holding that could win big or lose big. This way, you will no longer be skewing the performance return or strategy of your “normal” investment portfolio. 3. The “No Rhyme or Reason” Mutual Fund Strategy “My portfolio has taken quite a beating since December 2021. My investment adviser — he is with Portfolio Strategies and Solutions (pseudonym) — has offered no advice over the last eight months, which I find unacceptable. Please let me know if you would be interested in giving me an unbiased perspective regarding my next moves to correct and rebalance my investments. My wife and I are in our 60s, and our objective is quite straightforward: growth for the long term so that we can draw around 4% per year, which combined with our pensions will support our lifestyle.” First, let me say I am appalled that you have not received any communication from your adviser in the last eight months, particularly amid the steepest drop in market values in the last 50 years! This is obviously unacceptable. Second, I find it quite ironic that a firm called Portfolio Strategies and Solutions would continue to associate with an adviser who clearly hasn’t offered you any type of portfolio strategy. Why do I say this? As you explained, your investment objective is quite straightforward, yet your portfolio holdings are unnecessarily complicated. There are too many different mutual funds and too much variation in the percentage weightings for each fund. I can’t think of a reason for this other than your adviser having a self-serving interest in selling a bunch of funds with higher management expense ratios (MERs) so that he can earn as much as possible on top of his fee-for-service. For confidentiality reasons, I cropped the adviser’s name from the statement excerpted above. When I googled his name, I found his main qualifications are a high school diploma and a mutual funds sales license. Sadly, the lack of a CFA charter or other appropriate education is still all too common in

How will technology influence women’s wealth in the years ahead? I participated in a dynamic panel discussion on VoiceAmerica Business Channel: Technology Revolution Radio, hosted by Bonnie D. Graham on 20 July, that addressed this very question. My fellow panelists were three women leaders who are all passionate about the future of women’s wealth and technology: April Rudin, founder and president of The Rudin Group, which designs bespoke marketing campaigns for some of the world’s leading wealth-management firms, fintechs, and family offices; Eva Grønbjerg Christensen, founder and CEO of the tech start-up Sustainify, which provides sustainability data to investors; and Iris ten Teije, co-founder of Koia, a platform on which anyone can buy, sell, and trade fractions of such iconic assets as watches, whisky, and Pokémon cards using non-fungible tokens (NFTs). Our conversation identified and explored three key themes. What follows are lightly edited excerpts from our discussion, reproduced with Graham’s permission. 1. The Shift from a Male-Centric to a Female-Centric Investing Environment According to the Financial Times, “Globally, the investable assets of wealthy individuals is expected to double in almost every part of the world by 2030.” And we know that wealth transfer may be the single most important demographic trend around finance and investing in history. Critically, the bulk of this wealth transfer is going to women. April Rudin: Women surpass men, standing strong at 51% of the population. Widows and other segments of women will rise as the main contact for firms and funds seeking to onboard new assets. Women continue to dominate the control of family private wealth as their husbands’ life expectancies are shorter and financial advisers are unfamiliar with how to serve and market to this growing segment. Further, women will continue their dominance in creating wealth themselves through their own entrepreneurial ventures, other investments, etc. And financial services firms need to know how to serve and appeal to women whose wants/needs are different along with their success measures. Barbara Stewart, CFA: Because women live longer, often women, older women, are surviving and controlling the investment assets. They may find and work with an investment adviser directly, but sometimes they won’t. And in that case, it seems likely that managing those senior assets will fall to the children of that couple. And most of the time that will mean the daughters. I wrote about this phenomenon in my Enterprising Investor post “Daughters: The Rising Wealth Influencers“: “’Women now outpace men in hours spent caregiving for their aging parents and their in-laws: Women provide nearly two-thirds of elder care, and daughters are 28 percent more likely to care for a parent than sons. . . . Investing will become a larger and larger part of elder care. Daughter Care is not only a real thing; it is a growing thing. Daughters will be responsible for managing investment portfolios.” Iris ten Teije: Changing money culture will cause more women to invest. The culture around talking about money is changing rapidly. With finfluencers and new platforms coming up, it’s becoming increasingly normal to discuss salaries and investments. This increased level of transparency is giving everyone, but especially women, the confidence they need to get started investing, to have the courage to ask for a raise, etc. Eva Grønbjerg Christensen: We are seeing a power shift due to a money shift and a wealth shift. With the increase in women’s knowledge about finance, we’ll also see an increase in power. Knowledge is power, and when we watch the wealth grow among women, we’ll see growth in financial products and solutions designed for women. Also, women will pave the way for other minority investors. Technology products are increasing opportunities to share and obtain knowledge, providing access to financial products, and enabling a shift in power and opening doors. 2. Technological Tools Are Propelling More Equal Wealth Distribution From the 2022 Rich Thinking Quantitative Survey, an amazing 64% of 18-to-29-year-old US women either already invest or plan to start within the year. That’s higher than any other age group. Of the women in this demographic who are already investors, 96% use online platforms.  Stewart: New female-friendly concepts and investing spaces have emerged. Women — and their daughters — can visit financial education sites, platforms, and communities where they can communicate, benefit from other people’s knowledge, share information, and be inspired. This space will continue to evolve at an exponential rate. ten Teije: Investing based on values, interest, and passion will grow. Thanks to technology tools, it’s easier than ever to invest in what you’re passionate about or care about, be they collectibles, thematic ETFs focused on, for example, climate or women-led companies, or start-ups. This positive trend will get more women engaged in the world of investing. Grønbjerg Christensen: Sustainable investing will be one way we narrow the gender wealth gap. Currently, we see that sustainable investing is going from niche to mainstream — pushed by regulations, climate awareness, social and equality issues, and many new investors in the market. Because many of these new investors are female or Gen Z and care about more than just profits, we’ll see an increase in investments based on personal values and holistic thinking. Companies and investments are judged on their ability to weather different crises, whether environmental, social, or financial. Here, different technical tools will help propel the change to more equal wealth distribution. This has already started as bottom-up, where online communities and different technology platforms and tools make it easier for underrepresented investors to share knowledge and experiences and access the market without the traditional gatekeepers and financial “experts.” Rudin: Social media will continue to be a “go-to place” for NextGeners for financial literacy information. The NextGeners continue to value their friend’s and community’s knowledge versus that of authority figures like parents and banks. According to the Viacom Disruption Index from 2013, 71% would rather go to the dentist than trust what banks are telling them. And this report was just the tipping point. Since then, there has been

Correlations between world stock markets began to increase in the 1970s. This trend endured for nearly a half century as globalization took hold and defined much of the era. But that all changed when COVID-19 broke out in earnest in February 2020. While tariff disputes had already disrupted supply chains in the years prior, the onset of the global pandemic in early 2020 accelerated the decoupling among global equity markets and transformed their relationship to one another, ushering in what may be a regime change in world finance. Our examination of stock market indices since 2015 reveals one clear takeaway: Every single index’s average correlation with all other indices has fallen. For most, the drop was slight. For instance, the S&P 500’s correlation with all other markets fell from 0.71 from 2015 to 2022 to 0.66 during the January 2022 to December 2023 time frame. But for the Shanghai Stock Exchange Composite Index (SSE) and the Hang Seng (HSI), in Mainland China and Hong Kong SAR, and the RTS, in Russia, the correlations diverged from all other markets over the latter period. 2015 to 2020 February 2020 toDecember 2023 January 2022 toDecember 2023 S&P 500 0.71 0.70 0.66 FTSE 250 0.69 0.71 0.60 DAX 0.68 0.71 0.64 CAC 40 0.68 0.69 0.62 NKX 0.62 0.63 0.56 HSI 0.56 0.35 0.22 SSE 0.42 0.35 0.16 TSX 0.70 0.73 0.65 RTS 0.57 0.42 0.10 BVP 0.65 0.68 0.63 KOSPI 0.54 0.59 0.37 SNX 0.56 0.63 0.50 IPC 0.57 0.65 0.56 AOR 0.64 0.71 0.63 The SSE and the HSI averaged, respectively, a 0.42 and a 0.56 correlation with all other indices from 2015 to 2020. But from 2022 to 2023, these same correlations declined to 0.16 and 0.22. The RTS’s average correlation, meanwhile, plunged from 0.57 to 0.10 across the two sample periods. These three indices experienced the largest drops in their co-movements with other global equity indices from 2015 to December 2023.  The following tables show the correlations between the various market indices and their counterparts from 2015 to 2023. In addition to the equity markets mentioned above, our analysis includes the FTSE 250 in the United Kingdom, the DAX in Germany, the CAC 40 in France; the Nikkei (NKX) in Japan, the TSX in Canada; the BVP in Brazil, the KOSPI in South Korea, the SNX in India, the AOR in Australia, and the IPC in Mexico. The average correlation across all pairs is 0.65. Global Markets Correlation Changes2015 to 2020 S&P 500 FTSE 250 DAX CAC 40 NKX HSI SSE TSX RTS BVP KOSPI SNX IPC AOR S&P 500 1.00 FTSE 250 0.85 1.00 DAX 0.82 0.79 1.00 CAC 40 0.78 0.81 0.91 1.00 NKX 0.78 0.73 0.84 0.81 1.00 HSI 0.65 0.55 0.52 0.54 0.54 1.00 SSE 0.51 0.38 0.44 0.37 0.47 0.72 1.00 TSX 0.86 0.85 0.78 0.77 0.67 0.53 0.39 1.00 RTS 0.66 0.61 0.60 0.61 0.51 0.52 0.42 0.71 1.00 BVP 0.77 0.72 0.71 0.69 0.66 0.69 0.48 0.72 0.58 1.00 KOSPI 0.56 0.55 0.52 0.51 0.39 0.54 0.43 0.64 0.71 0.53 1.00 SNX 0.67 0.66 0.58 0.55 0.50 0.55 0.31 0.67 0.36 0.64 0.56 1.00 IPC 0.58 0.67 0.69 0.65 0.50 0.48 0.24 0.66 0.57 0.66 0.58 0.63 1.00 AOR 0.77 0.82 0.75 0.76 0.67 0.43 0.33 0.83 0.54 0.57 0.53 0.68 0.60 1.00 The correlations between all indices from February 2020 to December 2023 appear in the chart below. The values in italics indicate those correlations that decreased relative to their 2015 to 2020 counterparts. The correlations of the SSE, HSI, and RTS to most if not all other indices declined over the 2020 to 2023 sample period. Supply chain disruptions, COVID-19 countermeasures in China, and the sanctions imposed on Russia due to its 2022 invasion of Ukraine could all be potential drivers of this phenomenon. Yet even as geopolitical considerations made Russia more dependent on China over the period, the performance of their equity markets nevertheless diverged from one another. In the United States, the S&P 500’s correlations with the NKX, HSI, SSE, and RTS fell but increased with all the others. Global Markets Correlation ChangesFebruary 2020 to December 2023 S&P 500 FTSE 250 DAX CAC 40 NKX HSI SSE TSX RTS BVP KOSPI SNX IPC AOR S&P 500 1.00 FTSE 250 0.84 1.00 DAX 0.87 0.86 1.00 CAC 40 0.83 0.87 0.93 1.00 NKX 0.75 0.70 0.76 0.73 1.00 HSI 0.33 0.37 0.35 0.36 0.21 1.00 SSE 0.37 0.35 0.31 0.29 0.31 0.63 1.00 TSX 0.91 0.87 0.89 0.88 0.70 0.39 0.38 1.00 RTS 0.44 0.43 0.50 0.43 0.54 0.29 0.31 0.44 1.00 BVP 0.83 0.80 0.81 0.73 0.78 0.36 0.43 0.80 0.43 1.00 KOSPI 0.65 0.65 0.68 0.62 0.62 0.22 0.24 0.76 0.36 0.65 1.00 SNX 0.70 0.77 0.67 0.66 0.65 0.30 0.35 0.77 0.46 0.67 0.74 1.00 IPC 0.77 0.78 0.81 0.82 0.66 0.27 0.31 0.85 0.32 0.74 0.69 0.67 1.00 AOR 0.84 0.92 0.81 0.82 0.73 0.43 0.30 0.90 0.43 0.81 0.73 0.79 0.78 1.00 Our final table displays the correlations between all indices from January 2022 to December 2023, again with the values in italics signifying the correlations that dropped compared with the 2015 to 2020 period. Those in bold italics are those correlations that went negative. Here, too, the HSE and SSI correlations with nearly all other markets tailed off, particularly with both the KOSPI and SNX. This is a major pivot from the pre-pandemic years and may reflect greater competition amid supply chain disruptions and reorganizations. Global Markets Correlation ChangesJanuary 2022 to December 2023 S&P 500 FTSE 250 DAX CAC 40 NKX HSI SSE TSX RTS BVP KOSPI SNX IPC AOR S&P 500 1.00 FTSE 250 0.78 1.00 DAX 0.87 0.85 1.00 CAC 40 0.86 0.87 0.95 1.00 NKX 0.86 0.59 0.70 0.65 1.00 HSI 0.21 0.28 0.27 0.24 0.02 1.00 SSE 0.18 0.21 0.17 0.17 0.16 0.66 1.00 TSX 0.89 0.79 0.87 0.88 0.68 0.28 0.18 1.00 RTS 0.14 0.05 0.17 0.06 0.29 0.18 0.15 0.02 1.00 BVP 0.84 0.80 0.82 0.76 0.83 0.21 0.26 0.80 0.17 1.00 KOSPI

The Puzzle of Sustainable Investment: What Smart Investors Should Know. 2024. Lukasz Pomorski. Wiley. In The Puzzle of Sustainable Investment, Lukasz Pomorski, senior vice president at Acadian Asset Management and an adjunct professor at Columbia University, presents a collection of important tools for the sustainable investor to navigate the fiercely contested subject of environmental, social, and governance (ESG) investing. He analyzes the channels through which sustainability shapes corporate decisions and discusses many practical examples and case studies that provide a succinct summary of the industry’s key issues. Pomorski adeptly discusses the good, the bad, and the unknown of sustainable investing while acknowledging that the answer to some of the critical questions is the dreaded “it depends.” Based on a simple thought experiment, Pomorski correctly concludes that ESG characteristics are a source of information and some of this information may be helpful in pursuing financial goals irrespective of how investors feel about ESG investing more broadly. Therefore, by a simple leap of logic, the ESG-aware portfolio will exhibit a higher Sharpe ratio than the ESG-unaware portfolio. ESG integration (incorporating ESG considerations into one’s views of risk and return) is a good thing since it may help investors build better portfolios. Since ESG investors also build constraints into their investment process, however, it may lead to the formation of a “sin premium” or relatively higher expected returns from holding securities with poor ESG scores, such as tobacco or fossil fuel companies. These higher returns are not a compensation for risk or for poorer quality of future cash flows but, rather, a direct consequence of investors’ tastes and preferences. Pomorski displays an ESG-efficient frontier of a carbon-aware portfolio that shows reducing carbon to 30% of benchmark emissions reduces financial attractiveness by close to 5% and a reduction to 10% of benchmark emissions costs about 15%. This chart exposes the risk–return trade-off in reducing carbon intensity and financial attractiveness in a portfolio. Pomorski references a new paper[1] that analyzed thousands of stocks traded in 48 different countries and assessed ESG ratings from seven different providers. Based on the principles of market efficiency, he supports the report’s conclusion that there is very little evidence that ESG ratings are related to global stock returns. Later in the book, he discusses how any outperformance will likely need to arise from investing in companies that exhibit improvement in financially material ESG factors. Pomorski supports the claim, however, that ESG ratings may provide insights about the risk of the underlying companies. For example, a portfolio tilted toward stocks with strong ESG ratings will hold relatively safer stocks than those in an otherwise similar portfolio instead tilted toward poor ESG ratings. Three case studies, involving Engine No. 1 and ExxonMobil, green bonds, and building net-zero portfolios, are discussed to illustrate positive impact through investment portfolios. As a real estate finance practitioner, I found the green bond case study to be most insightful. Since ESG-motivated investors are willing to pay a premium for labeled bonds (green bonds), this “greenium” means that investors are willing to provide the company with cheaper capital, provided that the use of proceeds is for green projects. Green bonds have impact through the financing cost channel, whereas in the ExxonMobil example, the impact comes through the control channel. Finally, Pomorski explores how shorting and commodity futures can be used as part of the toolkit in an investor’s ESG integration process. In summary, The Puzzle of Sustainable Investment is a thoughtful and practical book with rigorous research backing much of Pomorski’s conclusions. Since Milton Friedman articulated his shareholder-primacy theory in 1970, we have observed an evolution of how we think about the role of business and the corporation in American society. Although global sustainable flows turned negative for the first time on record in the fourth quarter of 2023, the most pessimistic assessments of sustainable assets indicate that at least $3 trillion is currently invested in sustainable strategies. [1]R. Alves, P. Krueger, and M. A. van Dijk, “Drawing Up the Bill: Is ESG Related to Stock Returns around the World?,” working paper, University of Geneva (2023). source

The benefits of factor investing as stand-alone strategies are well documented. Less well known is the positive impact factor strategies can have when they are added to institutional investors’ completion portfolios. By employing factor strategies at the plan level, asset owners can fine-tune their allocations to suit their specific objectives in an efficient and cost-effective manner. In this post, I will discuss how factor strategies can be effectively utilized within completion portfolios to enhance plan performance and risk control. The symbiotic nature of these two commonly pursued goals in institutional portfolios begs the question, “Why wouldn’t you include factor strategies in your completion portfolio toolkit?” Review: Factor Strategies and Completion Portfolios Factor strategies target specific investment attributes like value, size, momentum, low volatility, low investment, and high profitability. Attributes such as these are the primary drivers of asset returns and have historically demonstrated a persistent risk premium. An integral part of modern portfolio management, factor strategies offer investors a systematic approach to capturing specific risk premia and enhancing portfolio diversification. Now let’s look at a completion portfolio. It is a strategic program designed to complement existing holdings and fill in any gaps or inefficiencies within an asset owner’s overall portfolio. These portfolios make supplementary allocations aimed at achieving specific objectives, such as enhancing diversification, managing risk, or capturing additional sources of return. The concept of completion portfolios stems from the recognition that traditional asset allocations may not fully capture all available investment opportunities or adequately address specific investment goals. Completion portfolios are tailored to address these shortcomings by incorporating assets or strategies that can provide complementary benefits to existing portfolio holdings. Completion portfolios can take various forms, depending on asset owners’ objectives and risk tolerance. They may include different asset classes and strategies that offer unique risk-return profiles and low correlations to traditional stocks and bonds. One common application of completion portfolios within the context of institutional asset management is where investors seek to optimize portfolio efficiency and achieve specific performance benchmarks. In this way, completion portfolios may be employed to fine-tune asset allocations, adjust risk exposures, or exploit market inefficiencies, thereby enhancing overall portfolio performance and risk-adjusted returns. Clearly, completion portfolios play an important role for asset owners by providing them with a flexible and dynamic framework to address evolving investment objectives and market conditions. Whether used to enhance diversification, manage risk, or capture additional sources of return, completion portfolios offer a strategic tool for asset owners seeking to optimize their overall investment portfolios and achieve their long-term investment goals. The Benefits of Adding Factor Strategies There are several ways in which factor strategies can help enhance the building of completion portfolios. The first is diversification enhancement. Factor strategies offer an opportunity to diversify a completion portfolio beyond traditional sector and geographic approaches to investing. By allocating to factors with low correlation to existing holdings, asset owners can potentially reduce overall portfolio risk and enhance risk-adjusted returns. The second benefit of utilizing factor strategies in completion portfolios is risk management. Certain factors, such as low volatility, have defensive characteristics that can help mitigate downside risk during market downturns. Incorporating these factors in a completion portfolio can provide additional portfolio stability during periods of heightened market volatility. Performance enhancement is another potential benefit of using factor strategies in completion portfolios. Factor strategies can generate excess returns over broad market indices over the long term. By tilting toward factors that have historically delivered superior risk-adjusted returns, completion portfolios can capture these additional sources of return and potentially outperform the overall market. A major role of factor strategies in completion portfolios is that they can provide targeted exposure. Completion portfolios can be customized to target specific factors based on asset owners’ objectives and risk tolerances. Whether seeking to capitalize on value opportunities or capitalize on stock momentum, factor strategies provide a systematic framework for achieving targeted exposures within the portfolio. Factor strategies can also imbue completion portfolios with enhanced adaptability. Asset owners can target factor exposures dynamically based on changing market conditions, economic outlook, or investment goals. This adaptability is particularly valuable in completion portfolios, where the goal is to calibrate allocations to optimize risk-return characteristics. Conclusion Factor investing is one of the pillars of modern investing. The benefits of standalone factor strategies are well known, and there is a growing recognition of their value in completion portfolios. In this post, I highlighted the varied benefits that factor investing can bring to completion portfolios including diversification enhancement, risk management, performance enhancement, targeted exposure, and adaptability. source