CFA Institute

Buffett’s Early Investments: A New Investigation into the Decades When Warren Buffett Earned His Best Returns. 2024. Brett Gardner. Harriman House. I became aware of Warren Buffett in the early 1980s when a graduate school classmate encouraged me to read John Train’s The Money Masters. At the time, Buffett was unknown to the public and even to many in the business community. Some four decades later, perhaps more has been written about him than any other businessperson or investor. The writings include biographies by journalists, friends, and former employees. There have been books detailing his investment strategies and words of wisdom, as well as magazine and academic journal articles. The question is, what can Brett Gardner offer about Buffett’s investments that has not been written before? Fortunately, Gardner, a value investor and analyst at Discerene Group, a private investment partnership, has taken a different path from the authors of other investment books. Rather than scour through Buffett’s shareholders’ letters at Berkshire Hathaway, he digs into Buffett’s early, pre-Berkshire investments. The result is a fresh look into the origins of Buffett’s investment approach. We have previously read about Buffett’s transformation from a value investor who picked investments simply because they were cheap, “cigar butt” investing, to an investor who sought out great businesses at fair prices. Gardner takes us through this journey by examining 10 stocks from Buffett’s early investment years. Of the 10, only American Express and Disney are household names. Most others are likely little known to even the most devoted Buffett followers. The book is divided into the Pre-Partnership Years and the Partnership Years, with each section highlighting five stocks. In attempting to provide a deeper understanding of Buffett’s methods, Gardner takes a unique approach to glimpsing into Buffett’s mind. Rather than simply looking for clues in his words, Gardner uses financial information available to Buffett when he made the investments. Three criteria drove the author’s choice of the 10 investments he selected. First, could he obtain the relevant financial documents, such as Moody’s Industrial Manual and company annual reports? Second, he wanted to add value by not rehashing investments that had been widely written about. Finally, how interesting was the story behind the investment? Did its price embed misconceptions that he could correct? Gardner begins with Buffett’s 1950 purchase of Marshall-Wells Company, North America’s largest hardware wholesaler. Going back in time, Gardner pulls information from Moody’s manuals and tries to discern the value in Marshall-Wells that Buffett might have perceived. Gardner asks, “Why did Buffett invest in the company?” In his early years as an investor, Buffett focused on Benjamin Graham’s philosophy of seeking cheap stocks. Marshall-Wells’s valuation metrics, e.g., P/E and EV/EBIT, which are presented in the book, likely piqued Buffett’s interest in Marshall-Wells, and the fact that its hard assets offered downside protection and a margin of safety. Although the company would struggle and eventually be acquired, Gardner points out that investors who bought the stock at Buffett’s purchase price likely earned respectable returns. As the author moves through the Pre-Partnership Years, we get a glimpse into the model that Buffett would follow in transforming Berkshire Hathaway from a New England textile firm into one of America’s largest conglomerates. The lesson comes from Micky Newman, the son of Benjamin Graham’s partner Jerome Newman. The 1954 purchase of shares in Philadelphia and Reading Railroad (P&R) was the beginning of a model Buffett would follow of using cash from a moribund company to acquire profitable businesses. Newman, who later became P&R’s president, used the cash from liquidating inventories at P&R for such acquisitions. He preferred businesses where management would stay on to run the subsidiaries, a hallmark of Buffett’s acquisitions with Berkshire. One of the more interesting investments is Buffett’s purchase of American Express shares in 1964. The chapter begins with an entertaining look at the famous Salad Oil Scandal, which provided an opportunity to purchase American Express at a compelling price. Although Gardner does not have much information about Buffett’s thinking, he attempts to piece together Buffett’s logic in acquiring American Express. The biggest concern for investors was the salad oil liability. Going beyond simply purchasing the stock because it was cheap, Gardner points out, Buffett recognized the importance of American Express’s reputation. To determine if the scandal impacted American Express’s core businesses of Travelers Cheques and credit cards, he surveyed local restaurants to gauge credit card usage. Buffett even contacted American Express CEO Clark to praise him for honoring the subsidiary’s liabilities rather than using bankruptcy to divest the problem. This appears to be the beginning of Buffett’s evolution from a passive investor to an activist shareholder. In Buffett’s Early Investments, Gardner dispels the myth that Buffett succeeded simply by sitting in a room with Moody’s Industrial Manuals. Buffett’s analysis went well beyond the financials. His purchase of Studebaker presents an example of his hands-on approach to investing. Studebaker, an automobile company successful enough to be included in the Dow in 1916, had fallen into hard times. In 1965, the company’s single-digit price-to-earnings ratio and tax-loss carryforward made the stock intriguing to Buffett. At the time, Studebaker had 10 divisions, but Buffett and Sandy Gottesman, founder of First Manhattan, believed that the STP motor oil additive was the most important. To estimate the demand for STP, Buffett traveled to Kansas City to count railcars of STP. In another example of Buffett’s exhaustive leg work, he and Charlie Munger used family visits to Disneyland to evaluate the profitability of rides. The book is not just about Buffett’s successes but also looks at less successful ventures such as Cleveland Worsted Mills Co. and retailer Hochschild, Kohn & Co., which produced lessons that shaped Buffett’s investment philosophy. Complementing his meticulous analysis, Gardner writes in a fluid and engaging style that makes Buffett’s Early Investments an enjoyable read, even for those who may not wish to delve deeply into Buffett’s strategies. His insights into companies like Disney make his historical overviews well worth the read. Examining Buffett’s early

Market risk is the potential for losses in securities due to fluctuations in market factors like interest rates, currency values, FX/commodity spot rates, and equity prices. These risks are inherent in all traded securities, from corporate bonds to commodities. Each type of security may face multiple risks simultaneously, making market risk a crucial consideration for investors and financial institutions. Compounding these risks is model risk, which refers to the risk inherent with the development and usage of a model to determine financial outputs and decision making. An inefficient or incorrect modelling technique can sometimes lead to drastic repercussions for the firm. Understanding and managing this risk is therefore essential for making informed financial decisions and safeguarding against potential losses. More on Market Risk Various risk factors in the security’s structure determine the type and extent of the market risk it carries. The most widely studied and observed market risk types include interest rate risk, credit risk, foreign exchange risk, equity risk, and commodity risk. A single security can exhibit just one or more of these risks. A corporate bond, for example, exhibits not just credit risk but also interest rate risk, and if it is denominated in a foreign currency, it also carries FX risk. Broadly, we can think of market risk as the fluctuation in the value of a security due to the market-related risk factors such as interest rates and equity price movements. However, it has far-reaching impacts since these security valuations are utilized to make more decisions such as investments, regulatory compliance, and portfolio optimization, among others, depending on the profile of the company or risk manager. More on Model Risk A model has various components, namely the inputs/data, assumptions, logic/process, and final output. An inefficient or incorrect modelling technique along any of these process components can sometimes lead to drastic repercussions for the firm. The SR11-7 regulatory framework defines how model risk should be managed by banks, and it is relevant for other financial firms. Market Risk and Model Risk: Dependencies Although market and model risk represent different dimensions of riskiness, they are interweaved in a sequential way. This is evident since quantification or determination of market risk by a firm and all resulting decisions are usually represented as an output of financial models. Whenever corporate managers are focused on managing market risk proficiently, the process involves managing model risk equally efficiently. Thus, it makes sense to view these two risks in conjunction with each other when estimating costs, time, and resources to manage a firm’s investment -or market-related risks. An example would be the use of a financial model to determine the value of a securities portfolio which in turn would determine a buy/sell decision. If the valuation model makes incorrect assumptions by not considering diversification/hedging effects in the portfolio, this might lead to incorrect decision making which may lead to not just financial impact for the firm but also reputational and regulatory risks. Model risk is a crucial risk that needs to be managed effectively by financial institutions, not just to ensure sound market risk management decisions or comply with regulatory requirements but also to survive and thrive. In cases in which firms use third-party vendors for pricing and valuations, model risk is compounded because most vendors also use models to determine their numbers. In such cases, clients must conduct due diligence to ensure third-party vendor models are validated and/or audited. Regulatory Use Case The Fundamental Review of Trading Book (FRTB) is a market risk regulatory framework with a lot of quantitative techniques enlisted by the regulator to quantify market risk carried on banks’ trading books in the form of capital charges. One crucial change in this regulatory framework is a shift from existing value at risk (VaR) based techniques to expected shortfall-based market risk metrics calculations. This shift requires modifying existing market risk models or in some cases rebuilding these from scratch to efficiently carry out these FRTB customized calculations. This gives rise to a wide amount of model-related risk from new assumptions, input data, modifying codes/software programs, and output metric customization. If FRTB model assumptions are changed, the capital charge numbers may vary considerably. Application of this framework to manage market risk more efficiently introduces extra costs and complexities to manage model risk inherent in new or updated custom models to carry out these FRTB specific calculations. Key Takeaway Risk managers must look at market and model risk through a single lens to see the complete picture of their market-related investment and trading risks, as well as management costs, complexities, time, and regulatory requirements. References [1] https://www.bis.org/bcbs/publ/d457.htm [2] https://www.federalreserve.gov/supervisionreg/srletters/sr1107.htm source

Risk is not simply a matter of volatility. In his new video series, How to Think About Risk, Howard Marks — Co-Chairman and Co-Founder of Oaktree Capital Management — delves into the intricacies of risk management and how investors should approach thinking about risk.  Marks emphasizes the importance of understanding risk as the probability of loss and mastering the art of asymmetric risk-taking, where the potential upside outweighs the downside. Below, with the help of our Artificial Intelligence (AI) tools, we summarize key lessons from Marks’s series to help investors sharpen their approach to risk. Risk and Volatility Are Not Synonyms One of Marks’s central arguments is that risk is frequently misunderstood. Many academic models, particularly from the University of Chicago in the 1960s, defined risk as volatility because it was easily quantifiable. However, Marks contends that this is not the true measure of risk. Instead, risk is the probability of loss. Volatility can be a symptom of risk but is not synonymous with it. Investors should focus on potential losses and how to mitigate them, not just fluctuations in prices. Asymmetry in Investing Is Key A major theme in Marks’s philosophy is asymmetry — the ability to achieve gains during market upswings while minimizing losses during downturns. The goal for investors is to maximize upside potential while limiting downside exposure, achieving what Marks calls “asymmetry.” This concept is critical for those looking to outperform the market in the long term without taking on excessive risk. Risk Is Unquantifiable Marks explains that risk cannot be quantified in advance, as the future is inherently uncertain. In fact, even after an investment outcome is known, it can still be difficult to determine whether that investment was risky. For instance, a profitable investment could have been extremely risky, and success could simply be attributed to luck. Therefore, investors must rely on their judgment and understanding of the underlying factors influencing an investment’s risk profile, rather than focusing on historical data alone. There Are Many Forms of Risk While the risk of loss is crucial, other forms of risk should not be overlooked. These include the risk of missed opportunities, taking too little risk, and being forced to exit investments at the bottom. Marks stresses that investors should be aware of the potential risks not only in terms of losses but also in missed upside potential. Furthermore, one of the greatest risks is being forced out of the market during downturns, which can result in missing the eventual recovery. Risk Stems from Ignorance of the Future Drawing from Peter Bernstein and philosopher G.K. Chesterton, Marks highlights the unpredictable nature of the future. Risk arises from our ignorance of what’s going to happen. This means that while investors can anticipate a range of possible outcomes, they must acknowledge that unknown variables can shift the expected range. Marks also cites the concept of “tail events,” where rare and extreme occurrences — like financial crises — can have an outsized impact on investments. The Perversity of Risk Risk is often counterintuitive. To illustrate this point, Marks shared an example of how the removal of traffic signs in a Dutch town paradoxically reduced accidents because drivers became more cautious. Similarly, in investing, when markets appear safe, people tend to take greater risks, often leading to adverse outcomes. Risk tends to be highest when it seems lowest, as overconfidence can push investors to make poor decisions, like overpaying for high-quality assets. Risk Is Not a Function of Asset Quality Contrary to common belief, risk is not necessarily tied to the quality of an asset. High-quality assets can become risky if their prices are bid up to unsustainable levels, while low-quality assets can be safe if they are priced low enough. Marks stresses that what you pay for an asset is more important than the asset itself. Investing success is less about finding the best companies and more about paying the right price for any asset, even if it’s of lower quality. Risk and Return Are Not Always Correlated Marks challenges the conventional wisdom that higher risk leads to higher returns. Riskier assets do not automatically produce better returns. Instead, the perception of higher returns is what induces investors to take on risk, but there is no guarantee that these returns will be realized. Therefore, investors must be cautious about assuming that taking on more risk will lead to higher profits. It’s critical to weigh the possible outcomes and assess whether the potential return justifies the risk. Risk Is Inevitable Marks concludes by reiterating that risk is an unavoidable part of investing. The key is not to avoid risk but to manage and control it intelligently. This means assessing risk constantly, being prepared for unexpected events, and ensuring that the potential upside outweighs the downside. Investors who understand this and adopt asymmetric strategies will position themselves for long-term success. Conclusion Howard Marks’ approach to risk emphasizes the importance of understanding risk as the probability of loss, not volatility, and managing it through careful judgment and strategic thinking. Investors who grasp these concepts can not only minimize their losses during market downturns but also maximize their gains in favorable conditions, achieving the highly sought-after asymmetry. source

Introduction Much of the crypto world is, by definition, cryptic and difficult to understand. But two crypto trends are crystal clear: Both talent and money are flooding into the digital currency market. Almost every day brings a fresh announcement of software developers from Google or financiers from JPMorgan joining crypto start-ups that are about to revolutionize something. Indeed, while the total market capitalization of cryptocurrencies has fallen from its previous heights, it is still above the $2 trillion threshold. That’s the equivalent in value of the entire German stock market, which includes such blue-chip companies as Siemens, BMW, and Volkswagen. It is as easy to invest in crypto today as it is in equities, but what is actually being bought is not as clear. When investors purchase Shiba Inu — a token with a $15 billion market capitalization and a Shiba Inu hunting dog mascot — SHIB tokens are deposited into their digital wallets. But what do they really own? And what drives SHIB’s performance? Theoretically, the more popular the token, the higher the price. But does that relationship hold up in practice? Let’s investigate. Tokens vs. Coins Before diving in, we first need to define some basic crypto terminology: A token is a smart contract based on a blockchain, and a crypto coin is the native token of a particular blockchain. For example, ETH is the coin of the Ethereum blockchain, but SHIB is a token based on Ethereum. While all coins are tokens, not all tokens are coins. The number of tokens has exploded over the last couple of years, and tokens now outnumber coins by a factor of eight. Ethereum and Binance Smart Chain account for a combined 85% or so of the market share of the blockchain infrastructure layer where tokens are bought and sold. This raises the question of whether all of the 1,000 or so coins currently available are necessary. Over the long term, they probably aren’t. Cryptocurrencies: Number of Tokens and Coins Sources: CoinMarketCap, FactorResearch Token Financing Crypto start-ups are financed through equity and tokens. Raising capital via equity means issuing shares that are privately held by angel investors, venture capitalists, and the like. These shares represent an ownership stake that entitles the recipients to dividends and proceeds when the company is sold. Token financing is very different: It gives investors no legal claim to the underlying business. As a consequence, token and equity investing are not really comparable. Naturally, start-ups pursuing token financing need to convince investors there is value to be gained by participating in the token sale. The typical pitch is that the start-up’s product requires the use of tokens. This can create rather complex ecosystems that resemble small economies with their assorted stakeholders: The start-up is the equivalent of the government, the product a stand-in for goods, the users for consumers, and the token for the currency or medium of exchange. Since each token represents a currency, demand and supply should determine its price. Token and coin issuers can influence supply: Bitcoin, for example, limits the total number of tokens to 21 million, and Ethereum has bought back ETH tokens and “burned” them. Since the tokens represent cryptocurrencies, their demand should be influenced by their popularity. What’s the Correlation between Token Price and Token Volume? The relationship between the product of the start-up and the underlying token is not straightforward, however, and is thus hard to evaluate. Stockholders would love to own shares in a booming, revenue-generating business. But token investors have no claim on such cash flows. Worse, token investors face an information deficit since start-ups release little to no financial data on the underlying business. This puts them at a major disadvantage relative to equity investors. The best way for token investors to understand the value of their holding is to interpret the change in token volume as a proxy for the demand of the associated product. The more popular the product, the higher the demand for the token, which should reflect an increasing volume of the token on the exchange. But that relationship doesn’t hold up under scrutiny. The rolling correlation between changes in token volume and token price across all tokens between 2014 and 2022, on both a monthly and annual basis, is close to zero. This indicates that there is no positive relationship between the business of the start-up and the price of its token. Token Price to Token Volume Correlations Source: FactorResearch But what about the correlation between token volume and the price for all tokens? The crypto space has its share of bad actors, and some token issuers may be more interested in fleecing underinformed investors than in building long-term businesses. So, what if we limit our universe to only the most successful tokens by market capitalization: the top 1,000, the top 100, the top 50, and the top 10? The last of these categories has a combined market cap of approximately $100 billion and includes Chainlink and Uniswap. These tokens are associated with products that have some of the largest user bases in the crypto community. If they were normal companies, their equity would be quite valuable. Again, the correlation between volume and price is negligible no matter how it’s measured. So, perhaps product and token have no bearing on one another in the crypto space. But if product utility doesn’t drive token performance, what does? The obvious answer is speculation. In cases like Shiba Inu, this is pretty obvious. SHIB is a meme token with no underlying product. At best, it is a gamble on other investors piling in and driving up the price. This represents speculation in its purest form. Investors are simply playing a game of musical chairs and betting that they will find a seat before the music stops. Top Tokens Price and Volume Correlations, 2017 to 2022 Source: FactorResearch Axie Infinity provides a good case study of how this dynamic plays out. An online game in which players battle each other to earn tokens called

Consumer and business sentiment affect everything from momentum in stock markets, to elections, to purchasing decisions. But what factors drive consumer and business sentiment? To answer that question, we looked at measures of sentiment — also known as confidence — and their underlying determinants going back to the 1980s. We found that the factors that have historically accurately signaled the direction of sentiment are no longer reliable. We examined the University of Michigan Consumer Sentiment Index (UMCSENT), the Consumer Confidence Index (CCI), and the Business Confidence Index (BCI). We then pulled data on various macro factors. These included unemployment, interest rates (Fed funds rate), inflation, GDP growth, loan delinquency rates, personal savings rates, stock market returns, and labor force participation rates. Next, we regressed each of our consumer and business sentiment measures against each of the macro variables, partitioning the sample by decade. Figure 1 presents the results for our model using UMCSENT as the dependent variable. Figure 2 uses CCI, and Figure 3 uses BCI. In the tables, a “+” symbol denotes that the coefficient in our model was significant and in the correct direction, (i.e., based on historical expectations). An “x” symbol denotes that the coefficient was either insignificant or in the incorrect direction (i.e., not what we have seen historically). Figure 1. University of Michigan Consumer Sentiment Index (UNCSENT) Figure 2. Consumer Confidence Index (CCI) Figure 3. Business Confidence Index (BCI) The first interesting finding is that in our consumer sentiment measures during the 1980s, almost all the variables were significant and in the direction you would expect. GDP growth led to great consumer confidence; greater unemployment led to lower consumer confidence; greater inflation led to less consumer confidence, etc.  But as time went on, our model became less predictive. By the post-COVID period, an increase in GDP did not lead to an increase in consumer sentiment. An increase in unemployment also had no impact on sentiment. In fact, only two variables out of eight had significant power in predicting the direction of consumer sentiment: inflation and the stock market returns. To put some numbers to the coefficients in our model, during the 1980s a one percentage point increase in inflation led to a 3.4-point drop in the Michigan index, and a 1% increase in unemployment led to a 3.6 drop in the Michigan index. Indeed, during the post-COVID period our model has become much more muted. From 2020 forward, a 1 percentage point increase in inflation led to just a 1.1-point drop in the Michigan index, and a 1% increase in unemployment led to just a 2.3 drop in the index. Further, the strength of our model (i.e. the predictive power) has also decreased over time. The Adjusted-R^2 was 0.88 in the 1980s and dropped to 0.72 in the present day.  We see similar results in the BCI model as well but not to the same degree that we see in our consumer sentiment results. What may be the underlying cause of all this? There are likely many factors, but one highlighted by past literature could be partisanship. Individuals have noted that individuals switch their views on the economy and sentiment to a much greater extent in the present day based on who holds political office. The upcoming US presidential election could be one of the underlying factors that we omitted in our study. Whatever the case, unemployment, labor force participation, and GDP growth no longer explain how consumers are feeling about their prospects. The root causes of this phenomenon deserve more careful study. source

Women are reshaping the world of alternative investments, driven by growing wealth, increased financial fluency, and expanding access to new platforms. From healthcare innovations to blockchain-powered opportunities, women are not only investing more but also redefining what success looks like in alts. The future is clear: women are transforming the alternative investment landscape. This post is the second in a two-part series sharing insights about women and alternative investing today through the lens of more than 50 finance industry leaders from around the world. Here, I share some of the key highlights and select quotes, edited for clarity. When we talk about women and alternative investments, everything we talk about is part of a broader context of economics, monetary policy, regulatory environments, politics, and culture. This is especially true for “money culture.” These elements are often interrelated, and they vary considerably by country or region, as illustrated by the following insights. Women’s Wealth Is Growing. So Is Their Need for Financial Fluency The ongoing generational wealth transfer is accelerating, with women poised to play a leading role. Women are living longer, inheriting family assets, and becoming key decision-makers in their financial futures. “Women are breadwinners and earning more for their families while taking greater control of their finances,” emphasized Alicia Syrett, Founder and CEO at Pantegrion Capital and Founder of Madam Chair, New York. Caroline Miller, an independent corporate director based in Montreal, Canada, noted, “Women are transitioning from the high-spend phase of child-rearing to managing aging parents’ finances and sustaining their lifestyle amid rising costs. Their goal isn’t just financial literacy, it’s financial fluency.” This shift is creating a new wave of female investors prepared to navigate complex financial landscapes with confidence and long-term strategies. New Platforms and Tokenization: A Boon for Women Digital transformation has democratized investment opportunities, making alternative investments more accessible than ever. “Fintech tools like robo-advisors and AI-driven platforms simplify the process, offering transparency and ease for retail investors,” expressed Sofia Beckman, Co-Founder and Partner at North House in Stockholm. Diana Biggs, Partner at 1kx in Zug, Switzerland, remarked, “Tokenization is a game-changer — it eliminates traditional barriers like cheque size and gender, allowing smaller investments and expanding access to private equity for women.” Hanna Pri-Zan, Chairperson of Israel Experience in Tel Aviv, highlighted Israel’s progress: “In 2010, only 30% of women had securities accounts. Today, that number has risen to 42%, thanks to improved ease of account setup and digital platforms.” Platforms like Moonfare and Crowdcube are enabling retail investors to enter the private equity space with smaller stakes, breaking the long-standing exclusivity of the ultra-wealthy, noted Callum Woodcock CEO of WineFi in London. Healthcare Is the #1 Sector of Interest HealthTech and FemTech have emerged as leading sectors of interest for female investors, driven by women’s recognition of gaps in healthcare innovation. “Women know how to invest in health and wellness sectors because they understand these needs firsthand,” said Alice Tang, Chief Operating Officer at MA Asset Management in Sydney. Charlotte Beyer, Founder and Principle of Quest Foundation and Founder of Institute for Private Investors in New York, shared her excitement: “I invested in a venture working on a male birth control pill. Women are driving groundbreaking innovations that challenge traditional healthcare norms.” Anna Pearson, Co-Founder of Harriet in Singapore, highlighted the struggles within FemTech: “The market is expected to hit $60 billion by 2027, yet many companies still struggle to secure funding. This highlights the need for greater support in this critical sector.” Investing Culture Cultural dynamics play a significant role in women’s engagement with alternative investments. In male-dominated regions like Switzerland, women can be cautious and won’t invest in what they don’t understand, while men sometimes jump in with overconfidence, observed Peter Wüthrich, Consulting Investor at Gehrenholz GmbH in Zürich. In contrast, Singapore, Malaysia, Indonesia, Taiwan, Australia, and Turkey show greater gender parity, according to my interviewees in the region. Metin Aslantaş, Partner & TMT Country Leader at Deloitte in Istanbul, commented, “Turkish women invest strategically, focusing on less-risky products and staying in the game longer. They often outperform male counterparts in long-term gains.” JoAnn Fan, Venture Capitalist and Board Director at Cheng-An Investment Company in Taipei, added, “Many women here are second-generation family business leaders. They actively enhance their portfolios with private equity and private credit, showing strong engagement with alternative assets.” Regulatory Frameworks and Policies Regulations heavily influence accessibility to alternative investments. Anna Jonsson, CEO, Storebrand Asset Management in Stockholm, noted, “Strict rules around marketing illiquid products require exhaustive onboarding processes, which can deter potential investors, especially women.” In India, Hansi Mehrotra, Founder, The Money Hans in Bengaluru, pointed to innovative solutions like gold bonds: “They offer a 2.5% yield and exposure to gold without the hassle of physical storage, making them attractive for conservative investors.” Meanwhile, in Australia, Anna Shelley, Chief Investment Officer at AMP in Melbourne, highlighted the country’s value-driven culture: “Our superannuation system focuses on low-fee, high-performing products. High-fee fund managers don’t even bother entering this market.” Geopolitics and Alternative Investments Geopolitical factors are influencing investment trends, particularly in Ukraine and Lithuania. Olga Burenko, Vice-President of Investment Banking at Dragon Capital  in Kyiv, shared, “War memorabilia has become an investment in resilience — it tells the story of our brave people and their sacrifices.” Nora Laurinaityte,Green Finance Expert at INVEGA in Vilnius, Lithuania, emphasized the shift in perception: “Defense tech, like drones and radar systems, is no longer seen as macho. These investments are practical tools for resilience and security.” Pension Systems and Tax Policies Pension systems and tax policies vary greatly across regions, shaping women’s investment behaviors. Judith Sanders, Sustainable Investment Strategist at ABN AMRO Bank N.V. in  Amsterdam, observed, “Our pension system reduces the need for aggressive private capital investments, but as social costs rise, this may change.” In Eastern Europe, tax-incentivized retirement plans are encouraging long-term investments. Kateřina Bendová, a financial advisor in Prague, noted, “These plans are great opportunities, but many older generations remain hesitant to embrace them fully.” Lack of

Risks and Returns: Creating Success in Business and Life. 2024. Wilbur Ross. Skyhorse Publishing. President of Faulkner, Dawkins & Sullivan Securities Corporation at age 29. Head of investment banking at Rothschild, Inc. Founder of a private equity firm. Board president of The Dakota cooperative apartment building when resident John Lennon was shot to death there. Vice chairman of the Brooklyn Museum. Chairman of the Smithsonian Institution’s National Board. President of the Japan Society. Trustee of Sarah Lawrence College. US Secretary of Commerce. Wilbur Ross has excelled in a wide variety of leadership roles. His memoir Risks and Returns emphasizes both the qualities that contributed to his success and the lessons he has drawn from his experiences. This highly readable book also contains numerous entertaining anecdotes about, and descriptions of, the lifestyles of the rich and famous. Its educational value to CFA charterholders primarily involves the following topics. Bankruptcy Process Ross earned the soubriquet “King of Bankruptcy” as an investment banker advising parties in negotiations to settle claims of companies that defaulted on their debts — as well as a principal who acquired and revived several such companies. Understanding bankruptcy resolution and turnrounds is essential for investors in lower-rated and distressed bonds, and most commentary on the subject is written by lawyers and securities analysts. That literature is quite informative, but Ross is able to provide a fresh and valuable perspective by drawing on his involvement in such prominent bankruptcies as Drexel Burnham Lambert, Federated Department Stores, Pan Am, Texaco, Trump Taj Mahal, and Trans World Airlines (TWA). Especially noteworthy is how Ross highlights the importance of labor relations in resurrecting failed businesses. He notes that the unprofitable steel subsidiaries of Ling-Temco-Vought (LTV), which WL Ross & Co. acquired, were hampered by the existence of 32 separate job classifications. The rolling mill operators and the maintenance workers were able to perform each other’s jobs. When the mill was running, however, the maintenance team sat around playing pinochle, and when the mill broke down, the operators were idled. Ross induced the plants’ union to reduce the job classifications to five, which greatly increased efficiency. Trade Policy Issues of international trade have important investment implications both at the macroeconomic level and for corporations that export goods, source parts offshore, or compete with imported products. Many readers undoubtedly share this reviewer’s free trade orientation, and they will find their certitude challenged by Ross’s defense of protectionist measures to counter trade barriers erected by other countries. He notes that ardent free trader Lawrence Kudlow supported the Trump administration’s tough stance against China, saying that country’s behavior regarding trade puts it in a category by itself. Cryptocurrency Ross’s skepticism about Bitcoin and its brethren extends beyond the most common criticisms. “Having seen hackers penetrate our most secret federal agencies,” he writes, “the notion that only the pseudonymous founder of cryptocurrency, Satoshi Nakamoto, could figure out the algorithm that creates it seem[s] highly improbable” (p. 336). He also declares unproven the assumption that sufficient demand exists for the supply of Bitcoin that can ultimately be created. It does not detract from the overall excellence of Risks and Returns to surmise that some investment professionals who read it will remain unpersuaded by Ross’s arguments on certain controversial topics. So much the better if his willingness to wade into such issues sparks lively debate. Here is just one example of the potential for productive dialogue that the book creates: Outside the financial sphere, Ross hails former New York mayor Rudolph Giuliani’s success in “drastically reducing crime.” On the contrary, argues the Poynter Institute — a journalism school and research organization judged by public benefit corporation AllSides Technologies to show no political bias toward either the left or the right — independent studies generally have found no link between the Giuliani administration’s tactics and the drop in the crime rate. Violent crime had already been declining in New York for three years before Giuliani took office in 1994, according to US Justice Department records. Moreover, crime fell sharply throughout the country in the 1990s, with San Francisco leading other major cities. Many criminologists attribute the nationwide drop in crime to a complex combination of causes, including a waning of the crack cocaine epidemic. In addition to thought-provoking commentary on a wide variety of topics, Risks and Returns provides fascinating glimpses of financial history. Readers learn about the end of fixed commissions on the New York Stock Exchange and the birth of the loan-to-own strategy. Ross also recounts his early career as an innovative airline analyst. He distinguished his team’s efforts from the competition by using weekly takeoff and landing data to forecast carriers’ monthly earnings, which the Civil Aeronautics Board required them to report. Ross describes his encounters with financial luminaries such as Carl Icahn, Victor Posner, and Paul Singer, as well as confrontations with American communists and Neapolitan organized crime lords. Readers’ interest will never flag as they glean the chunks of wisdom that they can productively apply to investment analysis. source

Private equity (PE) and private debt (PD) are often viewed as distinct investment strategies, but they are increasingly intertwined in today’s financial landscape. The ongoing spat between KKR and Bain Capital over Fuji Soft[1] highlights how PE firms can be hostile toward each other, yet the rise of private credit has led to more collaboration between these entities. This post explores the evolving relationship between PE and PD and the implications for investors, regulators, and the broader economy. Early in 2023, Apollo and Blackstone’s credit arms were among a syndicate of lenders backing the financing of Carlyle’s investment in healthcare technology firm Cotiviti, in what was the largest PD transaction ever. This $5.5 billion loan was slightly larger than the $5 billion lending facility offered by Blackstone to support the take-private of Zendesk by PE firms Hellman & Friedman and Permira the year before.[2] “Club deals” acquired a bad reputation in the aftermath of the global financial crisis (GFC) when several PE groups were accused of collusion.[3] Such deals are back in vogue under a different guise. Access to Inside Information Alternative fund managers, obsessed with controlling the investment process,[4] have come to enjoy playing on both sides of the funding structure. Participating across the capital equation gives these managers access to confidential information without falling foul of the sorts of insider trading rules that hamper public markets. No regulation prevents a financial sponsor from purchasing or selling on a public exchange the bonds of a company it owns before the company publicly discloses price-sensitive information. Likewise, a PE owner can time the sale of stocks in a partially listed company still in its portfolio even as it holds director or observer seats on the company’s board. One example is Blackstone’s incremental disposal of its stake in Hilton between 2013 and 2018. Throughout the disposal period, Blackstone held shares in the hotel operator and was able to access and trade on private information ahead of any public disclosure.[5] Conflicts of Interest and Performance Enhancement Alternative asset managers are engaged across the entire capital structure, acting as equity sponsors, unitranche providers, senior and/or mezzanine lenders, and bondholders. The risk of conflicts of interest has been highlighted, for instance, by academic research on PE firms that invest equity in buyouts while also managing collateralized loan obligations (CLO) funds.[6] Given the development under the same roof of PE and PD entities, why should a private lender not become a loan-to-own provider if it enhances investment returns, irrespective of which LP investors get preferential treatment or whether this is detrimental to other LPs? Private debt instruments also provide fund managers with a minimum guaranteed return on assets. Granted, yields are much lower than those achieved in PE, but with corporate valuations near all-time highs, traditional 20% IRR targets are no longer attainable for buyouts. The high single-digit returns from credit arms offer more stability in revenues – fees and fixed loan margins are more predictable than carried interest on capital gains as those become harder to generate in a market with excess dry powder. A welcome upside to developing multiple relationships with portfolio companies is to hold them hostage during periods of negotiation and maximize fee generation from any corporate event such as a financial restructuring or to amend and extend loans. Private capital fund managers can charge director fees as owners, arrangement and consent fees as lenders, and deal fees as aquirers or sellers. Putting a floor on performance is another way for asset managers, particularly those publicly listed who need to keep shareholders happy, to reduce volatility. Managing volatility — sometimes “laundering” it via accounting trickery[7] — seems to be a key consideration for alternative fund managers keen to differentiate private capital offering from public markets. Secrecy and Opacity Insufficient transparency is inviting speculation about what impact widespread credit defaults during an economic crisis could have on the sector and the broader economy.[8] Rating agencies have pointed out that private credit lenders do not have to report their marks to market the way regulated traditional lenders like banks do.[9] Making disclosure voluntary is a sure way to hide financial distress. Another way is to allow borrowers to defer interest payments and even principal repayments indefinitely.[10] Overleveraged businesses could become zombies, proving unable to ever repay their uncovenanted loans, which would be constantly refinanced and rescheduled until the economy recovers or interest rates start falling again. Of course, this scenario fails to capture the consequences of a prolonged recession or structural market disruption that would doom any prospect of recouping the original equity, or even a substantial portion of the debt. The limited level of public disclosure expected from private capital firms implies that it will become ever more challenging to monitor their behavior. Information asymmetry is amplified by the existence of equity providers and lenders under the same roof. It is unclear how many portfolio companies with equity holdings from PE powerhouses also borrow from the credit divisions of the same PE firms. And there is no comprehensive information showing the many transactions on the credit and equity relationships linking the major PE groups. For instance, KKR Credit does not publicly disclose what proportion of its PD loans are allocated to the portfolio companies of its peers Apollo, Blackstone, Carlyle and TPG. Growing Market Risks The more mutual relationships these large fund managers have amongst each other, the more likely they are to cooperate rather than compete on transactions. Anecdotes like the fight that saw lender Fortress push TPG-backed Vice Media into administration after the media firm failed to meet loan commitments (leading to an equity loss for TPG and other investors[11]) should not be interpreted as the signs of financial warfare. Pervasive collaboration rather than open conflicts between private capital fund managers is a more likely scenario. PE firms with a strong credit division can influence private lenders of their portfolio companies by threatening to act tough themselves when the shoe is on the other foot and they are themselves lenders

Validation of Risk Management Models for Financial Institutions: Theory and Practice. 2023. Edited by David Lynch, Iftekhar Hasan, and Akhtar Siddique. Cambridge University Press. Because of their high leverage, financial institutions need to maintain a strong focus on risk modeling, both for sound firm management and as a regulatory necessity. Modeling of current and potential risks is critical to well-grounded financial decision making. Getting risk measures wrong can have dire financial consequences. Validation of Risk Management Models for Financial Institutions, through a set of thoughtful articles, describes how effective structuring and testing of the modeling techniques used in risk management can support better financial decision making. The book does not address the question of why financial institutions may fail, which matters because financial failures and blowups continue to be accepted as part of doing business in the financial industry. This set of edited papers does, however, provide insights on how risk models are built, tested, validated, and used in a variety of financial activities. Get the models right, and a financial firm has a better chance of survival. David Lynch, Iftekhar Hasan, and Akhtar Siddique, the editors of this book, have collected 17 papers from leading experts on issues of model validation, which they define as “the set of processes and activities intended to verify that models are performing as expected, in line with their design objectives and business uses.” These papers encompass varying levels of complexity and depth concerning the validity of model assumptions and predictions. From methodological issues to cases on specific businesses, the contributors focus on in-sample training and out-of-sample tests as validation exercises. Successful validation requires substantial data and a formal way of concluding whether a model is within an error tolerance. For financial firms, the margin for error is small. Poor testing and validation may mean the difference between financial success and firm failure. In the first few chapters, the book centers on value at risk (VaR) modeling, the workhorse of risk models. Even with its well-known limitations and the dislike it has engendered among many traders, VaR models serve as a good foundation for risk assessments. There is no viable alternative to this backbone approach for financial institutions, but it requires extensive modeling and structural thinking to be effective. These core chapters extend modeling of the problem to the entire distribution of prices and not just a risk threshold, while also discussing the key issues of conditional backtesting and benchmarking for the ongoing monitoring of risks. Of course, one of the existential risks over the last decade has been the COVID-19 pandemic. Research points to the failure of VaR models to react quickly enough in the spring of 2020. There is reason to hope, however, that future outlier events can be addressed more effectively by including past data extremes in the analysis. Unfortunately, as clearly enunciated in this book, the fundamental stress-testing problem in regard to extreme events is that we simply do not have enough stress periods to train risk models properly. Several chapters, representing more than half the book, focus on credit risk modeling by discussing issues of counterparty risk, retail credit models, and wholesale banking of large loans. Here, there is a focus not just on market price dynamics but also on allowance for loss. Proper modeling of the probability of loss and loss given default is critical to measuring risks, especially given the currently high growth in private credit funds. While VaR modeling has dominated trading businesses, credit default modeling may be more critical for firm risk, given the increased difficulty of hedging these events. Again, with a limited number of recessions and unique credit events, the measurement and validation of loss assumptions are not easy issues to address. The goodness of fit for any model must be balanced against the adequacy of the sample data. Contributors to this volume present the problems associated with credit management both analytically and through a case study. Examining trading and lending business risk is critical, but there is also a need to roll risk up to the enterprise level, a key topic when thinking about firm risk. Models must also be balanced against operational risk and the demands of supervisory stress testing by regulators. All these issues are addressed in various chapters, but the common drawback of any edited book of research papers is present: The papers have varying quality and complexity, and the integration of topics does not always flow effectively for the reader who desires a sequentially organized review of the essential topics. Unfortunately, model construction and validation often do no more than fight the last battle on losses or address the desires of regulators. The process does not prepare institutions for black swans, tail events, or the consequences of making the wrong decisions. While not the focus of model validation, dealing with “unknown unknowns,” extreme scenarios, and unique risk events is fundamental to improved risk decision making. In a complex financial world, diversification and leverage are key components of risk management that influence the effectiveness of validation. Validating on the basis of past data is the best this book has to offer for building models, yet addressing uncertainty, ambiguity, and the complexity of markets is necessary for any useful risk discussion. With its focus on model validation, the book deals with a narrowly specialized topic. Nevertheless, any reader involved in investment management or financial institutions will find it useful for generating keener insights into building and interpreting risk models. Losses at money managers and hedge funds, like the faltering of financial institutions, are often associated with risk model failure in the form of giving incorrect or ambiguous answers or focusing on the wrong risks. Reading this book is not going to prevent bad decisions or constrain inappropriate risk taking, but it will improve model building, which is foundational for minimizing losses. Many potential readers of Validation of Risk Management Models for Financial Institutions may not be focused on managing financial risk, but gaining a deeper understanding of model validation

I interviewed 50 amazing people — 25 women and 25 men — from different professions and industries for my 14th annual research paper released on International Women’s Day, 8 March 2024. To celebrate the occasion, I wanted to share some examples of how women around the world are investing. Below are 10 responses to the question: What’s in your investment portfolio? While I was conducting my interviews, I realized that a prospective client’s existing investment portfolio is a potential diagnostic tool for investment advisers. We often look at their portfolio as something that needs to be “fixed,” but what’s in it may reveal useful information about what is important to the prospect and how they may have worked with their previous adviser. This strikes me as very similar to how medical clinicians use diagnostic tests to establish whether a patient has a particular condition.  When working on a prospect’s investment policy statement (IPS), we normally think about whether they want to exclude oil or tobacco stocks, but maybe they have other unique preferences that have led them to invest in a certain way. Using their existing portfolio to diagnose their investing habits and persona just might lead to a higher conversion rate. Valentina Díaz Estévez, Finance Professional, Dublin “I’ve lived in several different cities: Río Gallegos in the south of Argentina during my childhood, Paraná, Buenos Aires, and now Dublin. I love new experiences: Learning how to start again makes me a stronger person. I try to learn from every step in my life. Currently, I am in Ireland, where I have embarked on a master’s of science program in fintech at the National College of Ireland (NCI) in Dublin. I am honored to have received the Government of Ireland International Education Scholarship (GOI-IES) for the 2023 to 2024 academic year, a prestigious award granted to only 60 recipients out of over 5,000 applicants. “In terms of my investment portfolio, it is diversified with 70% in US dollars and 30% in Argentine pesos when I was living in my country. Half of my dollar holdings are invested in Latin American funds, while the other half is allocated to S&P exchange-traded funds (ETFs) and more conservative stocks, such as Proctor & Gamble, McDonald’s, Walmart, and Coca Cola. My pesos are invested in funds that are linked to inflation, and I keep about 10% liquid in money market funds to pay for my day-to-day expenses. Additionally, I always maintain a small allocation to gold as a hedge for quality during periods of volatility.” Umulinga Karangwa, CFA, Founder, Equity Investment Adviser, Africa Nziza Investment, Cape Town “I started my career as a tax advisor, but I found the hours to be grueling so decided to shift to finance. In the last 20 years, I’ve worked and lived in Belgium, the UK, and Africa. I now do business in both Cape Town, South Africa, and Mauritius, and for convenience, I own an apartment in each city. My firm Africa Nziza provides investment advisory services for institutional investors and investment appraisal services for private equity investors, and we conduct independent investment research on investment opportunities in the region. “My personal investment portfolio consists of 30% real estate and 70% equities and ETFs. Living in Africa, you have to buy real estate to hedge against inflation (currently 7%), and this issue is compounded by the depreciation of the currency. Mauritius and South Africa are not very investable stock markets. My pension fund is still housed in Europe, and it is invested mostly in ETFs. Otherwise, I’ve held onto the S&P 500 for 20 years now, and it has appreciated so much more than anything else. I didn’t mean to have so much of my money in the US market; it just happened. Ten years ago, I decided not to rebalance — why argue with success?” Sabrina Amélia de Lima, Portfolio Specialist, Itaú Unibanco, Belo Horizonte, Brazil “My investment portfolio is focused on global diversification. I believe this is the cornerstone of risk management, portfolio construction, and achieving long-term consistent stable returns. Here is the breakdown of my portfolio:  “20% in inflation-linked assets, such as national treasury bonds earning about IPCA [the official Brazilian inflation index] plus 6% in debentures of good companies  “20% in international ETFs, such as IVV, QQQ, and VNQ, and equities, including Coca-Cola, Meta, Alphabet, PayPal, and Ferguson PLC “5% in alternative assets, such as cryptocurrency funds via ETFs “5% in mature companies in the Brazilian stock market, such as Itaú, Vale, and Weg “50% in fixed-income funds and multimarket funds managed by Itaú Asset, Kinea, Kapitalo, Vinland, and others  “My profile is more aggressive in that I accept taking risk in order to seek greater returns. My main concerns are inflation protection and geographical diversification.” Sloane Ortel, Founder and Chief Investment Officer, Invest Vegan, Provo, UT  “I formed a long-term view of how I wanted to shape this industry, and I started Invest Vegan in 2021. “We currently have 19 holdings in the Invest Vegan portfolio including: “Farmer Mac: This mission-driven lender was chartered by Congress to create a secondary market for agricultural credit and reduce the cost of borrowing for American farmers; 99% of its business is recurring fees and net effective spread. “Welltower: a REIT that is one of the largest investors in senior assisted living. Staff turnover is destructive in that business, and I love that they are focused on meaningfully higher staff retention, which also drives meaningfully higher results. “Duolingo: an app that helps anyone learn languages, music, and math for free. These universal skills are among the most meaningful drivers of economic mobility and personal fulfilment for individuals. “To me, veganism is a coherent ethical system that focuses on avoiding harm to living things and seeks a regenerative relationship with the world. It’s not a diet. It’s 1,000 tiny steps that touch on everything from your toothpaste to choosing trains over planes. I named the firm Invest Vegan because, to me, that kind of holistic thinking