CFA Institute

The legendary musician Prince exhorted us to “Party like it’s 1999,” but today, as a small-cap stock investor, I’d flip the calendar one year ahead, to 2000. That’s because by March 2000, the NASDAQ had peaked at 5048 and by April had plunged by almost 35%. The following 18 months were no party either. Many former high-flying tech stocks, including Pets.com and Priceline, lost all or nearly all their value. Even stalwarts like Intel, Cisco, and Oracle experienced major drawdowns. In fact, trillions of dollars vaporized during this infamous period that became known as the dot-com bubble. But for some investors, the aftermath of the dot-com bubble was one of the best times to deploy capital ever. It was the all-too-rare opportunity to acquire meaningful positions in quality companies for which the market simply had no appetite. I believe that quality small caps are in a similar position today. These days, small caps are unloved, unwanted, and uninvited to the party. And there has been a party — a big one hosted by a handful of mega-cap tech stocks, particularly those perceived as bellwethers of all things artificial intelligence (AI)-related. The parallels between AI mania and the dot-com era are hard to ignore. Back in 1999, any company that touted its internet bona fides was a market darling. Spoiler alert: It did not end well. Nevertheless, it was an excellent time for selective stock picking, and there are familiar echoes in today’s Canadian small-cap technology stocks. What’s Happening Now — Why the Big Discount? In life, as in investing, everything happens for a reason, or several reasons. And that holds true for the absolute and relative low valuations for small-cap stocks. 1. Big pools of capital are increasingly going private. Pension funds and other large institutional investors are looking to generate alpha. In the past, they would allocate a portion of their investments to small-cap public companies to achieve that. Today, these investors are shifting their portfolios away from public markets and into private markets. When only a handful of stocks are driving most of the gains, asset managers have a hard time achieving outperformance. Hence, the diversification benefits of private equity and its alpha potential look appealing. For example, Yale University’s endowment fund has nearly 40% in private equity and venture capital funds today compared with only 5% in 1990. As demand for small-cap stocks declines, so do their valuations. 2. Investors are chasing performance. We have all heard of the Magnificent Seven, the mega-cap tech stocks that have driven recent equity returns: Nvidia, Microsoft, Amazon, Apple, Alphabet, Tesla, and Meta. To put things in perspective, Apple is worth more than all the smaller US companies contained in the entire Russell 2000. Investors have been chasing large-cap returns, and the five-year track record of the NASDAQ is excellent. That was true back in January 2000 as well. 3. There’s the macro and the micro. At the macro level, the small-cap market turned over in 2021 and has faced the headwinds for almost 2.5 years now. Rising interest rates were priced into small-cap valuations, and with different debt dynamics from their larger peers, smaller companies generally sell off first ahead of a potential recession. Smaller companies, especially those in earlier growth stages, tend to carry more debt, and that debt tends to have a shorter average maturity — 5.7 years vs. 8.2 years — which puts them at greater risk in tighter monetary environments. Smaller companies also have fewer sources of financing to rely on. What Are the Upside Catalysts? Against this backdrop, where are the opportunities in small-cap stocks? Smaller companies tend to lead the way ahead of a recovery. When monetary policy becomes more dovish, perhaps as early as the first quarter of 2024, small-cap equities should respond strongly. As performance leadership continues to narrow, institutional funds, among other investors, will begin to look elsewhere, and quality small caps are one place where they will likely deploy capital. Because small caps tend to be less liquid, a spike in demand can potentially generate significant surges in share prices and a re-rating. Mean regression dictates that, at some point, small-cap valuations will return to their long-term average. The M&A market is another source of potential upside for small caps. Today, willing sellers are hard to find. Many quality companies came to market at high valuations, and management teams have psychologically anchored to those higher multiples. But in time, their shareholders and board members will accept the new reality and realize that acquisition may be the best path to continued growth. The small-cap premium historically implies that small-cap stocks outperform their large-cap counterparts over the long term. For example, from 2000 to 2005, after the telecom boom and bust, the S&P 600 outperformed the S&P 500 by 12% per year on average. We’re in a period with a compressing multiple in small caps compared with large caps. As of September 2023, the forward P/E of the S&P 600 is 13.8. The last two times the S&P 600 had a forward P/E in this range was during the global financial crisis (GFC) and at the start of the global pandemic. On both those occasions, those investors who deployed capital to small caps were well rewarded. There could be a similar opportunity today. If you liked this post, don’t forget to subscribe to 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 / jjwithers Professional Learning for CFA Institute Members CFA Institute members are empowered to self-determine and self-report professional learning (PL) credits earned, including content on Enterprising Investor. Members can record credits easily using their online PL tracker. source

The Behavioral Portfolio: Managing Portfolios and Investor Behavior in a Complex Economy. 2025. Phillip Toews. Harriman House. In The Behavioral Portfolio, author Phillip Toews — the lead portfolio manager of the Toews Funds and the Agility Shares exchange-traded funds, as well as the co-founder of the Behavioral Investing Institute — seeks to reconcile two largely unacknowledged problems in the investment advisory industry. First, the history and risks of both bond and stock portfolios far exceed what most investors and advisory practices can tolerate. For example, the United States experienced a 36-year bond bear market from 1945 to 1981 and a 14-year stock bear market around the time of the Great Depression. Second, the approach that most financial advisors take to communicate about portfolios is ineffective in helping clients avoid known biases and poor decision making. In addressing the first problem, the author instructs financial advisors to create robust “behavioral portfolios” designed to invest optimistically while addressing the real-world contingencies of investing in a high-debt world and the many downside risks that it presents. The US total public debt-to-GDP ratio currently stands at approximately 122%, a dramatic increase from approximately 39% in 1966. The criteria to consider when building behavioral portfolios include comprehensively addressing tail risks, providing long-term above-inflation growth, capturing gains during rising markets, and preserving gains. In the author’s behavioral portfolio execution example, the conventional Norway model construct of a 60/40 stock/bond allocation, is modified in two ways. First, half of the stocks are placed in a hedged equities fund. Second, the conventional bond allocation is replaced by adaptive fixed income, allowing the strategy to adapt to negative bond market environments. Therefore, this example of the behavioral portfolio, which is based on Morningstar data, consists of three components: conventional equities (MSCI World NR USD), hedged equities, and adaptive fixed income. In my favorite section of the book, the author compares his behavioral portfolio with a conventional portfolio and presents several charts for a 16-year timeframe from 2008 to 2023. For example, in the three calendar years in the sample in which the benchmark experienced meaningful losses, the behavioral portfolio showed lower drawdowns, which in some cases (e.g., 2008) were significant. In the sample, the behavioral portfolio had slightly higher average mean returns, an 80% up capture ratio, and a 0.97 correlation to the benchmark during rising markets. Finally, the left tail of the behavioral portfolio is much shorter than that of a traditional portfolio, and the right tail is also compressed. In addressing the second problem, that of financial advisor–client communication to prevent poor decisions, the author correctly emphasizes the importance of “behavioral coaching,” which can be an important part of the advisor–client relationship. He shares specific, proactive strategies that can train investors to not only understand portfolio components but also embrace contrarian decision making that helps avoid known biases. Communicating the unique value of the behavioral portfolio to investors is an important part of these strategies. The author argues that financial advisors should shift the emphasis from reactive explanations to proactive preparation in communication with clients. That mindset shift can make a significant impact in helping clients stay disciplined through different market cycles. At the end of the book, Toews adeptly uses the hero’s narrative to describe the advisor’s role. Toews adroitly critiques the antiquated 60% equity/40% bond portfolio with precision, exposing its flaws in today’s market. Real-world examples drive his points home, making complex financial ideas accessible. For financial advisors and casual investors alike, this is an important book for moving away from traditional investing strategies. Although The Behavioral Portfolio: Managing Portfolios and Investor Behavior in a Complex Economy was written for advisors, it is also a recommended read for retail investors trying to decide on their own portfolio mix. The book challenges traditional portfolio construction, arguing that many common approaches leave investors exposed not only to economic shocks but also to the emotional responses that often accompany market dislocations. source

Economic data reflect global supply chain restructuring. Nearly two years into the regionalization, nearshoring, re-shoring, and “friend-shoring” of the global supply chain restructuring process, US and overseas economic data are revealing the consequences. As the supply chain shifts, accelerated by pandemic disruptions and policy uncertainty, previously dependable — and popular — data correlations are shifting as well. Consider US manufacturing. While technology, financial, and consulting firms have announced major layoffs amid 15 months of monetary tightening by the US Federal Reserve, the manufacturing sector remains resilient. Indeed, expansionary fiscal policies continue to spur positive growth and inflation, which, combined with federal efforts to move semiconductor production onshore, has triggered a manufacturing boom — and with it a severe labor shortage. Given an aging workforce and an economy and culture that emphasized college education over vocational training for generations, there are simply not enough skilled workers — electricians, welders, and semiconductor technicians — to meet demand. On the other side of the Pacific, “de-risking” among large North American and eurozone importers has created its own economic ripples. Export trade flows are shifting, according to a survey of 15,000 vendors at the 2023 Canton Fair in Guangzhou, China. While producers previously leveraged vertical integration to export vast volumes of finished goods to advanced economies, many manufacturers from Guangzhou to Shanghai are now fulfilling smaller orders of intermediate goods to “nearshoring” emerging market (EM) destinations for final assembly. In this new paradigm, exports from the port of Qingdao, a shipping hub for EM destinations, rose 16.6% year over year in the first quarter of 2023, while container volume through the ports of Shanghai and Zhoushan, which serve European and North American routes, declined 6.4%. In aggregate, East Asian manufacturing centers are addressing overcapacity while select US sectors face capacity shortages. Such transformations are rarely costless. The once consolidated “factory gate price” is also undergoing a geographical shift. The optimization of global supply chains and vertical integration across key Asia manufacturing hubs over previous decades fueled co-movements between major export nations’ Producer Price Index (PPI) / factory gate price and Consumer Price Index (CPI) data in advanced economies. But these relationships hinged on the now disrupted pre-pandemic supply chain. With finished goods assembly more widely distributed across EM locales and amid ongoing supply chain retooling, US inflation and prices at manufacturing hubs may have weaker data correlation. Why? Because a more diffuse and less integrated supply chain will cement factory gate prices in different nations because of idiosyncratic local labor and materials considerations. With these factors in mind, a more geographically redundant but less efficient trade regime will likely be inflationary, as the new weighted average PPI will reflect various non-optimized pricing data. Alternatively, costs for energy, raw materials, and other commodities could serve as leading indicators in a more complex but resilient global supply network. US CPI and Bloomberg Commodity Index Sources: US Bureau of Labor Statistics, Bloomberg, Kekselias, Inc. Supply Chain Transformation = Uncertainty Given the current policy and business focus on supply chain redundancy, further diversification rather than consolidation and cost optimization is likely in the weeks and months ahead. Thus, the structure of global trade will continue to transform before it achieves a new equilibrium. This implies more data volatility, weaker relationships between once correlated peers, and perhaps most importantly, emerging opportunities for investors who understand and anticipate the new supply chain paradigms and data co-movements. 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 / Natee Meepian 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

Central banks are playing a critical role in addressing climate change by steering the financial sector toward sustainability. However, there is a significant disparity, particularly in developed countries such as the United States, between the creation of climate change strategies and their execution. This gap is apparent in the struggle to reach 2030 CO2 emission reduction targets, and points to the need for more practical measures[i]. The immediacy of the situation calls for a reinterpretation of financial principles. Central banks across the globe, historically focused on controlling inflation and fostering economic growth, have evolved to serve an essential role in guiding the market toward environmental sustainability. They are increasingly integrating climate risk factors into their economic evaluations. Over the past four decades, various economic philosophies have shaped the financial landscape in developed nations, with ideologies ranging from the laissez-faire principles of Neoliberalism to the proactive governmental roles suggested by Keynesianism, as well as the contemporary Modern Monetary Theory (MMT). Despite its fresh perspective on government spending and debt, MMT doesn’t accentuate the contribution of central banks, such as the Federal Reserve, toward environmentally friendly investments. Economists have voiced concerns about MMT, particularly relating to public debt and climate finance[ii]. The United States, recognized as a significant contributor to global CO2 emissions, is being pressured to amplify its efforts to curb climate change. Traditional economic theories, such as neoclassicism, forecast substantial financial obstacles, including a potential rise in inflation stemming from the enormous investments required for climate change mitigation. On the other hand, MMT believes the move is more political, proposing government backing to facilitate the ecological shift and advocating for government subsidies to aid the green transition[iii]. The practicality of MMT is under debate, however, with concerns about continuing inflation risks and declining international demand for US Treasury bonds. A more appropriate approach for US policymakers is to follow the European Central Bank (ECB) model and green regulatory framework. The ECB Model The ECB is stepping up its game, aligning its financial strategy with the EU’s climate objectives. It is revamping its Corporate Sector Purchase Programme and collateral framework and merging practical climate action with market neutrality. The ECB’s strategy is fondly dubbed ‘Green Quantitative Easing,’ focusing on purchasing green assets to support environment-friendly projects and lower finance costs. It’s a strategic move, nudging the European economy toward sustainable growth and development[iv]. In addition, the ECB is tackling climate-related financial risks head-on by introducing new tools and processes. The Fed’s Role in Tackling Climate Change Recognizing climate change is a considerable financial hazard, the US Federal Reserve initially took a research-focused approach before moving toward policy initiatives. This shift is a departure from the norm for the Fed, traditionally seen as neutral but now emerging as an essential pillar in tackling climate change’s financial and economic consequences. The divided nature of American politics and the substantial clout of the fossil fuel industry[v] substantially restrict the potential for more audacious climate action initiatives. As the US finance sector considers this paradigm shift, top-tier banks are shaping policies to boost green-oriented initiatives. These efforts are gaining momentum through innovative hybrid asset classes and new investment tools that marry traditional asset characteristics with a sharp focus on environmental sustainability. Their objective is twofold: achieving financial gains while advancing environmental goals, such as reducing carbon footprint and promoting renewable energy.  New asset classes — like those discussed in CFA Institute Research and Policy Center’s “Navigating Transition Finance” report — strive to consolidate funding avenues, giving birth to new financial instruments crucial to green economic tactics. Yet, this quest for innovation isn’t a lone journey. Central banks are teaming up with giant asset managers, including pension funds and sovereign wealth funds, making for a powerful alliance. Still, this cooperation underlines a significant challenge: there is a pressing need to direct a large share of these resources toward investments that align with climate preservation[vi]. The Role of GSIBs In the face of escalating regulations, societal changes, and technological advancements, Global Systemically Important Banks (G-SIBs) are amplifying their emphasis on strategies related to climate change. These strategies include promoting green financing, minimizing investment in high-emission sectors, and improving climate risk management. As a reflection of public demand and emerging opportunities offered by green finance, G-SIBs have pledged almost $9 trillion for sustainable financing by 2030. This commitment marks a notable advance toward the projected $130 trillion required for a worldwide transition to a net-zero economy by the midpoint of this century[vii].  The Fed has a significant role in fostering a greener economy. It can encourage environmentally conscious investments. Its partnerships with the Environmental Protection Agency and Securities and Exchange Commission further empower its capabilities. Furthermore, its participation in global discussions on sustainability reinforces its mission to reshape our financial backdrop without compromising its cherished independence[viii].  Now more than ever, green economics is vital in macroprudential policy. Financial organizations reluctant to adapt to an economy aware of its carbon footprint risk severe instability[ix]. In contrast, those who respond to these changes promptly stand to profit from the emerging green opportunities. The challenge for the industry lies in reducing direct and transitional climate risks and catering to the growing group of investors and borrowers who deem environmental sustainability a priority. The Fed’s Supervision Climate Committee (SCC) plays a significant role in fortifying financial organizations against the disruptions caused by climate change. The SCC is at the forefront of understanding and addressing the financial consequences of climate change. Their work includes evaluating risks, devising mitigating strategies, and ensuring that regulatory standards are adhered to for effective climate risk management.  In addition, the SCC extends its efforts to comprehend the economic implications of climate change through extensive research. It works tirelessly to increase stakeholders’ awareness and provides the crucial guidance and resources that financial institutions need. The SCC also holds sway over Congressional climate expenditure, thus shaping legislative and fiscal strategies concerning environmental policies[x]. In 2023, Fed Chairman Jerome Powell acknowledged the multifaceted financial implications of climate change. He emphasized, however, that the Fed would not nudge

Brian Minns, CFA, will speak at the Climate Risk and Returns Conference from CFA Institute, held 20–21 April 2023 in New York City. Partnerships among institutional investors are crucial to achieving a low-carbon economy. As institutional investors, we have a fiduciary duty to act in our beneficiaries’ best interests and earn sufficient investment returns to meet their expectations. To achieve this, we also need to ensure there are stable financial, social, and environmental systems on which to build those returns. At University Pension Plan (UPP), we believe promoting healthy systems goes hand in hand with our fiduciary duty to our members. That’s why, when we developed our response to climate change and our net-zero approach, we set our sights beyond our own portfolio, because we know that emissions must also decline in the real world and that a well-managed, low-carbon transition requires systemic change from all corners of the global economy. The net-zero transition also presents opportunities for investors — institutional and otherwise — to build confidence, resilience, and competitiveness in the wider economy through profitably financing activities that support sustainable solutions and lower emissions. By contributing to collaborative initiatives with the global investing community, investors create reciprocal relationships through which we can share expertise and best practices, leverage resources, and amplify our influence to create the change we need. In this way, we can reduce uncertainty and risk and maximize our return-generating potential. Such collaborative effort among asset owners is one of the most effective means for organizations like ours to catalyze systemic change and carry out our shared fiduciary duty. Systemic Risk Requires Collective Action When investors directly engage and set expectations for both the companies they own and the external managers they partner with, we help keep these firms focused on the transition pathway, on improving their resiliency and lowering emissions. Investors also need companies to improve their climate-related disclosures to better track their progress toward net-zero goals and make more informed investment decisions. Such finance-led groups as Climate Action 100+ and the Institutional Investors Group on Climate Change (IIGCC) work to ensure sound science, alignment, and consistency across all member activities. By engaging with various high-emissions companies through a common set of objectives, we are working not only to change their behavior but also to improve climate-related expectations and the structure of information flows for all companies and investors. Collective Advocacy to Protect and Enhance Value Through collective advocacy with policymakers and regulators, investors can encourage rules and frameworks that support the interests of our beneficiaries and create the conditions for a well-managed climate transition. Investors can collaborate and amplify their voices through such well-established industry initiatives as the UN-convened Net-Zero Asset Owner Alliance (NZAOA), a member organization composed of 85 institutional investors with more than US$11 trillion in assets under management (AUM), and the Ceres Investor Network on Climate Risk and Sustainability, which collectively represents more than 220 investors and in excess of US$60 trillion AUM. Through our participation in policy working groups, such as those convened by the Canadian Coalition for Good Governance and the Responsible Investment Association, we can define and promote good corporate governance practices in Canada and around the world. We can also influence public policy to improve governance standards. More transparency, accountability, and disclosure, in turn, help manage risk and protect the value of investments. Partnership in Times of Change Makes the Collective Stronger As domestic and international climate transition regulations and incentive frameworks evolve, investors face new legal and reputational risks as well as potential impacts on returns. Rather than navigating this evolving landscape alone, they can join investor alliances and help coordinate policy advocacy, facilitate improved knowledge sharing, and mitigate old and new risks. For example, to counteract greenwashing and provide investors with more and better information to help guide their decisions, the International Sustainability Standards Board (ISSB) will implement new global accounting standards for measuring and reporting climate-related impacts in January 2024. Collaborative investor groups contributed to the development of these new standards and stand ready to support their launch around the world. Once again, individual investors would be hard pressed to keep up with the rapid pace of change in this area or to develop the collective influence that a group of investors can muster. There are many options to join with like-minded investors in local markets or on the international stage. The global low-carbon transition will continue to pose a challenge for all types of investors and present both risk and opportunity along the way. Net zero won’t be achieved in isolation but will take collective action throughout the financial community. Together, through partnerships among institutional investors and investors of all sizes, we can help shape the future of finance and bring about the systemic, global change required to make net zero a reality. If you liked this post, don’t forget to subscribe to 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 / JamesBrey 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

Themes in Alternative Investments. 2023. Shaen Corbet and Charles Larkin, eds. De Gruyter. The alternative investment space continues to grow beyond hedge funds and private equity to embrace various types of financial innovation. This volume affords the topic a rich and varied presentation from several authors, not only of investments but also of themes that occupy this realm of the investment universe. Opacity and illiquidity are part and parcel of this evolution. With new opportunities come challenges in performance measurement, due diligence, and regulation. Technological innovation proceeds apace, effective oversight less so. Analysts, portfolio managers, risk professionals, and regulators will find this work a timely and useful compendium. Officialdom in a regulation-averse incoming presidential administration in the United States that has promoted digital currency with abandon would do well to heed the lessons contained within its covers. CFA charterholders and candidates will also find value in this text as they will increasingly be confronted with the realities and challenges of the ever-changing alternative asset category. The selection of topics in this book appears at first blush to be random. Not so. Rather, the chapters represent a cross-section of issues relevant to the current state of nontraditional investments. Information asymmetry is a common thread, presenting an ongoing challenge to regulators and practitioners who aspire to a greater understanding of the complexities of this category. An account of the Mozambican tuna bond scandal underscores the risks inherent in less developed markets. This study on state-owned enterprise misappropriation of funds earmarked for tuna fishing and maritime security reminds us of how rapidly things can devolve. The revelation of the misused funds occasioned a collapse of the national currency and a sovereign debt default. Poor due diligence and oversight by lenders who approved these loans offer a cautionary tale for risk managers and regulators who deal with higher-risk economies. Relatedly, the discussion and analysis of Silicon Valley Bank’s rise and fall suggest ongoing deficiencies in regulation and policy. Regulatory surveillance and capital requirements arising from the Dodd-Frank Act, enacted in the wake of the 2007-2009 Global Financial Crisis, were intended to head off the collapses of financial institutions of the sort that led to that calamity. Yet a relaxation of the applicability of regulatory scrutiny and stress testing to banks with assets under $250 billion during the first Trump administration afforded SVB freer rein in its underwriting of loans to the technology sector, subjecting it to a far greater degree of industry-specific risks. A confluence of strategic choices, such as the bank’s vast pandemic-era accumulation of deposits that it invested largely in interest-rate-sensitive US Treasury and mortgage-backed securities, along with the exogenous shock of the Federal Reserve’s decision to raise rates to staunch inflation, served the bank poorly when it was hit with a surfeit of withdrawal requests. Finding itself caught out, SVB had to sell fixed-income holdings at a significant loss, which in turn, occasioned a vicious circle of ever-increasing withdrawal requests. This reverberative effect further eroded investor confidence and the bank’s share price, resulting in SVB’s implosion. The implications of this collapse were far-reaching: interest-rate risk management is critical, as is portfolio diversification to mitigate sector-specific risks. Centralized and decentralized finance appear to have more in common than would seem to be so at first glance. Opacity, illiquidity, and risk concentration are as relevant in the digital currency space as they are in the world of fractional-reserve banking. The book’s analysis of FTX’s rapid ascent and decline underscores the seemingly ephemeral nature of the burgeoning cryptocurrency industry. Indeed, the company’s travails and downfall should serve as a powerful reminder that the promise and potential of decentralized finance are as fraught with risk as their counterparts in the conventional kind. In this instance, fraudulent conduct was very much at work; the lure of innovation and subsequent disarray emphasizes the importance of rigorous due diligence. More intensive regulation and corporate governance will be critical prospectively. This necessary regulatory rigor should likewise apply to the novel seductiveness of the non-fungible token (NFT), a digitized innovation using the blockchain technology chassis that undergirds cryptocurrencies to create a distinct noninterchangeable item of value. NFTs have gained popularity in art, music, and real estate as a means of identifying a work’s originality and ownership. Yet these items are subject to various types of fraud—rug-pull schemes, price manipulation, illusory value creation, and so-called tech enamorment or undue fascination with the novelty of this technology with indifference to its potentially adverse impact on society. Market saturation of these tokens, the questionable promise of decentralized finance, and the precarity of their value in the wake of the FTX exchange collapse suggests that these are early days for a product requiring more scrutiny and oversight. Two chapters provide an interesting and fairly detailed examination of the challenges of investing in wine. Outside the expertise of most advisors, highly specialized knowledge of such industry dynamics as terroir, weather, vintages, and agriculture is essential, as is knowledge of industry dynamics. The lack of consistent data makes investing in wine a daunting task. And there are different ways to obtain exposure including direct investment, bespoke allocation through the guidance of a wine investment management company, and wine mutual funds managed like hedge funds. In addition, the sector lacks quality data, and there are varying opinions on risk and return measurement. Investment advisors would suggest a small allocation to this sector. Would it be better to imbibe than invest? Another chapter revisits what can be considered more traditional alternative investments. As the discussion of private equity and hedge funds makes plain, regulation is often uneven and incomplete. In the aftermath of the Global Financial Crisis, the private market space has been subject to greatly expanded regulation. Views contrast on its benefits in a realm where opacity is necessary to achieve alpha yet simultaneously presents risks to consumers. As hedge funds and private equity funds have grown since the crisis, they have presented systemic risks that regulation needs to address. The emergence of the Dodd-Frank Act

In the ever-evolving landscape of artificial intelligence (AI), the trends point toward an insatiable appetite for larger, more powerful models. Large language models (LLMs) have become the torchbearers of this trend and epitomize the relentless quest for more data, more parameters, and inevitably, more computational power. But this progress comes at a cost, one not adequately accounted for by Silicon Valley or its patrons — a carbon cost. The equation is straightforward yet alarming: Larger models equate to more parameters, necessitating increased computations. These computations, in turn, translate to higher energy consumption and a more substantial carbon footprint. While the benefits of AI, which range from predicting weather disasters to aiding in cancer research, are clear, the environmental viability of less critical applications, such as generating AI-based superhero selfies, are more open to question.  This predicament brings us to the heart of a significant challenge in modern computing: Moore’s Law. For decades, this axiom has anticipated the exponential growth in computing power. However, this growth has not been matched by a proportional increase in energy efficiency. Indeed, the environmental impact of computing, especially in the field of AI, is becoming increasingly untenable.  These ecological costs are profound. Data centers, the backbone of AI computations, are notorious for their high energy demands. The carbon emissions from these centers, which often rely on fossil fuels, contribute significantly to global warming and stand at odds with the growing global emphasis on sustainability and environmental responsibility.  In the era of net zero, corporate environmental responsibility is under intense scrutiny, and numerous companies are quick to trumpet their commitment to energy efficiency. Often they acquire carbon credits to balance their carbon footprint, even as critics dismiss such measures as mere accounting maneuvers rather than a substantive change in operational behavior. In contrast, Microsoft and other select industry leaders are pioneering a more proactive approach. These firms are optimizing their energy consumption by conducting energy-intensive processes during off-peak hours and synchronizing their operations with periods of maximum solar output and other times of higher renewable energy availability. This strategy, known as “time-shifting,” not only mitigates their environmental impact but also underscores a tangible shift toward sustainability. Enter the realm of environmental, social, and governance (ESG) regulation, a framework that encourages companies to operate in a socially responsible way and consider their environmental costs. ESG scores, which rate companies based on their adherence to these principles, are becoming a crucial part of investment decisions. AI development, with its high energy demands, faces a unique challenge in this regard. Companies involved in AI research and development must now reconcile their pursuit of technical innovation with the necessity of maintaining a favorable ESG score. But have the ESG vendors caught on to this hot problem?  In response to these challenges, carbon aware, green AI, and eco AI and other concepts are gaining traction. These initiatives advocate for more energy-efficient algorithms, the use of renewable energy sources, and more environmentally conscious approaches to AI development. This shift is not just a moral imperative but also a practical necessity, as investors and consumers increasingly favor companies that demonstrate a commitment to sustainability.  The AI community is at a crossroads. On one hand, the pursuit of larger and more complex models is propelling us toward new frontiers in technology and science. On the other, we cannot ignore the associated environmental costs. The challenge, therefore, is to strike a balance — to continue the pursuit of groundbreaking AI innovations while minimizing their ecological toll. This balancing act is not just the responsibility of AI researchers and developers. It extends to policymakers, investors, and end-users. Policy interventions that encourage the use of renewable energy sources in data centers, investment in green AI start-ups, and a conscious effort by users to favor environmentally friendly AI applications can collectively make a positive difference.  The journey of AI is a story of technological achievement, but it must also be one of environmental responsibility. As we continue to push the boundaries of what AI can accomplish, we must also innovate in how we power these advancements. The future of AI should not just be smart; it must also be sustainable. Only then can we ensure that the benefits of AI are enjoyed not just by current generations but by the many generations to come. If you liked this post, don’t forget to subscribe to Enterprising Investor and the CFA Institute Research and Policy Center. All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer. Image credit: ©Getty Images / Jordan Lye 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