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Enterprising Investor

Michael Pettis on China: “The Growth Rate in Investment Is Going to Collapse”

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· Economics
Michael Pettis

“What the world desperately needs is demand,” asserted Michael Pettis, professor of finance at the Guanghua School of Management at Peking University, in the closing session at last week’s 65th CFA Institute Annual Conference in Chicago.

With the United States likely to increase its savings rate and the euro in turmoil, he expects Spain to default and leave the eurozone soon. So who will be buying goods in the global marketplace? China has net negative demand, he noted, and will not be the solution to the world’s demand problem. China’s growth has been fueled by government investment, and even in the best-case scenario, he said, “the growth rate in investment is going to collapse.”

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Bankable Insights: Overcoming Anxiety is Key to Investment Success

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· Behavioral Finance, Corporate Finance, Derivatives, Economics, Equity Investments, Financial Statement Analysis, Fixed Income, Leadership, Management & Communication Skills, Portfolio Management, Private Wealth Management, Risk Management, Standards, Ethics & Regulations (SER)
Behavioral Finance and Investment Management

Back in 2007, Wall Street Journal investing columnist Jason Zweig contributed a fascinating essay entitled “Fear” to a monograph, Behavioral Finance and Investment Management, published by the Research Foundation of CFA Institute. The essay was adapted from Zweig’s book, Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich, and it’s just as relevant today as it was back then — when, it’s perhaps worth noting, the S&P 500 and other key benchmarks were higher than they are today.

In the essay, Zweig discusses a subject near and dear to my heart as a former investment manager and author: anxiety and its deleterious effects on investment decision making, and hence on performance. Thankfully, human beings are seemingly unique among animals in that we can use our minds to overcome these hard-wired instincts. If only we had a road map for how to do that.

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Unapologetic after All These Years: Eugene Fama Defends Investor Rationality and Market Efficiency

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· Behavioral Finance, Portfolio Management
Eugene Fama with moderator Robert Litterman

Addressing the 65th CFA Institute Annual Conference in Chicago last week, Professor Eugene F. Fama of the University of Chicago Booth School of Business recounted a lifetime of distinguished scholarship and achievement. The unofficial “father of modern finance” took on recent criticisms of the efficient markets hypothesis (EMH) and issued stinging rebukes of “too big to fail” banks, underfunded pension plans, active investment management, and behavioral investors.

With regard to the financial crisis, Fama said, “I take a particularly contrary view on it. I don’t think it was a financial disaster that caused an economic disaster. I think you can’t reject the hypothesis that it was an economic disaster that caused the financial disaster.”

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Take 15: Dark Pools and Market Transparency

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· Equity Investments, Standards, Ethics & Regulations (SER)

Frédéric Romand discusses the role of dark pools and their relative merits and drawbacks in the context of equity market investing. The importance of transparency and information quality is also addressed, along with efforts to achieve more consistent regulation.


This episode of the Take 15 Series was originally released on 30 April 2012.

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Daniel Kahneman: Psychology for Behavioral Finance

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· Behavioral Finance, Leadership, Management & Communication Skills
Daniel Kahneman

Nobel Prize winner Daniel Kahneman is one of the founding fathers of behavioral finance. Although he holds a doctorate in psychology, not economics, he has had a profound effect on the dismal science. These days economic actors — that’s you and me — are not seen as rational, but rather human and prone to cognitive biases. This simple observation holds significant implications for the theory and practice of finance, ranging from the reliability of the Efficient Market Hypothesis and the Capital Asset Pricing Model to listening to a company presentation at a sell-side conference, speaking with investor relations professionals, building financial models, determining when to buy or sell securities, and even how to optimally organize an investment firm.

So wouldn’t it be nice to know what the good doctor knows? At the recent 65th CFA Institute Annual Conference, Kahneman distilled much of his research findings into bite-sized portions. What follows is a summary of his talk.

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Hedge Funds: Important Liquidity Providers and “Small Enough to Fail”

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· Portfolio Management, Uncategorized
Sebastian Mallaby

Sebastian Mallaby, author of More Money Than God, spoke to delegates at the 65th CFA Institute Annual Conference about the role of hedge funds in our financial system, making the case that their pursuit and exploitation of mispriced assets makes them critical providers of liquidity to markets and capitalism. Properly aligned incentives, the use of short positions and leverage, and trading flexibility, Mallaby said, are what allow hedge funds to deliver alpha. Posing much less risk to the financial system than “too big to fail” banks, hedge funds are, in contrast, “small enough to fail.”

Recounting the evolution of hedge funds, Mallaby noted that Alfred Winslow Jones created the first “hedged” fund in 1949, using short positions to offset his long positions. Jones also claimed 20% of his fund’s profits, reportedly modeling his compensation after Phoenician merchants, who retained a similar amount of profits from their ventures and distributed the balance to investors. Like Jones, most hedge fund managers today have significant personal stakes in their funds. Having real skin in the game separates hedge fund managers from more traditional asset managers, and Mallaby sees this as an important governor on risk-taking.

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Take 15: China: Nothing Is Investable, but Everything Is Tradable!

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· Economics

Fraser Howie, managing director at CLSA Asia-Pacific Markets in Singapore, discusses fundamental issues with China’s banking system. Specifically, he explains China’s continual creation of superficial solutions to problems, which often fail to solve the underlying issues.


This episode of the Take 15 Series was originally released on 2 May 2012.

Are you viewing this post on a mobile device? Download the CFA Institute app from iTunes or Android Market to watch this and other videos.

Using Social Network Effects to Enrich Yourself Like Facebook Does

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· Leadership, Management & Communication Skills, Portfolio Management
Brian Uzzi

With its widely anticipated initial public offering, Facebook is seeking a market value of as much as $100 billion. If successful, the IPO would yield the company a higher price-to-earnings multiple than virtually every other company in the Standard & Poor’s 500 index. So why such investor enthusiasm for a company with fewer than 2,500 employees worldwide? According to Brian Uzzi, professor of leadership at Northwestern University, the answer comes down to the emerging science of networks. In a session at the 65th CFA Institute Annual Conference in Chicago, Uzzi dissected the network effect: he explained how personal networks can be not only key assets for investment professionals but also a source of collective intelligence about financial markets, which, if properly harnessed, can help money managers make better investment decisions.

Uzzi began his talk by differentiating between two types — one akin to a modern-day Paul Revere, and one more like William Dawes. Revere, of course, was the American patriot who traveled from Boston, Massachusetts, by horseback on April 18, 1775, to alert colonists that the British were coming. His message spread far and wide, and Revere is credited with helping to raise the Continental Army that ultimately defeated British forces. His role in the American Revolution is memorialized in a Henry Longfellow poem titled “Paul Revere’s Ride.”

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Eurozone Crisis: The ECB’s Long-Term Refinancing Operation Has Tamed Spreads, But Now What?

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· Economics
European Central Bank, ECB, chief Mario Draghi, smiles during a press conference at the ECB's headquarters on Wednesday April 4, 2012. Draghi says a weak eurozone economy has held back businesses from applying for loans despite the abundant cash made available by the central bank's massive amounts of cheap credit to lenders. (AP Photo/dapd/ Thomas Lohnes)

Since the European debt crisis began some three years ago, it has taken many twists and turns. In December of 2011, the European Central Bank (ECB) initiated the Long-Term Refinancing Operation (LTRO) — which is the European equivalent of the Troubled Asset Relief Program, or TARP, launched in the United States in the immediate wake of the financial crisis of 2008. Through the LTRO the ECB has lent out €529.5 billion ($712.81 billion) in cheap, three-year loans to about 800 lenders. So what exactly is the LTRO, and how did it work?

In effect, the LTRO is a state-sponsored carry trade designed to reduce interest rates more broadly in Europe and in the peripheral sovereign debt in particular. Another phrase for carry trade is yield curve speculation in which an investor (in this case a bank or financial institution) borrows short term at low rates and lends (or buys bonds) longer term at greater yielding rates — thereby earning a spread. The reason it is speculative is because there is typically no assurance that the asset will produce the income stream it is expected to produce, or more to the point, there is no assurance that rates will remain low — in such case the long-term asset (bond, loan, etc.) would decline markedly in value and short-term borrowing costs could rise markedly, thereby squeezing the investor and possibly turning the spread from profit to loss.

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Search for Stability: Regulation, Reform, and the Role of Monetary Policy

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· Economics, Standards, Ethics & Regulations (SER)
Randall Kroszner

Randall Kroszner, a professor at the University of Chicago Booth School of Business and a former governor of the U.S. Federal Reserve Bank, discussed the fragility of the banking system and the role of monetary policy during fiscal crises at the 65th CFA Institute Annual Conference in Chicago yesterday. Kroszner joked at the start of his session that the U.S. credit crisis was “his fault,” since he served as a Fed governor from 2006 to 2009. Fortunately for the audience, Kroszner’s current occupation allowed him to speak off script — a luxury he did not have during his tenure at the U.S. central bank.

Kroszner opened his discussion by noting that leverage, liquidity, and interconnectedness make the banking system extraordinarily fragile as compared to other industries. The banking model is to borrow short and lend long, which creates a funding mismatch, and banks rely enormously on short-term financing, which can change very quickly. In addition, he pointed out, any nonfinancial institution with a leverage ratio of 10:1 is far too overleveraged. But a bank with the same leverage is extremely well capitalized. The problem was that just ahead of the crisis, many banks only had 3–4% core capital, and that left very little room for asset volatility.

Read more on the Annual Conference blog →