Practical Investment Management by Robert.A.Strong slides ch23
Transcript of Practical Investment Management by Robert.A.Strong slides ch23
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CONTEMPORARY ISSUES
Practical Investment Management
Robert A. Strong
CHAPTER TWENTY-THREE
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Outline
The Chartered Financial Analyst Program
Themes Competence Presentation Standards Fiduciary Duties
Ethics
Ethics Training and Industry Reform Standards of Practice and the SEC GAO Report on Unscrupulous Brokers
Price Manipulation Analyst Objectivity Mandated Ethics Training
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Outline
The Dot.com Phenomenon The Industry and the Players The Role of Advertising The Security Analysis Dilemma
Changes in Market Mechanics
Derivatives The Definitional Problem
Educational Efforts Internal Controls
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increasing the technical competence of
those in the investment business, the accurate presentation of investment
results,
adherence to fiduciary duty , and the maintenance of a high ethical standard of
conduct.
The Chartered Financial Analyst Program Themes
ADD YELLOW RULES TO THIS CH.
There are four motivating factorsbehind the CFA program :
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As the investment industry grows incomplexity, continuing education becomes all
the more important.
From a fiduciary perspective, compliance with
AIMR reporting requirements is becomingmandatory.
According to a recent poll, more than two-
thirds of Americans think that financialadvisors put their own interests ahead of
those of their clients.
The Chartered Financial Analyst Program Themes
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Ethics Training and Industry Reform
One researcher finds that failure toestablish trust is the primary reason for the
lack of success with cold calling.
Another study found that while 94% of
money managers had some form of ethics
and professional conduct policy, about half
admitted that they did not have any
assessment process in place.
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The Securities and Exchange Commission has made it a top priority to raise the
standards of practice among retail brokers.
Investors can take their broker to court for
malpractice. Dramshop cases are thosefinding that brokers have a responsibility
to ensure that clients do not commit
financial suicide.
Standards of Practice and The SEC
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On the other hand, the corporationshould be free from opportunistic
gadflies trolling for out-of-court
settlements.
The SEC is also taking steps to make themutual fund prospectus morecomprehensive and comprehensible , so as
to enable the average investor to makebetter investment decisions.
Standards of Practice and The SEC
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Most states also exercisesome type of regulatory
control over the securities
offered for sale within their
borders.
The SEC has little patience for misleadingadvertising too.
Standards of Practice and The SEC
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A principal conclusion of the report is that
“existing disciplinary policies and practices
may not adequately ensure investor
protection.”
GAO Report on Unscrupulous Brokers
In 1994 Congress instructed the
Government Accounting Office
(GAO) to review the oversight and
disciplinary actions of the SEC and
other organizations with regard tounscrupulous brokers.
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Price manipulation is illegal. The mostcommon version involves posting false
information on the Internet via chat rooms
or phony research reports in an attempt to
“pump and dump” a stock.
Analyst objectivity : A conflict of interest
may arise between the investment banking
function of an investment house and itsresearch department.
Ethics Training and Industry Reform
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In 1992, Congress reauthorized the CFTC, andethics training was mandated for futures
professionals.
Other organizations are following suit. In 1995
for instance, the SEC issued a regulation
prescribing continuing education
requirements for stockbrokers.
Mandated Ethics Training
The Commodity Futures Trading
Commission (CFTC) is the federalagency overseeing the futures
industry.
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The Dot.com Phenomenon
One of the factors contributing to
the substantial bull market during
1999 is what some people call the
dot.com phenomenon, where we
• com
witnessed the growth of Internet firms, theproliferation of day trading, and sky-high
valuations for companies with no earnings.
Since then, the market has declined three
years in a row, and many of the darlings of
1999 are bankrupt.
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The Industry and the Players
The customer relationship is changing.
Internet firms identify potential customers andbuild a product specifically for them.
People have convenient access to the Internet,
even while they are at work.
Projections of future earnings seem tomatter more to the market than profits. All along, there have been very few profitable
Internet companies.
The strategic alliances of Internet firms with
traditional companies may be the start of a
new trend.
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The Dot.com Phenomenon
Internet firms spend heavily on advertising,
but hope to permanently reduce thisexpenditure because of repeat business and
“stickiness”.
The security analysis dilemma: If the capitalmarket is reasonably efficient, how does it
settle upon such huge valuations for firms
with no profits and a very unclear future?
The price-earnings ratio for Internet firms in mid-1999 was about eight times as large as the PE for
non-Internets.
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The Dot.com Phenomenon
Insert Table 23-5 here.
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Whether Internet valuations are “loopy” or
the reflection of a new era in investing ishard to say.
Merrill Lynch sums up things this way:
The Dot.com Phenomenon
With these types of investments, we wouldalso argue that the real “risk” is not losingsome money - it is missing much-bigger upside. Investing in hyper-growth stocks isnot about preserving capital (that’s what
bonds are for); it is about making sure thatyou are on board the train if and when itleaves.
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Changes in Market Mechanics
Internet trading reduces trading costs and
brings more investors to the marketplace.
However, it may also encourage gambling
and disregard for professional advice.
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Changes in Market Mechanics
Substantial structural changes are alsobeing made to the brokerage systems.
Many exchanges are implementing ways to
extend trading hours.
Many brokerage firms are also revising their fee
structure and broker compensation scheme.
Mergers and alliances are being discussed too.
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Derivatives : The Definitional Problem
What is a derivative ?
Like the word speculation, the word
derivative is impossible to define succinctly.
One workingman’s definition of derivative is“anything whose value derives from the
value of something else.”
An alternative definition may specificallyinclude reference to off-balance sheet items
like interest rate caps, swaps or floors.
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Derivatives : Educational Efforts
A fact not well understood by everyone is
that derivatives are neutral products. They are not inherently good or bad, and their
risk and utility depends on what the user does
with them.
Another misconception is the belief that
investors with a large investment position
have some type of risk-return advantage
over the small investor. In fact, someone holding a large position may
be taking a substantial risk.
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Derivatives : Internal Controls
In 1995, the 233-year-old Barings Bank went
broke because of the actions of a 28-year-old, Singapore-based futures trader named
Nick Leeson. Prior to the collapse of the British bank, Leeson
was writing straddles on the Japanese Nikkeiindex.
In response to the uncomplimentary
attention brought to the derivatives industry,
the Futures Industry Association assembleda group to seek ways to lessen the likelihood
that a similar scandal will happen again.
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Review
The Chartered Financial Analyst Program
Themes Competence Presentation Standards Fiduciary Duties
Ethics
Ethics Training and Industry Reform Standards of Practice and the SEC GAO Report on Unscrupulous Brokers
Price Manipulation Analyst Objectivity Mandated Ethics Training
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Review
The Dot.com Phenomenon The Industry and the Players The Role of Advertising The Security Analysis Dilemma
Changes in Market Mechanics
Derivatives The Definitional Problem
Educational Efforts Internal Controls