Practical Investment Management by Robert.A.Strong slides ch23

8/14/2019 Practical Investment Management by Robert.A.Strong slides ch23

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CONTEMPORARY ISSUES

Practical Investment Management

Robert A. Strong

CHAPTER TWENTY-THREE



South-Western / Thomson Learning © 2004 23 - 2

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




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




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 :




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




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



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.




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.




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.



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



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.



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.



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.




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.





Insert Table 23-5 here.




Whether Internet valuations are “loopy” or

the reflection of a new era in investing ishard to say.

Merrill Lynch sums up things this way:


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.





Internet trading reduces trading costs and

brings more investors to the marketplace.

However, it may also encourage gambling

and disregard for professional advice.





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.




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.




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.




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.




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



South Western / Thomson Learning © 2004 23 24

Review

The Dot.com Phenomenon The Industry and the Players The Role of Advertising The Security Analysis Dilemma


Derivatives The Definitional Problem

Educational Efforts Internal Controls

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