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Chapter 25
Contemporary Issues in PortfolioManagement
Portfolio Construction, Management, & Protection, 5e, Robert
A. Strong
Copyright 2009 by South-Western, a division of ho!son "usiness #
$%ono!i%s. A&& rights reserved.
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There are clearly some real bad people out there who have
done
bad things, but there are also 15,000 companies out there,
thegreat maority of which are run by honest people! "avingsaid
that, there has been a general erosion of professionalstandards
#fueled by$ an attitude that %everybody else isdoing it and a
perceived need to meet 'uarterly earnings
numbers! (e)ve got to get bac* to an honest approach and
abroad+gauged concept of what we really mean by
management performance!
William Donaldson, Chairman, Securities &
Exchange Commission
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Introduction So!e %onte!porary issues are fa%tua&(
) he rising i!portan%e of $*%hange-raded +unds
) n%reasing&y %o!!on pra%ti%e of %ertifi%ate&ess
trading
) ntegration of s&a!i% so%iety, and Shariah &a hi%h does
notper!it paying or re%eiving interest, into the g&oba&
!aretp&a%e
So!e %onte!porary issues are %ontroversia&() Se%urity
ana&yst ob/e%tivity has been the sub/e%t of nu!erous
Congressiona& hearings) Sto% &ending and progra! trading
have i!age prob&e!s
) erivatives are not per!itted in so!e portfo&ios
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$*%hange-raded +unds ortfo&io of sto%s, bonds, futures, or
other assets
that trade throughout the day
3utua& fund e*%hanges on&y tae p&a%e at the
end-of-day net asset va&ue
n 3ar%h 2004, there ere 11 $+s ith 6578bi&&ion in the
nited States
$+s provide transparen%y and &i:uidity) ortfo&io
%ontents are pub&ished
) nvestors %an e*it at any given ti!e
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Security Analyst O!ecti"ity here is a theoreti%a& ;fire
a&&< beteen the
invest!ent baning fun%tion of an invest!ent
house and its resear%h depart!ent) A %onf&i%t of interest
!ay arise if an invest!ent ban is%ourting a fir! for so!e
underriting business at the
sa!e ti!e that its ana&ysts are deve&oping an
invest!ent opinion
) n the &ate 8990s, &ess than 2 per%ent of
ana&yst
opinions ere ;se&&
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Security Analyst O!ecti"ity
#cont$d% n 2008 and 2002, there ere so!e high&y
visib&e
brea%hes of this fire a&& n 3ar%h 2002, the =AS
fi&ed ru&es ith the
S$C that address the &a% of ob/e%tivity he C+A nstitute
issued a do%u!ent on Resear%h
>b/e%tivity Standards for pub&i% %o!!ent he S$C adopted
Regu&ation Ana&yst Certifi%ation
in Apri& 200') Re:uires ana&ysts to %ertify that their
reports ref&e%t
their opinions and not so!eone e&se?s
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Stoc 'ending Stoc lending(
) s the pra%ti%e by hi%h one institution &oans
sto% to another institution
) s often used to support short-se&&ing by
%usto!ers of the se%ond institution
) Can earn substantia& in%o!e ith very &itt&e
ris
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Stoc 'ending #cont$d% Sto% &ending is si!i&ar to a
repur%hase
agree!ent(
) he institution anting to borro sto%@uts up
%o&&atera& about 802 per%ent of the
se%urities &entB
@Agrees to return the se%urities at a &ater date
) he &ender %an earn interest on the %ash
%o&&atera&
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(echanics o) a Short Sale A short sale(
) nvo&ves borroing se%urities fro! so!eone
) Se&&ing the se%urities to another !aretparti%ipant
) $ventua&&y pur%hasing shares fro! another
!aret parti%ipant and) Returning the substitute shares to the
origina&
&ender
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(echanics o)
a Short Sale #cont$d% A short sa&e is nor!a&&y
!otivated by a
bearish senti!ent
he a%tua& &ender in a short sa&e is
nor!a&&yan unnoing parti%ipant
) A hypothecation agreementgives the broer
the right to &end shares to so!eone e&se@he investor %an
sti&& trade the shares and %ontinues
to earn dividends
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(echanics o)
a Short Sale #cont$d% he short se&&er(
) as an ob&igation to return hat as borroed
at so!e point in the future) 3ust pay dividends to the
&ender
) $ventua&&y co"ers the shortby repur%hasing
shares to rep&a%e the shares borroed ear&ier@f the
pur%hase pri%e is be&o the se&&ing pri%e, theshort
se&&er !aes a profit
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*o+ a Stoc 'ending
ransaction Wors f the %usto!er ants to short se&&(
) he broerage fir! first %he%s if other %usto!ers have
the sto% in their !argin a%%ounts
) he broerage fir! !ay use a stoc loan )inderto
&o%ate another fir! ith the needed shares
) he first fir! deposits %o&&atera& ith the se%ond
fir!
-bi&&s or %ashB
@ art of the interest is used to pay a finder?s fee to the
sto%
&oan finder
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Ad"antages o) Stoc 'ending Sto% &ending is very
&u%rative
) n 8999, the tota& in%o!e to sto% &enders approa%hed68
bi&&ion
) n 2005, over 62.1 bi&&ion of short-ter! bonds Sto%
&ending %an be used by broerage fir!s to
finan%e the !argin pur%hases of their %usto!ers Sto% &ending
is popu&ar hen !arets see
in%reased !erger and a%:uisition a%tivity() (erger
aritrageinvo&ves buying shares of &ie&y
taeover %andidates and short se&&ing shares of
theanti%ipated a%:uirer
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Disad"antages o)
Stoc 'ending A %usto!er potentia&&y gives up the right
to
vote(
) he short se&&er is essentia&&y a negative
oner
So!e ris is asso%iated ith the possibi&ity
that the sto% borroer !ight not return these%urities) Sto%
&oans are ;!ared to !aret$,
C">, C3$, G++$) erivative asset edu%ation is designed to
give
peop&e !ore %hoi%es
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0etting 3oard Appro"al >n%e the portfo&io !anager is
%onvin%ed of
futures andHor options, he !ust %onvin%e(
) "oards of trustees) Supervisors
) +und benefi%iaries
he !anager shou&d be ab&e to e*p&ain the!erits of
derivatives using everyday&anguage
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ortfo&io 3argining (arginis a su! of !oney invested as a
good faith deposit
) !proving the %han%e that any &osses i&& be
paid
"istorically,!argins a!ount ere based on portfo&io asset
positions individua&&y) Ris of &oss in
portfo&ios ith off-setting positions is &i!ited
Today,institutiona& investors and individua&s ith
&argeportfo&ios are a&&oed to post !argins based
upon net&osses arising fro! the intera%tion of se%urities) Gess
!oney has to be put into perfor!an%e bonds
) Geaves !ore !oney for additiona& invest!ent
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s&a!i% +inan%e s&a!i% &a, or Shariah, forbids(
) aying or re%eiving interest@ en%e, 3ost 3us&i!s rent
) nvest!ent in fir!s dea&ing in interest produ%ts
&iebansB
) nvest!ent in fir!s dea&ing ith a&%oho&,
toba%%o,ga!b&ing, pornography, or defense
3us&i!s enter into so!ehat e&aborate;partnerships<
ith bans to pur%hase ho!es) nstead of paying interest, they buy out
the ban?s
onership position over ti!e
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Stru%tured +inan%e Ienera&&y in%&ude options and
futures to a&ter the
ris and return %hara%teristi%s of so!e portfo&io
$*a!p&es in%&ude() Se&&ing a %a&& for
revenueB and ho&ding the sto%
) Shorting a sto% and buying a %a&&@ he %o!bination a%ts
&ie a put
.S. investors are &ess &ie&y to invest in
stru%turedprodu%ts
) '0E of $uropean and Asian portfo&ios %onsist ofstru%tured
produ%ts
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Chartered 4inancial
Analyst .rogram he Chartered 4inancial Analyst program
began in 8959 hen the nstitute of Chartered
+inan%ia& Ana&ysts C+AB as for!ed@ ro!otes invest!ent
edu%ation and ethi%a& behavior
@ Aarded the first %harter in 89'
he +inan%ia& Ana&ysts +ederation +A+B !erged
ith the C+A in 8990 to for! thessociation for-nvestment
Management and .esearch /-M.
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he C4A .rogram Exams o earn the C+A designation, %andidates
!ust pass three separate e*a!s taen at
&east a year apart
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he C4A
.rogram Exams #cont$d% Geve& is entire&y ite! sets
) Covers basi% too&s and inputs to the invest!ent
va&uation pro%ess
Geve& is a&so entire&y ite! sets
) $!phasiJes se%urity va&uation and spe%ia&iJed
topi%s
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he C4A
.rogram Exams #cont$d% Geve& is essay, va&uation,
ana&ysis, and
ite! sets
) Covers portfo&io !anage!ent
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C4A .rogram hemes Co!peten%e
resentation Standards
+idu%iary uties
$thi%s
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Competence eop&e ho %o!p&ete the C+A progra! are
te%hni%a&&y very %o!petent and are &ie&y to
eep their noses %&ean during theirprofessiona&
%areers
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.resentation Standards C+A %andidates &earn
state-of-the-art
standards and !ay prepare their on
reports in a%%ordan%e ith C+A nstitutere:uire!ents
+ro! a fidu%iary perspe%tive, %o!p&ian%eith C+A nstitute
re:uire!ents is on itsay to being !andatory
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4iduciary Duties +idu%iary duties re:uire %ondu%t that(
) s in the individua& %&ient?s best interest
) s fair to the %o&&e%tive group of a&&
%&ients
Resear%h reports are an i!portant part of
fidu%iary duties
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Ethics he %overage of ethi%s in the C+A progra!
is very usefu&(
) +or e*a!p&e(@Ana&ysts !ust distinguish beteen fa%t and
opinion
@Resear%h reports shou&d be ob/e%tive, unbiased, and
have a reasonab&e basis
@"igger %&ients shou&d not be given
preferentia&treat!ent
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-egulation 4air Disclosure -egulation 4Das approved by the
S$C
in August 2000
he ey provision() revents %o!panies fro! giving !ateria&
infor!ation to se%urity ana&ysts, !utua& funds,
or institutiona& investors un&ess the
%o!panysi!u&taneous&y issues the sa!e infor!ation to
the genera& pub&i%
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he SEC .osition he purpose of Regu&ation + is(
) o in%rease the :uantity and :ua&ity of
avai&ab&e
infor!ation to investors
) o e&i!inate hat so!e per%eive as an unfair
advantage histori%a&&y en/oyed by Wa&&
Street?s
big guns
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he Industry .osition $viden%e indi%ates that lessinfor!ation
is
avai&ab&e to the pub&i%(
) Co!panies are re&u%tant to anser :uestionsnot
pub&i%&y ansered before
) Co!panies have begun to provide &ess
infor!ation beteen :uarter&y reports
) Kuarter&y %onferen%e %a&&s beteen fir!s and
the broerage industry have be%o!e s%ripted
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C4A Institute -esponse C+A nstitute study hen Regu&ation
+
as first announ%ed anti%ipated that(
) ;to avoid any possib&e S$C enfor%e!enta%tions,
%orporations i&& redu%e their
%o!!uni%ations to Lsound bites? and
Lboi&erp&ate? dis%&osures, hi%h %ontain
&itt&e
infor!ation to ana&ysts and the pub&i% at &arge
