Investment Management E-Book

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 783

Veröffentlichungsjahr: 2009

Beschreibung

Praise for Investment Management "A compelling analysis of the challenges of investment management, and why investment management firms require innovation to succeed." --Blake Grossman, CEO, Barclays Global Investors "Great investment managers understand that positioning portfolios for clients should not be an act of conformity, but rather a constant journey of shifting fundamentals and opinion. Wayne and Ralph bring this fact to life by addressing some of the key challenges to serious investment thinking, using top-level researchers in their respective fields. For those investment managers and clients who want to go beyond the ordinary." --Jeff Diermeier, former CEO of CFA Institute and retired CIO of UBS Global Asset Management "The essays in this book provide an invaluable reference point of serious readings for money managers. The works provide the analyst with the most recent scholarship in a single book, presenting ideas and philosophy that will lead me back to its various sections time and time again." --Kenneth S. Hackel, CFA, President, CT Capital LLC "The crash of 2007-2009 brought a harsh conclusion to a quarter of a century of unprecedented growth and prosperity for the investment management industry, which faces no less a task than reinventing itself. Rieves' and Wagner's contribution to the way forward couldn't be timelier." --Richard Ennis, Principal, Ennis Knupp + Associates "This book uniformly focuses on the best practices to which investment management professionals should commit. I highly recommend this book to investment managers, sales people, and trustees of pensions, endowments, trusts, and mutual funds." --Jack Clark Francis, PhD, Professor of Economics and Finance, Bernard Baruch College

Leseprobe

Table of Contents

Title Page

Copyright Page

Dedication

Foreword

Preface

A DISAGREEABLE REALITY

A MAP FOR THE PLAYERS

OUR PERSPECTIVE

Acknowledgements

Editorial Advisory Board

Praise

Introduction

RESTRUCTURING OF INVESTMENT PLANS—OUT WITH THE OLD; IN WITH THE NEW

EVOLVING INVESTOR SKILLS AND PREFERENCES—THE CLIMB TO HIGHER GROUND

GLOBALIZATION—BROADER OPPORTUNITY SET AND EXPANDING COMPETITION

SPECIALIZATION IN PROFESSIONALS’ ROLES—CREATING BARRIERS TO ENTRY AND A ...

ADVANCES IN TECHNOLOGIES AND SYSTEMS— PENNY-WISE OR POUND-FOOLISH ?

PROLIFERATION OF CONSULTANTS AND THEIR CHANGING ROLES—GATEKEEPER, COMPETITOR ...

DISTRIBUTION OPPORTUNITIES

SUMMARY

NOTES

PART One - The Challenges of Changes and Crises

CHAPTER 1 - The Discontinuity Challenge

THINKING ABOUT DISCONTINUITIES

DECISION MAKING IN NORMAL TIMES

TALEB’S BLACK SWANS

WHERE WE GO WRONG

STAYING AHEAD OF THE GAME: A POTPOURRI OF IDEAS

CONCLUSION

NOTES

CHAPTER 2 - The Sub-Prime Crisis as a “Predictable Surprise” Strategic Lessons ...

FROM BLACK SWANS TO PREDICTABLE SURPRISES

BARRIERS TO PREVENTING PREDICTABLE SURPRISES THAT TURN BAD

THE SUB-PRIME CRISIS AS A PREDICTABLE SURPRISE

HOW COULD THE SUB-PRIME CRISIS HAVE BEEN PREVENTED?

A THREE-STEP INSTITUTIONAL CALL TO ACTION

DECISION MAKING UNDER UNCERTAINTY IN A PENSION FUND CONTEXT

MORE HARD QUESTIONS

WEAK LINKS IN THE CHAIN

AGENCY, ASYMMETRY, AND COLLECTIVE ACTION ISSUES

LEADING THE WAY

NOTES

REFERENCES

CHAPTER 3 - The Solidarity Challenge

THE SLEEPING GIANT

CHALLENGE #1: THE DIVERSITY OF FIRMS

CHALLENGE #2: THE LEXICON CHALLENGE

CHALLENGE #3: ALPHABET SOUP

CHALLENGE #4: THE GDI SYNDROME

CHALLENGE #5: AVERSION TO PUBLICITY

CHALLENGE #6: WHO LIKES REGULATION?

CORE CHARACTERISTICS AND SHARED VALUES

THE CASE FOR SOLIDARITY: WHAT’S AT STAKE

THE ASSAULT ON THE ADVISERS ACT

THE BOTTOM LINE—AND THE CHOICE

NOTES

PART Two - Keeping the Challenges in Perspective

CHAPTER 4 - The Failure of Invariance

NOTES

REFERENCES

CHAPTER 5 - Inverted Reasoning and Its Consequences

CHAPTER 6 - Fatal Attractions for Money Managers

MINDLESS ROUTINE

THE LAWS OF PROBABILITY

INFORMATION OVERLOAD

PSYCHOLOGY OF CHOICE

FORECASTING

OVER CONFIDENCE

FOLLOW THE LEADER

TOUCHY-FEELY SYNDROME

STATISTICAL BLACKOUT

BAD DOG

NOTES

CHAPTER 7 - Renzo Gracie’s Brazilian Jiu Jitsu Academy

CHAPTER 8 - Managing Outside the Box

BENCHMARKS AND BULL MARKETS

NEW WINE IN OLD BOTTLES

NEW BOTTLES

TWO KINDS OF STYLE DRIFT

PART Three - The Challenges Under Transformation

CHAPTER 9 - The Evolving Challenges of Quantitative Investing

COMPUTERS AND FINANCE: THE BIRTH OF QUANTITATIVE INVESTING

QUANTITATIVE INVESTING GROWS UP

FUNDAMENTAL OR QUANTITATIVE: ART OR SCIENCE ?

QUANTITATIVE INVESTING: LONG LIVE THE KING

PITFALLS FOR QUANTS: THE SHINY ROCK

THE BEST OF BOTH WORLDS: ART AND SCIENCE

CHAPTER 10 - EMH and the Matter at Hand

A WELL-REASONED ASSUMPTION

THE BEHAVIORALIST TAKE—AND THAT OF OTHERS

HOW CAN IT WORK WHEN IT DOESN’T WORK?

LUCK

CONCLUSION

NOTES

CHAPTER 11 - The Attribution Challenge

GETTING THE BENCHMARK RIGHT

PERFORMANCE ATTRIBUTION

ATTRIBUTION FOR ANALYST AND MANAGER INCENTIVE COMPENSATION

CONCLUSION

REFERENCES

CHAPTER 12 - The Academic Challenge An Interview with Professor Stephen Brown ...

SUMMARY

NOTES

REFERENCES

CHAPTER 13 - The Elusiveness of Investment Skill

SCARCITY AND VARIETY

THE TWO MAIN INSIGHTS

INEFFICIENT MARKETS VS. MARKET INEFFICIENCIES

UNPREDICTABILITY VS. RANDOM WALKS

UNPREDICTABILITY AND PHYSICS ENVY

NEGATIVE FEEDBACK LOOPS

A CLOSER LOOK AT THE COIN-TOSSING ANALOGY

HOT HANDS, SKILL, AND PERFORMANCE

NOTE

PART Four - The Clients’ Challenges

CHAPTER 14 - The Client Challenge—Trustees as Leaders

A QUICK REVIEW

PROCEDURAL PRUDENCE

SOME HISTORY

THE CHALLENGE

INVESTMENT MANAGERS AND THE FFS LEADERSHIP PROGRAM

CONCLUSION

CHAPTER 15 - The Kool-Aid Quandary and the Enduring Lure of Outperformance

THE DREAM

THE HIGH COST OF DREAMING

SELLING THE DREAM

WHEN DREAMS FAIL TO MATERIALIZE

A LITTLE HELP FROM FRIENDS

CONCLUSION

CHAPTER 16 - The ESGI (née SRI) Challenge

TWO-AND-A-HALF TRILLION, AND COUNTING

THE OVERRIDING CONSIDERATION

A NEW LABEL

CORPORATE GOVERNANCE

SOCIAL ACTIVISM

PROXY ACCESS

CONCLUSION

CHAPTER 17 - The Marketing Challenge

THE IMPORTANCE OF RELATIONSHIPS

INSTITUTIONALIZATION OF THE RETAIL SALES PROCESS

IDENTIFYING YOUR EDGE AND DISTINGUISHING CHARACTERISTICS

COMMUNICATING THE RIGHT STORY

FIVE MEASURES OF SUCCESS

THE ROLE OF CONSULTANTS

SUMMARY

NOTES

CHAPTER 18 - The Selection and Termination of Investment Management Firms by ...

I. INSTITUTIONAL DETAILS

II. DATA SOURCES AND SAMPLE CONSTRUCTION

III. THE SELECTION OF INVESTMENT MANAGERS

IV. THE TERMINATION OF INVESTMENT MANAGERS

V. ROUND-TRIP TERMINATION AND SELECTION OF INVESTMENT MANAGERS AND SELECTION

VI. CONCLUSIONS

APPENDIX: STANDARD ERROR CALCULATION

NOTES

REFERENCES

PART Five - The Execution Challenges

CHAPTER 19 - The Market Price Challenge

THE ROLE OF PRICES

THE ATTRIBUTES OF PRICES

PRICE DETERMINATION

PRICE-REPORTING CHALLENGES

CHAPTER 20 - The Sell-Side Challenge

A NEW LIQUIDITY LINGUA FRANCA EMERGES AS ALGOS SMOOTH LUMPY FLOWS

THAT WAS THEN

THIS IS NOW

WHITHER CAPITAL?

NOTES

CHAPTER 21 - The Trading Challenge

MUCH MORE ATTRACTIVE ALTERNATIVES

INCREASES IN SPEED

SIGNIFICANT REDUCTIONS IN THE COST OF TRADING

PERPLEXING CHANGES IN THE WAY TRADERS ACCESS AND PROCESS MARKET INFORMATION

COLOR

THE CRAZY, OVERLAPPING WORLD OF INVESTORS, BROKERS, AND EXCHANGES

WHAT DOES TODAY’S TRADING DESK LOOK LIKE?

CONCLUSION

NOTES

CHAPTER 22 - The Settlement Challenge

GLOBALIZATION

VOLUME AND VOLATILITY

EUROPEAN MARKET AND REGULATORY CHANGE

COMPETITION AND FRAGMENTATION

DIFFERENCES IN OPERATING MODEL

CONCLUSIONS

NOTES

PART Six - The Challenges to Management

CHAPTER 23 - Investment Belief Systems A Cultural Perspective

I. BELIEFS, BELIEF SYSTEMS, AND CULTURE

II. INVESTMENT BELIEF SYSTEMS IN ACTION

III. MANAGING BELIEF SYSTEMS

IV. EVALUATING BELIEF SYSTEMS

SUMMARY

ACKNOWLEDGMENTS

NOTES

REFERENCES

CHAPTER 24 - Ethical Leadership in the Investment Firm

CONTEXT AND DEFINITIONS

ETHICS AND INTEGRITY IN THE INVESTMENT WORLD

BEHAVIORAL FINANCE AND ETHICAL DECISION MAKING

ETHICS AS A LEADERSHIP AND CULTURAL ISSUE

GUIDING PRINCIPLES FOR RIGHT VERSUS WRONG ETHICAL DECISIONS

ETHICAL CHOICES: FOUR PARADIGMS FOR RIGHT VERSUS RIGHT

PROCESS FOR RESOLVING ETHICAL DILEMMAS

THE FINAL PIECE: ENERGETIC INTEGRITY

ACHIEVING THE PEACEFUL STATE OF MIND

SUMMARY

NOTES

CHAPTER 25 - The Adaptive Leader

FEEDBACK

THE SCORECARD

COHESION AND SLUDGE

YOUR FIRM’S CULTURE

THE CRITICAL FACT

SUMMARY

NOTES

CHAPTER 26 - The Staffing Challenge

WHAT SHOULD TODAY’S INVESTMENT MANAGERS BRING WITH THEM FOR THE FUTURE?

SEVEN CHARACTERISTICS OF SUCCESSFUL PORTFOLIO MANAGERS

ASSESSING YOUR FIRM

A CHANGE OF PERSPECTIVE

THE FCM MATRIX FOR SUCCESS© IN INVESTMENT MANAGEMENT

UTILIZE CRISIS AS OPPORTUNITY

FOCUSED QUERIES

THE INVESTMENT PROCESS

EARLY WARNING SYSTEM

COACHING ANDTRAINING: CUSTOM-MADE LEARNING PROCESSES

CONCLUSION

NOTES

CHAPTER 27 - The “Same Page” Challenge: Communicating Effectively

THE ART OF CLEAR COMMUNICATION

THE WORLD-CLASS DISCUSSION MODEL

MESSAGING WITH IMPACT

CHOOSING THE RIGHT METHOD (HINT: IT’S PROBABLY NOT E-MAIL)

COMMUNICATING WITH THREE KEY AUDIENCES: CLIENTS, CONSULTANTS, AND REPORTERS

NOTES

CHAPTER 28 - The Data Management Challenge

OLD-SYSTEMS THINKING ISN’T GOOD ENOUGH ANYMORE

HOW DID ALL THIS HAPPEN?

WHERE ARE THINGS HEADED?

HOW TO PROCEED

HOW DO YOU CONTROL THESE PROJECTS?

END GAME: A BRAVE NEW WORLD WITH WELL-MANAGED DATA

ACKNOWLEDGMENTS

About the Editors

About the Contributors

Index

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Library of Congress Cataloging-in-Publication Data

Investment management : meeting the noble challenges of funding pensions, deficits, and growth / Wayne H. Wagner and Ralph A. Rieves, editors. p. cm.

Includes index.

eISBN : 978-0-470-49834-7

1. Investments-United States. 2. Business cycles-United States. I. Wagner, Wayne H.

II. Rieves, Ralph A.

HG6041.I58 2009

332.6-dc22

2009005642

To Sumner and Caroline Levine, with enduring regard.

—RAR

To Larry Cuneo, for 40 years of fighting the good battles together.

—WHW

Foreword

When the story of investing from the late 1990s to 2010 is written, students of financial history might find themselves scratching their heads and saying: “Efficient Market What?”

From the tech-stock bubble to the tech-stock collapse, we saw stock prices soar and collapse within a very short period. How could JDS Uniphase Corp. - a stock with modest revenues and no profits - hit a peak of $153.421 on March 7, 2000 and then lose 99 percent of its value by the end of 2002?* There was the matter of a $56 billion loss in 2001. So, shouldn’t Mr. Market have had some idea of what was coming?

Low-interest rate policies and lax lending practices led to a credit crunch that wiped out Bear Stearns Company, Inc. and Lehman Brothers Holding, Inc and destroyed the value of previously world-beating financial stocks like Citicorp and Bank of America Corporation. How could these and the other stock values implode virtually overnight? If the market was efficiently priced all the time, or even every third day, then Jack the Ripper was a great humanitarian and Robert Mugabe should win the Nobel Peace Prize.

This has been a period when bell curves - the statistician’s mainstay - were mocked, when “fat tails” became part of the common lexicon, and Nassim Nicholas Taleb became the portfolio managers’ patron saint (apparently with not one of them having read any of his books.)

“Risk” is now the first word out of every advisor’s and every trustee’s mouth, after having been undervalued (or totally ignored) for most of this decade. A decade when the behavioral finance theorists finally gained an upper hand on the classicists: When William Sharpe moved beyond mean-variance analysis to Kenneth Arrow’s state/preference theory as a way to explain the pricing of securities. And when Andrew Lo revived Herbert Simon’s notion of “bounded rationality” using “satisficing heuristics” or rules of thumb to explain economic behavior.

This has been the decade when institutional investors threw out the straightjacket of style boxes and gave unfettered freedom to a new breed of hedge fund managers - and paid them a 2 percent maintenance fee and 20 percent or better of the upside for the privilege of employing their “talent.” Not surprisingly, those clients are rethinking such fee structures.

I am sure some efficient market theorists will come up with an explanation of how all this fits into a universe that is rationally priced most, if not all, of the time. But I’m not sure she or he will sell as many textbooks as have been sold in the past.

Those two key questions of institutional investing still remain: Can active managers add values consistently and over time? And how effective are trustees and their consultants at picking managers?

If you are a trustee or are running a money management firm, you have to deal with all the issues I have addressed. The chapters in this book probe these issues. The authors skew many fallacies and misconceptions of the investment world. These authors don’t offer any one-size-fits-all solutions. They do highlight many of the key problems that institutional investors face in any environment, not just the one that has characterized this decade.

Every money management firm, as well as every pension plan, endowment, or trust will come up with their own respective solutions. The solutions will be based on their own capabilities and needs. Moreover, the solutions should also be based on an acute mindfulness of human limitations regardless of imputed experience or “wisdom.”

Again, there are no easy solutions, but this book does describe the most important challenges that every diligent manager and prudent trustee must acknowledge and address.

Joel ChernoffExecutive EditorPensions and Investments

Preface

Some investment managers performed relatively well during the 2008 credit crisis. They cut themselves away from the herd and adhered to their own disciplines and guidelines. These investment professionals have a heightened consciousness about their assumptions and a fierce commitment to reexamining those assumptions. Much earlier than 2008, we believed that the willingness to “think about one’s thinking” was a key characteristic of a proficient money manager. And this belief was what prompted us to undertake this book.

People in the investment industry are among the most highly educated in the world; nonetheless, those associated with large investment portfolios need to stay abreast of the search for knowledge in finance. This is similar to the ongoing education of physicians, who need to stay abreast of the most recent developments in medicine. Both sets of professionals bear burdens of implicit and explicit trust.

Investment professionals face increasing pressure to fund the retirement of millions of workers, as well as meet the capital formation needs that sustain businesses around the world. The rate at which that pressure increases pales, however, in comparison to the rate at which changes are occurring in areas that directly impact the practice of investing. Merger activities among bourses and exchanges, plus the continued emergence of electronic trading platforms, are the obvious transforming events. However, new risk management strategies and instruments are even more impacting.

A DISAGREEABLE REALITY

Many investment professionals attempt to catch hold of the fast-moving trains of investment innovation.

The latest return-enhancing concepts are captured, refined, and implemented with the hope that one has achieved enough advantage to craft a more enduring investing modus operandi. That hope is unlikely. The competition is too fierce. There is much traction up the learning curve. The willingness to synthesize what is known and to analyze what is happening confirms that all the players in the capital markets know that they are engaged in a complex state of affairs. What aggravates that complexity is not just the constant change in venues, theories, and strategies, but also what Peter L. Bernstein characterized as a “state of disagreeable reality . . . . being wrong on occasion is inescapable.”

A MAP FOR THE PLAYERS

This work is intended to assist investment managers and the attendant players (trustees, regulators, and vendors) as they meet the challenges we characterize as noble. The authors of the chapters in this book strove to be descriptive. The goal is to describe circumstances in a manner intended to heighten an already-sensitized awareness. The rate of changes within the milieu precludes prescribing any specific process or action. If there is prescription, it is only included to suggest means that a professional investor might consider when crafting (or re-crafting) an investment policy and a strategy. The chapters in this work are divided into five parts. Each part contains subjects that are tangential to each other.

Part One: The Challenges of Changes and Crises

The 2007-2008 credit crisis roiled the already-turbulent environment in which asset managers confronted their stewardship challenges. Jacqueline Charnley and Christine Røstvold describe the turbulence and change in the industry, and introduce the themes prevalent in this book. Wayne Wagner reminds us to take a historical perspective to ascertain the frequency of market shocks. He proposes some possible methods to address the challenges that those shocks bring. Keith Ambachtsheer recommends the collective actions that can be marshaled to avoid another asset erosion. And David Tittsworth addresses the need for industry solidarity in protecting regulations that have served and protected the advisory profession and beneficiaries since the enactment of the Investment Advisors Act of 1940.

Part Two: Keeping the Challenges in Perspective

This part presents a selection of previously published works. They are included because they are elegant discourses on some attitudinal challenges forever present. The first of these is a chapter from Peter L. Bernstein’s classic book, Againstthe Gods: The Remarkable Story of Risk. He cites the research that challenges (and sometimes refutes) the assumptions held about risks and investor behavior. Bernstein’s chapter is followed by revisiting George C. Selden’s work from a century ago. In this work, Selden reminds us again that “Historical parallels can be misleading.” Arnold Wood’s classic paper follows, in which he reflects on “the triumph of temptation over reason.” Few financial books in this century have had such a conspicuous reception as Richard Bookstaber’s A Demon of Our Own Design (Hoboken: Wiley). From that book, we have excerpted three pages of an analogy that prompts some incisive thinking about innovation and regulation. Robert Jaeger concludes Part Two with an update of his reflection on fads and fashions in the business.

Part Three: The Challenges Under Transformation

These chapters address the “town-and-gown” issues of the investment process. While the content in these chapters is likely to be overrun by events and discoveries now emerging, nevertheless, these chapters are essential for the intrepid and enterprising who utilize all of the navigational and meteorological aids in their voyages across the global markets. Quantitative managers Bob Hagin and Kathleen DeRose address the investors’ challenges in the face of rapid technological change. We follow their discourse with a chapter discussing the relevance of EMH, and Ron Surz lays out the case for more informed and rigorous attribution analysis. We then share Harry Liem’s insightful interview with Stephen Brown about the academic challenges. Robert Jaeger again concludes a part with a reflection on investment skill.

Part Four: The Clients’ Challenges

The proper focus of investment management is on the client. Recent events and changes are more momentous from the clients’ perspective than from the perspective of any particular purveyor of services or advice. The focus of the chapters in Part Four differs somewhat from the other chapters in this book. They are written so as to inform clients about some issues, as well as to heighten an investment manager’s understanding about what this business is all about. The staff at fi360 and Ted Siedle each contributed chapters about trustees taking responsibility for discernment and oversight. There is a chapter addressing fiduciary duties and the future of “sustainable” investing. And Ron Gold prescribes the most effective ways of communicating with and marketing to present and prospective clients. The key feature of Part Four is the complete reprinting of the August 2008 paper by Amit Goyal and Sunil Wahal, “The Selection and Termination of Investment Management Firms by Plan Sponsors”—a paper we would like to have titled “Suspicions Confirmed.”

Part Five: The Execution Challenges

These chapters describe the transactional aspects of portfolio management. Timely and cost-effective trades are critical concerns. Understanding the technology and the evolving structures within markets and venues is crucial. Again the focus is on clients and costs. Francis Gupta and John Prestbo address how much cost benefits have been achieved through technology and adaptability. Steve Wunsch discusses the impact on the sell side from recent rule changes and advances in algorithmic trading. Wayne Wagner reminds us that transactional basis points will always impact performance. And Steve Webb and Simon Bennett of CAPCO discuss the impact of globalizations on clearing and settlement processes.

Part Six: The Challenges to Management

This part includes the “best practices” chapters. Managing an investment firm is as important as managing portfolios. These chapters focus on the attributes and characteristics necessary to sustain the growth of a firm: Substantiating policy, building a professional team, and utilizing emerging technology. John Minahan talks about examining one’s beliefs in light of theory, evidence, and alternative points of view. Jim Ware and Jim Dethmer address the leadership issues of ethics and of adaptability. Monika Müller provides keen insight about the challenges of staffing. Jamie Ziegler reminds readers that empathy and candor are key elements in communicating among peers, as well as with clients. Don DeLoach writes about the challenge of effective information management in the face of the increased flow of data, and the rapidity of technological change.

OUR PERSPECTIVE

Our conviction that a willingness to reexamine one’s assumptions is a key characteristic of proficiency has been derived from decades of working with scores of money managers, analysts, trustees, and theorists. While our work is, for the most part, tangential to actually managing assets, it has not been conducted from a distance.

Investment professionals, trustees, and regulators agree that Wayne’s work has saved investors billions of dollars. He was a founding partner of Wilshire Associates and designed the algorithms that governed the world’s first index funds at Wells Fargo. Later, his Plexus Group validated the hidden delay and opportunity costs of trading. He is a fierce advocate for higher degrees of transparency and efficiency in trading. As the acknowledged authority on those subjects, he is invited to speak and write about them in venues around the globe. And he is the “quant’s quant,” as evidenced by his having been a director of the Institute for Quantitative Research in Finance for the past eight years.

As an executive editor at two book publishing enterprises, as well as being a co-founding editor of the Journal of Financial Consulting, Ralph has overseen the publication of over 100 books and references by the marquee players and academics in the field. Now a principal with Farragut, Jones & Lawrence, he advises emerging enterprises about the operations of capital markets, as well as assisting trustees in implementing the best practices of fiduciary oversight.

Our experience in the industry, as well as our regard and affection for it, is exceeded by those whom we invited to contribute to this book. Moreover, their contributions and achievements in meeting the noble challenges of global stewardship far exceed ours. We are blessed to have such a roster of seasoned pros.

Those readers who have joined the industry within the past five years may be bemused by the senior flavor of our list of authors and advisors. Here is our response to your bemusement: We chose our authors and advisors because, like us, they have learned to detect the industry’s feedlot residue not only when they smell it, but also when they hear it or read it. Our wish is for you to acquire that same acuity, sooner rather than later.

In a time when capital flows instantly through borders, that which enhanced return this morning probably won’t work after lunch. The model-building challenge, then, is how the stewards of the world’s assets shouldthink about their thinking. We hope that this work will assist in that enduring challenge.

Acknowledgments

This book would not exist without the critiques, encouragement, and admonishments of our editorial advisory board. It is customary to “window dress” advisory boards for books like this with names of widely acknowledged authorities. In many instances the time demands on such marquee names preclude any real involvement in the development of the book. Such is not the case with our all-star lineup.

Doug Harman and Jim Ware have been our sage sources about what really works where the rubber meets the road. Once more, how you run your business depends on thinking about your thinking. Jim and Doug do that all the time, so they set good examples for us. Listening and adhering to their suggestions kept this work moving in the direction to which we aspired.

Bob Hagin and Keith Ambachtsheer were involved from the inception of this project. Their advice and their contributions were invaluable. More importantly, their support and enthusiasm sustained us throughout the development of this book. That’s what longtime friends are for.

Executing trades and controlling transaction costs are the most enduring of the challenges addressed in this book, and are so recognized by portfolio managers. For decades, Jay Peake and Bob Schwartz have been fierce advocates for appropriate transparency and efficiency in global financial markets. Their efforts in encouraging the education and enlightenment of investors have resulted in heightened consciousness about the necessity of sound execution decisions. Their efforts have saved investors billions of dollars. Without their advice and critiques, there would be no Part Five.

If there is a prevailing theme in this book, it is about focusing on the client. For two decades, Don Trone has been a prominent advocate for trustees and beneficiaries. His observations about their sensitivities as well as their mandated duties greatly influenced the structure of Part Four.

Doug Schmidt oversaw the compilation of all these words. Without his editorial and organizational skills, the manuscript for this work would not have been “acceptable, in all respects, to the publisher.”

The theme and coverage of this book evolved from bouncing some ideas off two “downtown” friends in the spring of 2007. During the subsequent work on this book, we would recall our visits with Ed Altman and Tom Ho. Their dispassionate and informed observations were critical in maintaining theme and focus.

Not surprisingly, Peter L. Bernstein’s name appears several times in this book. It is PLB who continues to ennoble the challenges of global stewardship. He is inspiration personified. His work and writing have enriched us all.

We selected John Wiley & Sons as our publishing partner because we had been well served by them with our previous books. Emilie Herman, Kate Wood, and Michael Lisk exceeded our expectations.

During our work on this book we were frequently reminded that recreation and communion with our life partners would enhance our productivity. Thank you, Carol and Beth. We are blessed for your loving reminders. And for the fun.

Editorial Advisory Board

The development of this book was funded by Farragut, Jones & Lawrence, Inc. FJL underwrites the writing of reference sources for institutional investors. FJL also advises about best practices in fiduciary oversight.

Keith Ambachtsheer, CFA is director of the Rotman International Centre for Pension Management at the University of Toronto, and is an adjunct professor of finance at the Rotman School of Management. He is founder and president of KPA Advisory Services in Toronto, which provides strategic advice on governance, finance, and investment matters to governments, industry associations, pension plan sponsors, foundations, and other institutional investors around the world. He is also a co-founder of CEM Benchmarking Inc., which monitors the organizational performance of pension plans around the world. He is the author of three books about pension funds and a frequent contributor to the Financial Analysts Journal, for which four of his articles were awarded the Graham and Dodd Award for excellence in investment writing.

Doug Harman, CFA, CPA is the president and chief compliance officer of Harman Investment Advisors Inc. He is a certified public accountant and a chartered financial analyst. He has served on the examination committee of the CFA Institute. He has also served as president and director of the CFA Society of Chicago. In addition, he has been director of the Financial Analysts Federation, as well as governor of its successor organization, the CFA Institute.

Robert L. Hagin is the CEO of Hagin Investment Management in New York, which provides quantitative asset management to institutional clients and qualified individual investors. He is a 35-year veteran of the industry, and pioneered the use of computers in investments and finance. He is the author of five books about portfolio management, the most recent of which was Investment Management:Portfolio Diversification, Risk and Timing (Hoboken: Wiley). He has led investment and research teams at Kidder Peabody, Miller Anderson, and Sherrerd, and was executive director at Morgan Stanley Investment Management. He has been an editorial advisor to the CFA Institute and to IMCA. He is a founding member of Q-Group, past president of the New York Society of Quantitative Analysts, and a former professor at the Wharton School. He holds a PhD from UCLA.

Junius Peake is emeritus professor of finance at the Monfort School of Business at the University of Northern Colorado. He is an acknowledged pioneer in the development of clearing and settlement processes. A Wall Streeter for decades, he was one of the first proponents of using computers to execute trades. He served on the original CUSIP committee that standardized the identification of securities. He is former vice chairman of the NASD. He was one of the original advocates for the decimal pricing of U.S. securities transactions. He is a frequent speaker and writer about trading infrastructures and regulations.

Robert A. Schwartz is the Marvin Speiser University Distinguished Professor at the Zicklin School of Business at Baruch College of Business of the City University of New York. In 1995, he was named the first chairman of Nasdaq’s Economic Advisory Board of Business and served on that board until 1999. He is a member of the advisory boards of several journals including the Journal of Trading. He is the author of 15 books, including The EquityTrader Course with Reto Francioni and Bruce Weber (Hoboken: Wiley). He and Bruce Weber also developed the trading and market structure simulation, TraderEx (etraderex.com). He has served as consultant to Nasdaq, the NYSE, and Deutsche Borse. He holds a PhD from Columbia University.

Donald B. Trone, AIFA is president of the Foundation for Fiduciary Studies. He was a founding principal of fi360. He is an acknowledged innovator in defining and developing leadership protocols and fiduciary practices for prudent investment decision makers. He is the author of five works about fiduciary legal and ethical challenges and the oversight of investment managers, including The Management of Investment Decisions (New York: McGraw-Hill). He is a graduate of the U.S. Coast Guard Academy, and served as a helicopter search-and-rescue pilot in the Coast Guard. He earned a Master’s degree in financial services from the American College.

James W. Ware, CFA is managing partner of Focus Consulting Group. Focus Consulting Group helps financial leaders understand and leverage their firm’s culture for competitive advantage. He is the author of several books on leadership, the most recent of which is Key Behaviors of High Performing Investment Teams (Hoboken: Wiley). He is on the advisory staffs of Institutional Investor and the CFA Board of Regents. He has taught at Northwestern University’s Keller Graduate School of Management. He writes a quarterly column for the CFA website: “Firm Success: Leading the Investment Firm.” He earned an MBA from the University of Chicago.

In reality, knowledge is a very dynamic universe—and what is most valuable is not the body of knowledge but the leading edge of it.

—Bill JamesBaseball Historian

Introduction

A Sea of Changes and Waves of Opportunity

Jacqueline Charnley andChristine Røstvold

The 2008 financial crisis roiled an already-turbulent environment. The authors review major elements of that pre-crisis turmoil as fiduciaries and asset managers confront their stewardship challenges. As John Minahan of New England Pension Consultants observes in Chapter 23 of this book, “In rapidly changing times it is especially valuable to examine one’s beliefs in light of theory, evidence, and alternative points of view.”

The decline of capital and credit markets across the world in 2008 and 2009 profoundly changed the landscape for institutional investors, but the obligations and commitments remained the same. The magnitude of change in the institutional investment industry continues to accelerate, creating a sea of challenges and waves of opportunities for investors, consultants, and investment managers alike.

In 1980, total pension assets were less than $1 trillion. According to Watson Wyatt, the world’s 300 largest pension and investment funds grew to $12 trillion as of 12/31/07. But 2008 turned the investment world upside down. Let’s compare and contrast the change from December 31, 2007 to December 31, 2008.

As of December 31, 2007, at least 12 firms reported that they managed more than $1 trillion, including one firm that managed over $2 trillion. December 31, 2008 showed the severe impact of the market declines. None of us would have imagined that Bear Stearns, Lehman Brothers, American Insurance Group, or Merrill Lynch would be out of business or purchased by competitors. The $50 + billion fraud engineered by Bernard Madoff took everyone by surprise, including the Securities and Exchange Commission (SEC) and industry experts. See Exhibit I.1.

EXHIBIT I.1 Assets Under Management (in $T)

Sources: Nelson Marketplace, directly from managers, managers’ websites, published articles, Watson Wyatt’s The World’s 500 Largest Asset Managers Year End 2007.

Institutional investors now face even more complex issues in managing their investment programs, achieving risk/return objectives, and meeting their actuarial assumptions, or payout and income needs. Investment managers face unprecedented needs to cut expenses and reduce staff, fierce competition, deeper scrutiny, and cumbersome, likely increased regulatory requirements. At the same time, investors and managers alike benefit from new asset-allocation tools, an abundance of innovative investment instruments, breakthroughs from academia, technology and mathematical science, and globalization. Debates over benefits, necessary regulations, reporting requirements, transparency, correlations, and costs abound. Opportunities are emerging from the collective efforts of governments around the world, as well as private sectors working together to resolve the 2008- 09 financial crisis. We face a whole new world.