June 2008 CFA Institute Annual Conference InsIde ... Documents/Newsletter/CFA...seller Freakonomics,...
Transcript of June 2008 CFA Institute Annual Conference InsIde ... Documents/Newsletter/CFA...seller Freakonomics,...
June 2008InsIde:
edItor’s note . . . . . . . . . . . . . . . . 2
PresIdent’s Letter . . . . . . . . . . 3
CFA ConFerenCe FeAtures: unobserved Incentives & the Impact of economics on daily Life . . . . . . . . 4
Impact of the Highly Improbable: randomness & Black swan Blindness . . . . . . . . . . 8
Investment tHeme: this is Your Brain on the market . . . . . . . . . . . . . . 5 – 7
IndustrY deveLoPment: Global Integration and Growth of Global middle Class during the next 25 Years . . . . . . . . . . . . . 10
uPComInG events . . . . . . . . . 10
memBer rePort . . . . . . . . . . . . 11
CFA Victoria members Millie Chow, CFA, (left) and Vicky Ng, CFA, (right) warm up to the spirit of the
2008 CFA Institute Annual Conference in Vancouver.
“You can’t reward people for making bad eco-nomic choices.” Steven Levitt discusses incorrect assumptions about causations and correlations and how economics often disproves conventional wisdom. Presentation synopsis on page 4.
Published by CFA Victoriawww.cfavictoria.com
CFA Institute Annual Conference vancouver 2008
Nassim Nicholas Taleb hits his stride as he expounds upon the pitfalls related to statistical techniques and financial modeling in estimating risk. Presentation synopsis on page 8.
opinions expressed in the CFA victoria newsletter do not necessarily represent those of the authors’ firms of employment or of CFA victoria and do not constitute a solicitation for the purchase or sale of any financial instruments . Information herein is obtained from various sources and is not guaranteed for accuracy or completeness . the authors’ firms and CFA victoria there-fore disclaim any liability arising from the use of information in this publication .
newsletter
Do you have a story idea or a topic that will interest and inform CFA Victoria members? Send an e-mail to let us know what you would like to see in the newsletter or if you want to write something yourself.
Potential topic areas include, but are not limited to:• Industrydevelopments• Investmentthemes• Profilesofnotablemembers
Ifyouhaveanideaforanarticle, please send it toGord Walker, [email protected]
editor’s noteGord Walker, CFA
Welcome to the inaugural issue of the CFA victoria newsletter . this issue is a milestone for CFA victoria . the society has grown to where it can now regularly provide such a report to members and others, al-lowing them to become more aware of CFA victoria’s goals and activities . I hope you enjoy reading this first effort and all of our subsequent issues .
the launch of this newsletter fortuitously coincided with CFA vancouver hosting the 2008 CFA Institute Annual Conference, whose theme was Connecting theory and Practice: Investment management in the Global economy . Given the added interest of this year’s Conference being held just a short float-plane ride away, this issue of the CFA victoria newsletter prominently features material from the Conference . We have two CFA Conference features, provided by Philippe monier, CFA, and vicky ng, CFA, who at-tended . the first is Philippe’s synopsis of the presentation by the Conference’s opening speaker – steven Levitt of Freakonomics fame . the second is vicky’s synopsis of nassim nicholas taleb’s presentation on the Impact of the Highly Improbable: randomness and Black swan Blindness . Both speakers were a pleasure to listen to, enlightening and entertaining, and Philippe and vicky have each done a fine job of capturing the spirit and content of these sessions for you to enjoy .
A common thread that ran through Levitt’s and taleb’s presentations is that neither of them seemed to have much faith in homo economicus – that rational, perfectly informed, and self-interested individual who is the theoretical cornerstone of conventional economic and investment theory . Following this thread a little further, this issue’s Investment theme examines how flesh-and-blood investors really make decisions and explains some of the biological underpinnings of innate cognitive functions that shape our decision-making processes . We thank the toronto CFA society for allowing us to reprint this article by Anne maggisano, this is Your Brain on the market, from its newsletter, the Analyst .
much of the groundwork necessary to launch the CFA victoria newsletter was done by CFA victoria board members Chelsea Kittleson and Landon downs . they each exemplify how volunteers can best give back to the profession and the community, and I thank them for their efforts .
Wrapping up, I’d like to say how much I personally enjoyed attending the CFA Institute Annual Confer-ence in vancouver and how impressed I was with the character of the individuals I spoke to there, evi-dent in their knowledge, intelligence, and commitment to enhancing our profession . the CFA charter is not a credential easily earned, but charterholders can deservedly take pride in belonging to a select group whose membership is based on merit and integrity . In a small way, the CFA victoria newsletter is intended to help CFA victoria members benefit more fully from the privilege of belonging to this com-munity and enable others to better understand what the CFA designation represents .
Share your knowledge and insights with readers of the CFA Victoria Newsletter
Newsletter June 2008
2
President’s LetterAnna nemeth, CIm, CFA
In 1997 CFA victoria was founded, with just 14 members, as a Chapter of the vancouver society of Financial Analysts . today we have our own society, which has grown to 80 members . to guide the future development of CFA victoria, our board of directors recently developed the society’s first strategic plan to lead CFA victoria to 2012 and beyond . our mission is to
1 . Promote professional excellence and the highest ethical standards
2 . support society members and CFA candidates through informative, relevant education, and networking opportunities
3 . Build awareness of the CFA Charter within the local community
In keeping with this mission, CFA victoria has held many events over the past year where attendees had the opportunity to hear interesting and highly qualified speakers discourse upon various financial issues . Andrew shortreid, vice President and Program Chair, has done a wonderful job organizing these events, which altogether represent six hours of Professional development (Pd) credits . notable among the speakers was noreen Harrington, the whistle-blower who tipped off new York Attorney General eliot spitzer to illicit trading in mutual funds in 2003; noreen captivated attendees at both our CFA victoria Candidate reception and our Christmas dinner/Charter Award Ceremony .
We have also sought to raise the profile of the CFA designation and of CFA victoria . Jeff Good, Pub-lic Awareness Chair, and Chelsea Kittleson, education Chair, have both been instrumental in this . A highlight of our public awareness campaign is the society’s sponsorship of the arts in victoria through the victoria symphony, Pacific opera of victoria, the victoria operatic society, and the Belfry and the Langham Court theatres . CFA victoria is also lead sponsor for two upcoming shows at the Art Gallery of Greater victoria .
on the educational side, Chelsea has organized information sessions at uvIC for CFA candidates as well as the Boston mock exam for candidates wishing to confirm their ‘battle-readiness’ a month before the actual CFA exams . Furthermore, she has administered our scholarship program through which we award up to 10 scholarships to worthy candidates each year .
Financially, CFA victoria is on solid footing . We thank our treasurer, trent moore, for keeping us well within budget and in a surplus position . revenues from job postings and from annual dues are the two biggest contributors to our earnings .
Jeffrey Hamel, our membership and technology chair, has been key in getting our new and improved CFA victoria website launched (www .cfavictoria .com) . moreover, during his tenure the society member-ship has grown by 14% and we are now striving for 100 members within the next three years .
CFA victoria’s success has come through the hard work and countless volunteer hours of our current and past boards . I am fortunate to have had the privilege of working with such enthusiastic, creative and dedicated individuals during my six years of involvement with the society . Leaving our board this year are Chelsea Kittleson and Landon downs, both of whom have contributed much to the society . I thank them on behalf of our board and our members . In addition, I offer special thanks to sue-Anne Fimrite, Past President, who has been involved with the board since inception and has contributed hundreds of volunteer hours over the past 11 years . We will miss her energy and effervescence .
In closing, I urge all members to consider volunteering to help CFA victoria better serve our members and fulfill our mission . Participating on a society committee is a good way to expand your network with-in the financial community and enhance your career opportunities . We are always looking for members willing to contribute some of their time, energy and ideas . Please contact me at anna .nemeth@td .com if you would like more information on how you can help .
NewsletterJune 2008
3
steven d . LevItt, CoAutHor oF the best-
seller Freakonomics, and dubbed “the Indiana
Jones of economics” by the Wall street
Journal, was opening speaker at the CFA
Institute Annual Conference in vancouver on
may 11, 2008 . director of the Becker Center
on Chicago Price theory at the university of
Chicago, Levitt is noted for his pioneering
work on natural experiments in econom-
ics . A witty and entertaining presenter who
analyses economic activities with a somewhat
disconcerting approach, there is little doubt
that he entertains his students while educat-
ing them in his brand of economics .
Levitt began by illustrating the value of
incentives, telling the story of an Inter-
nal revenue services employee, John
szilagyi, who was struck by the odd
names of children listed as dependents
on tax returns – names such as “Fido” .
szilagyi suggested in the early 1980s that a
social security number be required for each
child claimed on the tax form, but it took five
years and considerable persistence on his
part before the change was implemented .
After the change, a sudden ‘disappearance’
of some seven million children in the u .s .
occurred, obviously children invented for
the purpose of cheating on income tax . this
simple innovation championed by szilagyi
saved the government roughly $2 billion
a year from fraudulent claims, but the only
reward he eventually received was a $25,000
bonus .
one lesson from this story is that incentives
strongly influence not only the decision to
cheat, but also the generation of ideas . thou-
sands of Irs employees over several decades
could have had the same insight as szilagyi,
but in a situation where initiative and change
were not valued they had little incentive to
act on such an idea . Another lesson is that
while ideas seem scarce, even breakthrough
ideas are easy to find if you really look . Levitt
stated, though, that one often needs to “fight
through conventional wisdom” .
Levitt explained that he is not the kind of
economist who makes big statements on
how the world works, and claimed that many
economists today are actually less interested
in the economy than in math . A Harvard
graduate and a Ph .d . in economics from mIt,
he surprisingly admitted to being poor in
mathematics himself, relying in his work on
not much more than a good knowledge of
economics .
explaining why his career took the path it has,
Levitt said his father advised young steven
to follow his example and concentrate on
what steven was good at . Levitt senior was a
medical doctor who specialized in medicine
regarding intestinal gas, an area where he
expected little competition . ultimately, he
became a top-ranked specialist in that area .
taking his father’s advice to heart, steven
Levitt concentrated on the empirical study of
the stuff and riddles of everyday life, and his
conclusions regarding these matters regularly
turn conventional wisdom on its head . In this
area, now sometimes referred to as Freako-
nomics, Levitt expected little competition
among economists!
to give an example of the sort of questions
that interest him, Levitt told the story of a
man who started a business selling dough-
nuts in company offices . trusting people
to be honest, in each office he left a box of
doughnuts with a price list and a locked box
in which people paid . most people liked the
service and paid honestly, so the business was
a success with net annual revenues of some
$100,000 in the 1980s . the entrepreneur then
offered Levitt a mass of data on his business,
which he had conscientiously recorded each
day for 15 years, asking if Levitt could find
ways to improve the business . Levitt then
built a model to optimize profitability,
but his complex algorithm showed that
he could improve net revenues by, at
best, $200 a year!
during the process, though, Levitt dis-
covered that this business operator had
raised prices only four times in those 15 years .
Levitt thought that although the business
model was good, the operator was probably
under-pricing . While the operator had daily
feedback on the quantities of doughnuts he
should supply at each location, he had little
feedback on how customer demand reacted
to price changes . Without empirical data, his
ability to confidently make pricing decisions
was limited .
Levitt said that since the publication of
Freakonomics, other business leaders had
asked him for advice . He generally was happy
to provide his services … for free … the
only condition being that these businesses
allow him to use the data he collected for his
published research . However, the impact of
his efforts has not always been as productive
as it could be .
unobserved Incentives and the Impact of economics on daily LifePhilippe monier, CFA
Continued on page 9.
CFA ConFerenCe FeAtures
If you give people bad incentives, then things go wrong.
Newsletter June 2008
4
this is Your Brain on the marketBy Anne maggisano, CIm Reprinted from The Analyst, March 2008, courtesy of the Toronto CFA Society.
“Man will become better when you show him what he is like.” – Anton Chekhov, as quoted by Steven Pinker in The New York Times Magazine (January 13, 2008)
Continued on next page.
Investment tHeme
tHe ImPACt And sCoPe oF evolutionary
psychology is hard to ignore these days .
In the popular press, the new York times
magazine recently featured an article by
steven Pinker as its cover story, arguing that
human morality must be understood to have
a biological cause . If this isn’t indicative of a
move to the mainstream, then one only has
to look to the institutional bastions of finance
to understand how what was at one time a
controversial topic has now become
the norm . Harvard university offers an
annual education course for executives,
“Investment decisions and Behav-
ioural Finance,” designed to illuminate
how our human decision-making
process can be applied to the invest-
ment context . the most prestigious of
finance institutions, CFA Institute, chooses to
offer their “efficient markets and Behavioural
Finance” webcast program for free on their
web page . our very own toronto CFA society
re-invited terry Burnham, author of mean
markets and Lizard Brains: How to Profit from
the new science of Irrationality, to speak for a
second time at a luncheon seminar in January
of this year .
this article reviews developments in the
realm of cognitive psychology and their
implications for our understanding of market
efficiency . specifically, it demonstrates how
our individual and collective decision-making
processes provide a mechanism to explain
how and why markets become inefficient
for periods of time . through understanding
the mechanism of irrationality, investors can
profit in two ways . First, by learning how to
systematically manage their own individual
decision-making biases . second, by identify-
ing opportunities that arise when capital mar-
kets become inefficient due to widespread
biased decision-making .
Involuntary decision-making
Functional mrI neuroimaging studies show
that much of our decision-making is low-level
processing, occurring in the oldest parts of
the brain from an evolutionary standpoint:
the limbic system, basal ganglia and brain-
stem . these low-level processes are designed
to pick up regularities in the environment
unconsciously and automatically, without our
control or awareness of them . For example,
daniel Levitin in his book this Is Your Brain on
music summarizes how this part of the brain
detects and processes the meter, pitch, and
loudness of a song instinctively, motivating
our assumptions about the song even before
higher-level cortical areas that are involved in
knowledge, cognition, and memory become
involved . For investors looking at stock mar-
ket price fluctuations, the hard-wiring in our
brain unconsciously recognizes patterns such
as rising prices, motivating our conviction
that future prices will follow that trend . the
brain continuously updates its expectations
about the future, taking immense satisfaction
(an emotional response) when the real world
matches our predicted expectations .
In fact, scientists have discovered that our an-
ticipation or expectation of a reward (i .e . that
stock prices will go up) activates the nucleus
accumbens, the part of the ancient brain that
mediates pleasure and positive well-being
through the neurotransmitter dopamine . this
sets up a positive feedback “reward system”
whereby past performance sets up expecta-
tions that the trend will continue, activating
the release of dopamine into the nucleus
accumbens and creating emotions of excite-
ment, pleasure, and greed . For example,
when we buy a lottery ticket or a stock that
we believe is a clear winner, the possibility of
financial gain activates the reward sys-
tem even without the outcome of win-
ning the money . moreover, if in fact we
do make money, we will become more
excited about the possibility of making
money again and we will be more likely
to re-create the conditions that entail
the possibility of making money again .
many things other than money that are found
rewarding also work through this positive
feedback system: beautiful faces, exercise,
food, the anticipation of narcotics . Because
the greed and emotion from this reward sys-
tem lies below our level of awareness, it drives
our behaviour without any involvement of
the higher cortical areas of the brain that are
intimately involved in conscious cognition .
there is a second system that is implicated
in our unconscious decision-making: the
loss-avoidance system . once we understand
that our ancestral brain is designed to detect
regularities in our environment, we can
conceive how it is equally responsive to any
change in that environment because change
could signal imminent danger . For example,
Many things other than money that are found rewarding also work through this
positive feedback system: beautiful faces, exercise, food, the anticipation of narcotics.
NewsletterJune 2008
5
when we predict that a stock price will con-
tinue to follow its upward trend, but it in fact
reverses direction, our brain senses the break
in trend and activates that part of the brain
that generates our emotional responses of
fear and anxiety (the amygdala) . once again,
it is the anticipation that something bad will
happen—the pain of loss—that guides our
intuitive response to flee, whether that be
running away from a lion, or selling a stock
immediately . Implicated in the loss-aversion
system is the release of noradrenaline from
the locus coeruleus, a hormone that leads
to the panic reaction that can shut down
other systems, including the frontal cortex .
once again we can see that contrary to what
we would expect, it is our primal base-level
responses that are driving our behaviour, and
they operate somewhat independently of
our higher cognitive levels of thinking and
rational decision-making .
Collective decision-making
these studies have been extended to
understand how individuals make decisions
in the context of a large group . the most
well-known study of social conformity and
social independence was performed in the
1950s by solomon Ash . Individuals are asked
which line (A, B, or C) is equal in length to line
X . most people choose the correct answer A
when they are asked on their own . However,
when positioned in a group setting where a
significant proportion of the members are
primed to give an incorrect answer, that same
individual will change his/her answer to con-
form to the group norm .
Friday July 11, 2008
Olympic View Golf Course(www.golfbc.com/courses/olympic_view)
Golf (including cart) and dinner$125 (CFA Victoria Members) and $150
(non-Members), Dinner only: $40Ifyourcompanywouldliketosponsorahole,
the cost is $100(Prizes are encouraged as well)
Please contact Charles (see below) for more information
First tee-off time is 12:00, last tee-off time will be approximately 14:00
Texas Scramble formatPrizes for Best score, Worst score,
Closest to the pin, Longest drive, etc.BBQ dinner starts at approximately 6:00pm
To reserve, please send the following information as soon as possible to:
GOLF TOURNAMENTAttn: Charles Volkovskis
Email: [email protected], Fax: (250) 387-7874
Name, Company Society Member: Yes/No
Club Rentals: Yes/No Skill Level: Good/Average/Bad
Special Requests: foursome, tee-time, etc.
Make cheques payable to: CFAVICTORIA
Forward to: Charles Volkovskis
bcIMC,3rdFloor,2940JutlandRoad,Victoria, BC, V8T 5K6
“This is Your Brain on the Market” continued from page 5.
CFAVICTORIA
12th Annual Golf Tournament
Continued on next page.
Investment tHemeNewsletter June 2008
6
Gregory Burns extended this study to deter-
mine if social conformity, or agreeing with the
group even when the group is incorrect, is a
result of conscious decision-making . using
functional mrI technology to map the brain,
he discovered that social conformity does
not result in activation of the cortex and
hence is not a result of conscious decision-
making . more significantly, social conformity
activates the regions of the brain involved in
instantaneous perception, suggesting that
our perception can be altered by social influ-
ences . In contrast, social independence from
the group, or standing up for one’s beliefs in
the face of group opposition, activates the
amygdala—that region of the brain that is
involved in the emotion of fear and the
activation of the loss-aversion system .
these studies suggest that social
conformity is once again an instinctive
process, mediated either by an uncon-
scious change in our perception or an
aversion to the fear response and the
potential for pain .
How does our decision-making affect
market efficiency?
under conditions of market efficiency, the
market price of an investment reflects an
unbiased estimate of its value . For practical
purposes, what this means is that investors
are unable to consistently and systemati-
cally beat the market and the best course of
action is to choose indexation over active
management . However, there are moments
when markets display inefficiencies—most
noticeably during speculative bubbles and
crashes—and investors can choose to exploit
these moments for profit .
one explanation for how market efficiency
comes about is put forward by William sharpe
and michael mauboussin among others as the
“Wisdom of Crowds” approach . the Wisdom
of Crowds theory of market efficiency argues
that there are three necessary and sufficient
conditions under which markets are efficient:
diversity, aggregation, and incentives . A
market is efficient if it is cognitively diverse,
if there is a method by which to bring the
information together, and if there are incen-
tives for being right . However, if one of these
three conditions breaks down, then markets
become inefficient .
Accepting the assumptions of the Wisdom
of Crowds theory, the results of behavioural
finance threaten market efficiency at the level
of diversity . more specifically, as mauboussin
points out, it is not the irrational behaviour of
individuals that threatens market efficiency,
but rather the behavioural tendencies for so-
cial conformity that are implicated in market
inefficiencies . this view is also expressed by
William sharpe, nobel prize winning econo-
mist: “the basic argument [of the Wisdom
of Crowds] is that if we have enough people
even though they may be ill-informed and
irrational coming to market, it is entirely pos-
sible the prices of assets, thereby true risks
and rewards, are what you would get if they
were all rational and well informed .”
What this means is that investors must look
for signs of behavioural social conformity in
the marketplace as an indicator for market
inefficiency . such signs can appear in the
popular press and/or in the markets them-
selves and take the form of extreme bullish-
ness or bearishness, or sentiments of fear and
greed . In learning to locate social conformity,
one can take advantage of investments that
are priced below their intrinsic value .
How can individuals become
better investors?
the evidence of behavioural studies of
decision-making suggests that humans
generally behave in a sub-optimal manner
when it comes to investing . the studies show
that, broadly speaking, decisions are made
unconsciously in reaction to our hard-wired
tendencies to look for regularities in our
environment and create expectations based
on those patterns or on violations of those
patterns . moreover, our perception of our
environment is unconsciously influenced by
the group context in which we are placed
either out of fear of independence, or
by a change in perception .
studies of our behavioural tendencies
argue implicitly that investors must
put policies and procedures in place
by which to counteract our human,
instinctive drive to act based on sub-
optimal decision-making . For example, one
must objectively calculate the full spectrum
of outcomes for an investment in order to
counteract our instinctive belief that past
trends will continue into the future . Also, it is
imperative to create a list of stocks to buy at
low prices in order to counteract our instinc-
tive drive to sell at market bottoms . third, one
must insulate oneself from daily fluctuations
in market price in order to prevent oneself
from making investment decisions based on
price instead of value . Finally, one can favour
long-term decision-making to counteract
short-term emotional responses . the number
of behavioural modifications to counteract
our instinctive tendencies is endless; however,
by putting into place systematic procedures
to override these tendencies, we may become
better investors .
“This is Your Brain on the Market” continued from page 6.
Investors must put policies and proce-dures in place by which to counteract
our human, instinctive drive to act based on sub-optimal decision making.
Investment tHeme NewsletterJune 2008
7
over tHe PAst 12 montHs a number of
events have rocked the financial markets,
and how many of us can honestly say that
we clearly anticipated such incidents or their
severity? speaking at the CFA Institute Annual
Conference in vancouver on may 12, nassim
nicholas taleb explained why extreme events
are hard to predict and why these events
often have catastrophic impacts . Currently a
visiting professor at London Business school
and formerly dean’s professor in the sciences
of uncertainty at the university of massachu-
setts, Professor taleb is the author of Fooled
by randomness and more recently the Black
swan: the Impact of the Highly Improbable,
two highly regarded books that discuss, often
through anecdote, taleb’s thoughts on how
uncertainty works .
In his presentation, taleb explained that the
central problem concerning extreme events
is that the smaller an event’s probability, the
larger our sample set must be to reliably
estimate that probability, and as the probabil-
ity becomes smaller the more consequential
the impact of any error in estimating it will
be on the magnitude of the actual outcome .
Investors and others in the prediction busi-
ness have to be conscious not only of the
uncertain probability of extreme events, but
also the uncertain magnitude, good or bad,
of these events . How, he asked, do analysts
justify labelling something a 1-in-10,000-year
event when their sample sets cannot cover
nearly so long a time period? His answer:
purely from theory .
Mediocristan vs. Extremistan
modern portfolio management often uses
statistical theory based on the Gaussian
distribution (the normal distribution) to
forecast event probabilities . taleb believes
such theory is valid only in situations of “mild
randomness”, a world he calls mediocristan .
For example, adding one additional data
point to a reasonably large sample set of hu-
man heights will probably not greatly change
the distributive properties of the set because
extreme human heights are not that far from
the mean . In contrast, adding the annual
income of the world’s richest person to a
random sample set of the incomes of 10,000
people would change the sample distribution
considerably . In other words, in some cases
a small number of occurrences can account
for a large proportion of the total outcome .
Another example is that there are about
267,000 drugs available on the market, but
only 5% of all drugs account for most of the
profits of pharmaceutical companies . taleb
provided further examples, pointing out that
tail distributions dominate the likelihood of
social and economic events . these situations
belong to another world, one that taleb
calls extremistan . He warns that there is no
reliable structure in the probability distribu-
tions of extremistan .
taleb believes that statistics and probabil-
ity estimates are irrelevant in forecasting
extreme events and our world is shaped by
the dynamics of extremistan . Although most
people rely on past experience (i .e . data from
previous periods) to forecast the future, past
extreme probability distributions – gener-
ally referred to as tail distributions – are
not indicative of future extreme probability
distributions: previous outliers do not predict
future outliers .
to illustrate the difficulty in more worldly
terms, taleb compared the characteristics
of government change in Italy and in saudi
Arabia: the Italian government changes fre-
quently and somewhat unpredictably (high
volatility), but each change has relatively little
impact; the saudi government changes very
little (low volatility), but a change in govern-
ment could have a severe impact in many
ways (consider the 1979 revolution in Iran) .
Prognosticators also suffer from the fallacy of
single event probability . events in extremistan
do not follow a typical pattern . one might
successfully predict the occurrence of an
event yet be totally wrong about the form
that the event actually takes . An example
of this was the confidence of many knowl-
“I shiver at the thought that something fails.”
the Impact of the Highly Improbable: randomness and Black swan Blindnessvicky ng, CFA
Nassim Nicholas Taleb
CFA ConFerenCe FeAtures
Continued on next page.
Newsletter June 2008
8
edgeable people in 1914 that a few weeks of
limited battle would be enough to decide the
outcome of what tragically became the First
World War .
taleb stated that we therefore need to
consider two layers of stochasticity – one re-
garding event occurrence and one regarding
an event’s impact . even if we could reliably
predict the probability distribution of an ex-
treme event, it will remain difficult to predict
the event’s consequences .
moving on to discuss financial institutions, ta-
leb said that the global banking system used
to look like the governance situation in Italy,
but now looks more like that in saudi Arabia
– “I shiver at the thought that something fails” .
As the banking network (and other networks
such as power transmission grids) comes to
consist of fewer but larger entities, there will
probably be fewer and fewer small shocks
(e .g ., bank runs), but network effects due to
concentration and nonlinearities could make
large, infrequent shocks more consequential
than in the past .
Hedge fund returns are a case of life in
extremistan . A problem in the hedge industry
cited by taleb is that a steady stream of
positive returns (suggestive of an option-writ-
ing strategy) can be suddenly followed by a
suddenly ruinous negative return . one cause
of this problem is the difference between
the time scale used for manager compensa-
tion and that needed to realistically analyze
performance data – a hedge fund manager
will be well compensated during the steady
performance periods, but when disaster
strikes investors could lose all their profits
even though the manager keeps any bonuses
based on previous gains . taleb believes that
many investors expose themselves to such a
hazard because they do not understand the
nature of risk . For example, some people fail
to recognize that exposure to a 1-in-30-year
event is still risky even if their exposure lasts
for only 15 years .
during Q & A, taleb prescribed the use of
qualitative methods in extremistan to avoid
the pitfalls of black swans and wonders why
anybody would rely on a single number to
measure risk, especially one already proven
to be a poor measure . He also reminded the
audience that black swans can have a positive
impact, but cautioned that good black swans
usually happen over time while bad black
swans tend to go “Boom!” .
“The Impact of the Highly Improbable: Randomness and Black Swan Blindness” continued from page 8.
“Unobserved Incentives and the Impact of Economics on Daily Life” continued from page 4.
In one case, a consumer electronics company
approached him for marketing advice . For a
long time, this company had used both tv
advertising three times a year and full-page
ads in sunday newspapers every week in
each major newspaper market . Consultants
brought into investigate the effectiveness of
this advertising had reported a high correla-
tion between sales and the tv advertising,
but found that the newspaper advertising
was much less effective . Levitt was suspi-
cious of these findings and found that the tv
advertising had coincided with dates such
as Christmas and Fathers’ day when sales are
higher than normal regardless of advertising .
In other words, the consultants had confused
correlation with causality .
Levitt suggested testing the newspaper
advertising effectiveness through an experi-
ment where the company would stop adver-
tising in selected markets and compare sales
in those markets with sales in markets where
the ads continued . the company refused to
do this, since the local salespeople in the first
set of markets would be up in arms if news-
paper advertising was interrupted . Interest-
ingly, Levitt found that such an ‘experiment’
had been done inadvertently: an intern’s
mistake had led to no newspaper ads in the
Pittsburgh market for three months – without
any noticeable impact on sales . despite this
evidence, which Levitt felt warranted a more
thorough test, the company continues to
advertise in the sunday papers every week
without knowing if this is a total waste of
money . such is the battle against conven-
tional wisdom!
during the Q & A session, Levitt was asked
what incentives the government should
provide to prevent the sort of problems that
have damaged the Cdo and credit markets
since last summer .
After commenting on various aspects of this
issue, stating that “if you give people bad
incentives, then things go wrong”, he opined
that a government bailout is the worst thing
to do since “you can’t reward people for mak-
ing bad economic choices”, drawing applause
from the audience .
NewsletterJune 2008
9
WARHOL: Larger Than Life Art Gallery of Greater victoria CFA Victoria – lead sponsor
Exhibition may 30 to August 24, Gallery Hours
Reception and Mixer Friday, July 11, 8:00pm
one of the major artistic innovators of the 20th century, Warhol’s fame spread well beyond paint-ing and printmaking . Filmmaker, sculptor, author, collector, publisher, provocateur, music producer, celebrity—Warhol understood and negotiated the ride of fame, a sophisticated arbiter and ma-nipulator of popular culture and fashion .
Warhol: Larger than Life is an expansive project of over 150 paintings, drawings, prints, sculptures, photographs, archival ephemera and films span-ning some four decades of production . Work-ing directly with the Andy Warhol museum in Pittsburgh, PA, the Winnipeg Art Gallery enjoyed full access to its considerable collection of art and archives in organizing this exhibition .
CFA Victoria Annual General Meeting monday June 9, 4:30pm BC Investment management Corporation Boardroom 3rd Floor, 2940 Jutland road, victoria, BC
rsvP: Anna nemeth @ 356-4098 or anna .nemeth@td .com
CFA Victoria hosts Lunch with Westport Innovations Corporate Presentation Late June, check CFA victoria website for details
since 1995, Westport Innovations has engaged in the research, development, and marketing of high-performance engines and fuel systems which use gaseous fuels such as compressed natural gas (CnG), liquefied natural gas (LnG), hydrogen, and hydrogen-enriched compressed natural gas (HCnG) .
For more information on Westport Innovations, go to www .westport .com
CFA Victoria 12th Annual Golf Tournament Friday July 18 olympic view Golf Course See page 6 for further tournament details.
Moss St. Paint-In CFA Victoria – lead sponsor July 19
the Art Gallery of Greater victoria’s Annual moss street Paint-In (a not-for-profit event) features invited professional and emerging artists from victoria and region who demonstrate their art to 30,000 visitors walking moss street from Fort street to dallas road . the Paint-In offers visitors an opportunity to meet and discuss the artists’ work and methods and to see an enormous vari-ety of professional work at one time .
CFA Victoria and Polaris Minerals host a Site Visit to the Orca Quarry Company sponsored visit to industrial site for CFA victoria members and Friends
Port mcneil, BC
mid-August, check CFA victoria website for details For more information on Polaris minerals or the orca Quarry, go to www .polarmin .com
Upcoming CFA Victoria Programs, Events and News
At the CFA Institute 61st Annual Conference,
thomas P .m . Barnett, author of the forthcom-
ing book Great Powers: America and the
World After Bush (January 2009), discussed
the dominant trends that will shape the world
during the next 25 years .
In his presentation, Barnett divided the world
into two groups: those regions that have fully
integrated and those regions that have not .
the former group, which has largely recog-
nized the benefits of economic integration
and globalization, includes north America,
europe, russia, Australia, and parts of south
America . the latter group − Africa, the middle
east, and southeastern Asia − has resisted
the benefits of economic integration and
globalization .
According to Barnett, globalization can act
on a regional basis to reduce the number of
countries that have not integrated . For exam-
ple, China could help vietnam emerge from
the gap, whereas Brazil may eventually have
a similar impact on countries like venezuela .
Barnett suggests the united states could
serve as a model in this process because its
states unified out of mutual self-interest to
promote commerce and common security .
Barnett believes that this integration, with its
own regional variations, will be the dominant
dynamic of the next 25 years .
Additionally, the shift will serve as a catalyst
for interesting, unexpected results . For ex-
ample, Barnett believes that the 21st century
could be the most religious in human history .
He argues that as residents of newly integrat-
ing countries begin to lose a local culture − a
culture that may have been substantially
unchanged for hundreds of years − they
will need to find a new basis for a code of
behaviour . According to Barnett, this search
for spiritual guidance will result in greater
religious pluralism in which far more choices
will be available than in the past .
Global Integration And Growth of Global middle Class during the next 25 Years the 21st century will be “the most religious in human history .”
Continued on page 12.
IndustrY deveLoPmentNewsletter June 2008
10
members on the moveLandon n . downs
to macquarie Capital markets Canada Ltd .
landon .downs@gmail .com
Would you like to be included in members on the move?
It’s important to keep your contact infor-mation up to date and let others know where they can reach you .
Please let us know if you’re changing jobs or making any other move . send your information to Gordon .Walker@rBC .com with “members on the move” in the subject line .
CFA Charterholder Information
CFA charterholder 87%
non-charterholder 13%
Industry Classifications
Broker dealer, Investment Banking 11%
Commercial/retail Banking, Bank trust departments 8%
Corporate, Public sponsor & Foundation/endowment 2%
Insurance Company 2%
Investment Company/mutual Fund 23%
Investment management Consulting 20%
other businesses incl . government, academic, misc . 35%
Titles & Occupations
Analyst, equity & Fixed Income 3%
Analyst, other 5%
Ceo, Chairman, Partner, Principal 5%
Chief Investment officer 4%
Investment Banker 2%
Investment Counsellor 14%
Investment Firm manager 3%
Portfolio manager 21%
sales/marketing 7%
securities trader 4%
other 33%
CFA victoria membership ProfileCFA victoria now has 80 members and continues to grow . the following is a breakdown of our
membership by industry and title .
member reportWelcome new membersCFA victoria is pleased to welcome the fol-
lowing new members to our society:
Johann L . Kuntze, CFA
ministry of Finance,
treasury Board
Jill michaela sing, CFA
Hayes stewart Little & Co .
NewsletterJune 2008
11
officersPresIdent
Annamaria nemeth, CFA
vICe PresIdentAndrew P .A . shortreid, CFA
seCretArYLandon n downs
treAsurertrent Karl moore, CFA
Board of directors sue-Anne Fimrite, CFA
Jeffrey Kenneth Good, CFAJeffrey michael Hamel, CFA
Chelsea m . Kittleson, CFAtrent Karl moore, CFA
Annamaria nemeth, CFAAndrew P .A . shortreid, CFA
Committee Chairs ProGrAm
Andrew P .A . shortreid, CFA
eduCAtIon Chelsea m . Kittleson, CFA
memBersHIP & teCHnoLoGY
Jeffrey michael Hamel, CFA
PuBLIC AWArenessJeffrey Kenneth Good, CFA
voLunteer PuBLIC
AWAreness & ProGrAmsPhilippe monier, CFA
CFA victoria promotes the highest stan-dards of integrity, professionalism and ethical behaviour within the investment industry, and encourages professional development through the CFA Program . We facilitate the open exchange of infor-mation and opinions between members of victoria’s investment community .
CFA victoria mission
A Call for VolunteersCFA Victoria depends on volunteers to enable all of our activities and initiatives.
Youcanhelpbyapplyingyourtimeandskillsinanynumberofways.It’sagreatwaytomeetothersinthelocalfinancialcommunityandshowoffyourtalent.
Interested?Ofcourseyouare!ContactAnnaNemeth at [email protected] for more information.
2007 / 2008 CFA victoria Leadership
the Last Wordthe story that I have to tell is marked all the way through by a persistent tension between
those who assert that the best decisions are based on quantification and numbers, determined
by the patterns of the past, and those who base their decision on more subjective degrees of
belief about the uncertain future . this is a controversy that has never been resolved .
Peter L. Bernstein, Against the Gods – The Remarkable Story of Risk
Barnett’s presentation concluded with obser-
vations about China and its future . He noted
that the Chinese phenomenon is only 25
years old . In that quarter century, China has
gained economic experience that took the
united states 125 years to accumulate .
For a country that would otherwise be char-
acterized as an emerging economy, China has
rather unusual demographics, Barnett said .
the country’s one-child policy has resulted
in a population in which males significantly
outnumber females .
Additionally, China’s population is rapidly
aging . Barnett said that by the year 2036,
20 percent of the population of both China
and the united states will be older than 65 .
Whereas it took 64 years for the u .s . popula-
tion age 65 or older to go from 10 percent to
20 percent, the same change took China less
than 20 years .
Barnett noted that, historically, aging societ-
ies are generally nonbelligerent, and when
they also have rising incomes tend to move
toward political pluralism .
Reprinted in part courtesy of CFA Institute.
“Global Integration...” continued from page 10.
NewsletterJune 2008
12