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On the CFA Institute’s “Future of Finance”

All hail the CFA Institute.  They are trying to inject more ethics into the market through their “Future of Finance” initiative.  I largely agree, but think they are overly optimistic in some areas.

Here are their basic ideas:

Here are their dreams:

My main problems are with the dreams.  Yes, I eventually want every investor to work with someone who has a fiduciary interest in his well-being.  But many people don’t want to take the time to find the people who have their best interests at heart.  There are many things we can overcome, but we cannot overcome the laziness of investors, both retail and professional.  This laziness is part of the nature of man; a few cure it through consistent effort, but most don’t.

To that end, some blame belongs to the unintelligent investors who barge into a market without sufficient knowledge.  That’s how it should be, because in many areas of business those that try to compete with insufficient knowledge lose vitality because they don’t know the basics of the business.

You can’t protect people from stupidity.   Fraud is another matter.  Deception is different from dumb agreement.

But here is my main challenge to the CFA Institute: where do your ethics come from? Why are they right?  Are they God-given, or merely an agreement among men?

This matters a great deal, because if it is merely an agreement among men, many men will say, “So what! Why should I listen to you?”  If they are God-given, even if men argue with them, the answer comes back from God, “You are a sinner in many ways, including this.  When will you humble yourself to me, and trust in the sacrifice of my Son, which was the largest event in history?”

Ethics aren’t neutral; people disagree about what is right and wrong to a high degree.  Even in finance, there are considerable disagreements in what is the correct behavior:

  • Active vs Passive mangement
  • Value vs Growth
  • Does Technical Analysis work?  (Is there truly a single discipline there?  I don’t think so.)

That’s a considerable reason why it would be difficult to enforce the views of the CFA Institute over the markets.  There is no commonly agreed-upon view of how the markets work.  The views of the academics are ridiculous, and do not reflect market realities. But many asset allocators trust them, even though their results are poor.

Don’t get me wrong, I largely favor what the CFA Institute is proposing.  I just think it will be hard to turn it into public policy because of the large disagreements over how finance actually works.  Also, the degree to which neglectful parties buy into the markets through the persuasion of sellers, because they won’t look out for their own best interests directly.

So, look at what the CFA Institute is up to.  They are part of the “White Hats” in the market, like me, who argue for the good of investors.  My only difference with them is that their model of the market is not fully accurate.  Nor do they understand how men can err, even with detailed ethics codes.


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3 Responses to On the CFA Institute’s “Future of Finance”

  1. Greg says:

    While I applaud the spirit and intention behind this initiative, I think I am very safe in saying it is destined to fail like earlier CFAI initiatives.

    Back when we called ourselves AIMR, there was a lot more emphasis on “real world” financial practitioners. Not academics, not persons in some kinda-sorta related field. Definitely not lawyers who never set foot in the business school never mind a CAPM course (yes, I agree CAPM has many issues — just saying the lawyers haven’t even looked at the flawed model).

    Its great that some aloof professor wants to assume, for the purpose of this lecture, frictionless trading. No bid/ask spread, no taxes. Its convenient (but wrong) to assume returns are normally distributed — that makes it easy to solve equations without having messy real world considerations discredit the theories on which your teaching career depends.

    Unfortunately (for them), the real world is what matters. The equations, and assumptions behind them, are wrong. Period, end of discussion. They are wrong. Don’t tell us how you think the market “should” work if only these wrong assumptions were somehow valid.

    Academia his indoctrinated so many MBAs into these bad theories that graduates didn’t stop to ask how one could take a bunch of toxic garbage (subprime loans, etc) and swirl them around in a vat and come out with AAA securities. Yes, it works perfectly, in theory (in the classroom). In real life, there are a 1001 caveats — it is not cut and dry, black and white, yes and no simplicity like in the classroom.

    When lawyers and regulators (same thing) get involved, trying to enforce laws grounded in theories that don’t work in the real world — all the sudden regulators start accepting VaR risk measures without understanding all the caveats and assumptions behind them.

    Then the public starts reading about how they “can’t lose” because some whiz-bang Nobel Prize winning PhD has a model that proves stocks or home prices can only go up…

    While the media has portrayed these issues as “ethics” problems or legal violations — they are not really “ethical” issues. The business model is based on a faulty theory, and the salesforce (which doesn’t understand the model or the theory, much less the caveats) goes and sells the PhD’s bogus idea. The theory is wrong; the salesman / broker doesn’t understand that any more than the public does.

    As for improving ethics in the industry … CFAI has a recent history (under Tom Bowman) of trying to ingratiate themselves into cushy high paying regulator jobs. No, John Rogers is not Tom Bowman — but so far Mr Rogers has not acknowledged the elephant in the room.

    Beyond that, I still disagree with one of David’s earlier posts where he says “the industry” hates the public. Some people in finance might hate the public, some (like David?) go out of their way to try to help the public, and the majority fall somewhere in the middle. Painting the entire industry with the same brush is absurd.

    Why doesn’t CFAI try to get more charterholders into CEO positions? Why not get more CFAs onto the boards of directors of major banks / brokerages? In such positions of influence, these CFAs would be able to impose the CFA code of ethics on their organizations (and in some positions, they would have an obligation to do so).

    As far as I know, PIMCO’s Bill Gross is the only CFA charterholder in a CEO position of a major financial firm… and I notice he frequently doesn’t use the designation alongside his name (I am not accusing him of anything, just observing). If there are other major financial firm CEO’s with the designation, they keep it well hidden. And if there are so many CFA CEOs (with the commensurate obligation to follow the code of ethics) — then what is the problem?

    It seems to me the CFAI could have far more influence if they did not paint the industry with one brush. Distinguish between financial professionals who try to help clients (and get those professionals promoted within the industry). At the same time, identify those professionals who short change their clients and minimize their influence (or get them out of the industry).

    I think if we look at the real world, this is not happening. People who gamed the system are in the c-suite, while many people who tried to protect their clients are now “self employed”. CFAI seems rather oblivious to this reality.

    While I support the spirit of CFAI’s efforts, I doubt they will have much impact outside fantasy land.

  2. etaoinshrdlu2 says:

    As a Christian who has worked in the business, it is very good to see another Christian weighing in, evaluating an effort to address the huge issues. My two cents worth, as I see the overall state of things:

    The concept of a meaningful fiduciary standard for a sales-based industry, brokerage, is not going to work. That business model is under severe stress, as the adviser model expands, and if the fiduciary standard cuts into brokers’ revenues, well it just doesn’t compute. The difficulty is that the people who most desperately need to build assets cannot get the time of day from fee-only advisers; it is not profitable enough to serve them and they don’t know anything so they require as much handholding as millionaires. So they are left to people who stick them in load funds, or who are forever pitching them heavily-commissioned, underperforming gimmicky dreck.

    In biblical terms they don’t know their left hand from their right, or even how to tell an honest fiduciary from a shiny-suited vampire with a great office and slick pitch.


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.

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