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w w w. c fa u k . o rg s u p p o r t i n g A S I P , C FA a n d I M C p ro fe ss i o n a l s


Lessons for the credit market


Has the credit crisis changed the market forever?


What events in securitisation markets mean for the UK


Are they proving their worth?


How to use the slope of the term structure of credit spreads as an indicator of the direction of change


Why it's never easy to price OTC derivatives


The methodology of credit agencies

"What's important is that you've got to do the research."

Ella Brown, CFA ABN AMRO Asset Management



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Editor Maha Khan-Phillips Sub editor Duncan Farmer Editorial assistant Stuart Newman Design editor Catriona Dickson, Dojo Design Photography Abi Imaging Original design CG Business Communcations Professional Investor is published by CFA Society of the UK, 90 Basinghall Street, London EC2V 5AY. Tel: 020 7796 3000 Fax: 020 7796 3333 Email: [email protected] Website: Chief executive Will Goodhart Subscriptions Professional Investor is published four times a year. Subscription rates are: £145 for UK/Europe, £195 for the Rest of the World Advertisement Sales Steve Forsdick, Ten Alps Publishing [email protected] Tel: 020 7878 2334 CFA UK members and other practitioner readers are invited to submit articles for possible inclusion. Please email the society on [email protected] Contributed articles will be reviewed for possible inclusion by the Editorial Board. Editorial Board Richard Szwagrzak CFA (Chairman), Russell Sparkes ASIP, Brian Mairs IMC, Peter Gaston ASIP, Malcolm McIvor ASIP The society is not responsible for any material published in Professional Investor, and publication of any material or expression of opinions does not necessarily imply that the society agrees with them. Neither the society nor the publishers are jointly or severally authorised to conduct investment business and do not provide investment advice or recommendations to anyone. Printed by Wyndeham Grange, Southwick, West Sussex.

The CFA Society of the UK represents the interests of 7,000 leading members of the investment industry. The society, which was founded in 1955, is a leading member society of the CFA Institute and is committed to leading the development of the investment industry through the promotion of the highest ethical standards and through the provision of education, professional development, advocacy, information and career support on behalf of its members. CFA UK supports the CFA, ASIP and IMC designations. Articles are published without responsibility on the part of the publishers or authors for loss occasioned by any person acting or refraining from action as a result of any view expressed therein. Volume 18, Number 1. issn 0958-2541. © 2008 CFA UK

Will Goodhart


Last year's claim that London had surpassed

New York as the world's greatest global financial centre now

looks like hubris. London has been hit no harder than other centres by the credit crisis, but the uncertain initial response to the crisis and a series of missteps since then have damaged the city's reputation. One of the measures that has caused concern is the decision to change the taxation of non-domicile residents. In January, the government provided draft regulation relating to the proposed changes to the non-dom regime. There have been extensive responses by representative city bodies relating the proposals. There are widespread concerns that the legislation has been drafted without proper consultation and it has been suggested that the government should delay introducing the legislation. In order to provide some information on the potential response of the society's membership to the proposed changes in the taxation of non-domiciles, the society undertook an anonymous member survey in mid-February. The survey was sent out to 5,404 members. The society received 598 responses, 315 of the responses (53%) came from those claiming non-domicile status for tax purposes. 82% of all respondents believe that the proposals will damage London's standing as a financial centre. Of the 283 respondents that came from those that do not claim non-domicile status, 70% feel that London's reputation will be damaged by the move. Of the non-doms that responded to the survey, 55% moved to London less than seven years ago and 45% have lived here for more than seven years. Slightly more than a quarter (27%) of the non-dom respondents would not have moved to the UK if the regulations had already been in place; 35% would still have moved to the UK and 38% said that they were not sure. Just less than one in five of the non-dom respondents (18%) plans to leave within a year. A further 19% expect to leave before they reach the seven year residency limit and just 16% say that they will certainly stay. Just less than half (48%) are not sure what they will do because the final nature of the regulation is not yet known. The society has been careful not to comment on the regime directly. We are aware that a sizeable minority of respondents does not feel that the changes will have any adverse impact on the UK as a location for financial services and it is highly likely that non-dom members will have been more likely than others to respond to the survey. Nevertheless, the significant response rate to the survey indicates that we were right to offer members an opportunity to make their views known.


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"Investors did not seem to bother to do

Frank Fabozzi

Spotlight | page 7




featureN CO M E FOC U S F I XED I

14 17 20

2 FOC U S TO FAL L O N T H E SECONDAR Y M AR K E T S Ganesh Rajendra, CFA looks at the impact of the credit crisis on Europe's securitisation market. W H Y INF L AT IO N L INK ED B O ND S ARE P R OV ING T H EIR WO R T H Jonathan Gibbs, ASIP looks at why inflation linked bonds are a good diversifier in the current market. MOV ING INTO U NC H AR T E D T E RRI TO RY Matt King and Hans Peter Lorenzen look at the outlook for credit in 2008.


22 26 30

T HE CHANGI NG LAND S CAP E OF AS I AN F I XE D I NCO M E Victoria Ip-Cheung, CFA sees opportunities for fixed income growth in Asia. T HE CHALLE NGE O F VALUI NG OTC D E RI VAT I V E S Recent market events have compounded concerns over the valuation of OTC derivatives, writes Kevin Borrett. RAT I NG S E CURI T I S AT I O N ­ A P R IMER Stuart Jennings argues that ratings are an important tool in an investor's armoury.


t h e i r i n d e p e n d e n t r e s e a r c h"




the regulars

4 7 8 44


David Smith applies Rumsfeld's logic to the credit crisis.


A Q&A with Frank Fabozzi, CFA.


PI profiles Ella Brown, CFA, Hazel Moore, CFA, Matthew Tee, ASIP, Gary Dugan, ASIP, Fahad Changazi, CFA, Patrick Egan, CFA, and Mostyn Kau, CFA.


Papers on regulation, investment banking partnerships, institutional portfolio flows and international investments.



34 42 44

TH E SLOP E O F T H E T E R M STR U CTU R E O F C R ED IT S P R EAD S Mascia Bedendo, Lara Cathcart, and Lina El-Jahel find a useful indicator of the direction of changes in fu ture short-term credit spreads. ON E OF TH E WO R L DS BE S T KE P T SE C R E T S Daniel Broby, FSIP believes it is time investors took notice of Africa's fixed income opportunities. TH E CASH M AC H INE IS BR O K E N Myles Bradshaw, CFA looks at what impact the turmoil in Europe's securitisation markets will have on the UK economy.

50 52 54 55 56 57 58 62

UK CFA candidates outperform.


The 2008 CFA Institute Annual Conference.


CFA UK comments on CfDs and the `comply or explain' regime.


FF&P, T Rowe Price, Macquarie, Axa Rosenberg, ECM, and Aegon Asset Management all make member hires.


Daren Miller, CFA says the clock is ticking for candidates studying for the CFA Program exam.


Darragh Finn, ASIAI


Profiles of the new members who have joined CFA UK in the last quarter



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Applying Rumsfeld's logic to the credit crisis


hen the former US defense secretary Donald Rumsfeld goes to meet his maker, the obituary writers will have a field day. There will be his role as one of George W Bush's most formidable neocons and in pushing the invasion of Iraq. There will also be his rather inglorious departure from office. Inevitably, though, there will also be this passage, said by Rumsfeld in response to a journalist's question at a Pentagon press conference. "Reports that say that something hasn't happened are always interesting to me, because as we know, there are known knowns; there are things we know we know," he said famously. "We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns ­ the ones we don't know we don't know." You may ask what all this has to do with the credit crisis. Well, as some readers will be aware, Rumsfeld's terminology was direct from the pages of Fooled by Randomness by Nassim Nicholas Taleb, who is also the author of Black Swan. When I met Taleb a few months ago, not only was he proud that his words had been taken up, but he was quick to set them in the financial market context in which he specialises. Things have moved on a lot since I met him, but let me use the terminology to try to explain where we are and where we may be going. If we go back a few months, the `known known' was that America and the other advanced economies were set to slow, largely as a result of the impact of tighter monetary policy. All the major central banks, the Federal Reserve, the Bank of England, the European Central Bank (ECB) and even the Bank of Japan (BoJ) have raised interest rates in response to inflationary pressures. Come last August most of them had not finished the job; that certainly applied to the BoE, the ECB and the BoJ. The big `known unknown' during that period before August last year was America's housing market. From the middle of 2006 onwards all the measures of housing activity ­ starts, building permits, mortgage approvals, site visits ­ had begun to weaken dramatically. So had house-price inflation. Part of this was directly related to monetary policy and the Fed, which had after all raised interest rates from a low of just




1%. But part of it, as we now know, was sub-prime. It seemed unlikely that sub-prime could be as big as we now know it to be, or that it could seriously dislodge an economy growing robustly and with low unemployment. It is still not a given that the US will succumb to recession this year, though it will run it mighty close. But at a time of strong global growth, it will be hard to avoid the verdict that this slowdown/recession was home grown in every since of the world.


The `unknown unknowns' are those whose tentacles have spread around the world as a result of the credit crisis, itself thanks to sub-prime, and which has taken in Citigroup and Northern Rock along the way. How far are we through the crisis? Sir John Gieve, deputy governor of the Bank of England, suggested in January that the narrowing of the very large gaps of last year between money market and policy rates ­ Libor and Bank rate for example ­ meant we could be at "the end of the beginning" of the first phase of the crisis. But Gieve was careful to say there could be plenty more to come in the subsequent phases. As he put it: "The longer-term bank funding markets remain relatively illiquid, many securitisation markets remain effectively closed and general market sentiment remains fragile. Only a part of the total losses on sub-prime have yet been declared and not all the questions about the future of SIVs (structured investment vehicles) or the capitalisation of monoline insurers have yet been answered. The sub-prime chapter will not be closed for some months yet and there are still risks of re-ignition of acute money market conditions." That remains the official view. When central bankers and finance ministers of the Group of Seven (America, Japan, Germany, Britain, France, Italy and Canada) met in Tokyo in February they were joined by a special grouping of financial regulators and central bankers. The Financial Stability Forum warned of "a prolonged adjustment, which could be difficult". In particular, it warned that debt write-offs associated with sub-prime could eventually amount to $400 billion. At the time, less than a third of that had been revealed by the banks, leading the G7


"The sub-prime chapter will not be closed for some months yet and there are still risks of re-ignition of acute money market conditions."


to call for greater transparency and, in effect, avoid dribbling out the losses over an extended period. Does the fact that only a third of the losses had been declared when the G7 met in February mean that we are only a third of the way through the problem? Perhaps. The mood among policymakers is fairly grim, implying quite a long haul. The mood in the markets varies from day to day. But Rumsfeld's unknown unknowns will be with us for quite some time. Maybe it is the case, despite the warnings, that the crisis's greatest intensity was in the second half of last year, and that what lies ahead is the grinding process of resolving issues of

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bank capital, the willingness and ability to supply borrowers in the advanced economies and the risk of negative feedback effects as those economies and asset markets in them weaken. It is not all bad news. The `known known' of tighter monetary policy has been reversed dramatically in America with the Fed's dramatic January rate cuts, and has been partly reversed in Britain thanks to the Bank. The European Central Bank is in the process of relaxing its tough stance. The one thing we know about crises is that they get resolved. What we don't always know is when.

David Smith's website:




Frank Fabozzi, CFA

A need for renewed emphasis on research

PI ­ Looking back at your early career, what attracted you to the investment space and to fixed income? FF ­ I started out teaching at a university, where you're either interested in investment management or corporate finance. I thought investment management had much more interesting opportunities. I was attracted to fixed income because I once heard a speech by the treasurer of the World Bank on the importance of fixed income securities. At the time, in the 1970s, there wasn't an emphasis on the asset class in academic circles PI ­ How have markets changed since then? FF ­The market during the 1980s was growing in terms of products. You had collateralized mortgage obligations and non-agency mortgage-backed securities. But it wasn't until the second half of the 1980s that asset-backed securities that were backed by non-mortgage assets such as credit cards and auto loans were brought to the market. Unfortunately, as the structured product market grew there were institutional investors who were not very well informed about these products who were investing in them. There was a huge educational gap. Historically,

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it wasn't until the late 1980s that universities started offering courses in the bond area. There were times when I would make presentations about agency mortgagebacked securities at some universities and the faculty had no clue what these products were. Yet, 40% of the Lehman US Aggregate Index consists of agency mortgage-backed securities. Today, we see a lot more quantitative people being drawn to the fixed-income market on the buy side. We're getting more people in who are derivatives specialists and have a pretty good feel for credit risk modelling. A good number of freshly minted doctorates are moving into asset management firms specialising in the fixed income area, particularly in credit derivatives. Credit derivatives didn't even start until 2000/2001 but the market is moving in the

direction of credit. PI ­ Would you draw parallels to what is happening in the markets now to 1994?

FF ­ Well one's a credit

product (sub-prime mortgages) and the other an agency product (agency collateralised mortgage obligations) where prepayment risk was involved. There weren't any credit issues in 1994 that caused the problem. The problem at the time was that people starting learning about these products as the products were being introduced into the market. Suppose brain surgeons learnt brain surgery on the operating table with no training in medical school? Patients would die on the operating table while surgeons learned to hone their skills. It was the same with finance, where too many asset managers blew up their clients' portfolios because they didn't have the experience and

knowledge about these new structured products. The sub-prime market, on the other hand, is purely a credit issue. Investors did not seem to bother to do their independent research. The rating agencies used the data that they had available to reach their conclusion about the credit risk. But if you are institutional investor, particularly a highly leverage one such as a hedge fund, who is seeking to generate substantial returns from positions in sub-prime mortgage-backed securities, it is imperative that the manager do more than rely on published rating. Risk managers of financial institutions who lent to such institutional investors should have examined the credit risk to their institutional more carefully. Rating agencies had been publishing reports expressing their concerns with the market since mid 2005.


Frank Fabozzi, CFA

Career highlights:

Frank Fabozzi, CFA is Professor in the Practice of Finance at the Yale School of Management. He has taught at Yale since 1994, and is also the editor of the Journal of Portfolio Management. He sits on the board of directors of the BlackRock family of closed-end funds. In November 2002, Fabozzi was inducted into the Fixed Income Analysts Society Hall of Fame and in 2007 was the recipient of the C Stewart Sheppard Award. Fabozzi has authored and co-authored some of the industry's most widely used reference books, including The Handbook for Financial Instruments, Fixed Income Mathematics, Foundations of Financial Markets and Institutions and Capital Markets: Institutions and Instruments. When he is not teaching, consulting, or writing, Fabozzi spends time with his three children.




"If you don't have any proprietory research muscle, how are you going to know something that the rest of the market hasn't figured out?"




Career hightlights: Equity analyst at Richard Greenshield Equity analyst at JPMorgan Head of European equity research at Credit Suisse Asset Management Global head of equity research at ABN AMRO Asset Management


Ella Brown, CFA

Global head of equity research ABN AMRO Asset Management



ucked away in the south-western corner of Canada's Manitoba province, lies Souris, a small town with a population of 1,683. It's inhabitants are made of sturdy stock. In summer, they face temperatures of up to 40°C. In winter, the temperature can plummet to -50°C. Keeping warm is a matter of survival. It is one of the reasons why London's climate doesn't faze Ella Brown, global head of equity research at ABN AMRO Asset Management (AAAM). A native of Souris, her international investment career has placed her far from her home town. "London is my home now. I have a British passport and I love being part of such an international city," she says. Brown graduated from the University of Manitoba with a double major in finance and accounting. She was recruited as an equity analyst at Richard Greenshield (now part of Royal Bank of Canada) in Winnipeg and within a year, she was transferred to Toronto. "It was the centre of the financial industry, so it was exciting. I stayed with Richard Greenshield for six years, which was when I did my CFA. I began to realise that there was a whole world outside Canada that I was curious about, and decided the best way to explore bigger international opportunities was to get an MBA." She did that at the University of Chicago, but before graduating, Brown began the milk round. She decided she wanted to try working in a business with a tangible product "like managing a factory that made hub caps". But she was in for a rude awakening. "I interviewed with United Airlines, and people there were saying how exciting it was to make a decision about pricing and then read about it in the Wall Street Journal the next evening when they got home. It sounds like a little thing, but it stopped me in my tracks. I couldn't believe that they waited until the evening to read the Wall Street Journal and that they weren't on top of the news, and didn't appreciate the potential impact of events. I realised then I wanted to stay in the investment industry because it was stimulating."

She joined JPMorgan as an equity analyst and moved to London. After eight years, many of which were spent in portfolio management, she moved to Credit Suisse Asset Management, where she headed the European equity research department. Brown believes that all three main research models (where equity research is the training ground for future portfolio managers, where it is a standalone research department with its own analysts and where research and portfolio management are undertaken by the same person) have their advantages. "Any of these can be successful. What's important is that you've got to do the research. If you don't have any proprietary research muscle, how are you going to know something that the rest of the market hasn't figured out?"


Since joining AAAM in May 2006, however, Brown has focused on restructuring the team. "I moved ABN AMRO away from having a standalone department and redistributed the talent to each one of the product teams. There were so many different kinds of products when I joined nearly two years ago that I didn't think it was realistic to have that model. Research can go from the black box spectrum to a more fundamental model, but you have to be generating an information advantage to be competitive. I think it's important that asset management teams follow their model and stay true to it." She describes her management style as consistent and fair. "That's always what I've valued in my own bosses and I try to treat people how I like to be treated." But Brown has the unenviable task of redesigning the teams at AAAM and Fortis, following Fortis' takeover of the company. "Research at Fortis is structured the same way as I implemented it here a year ago. The downside is when you merge two companies who do a lot of the same things, there's an awful lot of overlap. It leads to some difficult decisions about which team goes to the new company," she says. When she's not busy at work, Brown spends her time travelling "off the beaten track". In the past few years, she has gone camping in Botswana, explored the Yukon and visited Syria. Is her adventurous spirit part of her Souris heritage? "It just might be, you never know," she says.


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Hazel Moore, CFA

Chairman and co-founder First Capital



"Taking the CFA was really a way for me to kick start my career from a financial perspective"



f it was not for karate, Hazel Moore may never have found her way in to the investment profession. Moore captained Cambridge university's karate team when she studying for an MA in natural sciences. "We'd organised an exchange programme with KEIO University in Japan. We went there to study karate. I was in Asia and I thought: here I am, I'd like to spend a little more time and see what's going on." Moore ended up in Hong Kong and decided to look for a job. "What does one do in Hong Kong? They look for a job in the financial world. I wrote letters to people saying: `I don't know much about what you do but I'm willing to work hard and learn' and someone took pity on me." That `someone' was stockbroker WI Carr. It was an interesting time to be in the financial industry: the violence in Tiananmen Square had just happened and the stock market was in the doldrums. "There was pessimism about the handover of Hong Kong to the Chinese and what would happen," Moore says. Luckily, the economy started to take off and it became "a tremendously exciting place to be". Because of her scientific and technical background, Moore was assigned to technical stocks, but she had no grounding in economics and fund management. "Taking the CFA was really a way for me to learn what I was supposed to be doing as a research analyst and kick start my career from a financial perspective. So I was interviewing companies and covering stocks and studying for my CFA at the same time." Moore worked in Asia for five years as a research analyst before moving back to London, where she continued with WI Carr for two more years. Then she took a career break, learnt Spanish and went travelling. "I came back to the UK when the internet boom was gathering momentum. I started working with friends who were setting up technology companies. These were brilliant technical people who didn't have much commercial knowledge. They needed money to set up their businesses but they didn't have any idea how to talk to investors." She put her own money into some of the ventures and realised there was an opportunity to build a business. "Most of the companies were too small to attract the attention of the accounting firms or investment banks. The reason for setting up the company was to bring a level of professional expertise to venture capital. I knew a lot about what made a good investment case and what didn't and what investors needed to see and the metrics they used to evaluate companies," says Moore who is now on maternity leave with her third child. First Capital was born, specialising in fundraising and M&A for technology companies. One of the first companies Moore fundraised for was Oxonica, an Oxford university spin-off which developed a catalyst to reduce a vehicle's fuel consumption. "We had a really exciting product technically, but we had to convince venture capitalists to take them through two or more years of technical trials before the product came to market," says Moore. Now, Oxonica is listed on AIM and has attracted customers such as Stagecoach. She believes the CFA has a lot to offer the private equity profession. "One of the things that struck me when I first went into venture capital was that there were relatively few investment professionals who are CFAs. I think there's a real case for more vigour and more professionalism in the industry."


Five years later however, he decided to switch to consultancy. "I enjoyed fund management but I didn't feel that it was a job I wanted to be doing when I was 40. I saw an advert for a job at Watson Wyatt and it coincided with what I was feeling at the time." Tee has been with Watson Wyatt for seven years. "I fitted with research straight away, but dealing with clients was very new to me. It was a steep learning curve. Then I began to get a real buzz from helping trustee boards and lay people understand investment concepts, so much so that I gave up research to spend all my time on the client side." His timing could not have been better. The past few years have seen a rapid evolution in the business of consulting. "When I joined they were still talking about plain vanilla products. Now we're talking about alternatives, swaps, structured products, and a lot of really exciting high-alpha boutique managers. I was fortunate to be part of the evolution." When he's not busy with clients, Tee plays golf. He also enjoys spending time with his eight-year-old daughter, who, he says, can start dabbling in the stock market when she's 12 ­ "providing it's with her own money!"

Matthew Tee, ASIP

Senior investment consultant, Watson Wyatt



ew investment professionals can claim to have played the stock market when they were 12 years old, but Matthew Tee is an exception. "My father used to invest in the stock markets ­ he was a complete amateur. It was something we talked about and

I got very interested in it. On a small scale, I gave him all the money I'd saved up and we invested it!" Tee never looked back. After graduating from Birmingham university in 1988 in economics and maths, he looked for jobs with fund managers and consultants. "I was lucky enough to be offered jobs at both. I chose fund management because I figured I could always switch to consulting ." He started working in the investment management division of Norwich Union. "What surprised me was the sheer volume of information you had to deal with. When you do this professionally, you have broker research, Reuters and Bloomberg, and a lot of other things. It took a while to work out that only a small amount of it was ever value added." After seven years, he decided he wanted to do something more entrepreneurial, and moved to Pictet. "They had a small volume of assets and were looking to grow the business. It was challenging and exciting."

Gary Dugan, ASIP

CIO, Merrill Lynch Global Private Client EMEA



ooking back at his 25-year career in the City, Gary Dugan says it was all a question of being in the right place at the right time. "I took a degree in economics at Salford university and joined the National Coal Board Pension Fund." Joining the Coal Board opened up the investment

industry. He worked as an equity analyst for the UK market, spending two years looking at consumer sectors before moving on to oil and chemicals. "What the Coal Board was good at was training. We spent a lot of time on balance sheets and profit and loss. It was a highly analytical style of investment management," he says.

After leaving the Coal Board, Dugan joined Eagle Star Insurance managing pension fund money. From there he went to Baring Securities, where he focused on pan-European securities. In 1993, after the market crash in Japan, Dugan moved to JPMorgan, where he spent the next 11 years. By the time he left he was managing director and global markets strategist for JPMorgan Institutional Investment Management and the private bank. Dugan then moved on to Barclays Wealth, heading


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research and investment strategy. He was responsible for restructuring a variety of investment products, including their multimanager product. Dugan, a father of three, joined Merrill Lynch in August 2007 in the new role of chief investment officer. Over the years, he has built an expertise in corporate restructuring. "It established my career. I advised companies on what they needed to do, and was even able to talk to the European Parliament about it." He believes there is too much short-termism in the market at the moment. "If you look at the length that any one UK stock is held, it's 12 months now. We've also lost the National Coal Board fund and institutions like it, which brought some stability to the market because they tended to be the buyers when markets fell sharply. They were focused on the long term value of the markets." It is one reason why Dugan believes that the CFA has a lot to offer. "I think it's important that we maintain standards of analysis and guidance to clients, and manage money in a way that is based on facts, rather than perception. It's also important that the industry is manned by professionals, and the CFA has been very useful in bridging the gap between the academic work that goes on in the industry and the practioners." When he is not at work, Dugan coaches and umpires hockey games.



Fahad Changazi, CFA

Insurance analyst, Cazenove Equities



ahad Changazi may have begun his career with a focus on fixed income, but he believes that equities are more interesting. "You have to be a lot more thorough in equity research, as you get share price moves that are related more to company specific information. I have a friend working in fixed income research and he doesn't have detailed models, its more about the `bigger picture' on the fixed income side," he says. After graduating from the the London School of Economics in 2000, Changazi joined Standard & Poors' and spent four years as ratings analyst covering the insurance sector. "The next logical step was to move to sell-side research where things are more dynamic," he says. He joined Cazenove, where he covers the pan-European non-life insurance sector. Changazi's day starts at 7am, when he starts to monitor what's happening in his sectors. "If there are results or announcements, we have to respond

Patrick Egan, CFA

Research analyst, Russell Investments


atrick Egan moved to London in 1999 after earning a BSc in Management Engineering from the Ateneo de Manila university in the Philippines where he was born and raised. "My mother was working here at Laura Ashley and my brother was doing an MBA at London Business School, so it made sense to move here when I finished university," he says. He wanted a career in investment management and joined Barclays as part of its Business Leaders Programme in 2000. He was sent to Barclays Wealth, where he joined the funds research team. Egan was in for a surprise. "I had recently put some of



quickly, going through the numbers and communicating the potential impact on the company and its investment case to the salesforce and clients. Other than this, you have to think about creating a more thematic piece, and then there is always trying to think `outside the box' and trying to come up with thought provoking research." He believes the industry has changed a great deal in the last few years. "The great bear market from 2001 to 2003 exposed a lot of inadequacies in the insurance sector, which was down in those years by around 80%. This was primarily because risk management was lax. There was a lot of investment risk on the books, and there was a focusing on just getting the business through the door and to make returns from the investment markets." Now, he argues, the industry has become more focused on risk management, on profitable underwriting and on capital management. "Rating agencies are a lot more focused on asset risk, as are regulators." He believes there are lessons to be learnt from the subprime crisis. "Investors would be more risk conscious going forward, and investigating underlying risks in more depth. The problem is that once you see that triple A rating on the product you think it's fairly safe. But those things are based on past historic information on default rates. Also, the rating agencies don't have the time or resources to explore these products in depth. They rely on data from the companies or bankers who want their instruments to be rated!" my own money into a fund of funds. Ironically, it was being managed by the same team I joined." Egan decided to study for the CFA. "When I joined Barclay's undergraduate programme we attended a number of courses and people said the CFA was the pre-eminent qualification to have if you wanted to be in the investment industry. I learnt a lot. It was so early in my working career that everything was new to me." He obtained his CFA designation in 2003 and completed the Masters in Finance programme at London Business School in 2006 and joined Russell Investments. "I research managers who invest in European equities. The best part of the job is meeting managers and discussing their investment philosophy and interrogating them on what positions they have in their portfolios. I like drilling down to what really happens. Managers often say one thing but end up doing something different." He says he tries not to have a first impression when he goes in to meetings. "A lot of managers are smooth presenters equipped with strong marketing skills and snazzy presentations. You have to look beyond the marketing. While it is easier for us when a manager is extremely articulate and open, there are also managers who have difficulties with presentation but who can really deliver."

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Mostyn Kau, CFA

Director, global funding, group treasury, Westpac Banking Corporation


ostyn Kau began his career as a chartered accountant. After completing a B.Com in accounting and finance at the University of Western Australia, he joined a small three partner accounting firm. Then he qualified as a chartered accountant and moved to Deloitte as a tax consultant. He realised that he wanted to do something more `dynamic'. "I wanted to see the world and decided I wanted to go into banking. I moved to London with a two-year visa in hand and combined various holidays around Europe with some consulting and contract work." The work was still middle-office accounting, and Kau was keen to have a front-office role. After his visa expired, he moved to Sydney and joined Westpac. Originally in a treasury accounting role, a job came up in the front-office and in London. "At that point I was looking to come back to London for both professional and family reasons, so it was great." Kau moved into a market-focused treasury function role, initially focusing on short-term funding and trading interest rates. "We are a classical retail bank. I sit in the institutional part of the bank and we fund the bank's balance sheet in the wholesale debt markets." Since the sub-prime crisis began, this has proved challenging, he says. "We've had to be proactive and do a lot of work with our investors. We've always considered our relationship with investors as vitally important and have maintained the diversification of the funding markets we go in to as widely as possible. It's literally a global business that we run and that holds us in very good stead in times like these." He says he enjoys his current role, now concentrated on the bank's strategic long-term funding and plans to continue in treasury. "It's a very good mix of my skills. Being able to understand the balance sheet is very important to what I do and because I've come from an accounting background it helps. I also traded interest rates so I understand the markets." Kau began his CFA when he was in Sydney, but completed it in London in 2003. "I found it very useful. I did it because I wanted to understand about asset allocation and how to value assets and it provided a great basis on how to identify value."




A new dawn after the perfect storm?

The credit crisis of 2007 had a profound impact on Europe's securitisation market. Ganesh Rajendra, CFA takes a look at what 2008 will bring



n developing a view for 2008, we make the central premise that the banking markets will stabilise. By this we mean that prices can be reasonably re-established for financial credit. Any such stabilisation would create steady, more conducive conditions for the asset-backed markets to recover, noting the historically tight relationship between securitised bond pricing and bank credit in Europe. Some correction in structured finance spreads would also be fully justified, considering how oversold the market is currently from a fundamental or fair-value perspective. In this regard, we are most bullish on the senior AAA spread outlook for a number of reasons. First, the senior part of securitisation capital structures has generally been disproportionately impacted by the credit crisis, thus any mean-reversion would yield outperformance. Second, we expect the renewed bid for assetbacked product, even at the current historically cheap prices, to be defensive. And lastly, the implementation of the Basle-II capital accord should, at the


margin, make AAA bonds more attractive for banks from a risk capitaladjusted return perspective, or at the very least act as a greater disincentive for banks to sell senior paper.


Still, overall we see structured finance bonds underperforming financial credit in any recovery leg to the current crisis. Given the loss of faith in tranching technology (stemming precisely from the destructive effect of systemic sub-prime losses on the valuations of senior AAA ABS CDOs in the US) as well as the re-rating of the liquidity and defensive qualities of securitised products, we expect the asset-backed market to generally trade at a spread premium to plain vanilla credit, re-establishing a pricing relationship that characterised the credit markets back in the earlier days, specifically the period prior to 2002. There are also more technical and fundamental reasons why we believe structured finance may lag the recovery in financial credit. The asset overhang

risks in the European securitisation market remain appreciable, in our view, reflecting the fact that disaffected SIVs, conduits and most money market funds remain ready sellers, with business and funding models that are generally not recoverable at this point. We estimate that, collectively, these investors have either sold down or transferred onto parent bank balance sheets around 30% of European ABS/CDOs that was under management pre-crisis, which suggests on our estimates that some 200 to 250 billion of paper (netting expected redemptions near-term) is still positioned to be sold, an overhang amount that we believe is not insignificant. The overhang risks aside, we note also that the US ABS/CDO market is increasingly being branded and traded like a `distressed' credit market, and to the extent this investment mindset prolongs, we believe it will be more difficult for a price recovery in the European securitisation market to be fully realised. The other reason for why we expect a more protracted recovery in the



the observation that even prior to the credit crisis, a number of sectors, including leveraged loans, UK mortgages, Spanish SME loans and mortgages, were clearly poised to weaken given the growing pressures on affordability amid record high borrower gearing. The recent credit shock amplifies these risks, in our view. Put simply, the sharp contraction in credit supply to the front-end asset markets (this liquidity squeeze is already in evidence) is likely to impact borrower payment behaviour, particularly in sectors where refinancing has come to be pivotal in borrower debt servicing ability. Consider that securitisation funding played a very influential role in the marginal financing of many asset markets in the last two to three years, fuelling not only more borrower-friendly credit practices but also the proliferation of new non-bank lenders (think debut non-conforming platforms, CLO managers and CMBS conduits, for example). Asset prices in such markets ­ sharply in EXECUTIVE SUMMARY were also driven higheraccount ultimately some cases ­ again on of the marginal liquidity channelled · Some correction in structured from the structured finance market. finance spreads in 2008 would be We are generally cautious about the fully justified, considering how credit outlook for sectors such as UK oversold the market is currently. and Spanish mortgages, Spanish SME · Overall structured finance bonds loans, leveraged loans and UK conduit will underperform financial credit. CMBS, and are especially bearish on the · There will be a greater focus on the UK non-conforming RMBS market, secondary market in European where we see the degree of borrower securitisation over 2008. refinancing needs as being the greatest structured finance market is based on and most imminent. UK nonconforming mortgage borrowers, our expectations for credit arguably more so than any other fundamentals. In short, we are bearish about the credit and rating outlook for borrower constituency, are thus facing sizable payment shocks and a much less certain sectors in European securitisation over 2008, and fear that a liquid mortgage market to refinance into better macro-backdrop for a recovery in in 2008. We also see further lender asset-backed spreads may coincide with vulnerability playing out as the credit crunch takes a more complete toll on greater evidence of collateral weakness wholesale-dependent banks and nonand/or rating risks, which could well banks, potentially adding a further layer serve to stall any such recovery. of risk to credit performance in some asset classes. A likely further deceleration CREDIT OUTLOOK in asset prices ­ particularly real estate To elaborate on our views for credit ­ will also serve to heighten loss severity trends going forward, we begin with




bp 180 160 140 120 100 80 60 40 20 Credit card ABS Prime MBS SME CLOs CMBS Lev loan CDOs Nonconforming MBS 2007 end Historic wides 2007 tight

AAA senior asset-backed sectors


Securitisation funding of outstandind assets (%)





Portuguese mortgages

UK non-conforming mortgages European leveraged loans

Spanish mortgages

UK prime mortgages

Spanish SME loans

Dutch mortgages

UK commercial mortgages

Australian prime mortgages

Source: Deutsche Bank (based on various sources) Note: Estimates only. Use of securitisation in funding of recent marginal asset production likely to be higher. FIGURE 3: UK BORROWERS MAY HAVE A SHOCK WHEN THEIR 2-YEAR FIXED-RATE MORTGAGES END

% 60 50 40 30 20 10 0 -10

Refi to prime

Refi to same product

Revert to product SVR

Prime 10

Prime rpt

NP & light 10

NP & light rpt

Med & unltd 10

Med & unltd rpt

Source: Deutsche Bank (Mortgage products are Prime, Near Prime (NP), Light, Medium, Heavy and Unlimited adverse credit mortgages. Also both Interest Only (IO) and Repayment)

W W W. C FA U K . O R G


UK buy-to-let mortgages






Eur bn: Other ABS 500 450 400 350 300 250 200 150 100 50 Auto & credit card ABS CMBS CDO RMBS

Ganesh Rajendra, CFA

Career Highlights: Ganesh Rajendra, CFA, is a managing director and head of securitisation research for Europe and Asia at Deutsche Bank. Prior to joining Deutsche Bank, Ganesh worked at Merrill Lynch in the international structured credit research team. He is a graduate in actuarial mathematics from the London School of Economics and a contributing author to a number of books on securitisation.









2008 ( F)

Source: Deutsche Bank

be more severe than in the US, where our research colleagues are projecting a 30% fall in new issuance over 2008. Deal flow totalling 250 billion would roughly equal the amount of redemptions expected in the European structured finance market over 2008, meaning that the outstanding market risks in selected securitisations, given that should remain broadly flat this year, default risks in some of the markets have which would be consistent if not been over-inflated in the run up to the accommodative of our expectations for credit crisis. trends in demand technicals over 2008. Therefore we believe that the We believe the coming primary frequency of negative rating actions will market vintage will be the most superior increase noticeably over 2008. This in recent memory, with better quality coming year is likely to be the first time borrowers and assets reflecting the since the European securitisation market's tightening in credit standards that is inception that rating risks become already well underway currently. We meaningful. Subordinated bonds among expect structures to be tightened also (in terms of hedging, substitution the weakest deal outliers in the most requirements, collateral eligibility, credit vulnerable sectors will be most at risk. enhancement, etc), with a greater credit PRIMARY VOLUMES de-linkage from sellers and other third Our forecast for primary volumes in 2008 party risk likely to be a key feature of is 250 billion, which would represent an securitisation templates to come. A unprecedented 45% decline from 2007 greater simplicity to capital structures is also likely ­ in this regard we anticipate full year issuance, taking supply back to more in the way of senior/sub, discrete levels last seen in 2004. We expect the European primary market contraction to SPV structures with a lesser degree of



tranching compared to the preceding pre-crisis deal vintage. There is plenty of precedence in the history of the financial markets for such de-risking and/or simplification post-crisis, for example in the US home equity ABS market in 1996/7. Based on our assumption that any recovery in secondary bond prices may be prolonged, we see some possibility that the new primary deals clear inside of legacy paper, with this spread discount justified by superior credit and structural fundamentals. All things considered, we expect a much greater focus on the secondary market in European securitisation over 2008, which we see as a fundamental shift in market dynamics considering the heavy emphasis historically on the primarly structured finance market.

Disclaimer: The opinions or recommendations expressed in this article are those of the author and are not representation of Deutsche Bank as a whole. DB does not accept liability for any direct, consequential or other loss arising from reliance on this article.


Why inflation linked bonds are proving their worth

The global inflation linked bond market is no longer an obscure part of the investment universe, writes Jonathan Gibbs, ASIP



he global inflation linked bond market has grown rapidly in recent years. With capitalisation of outstanding bonds of G7 and EU countries now in excess of $1.3 trillion, it can be said that the market is no longer a tiny backwater, and has reached a kind of critical mass. The number of other issuers is also growing, with South Korea, Turkey and Brazil among recent issuers of the now market standard `Canadian model' of inflation linked debt. This growth has greatly widened the opportunity set for investors, and created a much more actively managed asset class than in the past.

The growth has been concurrent with a gradual, but crucial, reduction in investors' risk appetites, as regulatory, accounting and demographic changes have enforced sharper focus on the risk in funds, particularly pension funds. Not only the level of risk, but the appropriate mix of risks has become more important, and this has boosted demand for lower risk real assets. A perennial bugbear for market participants has been the lack of liquidity, but this has improved greatly over recent years. Turnover has risen to healthy levels in the major markets, and this is helped by the two biggest markets, the US and Eurozone, not having the


· Global inflation linked bonds have proved a strong diversifier in recent years. · The current credit crisis has only served to increase the focus on lower risk markets such as inflation. · The Eurozone will be one of the key areas of growth going forward.

buy-and-hold culture that was (and to an extent still is) prevalent in the older markets especially the UK. Figure 1 shows aggregate bank to client turnover in the US TIPS market since 2000.





90,000 80,000


70,000 60,000


50,000 40,000


30,000 20,000


10,000 0 2004 2005 2006 2007










Source: ICAP

Source: US Treasury

W W W. C FA U K . O R G





4.0 EU UK US



2.5 2007 30 Nov 31 Dec 31 Oct 1 Oct 2.0

Source: ICAP






0.0 2007 21 Sept 13 July 27 July 29 June 10 Aug 24 Aug 7 Sept 19 Oct 2 Nov 5 Oct 16 Nov 30 Nov 14 Dec 28 Dec -0.5

Source: Bloomberg

and European breakeven rates (market implied inflation expectations) have fallen slightly as lower growth and inflation are priced in, whereas in the UK, the demand for index linked bonds and swaps has driven breakevens in longer maturities to new highs. (See figure 3.) The latter is partly a function of excess demand from pension funds (some of whom may be panicking out of risk assets in the current turmoil), and partly of a lack of supply from corporate issuers such as utilities, who are unable to issue effectively now that the monoline credit insurers are overshadowed by credit worries. In terms of total return though, inflation linked bonds have been among the best performing assets since the credit crunch kicked in. The Barclays Global Inflation Linked Index has returned over 6.5% from the end of Q3 2007 to time of writing, well in excess of gilts and European government bonds. Most equity markets are also substantially lower. This has been led by the US TIPS market, one of the few noncommodity markets to deliver double digit returns in 2007. Much has been made of the current environment being the perfect scenario for inflation linked securities. Indeed, the `stagflation light' suggested, where weak growth is accompanied by higher inflation, is indeed theoretically favourable for real yields (as these are essentially the price of investment capital, the demand for which, and therefore the price of which, falls in recessions) and breakevens (inflation expectations). However one is forced to ask what is already priced in by the market, and the answer may be quite a lot. In the UK, real yields are at extremely low levels, not so much as a result of a gloomy economic outlook, more due to the pension fund driven demand/supply imbalance already mentioned. For other markets, the recession/depression argument has been bought into, but less so the inflation. That is, real yields have fallen but breakevens have not risen. There may still, therefore, be some `juice' left in the market.


Equivalent data for cash bonds for the Euro market is not available, but the growth in turnover here can be demonstrated with data from the inflation swap market, shown in figure 2. More than any other, the Euro market in inflation linked bonds has grown concurrently with its swaps market, and this has led to greater interaction between the two.


The current credit crisis has only served to increase the focus on lower risk markets such as inflation. The reactions of the various markets have been sharply contrasting however. US

In the US the effect of the credit crunch has been seen far more clearly in real yields than in breakeven inflation rates. Figure 4 shows the 20 day rolling yield beta for 10 year TIPS. This is the ratio of the change in real yield to the change in nominal yield. As the credit crunch bit, betas rose as the market priced in recession far more than it priced in inflation. When beta holds above 1 for a period (indicated by a rolling average) basis, this is clearly a repricing of capital investment intentions rather than inflation expectations.

"The current credit crisis has only served to increase the focus on lower risk markets such as inflation"









100% Barclays Global IL

10.5 7.5 10.0 Return (%) 7.0 Return (%) 9.5 9.0 8.5 6.0

100% UK IPD


100% ML A

5.5 4.0 4.1 4.2 4.3 Risk (%) 4.4 4.5 4.6


100% Barclays Global IL

7.5 2.5 3.0 3.5 4.0 4.5 5.0 Risk (%) 5.5 6.0 6.5 7.0

Source: Bloomberg

Source: Bloomberg

This situation has plainly eased a little into the New Year, but betas remain elevated. The market has priced in far more of a real yield event than a breakeven event.


demand, these attributes make global inflation an attractive portfolio ingredient.



In such fevered times diversification of risk comes sharply into focus, and global inflation linked bonds have proved a strong diversifier in recent years. Its relatively low correlation with other bond asset classes means it has supplied some protection to those exposed to credit risk in recent times, and the efficient frontier in figure 5 shows the effectiveness of spreading risk between global inflation, and for example, single A credit risk. Inflation linked bonds and swaps are also of course real assets, and their very low and indeed in cases negative correlation with other, riskier, real assets, has also proved beneficial. Figure 6 above shows the risk/return relationship for global inflation (GBP hedged) against the IPD property index in the UK, showing similar portfolio benefits. Global inflation would therefore appear to be a strong diversifier in any wider portfolio of assets, whether within the bond universe or beyond. In a period when uncorrelated risk is in high

W W W. C FA U K . O R G

The Eurozone appears to be one of the key areas for growth in the global inflation market going forward. Swaps markets are already operating, albeit with sporadic liquidity, in domestic inflation in Spain Ireland and Portugal. As yet though, France is the only Eurozone country to issue bonds indexed to domestic CPI. It remains to be seen if this changes, but swap markets will doubtless continue to grow and diversify. Further emerging market issuance is likely, and indeed it is more than possible that some current issuers will be classified as `emerged' and moved into mainstream indices. This is likely to further increase the power of portfolio diversification of global inflation portfolios, as further uncorrelated risk is brought into the investment universe. To conclude, while global inflation is no longer an obscure part of the investment universe, it is still less focused upon than it may deserve. Periods of market turmoil such as those of recent months emphasise the value of diversification, a property supplied in good measure by this asset class.

Jonathan Gibbs, ASIP

Career highlights:

Jonathan Gibbs, ASIP is investment director responsible for all inflation linked products at Standard Life Investments. Before joining the company in 2002, he was divisional director, government bonds, at Henderson Global Investors. Prior to this he was an investment manager with the Kuwait Investment Office in London.



Moving into uncharted territory

The sub-prime crisis has been different from events in the past. As a result, the credit outlook for 2008 doesn't really fit into any mould, believe Matt King and Hans Peter Lorenzen



· In principle the prompt action of the Fed should help the economy recover during the second half of the year. · Still, it is hard to avoid the view that for corporates and consumers the worst still lies ahead.


he second half of 2007 was extremely challenging, not just in spread performance terms, but also because, for most credit investors, so much of the turmoil originated in what were previously relatively esoteric markets. With so many moving parts, from CDOs of ABS, SIVs, and conduits to the general economy, and just pure sentiment, 2008 will take the credit market into uncharted territory.

tranches of the ABX and TABX, prompted writedowns on the super senior tranches of CDOs of ABS, a large portion of which banks had retained on balance sheets. The writedowns then served to re-intensify the liquidity premium into year-end, as investors started to worry about the fundamental impact of such a widespread withdrawal of liquidity. Thus we ask one of the biggest questions that hangs over 2008: to what extent will the sub-prime fallout feed through to the real economy?


the exception of 2000-2003, from gains on financial holdings. On paper, the average consumer is therefore not currently in dire straits. If employment and equity markets hold up, they should be capable of sustaining their spending patterns in 2008. But there is a significant risk to this view: gains on their assets ­ both real estate and financial ­ are nominal, whereas the debt they have accumulated is real. If ­ as looks increasingly likely ­ asset prices fall sharply, the downturn could be exacerbated by US consumers increasing their savings rate in response to declining wealth levels. That's one important reason why such polarised outlooks on the US economy in 2008 can, and perhaps must, co-exist. Even at the macroeconomic level, tail risk rears its ugly head.



The `sub-prime' crisis really amounts to a classic case of financial contagion and deleveraging, for which sub-prime has been the trigger. The result has been a shift from extreme risk appetite to extreme risk aversion, where not even the inter-bank markets are functioning normally. In its initial stages, the crisis revolved around the hits to investors in junior tranches of CDOs of ABS. Then sub-prime fears returned with a vengeance in October. Further deterioration in housing markets, mirrored in the fall in even senior



The US consumer is often singled out as the single most vulnerable element in the US economy. But there's a little more to it than that. Debt levels for the average consumer have been growing rapidly in recent years, and they are near a record level to GDP, but their assets have been growing even faster in absolute terms. In fact, their net worth relative to their disposable income has only been higher than now for a very brief period during the tech bubble. Looking over the last fifty years, this ratio has been well correlated with the savings ratio in the US. Simply put, as the average US consumer has grown wealthier relative to their income, they have spent an increasing portion of the marginal dollar, saving less and less. If it is not from savings, then where are those wealth gains coming from? Since the mid-1990s they have come from real estate and, with

With all this focus on the US economy, it is worth emphasising that the global picture in 2008 looks very different from previous cycles. Unlike the slowdown in the early nineties and following the tech bubble burst, our economists are not expecting that global growth will slow massively in 2008 from the rapid pace in recent years. With emerging markets making up a much larger share of the global economy than in previous cycles and their growth being increasingly domestic in origin, our economists expect that emerging markets will contribute about half of global growth this year. This in turn is likely to help sustain investment in those markets. So for 2008, it looks like the effects will be felt most severely in the US and Europe, with emerging markets suffering rather less.


But even if the macroeconomic view looks neither like the events of 1998 nor 1990, from a corporate perspective they seem more similar, and to the late nineties in particular. The M&A boom we saw in 2007, which already tops the peak of the previous cycle in value terms, may well be dented by a smaller


contribution from private equity. But in cycle after cycle, we have seen that even as organic revenue and profit growth slows, corporates try to smooth the ride for shareholders by using their financial flexibility to sustain growth momentum in earnings per share. There are few signs that things should be any different this time round. In fact, the macro equivalent of a cash-flow statement in the US flow of funds data shows that the funding requirement (which roughly translates into a final free cash flow), as a percentage of corporate GDP, is currently the highest it has been in decades ­ principally due to the large increase in share buybacks and M&A. Our base case is that most of this will continue through 2008, prompting comparisons (at least from a corporate perspective) with 1999-2000. Why should corporates continue to spend and to raise debt? Because it still makes good sense or them to do so. Credit spreads may have widened in recent months but, with yields also sharply lower, the simple comparison of the cost of debt versus the cost of equity suggests corporates are still being incentivised by financial markets to increase leverage. That leaves us expecting that the rise in net debt we saw in 2006 and 2007 will continue into 2008. But the profit outlook is much weaker ­ our equity strategists expect around -1% EPS growth in the S&P 500, which will be lower still once the effect of buybacks has been stripped out. Assuming net debt continues to grow at the same rate as in 2006-7 (8%), leverage will rise much more meaningfully in 2008 than it has in previous years. And while debt growth may be curtailed under more severe economic scenarios, in these cases the impact on earnings is probably so negative that leverage will rise sharply in any case. At these levels, much of this is in principle priced into credit spreads. But it feels hard at present to feel very optimistic about that, given the likely combination of simultaneous ratings downgrades and extra bond supply.

US ECONOMY: 1990 OR 1998?



Regional contribution to global GDP (%) 5 4 3 2 1 0 -1

Other Industrials

EU 15










We are left with an outlook that doesn't really fit into to the mould. From a consumer and macroeconomic perspective, things are looking more and more like 1990, notably in terms of the sharp retrenchment in US residential investment and the sharp tightening in bank lending standards. But nonfinancial corporates are still under pressure to relever balance sheets to help improve earnings, much like 1998. Banks, admittedly, have suffered such severe writedowns that even the equity analysts are telling them to raise equity, cut dividends, and get their balance sheets back into shape. But they are the exception rather than the rule: the corporates' very strength makes a sharp deterioration look highly likely. In

· EM now accounts for nearly half of global growth. · Sharp contrast with 1998 and 1990. · EM growth increasingly internally driven.

Source: IMF World Economic Outlook.

principle, the prompt action by the Fed thus far, and the easing to 2% we anticipate by the end of the second quarter, ought to help the economy recover during the second half of the year. But with securitization markets still effectively closed, and banks' struggles to shrink their balance sheets making them reluctant to lend to almost anyone, it is hard to avoid the view that for corporates and consumers the worst still lies ahead.


Career highlights:

Hans Peter Lorenzen

Career highlights:

Matt King is managing director and global head of credit products strategy at Citi. Prior to joining Citi, he was head of European credit strategy at JPMorgan. Before shifting into credit strategy, he spent three years as a government bond strategist. He is a graduate of Emmanuel College, Cambridge, where he read Social & Political Sciences.

Hans Peter Lorenzen is a director in the European credit products strategy team at Citi. He has worked in credit strategy for the past seven years and specialises in flow credit products and relative value. He joined Citi in 2007 from BNP Paribas, having also worked for ABN AMRO in London. Prior to that he worked at the Danish central bank and the Danish Ministry of Finance.

W W W. C FA U K . O R G



The changing landscape of

Asian fixed income

Victoria Ip-Cheung, CFA examines the market for Asian fixed income and outlines her views on the opportunities for investors



n recent years, Asian fixed income has enjoyed increased attention due to investors' search for yield and for a broader diversified source of return. However, all too often, investors have viewed Asia as a homogenous credit market. But those that do, risk failing to understand the subtle changes that are going on. Local insight is vital in understanding the impact of both changing market trends and the longer-term structural influences that present professional investors with a wealth of fixed income opportunities.


The JPM Asian Credit Index (JACI) has seen spread compression from 155 basis points (bp) to 117 bp and the i-Boxx ABF Pan Asia Index has generated a total return of 18.8% from December 2005 to May 2007. The weighting of Asian fixed income has recently



increased in the portfolios of global investors, governments, institutions and, more recently, hedge funds. Since spreads traded at their tightest in May 2007, Asian fixed income has also been influenced by the global credit markets, seeing spreads widen from 117 bp to 236 bp. In our view, Asian fixed income needs to be seen as an asset class made up of two distinct groups: the larger G3-denominated Asian issuers and local bond/currency markets. G3denominated Asian issuers (both corporate and sovereign) commonly tap the US dollar market and, to a lesser extent, the euro market. This market has the most diverse investor participation and has a wider representation in issuer type. Over the past few years, the composition of what was commonly referred to as US dollar-denominated Asian debt has changed, moving from a high concentration of Asian sovereigns and banks, to an increasing share of


· Asian fixed income is a multidimensional market. · There will be a divergence of performance across different sectors. · There may be opportunities in both currency and credit in the near term.

corporate issuers, both investment grade and high yield. For example, the market capitalisation of the non-investment grade market has increased by about 10% to 30% of the entire JACI index in the past five years.


After the Asian crisis, most sovereigns have seen significant fiscal improvement and have reduced their dependence on foreign borrowings by relying more on local currency markets. At the current


denominated Asian bonds. However, due to more solid credit fundamentals (Asian credits have a higher percentage of issuers with ratings positive or stable compared with the US and Europe), we expect Asian credits to perform well versus US corporate credit. The chart on the bottom right shows that Asian high-grade issuer credit spreads have been tighter than US high-grade issuers in the past few years. But a recent sell-off has caused a convergence of spreads between these two sectors, which we expect to correct in the medium term.


point of the credit cycle, net issuance is set to decline, especially in the high-yield sector. That said, the emergence of the high-yield corporate market not only allows more choice for investors, but also allows the assessment of relative value and opportunities across the capital structure (equities vs bonds). In addition, the development of a high-yield sector permits thematic and sector plays. We expect a divergence of performance to appear across the different sectors, in particular, we expect more pressure on the Chinese property sector over the government-engineered slowdown. On the other hand we expect a weakening global economic environment. Banks in Asia should perform better than their US counterparts as they are generally well capitalised and have relatively limited exposure to sub-prime debt. In the near term, the negative effects of the global sell-off in credit product (corporate debt, mortgage backed debt, and CDOs), will continue to spill over to G3-

A lot of discussions have centred on the possibility of the decoupling of Asian economies away from the US. The view is that intra-regional trade has increased substantially with China becoming an increasingly larger trading partner. However, data shows that most Asian economies still rely on exports for growth and a large portion goes to the US directly and indirectly, in the form of raw materials and intermediate goods. The implications of this for Asian currencies and interest rates suggest the USD and US interest-rate policies will continue to have a dominant effect on the Asian markets. That said, there is rising inflation pressure in countries ranging from Singapore, China, Indonesia and Malaysia. As witnessed by the recent rhetoric of the various Asian central banks, we expect they will not engage in aggressive interest-rate policies to curb inflation but rather allow for more currency adjustment. Previously, most Asian currencies tended to be loosely anchored to the dollar. However, with the increasing significance of intra-regional trade, Asian currencies now tend be more correlated with each other. The dynamics of the Asian economies and capital markets are rapidly changing and presenting new

opportunities. For example, the Chinese renminbi is still on an appreciating trend and is trading against a basket of currencies rather than its largest trading partner, the US. Running correlation analysis suggests that the Asian currencies are also increasingly influenced by the movement of the Chinese renminbi as intra-regional trade rises in importance. The other interesting development is the increase in domestic influences like inflation and local investor demand, which are becoming more prominent in determining market trends. Previously, the most dominant domestic factors influencing both currency and interest rates tended to be political news and capital flows. For example, India raised interest rates in response to rising domestic inflation early in 2007, resulting in a strong total return due to higher yields and appreciating currency in the first six months of 2007. Another example is Hong Kong, which remains under a currency board system. The peg suggests its interest rates should follow



US HG Corp Spread 400 350 300 250 200 150 100 50 Dec 01 Apr 02 Aug 02 Dec 02 Apr 03 Aug 03 Dec 03 Apr 04 Aug 04 Dec 04 Apr 05 Aug 05 Dec 05 Apr 06 Aug 06 Dec 06 Apr 07 Aug 07 Dec 07 Asian HG Corp Spread

Source: JP Morgan and Citigroup

"The weighting of Asian fixed income has recently increased in the portfolios of global investors, governments, institutions and, more recently, hedge funds"


Spread in asis points



the period 2004-2007. The ability to identify factors that are uncommon to a currency bond system enables the investor to enjoy this kind of outperformance.


and reserves in Asia and the Middle East. It is experiencing remarkable growth, increasing at an average of 40% a year. Since global players are showing increased participation in this market, we expect further cross-border issuance and interregional flows between Asia and the Middle East.


Victoria Ip-Cheung, CFA

Career highlights Victoria Ip-Cheung, CFA is responsible for overseeing all fixed income activities in Hong Kong and the Asian territories for Manulife. She joined the company in 2000, and was previously head of fixed income at HSBC Asset Management for Hong Kong. She has 19 years of investment experience and is a graduate of the Wharton School of Business. She is also a member of the Hong Kong Securities Institute.

US rate movements. With a credit rating lower than that of the US, there should be a risk premium over the US interest rates. However, Hong Kong interest rates have traded at a discount to the US which has persisted since 2003 as low lending growth led to ample liquidity in the system. One may be surprised to find that the 10-year HKD government bond delivered a cumulative 2.6% excess return over the 10-year US Treasury for

Over the longer term, structural influences are emerging that will change the landscape of these capital markets. A strong equity culture has historically dominated the Asian region as evidenced by the much larger capitalisation of the stock market relative to the bond market. Nonetheless, long-term structural changes are happening that would buoy the development of the bond market. Countries like Indonesia are coming up with new amendments to pension fund regulations, which many expect will increase investor demand for fixed income. China, whose bond market is quite large but segmented, has just enacted policy change that prevents commercial banks guaranteeing corporate bonds. In the long term, this should result in the development of a real credit market and improve the sophistication of investors in terms of credit risk identification. As with all other market developments, it will take time to see the positive effects. Without the commercial bank guarantees, we will need to be more selective in our credit picks, but believe the wider spread environment may offer investors greater relative value.


An additional development has been the rapid rise of the Islamic bond market. This market grew chiefly in Malaysia as a result of high levels of surplus savings

"The dynamics of the Asian economies and capital markets are rapidly changing and presenting new opportunities"



The long-term positive story of Asian fixed income arises from well-publicised infrastructure needs for Asia. As a result, we expect a full spectrum of debt instruments other than public securities in the arena of fixed income or quasifixed income. Private placements have been developing with transactions for a variety of industries using more sophisticated structures, such as equity kickers. Other pockets of growth are the REIT and the securitised market. While we witness different pockets of growth, one of the impediments in the development of the Asian bond market is the domination of Asian banks as suppliers of capital. The syndicated loan market is well developed and priced at tight levels. With the credit cycle potentially turning, this presents an opportunity for corporates to diversify their funding sources. To conclude, Asian fixed income is a multi-dimensional market. The key to investing in this area is the ability to realise that it as a diversified group instead of a homogeneous block called Asia. In the near term, as this credit cycle is turning, there may be opportunities in both currency and credit. Longer term, with steadily improving credit fundamentals and large infrastructure needs, we will see a wider spectrum of instruments and continued growth in this market. The outstanding question is how quickly the disintermediation of Asian banks occurs. Perhaps as investors recognise the need to diversify income sources, Asian banks will no longer be the dominant supplier of capital. This will allow for a more balanced and efficient landscape for both investors and borrowers.


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The challenges of valuing OTC derivatives

Recent market events arising from the credit crunch and high-profile trading losses and control failures have compounded concerns over the valuation of OTC derivatives. Kevin Borrett explains why it is so difficult and why it is important to get it right



t is a well-documented fact that the use of OTC derivatives has grown significantly over the past few years. These instruments ­ unique bi-lateral contracts which can vary considerably in complexity ­ and the widespread increase in their use have put a strain on the operational and technological capabilities of many financial institutions. The control functions and back offices have been stretched to breaking point, a situation which is set to be exacerbated by the recent introduction of UCITS III regulations in Europe, facilitating broader usage of these instruments within the retail asset management industry. Recent market events arising from the credit crunch and high-profile trading losses and control failures have compounded concerns over the valuation of these complex derivative instruments. As a result, investors and regulators are becoming increasingly discerning and less comfortable with being solely reliant on internal or counterparty valuations. There is increasing demand for fully independent valuation sources which are at arms length from the parties to a trade, and which rely on observable or consensus market data and apply consistent valuation methodologies and practices.


So why are certain derivative products considered hard to value? The issue stems fundamentally from



a lack of observable trading activity or quoted prices. Many products are sold on origination, often to a single buyer with the intention of holding the asset to maturity. In such instances, and unless the buyer is comfortable valuing at cost instead of to market, there is little alternative to using mathematical models. This introduces the dynamic of model complexity ­ different models provide different answers even if the input set is consistent. There is a lack of available data to populate the model and, what is worse, some model inputs are inherently unobservable. These issues have given rise to the development of specialised independent valuation and data providers In recognition of the issues at stake, industry bodies have been developing a set of core valuation principles, notably the IOSCO valuations paper for hedge funds released in March 2007, in order to define industry best practice in this complex area. The following themes have arisen in these forums: · Independence Not all funds or financial institutions possess the scale, clear structural segregation and sophistication to manage fully independent, internal valuation processes and conflicts of interest can arise. They, or their governing bodies, should therefore seek independent verification of their valuations on a regular basis by a suitably-qualified third party. This should encompass both independent

modelling of the trade and independent supply of the required data and model inputs by an unconnected party. · Price/data availability and bias Reliance on single counterparty or broker sources, or deal originators closely linked to the financing of inventory, needs to be controlled and mitigated. Wherever possible, pricing or valuation inputs should be sourced or derived from a variety of independent market participants (such as exchange prices or consensus pricing), particularly where the valuation is also influenced by the manager or a connected party that may have a vested interest in the asset or fund's performance. · Reconciliation and audit In many instances, there is a clear reluctance among counterparties to divulge or provide transparency on valuation methodologies and inputs used in determining a valuation. The ability and effectiveness of price challenges can therefore be compromised. Equally, internal control groups and their auditors should be able to describe and audit the valuation processes, data inputs and models used to provide or independently verify valuations ­ that is to say, no `black boxes'. Comprehensive, documented valuation policies and procedures should be established and consistently applied and any price discrepancies or


measurements (that is, market based or non-market based, as illustrated below); · The use of OTC derivatives has · the assumption of an orderly grown significantly. transaction in the principal market · Investors are becoming less for the item. This assumes adequate comfortable with being solely exposure to the market prior to the reliant on internal or counterparty measurement date and the absence of valuations. compulsion (duress) or forced · Various changes in the market will liquidation or distressed sale; cause a fundamental shift in the way · fair value is based on assumptions the industry values OTC derivatives. that market participants would use; · new financial disclosure of assets and liabilities measured at fair value based on their level in the hierarchy. The application of this new hierarchy over-rides must be fully researched, is best illustrated by specific examples: understood and documented. · Level 1: actively quoted or exchange ACCOUNTING STANDARDS close prices such as Google equity Recent developments in accounting traded on Nasdaq; standards and reporting also recognise · Level 2: observable inputs (other than these issues. The Fair Value Measurement quoted prices in Level 1), values based ­ FASB 157 Statement, which was on consensus prices or comparable issued in September 2006, is a case in transactions, matrix pricing, models point. This directive has implications for based on interpolation such as both the compilers and users of financial evaluations of less liquid corporate statements generated under US bonds where more liquid comparables generally-accepted accounting principles exist; standard interest-rate swap (GAAP) after November 2007, and valuations based on broker-quoted includes a number of significant changes rates; · Level 3: unobservable inputs that to previous standards, including: · a new definition of fair value: the reflect the reporting entity's own FASB now defines fair value as an assumptions about what market `exit price', the price that would be participants would use (inputs derived received to sell an asset or paid to through extrapolation or transfer a liability in an orderly interpolation that are not transaction between market corroborated by observable market participants at the measurement date data). For example, a privately placed [SFAS 157 paragraph 5]. This is in bond of an issuer with no other contrast to what was previously reference debt; callable range accrual viewed as an `entry price' under the note and sub-prime mortgage CDO. EITF02-3 premise; We believe these changes, coupled · a fair value hierarchy used to classify with a desire for greater transparency the source of data used in fair value among investors and the markets at large, will cause a fundamental shift in the way the industry values OTC derivatives. Participants will be looking to use FAS 157 Level 1 or 2 compliant sources where possible, with a consequential shift away from single data sources or counterparty prices, or providers that derive data based solely on model extrapolation. Greater focus will be placed on valuation sources independent of the reporting entity and, in particular, on the usage of consensusbased approaches which collect valuation input data from multiple independent banks or sources.



Kevin Borrett

Career highlights:

"Greater focus will be placed on valuation sources independent of the reporting entity"

W W W. C FA U K . O R G

Kevin Borrett joined Markit in 2007 as a managing director. He has responsibilities for Markit Portfolio Valuations, a valuations service dedicated to the needs of buy-side institutions. Before joining Markit, Kevin was head of operations at AXA IM's hedge funds platform, and spent five years at CSFB in a variety of roles, including global head of derivatives middle office and European head of OTC derivative operations. He also worked for NatWest Global Financial Markets for 10 years, with roles in front office, market risk and equity derivatives middle office.



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Rating securitisation ­ a primer

Stuart Jennings explains what ratings are, how they are arrived at and why they are an important tool in an investor's armoury



· Ratings are intended as broadly consistent indicators of relative vulnerability to default; they are not intended to be a predictive indicator of actual default rates. · In determining assumptions, data with respect to past performance of similar assets to those being securitised is important.

ecuritisation and structured finance have become increasingly prominent in funding for UK companies and banks in the 21st century. Assets such as residential and commercial mortgages, corporate loans and bonds, consumer leases, credit card receivables, trade receivables and many others have been securitised. This generally takes the form of isolation of the assets in a special purpose vehicle (SPV), which then issues corresponding debt securities, backed by the portfolio of


assets, to the financial markets. Rating agencies offer credit opinions for securitisation funding transactions through credit analysis of the underlying portfolio of assets and transaction structure and assigning ratings to the various corresponding tranches of securities that are issued by the SPV to the capital markets. Thus, it is important to know what ratings actually mean and the various methodologies used in deriving them for different asset classes.





Ratings are intended as broadly consistent indicators of relative vulnerability to default; they are not intended to be a predictive indicator of actual default rates or a specific percentage of expected loss. Structured finance ratings are typically assigned to an individual security or tranche in a transaction, and not to the issuer itself. They generally only reflect a relative likelihood of default (or first dollar of loss) and not its loss severity given a default. However, to ascertain the likelihood of a default, the loss severity of the underlying assets is typically analysed. For example, in analysing a portfolio of residential mortgages, both the default likelihood and recovery prospects of underlying mortgage loans will be assessed, as both affect the cash flows available to the securitisation structure's bondholders. However, the rating of the bonds issued against this portfolio generally assesses only the relative likelihood that the cashflows available from the mortgages support the relevant tranche of the securitisation, and prevent a default ­ not the loss severity on that tranche if it does default. The rating process involves various stages prior to ultimately assigning ratings via the issuance of a rating letter. Assigning a rating is not the end of the process ­ the agency usually continues to monitor transactions throughout their life to ensure that the ratings initially assigned continue to be appropriate. The rating process begins with initial contact from an arranging investment bank presenting a proposal for a securitisation transaction backed by assets from a particular originator bank or company. More esoteric transactions may require the agency to perform an initial feasibility analysis ­ this might include assets from a sector which has hitherto not seen securitisation. For generic sectors, following receipt of sufficient information, the agency would proceed to its rating analysis.

W W W. C FA U K . O R G

"The results of the cashflow modelling determines the amount of note issuance that can be supported given a particular rating scenario"


Financial analysis of the transaction consists of two distinct phases: first, an assessment of the composition of the underlying portfolio and the assets that comprise it; and second, using the results of the asset analysis in a cashflow model to simulate the proposed transaction's liability structure and priority of payments to which the cashflows from the assets will be applied. The asset analysis will generally involve developing a `base case' that will require the development of an `expected' level of defaults, loss severity and recovery given a normal and steady-state set of circumstances. Scenarios for the various rating categories being examined will involve stressing expected defaults, recoveries and losses to varying degrees depending upon the rating category. In determining such assumptions, data with respect to past performance of similar assets to those being securitised is important. For residential mortgages, for example, an analysis of `static pool' data is the ideal where the performance of receivables originated in a particular year is tracked through their lifetime. This allows an assessment of different `vintages' of receivables and their reaction to prevailing economic circumstances during their lifetime. The assumptions developed serve as inputs to rating models developed specifically by the agency to analyse the underlying assets. These models are diverse and each asset type will have its own set of assumptions and specific rating model to perform this analysis.

Once default, loss severity and recovery assumptions for rating categories have been developed from the analysis of the assets, these can be used as inputs to a cashflow model that replicates the proposed financial structure of the transaction. A cashflow analysis will replicate the proposed use of the cashflows generated by the underlying portfolio of assets. The use of cashflows will be dictated by what is known as a `priority of payments' prescribed within the transaction documents. This determines which parties on the liability side of the transaction will receive cash in priority to other parties; conversely, it determines which parties would be the first to stop receiving payment if there were insufficient funds available to meet all liabilities on a particular payment date. The cashflow modelling will also see certain factors stressed. This includes rising interest-rate scenarios, as well as stressed levels of prepayment that will reduce the volume of excess spread. Stresses on the timing of when defaults occur will also be cashflow modelled, as well as the period of time until recoveries are realised. The results of the cashflow modelling determine the amount of note issuance that can be supported given a particular rating scenario without there being a shortfall in principal repaid by legal final maturity of the transaction, or any shortfall in interest paid throughout the life of the transaction such that an event of default would occur. The resulting note tranching determines the degree of





way the assets perform, the extent to which assets might default, as well as the degree to which losses are incurred and recoveries are realised on defaulted positions. As part of the rating process, the agency will require a visit to assess the quality of underwriting at the originator, as well as the servicing ability of the servicer. The agency will use this visit to benchmark against the abilities observed at other originators and servicers who operate in the same sector. As a result of the originator and servicer review, the rating agency may effect adjustments to the base financial analysis.


Stuart Jennings

Career highlights:

Stuart Jennings is a managing director in the EMEA structured finance group at Fitch Ratings in London. He heads the group's special projects and research team. Prior to joining Fitch in 1999, Jennings was an associate in the asset securitisation group at Credit Suisse First Boston, and before that was an audit manager at KPMG. Jennings earned his BA degree in accounting and French at the University of Kent at Canterbury. He is also a qualified chartered accountant.

The way in which a transaction is intended to function needs to be defined in, often complex, legal documentation. A detailed review of this documentation is needed to ensure that the manner in which arrangers and issuers have represented that the transaction should function is, in fact, accurately reflected in the transaction documentation. Legal opinions will generally need detailed review by counsel representing the rating agency to ensure that all legal risks that could be identified as affecting the transaction are adequately addressed and opined on, in a sufficiently robust manner.


a `pre-sale' report for public securitisation transactions, which it will publish on its website. The report is intended as a useful aid to investors during the process of their investment decision. For example, pre-sale reports published by Fitch will usually include a summary of the transaction features, the nature of the underlying collateral, highlights of credit committee concerns and an overview of the rating methodology used to rate the transaction. At the time the pre-sale report is published, the agency will issue expected ratings alongside. Once legal documentation and reviews have been finalised and the transaction proceeds to a closing date, the pre-sale report is converted to a final report and final ratings are issued by the agency. The final ratings are assigned in a letter issued by the agency to the directors of the SPV ­ receipt of the final rating letter from the relevant agency is usually a condition precedent to final document signature and ultimate moving of monies on the closing date.


credit enhancement ­ which might be in the form of subordination of lower-rated notes or a reserve fund of cash available to meet principal losses and revenue deficiencies.


The transaction is exposed to certain operational risks. Base assumptions developed by rating agencies will assume a market-average quality in the way assets were originated and underwritten by the seller. Similarly, the analysis assumes a market-average quality in the way assets are serviced on an ongoing basis. If assets were originated or are serviced in a way that diverges from the market average, then this may impact the



The credit committee will consist of senior staff members of the rating agency. At the committee, the lead analyst who has performed the bulk of the work in respect of the transaction will present his recommendations in terms of credit enhancement levels, as well as the underlying assumptions that were used for the analysis. Financial, legal and operational aspects of the transaction will be discussed by the credit committee prior to a decision being reached on the rating proposals.


The rating agency will generally produce

The closing date is not the end of the rating process. A structured finance rating is usually designed to be in place throughout the life of the transaction. This means that the agency monitors the progress of the transaction throughout its life to ensure that the ratings remain appropriate. Certain circumstances may arise that warrant a change of rating. For example, performance of the underlying asset portfolios may prove better or worse than expected in the base case analysis. The servicing abilities of the servicer of the portfolio may deteriorate. Swap counterparties involved in the transaction may themselves be downgraded. In these circumstances, rating actions may be taken. Initially, a more intensive period of monitoring may take place that may be accompanied by a rating watch. Rating watches are an indicator to the investor that a rating change could result in the near future.


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The slope of the term structure of credit spreads

Mascia Bedendo, Lara Cathcart and Lina El-Jahel propose an unstructured approach to determine credit spread slope and find that it is a useful indicator of the direction of changes in future short-term credit spreads


he empirical literature on credit spreads focuses on three main issues: the shape of the term structure of credit spreads across credit ratings, the constituents of corporate bond yield spreads and the economic determinants of the level and changes in level of corporate spreads. The motivation of these studies stems from the existing theoretical frameworks for modelling default risk, mainly the structural and reduced-form approaches. We proposed a unified framework which allowed us to analyse the effect of economic variables on the long and short ends of the term structure of credit spreads. Identifying the economic determinants of the slope has important implications for the risk management of portfolios including long- and shortmaturity bonds, as it shows which variables have a differential effect across the maturity spectrum of credit spreads. In addition, a rich literature on the slope of the risk-free term structure concludes that it may predict the direction of future changes in the level of interest rates. We therefore checked whether the credit slope could also be used as an indicator of the direction of future changes in credit spreads. Our approach followed an unstructured approach to test the explanatory power of market and idiosyncratic equity components, interest rate and liquidity variables on the credit slope. We found that both market and





· Both market and idiosyncratic equity variables play a significant role in explaining the slope of the credit spread term structure. Credit spread slopes can be employed to predict the direction of changes in future short-term credit spread levels. The credit spread term structure is generally upward sloping for investment-grade bonds and downward for speculative bonds.




idiosyncratic equity variables play a significant role in explaining the slope of the credit spread term structure. This suggests that changes in these variables translate into non-parallel movements in credit spread curves. In particular, we found that equity market returns, idiosyncratic volatility and interest rate variables are important determinants of the credit slope and that the strength of their effect depends on the bond rating. We also found that credit spread slopes can be employed to predict the direction of changes in future short-term credit spread levels. This fact has implications for the trading and risk management of risky bonds along the maturity spectrum. Finally, we found that the credit spread term structure is generally upward sloping for investment-grade bonds and downward sloping for speculative bonds, in line with the predictions of structural models.

We used the Fixed Investment Securities Database (FISD) and the National Association of Insurance Commissioners (NAIC) transaction data. The FISD database, provided by Mergent, includes detailed information about issuers and issues of all US corporate bonds maturing in 1990 or later. The NAIC database provides pricing details of all corporate bond transactions by US insurance companies between January 1995 and December 2001. We restricted our attention to fixed-rate US dollar bonds issued by the industrial and financial sectors that are non-callable, non-puttable, non-sinking fund and non-convertible. To avoid liquidity issues, we selected bonds with maturities ranging from only two to 30 years that pay coupons on a semi- annual basis. We excluded AAA-rated bonds, as their average credit spreads turn out to be higher than spreads computed for AA- and A-rated bonds. To filter out potential pricing errors, we excluded investment-grade bonds with transaction prices below $80 and above $135, as well as investment-grade and speculative bonds with negative credit spreads. To allow for computation of firm-specific variables, we used bonds for which data on the issuer's daily equity returns were available over the four months before the transaction date. After applying all these filtering criteria, sufficient data for investigating the credit slope for investment-grade bonds


were gathered across three ratings (AA, A and BBB) for the industrial sector and two ratings (AA and A) for the financial sector. The observations for speculativegrade bonds have been aggregated across ratings and sectors for the analysis of the class as a whole.




Financial AA Credit spreads Average Std. dev. Min. Max. Avg. maturity No. of bonds No. of companies No. of bonds/No. of companies Credit spread slopes Average Std. dev. Min Max No. of neg. slopes No. of pos. slopes Credit spread curvatures Average Std. dev. Min Max No. of neg. curvatures No. of pos. curvatures 109 46 0.3 331 6.7 479 52 9.2 A 117 55 0.4 393 7.3 1190 163 7.3 AA 80 42 0.1 321 8.4 253 66 3.8

Industrial A 115 62 0.1 399 10.6 911 219 4.2 BBB 162 90 0.1 683 9.8 835 277 3.0

Speculative Grade

For all bonds in the sample, credit spreads were computed as the difference between the yield to maturity of each bond and the contemporaneous Treasury yield for the same maturity, compounded at the same frequency. We downloaded the benchmark Treasury rates with maturities of two, three, five, seven, 10, and 30 years from Datastream and used a simple linear interpolation method to derive the entire Treasury curve. We needed to fit entire term structures of credit spreads and calculate measures capable of describing the slope. Ideally, credit spread term structures should be derived at the individual firm level for firms whose bond issues span several maturities. Unfortunately, our database did not include bond transactions for a sufficient number of such companies. Therefore, we fitted credit spread term structures across portfolios of bonds issued by different companies. For investment-grade bonds we performed our analysis for portfolios of bonds homogeneous by credit rating and activity sector. This also allowed us to verify whether our findings were general or group specific. The aggregation of bonds for ratings and sectors of activity may introduce two sorts of biases. The first is caused by the non-homogeneity of the issuers' credit quality across maturities. Helwege and Turner (1999) document a downward bias in the slope of the yield curve for portfolios of speculative-grade bonds, explained by the higher quality of the companies that issue long-maturity debt. To investigate the severity of this bias in our sample, we compared the proportions of issuers belonging to each sub-rating group across short and long time-to-maturity debt. For simplicity, we

W W W. C FA U K . O R G

497 627 9 6420 7.96 515 221 2.3

36 21 -19.8 119 4 146

33 17 -3.4 91 2 165

23 23 -5.3 116 14 127

26 20 -5.7 109 10 157

37 32 -7.3 132 15 151

-157 254 -956 216 56 16

3.9 3.4 -2.7 13 8 142

4.1 4.8 -13.3 18 21 146

1.9 2.8 -7.7 12 29 112

2.7 4.7 -10.7 20 39 128

4.8 7.6 -31.7 27 34 132

-17 117 -476 219 40 32

"We fitted credit spread term structures across portfolios of bonds issued by different companies"

focused on the rating class A and on the period 1999­2000. We found that, for the financial sector, the proportion of A+(A-) bonds with time to maturity between eight and 10 years is equal to 35.86% (17.77%), not too dissimilar from the 30.65% (21.13%) recorded for the bucket between three and five years to maturity. For the industrial sector, the proportion of A+ (A-) bonds with long time to maturity is equal to 11.56% (22.64%), even closer to the 13.94% (22.30%) reported for the bonds with less than five years to maturity. The similarity of the credit quality of the issuers of bonds with short and long time to maturity is not surprising, given that we worked with bonds traded in the secondary market rather than with newly issued bonds, for which the bias is larger. Our findings suggest that our analysis for investment-grade bonds should not be






CS slope

CS curvature


Basis points






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significantly affected by this bias. We were surprised to find that most changes in rating occur within the same rating class, with only 9.89% of the financial bonds and 14.02% of the industrial bonds traded migrating to a lower rating class, and 2.80% and 1.29% migrating to a higher rating. Because 75% of the relevant downgrades take place in mid-October, we concentrated on this period. For the three months before, we re-estimated the level and slope of the credit spread term structures by excluding the bonds that were later downgraded and we compared them with the original figures. On average, we found an upward bias of 5.4 basis points (bps) in the credit spread level and -1.5 bps in the slope for the financial sector and a slightly larger bias of 8.6 bps in the level and 2.2 bps in the slope for the industrial sector. For investment-grade bonds, in each period we fitted a smoothing cubic spline to the observed credit spreads to generate an entire term structure spanning maturities from two to 30 years. In our case, a smoothing coefficient of 0.01 was a satisfactory compromise between goodness of fit and



danger of over-fitting the empirical spreads. As expected, because the financial sector includes a larger number of bonds issued by a smaller number of companies (see table 1), this translates into less dispersed credit spreads and a more accurate fit. We provide summary statistics for the three main shape factors: level, slope and curvature. For investment-grade bonds, as a measure of the level of credit spreads we selected the average of the estimated spread levels at three, seven and 10 years to maturity on the spline. For the slope we used the difference between the 10and three-year-to-maturity spread levels estimated on the spline. The curvature of the credit spread term structure was measured by a butterfly portfolio consisting of a long position in an intermediate-maturity bond (seven years to maturity) and short positions in one short-maturity bond (three years to maturity) and one long-maturity bond

"Idiosyncratic variables are fundamental to the structural approach"

Jul 01


(10 years to maturity). The choice of adopting three- and 10-year-to-maturity bonds as, respectively, the short and the long ends of the term structure, is justified by the small number of bonds in our sample with shorter or longer time to maturity. Also, this choice minimises the chance that the results of our analysis could be biased by liquidity issues, given that bonds with maturities within this range are widely traded. As expected, credit spreads are higher on average, as well as more dispersed, for lower rating groups. For investmentgrade bonds, the credit spread term structures are upward sloping, with few exceptions (less than 10%). On average, financial bonds have a shorter time to maturity than industrial bonds, and their credit spreads are less dispersed. This latter aspect can be explained by looking at the total number of bonds and companies considered. Compared with the industrial group, the financial sector includes a larger number of bonds issued by a smaller number of companies (average number of bonds per company is 8.25 versus 3.6). Credit spread slopes are steeper and flatter for financial bonds, but again they are more dispersed for industrial bonds. For the industrial sector we recorded a steepening of the credit slopes for BBB bonds which, together with a larger curvature, may be indicative of more hump-shaped curves peaking for longer maturities. As illustrated in figure 1, the most striking feature about the curvature of the term structures is its small magnitude, with average values between two bps and five bps. This can be explained by the narrow range of maturities considered. As expected, in most cases, the credit spread term structures are concave. For the purpose of our analysis, it would also be interesting to investigate


the slopes of speculative grade bonds. Unfortunately, given the limited number of observations available, we are not able to refine our study by sector and rating, and could only consider the noninvestment grade category as a whole. The aggregation across sectors and ratings, coupled with the lack of sufficient observations across the maturity spectrum, would severely undermine the accuracy of the cubic spline approach. The only viable solution therefore was to group the credit spreads by buckets of bond maturities. We computed the average three-year-to-maturity credit spread level as a simple average of the credit spreads for bonds having maturities between two and four years. Similarly, we computed the seven- and 10-year-tomaturity credit spread levels as averages for the buckets of bonds from six to eight, and from nine to 11 years to maturity, respectively. As for the investment-grade class, measures of credit spread levels, slopes, and curvatures were computed from three-, seven- and 10-year spreads, estimated from the buckets rather than from the splines. As expected, the results indicate that average credit spreads for speculative bonds are much larger in magnitude and more dispersed than those of investment-grade bonds. Also, junk bonds have a shorter average maturity than high-quality bonds. The average numbers of issued bonds per company are 5.5 and 2.3 for investmentgrade and speculative-grade bonds, respectively, which confirms that the speculative class is heterogeneous. On average, the credit slopes for junk bonds are steeper in absolute terms, and predominantly negative, than those for investment-grade bonds, thus confirming the predictions of structural models. Finally, the credit spread term structures are mainly convex.


important in explaining credit spreads and their dynamics. In general, we expected changes in variables that lead to an increase in the default probability to produce a steepening of the credit slope as a result of a larger widening of the credit spreads at the long end for investment-grade bonds and at the short end for speculative-grade bonds (given the higher uncertainty associated with these maturities for the two rating categories). As a measure of equity market volatility we took the standard deviation of daily returns on the S&P 500 over the four months preceding (but not including) the bond transaction date. In the structural approach, higher asset volatility implies higher probability of default. The asset volatility, generally approximated by the company's equity volatility, includes both an idiosyncratic and a market component. Whereas idiosyncratic volatility has trended upward since the mid-1970s in accordance with corporate-bond spreads, market volatility has not shown a clear upward trend.



Lina El-Jahel

Career highlights:

As a measure of equity market returns, we computed the cumulative return on the S&P 500 over the four months preceding the bond transaction date. Recent past returns on an equity index represent a good indicator of the overall state of the economy. Several studies conclude that credit spreads behave counter-cyclically, increasing during recessions and decreasing during economic expansions. Therefore, we expected a negative relation to hold for credit slopes.

Lina El-Jahel, MSc Finance programme director, Tanaka Business School, Imperial College, London. She completed a PhD in finance at Birkbeck College and obtained the ESRC Young Researcher Fellow award. Prior to joining Tanaka in 2001 she was based at the Lancaster Business School. She has direct experience of financial markets through her time as a consultant for central banks, hedge funds and investment banks. Recently, she has worked for Deutsche Bank AG London.

We focused on a group of explanatory variables that the theoretical and empirical literature recognises as

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and its potential effect on credit spreads. Intuitively, periods of significant flight to liquidity should be characterised by high levels of credit spreads as a result of the migration from corporate bonds to more liquid Treasury bonds. We used a measure of liquidity slope (the difference between Refcorp premia at 10 and three years to maturity) to assess the effect of the flight to quality on credit spread slopes. We did LIQUIDITY PREMIUM We used the difference between the yield not expect a steepening of the liquidity slope on the government bond market to on the Refcorp bonds and the yield on the Treasury zero-coupon bonds for the lead directly to a steepening of the credit corresponding maturity as a measure of slope. Flights to quality on the government bond market may lead to a liquidity premium. Refcorp bonds are generalised migration from corporate to virtually risk-free; therefore, the calculated risk premia measure the flight Treasury bonds, especially over the range to liquidity on the risk-free bond market of maturities considered.





Financial Sector Panel A. Rating Group AA Regressions: Intercept

S &P t

Panel B. Rating Group A 5 17.93 (0.76) 0.44 (1.13) -0.90 (-4.26)** 37.64 (2.58)** 1.10 (2.44)** 0.40 (1.74)* -0.42 (-0.13) -27.70 (-2.65)** -5.37 (-0.20) 150 0.3653 1 20.80 (4.80)** 0.70 (2.63)** -0.77 (-2.92)** 5.09 (0.46) ­ ­ ­ ­ ­ ­ ­ ­ ­ ­ 167 0.1011 2 9.59 (2.59)** ­ ­ ­ ­ ­ ­ 2.03 (6.29)** 0.49 (1.76)* ­ ­ ­ ­ ­ ­ 167 0.1654 3 4 5 -4.39 (-0.22) 0.51 (1.55) -0.59 (-2.39)** 13.73 (1.02) 1.02 (2.40)** 0.53 (1.77)* 3.70 (1.40) -18.61 (-2.47)** -6.43 (-0.32) 167 0.2784

1 17.91 (3.49)** 1.01 (3.42)** -1.03 (-5.05)** 35.33 (3.13)** ­ ­ ­ ­ ­ ­ ­ ­ ­ ­ 150 0.3212

2 11.22 (2.83)** ­ ­ ­ ­ ­ ­ 2.12 (7.09)** 0.44 (2.12)** ­ ­ ­ ­ ­ ­ 150 0.1648

3 13.02 (2.55)** 0.39 (1.08) -0.86 (-4.28)** 38.45 (3.37)** 1.25 (3.44)** 0.48 (2.41)** ­ ­ ­ ­ ­ ­ 150 0.3762

4 103.54 (6.80)** ­ ­ ­ ­ ­ ­ ­ ­ ­ ­ -11.49 (-4.62)** -37.01 (-5.47)** 53.59 (2.23)** 150 0.1828

S &P










t slope



rt N 2 Adj. R

11.81 60.37 (2.63)** (4.86)** 0.01 ­ (0.05) ­ -0.59 ­ (-2.94)** ­ 7.78 ­ (0.67) ­ 1.78 ­ (4.33)** ­ 0.45 ­ (1.77)* ­ ­ -3.66 ­ (-1.85)* ­ -24.19 ­ (-4.36)** ­ -8.53 ­ (-0.42) 167 167 0.2084 0.1568

** Significant at the 95% confidence level.

* Significant at the 90% confidence level.


Idiosyncratic variables are fundamental to the structural approach. Following this approach, changes in firm-specific variables that bring the firm closer to its default boundary lead to a widening of credit spreads. In particular, we expected this effect to be stronger for longer maturities for investment-grade bonds and for shorter maturities for speculativegrade bonds, resulting in a steepening of the slope. Idiosyncratic variables were computed on the equity portfolios of the companies that issued the bonds traded during each 15-day period, with weights proportional to the number of bonds issued by each firm. We obtained the issuers' equity price series from the Center for Research in Security Prices (CRSP) database and adjusted them for stock splits and other events. When the issuer is a subsidiary, the equity returns of



the parent company were considered. If the issuer was taken over and all its debt acquired by the new company, the equity returns of the latter were considered. If a merger or takeover took place within the four months preceding the bond transaction date, the observation was discarded. We computed the idiosyncratic equity variables on the excess returns relative to the S&P 500 index, rather than sector-specific market indexes, which may have been more appropriate but not actively traded.


The idiosyncratic equity volatility was measured by the volatility of the equity portfolio with weights defined as previously. We computed the variance-covariance matrix of the issuers' equity excess returns over the four months preceding

the bond transaction date, following an exponentially weighted moving average (EWMA) technique. Because we worked with portfolios, the correlation structure represents an important component of the overall volatility; therefore, it was appropriate to use the idiosyncratic volatility of the portfolio rather than the average idiosyncratic volatility of its components. In our analysis we assumed that the correlation of idiosyncratic risks was approximated by the correlation of the corresponding equity excess returns. To investigate whether our choice of estimating idiosyncratic portfolio volatilities computed on EWMAs is appropriate, we also computed simple standard deviations of daily excess returns over the past four months as individual volatility estimates. In all cases, the more forward-looking EWMA outperforms the alternative volatility


measure. Following the argument offered for the equity market volatility, and the effect of firm-specific equity volatility on the credit spread level, we could also expect a positive relation between idiosyncratic volatility and the slope of the credit spread term structure.


implies a higher expected growth rate for the firm's value, which lowers the price of the default option. As the value of the default option decreases, credit spreads tighten and the slope is flatter.



Idiosyncratic returns reflect the firm's health and can be used as a highfrequency proxy for leverage. In our study, this measure is preferable to the more traditional leverage ratio for several reasons. First, the definition of leverage ratio for a portfolio of bonds issued by different companies is not straightforward. Second, accounting data are only reported quarterly; therefore, the effect of changes in leverage ratios on the credit spread term structure might be underestimated. According to structural models, a decrease in leverage (positive returns) moves the firm away from its default boundary and hence decreases the probability of default and the credit spreads. We expected this decrease in uncertainty to lead to a flattening of the slope.


We computed the slope of the defaultfree term structure as the difference between the 10- and three-year-tomaturity benchmark Treasury yields. Most of the recent literature agrees on the effects of macroeconomic variables on the slope of the yield curve. More specifically, the slope of the yield declines (increases) when restrictive (expansionary) monetary policy shocks occur. A scenario of improving economy could, in turn, increase the growth rate of firm value and reduce default risk. Therefore, we expected a negative relation between the slope of the default-free term structure and the slope of the credit spread term structure.


Lara Cathcart

Career highlights:

We took the level of the three-year-tomaturity benchmark Treasury rate from Datastream at the end of each 15-day period as a measure of the risk-free interest rate level. The literature agrees on the strong negative relation between the level of risk-free interest rates and credit spreads (see Longstaff and Schwartz 1995; Duffee 1998; CollinDufresne, Goldstein and Martin 2001). This is in line with the predictions of structural models, according to which the expected cash flows of the default option at maturity are discounted at the risk-free interest rate. A high interest rate level reduces the present value of the cash flows and, subsequently, the price of the option. Furthermore, the drift of the risk-neutral process driving the firm's asset value equals the risk-free interest rate. An increase in the interest rates

W W W. C FA U K . O R G

The curvature of the default-free term structure is measured by a butterfly spread built on the three-, seven-, and 10-year-to-maturity benchmark Treasury yields. Variations in the yield curve curvature are the result of changing economic variables that produce a different effect on medium-term and short/long-term interest rates. A recent empirical investigation by Christiansen and Lund (2002) highlighted a significant positive relation between interest rate volatility and the curvature of the yield curve. However, it is more difficult to predict the relation between interest rate volatility and the credit slope.


Lara Cathcart is a senior lecturer, Tanaka Business School. She completed a PhD in finance at Birkbeck College. Her research focuses on the study of fixed-income products, credit risk and derivative pricing. She lectures mainly on the MSc in Finance and the MBA programmes and is the Maths-Finance seminar co-ordinator. She has published papers and presented her research at international conferences. She has served as a consultant to financial institutions and recently to HM-Treasury on the Government Housing Finance Review 2008.

We estimated a series of ordinary least squares (OLS) regressions for the slope of the corporate bond yield curves, using as regressors the determinants identified earlier: market, idiosyncratic and interest rate variables. It is important to emphasise that the slope of the term structure of credit spreads is stationary, which allows for a sound econometric

time-series analysis. We assessed the relative importance of each group of variables separately as well as jointly. The result for the investment grade bonds of the financial sector are reported in table 2. The Newey­West technique was employed to obtain a heteroskedasticity and auto-correlation consistent covariance matrix of the estimated coefficients. To rule out persistence in our selected variables, we tested for stationarity of the regression residuals. In all cases we rejected the null hypothesis of unit root. Low equity market returns lead to a steepening of the credit spread term structure. When markets are depressed, investors shift to the shorter end of the curve, pushing up the yield on longPROFESSIONAL INVESTOR


"In most cases, we did not find liquidity slope to be a significant determinant of the slope of credit spreads"

maturity corporate bonds. In most cases, higher market volatility leads to a higher credit spread slope. The factor loadings on market return and volatility have stronger economic significance for the slope the higher the credit rating. For example, for the financial sector slope regression, the equity market volatility coefficient decreases from 1.01 for the AA rating to 0.70 for the A rating. A higher liquidity slope premium reflects more liquidity shortage at the long end (10-year maturity) relative to the short end (three-year maturity). In most cases, we did not find liquidity slope to be a significant determinant of the slope of credit spreads. This may not be surprising, however, considering the range of maturities under investigation. In fact, a flight to liquidity would result in a general widening of the spreads between all corporate bonds and Treasury bonds. To help understand the role of liquidity from the perspective of the structural approach, we calculated the percentage of credit spreads explained by this variable. For financial A-rated bonds with three and 10 years to maturity, we obtained 25.74% and 27.65%, respectively, which indicates an upward-sloping Treasury liquidity component. However, we should not draw general conclusions on the slope of the non-default component (the component of credit spreads not explained by the predictions of structural models) based on our measure of the liquidity premium. An illustrative example comparing the empirical spreads with those predicted by Merton (1974) shows that, on average, only 37.28% of the three-year spread and 45.40% of the 10-year spread are explained by default, leaving out a downward-sloping nondefault component. These results are not



contradictory, as a rigorous analysis of the credit spread components would require the investigation of other key determinants such as taxation, market premia, and individual bond's liquidity. For the financial sector we find an average R2 across ratings of 21%, using equity market and liquidity variables as regressors. For speculative-grade bonds, market variables turn out to have a significant effect on the slope. As expected, low equity market returns and high market volatility lead to a steepening of credit slopes. On the other hand, a higher liquidity premium produces a flattening of credit slopes, which may be due to the degrees of uncertainty on the short end of the term structure. For speculativegrade bonds, we found that equity market and liquidity variables explained 29% of the credit slopes.


Also, using portfolios of bonds might weaken the effect of idiosyncratic variables and understate their importance relative to market-wide variables. For the financial sector, idiosyncratic variable explain on average 17% of the credit slope. We also checked the joint explanatory power of market and idiosyncratic variables. For the financial sector, the average R2 across ratings increases by 8% after the addition of the idiosyncratic variables. This suggests that idiosyncratic variables contribute significantly to the slope of credit spreads. For speculative-grade bonds, the overall aggregation over sectors and ratings is not appropriate to investigate the effect of idiosyncratic variables, as it significantly reduces their effect. The signs of the coefficients indicate that higher idiosyncratic returns (proxy for lower leverage) lead to a flattening of the slope, whereas higher idiosyncratic volatility translates into a steepening of the curve. However, these variables are not statistically significant. Our results for junk bonds confirm the important role played by market variables in explaining credit slopes, but we were not able to disentangle and assess the role of idiosyncratic variables.


As expected, the sign of the idiosyncratic volatility was positive and significant for the slope. We found it interesting that 10-year spreads are more sensitive to an increase in idiosyncratic volatility than three-year spreads, thus the steepening of the credit spread curves. The effect of idiosyncratic returns on the slope of credit spreads is difficult to interpret. Higher idiosyncratic returns are a proxy of lower leverage and should lead to an improvement in credit spreads, but it was harder to disentangle the differential effect of this variable on the long and short ends of the credit spread curve. This factor is significant but, according to our results, may lead to a steepening or flattening of the curve. We believe this may be due to our portfolio approach to constructing the splines.

The Treasury slope is an important determinant of the credit slope across all ratings and sectors. The slope of the yield curve tends to vary over the business cycle, as it reflects the dynamic relation among the bond market, economic activity and monetary policy: it tends to steepen when market interest rates fall and flatten when market rates rise. The long end of the yield curve is less responsive to monetary policy changes; hence, a steepening of the yield curve following a decrease in the short rate would result in a flattening of the credit curve. This is consistent with both the Fama and French (1989) findings that credit spreads widen when economic conditions are weak, and the fact that a weakening of the economy is generally linked to a decrease in the yield curve


slope. Movements in the slope of the yield curve may also anticipate monetary policy changes and therefore provide an expectation of future short rates. Litterman and Scheinkman (1991), in fact, found that the slope of the yield curve is one of the most important factors driving the term structure. In that respect, we expected and found that the slope of the yield curve explained the slope of the credit curves with a negative sign. For the financial sector, the effect of interest rate variables on the slope of credit curves is more pronounced for higher ratings. For example, for the slope regression, the factor loadings on the interest rate slope are -37.01 and -24.19 for the AA- and A-rated bonds, respectively. For the same sector, interest rate variables on their own are able to explain 17% of the slope of the credit spread term structure. The results are, in general, consistent with the individual regressions. However, the role of some variables may be weakened in the overall regression because of the potential relations among them. In general, we found that adding the interest-rate variables to equity market, liquidity and idiosyncratic variables improves the adjusted R2. For example, for the financial sector the average R2 across ratings increased by 3%. For speculative-grade bonds, we find interest-rate variables to be statistically weak, as they can only explain 7% of the credit slope. The results from the joint regression highlight the effect of market variables, although as predicted we were unable to fully isolate the effect of idiosyncratic and interest-rate variables because of the heterogeneity of the sample.


measured at the beginning of the 15-day period. The coefficient for the credit spread slope is positive and statistically significant for investment-grade bonds across ratings and sectors. This indicates that steeper (flatter) curves are normally associated with an increase (decrease) in the three-year spreads one period ahead. For speculative-grade bonds, which display negative credit slopes, a significant positive coefficient on the slope indicates that steeper (flatter) curves lead to a decrease (increase) in the three-year spreads one period ahead. We found that the information content of the credit slope exceeds the information content of the slope of the yield curve by estimating OLS regressions of the three-year maturity credit spread on the slope of the yield curve. The slope of the credit spreads is not only affected by interest rate variables but also by market- and firm-specific variables. The preceding results suggest a mean-reverting behaviour of the credit slope. After fitting a discrete-time version of an Ornstein­Uhlenbeck process to the observed slopes for investment-grade bonds, we found significant evidence that credit slopes tend to revert to their long-run mean. Average half-lives of 22 and 23 days were recorded for the AA- and A-rated financial bonds, whereas 16, 16, and 15 days are found for the AA-, A- and BBBrated industrial bonds. These findings have important implications for the risk management and trading of bond portfolios and credit derivatives.



Mascia Bedendo

Career highlights:

Mascia Bedendo is a Assistant Professor, Bocconi University. She completed a PhD in finance at the University of Warwick. Her research focuses on credit risk, credit derivatives, option volatility and the link between credit and equity markets. She teaches derivatives and risk management on the MSc in finance and on the MBA programme at Bocconi. She has published her work in academic and practitioners' journals and she has presented her research at international conferences. She has served as a consultant to financial institutions and hedge funds.

Few studies however, investigate the information content of credit spread slopes. For this purpose, we regressed 15-day changes in the three-year-tomaturity credit spread against the slope of the credit spread term structure

W W W. C FA U K . O R G

We found that the contribution of idiosyncratic volatility in explaining the credit slope is more pronounced than that of equity market volatility. We also found that interest-rate variables are important determinants of the slope of the credit spread term structure. These findings have important theoretical implications, as firm-specific and interest rate variables are essential ingredients in structural models. It is more difficult, however, to compare the relative effect

of market equity returns and idiosyncratic returns across ratings. In general, we found that equity market returns were also important determinants of the credit slope and had higher economic significance as the credit rating increases. We also provided evidence that the credit slope displayed a mean-reverting behaviour and could be usefully employed to predict the direction of changes in future short-term credit spreads. Moreover, our results confirmed the role played by market variables in explaining credit slopes, as well as the information content of the slopes for predicting future short-term credit spreads.



One of the world's best kept secrets

Daniel Broby, FSIP explains why the times has come for investors to take notice of Africa's fixed income opportunities



he vast majority of African countries have rudimentary fixed income markets, with debt instruments usually of short duration. Government bonds do not exist in most African countries but their arrival and/or increased sophistication is imminent. Africa is going through major financial and economic transition and according to former UN Secretary General Kofi Annan, Africa's development is one of the world's best kept secrets. As recently as 1990, Africa's gross domestic product was larger than that of China. Today, China is five times bigger. Now, economic growth in Africa has accelerated, averaging about 5% over the past six years and hit 6.7% in 2007. A sound and sustainable macroeconomic framework is a prerequisite for the adequate functioning of bond markets. Comfort can therefore be taken in the driver of this development, which is essentially, economic, social and political - in other words, across the board. It is also being driven by debt relief, a growing middle class and a new generation of often Western-educated political leaders. Risk is clearly mis-priced. Sovereign fixed income ratings tend to be clustered at the low end of the sub-investment grade scale. In the past, the continent was plagued by a spiral of inflation, economic and political turbulence, but with some exceptions this is no longer the case. Many of these countries or regions are now finally kicking in and


joining the global economy. The emergence of a sixth of the world's population from poverty, enjoying the rapid growth that globalisation brings, brings with it great opportunities, and fiscal discipline means bond investors can enjoy the benefits as well. At the same time there is a lack of competition, corporate margins are healthy and capital markets are coming of age. The role and importance of bond markets in economic growth and development is well documented: they facilitate efficient resource allocation by providing market-determined interest rates that reflect the true cost of capital.



· Government bonds do not exist in most African countries but their arrival is imminent. · In order to make investment in Sub-Saharan Africa it is necessary to understand diversity of the issuance base, or lack of it. · The biggest problem for a fixed income investor in the region is that the countries are diverse, lacking adequate depth and information on which to make informed decisions, such as ratings.

The picture is not all bright. Zimbabwe faces potential instability as do Somalia and Sudan. Botswana, Mauritius, South Africa, Seychelles, Namibia, Ghana and Senegal are all perceived to be affected by corruption but, interestingly, less so than China, India and Brazil. In fact, Botswana is rated A+ and even inflationtorn Zimbabwe has an index-linked bond market. All eyes are now on Kenya. The Kenyan elections led to rioting after six heavily populated areas reported turn-outs of between 102% and 116%. Despite that, the democratic picture is brighter than the crisis would suggest. The country has made good progress on the fixed income front and holds auctions on a weekly and monthly basis for treasury bills and bonds, using multiple price systems and competitive

and non-competitive bids accepted in all auctions. Overall, political stability is now the norm. Close elections in Zambia occurred with relative calm and the government has promoted a corporatebond market on the back of the yield curve it championed. In fact, over the whole region, the democratic impulse has taken hold and since 1994, there have been more than 100 elections. Indeed, in the former war zone of Angola, elections involved 126 parties, although no form of bond market has yet been developed. In order to make investment in Sub-Saharan Africa it is necessary to understand the diversity of the issuance base, or lack of it. Although 75% of the nations in Africa issue treasury bills, only 49% issue government bonds and a miserable 6% have any form of municipal issuance. Corporate issuance



"Close elections in Zambia occurred with relative calm and the government has promoted a corporate-bond market on the back of the yield curve it championed"

in, 2010, 2015 and 2024. Government papers take up a large proportion, some 85%, in the long-term securities market in Namibia, which has come about as a result of a long-standing government policy to fund its deficit in the local market as a way of facilitating the development of the local financial markets. The first Namibian bonds were issued in 1992.


is on the increase, but is present in only 40% of countries and the lack of a government yield curve presents problems. Any yield curve serves as a reference for the pricing of all other issues and has a decisive impact on the efficient conduct of monetary policy and affects the degree to which capital markets can be developed to facilitate risk management. Doing your homework in Africa is essential. There is a mix of formal rules, informal norms and enforcement characteristics that define the national markets. Understanding the structure of each individual country, as well as the transaction costs, is important. For example, the benchmark issuer in the West African Economic and Monetary Union (UEMOA) is the West African Development Bank, not a sovereign entity. Commodity-based economies are obviously important. These notably include oil, gas, metals and mining economies, but the presence of abundant resources does not, however, translate into a functioning fixed income market. One exception, and perhaps a model for the future, is Namibia, a small country with a BBB rating. The Namibian capital market's success is partly down to its close links with South Africa. The Bank of Namibia issues treasury bills and Internally Registered Stock (IRS) by open tender, but unlike treasury bills, these are capital market instruments issued for maturities exceeding 12 months. The Republic of Namibia has also issued government bonds maturing

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requires a great deal of work. Available information is clearly hard to get, while local regulations are varied and difficult to understand. Despite these challenges, these markets are now beginning to take shape and investors should take notice.


The biggest problem for a fixed income investor in the region is that the countries are diverse, lacking adequate depth and information on which to make informed decisions, such as ratings. Botswana, Namibia and Mauritius all have per capita incomes approaching that of South Africa, the region's only sizeable middleincome country, and they clearly have the best ratings. The rest are rapidly maturing, giving opportunity for yield pick-up on the back of rating upgrades and Nigeria, for example, has seen a significant decline across the entire yield curve. Nigeria now also has a well developed state issuance program, which enjoys federal backing. The problems the other African countries face will hopefully be solved as they have largely been in Nigeria. The fact that Africa's economies are not well diversified and often depend on a single commodity for generating the bulk of foreign exchange earnings actually makes fixed income investing interesting from a portfolio diversification point of view. Another positive from an investment standpoint is that strong corporate earnings growth remains the key driver of the region's progress. The challenges are many. The fixed income infrastructure, such as the legal and regulatory framework, as well as settlement depository systems, still

Daniel Broby, FSIP

Career highlights:

Daniel Broby, FSIP was formerly chief investment officer of Renaissance Investment Management. Prior to that he worked for Bankinvest, Denmark's third largest asset manager, as chief investment officer in 2000. Broby was the CFA Institute's President Council Representative for Europe, Middle East and Africa for four years and was presented with the CFA Institute's Society Leader Award in 2006. He now serves as a member of the Capital Markets Policy Council. He was elected an individual member of the London Stock Exchange in 1990 and is a Fellow of the Securities Institute in the UK.



The cash machine is broken

The European securitisation market has been crucial in making credit cheaper and easier to obtain in UK households. But the recent turmoil in the securitisation market will have significant implications for the British economy, writes Myles Bradshaw, CFA



· Tighter credit conditions will remove a key support for the consumer's already over valued primary asset: houses. · The commercial property market is facing similar stress. · Credit conditions for the whole UK economy can be eased by lower interest rates from the MPC.


unday is a terrible day for withdrawing money from the cash machine. With no staff working to refill the ATMs after the Saturday party crowd, any visit to the cash machine is invariably unsuccessful. But I am always confident that this is only a temporary `liquidity crisis' and that I will have full access to my `assets' come Monday morning. Many British mortgage lenders are probably wishing the same could be

said for their `cash machine', the European securitisation market.


The European securitisation market shuddered to a halt in August. Total issuance fell from 50 billion a month up until July to a paltry 15 billion after August. I don't want to dwell on why this happened ­ the deepening US sub-prime problems, mortgage asset write-downs, a collapse in investors' risk





"The Euro securitisation market has been crucial in making credit cheaper and easier to obtain for UK households"

and liquidity appetite, and a loss of funding for key buyers like asset-back commercial paper (ABCP) conduits, structured investment vehicles (SIVs) and banks ­ these topics have been well documented elsewhere. But why is the Euro securitised market relevant to the UK? Residential mortgage-backed securities (RMBS) accounted for over 50% of Euro asset-backed issuance, and the UK accounted for about 50% of total Euro RMBS issuance. In short, the Euro securitisation market has been crucial in making credit cheaper and easier to obtain for UK households. That's why the post-August turmoil in these markets is so important to the British economy. Since September 2007, weaker housing and business survey data has confirmed that growth is slowing sharply enough to elicit a cut in rates from the Monetary Policy Committee (MPC) of the Bank of England (BoE). The market anticipates further interest rate cuts, with two and five-year government and interest rate swap rates trading below base rates of the BoE. But it is important to distinguish between this `risk-free' interest rate and the actual cost of credit. Lower base interest rates only work if they lower the cost of credit for the people that matter: consumers and businesses. And the turmoil in wholesale credit markets, particularly the freezing up in the securitisation market, has tightened credit conditions rather than eased them. To offset this tightening, the MPC will likely have to cut rates to well below their historical neutral range.



CHART 1: UK RMBS (ISSUED IN EUROPE) AND NET MORTGAGE LENDING UK non-conforming and buy-to-let RMBS issuance (12mth rolling) Prime UK RMBS issuance (12mth rolling) Bank and building society net lending (12mth rolling) Specialist lender net lending (12mth rolling) 100,000


£ millions




0 2001 2002 2003 2004 2005 2006 2007

Source: Bank of England, Merrill Lynch

Chart 1 shows total UK RMBS issuance on a 12-month rolling basis broken down by type: prime, non-conforming and buy-to-let. Issuance has exploded since 2006 as new issuers came to the market; with some of the prime RMBS pools containing 30-50% buy-to-let mortgage loans. The growth of the non-conforming and buy-to-let RMBS segments has been especially important for widening the availability of credit in the UK by increasing the funding base for specialist mortgage lenders who have no access to retail deposits. The data in chart 1 show that specialist mortgage lenders have been the marginal mortgage lender over the past few years. According to the BoE they have tripled the value of annual net mortgage lending and increased their market share of mortgage approvals for house purchase from 5% to 22% since 2001. Much of this specialist mortgage lending has been in buy-to-let mortgages which, according to the Council of

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Mortgage Lenders, accounted for 10% of outstanding mortgages in the third quarter of 2007, up from 2% in 2001. To give an idea of how the RMBS market facilitated this lending expansion it is worth noting that between 2001 and 2007 annual non-conforming and buy-to-let RMBS rose 500% with total issuance of almost £100 billion, equivalent to one third of specialist mortgage lenders' net mortgage lending over the same period.


But this securitisation cash machine has broken down. Non-conforming UK RMBS issuance totalled 2.4 billion since August, down 80% on comparable 2006 levels. The lack of credit has already fed through to the High Street. The Council of Mortgage Lenders reported that gross mortgage




CHART 2: UK RMBS BOND SPREADS Weighted average UK RMBS spread over Euribor Weighted average UK non-conforming spread over Libor 150





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has jumped around 135 basis points to 3-month Libor +160 basis points in early January, while the cost of a prime mortgage loan has increased 70 basis points to 3-month Euribor +85 basis points. These spreads may well come down in 2008 but it is unlikely that they will quickly return to the levels seen twelve months ago. The widening in the spread between the base rate and 3-month Libor rates will have also increased the cost of funding for floating rate mortgages, which tend to be priced off BoE base rates. As such it is no surprise that BoE data show that quoted fixed mortgage rates have increased slightly since the summer, despite a 100 basis point fall in 2-year swap rates on the wholesale interest rate market. Mortgage fees have also increased. reported a doubling in average arrangement fees since 2005. These tighter credit conditions will remove a key support for the consumer's already over-valued primary asset: houses. The derivatives market currently prices an 8% decline in residential property prices in 2008. With a lower value for the consumer's chief collateral and less willing lenders, the MPC will need to lower rates substantially if they want to materially reduce the cost of finance for consumers.


Basis points

Source: Merrill Lynch

lending fell 8% in November, the first monthly fall since July 2005. A survey showed that the number of adverse credit mortgage products on offer had fallen 54% in the three months to October. A whole range of lenders have lowered maximum loan-to-value (LTV) levels, removed self-certified income mortgages and increased rental coverage requirements for buy-to-let loans. Some have with drawn completely from the market. Kensington Finance ­ the UK's first dedicated `sub-prime' lender ­ has `temporarily' withdrawn from the adverse credit market, Victoria Mortgages entered into administration in September while Paragon Finance, the dedicated buy-to-let lender, announced it won't be able to fund new loans beyond February. The fall in credit availability is particularly significant as we re-enter a heavy refinancing period for fixed-rate mortgages. Indeed, a few households may find that they are unable to refinance their fixed-rate mortgages and therefore move onto lenders' punitive standard variable mortgages. Fixed mortgage rates have risen since 2005. But tighter credit conditions mean that borrowers have benefited little from falling interest rates since September. Chart 2 shows that the estimated funding cost of a repackaged non-conforming mortgage loan on the RMBS market



The commercial property market is facing similar stress. According to the Investment Management Association, the top 32 on-shore commercial property retail investment funds generated average net monthly inflows of just under £400 million in the 12 months to July, attracted by annualised returns of 10-15%. But the lack of credit has seen the number of transactions collapse. According to the IPD, a real estate data provider, commercial property prices have fallen 8% from June to November. Investment inflows have turned to outflows, pressuring funds to sell properties to raise cash. Property funds have adopted defensive tactics, such as imposing 12-month notice periods for withdrawals and reducing retail unit prices around 8% by switching to an outflow rather than inflow pricing model. But a vicious circle of further fund withdrawals leading to forced asset sales looks likely. The derivatives market is currently pricing a 14% fall in commercial property prices in 2008. Why does this matter from a macro perspective? Firstly, real estate accounts for around one third of business investment. So a weaker commercial property market has a direct macroeconomic impact. Secondly, real estate accounts for almost 40% of banks' corporate lending and has been

"The lack of credit has seen a number of transactions collapse"


the only sector experiencing double digit annual growth over the last 12 months. Therefore, negative commercial property prices threaten to exacerbate a vicious circle by causing impairment of banks' balance sheets and in turn reduce willingness to lend. An ongoing fall in available finance for commercial property would undermine prices further.


Central banks have stepped in by providing term liquidity to the banking system in return for collateral ­ in the BoE's case down to AAA RMBS for a £10 billion 3-month tender. By providing term finance to banks, these measures should help to alleviate the supply-demand imbalance in wholesale inter-bank money markets and allow 3-month Libor rates to fall. Improving the functioning of the wholesale interbank market will at the margin improve the transmission mechanism between a lower base rate (risk-free interest rate) and the cost of credit (mortgage rates). But while this might make it easier for banks to finance their involuntary balance sheet expansion it will do little to address the reluctance of investors to finance Britain's mortgage market. Unless the central banks are willing to fund the assets of the entire financial system (both bank and non-bank institutions) these measures will not in themselves solve the credit crisis.


I don't like ending on a gloomy note so where are the chinks of light? Firstly, the introduction of Basle II in January and the UK Covered Bond Law in March 2008 might mitigate some of the credit tightening. Under Basle II banks only need to put up 10-20% of risk capital against mortgage loans compared to 50% today. This means that a bank targeting a tier 1 ratio of 10% would now need £1-£2 of

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risk capital as opposed to £5 of risk capital under Basel I per £100 of mortgage loans. By lowering the regulatory capital requirements, Basel II effectively lowers the required hurdle rate for new mortgage businesses (other things being equal). The only draw-back is that other things are not equal, and faced with declining rather than increasing values for property collateral, banks may choose to run with higher economic capital than prescribed by regulators. The introduction of a UK Covered Bond Law in March may also help at the margin. Unlike with RMBS, mortgages backed by covered bonds remain on banks' balance sheets. The issuing bank also takes the first hit on mortgage defaults and the pool of mortgage loans provides additional security in the event of the issuing bank defaulting ­ that's why covered bonds yield some 60bp less than RMBS. Currently, UK banks issue structured covered bonds that are not covered by legislation and are not UCITS 22(4) eligible. Regulations constrain EU banks to holding a maximum 10% of assets against any one counterparty unless the assets are UCITS eligible, in which case the limit is 25%. By making covered bonds UCITS 22(4) eligible, the UK Covered Bond Law might therefore increase demand for UK covered bonds from other European banks and in turn increase the supply of credit for UK banks. There are three draw-backs here, though. Firstly, the covered bond market is currently as shut to new UK issuance as the RMBS market. Secondly, specialist lenders will not be able to use this source of funding. Thirdly, the rules governing mortgage loans eligible for covered bonds are more restrictive than for RMBS.



Myles Bradshaw, CFA

Career highlights

Myles Bradshaw, CFA, is a vice-president and portfolio manager at PIMCO Europe's London office responsible for Sterling portfolios. Prior to joining PIMCO Myles worked at Threadneedle Investment Managers for six years where he managed Global and Sterling Aggregate bond portfolios. He started his career as an economist at HM Treasury, where he worked for three years, before becoming an investment analyst at Prudential/M&G for two years. Myles graduated from Oxford university with a MA in Philosophy, Politics and Economics. He is a CFA charterholder and successfully completed the IMC.

Credit conditions for the whole economy can be eased by lower interest rates from the MPC. Policy is still on the restrictive side of neutral, so the MPC has plenty of room to cut. Historically, 2.25% real rates have been sufficient in

this decade to restart the consumer's animal spirits and spending, but this cycle will require lower rates to counter the market induced credit tightening. To make investing in housing attractive again, mortgage rates will need to fall below the current gross rental yield of about 5% (assuming house prices are unchanged). The market is currently expecting the BoE to end its rate cut cycle at a base rate of around 4.5%. This does not look low enough.



Recent research

CFA Society of the UK monitors the research output of all CFA Institute Program Partners in the UK. Where possible, the society posts these pieces directly on its website. A selection of excerpts from these is published here


Alan D Morrison, University of Oxford Said Business School and the Center for Economic Policy Research William J Wilhelm Jr, University of Virginia McIntire School of Commerce and the Center for Economic Policy Research

provide the type of relationship-intensive services that they have always sold, in both advisory work and in complex security underwriting. At the other, they are engaged in capital-intensive business that is high-volume, low-margin and largely commoditised. Arguably, the high-tech, high-volume parts of investment banking do not sit happily with traditional relationshipintense businesses. Certainly, we see more and more boutique operations concentrating upon relationship businesses. Investment banking will always rely upon human agency relationships, and reputation. The challenge for investment banks in the future will be to create within very large companies the intimacy that these qualities require.

ABSTRACT ­ In 1970 the New York Stock Exchange relaxed

rules that prohibited the public incorporation of member firms. Investment banking concerns went public in waves, with Goldman Sachs the last of the bulge bracket banks to float. We explain the pattern of investment bank flotations. We argue that partnerships foster the formation of human capital and we use technological advances that undermine the role of human capital to explain the partnership's decision to go public. Investment banking in the second half of the 20th century was shaped by dual revolutions in computer technology and in financial economics. Many traditional investment-banking activities were transformed, as algorithms and technical prowess were substituted for old-fashioned, people-based, qualitative investment banking skills. These changes had an effect upon business schools: more and more investmentbanker skills can now be acquired in professional schools; and because banking skills are being more widely disseminated and because computers create economies of scale in their application, competition in investment banking has reached unprecedented levels. Information technology has transformed securities businesses, but its impact in other areas has been less pronounced. As a result, investment banking today is a rather bipolar activity. At one extreme, investment banks continue to




Tim Jenkinson, University of Oxford and CEPR Tarun Ramadorai, University of Oxford and CEPR

ABSTRACT ­ It is often taken as axiomatic that investors prefer

high levels of regulation. Yet companies have increasingly chosen to list on stock exchanges with lower regulatory requirements. In this paper we analyse whether investors value high regulatory standards for quoted companies. We use the unusual regulatory environment observed in London - two alternative regulatory regimes with the same trading technology - to analyse these issues. We focus on 218 firms that chose to switch their trading `down' from the highly regulated main market to the lightly regulated AIM market, and 56 firms that moved `up' to the main market. Switching firms on average experience down (up) announcement returns of approximately -4% (+5%). However, these initial reactions are reversed over several months after the switch. Our results suggest that particular investor clienteles exist for the two markets and that other investors who place little value on the higher regulatory standards become the relevant marginal investors when companies switch to AIM.



Kenneth A Froot, Harvard Business School and NBER Tarun Ramadorai, University of Oxford, Oxford-Man Institute for Quantitative Finance, London Business School, and CEPR


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UK CFA candidates outperform CFA Institute has announced that 39% of the 37,573 worldwide candidates in the rigorous Chartered Financial Analyst® (CFA®) program passed the Level I exam they took in December. The UK's position as a leading financial centre and a hub for financial training encouraged 3,802 candidates from the UK to register for the program. The pass rate for the UK candidates that sat the exam in December was 42%, three percentage points ahead of the global average. Says Will Goodhart, chief executive of CFA UK, the UK member society of CFA Institute: "Our candidates have again shown an outstanding commitment to their professional development and we look forward to congratulating them on the further success in the CFA Program in the next few years."

Ganesh Rajendra, CFA

Will Goodhart

Sub-prime crisis to reshape markets The sub-prime crisis is `a fundamental, market reshaping event' that will affect the market's structure for many years to come. Speaking at the society's February event on the crisis, Ganesh Rajendra, CFA, director and head of European securitisation research at Deutsche Bank, said: "It is a run on structured finance and all its constituents." In the course of an extensive report on the genesis of the crisis and its likely course, Rajendra observed that the relaxed monetary conditions of the last few years had "changed the way that asset lenders operated. This [the crisis] is a re-entrenchment of that liquidity and what little remains will be drastically repriced. In the US, the impact is working its way through. In Europe, we're going to see more volatility." While the impact on the banking sector has been most obvious to date (because of the banking sector's position as both the largest investor in and the largest issuer of

structured finance), Rajendra believes that the impact on the real economy will be rapid and profound. He observes that, with refinancing opportunities now sharply reduced, there will be a rapid increase in mortgage costs. Notes Gajendra: "The delinquencies that we're seeing now are still just the tip of the iceberg." Sreekala Kochugovindan, asset allocation strategist at Barclays Capital, agrees that the collapse of the shadow banking system will have a significant impact on real economies and that conditions ­ in the US at least ­ are compatible with a recession. Notes Kochugovindan: "There could be a much more prolonged slowdown. There's no justification for assumptions of a v-shaped recovery." She, too, points to the easy monetary conditions applied by the US' Federal Reserve as the source of excess liquidity. Her presentation noted that Fed rates had been substantially lower than might have been suggested by the Taylor Rule from 2003 to 2007. Observes Kochugovindan: "We've seen a breakdown in that relationship."

For more information see the feature on page 14.

Forecasting event suggests difficult year may be ahead At CFA UK's fourth annual forecasting event in midJanuary, Citigroup's head of European economics, Michael Saunders, cautioned that global growth is set to slow and that the consensus

forecast for growth may still be too high. Among his projections are that: · The effect on the US real economy is only just beginning to be felt. Households are only starting to get the picture. · The ECB will eventually cut rates. Forecasters tend to only expect ECB cuts after they have started easing. The ECB talks tough, but doesn't act tough. · European growth will slow. The Euro's strength is only just beginning to bite on exporters. · The UK economy is very vulnerable, and the MPC will cut rates ­ but more gradually than the Fed. Fiscal stimulus rescued the UK economy from last possible recession. Now the government's fiscal position is weak. Lastly, inflation is still a problem and inflation expectations are at their highest level since the Bank of England was made independent. Nevertheless, says Saunders: "Far worse lies ahead... The MPC will have to cut rates quite a long way." Speaking at the same event, Kevin Gardiner, global head of equity strategy at HSBC, noted that the market feels pretty grim, but, he added, "there's a lot of bad news in the price. We have been arguing that by the end of the year, the markets might rally and hit post-2003 highs." Among the reasons for guarded optimism, Gardiner noted that: · The comparison with the




potential impact on market values of the 2001 recession is misleading because valuations in that case were much higher beforehand. Equity markets are taking some comfort from central bank activity to take back control of money market rates. The bank capital writedowns are large, but are not that large relative to bank capital in aggregate. The tax deductibility of those writedowns has been overlooked by many. If you think credit was in excess supply, then we are returning to `normal' credit conditions, rather than `tight' ones. The link between US housing and consumer activity has loosened. Consumers don't rush to save ­ they just stop investing. And they've recently spent from current income, not from savings anyway. Companies have room to re-leverage, buy back stock, pay additional dividends and undertake M&A activity. system and how hard it is to prevent crises and boom/bust; finally, Emma Lawson, senior currency strategist at Merrill Lynch, spoke specifically about the GCC region and the impact of currency pegs on emerging markets currencies. The main conclusions were that: · The pegged currency regimes and the consequent accumulation of FX reserves have created global asset bubbles. · China and the GCC countries have been buying US dollars and depressing US interest rates by buying US Treasuries. · Surplus liquidity has created a misallocation of capital that has seen people rush into real estate and equity investment because credit has been so cheap. As Redeker points out: · Now that credit is not so cheap, the Fed is cutting rates to ease the strain on the financial system. · Rate cuts put pressure on the US dollar pegs, particularly for the economies of the Middle East which are purely pegged to the US dollar and also already running loose fiscal policies. · These conditions create booming, inflationary economies. The speakers observed that although the GCC states have been considering the issue of de-pegging for a couple of years, the Fed's quick action means that the pressure on them is becoming excessive. However, with fewer speculators in the trade (versus November last year) there is an opportunity for them to de-peg. Also with US President Bush in his last year in office, the political situation is less difficult for a break with the US dollar peg. The speakers expect a break to come at some point in Q2/Q3 2008 and that, if one goes, they all will. They point out that the UAE might already have broken, but appears to have been held back by pressure from Saudi Arabia. The expectation is that the GCC will move to a basket of currencies ­ a dirty float ­ where the basket composition is unknown in order to reduce speculation. This approach is similar to the actions taken by Kuwait. However, it was observed that Kuwait hadn't yet been that successful in dealing with the overheating in their economy, because they have been too focused on defending the dinar from speculative attack, rather than managing monetary policy. Marber on markets Brian Marber first presented to the society more than 30 years ago, in 1973. He believes that not much has changed in the intervening years, but decided nevertheless to give a slightly revised speech to members when he spoke in early February. Marber, who was the top ranked technical analyst for six successive years (1976-1981) has extensive experience of market conditions. In his recently published book Marber on Markets, he describes technical analysis as the triumph of experience over hope. The current market turbulence underlines the lack of certainty within the investment business. Says Marber: "Most people think markets are logical, but they are actually the opposite, illogical and emotional." Market uncertainties are exacerbated by people's perceptions and psychological reactions. In his presentation, Marber shared his views on how this uncertainty can be managed or reduced by using probabilities to arrive at share valuations. He says that there are a few things he has learned over the years. First, when he is asked "What will happen to the market?" he always replies "the market will go up and down, but not necessarily in that order". Second, "If you're promised the earth, that's what you'll get". In the same vein, he believes that you get what you pay for with free advice. Last, "food always finds its way onto light ties and not dark ones". He pointed out that he was wearing a light tie. As he says, "We never learn from our previous mistakes".






De-pegging the pegs CFA UK's FX Special Interest Group met again in earlyFebruary to discuss DePegging the Pegs. Hans Redeker, global head of FX Strategy at BNP Paribas, spoke first about the impact of US dollar pegs on global markets; then Keith Pilbeam, professor of international economics at City University, spoke about the evolution of the international monetary

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Brian Marber



The 2008 CFA Institute Annual Conference Connecting theory and practice: investment management in the global economy This year's conference will take place in Vancouver from May 11 to 14. The conference provides an unparalleled look at the trends and investment issues critical to success in today's global marketplace.


Speakers, including Blake R Grossman (CEO, Barclays Global Investors), Nassim Taleb (author of The Black Swan), and Professor Robert A Mundell (Columbia University), will cover a range of topics including asset and risk allocation strategies, practical implications of behavioural finance, opportunities following the 2007 credit/ liquidity crisis, economic and political effects of globalisation, investment strategies to exploit the growth of China, hedge fund alphas and betas, consequences of `black swans' and the future of the dollar and other currencies. Full details are available at conferences. The global investment research challenge The CFA Institute Global



Investment Research Challenge is a competition to engage CFA Program Partner university students with the investment profession. The competition offers students the opportunity to learn from leading industry experts and compete with peers from the world's top business schools. This annual educational initiative is designed to promote best practices in equity research among the next generation of analysts through hands-on mentoring and intensive training in company analysis and presentation skills. The UK and European regional heats of the Challenge are due to take place at event sponsor, Reuters, on April 16 and 17. This year it will involve 14 teams from the UK, Spain and Italy. The UK teams involved in this year's event include Stirling University, London Business School, the Tanaka Business School at Imperial College, ICMA Centre at the University of Reading, Leicester University and University of Exeter. CFA UK is coordinating the UK competition. The UK and regional finals are open and free for members to attend. Presentations start at 5.30pm and refreshments will be provided from around 6.45pm. If you would like to attend, please register your interest at CFA Institute people update CFA Institute announced that Robert R Johnson, PhD, CFA, has been named deputy chief executive officer.

Robert R Johnson, PhD, CFA

He will continue to act as managing director of the association's Education Division. In his new role, Johnson will report to Jeff Diermeier, CFA. The deputy CEO position was created to align the structure of CFA Institute with standard, global practices and to complete a broad-scale plan to align key organisational groups so that CFA Institute is comprised of three main functional groups: clients, products and infrastructure. While continuing to lead the Education Division, Johnson will also manage the association's professional ethics initiatives. Bob Johnson's new position became effective in December 2007. CFA Institute Centre for Financial Market Integrity It has been a busy period for CFA Institute Centre, with positions and responses made on a range of issues from CESR's consultation on Key Investor Information (KII) and the Hedge Fund Working Group (HFWG), through to the launch of a

new manual on Executive Compensation and calls to improve the credit rating industry's independence, quality and transparency. Work is also underway for the launch of a code of conduct for individual members of pension fund boards of trustees in the spring, and work continues in the areas of corporate disclosure and XBRL and ESG (environmental, social, and corporate governance) investing. More details can be found at www. cfainstitute/centre. The CFA Institute Centre launched a new manual which sheds light on the global components, risks and rewards of executive compensation.The Compensation of Senior Executives at Listed Companies: A Manual for Investors, which was launched in January, provides a comprehensive, in-depth examination of how executive compensation is determined, the elements of compensation, governance practices and associated risks for investors. It is structured in two parts: the first outlines some common corporate governance structures instrumental in setting compensation and describes the purpose and implications of each; the second considers the principal elements of executive pay. The second section also describes the reasons each compensation element is offered, how it may influence the actions and decisions of company managers and the factors


investors and investment professionals should consider with regard to each. The manual complements the CFA Institute Centre's The Governance of Listed Companies: A Manual for Investors CFA exam curriculum. Linked to the launch of the new manual, CFA UK will co-host an event with CFA Institute Centre on April 22. Details can be found at Recent responses to consultations from the CFA Institute Centre have included a response to CESR's consultation on Key Investor Information (KII). Here, CFA Institute Centre strongly supported the aims of the consultation by producing a two-sided document describing the key investment characteristics of a UCIT. However, we are concerned that such a space constrained document would sacrifice useful content with explanatory text to cater for the lowest common denominator of investor ability. Our solution was to create a central investor `knowledge base', containing all generic explanatory information matching the content on the KII. In response to the UK Hedge Fund Working Group consultation, CFA Institute Centre called for a single Global Hedge Fund Standard, grounded in the fair and ethical treatment of investors. The Centre offered its Asset Management Code as the vehicle to align hedge fund manager behaviour with the interests of investors. In partnership with CFA

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UK, CFA Institute Centre responded to the FSA's consultation on disclosure requirements for holders of Contracts for Difference (CfD). In the response, we observed a potential market failure, not recognised by the FSA, of liquidity constraints on security pricing, from unreported liquidity drawdown caused by market maker hedging to facilitate the construction of the customer's CfD. We believe that this hedging activity makes market makers quasi investors, and therefore ought to be reported to the market under the FSA's `major shareholder notification' requirements. By coincidence the Swiss regulator is debating whether the purposeful drawdown of liquidity to influence a security price, known as `cornering' is a manipulative act. Charles Cronin, head of CFA Institute Centre, has undertaken a number of society outreach activities across the EMEA region. These included visits to Stockholm, Paris, Nicosia, Amman, Istanbul, Geneva, Zurich and Frankfurt.


Level 1 CFA Program success The 2007 examination year ended on a high with 39% of the 37,573 worldwide candidates in the Chartered Financial Analyst® (CFA®) Program passing the Level I exam they took in December. The UK's position as a leading financial centre and a hub for financial training encouraged 3,802 candidates from the UK to register for the CFA Program's December sitting. A total of 1,280 candidates who sat the exam passed it, and the pass rate for candidates in the UK was slightly ahead of the global average at 42%. 519 new charterholders in UK In January, CFA Institute released the figures showing that 519 UK candidates in 2007 passed the rigorous exams and became charterholders. This represents 8% of the 6,427 new charterholders worldwide. There are now more than 80,000 charterholders in 131 countries and territories. Details of new charterholders were published in the Financial Times and Wall Street Journal Europe. Executive education and inaugural private equity course Saïd Business School, Oxford has teamed up with CFA Institute to provide its first joint executive education programme on private equity. "Private equity is here to stay, despite the turbulence of the recent credit crunch. It has fundamentally changed the corporate and financial landscape, yet its structure is not widely understood" said course director and renowned private equity expert Tim Jenkinson. The programme runs from June 16-19 and will give delegates the tools needed to understand the private equity phenomenon. Further details can be found at execed/finance/pe. The course qualifies for 26.5 CFA Institute CE credit hours.

Tim Jenkinson (left) and Saïd Business School (below)

Charles Cronin

In addition to the private equity course, CFA Institute is running programmes with London Business School (Hedge Funds, March 17-19), EDHEC (First Annual Advances In Asset Allocation Seminar, March 17-19), The Swiss Institute (Fifth Annual International and Wealth Planning Seminar, May 5), INSEAD (The seventh Annual Global Investors Workshop, June 9-13). Details can be found at memresources/conferences.




Advocacy news


CFA UK's response to the consultation paper issued by the Hedge Fund Working Group was broadly supportive of the paper's overall approach and its emphasis on disclosure rather than regulation. However, one concern expressed in the society's response was that the success of the proposed code depends upon the proper application of the principle of `comply or explain'. A significant contribution to the light-touch regulatory regime in the UK has come from the use of the `comply or explain' approach as an alternative to formal regulation. However, the necessary and sufficient conditions to make this approach effective are not always understood fully, and the society has noted its concern that, given the current governance structure for hedge funds, recipients of `comply or explain' disclosures will not have the right of redress in the event of the explanations being thought unsatisfactory. The first necessary condition for the successful application of the `comply or explain' principle is that the option of doing nothing (neither complying nor explaining) is not available. In the case of the Combined Code this is achieved by the FSA requiring in the Listing Rules that companies explain noncompliance to their shareholders. The second necessary condition is that those who are entitled to an explanation have some power to remedy a situation of which they disapprove. This power is available to activist investors in companies and to shareholders at a company's general meeting. "The Hedge Fund Working Group invoked the `comply or explain' mantra, but did not rule out non-compliance coupled with non-explanation," says



Geoff Lindey, FSIP, chairman of the advocacy committee that developed the society's response. "Nor did they give aggrieved investors power to respond to inadequate or unacceptable explanations. `Comply or explain' is a powerful tool which can be effective if it is properly structured, but it is of no benefit if the structure which invokes it does not satisfy the two necessary conditions."


The CFA UK's Investment Professional Advocacy Committee (IPAC) together with the CFA Institute Centre for Financial Market Integrity has submitted a response to the FSA's consultation paper on disclosure of contracts for difference (CfDs). The paper put forward three options. 1. no change to the current disclosure regime, 2. the disclosure of substantial economic interest unless the holder has taken specific steps to preclude themselves from exercising influence over the underlying shares, and 3. disclosure by all holders of substantial economic interests above a 5% threshold held through CfDs and other derivatives. Before formulating its response, the society surveyed members on some of the issues raised. Over 300 individuals replied and the message received was clear: change was long overdue. A total of 81% or respondents support change to the current disclosure and an overwhelming 87% believe that all economic interests held through CfDs and other derivatives above a 5% threshold should be disclosed. The society, therefore, supports the FSA's initiative and agrees with the issues

raised but, with the benefit of members' comments received in the survey, was able to draw the regulator's attention to factors that they had not considered, such as: · the disproportionate power given to other large shareholders when, say, 20% of the equity is held through CfDs with a non-voting agreement; · the potential inability of companies to discuss strategic options with large shareholders when they are unable to identify the ownership of claims of CfD holders. Contrary to the FSA's stated preference for option two, the society supports option three. Clearly, costs must not outweigh the benefits of regulatory change, but the committee was unconvinced that the cost of implementing option three would be significantly higher than for option two. Furthermore, option three offers considerable additional benefits: it would be more legally watertight, more coherent and also consistent with the regulatory regime recently adopted by the Takeover Panel for options and futures. However, if option two were to be implemented, the society expressed the view that market-makers should be required to declare any part of their trading book holdings hedged to a CfD and which exceeds 3%.


The society has just completed a short survey of members on the potential impact of the proposed changes to the taxation of people resident, but not domiciled, in the UK. The survey revealed considerable concern about the continuing attraction of the UK as a place to work, and more than 80% of respondents said the changes would damage the city's reputation as an international financial centre. For more information on the survey results, check the news section on the society's website ­


around the world providing clients with specialist capabilities in equity underwriting, equity sales and trading, equities research and corporate broking. Hill expects Macquarie to build its research presence in the UK over the next few years. Hill was awarded the ASIP designation in 1995. Management. Helen started her investment career with the Bank of England. She passed the society's Associate examination in 1991.

Toby Joll, ASIP joins FF&P

leming Family and Partners, the independent multi-family office offering asset management, trustee services and advisory services, has appointed Toby Joll, ASIP as investment director. Joll joins from Schroders Private Bank where he was head of portfolio management. He joined FF&P in January. He joined CFA UK in 1996 and was awarded the ASIP designation in 1997.


AXA Rosenberg hires York Deavers, ASIP

T Rowe Price appoints Helen Ford, ASIP

elen Ford, ASIP has been appointed as a US equity portfolio specialist based in T Rowe Price's London office. Helen will be responsible for covering multiple US equity strategies for clients and prospects in the EMEA region. Helen, who has 20-plus years of investment experience, joins T. Rowe Price from the Kuwait Investment Office (KIO) where she was head of US equities for the past three years. Prior to joining KIO, Helen was financials and healthcare manager within Cazenove's global equity team, and before that she was head of US equities at SLC Asset



ork Deavers, ASIP has joined AXA Rosenberg as a portfolio manager with responsibility for managing European institutional client relationships. Previously, he was an active equity portfolio manager and strategist with Barclays Global Investors for six years. Deavers, who serves as a volunteer on the CFA UK's IMC Panel, joined the society in 1998 and was awarded the ASIP designation in 2001.

ECM captures Jens Vanbrabant, CFA


Toby Joll, ASIP

Shai Hill, ASIP moves to Macquarie

ens Vanbrabant, CFA joined European Credit Management in November as a portfolio manager on the corporates desk, with responsibility for utilities, chemicals, retail, autos, and some smaller sectors. Previously, Vanbrabant was a credit research analyst at JPMorgan in London covering a variety of industrial sectors (autos, machinery and equipment, building and construction) in the credit portfolio group. Vanbrabant was awarded his CFA charter in 2004.


ate in 2007, Shai Hill, ASIP was appointed head of smaller companies and special situations research at Macquarie Capital Securities. His unit will focus on a number of sectors which might be subject to regulatory change, have significant financing requirements and are not intensively researched by other investment banks. Previously, Hill was head of research at Arbuthnot Securities. Macquarie's global equities business, Macquarie Capital Securities, has teams located in the major financial markets

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Cockburn joins Aegon Asset Management

arah Cockburn, IMC has been appointed to Aegon Asset Management's property team. Cockburn joins as a fund manager and will report to investment director, David Wise. Previously, Cockburn, an IMC member of CFA UK since May 2007, was a fund manager at Akeler. Prior to that she worked at Morley Fund Management. At Aegon, she will be joining the team of property fund specialists that joined from Morley in July 2007.



Helen Ford, ASIP



The final push

The clock is ticking for candidates studying for the CFA Program exam, writes Daren Miller, CFA


deally, your studies should now be at least 60% complete. The time will fly between now and the exam, so make sure that you prepare for the final push. This quarter , I offer some recommendations to help wrap up your studies.

Leave at least four weeks for review


the remaining 90%. If you over-prepare for the exam, then the logical thought is that all learning outcome statements are potential exam candidates. CFA Institute warns that it is difficult for candidates to recover from a zero score on skipped exam topics.

Complete the end-of-chapter problems


· · · · · · · · Leave at least four weeks for review Take leave from work before the exam Don't skip any topics Complete the end-of-chapter problems Sit all of the sample exams Sit for a mock exam Make Ethics part of your everyday study Reward yourself and others

Earlier, I wrote that your target completion date for 2008 studies ought to be 20 April. This would leave almost six weeks for a thorough review. If this might be unachievable, then consider completing your studies by the first week of May ­ at the latest. It is impossible for most candidates to review over 2,000 pages of material in less time.

Take leave from work before the exam

Your focus in the days leading up to the exam ought to be the exam itself. After such a large investment in time ­ with a high opportunity cost ­ you will need your mental and physical strength for exam day. Take at least the full week off from work. Even if you have booked off that week, be prepared to stand up to your boss if you get recalled to work ­ or your leave gets cancelled by the human resources department.

Don't skip any topics

All end-of-chapter problems are assigned as `homework' in the curriculum. If you haven't attempted these, including some of the more difficult ones of Financial Statement Analysis, then you will be at a disadvantage. If you have been using prep-course material exclusively, then also be sure to read the examples in the curriculum. These can be found in blue boxes throughout the six volumes. Remember, the examiners will be guided by the curriculum, including tables, examples, and end-of-chapter problems.

Sit all of the sample exams

training providers. There is nothing like attempting questions under time pressure. But be aware that any mock exam does not carry the imprimatur of CFA Institute ­ the quality of the exam will only be as good of the person who wrote it. When you check your answers, make sure that you can cross-reference each question to the 2008 learning outcome statements for your level.

Make Ethics part of your everyday study

As difficult as some of the topics can be, it is not advisable to leave any potential points on the exam. In other words, don't gamble with notion that you will be alright on the rest of the exam. At Level I, for example, if you leave out Quantitative Methods, then you will be leaving 10% of points. This places you under greater pressure to achieve well on



As part of CFA Institute's strategy of making the curriculum fully selfcontained, wrap up your studies by attempting every online sample exam offered by CFA Institute. Each one costs US$50, and the first one is provided free of charge. You will get automatic feedback of your performance, and answers, rationale, and LOS references will be provided. Be sure to read the rules associated with the sample exams because in past years, CFA Institute has not permitted the printing out of the questions, including screen shots.

Pushing Ethics to the end of studies is a common strategy, but a flawed one. There are several hundred pages of material to cover, and it is best approached a little bit each day. Always study Ethics from the curriculum as this topic usually gets watered down in prep course notes.

Reward yourself and others

Plan to do something extravagant after June 7. It is common for even the best of candidates to worry about the arrival of the exam results. Planning relaxing time with friends and family is a good way to take your mind off the results ­ and to Sit for a mock exam To simulate exam-day conditions, register thank them for putting up with your study sacrifice for so long. for a mock exam from one of the main


Darragh Finn, ASIAI

Darragh Finn works in the Collective Investment Scheme policy team at the FSA. He is a regular member of CFA UK, having qualified as an Associate of the Society of Investment Analysts in Ireland. He is an active member of the Society's Investment Professional Advocacy Committee

leading firms in the investment management industry. I've recently moved to the Collective Investment Scheme policy team, which is a team of six. We update the rules relating to the Collective Investment Scheme section of the FSA Handbook. We publish consultation papers on various areas of regulatory change and liaise with trade bodies and investment management firms. Reform of the UCITS Directive and developments in relation to funds of alternative investment funds are areas keeping us busy this year. Another issue is the implementation of the Eligible Assets Directive and we have just had a consultation on that. We also liaise with European counterparts and with Brussels.

Why did you join the CFA Society of the UK?

Darragh Finn, ASIAI

allow that. In today's global world the CFA Institute offers great mobility. I also think the CFA Society of the UK does an excellent job in bringing investment professionals together through the range of events that it hosts and the eminent speakers that it invites to discussions. I'm delighted that I was able to transfer from the Irish Society, because being a member offers excellent opportunities.

Why did you join the Investment Professional Advocacy Committee?

Why did you join the Financial Services Authority?

I previously worked as an equity and credit analyst, having qualified as a chartered accountant with Grant Thornton. That gave me a broad range of experience of financial services. I thought I could put that experience to good use when I joined the FSA. I also thought my academic background would be helpful. I graduated with a Masters in law from University College Dublin. Essentially, I thought the FSA would be a good fit for me.

What has been your role at the FSA?

I spent three years working as a firm supervisor. This meant supervising some of the

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I qualified as a regular member after taking the exams of the Society of Investment Analysts in Ireland. I think one of the great things about CFA Institute is that you can move around internationally from one chapter to the next. A lot of professional bodies don't

It was in response to an email asking for help. I think the Society thought I would have something to bring to the Investment Professional Advocacy Committee, because of my experience with the FSA. I was delighted to join the committee and it offers me the opportunity to share ideas on regulatory matters with investment professionals, which I enjoy. It also keeps me up to date on areas of investment regulation.

What is the committee focused on now?

The committee meets approximately six times a year

and is chaired by Geoff Lindey, who brings a wealth of investment experience to the table. Our terms of reference are to identify and monitor areas of regulatory change which are likely to affect CFA UK members. We consult members as much as possible on current issues, often by emailing surveys to the membership. We did that recently with the FSA consultation on Contracts for Difference. We then draft responses to consultations, either by the FSA or by other bodies. Another example would be our response to the Hedge Fund Working Group, which recently published its final report. We try to express the society's views in response to relevant consultation papers. There is a paper on the listings regime in the UK, which we'll be discussing when we next meet. The consultation paper discusses ways to re-label the primary and secondary listing segments to help participants in the markets understand the obligations on issuers of various listed securities. But there are so many issues pertaining to investment regulation at the moment, that there's no shortage of work for the committee.



New members

November 2007 ­ January 2008

The society welcomes the new members who have joined over the last few months. To find out how to join please visit

Adams, Christopher, St Edmundsbury FS, IMC Brooke, Natalie, PRUPIM, IMC

Chris is a financial adviser for St Edmundsbury FS in Bury St Edmunds and has worked in the profession for over seven years across commercial banking, insurance and, most recently, in the financial services team of a local legal practice.

Adey, Michael, Barclays Capital, CFA Aiyeola, Olusegun, IMC

Natalie Brooke joined PRUPIM in November 2004. She now leads the media and communications team. She has a business degree from Queensland University of Technology.

Buggy, Niall, Risk Care Calnan, Mark, Watson Wyatt Caricati, Paulo, Western Asset Management, CFA Catachanas, Anthony, IMC Cederfeldt Malinis, Charles, Barclays Global Investors Chakraborty, Ekta, Kleinwort Benson Private Bank, IMC Chaudhry, Gulistan, Thames River Capital (UK), IMC Chodorowicz, Dustin, Nordicity Group, CFA

Olusegun is studying for an MSc in finance at the University Of Liverpool. He graduated from the University of Lagos in 2004 and worked thereafter for Bancass Capital Management in Nigeria.

Allison, Simon, IMC Andreassen, Leigh, RBC, IMC Arora, Shankar, Citigroup, Assefa, Abebe, Bank of America, Bailey, Michael, Winterthur Life, IMC Bakshi, Ashwinder Singh, Fidelity International

Ashwinder is a credit research associate in the fixed income team. He has been with Fidelity Investments for nearly three years, having worked both in Europe and Asia. Prior to joining Fidelity, Ashwinder worked at Standard & Poor's.

Barlow, Joshua Mincher, PAAMCO Europe, IMC Beaumont, Julian, Montpelier Group, CFA

Dustin is a partner at Nordicity Group, a boutique consultancy specializing in strategy consulting for clients in the broadcasting, media, and telecoms sectors. Dustin leads Nordicity's client engagements involving financial valuation and economic-impact analysis.

Clarkson, Ian, UK IFA Net, IMC

Julian is a business development manager at Montpelier Group, focused on developing and managing the firm's investment funds business. Prior to joining Montpelier, Julian was an associate in the corporate advisory division of ING Investment Bank.

Bell, Steven, IMC Black, Matthew, Credit Suisse, Bloemers, Tom, Deloitte

Ian is an IFA working with the firm UK IFA NET Limited, an appointed representative of the Lighthouse Group. Based in Glasgow, Ian covers the whole of the UK doing post-retirement planning for high net worth individuals. He has honours degrees from the University of Glasgow and is qualified to Dip PFS level with the CII.

Clough, David, Novator Capital Partners

David is middle office administrator on a credit fund at Novator. Previously, he worked as a CLO fund administrator at Mizuho and in the global securities business at ABN Amro. He received his BA in Business Finance from Durham University in 2005.

Congdon, Charles, Acadian Asset Management (UK), IMC

Tom is a manager in the consulting practice of Deloitte London. He focuses on the preparation of business cases, strategy development, execution and market research for large strategic and operational investment projects. He holds a MsC in Economics from Maastricht University. Tom is a CFA candidate member and will sit for the CFA Level II examination in June 2008.

Charles Congdon is vice-president at Acadian Asset Management LLP's recently-opened London subsidiary. Charles's role involves client service and marketing in the UK and Europe. He has worked in equity markets for over 20 years as a fund manager and marketer, in both the traditional and hedge fund space.




Croudace, Gustav, Man Investments, CFA Daly, Patrick, Credit Suisse Delavy, Claudine, Barclays Capital, CFA Hugill, Paul Nicholas, IMC Hunt, Daniel, Citigroup, CFA Inampudi, Kalyani, IMC Jardine, Christopher, Asset Services London, IMC

Since moving to UK in October 2007, Claudine has worked for BarCap in fund-linked derivatives structuring focusing on the reinsurance business. Previously, she worked for Swiss Re in Zurich and New York as a senior structurer of insurance-linked securities and alternative risk transfer transactions.

Dibb, Jeremy, Fidelity International, IMC

Christopher is a treasury analyst at Asset Services London, a private family office. Prior roles have been with State Street in various roles and a client advisor and portfolio manager with ABN AMRO.

Jouhal, Harjachak, IMC Joynathsing, Praveen, Credit Suisse

Jeremy joined Fidelity International on its institutional sales and marketing graduate rotation programme in 2007.

Donaldson, Matt, International Power

Matt works in the portfolio finance department at International Power undertaking valuation of prospective new business and valuation due diligence analysis. Previously, he was employed in accounting related roles at BHP Billiton and General Motors in Australia.

Dynan, John, IMC Elias, Gillian, European Bank for Reconstruction and Development, CFA Eriksson, Karl Niklas, IMC Fatin, Yosra, Citigroup, CFA

Praveen works in the hedge fund financing group of Credit Suisse where he advises hedge funds on the optimal financing products to deploy for their portfolio management strategy. Prior to joining Credit Suisse, he worked in the strategy and financial consulting practice of Andersen for five years. He holds an MBA from Insead.

Kadish, Arthur, Orbis Investment Advisory

Arthur graduated from the University of Oxford in June 2007 with a BA degree in Modern History and joined Orbis Investment Advisory Limited as an investment analyst in August of that year.

Kaufhold, Bernard Kawasaki, Keisuke, Hermes Investment Management, IMC Kerschl, Werner, Industry Funds Management, CFA

Yosra is on the Financial Management Associate Programme at Citigroup. She joined the bank having completed her MBA at London Business School in 2007. Prior to that, Yosra had worked as an investment banking analyst at HC Securities & Investment and as an equity research analyst at HC Brokerage in Egypt.

Ferrar, Guy, Credit Suisse, IMC

Guy works at Credit Suisse in the structured notes product control team.

Fingerle, Christian, Allianz Infrastructure Partners, CFA

Werner joined Industry Funds Management as an associate in February 2006 and was seconded to London in November 2007. Previously, he was a manager in PwC's advisory team in Melbourne. From 2001 to 2004, he worked with KPMG Financial Advisory Services in Vienna.

King, Gerard, IMC Klas, Guenter, Vodafone Kunnummal, Dilshad, Barclays Bank

Christian works on private equity investments in the infrastructure sector. He previously worked for Allianz Specialised Investments with a focus on renewable energy investments before joining Allianz Infrastructure Partners in 2008.

Francois, Pierre, Deutsche Bank, CFA Greco, Piero, IMC Hall, Lori, Ontario Teacher's Pension Plan Haria, Niraj Sureshchandra, SS7C Technologies, IMC

Dilshad works as an investment analyst on the Barclays UK Retirement Fund. He took on the role in 2005 and previously worked with Barclays Risk and Ernst & Young.

Kuznits, Isaac, Credit Suisse, CFA Lam, Kiu Ki, Mondrian Investment Partners, IMC le Grice, Kevin Andrew, PRUPIM, IMC Lee Yuen Ping, Serena, Standard Chartered Bank Li, Ying, Cass Business School, CFA

Niraj manages the fund services group at SS&C Technologies and previously worked in hedge fund administration.

Haug, Tomas, NERA Economic Consulting

Ying is an MSc student in Mathematical Trading and Finance at Cass Business School. Previously, he worked at the Shanghai Stock Exchange for six years.

Ma, Muxin, London Underground, CFA Maier, Stephanie, IMC Makri, Vasiliki, Royal Bank of Scotland Group Mallett, Will, Standard Bank, IMC Mandelbaum, Joel, Societe Generale

Tomas is a consultant at NERA Economic Consulting. He joined NERA's Infrastructure Team in 2004. He has provided valuation and financial modeling advice and regulatory and economic due diligence support to investment banks and private equity funds in the context of acquisitions in the European energy and water sectors.

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Manjengwa, Tapiwa, Algorithmics

Pan, Xiaoming, Algebris Investments, CFA Parsons, Marcus, IMC Patre, Rupesh, University of Liverpool, IMC

Tapiwa works for Algorithmics in the EMEA sales team selling risk management solutions to buy-side institutions. He started his career as an auditor at Deloitte & Touche before being selected for the Standard Bank treasury programme.

Martin, Johanna, IMC Mathew, Christopher, Morgan Stanley, CFA McCallum, Stuart, Pictet Asset Management, IMC McCardle, Mark Justin, Alan Grant Developments, IMC

Rupert is currently studying financial economics at the University of Liverpool.

Peng, Bill Jinbiao, University of Exeter

Mark is finance director for Alan Grant Developments, a property development company based in Scotland.

McKay, Linda, Hymans Robertson, IMC McKay-Lomatschinsky, Andrew McMurray, Amanda, Nstar, IMC

Bill joined the University of Exeter as lecturer in accounting and finance in September 2006. Previously, he taught at undergraduate and postgraduate level at Lancaster University. Prior to that, he worked with Arthur Andersen (China). His research interests are market-based accounting and accounting-based equity valuation.

Penninger, Michael, Bankhaus Spängler Popescu, Alice, AGF Funds, CFA Powell, Huw, Hill Martin, IMC Powley, Mathew, BNP Paribas Securities Services

Amanda is fund manager of the Three Pillars Investment Fund, an early-stage venture finance fund based in the North East of England. She has a PhD in Organic Chemistry (Cambridge) and an MBA (Cass Business School, London).

McPhater, Linsay, Aberdeen Asset Management, IMC

Linsay is a graduate business analyst in the institutional client service division at Aberdeen Asset Management. She has an MA in Economics from Aberdeen university and an MSc in Finance and Investment from Edinburgh university.

Meawad, Joseph, Mellon Analytical Solutions, IMC Muir, Thomas, Standard Life, IMC Mulholland, Philip, London Business School, CFA Murray, Matthew, Nguyen, Dao, RBC Capital Markets, CFA Obuon-Pajak, Angela Ofulue, Gregory, Tekno Group, IMC O'Kane, Craig, PRUPIM, IMC

Mathew has worked in the investment industry for three years and has been based in London for the last 18 months. He holds a BA in International Business and Economics.

Rana Noya, Angel Manuel, Adam & Company, IMC

Angelo is responsible for promoting and developing the sales of Spanish mortgages for both the RBS and NatWest branch networks in the South West of England. He is a qualified European Financial Adviser.

Raza, Sabina, Lehman Brothers Reynolds, Jacob, IMC Riddaway, Joe, PwC, IMC

Craig is associate director of investment. He is a qualified chartered surveyor and has a first class honours degree in Estate Management from HeriotWatt University. He is a member of the RICS.

Oldham, Gareth David, Morley Fund Managers, IMC Olivier, Phillip, Deloitte & Touche, CFA

Joe is an investment consultant in PricewaterhouseCoopers' investment consultancy practice. He graduated with a BSc in Mathematics and Statistics from the University of Leeds in 2003. He worked for HSBC Actuaries and Consultants while in further education and full time from September 2003 before joining PwC in July 2007.

Ross, Lindsay, Walter Scott & Partners, IMC Rothery, Timothy, Goldman Sachs, Rouse, David, Friar Gate, IMC

Phillip is a senior manager working in the actuarial and insurance solutions practice at Deloitte in London, where he focuses mainly on M&A and restructuring for life insurers. He started his career at a large South African life insurer in 1998, and qualified as a Fellow of the Institute of Actuaries in 2001.

Onslow, Matthew, IMC Osadebe, Patrick, IMC Palka, Marta, Aberdeen Asset Management, IMC

David graduated with a BA in Business Studies in 1995. He has been providing professional independent financial advice to private and corporate clients since 1998 and joined Friar Gate in 2004.

Rowan, Simon, HSBC

Marta works on the global strategy and asset allocation desk within the multi-asset department. She joined Aberdeen in August 2007 as an investment analyst having completed an internship the previous summer.

Simon started his career as an investment analyst with Walter Scott & Partners in Edinburgh before joining HSBC where he has worked across multimanager in London and wealth management in New York. He currently works for HSBC Private Equity with a focus on mid-market, UK-based companies.




Salo, Steven, Citigroup Tong, U-Lipp, Brevan Howard Asset Management, IMC Touloumi, Olga, HSBC

Steve is an associate in Citigroup's UK M&A team. Prior to joining Citi in 2007, Steve worked for Dresdner Kleinwort in its European M&A team. Previously, he worked at PwC in corporate finance and at National Australia Bank in asset structuring. He is a chartered accountant and has completed a Masters in Applied Finance and Investment.

Sanghvi, Amit Harish, Pantheon Ventures, IMC

Olga is on the international management scheme at HSBC. Currently, she is product manager, liquidity & balance sheet management within the global transactional banking unit. She studied in Greece, Spain and the US and has an MBA from University of Notre Dame.

Tsui, Jackie, KPMG Van Der Walt, Bert, Baring Asset Management, CFA IMC

Amit Sanghvi has been an employee of Pantheon Ventures since early 2007. Previously Amit working for Private Equity Intelligence, a private equity consultancy, as a senior analyst. He has a degree in Computer and Management Sciences from Hull university

Sansom, Bazil, SMBCE, IMC

Bert is an investment analyst at Baring Asset Management covering EMEA markets with special focus on oil and gas, energy, materials and mining and telecoms.

Verghese, Laurence, CIBC, CFA Vilar, Xavier, IMC Vinitsky, Anthony, CFA Walker, Stephen, Goodman Property Investors, IMC

Bazil works has been working in the corporate research team at SMBCE for a little over a year. Previously, he worked for Japan External Trade Organisation and graduated in Japanese from the University of London (SOAS) in 2006.

Sassoon, Danny, ORHPLC / ESV, IMC

Danny graduated with a BSc hons in Business Information Technology. He works with Paul Pullinger in developing diamond mining assets in Namibia as a director of Orange River Holdings, Zamco Holdings and other pan-African projects. Previously, he worked for Barclays Private Bank and ZAM LLP.

Shire, Saad, IMC Smith, John H., Marsh & McLennan Sofroniou, Achilles, EPIC Private Equity Soward, Markela, IMC Spirkova, Petra, In2 Consulting, IMC Su, Donggang Surana, Veenit, PwC

Stephen joined Goodman in January 2006 with eight years of multi-disciplinary property experience, five of which were based in Edinburgh. During that time he worked with Lloyds TSB's in-house estate team before moving to a private consultancy where he was responsible for the strategic asset management of the Royal Mail portfolio in Scotland.

Weeks, Nicholas, Hermes Investment Management, IMC Wehbe, Christopher, Lehman Brothers Wheeler, Richard, Benfield Group, IMC

Richard joined the Benfield Group in September 2004. His primary focus is on broking and advising clients on property catastrophe retrocession structures.

Wilcox-Brown, Ben Wilson, Mark, CFA Woodall, Ian, Mercer Investment Consulting, IMC Wren, Christopher, Seymour Pierce, IMC

Veenit is an ACA working for PricewaterhouseCoopers in its assurance division. He has had exposure to industries as diverse as reinsurance, real estate, manufacturing, gaming, and investment management.

Taylor, Steven, IMC Thirkell, Wesley, Goldman Sachs International, CFA

Wesley is an associate in the credit risk management and advisory division.

Thoong, Mimi Cai, University of London, IMC

Christopher read Law at Queens' College, Cambridge. He briefly worked at Allen and Overy before joining the British Army. He completed eight years' worldwide active service, rising to the rank of Major. He passed the IMC in April 2007 and now works as a corporate finance executive at Seymour Pierce.

Xu, Aihua, Investec Asset Management, CFA Yee, Jonathan, HSBC Bank, CFA Zhu, Qincheng, University of Cambridge Zverina, Kirsten, UBS

Mimi Cai is in the final year of her studies for a BA in Mathematics at Queen Mary College. She has undertaken internships at Credit Suisse and several hedge funds and looks forward to building a career in finance on graduation.

Ticehurst, Sarah, Henderson Global Investors, IMC

Sarah joined Henderson in May 2007 as an analyst for the CASPAR Property Fund. She previously worked as a chartered surveyor at Cushman & Wakefield.

Kirsten joined UBS in November 2004 and is currently quality assurance manager of software test teams in the UK, US and India for the investment banking division. She has worked in IT for 11 years, specialising in finance since 2000. She graduated from University of NSW in 1997 with a BCompSc (majoring in Molecular Genetics).

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Professional development programme and selected social events for London and Edinburgh supporting ASIP, CFA and IMC professionals

| Date

Wednesday March 5

Tuesday March 11

| Category

Evening seminar Evening lecture Evening discussion Networking/social Early evening seminar Evening discussion Networking/social Afternoon conference Evening lecture


| Details

Developments in research Eminent speaker ­ Anthony Bolton Implications for quantitative investment management of the events of 2007 with INQUIRE and the Actuarial Profession Spring reception Credit default swaps Hedge funds ­ transparency and conflicts of interest with LBS Scottish Annual Dinner Global investment risks Eminent speaker ­ Bill Browder, Hermitage Capital War stories from emerging markets Research, risk and return Lessons from the credit crisis Summer reception Behavioural finance

| Venue

Weaver Suite, CFA UK, 90 Basinghall Street, London EC2 Barclays Global Investors Limited, 1 Royal Mint Court, London EC3N Lehman Brothers, 1 Broadgate, London EC2M Royal Exchange. London, EC3V Weaver Suite, CFA UK, 90 Basinghall Street, London EC2 LBS, Regent's Park, London, NW1 Balmoral Hotel, Edinburgh tbc Weaver Suite, CFA UK, 90 Basinghall Street, London EC2 Honorary Artillery Company, Armoury House, City Road, London EC1Y Honorary Artillery Company, Armoury House, City Road, London EC1Y tbc

Wednesday March 12 Thursday March 27 Tuesday April 1 Tuesday April 15 X Friday April 18 Tuesday April 29 Thursday May 15 Wednesday June 18 Wednesday June 18 Thursday June 26

Networking/social Afternoon conference


Seminars and conferences



Social events

New listings

XScottish event

For full, up-to-the-minute details check

CFA UK seminars and discussions qualify for the CFA Institute Professional Development Programme.




Developments in research

Wednesday March 5 2008 Early evening seminar Lead volunteer ­ Michael Collins, CFA



Eligib l

e for

Thoughts on 1 successful investment ­ lessons of the past 30 years

Sorry d out t has sol en - this ev

Tuesday March 11 2008 Evening lecture Eminent speaker ­ Anthony Bolton

Eligib l

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credi t hou


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With the unbundling of commissions, it has become easier for fund ome management companies to look for research that they feel adds real value to their investment process. The speakers for this evening come from the independent and alternative research sector and will speak about the research product they are offering, how that is being used by investors and how they see investment research developing.

Speakers include

Neil Thorington is managing director of YouGovAlpha. He started his career in IT before moving into market research and consulting with IMS Health, where he headed the Primary Care Consulting Group. Neil holds a bachelors degree in Economics and Information Technology from the University of Natal at Pietermaritzburg. Nick Paulson-Ellis, founder and managing director of Clear Capital, an independent institutional equity research firm, focusing on UK small to mid cap companies: Nick launched Clear in January 2004. Previously he was a member of the founding team at Evolution Securities. Prior to that he worked for UBS in emerging markets equity research.


CFA UK is delighted that Anthony Bolton has accepted the society's invitation to speak to members about his experience as an investment manager. His talk will cover: · How he approaches investment ­ importance of balance sheet analysis · How investment has changed over the past three decades ­ ubiquity of data


Michael Collins, CFA, Henderson This should be of interest to analysts and fund managers covering the equity and credit markets, as well as anyone who is interested in how this large section of the investment industry is likely to develop.


Anthony Bolton left Cambridge University with a degree in engineering to start a career in the City. In 1979, he was recruited by Fidelity, as one of its first London-based investment managers. He has run the Fidelity Special Situations fund since 1979 which over 28 years has had an annualised growth rate of 19.7% (compared with 13.8% from the market. The Times recently described him as "probably the best stock picker in London". In surveys of professional investors, he is regularly voted the fund manager most respected by his peers.


16.30 for 17.00 prompt start ­ tea and coffee will be available from16.30. Drinks and canapés will be served at 19.00. Weaver Suite, CFA Society of the UK, 90 Basinghall Street, London EC2V 5AY (Nearest tube is Bank) Members £45 Non-members £90

17.30 for 18.00 prompt start ­ tea and coffee will be available from 17.30. Drinks and canapés will be served at 19.00 Barclays Global Investors Limited, 1 Royal Mint Court, London EC3N 4HH Members £25 Non-members £50

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Global investment risks conference 2008 Credit default swaps ­ the road ahead

Recent developments and outlook for 2008

Tuesday April 29 2007 Afternoon conference



it ho

Eligi b

le fo



The need for wise counsel based on experience has never been greater. CFA UK FA has gathered some of the smartest minds around to provide members with their views on h the credit crisis and on the other major risks to the global investment environment. ironment The programme will cover: · What is the likelihood of a severe global slowdown? · Will geopolitical risk increase in 2008? · How high will energy prices rise and what will be the impact? · How will societal and technological issues impact investment returns? · Are we at the outset of a renewed period of inflation? · Have central banks lost their credibility? · What/where are the upside risks?


Tuesday April 1 2008 Late afternoon seminar Lead volunteer ­ Patrick Steiner CFA

Credit default swaps (CDS) have expanded rapidly in recent years and have surpassed the cash markets in some credit products. The panel will briefly discuss where the CDS market has been and will focus on recent developments and the future direction of the market. It will address recent product innovations, changes and issues in legal Eligi ble f or documentation and the response of the market to credit market volatility.



cred it ho urs

Saul Doctor, Bloomberg Simon Richards, RAB Capital Plc James Warbey, Milbank


16.15 for 16.30 prompt start Drinks and canapés will be served at 19.00 Weaver Suite, CFA Society of the UK, 90 Basinghall Street, London EC2V 5AY (Nearest tube is Bank) Members £45 Non-members £90

Andrew Smithers, chairman, founded Smithers & Co which provides economics-based asset allocation advice to 80 of the world's largest fund management companies. He is a regular contributor to the Financial Times and the Nikkei Financial Daily and is often quoted by leading financial journals. Pippa Malmgren, president, Canonbury Group is a specialist in the interaction between policy and markets. Dr Malmgren has had extensive experience in the US, European and Asian financial markets and has a deep knowledge of the political and policy dynamics that affect asset prices. Gareth Shepherd, CFA is the World Economic Forum's Head of Financial, Economic and Societal Risks. After graduating in engineering, Gareth became a founding member of the niche risk consultancy InterSafe Group Pty Ltd. In 2000 he joined IC Capital Pty Ltd as an investment strategist moving to the Insurance Australia Group where he was group s manager, Ri until his present appoint at the World Economic Forum in 2006. Risk Charles Goodhart is the emeritus professor of banking and finance at the London School Goo of Economics. Before joining the LSE in 1985, he worked at the Bank of England for Economic seventeen years as a monetary adviser, becoming Chief Adviser in 1980. In 1997, he was ye appointed one of the external members of the Bank of England's new Monetary Policy on Committee. Besides numerous articles, he has written several books on monetary history. Paul Horsnell is managing director and Head of Commodities Research at Barclays Horsne Capital. He j joined Barclays Capital in 2003 from JPMorgan where he was Head of Energy Research. Prior to that, he was assistant director at the Oxford Institute for Energy Studies P and a Research Fellow and Tutor in Economics at Lincoln College, Oxford University. Paul d R is a past vice-president of the International Association of Energy Economists and is the author of Oil in Asia and (with Robert Mabro) Oil Markets and Prices.


13.30 for 14.00 prompt start. Drinks and canapés will be served at 17.30 Members £150 Non-members £250




CFA UK Annual Conference 2008

Research, risk and return rn

Lessons from the credit crisis

Wednesday June 18 2008 Annual conference


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BOOKING FORM Name: Company: Address: Tel: Fax:

The crisis that took hold in parts of the global financial markets last year and triggered substantial losses by financial firms has led to calls for improved analysis and management of financial risk. The CFA Society of the UK's 2008 annual conference will focus on risk and the investment profession. Bringing together leading academics, market participants and regulators, the conference will provide CFA UK's 7,000 members with a valuable insight into risk analysis and pricing, risk management, risk and the investment process and the regulatory environment relating to financial risk. Topics to be covered include: · The credit crisis: what went wrong and why was it a surprise? · Understanding liquidity risk · Risk and the investment process · Regulating financial risk management · The impact of the shadow banking system · Risk, uncertainty and monetary policy · The outlook for risk budgeting and risk modeling · Confidence, overconfidence and cycles in risk pricing · The myth of non-correlation

Key note speaker


I am a:

CFA UK member Non-member

Membership no:

I'd like to attend ­ please tick box and delete price as appropriate Research developments ­ March 5 2008 Eminent speaker ­ March 11 2008 Credit default swaps ­ April 1 2008 Global investment risks ­ April 29 2008 Research, risk and return ­ June 18 2008 Total Please complete and return I enclose a cheque payable to CFA Society of the UK Please bill my Visa / MasterCard / EuroCard / Switch for £ £ £ 45 / 90 Sold out £ 45 / 90 £ 150 / 250 £ 195 / 445

Nouriel Roubini, Stern School of Business, New York University

Other speakers include

Lindsay Tomlinson FSIP, BGI Todd Groome, IMF Riccardo Rebonato, RBS


Dimitris Melas, MSCI Barra Ed Fishwick, Blackrock

Please delete as appropriate and note that CFA UK does not accept Amex or Diners.

Card number: Start date: Signature: All delegates will be invited to attend the society's Summer Reception which will immediately follow the conference. Please complete the registration form and fax/post it, with your credit card number or cheque to CFA Society of the UK, 4th Floor, 90 Basinghall Street, London EC2V 5AY Tel: 020 7796 3000 Fax: 020 7796 3333 Email: [email protected] Expiry date: Issue no:

09.00 ­ 17.00. Honorary Artillery Company, Armoury House, City Road, London EC1. Nearest tubes are Moorgate or Old Street Early bird price if booked by May 2 2008 Members £195 Non-members £445 After May 2 prices will be Members £245 Non-members £495

W W W. C FA U K . O R G



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