cfa perspectives for growing wealth

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C F A P E R S P E C T I V E S F O R

GrowinG wealth

� CFA Perspectives for GROWING WEALTH CFA Society of Louisville

CFA Local investment industry experts Society of Louisville

C F A B O A R D O F D I R E C T O R S

Ben H. Thomas, CFA Jeffrey T. McGlaun, CFA Louis A. Lemos II, CFA Paul Morlen, CFAPresident Vice President Secretary Treasurer(502) 387-1514 (502) 560-2284 (502) 417-6244 (502) [email protected] [email protected] [email protected] [email protected]

Paul Stropkay, CFA Ray M. Scholtz, CFA John P. Vinsel, CFA Membership Chair Director Director(502) 727-0502 (502) 581-3137 (502) [email protected] [email protected] [email protected]

October 26, 2007

Dear Business First readers,

The CFA Society of Louisville is proud to once again publish this yearly investment supplement in conjunction with Business First. The CFA Society of Louisville is a subsidiary of the larger CFA Institute, the world’s largest association of investment management professionals. Locally, there are approximately 250 members consisting of portfolio managers, security analysts, investment advisors, and other financial professionals.

The CFA (Chartered Financial Analyst) designation is the highest professional accomplishment an individual in the investment industry can obtain. You can read more about what it means to be a CFA charter holder and the benefits of working with these professionals in the following pages. This year we are featuring articles – written by our members – on a wide variety of topics, including socially responsible investing (SRI), investing in municipal bonds and an interview with a member who gives us his outlook for the markets.

Also, since last week marked the twentieth anniversary of Black Monday (the second worst daily decline in the Dow Jones Average ever), we felt compelled to share some of our collective insight. We are pleased to present a collection of short stories from some of our members who witnessed that day first-hand as they tell you, in their own words, how they coped with the decline.

If you would like to learn more about the CFA designation or the CFA Society of Louisville, please visit our Web site at cfalouisville.com or contact any of the board members listed below.

Thank you for your trust and confidence.

Sincerely,

Ben Thomas, CFAPresident CFA Society of Louisville

CFA Society of Louisville CFA Perspectives for GROWING WEALTH �

By John Vinsel, CFA

Conventional investment strategies focus on risk and reward with risk understood to be the volatility of asset returns. Liability Driven Investing (LDI), on the other hand, focuses on the relationship between the assets that are being managed and the liabilities that represent the purpose of the portfolio.

This article will explain the basic concepts of LDI and briefly describe some applications.

Historically, LDI mainly has been discussed in the context of defined benefit pension plans. The liabilities of a defined benefit plan are the future payments that will be paid to retirees. The surplus or deficit of the plan is the difference between the present value of plan assets and the present value of plan liabilities. The value of a defined benefit plan’s liabilities is affected by interest rates (lower interest rates cause the present value of future payments to rise), wage inflation (annual salary is usually a factor in the benefit formula) and price inflation (if benefits are adjusted for inflation). An LDI approach would seek to allocate plan assets so that asset and liability values move in sync with each other.

One specific technique of LDI is the use of zero coupon bonds (U.S. Treasury strips, perhaps) with maturity value and date equal to projected payments. In the asset and liability context, the present value of a fixed amount future payment (liability) would rise and fall identically to the present value of a like-dated zero coupon bond. For future payments whose amounts are subject to a cost of living adjustment, inflation-indexed bonds might be used.

Government regulations and accounting rules in Europe have been important factors in the adoption of LDI overseas, especially in the United Kingdom and the Netherlands.

Briefly, the market value of both pension assets and

liabilities are included on a company’s balance sheet under international accounting standards. This leads to increased sensitivity of pension plan funding levels by corporate management, particularly during 2000 through 2002 when most global stock markets fell as interests also fell. For many companies, falling asset values combined with rising liability values, turned a pension surplus into a deficit.

Beginning this year, U.S. firms are now required to list pension surplus or deficit amounts on their balance sheets – this may lead to further adoption of LDI.

The ideas of LDI are also useful, however, for many more investors outside of the corporate pension industry. Investors whose main concern is maintenance of a stream of payments could benefit from the LDI approach. Examples are a foundation with an annual distribution goal, a university endowment, or a retiree whose assets will provide living expenses and perhaps a bequest.

A key component of LDI is determining the timing and amount of cash flows that are certain and placing assets in securities that ensure liquidity at the necessary time.

A foundation or endowment would budget its known distributions and purchase treasury strips or other discount securities to ensure liquidity of cash to fulfill planned

distributions. In addition to certain payments (perhaps for the next two or three years), a minimum level of future distribution amounts might also be established with investments in longer-term bonds made accordingly. For situations where future inflation is a factor in distribution levels (that is certainly the case for a retiree), inflation-indexed bonds might be used for a substantial portion of the assets.

An important consideration that is sometimes forgotten is the inflow of cash into an account’s pool of assets.

For example, an endowment whose known and expected annual contributions exceed expected spending might be able to devote nearly all assets to very long term assets. The only short-term securities would be cash that is ear-marked for spending prior to the next contribution.

Once an investor has taken care of certain (or minimum) payments through the bond investments described above, the investor (individual, endowment, a foundation, etc.) might allocate remaining assets in security types that are expected to produce attractive returns – this might be domestic stocks, foreign stocks, private equity, hedge funds, etc.

At this point, an LDI- oriented investor would look for the same risk and reward features that the mean variance investor would seek.

In the asset and liability context, the LDI investor who invests in a diversified mix of stocks would be linking unknown liabilities to the performance of the diversified portfolio. Future distributions above a minimum level would depend on how the “risky” portfolio performs.

The difference between LDI and conventional risk/reward investing should be clear at this point.

Conventional techniques, sometimes known as the mean variance approach, use ex-pected performance of asset classes (U.S. stocks, non-U.S. stocks, large cap stocks, small cap stocks, real estate, bonds, cash, etc.) as well as estimated correlations among asset classes to attempt to create a portfolio whose future performance will be the most favorable for the level of risk taken.

Diversification, or the inclusion of different asset classes and the use of many individual securities within each asset class, is a cornerstone of the mean variance approach.

Risk and how the investor perceives risk, is fundamental when comparing LDI with conventional investing. Cash, as an example, is considered a low-risk or no-risk asset in the conventional mean variance approach.

LDI considers the risk of cash or any other asset in terms of its similarity or dissimilarity to the offsetting liability. If the liability is a payment to be made 10 years hence, cash would be an extremely risky asset, as falling interest rates would cause the investment to fail to achieve the needed value for distribution.

LDI is entirely concerned with decreasing the risk of investment failure, and its ideas are important for invest-ment situations where wide variations in asset returns are unacceptable.

John Vinsel, CFA, Senior Portfolio Manager,

Fifth Third Investment Advisors, Louisville, Kentucky

Liability A smart alternative to the random walk! Driven Investing


By Richard Jones, CFA

In this publication last year, my friend and colleague, Lou Lemos, CFA, wrote an interesting article about investor behavior. Lou’s article was entitled Are you a Rational In-vestor or a Normal Investor?

Lou wrote about some of the impediments that plague many investors, including overconfi-dence; loss aversion – viewing gains and losses differently; and dysfunctional client- manager relationships.

The reality is that there are powerful behavior forces that tend to pull all but the most disciplined investors away from sensible strategies. It is instruc-tive to review market events over the past several years in order to better understand some of the challenges investors face and common mistakes they make.

Price changes (and the news reports that accompany and occasionally exacerbate them) exert a powerful effect on our psyche. Face it, it feels really good to invest in ebullient times.

The popular sentiment is, “We are all in this incredible age together, right?” Conversely, in times of turmoil, we all naturally feel apprehensive. Losses are painful. They make us feel foolish for not selling at the recent highs, and we worry about whether our regrets and frustration will only increase with further downturns.

When headlines are grim and market values have fallen sharply it feels right, or at least comfortable, to sell. “We know they will be cheaper still.”

The problem is that when we rely on price changes and headlines to be the main determinant of investment decisions, we run the very real risk of buying high and selling low.

Competition is one of the things that help to ensure U.S. and global economic growth. However, our competitive na-ture can cause all but the most disciplined investors to deviate from sensible strategies.

When asked, the majority of Americans rate their own driving skills, their children’s intelligence and other skills as above average.

Collectively, we abhor notions of being average. Armed with reams of informa-tion and a desire to get ahead, many investors radically change the composition of their invest-ment portfolios in a never-end-ing quest to beat the market.

Furthermore, our minds have developed so that we readily identify patterns with respect to complex problems even when patterns do not exist. These factors go a long way to help explain why investors look in the rear view performance

mirror and then allocate into the hot sector of the day - whether it was the oil stocks in the early ‘80s, tech stocks in the late ‘90s, or more recently, precon-struction Florida condos and - hush, hush - private equity. No doubt, people with good timing made handsome returns in these areas.

It goes without saying that it does not make sense to drive one’s car via the rear view mirror. Unfortunately, many people tend to move into hot investments long after the lion’s share of the returns have been made, and the market reflects heady expectations in the form of excessive valuations.

No one has a crystal ball

and we are all prone to make mistakes with respect to investment selections.

Warren Buffett’s mentor, Benjamin Graham, said “Buy stocks deliberately and sell them reluctantly” and “In the short-term the market is a voting machine, in the long run it is a weighing machine.”

How can we apply these words of wisdom? We need to acknowledge and accept that we are going miss some nice opportunities – errors of omission are very high. On the other hand, we can focus on things that are more readily discernible so we minimize errors of commission.

Careful consideration of

valuation and an assessment of a company’s fundamentals (sales, earnings, dividend history and prospects) are a good place to start.

The principle difference between bull and bear markets often is due to changes in valuation.

Imagine a company generates average annual growth in earnings of 10 percent for five years and, at the same time, its PE multiple doubles. Each $1 in earnings at the start of the period will grow to $1.61 after five years. If the starting PE was 15x and the ending PE was 30x (or 12x to 24x – it does not matter) then the share price would increase

from $15 to $48.30 or 26 percent annually. Earnings are up 61 percent and price is up more than 220 percent – the bullish voting machine at work.

If over the next five years the company continues to grow its earnings at 10 percent annually (e.g. from $1.61 to $2.59), but the PE falls back to 15x (due to concerns that favorable conditions have abated or at least other sectors now hold more promise), then the invest-ment return in the second five years would be a very disappointing decline of 4.2 percent annually, with an ending value of $38.89.

Please note that the return over the entire 10 years would

be precisely 10 percent. It is clear that if valuation at the time of sale is higher than at purchase, then results will exceed growth in earnings and other fundamental factors and vice versa.

Blackjack players know that taking a card when the tally is 12, 13 or 14 is prudent, but not foolproof, while taking another card when your hand is 18, 19 or 20 has a low probability of success.

Unfortunately, there is reason to believe that many investors respond primarily to past price movements of securities as the primary factor for their in-

Looking No one has a crystal ball

Back at Investor Behavior

See page 10


By George W. Rue III, CFA

Imagine a world where responsibility, accountability and sustainability could co- exist with solid financial performance. What if it were possible to match your good ethical and moral values with good returns? How would you feel knowing your financial decisions could not only secure your own financial future but also put investment capital to work in the creation of a more just, sustainable and healthy society?

It’s not only possible, but it’s an investment strategy dating back to Biblical times that has recently gained tremendous momentum in mainstream financial circles and in the media. It’s called Socially Responsible Investing or SRI, and investors and companies are reaping their just rewards.

What is socially responsible investing?

Socially responsible investing (SRI) describes an investment strategy which integrates personal values and societal concerns with investment decisions.

The concept was initially considered by those few investors who were deeply committed to social change.Now, many people are investing to make a positive impact on the future – the future of their community, the environment and the world their children will inherit. Thoughtful investors are finding ways to make a difference by integrating their values, faith, social concerns and their financial goals.

Growth of socially responsible investing

According to a Social Investment Forum Report, professional managers in the U.S. were investing $2.3 trillion in a SRI manner in 2005, growing from $639 billion in 1995. Another industry report from Celent predicts this figure will rise to $3 trillion by 2011.

SRI mutual fund assets grew

from $12 billion to $179 billion from 1995 to 2005, growing faster than the broad mutual fund industry. While SRI funds are a small piece of the $10 trillion U.S. mutual fund industry, they are continuing to win the attention of mainstream competition and the main-stream media. There are

approximately 200 mutual funds in the SRI universe.

Many factors are responsible for the increased awareness of this fast-growing invest-ment strategy, including the corporate scandals in the early 2000s, the tragedy of 9/11, concerns about global warming and the devastation

and lingering problems caused by Hurricanes Rita and Katrina.

As a result, there is a height-ened level of awareness of personal responsibility and investors are looking to invest their money in companies that are good corporate citizens,

If your financial circumstances change with the tide, your success depends on more than just investing. It takes careful planning, keeping a close watch on your situation, and adjusting your plan as new events occur in your life. Simply put, it takes the comprehensive services of PNC Wealth Management. We have been helping successful people achieve their financial goals for over 150 years. Our team of experts gives you access to the resources of a Fortune 500 company, with the comfort of personalized service right here in our community.

For a complimentary consultation and financial solutions that reach beyond investing, please call Richard Jones at (502) 581-3215.

500 West Jefferson StreetLouisville, Kentucky 40202pnc.com

The PNC Financial Services Group, Inc. (“PNC”) provides investment and wealth management, fiduciary services, FDIC-insured banking products and services and lending and borrowing of funds through its subsidiaries, PNC Bank, National Association and PNC Bank, Delaware, which are Members FDIC. PNC does not provide legal, tax or accounting advice. Investments: Not FDIC Insured. No Bank Guarantee. May Lose Value. ©2007 The PNC Financial Services Group, Inc. All rights reserved.

Beyond Investing

Seated left to right: Karen Eversole, Mary Helen Myles, Richard Jones, Ray Scholtz and Kathleen AmshoffBack Row left to right: Lou Lemos, Tom Poskin, Ford Lankford, Bob Bouhl, Warren Shaw and Susan Egger

Socially Responsible Investing Demystifying a popular approach

See page 11


By Jason Stuber, CFA

If you are a tax-sensitive investor and you are unaware of the current tax benefits of owning municipal bonds, you might be missing out on a great opportunity to minimize your tax bill.

Conversely, if your portfolio currently includes municipal bonds, you are surely aware of the benefits provided not only to individual investors but also to the municipalities that issue them. But buyers beware: The rules of municipal bond investing could change in the near future, potentially shaking up the municipal market. I will delve into these potential changes later, but first let us discuss what municipal bonds are and what they offer investors.

What are municipal bonds?Generally, municipal bonds are debt instruments issued by

cities, counties, states and other government bodies to fund various public projects such as new roads, schools, utilities, medical facilities, etc.

Municipal bond holders lend the funds to these municipalities for public projects in exchange for interest income and the promise to repay the principal back to the bondholder on a specific maturity date.

Municipal bonds come in many different variations, but the two main types are General Obligation (G.O. bonds) and Revenue bonds. G.O. bonds are backed by the full faith and credit of the issuing entity. This means that a state or local government will use all legal sources (i.e., property taxes, etc.) to secure the repayment of the bonds they issue.

Revenue bonds are backed by the projected revenue stream of the facility or project the bonds are issued to fund. For example, water utility bonds would be repaid by the revenue generated from customer payments.

Why would an individual own municipal bonds?Individuals purchase municipal bonds for two reasons:

The first reason is to provide funding for the above-mentioned public projects within one’s own state or community.

The second, and probably main, reason is that most municipal bonds offer individual investors tax-exempt income (although some do not).

This income is tax-exempt on federal and state levels and often at local government levels. This is most advantageous to investors within high income tax brackets looking to reduce taxable income, especially anyone concerned with the Alternative Minimum Tax, as more and more Americans are today. (Please consult your tax advisor with questions regarding your AMT status.)

Putting this tax advantage into perspective…Let’s consider the hypothetical case of a couple to illustrate

the tax advantages of municipal bonds.Our fictional couple resides in Kentucky and wants to invest

in some high quality (AA/AAA ratings) fixed income securities.They have a short-to-intermediate investment horizon, are tax

sensitive and are looking to purchase bonds of differing maturities not longer than 10 to 12 years into the future.

This couple decides that they are going to buy Kentucky municipal bonds. As of this writing, the current yield on 1-12 year Kentucky municipal bonds ranges from between 3.6 and 4.1 percent approximately, which is the range of yields that will be used in this example. While these interest rates do not seem great, I will show that they are very attractive when compared to current taxable bond yields.

We’ll assume our couple has a combined income of $100,000 and pays a total effective tax rate of 29.5 percent (25 percent

federal, 6 percent state). A municipal bond offering a 3.5 percent yield would result in a taxable-equivalent yield of approximately 4.96 percent for this couple. A municipal bond offering a 4 percent yield would produce a taxable-equivalent yield of approximately 5.67 percent. As you can see in this example and in the chart below, higher incomes and tax rates equal greater taxable- equivalent yields for our hypothetical couple.

TAXABLE-EQUIVALENT YIELD

Joint Income(total effective rate,

federal tax rate,state tax rate)

3.5% Yield

4.0% Yield

$100,000 (29.5%, 25%, 6%) 4.96% 5.67%

$200,000(37%, 33%, 6%) 5.56% 6.35%

$400,000 (38.9%, 35%, 6%) 5.73% 6.55%

These taxable-equivalent yields compare favorably to current taxable yields for U.S. treasury bonds and investment grade corporate bonds. As of this writing, 5- and 10-year U.S. treasuries are yielding 4.23 and 4.53 percent, respectively.

Investment grade corporate bonds rated AA/AAA and with maturities five and 10 years out are currently yielding approximately in the range of 4.8 to 5.2 percent for five years and between 5.5 and 5.7 percent for 10 years. In other words, when compared to taxable bonds, municipals bonds are cheap. The current favorable interest rate environment and tax treatment of municipal bonds should prompt tax sensitive investors to consider allocating a portion of their portfolio to the municipal bond sector.

Back to that potential municipal market shake-upBy state law, Kentucky collects taxes from Kentucky residents

on the interest earned from bonds issued by non-Kentucky municipalities. Kentucky is not alone – as at least 41 additional states tax bonds issued by other states. In 2003, some Kentucky residents and owners of non-Kentucky bonds decided to question the legality of this tax treatment on out-of-state bonds and sued the state. These individuals claim that Kentucky’s tax laws regarding municipal bonds unconstitutionally favors in-state versus out-of-state commerce. The claim is based on a “dormant Commerce Clause,” which is a judicial interpretation of the Commerce Clause of the U.S. Constitution that makes it illegal for states to “compete against each other in a way that burdens interstate commerce.”

A circuit court ruled in favor of the state in 2004. This ruling was overturned in favor of the claimants in January 2006 by the Kentucky Court of Appeals. After the Kentucky Supreme Court took a pass in August 2006, the U.S. Supreme Court agreed to take the case this past May, should hear arguments in late 2007 and should follow with a decision in early 2008.

Kentucky State product wise investment option

Municipal Bonds

See page 10


parthenonllc.com[502] 327-5660

This Way Lies Reason.

Disciplinedinvestment managementfor individuals, families

and institutions.

With the recent increased volatility in the stock market, it can pay to talk to someone who has been around awhile and experienced a number of different market environ-ments.

We recently had the opportunity to sit down with Bill Chandler and ask him to share his thoughts on where the market is currently heading.

For anyone unfamiliar with Bill, let us just say that over a 38-year career, Bill has more than earned his “investment stripes.”

Bill began his career in 1968 at Kentucky Trust Company, an affiliate of First National Bank, initially working as a bond portfolio manager.

He received his CFA Charter in 1978 and, in the following year, co-founded First Kentucky Company, a registered investment advisor to large institutions. The firm later changed its name to National Asset Management – reflecting both its growing reach and the recent affiliation with National City Bank, which had acquired First National Bank in 1988.

National Asset Management was tremendously success-ful and eventually was sold to INVESCO in 2001. Bill worked there until he retired in March 2007.

The text that follows contains his current view and specula-tion about the intermediate term U.S. stock market outlook,

based both upon his interpreta-tion of long-term market trends and the present economic and financial backdrops.

Q. On a scale of 1-10, with 1 being extremely bearish and 10 signaling maximum bullish, how do you rate the next five-year outlook for returns from investing in the S&P 500 stock index at a current level of modestly below 1500? A. Only 2-3. Q. Why so gloomy now, especially following the recent “10 percent correction”? A. My current interpretation of long-term U.S. stock market cycles suggests a good likelihood that the index will spend the majority of the next five or so years trading between the 1555 area (the “top” in 2000 and recently again in 2007) and about 800 on the downside. Q. Why such a specific set of boundaries, in your view?

A. Such a set of bound-aries would be in similar proportion to the flat chan-nel containing all the market index movements during the 1966-1981 time frame. It would also reflect similarities to two earlier 20th-Century multi-year trading range type markets, each of which was preceded by a major stock market peak of precisely the kind reached in 2000 follow-ing a several decade-long bull market run. Q. This sounds like “technical analysis.” Is there any fundamental support or other underpinning for your view?

A. Each of the three above-referenced, prolonged trading-range constrained stock markets followed major long-lived economic and stock market booms which led to “excesses” of valuation and speculation. And each also featured long periods of recessionary or

even depressionary economic retrenchments during the hangover periods following the booms. Q. So, you are forecasting a recession or depression? A. Implicitly, I probably am. Although I am certainly not a trained economic forecaster. Nevertheless, pre-conditions for a coming recession and, thus, the odds on one, appear suddenly much stronger against a backdrop of severe strains rippling through the U.S. housing markets and, more recently, spilling into the global credit and equity markets as well. Q. But, interest rates are “low” and falling, corporate earnings are rising and stock valuations seem in

line with historic norms, at least for the stock market averages as a whole. Could these considerations not lead to a happy ending and an upward trending market?

A. Eventually, yes. But this observer is of the strong instinct that more time and probable disappointments, not to mention greater “fear” and capitulation, are all likely precursors to an eventual launching of the next bull stock market. During an interim lull period equity valuations will likely ultimately reach deeply depressed, well below-normal levels, just as they did in the three prior market slump periods mentioned above. Each of those stock markets eventually bottomed with price-to-earnings multiples in the

Market Outlook for Next Five Years An interview with Bill Chandler, Jr., CFA

See page 11

Bill Chandler, Jr.


Larry Walker, CFARetired, Former Principal, INVESCO-NAM

In 1987, I was a pension investment consultant. A strong market rally began in late summer of 1982 and huge gains were added up into early 1987.

Valuations were getting stretched, and everyone was worried about a correction.

An additional and important new investment approach called Dynamic Asset Alloca-tion (also called portfolio insur-ance) was being sold to many of the largest pension plans in the U.S. The strategy worked in a highly systematic manner by triggering preplanned trades when certain market levels were met.

I had visited the floor of the NYSE several times in the months before the crash and was flabbergasted at the thousands and thousands of packages of orders stacked on shelves and desks everywhere on the exchange floor just waiting for a single phone call to trigger the buying or selling of these orders.

In the months leading up to the October crash, we had been warning our clients that the Dynamic Asset Allocation Strategy would make the market inherently unstable, and that it was a much better strategy to rebalance portfolios back to target allocations when those allocations got out of line.

When the crash happened, I think it was much more rapid and deep than we expected, but there was nothing anyone could do. The system was over-loaded with an imbalance of sell orders. In my memory the scariest part was the

difficulty in getting the stock market reopened the next day and keeping it open. As I recall, they came very close to not being able to keep the market open the next day. The concern was that if the market couldn’t open and find a non-panicked clearing price, it might be days or weeks before enough confi-dence in the system could be restored to reopen the market.

Alan Greenspan did the right thing in insuring the banks that the Fed would provide all the liquidity necessary. Fear was soon replaced by greed, and the rest is – as they say – history.

Jonathan V. Norman III, CFA, Senior Vice President, Hilliard Lyons Asset Management

Like I suppose many hundreds of investment firms across the country, we met in our conference room right after the market closed.

The striking thing was, that instead of any of us offering immediate opinions, we all just looked at each other trying to think of anything to say that would make any sense. The market – in one day – had declined by a percentage amount about twice as much as in any previous day in all its recorded history.

I remember that day the market was actually up a little bit in the first 15 minutes, and I did some previously planned selling in one account. After that, I stood back and watched. By lunch time, the DJIA was down 150 points, having been down 250 points, then it headed south for the rest of the day.

We had sounded some cau-

tionary notes in client newsletters during that summer and early fall, based on the speed and distance that the market had risen during 1987. Bond yields were about five times what stock yields were and P-E’s were very high. We never thought, however, that we would get a whole bear market in one day, but that is about what happened.

Sarah Clark, CFASenior Investment Officer, Private Client Group, National City

There are some dates I’ll never forget, like July 21, 1969 when Neil Armstrong walked on the moon, and Oct. 19, 1987, the Crash of ’87, Black Monday.

In 1987 I was a young professional working as a securities analyst. Equities were having a great year, the economy was strong and analysts were bullish. Leveraged buyouts were the rage. Michael Milken, king of junk bonds, was spinning gold out of ordinary stodgy companies.

On Monday, Oct. 19, the markets opened down and the declines picked up steam as the day wore on.

The declines in value were huge and, as analysts, we all gave up any pretense of work and just stared all day in disbelief at our Quotron machine, as our favored investments gapped down $20 or $30. Nothing escaped the sell-off. Later in the day – as people had time to think about the action – there seemed to be agreement that this was a buying opportunity . . . and they were right.

Wayne Hancock, CFA, Atlas Brown

In 1987, I was an independent trader of U.S. Treasury bond futures and options on the floor of the Chicago Board of Trade.

That year had been a bear market for treasury bonds as interest rates were rising from around eight percent up to 10 percent through early October.

In the mean time, the stock market was having a big advance of over 25 percent. We, on the bond floor, were envious of the stock option traders across the street.

The stock market began a pullback in August as interest rates kept moving toward double digits.

When the stocks broke on Oct. 19, after a lousy day that prior Friday, people on the floor could only watch in awe at what appeared to be a freefall. Sometime on Monday afternoon, Alan Greenspan an-nounced that credit would be available to companies on Wall Street. This sent the bonds up 12 points (rates down about 1.25 percent) in just a few moments.

I was fortunate to have been long some bond futures and long some options at the time. I found a broker on the floor who needed to buy bonds and I sold mine to him. I then pro-ceeded to close my option po-sition for a considerable profit.

Stock prices of some of the highest quality companies were at ridiculously low levels. Those people who went in on Tuesday and bought these great names enjoyed tremendous returns.

It was a great opportunity if you could keep your wits about you when – all around you – others were losing theirs.

Remembering Black Monday Recalling crash of 10/19/1987

Last week marked the twentieth anniversary of the October 19, 1987 market crash, commonly referred to “Black Monday.”

We thought it might be interesting to ask some of our members who lived through that day to reflect on how the crash affected them. Below are some of the highlights of four of our members.


NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE

Kathy Thompson, JD

E. Gordon Maynard, JD

Mark Holloway, CFA

Rose Wathen, CTFA

Todd Barron, CFP

Jeffrey Filcik, JD

Jacqueline L. Hamm, CFP

Jack Gillette

Douglas Harper, CFA

Brenda J. Smith, JD

Donna Wimbec

Susan Beatty

Jane Redmon

Pamela Peter, CFP

Jim Worthington, JD

Damon Massey, CTFA

Cynthia M. Armstrong, JD, CPA

Shannon Budnick

www.syb.com(502) 625-1005

CFA How does a Chartered Financial Analyst help you?

Designation Sets Bar High By Paul Harrison Stropkay, CFA

When it comes to profes-sional designations, supply is attempting to meet demand. New three- and four-letter designations have emerged,

cluttering business cards. Amidst the jumble, why should one look for CFA?

Established in 1962, the CFA Program sets the global standard for investment knowledge, standards, and ethics.

It is a graduate-level, self-study curriculum and examination program for investment specialists – especially securities analysts, money managers, and invest-ment advisors.

The Economist ranked the CFA Program as the gold standard among investment analysis designations.

Clients, employers, and colleagues know that a CFA charterholder has mastered a rigorous curriculum covering a broad range of investment

topics and is committed to the highest ethical standards in the profession.

To earn the CFA charter, candidates must sequentially pass three six-hour exams that are widely considered to be

among the most challenging in the investment profession. Preparation requires hundreds of hours of study over at least three years.

Forty-two percent of 71,897 candidates worldwide passed June 2007 CFA Exams. Successful completion of the CFA Program is a formidable challenge for even the most experienced investment profes-sional.

The CFA Candidate Body of

Knowledge, which sum-marizes testable topics, emphasizes Ethical and Professional Standards throughout the program.

It requires candidates to demonstrate proficiency in Quantitative Methods, Economics, Financial Reporting and Analysis, Corporate Finance, Equity Investments, Fixed Income, Derivatives, Alternative Investments, and Portfolio Management and Wealth Planning.

To earn the CFA charter, investment professionals must also satisfy applicable work-experience require-ments to demonstrate ex-perience in the investment decision-making process. In addition, candidates and

CFA charterholders must abide by and annually reaffirm their adherence to the CFA Institute Code of Ethics and Standards of Professional Conduct.

CFA Institute has developed Global Investment Performance Standards (GIPS), which are a set of ethical principles used by some investment management firms to establish a globally standardized, industry-wide approach to creating performance presentations that communicate investment results to prospects and clients.

These ethical principles and guidelines allow for “apples to apples” comparison of investment performance. This allows investors to have a consistent and fair comparison of performance across different investment managers.

Nearly all U.S. state securities

commissions grant CFA charterholders an exemption to their licensing exams. The NYSE and NASD provide an exemption from the analytical portion of the Series 86 exam. The Monetary Authority of Singapore and other regula-tors in Canada, Greece, Turkey, Hong Kong, the United Kingdom, and Thailand also recognize the CFA designation as meeting their licensing or qualification requirements.

Few designations can claim this level of recognition.

The CFA Institute and CFA charterholders stand for the highest standards of educa-tion, integrity, and professional excellence.

Paul Harrison Stropkay, CFA Vice President,

Harvey Investment Company, LLC

10 CFA Perspectives for GROWING WEALTH CFA Society of Louisville

vestment decisions. At extremes, investor behavior closely resembles the Blackjack player who takes a card when he has 20 and refrains when he/she has a tally of 12.

Careful consideration of valuation in the context of long-term ownership versus a renter’s mentality can aid successful decision-making.

It bears mentioning that during the last five years of the 1990s, many well known companies such as General Electric, Microsoft, AIG, Proctor & Gamble and Intel generated earnings growth that exceeded 10 percent annually, while at the same time their valuation expanded more than twice 1995 levels.

Heady performance like that tends to make many investors irrational and overconfident.

It is interesting to note that many of the largest and best known companies that comprise the U.S. market have continued to generate healthy earnings growth, while their share prices are the same as levels first realized eight to 10 years ago. In other words, they are now selling at valuation lev-

els that are less than 50 percent of their peak valuation and, in many instances, below their historical norms. While there is no means to accurately predict tops and bottoms, it is clear why rational investors carefully consider valuation with respect to equity investments.

Of late there has been a great deal of volatility in the financial markets. There are some very real concerns surrounding important segments of the economy, including the housing and credit markets – and the voting machine is making lots of headlines. It is nearly impossible to gauge how far the pendulum will swing.

However, stock prices tend to mirror the change in a company’s underlying fundamentals in the long run, which is the role of the weighing machine.

The CFA curriculum and the ongoing research of the CFA Institute exposes practitioners to a variety of techniques and strategies that can be deployed to help make assessments about individual securities and/or to try to construct and man-age sensible portfolios.

Using Wall Street research

reports, various well known databases and/or the company filings with the SEC, one can review company statistics for sales, earnings, dividends, cash flow, debt level, profit margins, etc., in conjunction with price history to get a sense of historical valuation.

One can then compare those statistics to current conditions and make an assessment about future prospects.

A partial list of questions one might ask to develop projections of “likely,” “worst,” and “best” case scenarios, include: 1) is the business well financed?; 2) are current economic conditions for the economy and the industry improving or deteriorating?; 3) is the company buying back shares or expanding its share base?; 4) is the business economically sensitive, counter-cyclical or relatively im-mune to economic cycles, etc.?

Based upon those factors, does the stock appear attractively, reasonably or ex-cessively valued?

In other words, how much of the news (good or bad) that is widely disseminated appears to be reflected in the company’s valuation?

What could cause a reversal in the company’s prospects or a significant change in its valu-ation? Would inclusion of the security help reduce portfolio risk via diversification or in-crease capital concentration?

It goes without saying that ‘buying stocks deliberately’ can be a challenging, albeit stimulating, endeavor.

If all one needed to do was look at recent price movements to achieve favorable outcomes, investing would be easy.

Unfortunately there is a lot more to it.

Like any successful endeavor, successful investing requires discipline and careful work. If you sense your portfolio lacks clarity and structure, you may be well served to consult an experienced investment professional.

We often find that the greatest value we can provide our clients is an understanding of reasonable expectations and portfolios that are designed to achieve their short, intermediate and long-term objectives.

Richards Jones, CFA PNC Wealth Management

Louisville, Kentucky

Looking Back at Investor BehaviorFrom page 4

What does this mean for KY municipal investors?

If the Supreme Court agrees with Kentucky and overturns the appellate court ruling, the status quo will remain for the state and its residents.

However, if the Supreme Court rules that Kentucky’s current municipal taxation laws are unconstitutional, then Ken-tucky will be forced to change existing laws and treat in-state and out-of-state bonds equally.

The two choices Kentucky will have are to either tax all municipal bonds interest or to exempt all municipal bonds from taxation. If the state chooses to tax all municipal bonds, Kentucky residents will lose a significant tax-saving investment opportunity.

But, if Kentucky was to exempt all municipal bonds from taxation, then residents could invest in non-Kentucky

municipals and continue to receive the current tax benefits experienced with Kentucky municipal bonds.

From an individual perspec-tive, being able to purchase almost any municipal bond in any state would be beneficial for diversification and yield purposes. Suddenly, what was a somewhat limited market of investment choices becomes enormous for Kentucky residents and having more investment choices is never a bad thing.

How could this affect public project funding in the state of Kentucky?

A change in current municipal tax laws could be negative from the perspective of the state and its taxpayers. If Kentucky is forced to tax all bonds equally, it will lose its internal fundrais-ing advantage for public projects (Kentucky investors will no longer have an

incentive to invest solely in Kentucky bonds for tax benefits.)

In theory, this likely will increase the cost of borrowing for Kentucky issuers, as the state will have to compete with other states for investor dollars.

Investors would demand higher yields for their investment dollars, making Kentucky bonds cheaper for investors and more expensive for the state. Who will likely make up these potential fund-ing differences? Tax payers, possibly?

What could this do to the national municipal bond market?

Nationally, this case could send ripples through the municipal bond market. If the current ruling is upheld, every state with municipal tax laws similar to Kentucky’s would face law suits and eventual change. Each state would face the same decisions and challenges that Kentucky would

face. Municipal bonds could become much more or much less attractive to investors, depending on new taxation laws. What has been a state-by-state market could become a huge national market and result in fund consolidation.

How should I invest in the municipal markets during the current limbo we are in?

Most experts have their opinions about which way the Supreme Court will rule on this case, but the fact is nobody knows for sure what the outcome will be. The most prudent way to view this case from an investor’s standpoint may be to keep investing as usual while this case plays out. This, of course, is a decision each investor should make individually, with the guidance of their personal investment and tax counselors.

Jason Stuber, CFA Fixed Income Portfolio Manager

Hilliard Lyons Asset Management

Kentucky Municipal BondsFrom page 6

CFA Society of Louisville CFA Perspectives for GROWING WEALTH 11

providers of sound financial returns.

Among SRI funds, religious- themed mutual funds or faith-based funds are currently the fastest growing subset. Faith–based investing is a socially responsible investment strategy that is based on the values of a particular theology with reli-gious organizations becoming increasing centers of influence on SRI. The purpose of church organizations is to express faithful stewardship while investing their resources con-sistent with their principles and values. According to a recent Morningstar survey, faith-based funds have assets topping $17 billion, up from $500 million just ten years ago. Today, there are approximately 50 faith-based investment funds available.

HistoryThe history of socially re-

sponsible investing stretches over centuries. Religious in-vestors from Jewish, Christian and Islamic faiths and many indigenous cultures have long married morals and money, giv-ing careful consideration to the way economic actions affected others around them and shun-ning investments that violated their traditions’ core beliefs. For example, in the American

colonies, Quakers and Methodists often refused to make investments that might have benefited the slave trade.

Socially responsible investing in its present form arose in the aftermath of the social and cultural upheaval of the 1960s, an out-growth of civil rights, feminist, consumer, and environmentalist move-ments and protests against the Vietnam War.

It raised public awareness about a host of social, environmental, and economic problems and corporate responsibility for them.

In the early 1970s a number of Protestant denominations formed the Interfaith Center on Corporate Responsibility to work together on shareholder advocacy.

Today, it is made up of 275 Catholic orders, dioceses, and healthcare systems, Protestant denominations and Jewish organizations.

ICCR brings together many faith-based investors to enter into dialogue with company managements and file share-holder resolutions involving the following issues: access to healthcare, fair employment and wage issues, corporate governance, enabling access to capital, environmental justice, global warming, promoting human rights, violence and

militarization of society, and water and food issues.

Today’s Socially Responsible Mutual Funds

The three pillars of SRI are: 1) positive and negative screens; 2) shareholder advocacy; and 3) community investing.

The earliest formalized ethical investment policies included negative screens that investors used to avoid the so-called “sin stocks” – companies that involve alcohol, tobacco, or gambling.

More recently, SRI has evolved beyond “negative” screening to include positive screens, social research, more widespread shareholder advocacy and community investing.

Social research is used to examine the social and environmental records of companies to determine which companies to include (positive screens) or exclude (nega-tive screens) in an investment portfolio. It is seen as a way to identify companies with better management and lower risks.

Shareholder advocacy is using a position as an owner in the company to actively encourage a company to improve. Shareholder advocacy can take many forms, from meeting with management to entering into a dialogue as a stakeholder to writing a letter to a company to filing a formal shareholder resolution calling for a company to take a particular action or report on the status of a shareholder concern.

Advocacy also involves actively voting proxies or casting your vote as a company shareholder.

Community investing channels affordable credit to communities that are normally underserved by traditional credit market to create jobs, build homes, and finance community facilities. Investors often accept slightly below-market rates of return to encourage investment that can build or rebuild communities.

Do you have to sacrifice performance for principles?

The performance of socially

responsible funds has been debated by many investment professionals for years. An impressive body of academic evidence plus real-world results has effectively refuted the contention that social screening will automatically result in underperformance. Investors are realizing that responsibility can walk hand- in-hand with prosperity.

What to expect if you invest in SRI funds?

Many investors believe that in addition to the benefits of own-ership, they bear responsibility for the impact their money has in the world.

Socially conscious investors can make money and make a meaningful difference as share-holder advocates by engaging with companies to promote a clean, healthy environment, treat people fairly, embrace equal opportunity, produce safe and useful products, and support efforts to promote world peace or consciously direct investment capital toward enterprises that do it better.

Motivated by a sense of responsibility that has finan-cial, social, and ecological dimensions, socially conscious investors understand that investment returns over the long-term are driven primarily by the performance of innova-tive, well-managed corpora-tions that are dependent on the health of human societies and ecological systems that sustain all economic enterprise. Some wish to put their money to work in a manner that is more closely aligned with their personal values and social priorities. Others are more interested in directing investment capital to push for social change.

All seek to use their money to catalyze the shift toward a more economically just and environ-mentally sustainable world.

Fortunately, making money and making a difference with your money has never been easier. Are you ready to put your money where your morals are and change the world for the better?

George W. Rue III, CFA, Chief Investment Officer, New Covenant Funds,

sponsored by the Presbyterian Foundation,

Louisville, Kentucky.

Socially Responsible InvestingFrom page 5

6-10 times range, compared to today’s mid-teens multiplier. And in all three cases, much, much more time than seven years elapsed between the time of the initial market peak and the breakout into a new uptrend. The previously referenced lull periods lasted about 15 years, or twice as long as the current retrench-ment period, thus far. Q. Anything else bothering you? A. Well, the national political pendulum, which swings gradually back and forth between conservative and progressive (populist) agendas, appears poised to embark on a swing away from the very pro-capital policies ushered in by Ronald Reagan in the early

1980s. The preceding 25-year long period of falling tax rates, smaller government, less regulation and generally “laize-faire,” pro-business economic conditions may be about to be replaced by a distinctly more re-distributionist set of policies, with higher taxes on capital, profits and “high” incomes. Not exactly a formula for rising profits or rising multiples is it! So, my bottom line is that now is not the time for expecting great things from the U.S. stock market on a trend basis. I hope I’m too pessimis-tic. I have noticed that we older folk do tend to become less optimistic about the future. So take my warnings with a grain of salt – but also with the caveat that financial history, like much else in history, does tend to repeat itself over time.

Market OutlookFrom page 7

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Next Registration Deadline: 15 February 2008 Three letters that speak volumes.

Tracked down one of the last ‘59 Gibson Les Pauls.

Without question, my second greatest thrill.

Earning the CFA charter is one tough act to follow. After all, the CFA Program is recognized around the world as the gold standard ininvestment management. Every candidate needs to master three levels ofrigorous coursework with uncompromising standards. What awaits you if you’re good enough to pass the exams? The kind of expertise designed to strike just the right chord with recruiters. To read real charterholder stories, visit www.cfainstitute.org/cfaprogram, or call 800.247.8132 for more information.

Actor dramatization. ©

2007 CFA Institute. All rights reserved.

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