CFA Institute

Conflict Is Far Wider in ScopeAuthor(s): Daniel J. Forrestal IIISource: Financial Analysts Journal, Vol. 28, No. 3 (May - Jun., 1972), pp. 105-106Published by: CFA InstituteStable URL: http://www.jstor.org/stable/4529471 .

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Value Merrill Levy Line Lynch Oliphant

Allied Chemical 1.47 1.07 1.26 1.04 Aluminum Co. .85 .96 1.14 1.19 Americanl Branlds .72 .54 .77 .53 Americail Can .82 .74 .81 .78 Amer. Tel. & Tel. .77 .52 .81 .65 Anaconda 1.16 .85 1.04 .96 Bethlehem Steel 1.52 .87 1.02 .78 Chrysler 2.01 1.38 1.52 1.74 Du Pont .82 .61 .73 .76 Eastman Kodak 1.06 .75 .84 .84 General Electric 1.36 .71 1.17 1.05 General Foods .61 .71 .86 .66 General Motors 1.23 .71 1.08 .90 Goodyear 1.14 .82 1.00 .67 Int'l Harvester 1.94 .86 .85 .86 Int'l Nickel 1.24 .72 .88 .67 Int'l Paner .58 .92 1.21 1.01 Johns-Manville 1.39 .89 1.08 .96 Owens Illinois 1.09 .74 1.16 1.20 Procter & Gamble .73 .64 .83 .46 Sears Roebuck 1.07 .76 1.03 .89 Standard Oil, Calif. .77 .67 .88 .91 Standard Oil, N. J. .63 .54 .70 .58 Swift & Co. 1.13 .84 1.00 1.15 Texaco .83 .75 .91 .90 Union Carbide 1.28 .91 1.05 .94 United Aircraft 1.28 1.08 1.25 1.46 U. S. Steel 1.50 .75 1.00 .80 Westinghouse Elec. 1.28 .90 1.02 .91 Woolworth 1.52 1.04 1.22 1.31

Average 1.13 .81 1.00 .92

If the betas from each source are first ranked from 1 to 30, the rank order correlation coefficients are as follows:

Value Merrill Levy Line Lynich Oliphant

Levy 1.00 .61 .56 .48 Value Linle 1.00 .77 .74 Merrill Lynlch 1.00 .86 Oliphant 1.00

A few stocks such as Bethlehem Steel, General Electric, International Harvester, International Paper, and U. S. Steel show wide discrepancies. If these betas were used by a security analyst, would he conclude, for exam- ple, that Bethlehem Steel was a vola- tile stock as indicated by Levy's 1.52 beta, or would he find it a conservative stock as suggested by Oliphant's .78 beta?

My point here is that betas should be used with caution by security ana- lysts in characterizing a particular stock. What is needed is more research on computational methods, including time spans, differencing periods, cor- rections for regressions toward the mean, and so forth.

DON PETERSON Investment Research Marine Midland Banks, Inc.

Value Merrill Levy Line Lynch Oliphant

Allied Chemical 1.47 1.07 1.26 1.04 Aluminum Co. .85 .96 1.14 1.19 Americanl Branlds .72 .54 .77 .53 Americail Can .82 .74 .81 .78 Amer. Tel. & Tel. .77 .52 .81 .65 Anaconda 1.16 .85 1.04 .96 Bethlehem Steel 1.52 .87 1.02 .78 Chrysler 2.01 1.38 1.52 1.74 Du Pont .82 .61 .73 .76 Eastman Kodak 1.06 .75 .84 .84 General Electric 1.36 .71 1.17 1.05 General Foods .61 .71 .86 .66 General Motors 1.23 .71 1.08 .90 Goodyear 1.14 .82 1.00 .67 Int'l Harvester 1.94 .86 .85 .86 Int'l Nickel 1.24 .72 .88 .67 Int'l Paner .58 .92 1.21 1.01 Johns-Manville 1.39 .89 1.08 .96 Owens Illinois 1.09 .74 1.16 1.20 Procter & Gamble .73 .64 .83 .46 Sears Roebuck 1.07 .76 1.03 .89 Standard Oil, Calif. .77 .67 .88 .91 Standard Oil, N. J. .63 .54 .70 .58 Swift & Co. 1.13 .84 1.00 1.15 Texaco .83 .75 .91 .90 Union Carbide 1.28 .91 1.05 .94 United Aircraft 1.28 1.08 1.25 1.46 U. S. Steel 1.50 .75 1.00 .80 Westinghouse Elec. 1.28 .90 1.02 .91 Woolworth 1.52 1.04 1.22 1.31

Average 1.13 .81 1.00 .92

If the betas from each source are first ranked from 1 to 30, the rank order correlation coefficients are as follows:

Value Merrill Levy Line Lynich Oliphant

Levy 1.00 .61 .56 .48 Value Linle 1.00 .77 .74 Merrill Lynlch 1.00 .86 Oliphant 1.00

A few stocks such as Bethlehem Steel, General Electric, International Harvester, International Paper, and U. S. Steel show wide discrepancies. If these betas were used by a security analyst, would he conclude, for exam- ple, that Bethlehem Steel was a vola- tile stock as indicated by Levy's 1.52 beta, or would he find it a conservative stock as suggested by Oliphant's .78 beta?

My point here is that betas should be used with caution by security ana- lysts in characterizing a particular stock. What is needed is more research on computational methods, including time spans, differencing periods, cor- rections for regressions toward the mean, and so forth.

DON PETERSON Investment Research Marine Midland Banks, Inc.

CONFLICT IS FAR WIDER IN SCOPE

Contrary to Richard West ("Con- flicts of Interest: Substance or Sub- terfuge?" Financial Analysts Journal, November-December 1971), I contend that the money manager-broker com- bine presents a conflict far wider in scope than unnecessary trading or ac- count churning. As research-oriented brokers expand their role as money managers, there is an inherent conflict when such firms both supply a re- search product to and compete for business with institutional investors, especially smaller institutions heavily or exclusively dependent on soft dol- lars for research input.

This conflict is more critical than that created by firms in the dual role of the supplier and competitor in

CONFLICT IS FAR WIDER IN SCOPE

Contrary to Richard West ("Con- flicts of Interest: Substance or Sub- terfuge?" Financial Analysts Journal, November-December 1971), I contend that the money manager-broker com- bine presents a conflict far wider in scope than unnecessary trading or ac- count churning. As research-oriented brokers expand their role as money managers, there is an inherent conflict when such firms both supply a re- search product to and compete for business with institutional investors, especially smaller institutions heavily or exclusively dependent on soft dol- lars for research input.

This conflict is more critical than that created by firms in the dual role of the supplier and competitor in

many other industries because of sev- eral factors unique to the securities industry: First, the value of the in- vestment product to the buyer, whether an asset management client or an in- stitutional account, can be influenced by his place in line with other buyers. Not only does an institution subsidize its potential competitor when dealing with a broker-money manager, it also runs the risk of enhancing prior pur- chases and sales in the broker's man- aged portfolios with his own trades in the same securities. Second, and close- ly related to the first, the different means of compensation to the broker (percentage of assets for money man- agement, commissions for supplying research) encourage the broker to dis- criminate between the two markets.

This specific conflict of the broker-

many other industries because of sev- eral factors unique to the securities industry: First, the value of the in- vestment product to the buyer, whether an asset management client or an in- stitutional account, can be influenced by his place in line with other buyers. Not only does an institution subsidize its potential competitor when dealing with a broker-money manager, it also runs the risk of enhancing prior pur- chases and sales in the broker's man- aged portfolios with his own trades in the same securities. Second, and close- ly related to the first, the different means of compensation to the broker (percentage of assets for money man- agement, commissions for supplying research) encourage the broker to dis- criminate between the two markets.

This specific conflict of the broker-

are looking up...at

Allegheny Ludlum

Industries

look inside: Annual1971 Annual Report

Some Allegheny Ludlum com- panies set sales records in 1971. Some didn't. But the key fact is that all our com- Allegheny Ludlum Steel Corpoation

panies continue to serve 'reWaHing(ordSteelCompany | , . , ~~~~~~~~~~~~~~~~~~~~~~~~~~Special Metals Corporation markets which are either True Temper Corptmation

growing or ready to grow Jacobsen Manufactunng Company

again. Write for your copy Camet Company

of our Annual Report-and The Arnold Engineering Co.

see how we're turning the Titanium Metals Corporation of America

corner with cautious optimism.

Allegheny Ludlum Industries, Inc., 2024 Oliver Bldg., Pittsburgh, Pa. 15222

FINANCIAL ANALYSTS JOURNAL / MAY-JUNE 1972 0 105

are looking up...at

Allegheny Ludlum

Industries

look inside: Annual1971 Annual Report

Some Allegheny Ludlum com- panies set sales records in 1971. Some didn't. But the key fact is that all our com- Allegheny Ludlum Steel Corpoation

panies continue to serve 'reWaHing(ordSteelCompany | , . , ~~~~~~~~~~~~~~~~~~~~~~~~~~Special Metals Corporation markets which are either True Temper Corptmation

growing or ready to grow Jacobsen Manufactunng Company

again. Write for your copy Camet Company

of our Annual Report-and The Arnold Engineering Co.

see how we're turning the Titanium Metals Corporation of America

corner with cautious optimism.

Allegheny Ludlum Industries, Inc., 2024 Oliver Bldg., Pittsburgh, Pa. 15222

FINANCIAL ANALYSTS JOURNAL / MAY-JUNE 1972 0 105

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Letters to the Editor

money manager receives remarkably little attention in the proliferating critiques on the investment industry. This conflict is a problem quite apart from potential churning of accounts or price advantages due to commission rebates again s t management fees. Commissions are obviously a neces- sary cost of business for the institu- tional investor, and because of the entry of many leading research and execution firms into money manage- ment, we have reached the point where an institution would severely dilute its research input by dealing only with "pure" brokerage houses.

A share of the blame for letting this conflict develop is due the institutions -for their increasing dependence on soft-dollar research, failure to use commission allocations to discriminate against competitor-brokers, and gen- erally passive attitude toward the issue. In this regard, unbundling of broker's services would, in addition to meeting the specific demands of an increasingly varied and discriminat- ing buyer of brokerage services, put greater pressure on institutions to de- fine their own needs, choose quality sources of research, and eliminate the remaining pockets of reciprocal or self-dealing commission allocations.

DANIEL J. FORRESTAL III Vice President First National Bank in Dallas

Letters to the Editor

money manager receives remarkably little attention in the proliferating critiques on the investment industry. This conflict is a problem quite apart from potential churning of accounts or price advantages due to commission rebates again s t management fees. Commissions are obviously a neces- sary cost of business for the institu- tional investor, and because of the entry of many leading research and execution firms into money manage- ment, we have reached the point where an institution would severely dilute its research input by dealing only with "pure" brokerage houses.

A share of the blame for letting this conflict develop is due the institutions -for their increasing dependence on soft-dollar research, failure to use commission allocations to discriminate against competitor-brokers, and gen- erally passive attitude toward the issue. In this regard, unbundling of broker's services would, in addition to meeting the specific demands of an increasingly varied and discriminat- ing buyer of brokerage services, put greater pressure on institutions to de- fine their own needs, choose quality sources of research, and eliminate the remaining pockets of reciprocal or self-dealing commission allocations.

DANIEL J. FORRESTAL III Vice President First National Bank in Dallas

Letters to the Editor

money manager receives remarkably little attention in the proliferating critiques on the investment industry. This conflict is a problem quite apart from potential churning of accounts or price advantages due to commission rebates again s t management fees. Commissions are obviously a neces- sary cost of business for the institu- tional investor, and because of the entry of many leading research and execution firms into money manage- ment, we have reached the point where an institution would severely dilute its research input by dealing only with "pure" brokerage houses.

A share of the blame for letting this conflict develop is due the institutions -for their increasing dependence on soft-dollar research, failure to use commission allocations to discriminate against competitor-brokers, and gen- erally passive attitude toward the issue. In this regard, unbundling of broker's services would, in addition to meeting the specific demands of an increasingly varied and discriminat- ing buyer of brokerage services, put greater pressure on institutions to de- fine their own needs, choose quality sources of research, and eliminate the remaining pockets of reciprocal or self-dealing commission allocations.

DANIEL J. FORRESTAL III Vice President First National Bank in Dallas

NOT SO FAST

The purpose of this letter is to make a brief comment re: "On the Short- Term Stationarity of Beta Coeffi- cients" by Robert A. Levy, Financial Analysts Journal, November- Decem- ber 1971.

Levy states that:

"Forecasts are clearly better over longer periods than over shorter periods . . ."

"First, there is a much greater de- terioration in forecasting accuracy when moving from 26-week to 13- week projections than when mov- ing from 52-week to 26-week pro- jections."

"Predictability improves materially as the forecast period lengthens, with much greater improvement

NOT SO FAST

The purpose of this letter is to make a brief comment re: "On the Short- Term Stationarity of Beta Coeffi- cients" by Robert A. Levy, Financial Analysts Journal, November- Decem- ber 1971.

Levy states that:

"Forecasts are clearly better over longer periods than over shorter periods . . ."

"First, there is a much greater de- terioration in forecasting accuracy when moving from 26-week to 13- week projections than when mov- ing from 52-week to 26-week pro- jections."

"Predictability improves materially as the forecast period lengthens, with much greater improvement

NOT SO FAST

The purpose of this letter is to make a brief comment re: "On the Short- Term Stationarity of Beta Coeffi- cients" by Robert A. Levy, Financial Analysts Journal, November- Decem- ber 1971.

Levy states that:

"Forecasts are clearly better over longer periods than over shorter periods . . ."

"First, there is a much greater de- terioration in forecasting accuracy when moving from 26-week to 13- week projections than when mov- ing from 52-week to 26-week pro- jections."

"Predictability improves materially as the forecast period lengthens, with much greater improvement

Table 3-4 Model Results NYSE Securities Tests of Stationarity of bit

Rank Order Time Time Correlation Correlation Period Period of b1t with of bit with Number of

t t-d Interval bi(t-d) bi(t--d) Securities

1946-66 vs. 1926-46 20 years .671 .671 216 1936-46 vs. 1926-36 10 years .655 .664 315 1946-56 vs. 1936-46 10 years .707 .708 549 1956-66 vs. 1946-56 10 years .513 .507 569

Table 3-4 Model Results NYSE Securities Tests of Stationarity of bit

Rank Order Time Time Correlation Correlation Period Period of b1t with of bit with Number of

t t-d Interval bi(t-d) bi(t--d) Securities

1946-66 vs. 1926-46 20 years .671 .671 216 1936-46 vs. 1926-36 10 years .655 .664 315 1946-56 vs. 1936-46 10 years .707 .708 549 1956-66 vs. 1946-56 10 years .513 .507 569

Table 3-4 Model Results NYSE Securities Tests of Stationarity of bit

Rank Order Time Time Correlation Correlation Period Period of b1t with of bit with Number of

t t-d Interval bi(t-d) bi(t--d) Securities

1946-66 vs. 1926-46 20 years .671 .671 216 1936-46 vs. 1926-36 10 years .655 .664 315 1946-56 vs. 1936-46 10 years .707 .708 549 1956-66 vs. 1946-56 10 years .513 .507 569

when moving from 13 weeks to 26 weeks than when moving from 26 weeks to 52 weeks."

Levy's main point is clear, viz. beta coefficients are more stable and amen- able to prediction over longer vs. shorter time periods.

With all of the current interest in beta coefficients; I would like to proffer some balancing data to those presented by Levy. I quote from page 36 of "The Measurement and Use of Portfolio Systematic Risk" by Frank B. Cam- panella, May 1970 (unpublished doc- toral dissertation, Harvard Business School):

"A final test was designed to ex- amine the stationarity of individual security betas. The 40-year period, 1926-1966, was divided into two 20- year and four 10-year subperiods. Security betas, using quarterly obser- vations, were computed for all of the securities which were on the CRSP tape continuously for each subperiod. These betas were then correlated for successive subperiods. Table 3-4 shows the resultant product moment and rank order correlation coefficients.

"The correlations are relatively high for both the twenty year and ten year periods over which values of bit were compared, indicating some stationar- ity of security b's over time. The drop in the correlation coefficient from .708 to .507 for the most recent ten year comparisons is, however, a rather un- settling indication that security b val- ues may be becoming less stable."

It would seem that, on the one hand, the Campanella data suggest some not insignificant deterioration of the inter- temporal stability of beta coefficients

when moving from 13 weeks to 26 weeks than when moving from 26 weeks to 52 weeks."

Levy's main point is clear, viz. beta coefficients are more stable and amen- able to prediction over longer vs. shorter time periods.

With all of the current interest in beta coefficients; I would like to proffer some balancing data to those presented by Levy. I quote from page 36 of "The Measurement and Use of Portfolio Systematic Risk" by Frank B. Cam- panella, May 1970 (unpublished doc- toral dissertation, Harvard Business School):

"A final test was designed to ex- amine the stationarity of individual security betas. The 40-year period, 1926-1966, was divided into two 20- year and four 10-year subperiods. Security betas, using quarterly obser- vations, were computed for all of the securities which were on the CRSP tape continuously for each subperiod. These betas were then correlated for successive subperiods. Table 3-4 shows the resultant product moment and rank order correlation coefficients.

"The correlations are relatively high for both the twenty year and ten year periods over which values of bit were compared, indicating some stationar- ity of security b's over time. The drop in the correlation coefficient from .708 to .507 for the most recent ten year comparisons is, however, a rather un- settling indication that security b val- ues may be becoming less stable."

It would seem that, on the one hand, the Campanella data suggest some not insignificant deterioration of the inter- temporal stability of beta coefficients

when moving from 13 weeks to 26 weeks than when moving from 26 weeks to 52 weeks."

Levy's main point is clear, viz. beta coefficients are more stable and amen- able to prediction over longer vs. shorter time periods.

With all of the current interest in beta coefficients; I would like to proffer some balancing data to those presented by Levy. I quote from page 36 of "The Measurement and Use of Portfolio Systematic Risk" by Frank B. Cam- panella, May 1970 (unpublished doc- toral dissertation, Harvard Business School):

"A final test was designed to ex- amine the stationarity of individual security betas. The 40-year period, 1926-1966, was divided into two 20- year and four 10-year subperiods. Security betas, using quarterly obser- vations, were computed for all of the securities which were on the CRSP tape continuously for each subperiod. These betas were then correlated for successive subperiods. Table 3-4 shows the resultant product moment and rank order correlation coefficients.

"The correlations are relatively high for both the twenty year and ten year periods over which values of bit were compared, indicating some stationar- ity of security b's over time. The drop in the correlation coefficient from .708 to .507 for the most recent ten year comparisons is, however, a rather un- settling indication that security b val- ues may be becoming less stable."

It would seem that, on the one hand, the Campanella data suggest some not insignificant deterioration of the inter- temporal stability of beta coefficients

while, on the other hand, the Levy data lead us to believe that longer time intervals give rise to better beta predictions. Between the two of them I am somewhat confused as to whether or not "Forecasts are clearly (em- phasis added) better over longer pe- riods than over shorter periods. . ..

The beta concept is gaining ground now at the practitioner's level. I hope that people won't seize it as another panacea and then be disappointed when they subsequently discover that it too is not an infallible tool.

JOHN DAVID MACEY Lecturer, Graduate and Undergraduate Business Programs Northeastern University

while, on the other hand, the Levy data lead us to believe that longer time intervals give rise to better beta predictions. Between the two of them I am somewhat confused as to whether or not "Forecasts are clearly (em- phasis added) better over longer pe- riods than over shorter periods. . ..

The beta concept is gaining ground now at the practitioner's level. I hope that people won't seize it as another panacea and then be disappointed when they subsequently discover that it too is not an infallible tool.

JOHN DAVID MACEY Lecturer, Graduate and Undergraduate Business Programs Northeastern University

while, on the other hand, the Levy data lead us to believe that longer time intervals give rise to better beta predictions. Between the two of them I am somewhat confused as to whether or not "Forecasts are clearly (em- phasis added) better over longer pe- riods than over shorter periods. . ..

The beta concept is gaining ground now at the practitioner's level. I hope that people won't seize it as another panacea and then be disappointed when they subsequently discover that it too is not an infallible tool.

JOHN DAVID MACEY Lecturer, Graduate and Undergraduate Business Programs Northeastern University

LETTER IMPERFECT

There is a mistake in your otherwise excellent article "Market Indexes and Their Implications for Portfolio Man- agement" (Sept.-Oct. 1971). In the "Market Indexes" appendix the for- mula labeled (2) which defines the periodic reallocation index since its inception should have i as its index of summation and N as its last term of the sum.

RICHARD BLAND MILES Mission, Kansas

For CHANGE OF ADDRESS:

Send old label and new address with Zip Code, six weeks before moving to: Financial Analysts Journal, 219 East 42nd Street, New York, N. Y. 10017.

LETTER IMPERFECT

There is a mistake in your otherwise excellent article "Market Indexes and Their Implications for Portfolio Man- agement" (Sept.-Oct. 1971). In the "Market Indexes" appendix the for- mula labeled (2) which defines the periodic reallocation index since its inception should have i as its index of summation and N as its last term of the sum.

RICHARD BLAND MILES Mission, Kansas

For CHANGE OF ADDRESS:

Send old label and new address with Zip Code, six weeks before moving to: Financial Analysts Journal, 219 East 42nd Street, New York, N. Y. 10017.

LETTER IMPERFECT

There is a mistake in your otherwise excellent article "Market Indexes and Their Implications for Portfolio Man- agement" (Sept.-Oct. 1971). In the "Market Indexes" appendix the for- mula labeled (2) which defines the periodic reallocation index since its inception should have i as its index of summation and N as its last term of the sum.

RICHARD BLAND MILES Mission, Kansas

For CHANGE OF ADDRESS:

Send old label and new address with Zip Code, six weeks before moving to: Financial Analysts Journal, 219 East 42nd Street, New York, N. Y. 10017.

106 n FINANCIAL ANALYSTS JOURNAL / MAY-JUNE 1972 106 n FINANCIAL ANALYSTS JOURNAL / MAY-JUNE 1972 106 n FINANCIAL ANALYSTS JOURNAL / MAY-JUNE 1972

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