This is the first issue of the Fink Center bulletin. We are grateful to Larry and Lori Fink for their generous naming gift to the Center! With their gift, the Center will be able to further enhance and expand its current operations, with more funds available for faculty research, student fellowships, as well as additional resources to offer a range of activities that support the center's mission of bridging academia and industry. Thank you for your support, Larry and Lori!
Pansy Yang, Ph.D. (Bio)
Executive Director of the Fink Center for Finance & Investments
As credit woes continue to ripple through various markets, institutions, and countries, hope fades that the end is in sight as new financial troubles seem to unfold every day. Stocks continue to unwind and credit conditions tighten further while inflation, unemployment, rising fuel costs, and the weakening dollar all add up to a generally bleak outlook. In this turbulent economic environment, we devote this issue of the bulletin to the credit crisis, the progenitor of the current imbroglio.
Two renowned risk experts who also happen to be co-authors of two popular books, Risk Management and The Essentials of Risk Management, divulge their insights. First, Dr. Robert Mark, CEO of Black Diamond Risk and Executive Director of the UCLA Anderson Masters in Financial Engineering program, sits down with the Fink Center for an in-depth interview on the importance of benchmarking the quality of a risk management program. Black Diamon Risk provides corporate governance, risk management consulting, risk software tools and transaction services. Prior to his current position, he was the senior executive vice-president and chief risk officer (CRO) at Canadian Imperial Bank of Commerce (CIBC). Bob shares his thoughts on quantitative finance, the key distinction between different types of model risks, ways to mitigate model risk, and some lessons learned.
Dr. Michel Crouhy, Head of Research and Development at NATIXIS, provides a comprehensive overview on the origins, key players, and issues in the credit crisis, and shares recommendations on how to forestall future crises. He has the bankwide oversight on all quantitative research and the development of new products and applications supporting the trading and structuring businesses. Prior to his career in the industry, Michel was a professor of finance at the HEC School of Management in Paris, where he was also the founder and director of the M.S. HEC in International Finance.
The Fink Center: A key challenge for stakeholders has been to benchmark the quality of a risk management program in terms of both a risk governance point of view as well as the value added that a risk management program provides to revenue generating business units. Where are we in terms of benchmarking the quality of a risk management program?
Dr. Bob Mark: Many a risk management program has looked great on paper until it failed to prevent dramatic losses in abnormal markets. The failure of stakeholders to benchmark the quality of a risk management program as well as to make the risk transparent in both normal and abnormal markets has wreaked havoc on both Wall Street and Main Street. For example, if the risks of the sub-prime market were accompanied with warning labels that made them transparent, then the current chaos on Wall Street and Main Street might have been substantially reduced. Further, the lack of transparency often leads to the fear that institutions may be hiding major potential losses. We have witnessed the unraveling of Structured Investment Vehicles (SIVs), the marking down of illiquid portfolios, the struggles associated with rolling over financing such as short term ABCP (asset-backed commercial paper), a dramatic increase in the number of foreclosures and so on.
For more information, please visit: http://mfe.anderson.ucla.edu
The credit crisis of 2007 started in the subprime mortgage market in the U.S. It has affected investors in North America, Europe, Australia and Asia and it is feared that write-offs of losses on securities linked to U.S. subprime mortgages and, by contagion, other segments of the credit markets, could reach a trillion US dollars. It has brought the asset backed commercial paper market to a halt, hedge funds have halted redemptions, or have failed, and special investment vehicles have been wound-down. Banks have suffered liquidity problems, with losses since the start of 2007 at leading banks and brokerage houses topping US$250 billion, as of April 2008. Financial institutions are expected to write off an additional US$80 billion in the first quarter of 2008. Credit related problems have forced some banks in Germany to fail or to be taken over and Britain had its first bank run in 140 years, resulting in the nationalizing of Northern Rock, a troubled mortgage lender. The U.S. Treasury and Federal Reserve helped broker the rescue of the investment bank, Bear Stearns, by JP Morgan Chase during the week-end of March 17, 2008. Banks, concerned about the magnitude of future write downs and counterparty risk, have been trying to keep as much cash as possible as a cushion against potential losses. They have been wary of lending to one another and consequently, have been charging each other much higher interest rates than normal in the inter bank loan markets.
Fink Center Distinguished Speaker Series
Andrew Weiss, founder, president and CIO of Weiss Asset Management visited UCLA Anderson to talk about the profits and perils of investing in dangerous places. Weiss' investment adventures included stories from Kazakhstan, Vietnam, Romania, Russia, and the Czech Republic.
Watch a video of this presentation (Windows Media)
Weiss graduated from Williams College and received his Ph.D. in Economics (with distinction) from Stanford University. In 1989 he was elected a Fellow of the Econometric Society. Weiss is Professor Emeritus of Economics at Boston University and has held academic appointments at Columbia University and New York University. Weiss was also a Research Economist in the Mathematics Center at Bell Laboratories. He has lectured at numerous major universities in the United States and in foreign countries, and he has also served as a consultant to the World Bank and the National Research Council (NSF).
Weiss' research has covered a wide range of topics including credit markets, development economics, economics of information and behavioral economic theory. He has published numerous articles in leading economics journals. His paper Credit Rationing in Markets with Imperfect Information (with Joseph Stiglitz) is the 12th most highly cited paper in economics.
Weiss Asset Management "WAM" is a Boston-based money manager, with an investment history that dates back to 1991. The firm combines a highly disciplined value investing, quantitative investment approach with economic analysis of data to maximize risk adjusted returns. The primary strategy is market neutral with arbitrage across various classes of securities, and other forms of arbitrage across various classes of equities.
International Finance Conference
Mark your calendars for a conference on international finance sponsored by the Fink Center for Finance & Investments and the Center for International Business Education & Research (CIBER). The conference will be held at UCLA Anderson, and will feature presentations by academics in the morning followed by practitioners in the afternoon. Our exciting line-up of speakers includes:
- Michel Crouhy (IXIS, Author of Risk Management)
- Roberto Rigobon (MIT)
- John Rutledge (Rutledge Capital, Economic advisor to Reagan and Bush)
- Luigi Zingales (University of Chicago)
More information to come. Please join us for this great event!
By Matthew Garrahan in Los Angeles
Published: May 7 2008 23:18 | Last updated: May 7 2008 23:18
The chairman and chief executive of BlackRock, the US asset manager, has donated $10m to one of the world's leading business schools to foster better understanding between the academic and financial worlds in the wake of the credit squeeze.
Larry Fink said he hoped the endowment to the UCLA Anderson School of Management, which he made with his wife, Lori, would help the school become a "bridge" between academia and the financial sector.
"A credit crisis is engulfing the US and Europe," said Mr. Fink, an Anderson alumnus and UCLA graduate. "Models haven't worked and now we have hundreds of billions of dollars worth of losses. We need a bridge between academics and industry."
BlackRock has emerged relatively unscathed from the effects of the credit crisis and this week agreed to pay $15bn (9.7bn Euros, 7.7bn Pounds) for a portion of mortgage debt held by UBS, in a deal that represents a 25 per cent discount to the face value of the debt.
The Fink endowment, which will be announced today, will provide funding for the Anderson school's centre of finance and help foster better knowledge of financial models. In recognition of the gift, Anderson will rename the centre the Laurence D. and Lori W. Fink Center for Finance & Investments. "With the resources Larry and Lori have provided it will allow the centre to be much more visible and active," said Judy Olian, dean of UCLA Anderson.
The endowment would allow constant dialogue between academics and financial professionals so that relevant topics could be "addressed in a sophisticated fashion,' she said. The gift would "enhance the reputation of the centre throughout the finance, academic and professional communities."
Mr. Fink said the turmoil in financial markets had convinced him of the need to make the gift to the business school. "If it wasn't for all the uncertainty in the world right now, Judy would have needed to pull my leg a lot harder," he said.
Mr. and Mrs. Fink are active philanthropists but have, in the past, tended to focus their efforts on medical research.
The $10m endowment is the largest individual gift to UCLA Anderson since John Anderson's naming donation in 1987. Part of the investment will be used to create the Laurence D. and Lori W. Fink Endowed Chair in Finance, which will support research in finance, and to establish Ph.D. and MBA fellowships for students at the school.
Ms. Olian said students would have greater access to financial market tools and networks, while the centre would also partner with the Master in Financial Engineering program, a new one-year course that was more quantitatively oriented than a typical MBA.
BlackRock, which is 49.8 per cent owned by Merrill Lynch, manages $1,360bn in assets. The deal with UBS comes weeks after BlackRock agreed to manage $29bn in mostly mortgage-related securities held on Bear Stearns' balance sheet as part of JPMorgan Chase's emergency purchase of Bear.
Copyright The Financial Times Limited 2008
By Steve Johnson
Published: Jun 02, 2008
The use of fundamentally-weighted indices will not produce better returns for investors, and may produce lower ones, claims an influential academic.
Fundamental indices, which weight stocks by earnings, dividends, sales or book value, have emerged as rivals to traditional market capitalisation-weighted indices, such as the S&P 500.
Academics and industry figures have argued that market cap-weighted indices are flawed, with funds tracking them forced to hold more of a stock when it is overvalued and less when it is undervalued, reversing the "buy low, sell high" mantra.
But Richard Roll, professor of finance at UCLA's Anderson School of Management, and Moshe Levy of Hebrew University's Jerusalem School of Business Administration, argue that this cannot be the case.
Their paper found that traditional index funds are "mean-variance efficient." Under the capital asset price model, which underpins the concept of index funds, this means no other type of portfolio can have both a higher return and a lower risk.
Prof Roll, who admitted to being surprised by the result, said: "Over the years, many studies have concluded that market index proxies, such as funds based on the S&P 500 or Russell 2000, are inefficient and that something else was better.
"This paper is essentially a rebuttal of that notion including, by inference, recent claims for the superiority of so-called fundamentally-weighted indexes.
"If Prof Levy and I are right, the claims for the superiority of fundamentally weighted indexes are wrong. If something is mean-variance efficient, there's no way it can be beaten."
He added: "With tens of billions of dollars invested in traditional market index proxies, doubts about the basic model have constituted a dark cloud hanging over one of the most fundamental models of modern finance."
A swathe of fundamentally driven exchange traded funds have been launched in recent years, holding out the promise of delivering market-beating "alpha" in a passive, mechanical manner.
WisdomTree of New York, a leading exponent, saw its assets under management triple to $4.5bn in 2007, according to data from Morgan Stanley, while Research Affiliates of California says close to $35bn is tracking its fundamental indices.
Dan Draper of Lyxor Asset Management, which runs ETFs based on Research Affiliates' Rafi indices in Europe, said there were signs investors were switching money from traditional index funds.
"We are hearing that a lot of pension funds are saying 'I'm going to take 10-15 per cent out of my market cap weighting and put it in fundamental weighting and see what happens'," he said. "The pension community has the most interest. It will work its way to wealth managers and family offices."
Research Affiliates' says its US large cap, US small cap and international equity indices have outperformed their traditional benchmarks over the past 10 years, with lower volatility.
Standard & Poor's said in April that its S&P 500 Equal Weighted Index, which has $7bn tracking it, has outperformed the traditional S&P 500 by 1.5 percentage points a year since inception in January 2003.
However, outperformance of individual indices over a specific period may be more a reflection of biases towards sectors or investment styles than conclusive proof of superior construction.
Fundamental indices tend to be skewed towards value rather than growth stocks and would be expected to perform strongly when value investing is in vogue.
Lee Kranefuss, chief executive of Barclays Global Investors' iShares division, the biggest ETF provider, dismissed fundamental indices as "an attempt to outperform in a primitive way;" in essence "a very slow-moving active strategy."
Copyright The Financial Times Limited 2008
An excerpt of the ASAM Class of 2008 Annual Report follows.
Purpose of Fund
Anderson Student Asset Management (ASAM) is a student-run investment fund (hereinafter, the "Fund") that aims to:
- Provide competitive risk-adjusted returns, and
- Enhance the educational and professional development of the student-managers through experiential learning in strategy development and fund management
In the 2007-2008 school year, ASAM was advised by Professor Robert Geske of the Finance Department at UCLA Anderson.
A portion of the Fund's long-term profits will be donated to UCLA Anderson for support in student scholarships and research in finance.
ASAM's objective is to preserve capital while pursuing favorable risk-adjusted returns. The student-managers adhere to stated investment policies established by UCLA Anderson and the Fund's faculty advisor.
The Fund seeks to achieve its objectives through a diversified portfolio of securities that meet the fundamental and technical specifications adopted and developed by its managers. The Fund's managers believe that, in a dynamic market, security prices sometimes violate sensible risk/return boundaries. The Fund seeks to identify and exploit these opportunities through large-sample quantitative techniques. Fund managers leverage research and analytical capabilities within the Anderson finance faculty, external academic, and professional resources. The student-managers, along with the faculty advisor, determine an optimal mix of equity, fixed income and cash investments.
Overall Performance Review
The following exhibits summarize the performance of the ASAM fund over the period April 25, 2007 to April 30, 2008. The performance of the S&P 500 Total Return Index and the S&P 500 Pure Value Total Return Index are also shown for comparison.
Performance of the overall fund may be attributed to the styles of the four distinct portfolios which comprise the overall fund. The F-Score portfolio tended to track the S&P 500 Total Return Index while the aggressive value styles of both the AFG and Parametric Optimization portfolios dragged down the overall fund to the vicinity of the S&P 500 Pure Value Total Return Index. Finally, the overall fund received boosts from both the Dynamic Asset Allocation portfolio's considerable exposure to well-performing emerging markets and the large cash position from liquidation of the AFG portfolio in November. A brief summary of each of the four portfolios follows.
The AFGView strategy is based on the Economic Margin Framework, a value based measurement system developed by The Applied Finance Group (AFG). In general, Economic Margin is a combination of Economic Value Added (EVA) and Cash Flow Return on Investment (CFROI). Economic Margin identifies four major drivers for value: profitability, competition, growth and cost of capital and uses the ValueExpectationsTM software as a quantitative screen to identify stocks.
Dynamic Asset Allocation
The Dynamic Asset Allocation (DAA) strategy uses regressions to solve for coefficients that optimally link the economic indicators to asset class performance over the past rolling 12 months, as well as placed caps on the strength of any one coefficient so that it could not dominate the asset weighting calculation. The strategy constantly adjusts the asset mix on a monthly basis as markets shift and the economy strengthens and weakens, hence the name "Dynamic" Asset Allocation.
The F-Score strategy is based on an academic paper which was published by Joseph Piotroski from the University of Chicago's Graduate School of Business in April 2000. The purpose of the strategy is to improve mean returns and decrease variance by attempting to identify future winners based on a simple accounting-based fundamental analysis. The strategy seeks to outperform the market by utilizing information obtained solely from the underlying company's financial statements. By using financial statement analysis, the strategy attempts to select firms that show improving financials that the market has not yet recognized and, by doing so, improve returns on a typical value strategy.
Parametric Optimization Strategy
ASAM's Parametric Optimization Strategy is based on the working paper "Parametric Portfolio Policies: Exploiting Characteristics in the Cross-Section of Equity Returns" by Michael W. Brandt, Pedro Santa-Clara, and Rossen Valkanov. The basic idea is to optimize the weights of stocks within a portfolio on the basis of each stock's characteristics (specifically size, value, and momentum) where each characteristic is associated with a documented market anomaly. This method contrasts with the Markowitz approach which attempts to optimize a portfolio on the basis of an estimated joint distribution of stock returns.
For the full report, click here.
The finance group is delighted to announce the promotion of Mark Garmaise to Associate Professor with tenure. Mark is one of the leading young scholars in finance as well as a great teacher. Please join us in congratulating Mark on his well-deserved promotion. Mark received his Ph.D. in finance from Stanford, and was a member of the finance faculty at the University of Chicago GSB prior to joining UCLA Anderson. Mark's research interests include corporate finance, real estate, financial contracting, banking, entrepreneurship, microfinance, and private equity. His research has appeared in the Review of Finance Studies, the Journal of Finance and the Quarterly Journal of Economics.
Bruce Carlin completed his first year at UCLA Anderson as an assistant professor in finance. Bruce teaches corporate finance at UCLA, and has been recognized for teaching excellence his first year here as the recipient of the Robbins Assistant Professor Teaching Award. He has also been recognized previously for teaching excellence at both Duke University and the University of North Carolina. After completing his M.D. at Northwestern, Bruce continued on to receive his M.B.A. from Washington University in St. Louis and a Ph.D. in finance from Duke University. His primary research interests are in the areas of theoretical corporate finance and consumer finance, and he has published in the Journal of Finance and the Journal of Financial Economics.
Hanno Lustig will be formally joining us this coming academic year as an assistant professor in finance. The finance department has enjoyed having Hanno as a colleague this past year during his visit from a short walk away, the UCLA economics department. Hanno received his Ph.D. in economics from Stanford, and prior to joining UCLA, he spent several years on the economics faculty at the University of Chicago. His research interests focus on asset pricing, macroeconomics, exchange rates and international finance. He has given invited seminars at MIT, Harvard, NYU, Northwestern University, amongst other leading schools in the field of economics. His research has been published in top academic journals, including the Journal of Finance, American Economic Review, and the Review of Financial Studies.
Two new students will be joining the doctoral program in finance this Fall.
Shaun Davies received a B.S. in engineering and a B.A. in economics from University of Colorado in 2005.
Konark Saxena received his undergraduate degree in computer science from the Indian Institute of Technology in 2002 and his MBA from Indian School of Business in 2006.
The Fink Center for Finance & Investments
UCLA Anderson School of Management
110 Westwood Plaza, Los Angeles, CA 90095