The CFA Institute on Indexing

I am currently laboring through the coursework to sit for the Level 1 CFA Exam in June. The CFA Institute offers the Charted Financial Analyst charter. The CFA designation is held by, among others, portfolio managers, investment research analysts, and investment bankers. I decided to pursue the charter, because I believe it will help me better serve our clients.

I was also interested in obtaining the base knowledge that portfolio managers use to actively manage portfolios. We do not practice active management. I have never been persuaded by Wall Street’s message to consumers that investors can beat the market. The academic research indicates that very few active managers actually deliver above-average risk-adjusted returns. But since there so many firms attempting to do this, I want to know how they attempt to go about it.

While I am still in Level 1 of the CFA program - there are three levels to the CFA curriculum – it has been very interesting to see the position that the CFA institute takes on the issue of active portfolio management.

Here are a few quotes from CFA Program Curriculum, Volume 5, “Equity and Fixed Income.”

“The majority of professional money managers cannot beat a buy-and-hold policy on a risk-adjusted basis.” P. 93

“Without access to superior analysts or the time and ability to be a superior investor, you should manage passively and assume that all securities are properly priced based on their level of risk.” PP. 93-94

I am using a review program produced by Kaplan Schweser to prepare for the exam. In Book 4, “Corporate Finance, Portfolio Management, and Equity Investments,” the author states, “money managers as a group have not outperformed the buy-and-hold policy. P. 184

Further, “since you cannot, in general, expect to beat the market, you should attempt to match the market while minimizing your costs. One way to match the market’s performance is to put your money into an index fund.” P. 184

I find this very interesting. Why are so many advisors putting their clients in funds that are actively managed? Do they actually believe they can identify the few portfolio managers who do beat the market? Do they realize that this small group of managers is not consistent over time? Just because a mutual fund earned a 5 star rating from Morningstar last year does not mean it will do so again this year.

Hopefully, I will pass the Level 1 exam and move on to Level 2 and Level 3. I am very curious about the additional insights I will have into the issue of active vs. passive investment management.