Annual Conference

CFA Institute Annual Conference
8–11 May 2011 · Edinburgh, Scotland
Hosted with the CFA Society of the UK

Now in its 64th year, the CFA Institute Annual Conference brings together investment professionals from around the world to hear industry leaders share insights on today’s most critical investment issues.

Experts examine market trends, uncover new investment opportunities, and deliver practical investment advice.

Over the past three years, which country’s central bank has pushed the boldest reforms in response to the financial crisis? After listening to a riveting talk delivered last month by Sanusi Lamido Sanusi at the 64th CFA Institute Annual Conference, I’m convinced that the answer is Nigeria.

When Sanusi, governor of the Central Bank of Nigeria, took the stage at Scotland’s landmark Usher Hall, I was not expecting an enlightening session on regulatory reform. After all, Nigeria does not usually make news headlines for its financial sector reform efforts — nor are central bankers, in general, known for their boldness. And Sanusi was speaking near the end of a whirlwind three-day conference that had already featured an outstanding lineup of distinguished speakers, including James Grant (Video) and Raghuram Rajan.

Yet more than any other speaker, Sanusi commanded the audience’s attention from the moment he began talking. He used no notes. He had no slides. With a mix of candidness and humor, the central banker drew spontaneous applause and laughter. And when Sanusi finished, he garnered the Conference’s only standing ovation. Considering his audience of 1,300 delegates from 62 countries — mostly experienced investment professionals from the world’s elite financial institutions — this was no small feat.

Sanusi provided delegates with a compelling review of financial reform in Nigeria. In addition to the usual steps to prevent a run on banks — such as liquidity and capital injections — reforms in Africa’s most populous country, according to Sanusi, have included the removal of bank management at a number of troubled institutions; prison sentences for some CEOs; recovery of a portion of stolen wealth; restrictions on the tenure and future employment of bank directors; restrictions on the use of demand deposits; recovery of the costs of bailouts from banks; and, last but not least, risk-sharing arrangements to better channel capital to the real economy.

Can you think of another central bank that is pursuing such bold reforms? I can’t.

Of course, in a developing country like Nigeria, reformers must battle a unique set of challenges. Sanusi explained that the collapse of oil prices, the stock market crash, and the global financial crisis were not the primary causes of the Nigerian financial crisis. However, they did help to expose a more fundamental and pervasive problem: corruption.

“Banks don’t fail,” Sanusi contended. “They are destroyed. And you have got to find who destroyed the bank.”

To prove his point, the central banker highlighted some shocking examples, including the case of a bank CEO who stole US$2 billion through fraudulent lending. Sanusi asserted that such a crime could only be discovered because his central bank had taken over the management of distressed institutions. There was a “conspiracy of silence,” Sanusi explained, among bankers, who wrongly assumed that unethical practices in other institutions would not affect their own enterprises. The central bank is now recovering most of the cost of the bailout from the banking sector, an effort which highlights the fact that malfeasance at one bank is indeed a threat to the shareholders of other banks.

“This whole idea that institutions should privatize their profits and socialize their losses is anathema to me,” Sanusi said, explaining the thought underlying the reforms. Despite being a former banker himself, he asserted that “the banking industry needs to be taught a little humility. It is too arrogant.”

Sanusi also addressed a question that was no doubt on the minds of many in the audience: How did the reform effort in Nigeria overcome political interference? His explanation was simple: The central bank won the support of the Nigerian public by disclosing details of wrongdoing in the banking sector, thus making it difficult for entrenched interests to short-circuit reform. The bigger issue, Sanusi argued, is ensuring that the financial sector serves the real economy and doesn’t become an “incestuous pool” that leads to “financialization” of the economy, as he believes has happened in the United States.

When Sanusi finished his speech, the first question from the audience was, “Would you please take over the [U.S.] Fed next?” The response: applause and laughter.

A final query struck a far more serious tone: Is the central bank chief personally in danger given the war he is waging on vested interests? Downplaying any threat to his life, Sanusi smiled and responded, “You die anyway when it is time to die; I am not worried at all.”

At the 10th Annual Research for the Practitioner Workshop preceding the 64th CFA Institute Annual Conference last month, Brian D. Singer, CFA, author of Investment Leadership and Portfolio Management and a former chair of the CFA Institute Board of Governors, delivered a presentation on portfolio management and risk.

Singer, who is currently chief investment officer of Singer Partners, LLC and previously served as head of Global Investment Solutions and Americas chief investment officer at UBS Global Asset Management, put forward a simple premise: that many portfolio managers are “unaware of the risks embedded in their portfolios.”

Singer’s point of view is that successful investing requires an understanding of risk factors and an allocation of risk capital to those factors which are compensated. At the same time, he argued, investors must eliminate uncompensated risk factors from their portfolios. Risk can be your friend, Singer said, but only if you are aware of what risks you face.

Because two-thirds of the variation in portfolio returns is driven by systematic risk factors (i.e., beta exposures), Singer said portfolio managers should shift their focus from a search for alpha driven by security selection toward an approach that allocates risk capital to beta factors. Examples of such beta exposures include inflation, credit risk, and illiquidity. Corresponding asset categories for risk budgeting purposes might be inflation-protected bonds, high-yield bonds, and real estate, respectively.

In short, returns originate in underlying economic drivers. Understanding this simple idea leads one to focus on harvesting systematic risk premia rather than pursuing the purported “free lunch” of unique alpha, Singer argued.

He summed it up simply, saying “a top down beta allocation framework is best.”