Archive for October, 2008

This crisis is a blessing in disguise for CFA charter-holders

Thursday, October 2nd, 2008

Lets understand the difference between two distinct branches of investment banking. i.e. Fixed Income and Equity.

 

Fixed Income Investing is sort of a science (or it was assumed to be at least). Universities offer Master and Phd programes in mathematical finance. There were qualifications even in financial engineering. These people tried to forecast future events based on history using mathematical models. No understanding of business model or use of judgment is required in fixed Income Investing.

After the burst of dot com bubble in USA, lot of money was invested in fixed income securities. These investments were based on home loans/mortgages. This was going on for last 7/8 years. Returns were good, forecasting was working, mathematical models were reliable.

 

Equity investing is an art. Forecasting returns from equities require use of judgment and understanding of business models. Something that financial mathematicians lacked completely. CFA is primarily about equity investments. Over the last many years, fixed income was offering better risk adjusted returns than equities. Therefore, lot of money was finding its way to fixed income instead of equities.

However, with this current crisis, everything has changed. Now historical mathematical models are useless as they failed to forecast this problem. Fixed Income Investing is dead.

However, savings by Arabs, Chinese, Russians and others need to be invested. Furthermore, printing of money by USA and European central banks is going to inject lot of cash into system. This money needs to be invested somewhere. Considering fixed income is no more reliable… only option is commodities and equities.

Commodity as investment class is Ok for short term but not for long term. Therefore, all this money will start flowing to equities.

Now financial scientists have never looked at balance sheet or income statement. Nor do they understand how businesses operate…how business make and spend money. If they want to stay in finance.. they need to start from basics.

CFA charter-holders can really take benefit of this environment as they are trained for equity investments.