The Wizard was focused on this sentence in "A Ratings Neutral Investment Policy" which gives one of the reasons for large losses by financial institutions in the current credit crisis:

"Failure to understand that complexity in product design is an intentional effort by investment banks and other product structurers to induce investors to overpay for a complex security that they are unable to value correctly"

The Wizard's e-mail said, "This is one of the first things I learned on coming to the [name omitted] Department.  Also interesting to note that CFA Charterholders have an ethical requirement to only recommend investments that they understand."  The Wizard provided a link to a key document on the website of the CFA Institute, which describes its mission like this:

"CFA Institute is the global, not-for-profit association of investment professionals that awards the CFA and CIPM designations. We promote the highest ethical standards and offer a range of educational opportunities online and around the world." It goes on to say "We have more than 90,000 voting members and 136 societies worldwide. All agree to abide by our Code of Ethics and Standards of Professional Conduct."

The Wizard honed in on this statement from the Code of Ethics and Standards of Professional Conduct:

"INVESTMENT ANALYSIS, RECOMMENDATIONS, AND ACTION

A. Diligence and Reasonable Basis. Members and Candidates must:

1. Exercise diligence, independence, and thoroughness in analyzing investments, making investment recommendations, and taking investment actions.
2. Have a reasonable and adequate basis, supported by appropriate research and investigation, for any investment analysis, recommendation, or action."

The Wizard's e-mail noted, "Interesting that word 'must.' For this reason, I have never recommended hedge funds for my employer's use since I don't understand them." The Wizard's humility is one of his many virtues, but his financial wisdom is perhaps his greatest.  Our post on a "Ratings Neutral Investment Policy" was just ruthlessly practical in pointing out that, if you don't do your homework, you'll get ripped off buying products that are unnecessarily complex or where the underlying assets (Hedge fund assets, CDO collateral, etc.) are not disclosed.  The Wizard invokes something much more important--integrity, morality and professionalism.  The 90,000 members of the CFA Institute are prohibited from recommending investments to their employer that they have not investigated with diligence, independence and thoroughness.  The Wizard clearly believes from his comments that a rating alone or a hedge fund's past returns alone do not meet this standard.  Wizard, our hat is off to you yet again.

In another interesting postscript to the "Ratings Neutral Investment Policy," a risk manager for whom I have great respect (we'll call him X-man) focused on the same sentence that the Wizard pointed out.  "Can't you take it out?," X-man asked.  He went on to explain that his boss had had primary responsibility for piling into CDOs in a big way, putting my friend's institution at risk. X-man told me, "I want to send this Ratings Neutral Investment Policy to my boss" but he feared that sentence might not enhance his career prospects.  "Don't worry," I told him, "I wrote it, not you, and you can tell that to your boss for me. Let's hope he's learned something from the tuition that's been paid."

My thanks to the Wizard and X-man.  Being good may be "more violent and daring than sailing around the world" but you guys, along with the 90,000 members of the CFA Institute, have to keep it up.

Donald R. van Deventer
Kamakura Corporation
Honolulu, May 14, 2009