The rise of the CFA

Bubbles aren't all bad. After the smoke from the bust clears, newcomers to the investment business, as well as veterans who got burned, realize they've learned some valuable lessons - the hard way.

Looking back over the past decade - through the rise and fall of tech, commodities, real estate and increasingly bewildering and volatile derivatives - one total has climbed relentlessly. That's the number of people who hold the international passport for hard-core financial professionals: the Chartered Financial Analyst designation.

The CFA was the brainchild of Benjamin Graham, who first proposed standardized training and accreditation for analysts in 1942. But it wasn't until two decades later, in 1963, that 268 candidates passed an exam and became the first CFAs. The following year, the current system of three levels of exams (candidates usually write one a year) came into effect, and is now administered by the CFA Institute in Virginia.

The number of people writing the CFA exams grew steadily until the early 1990s, then exploded just as stock markets started to soar. The program's popularity was, in part, a result of the increasing analytical and mathematical sophistication of the investment industry. As well, the CFA provides a standardized curriculum, which university finance and MBA programs lack.

Almost 200,000 candidates worldwide registered to take Level I, II or III of the CFA exams in the Institute's 2009 fiscal year (which ends July 31), up 14 per cent from fiscal 2008, with more candidates in Asia - mainly China, India and Singapore - than in the U.S. There are now about 85,000 CFA charter holders in 133 countries, and roughly 11,000 additional members of the Institute who belong to affiliated professional societies.

But wait a sec. Didn't financial markets around the world plummet by a third in 2008? With tens of thousands of CFAs now in positions of influence and authority, how can so many firms and individuals have made so many disastrous investments?

Two answers come to mind right away: Maybe the quality of the CFA brand is getting diluted as the ranks of charter holders swell. Or, maybe, in the process of building, buying and selling ever more complex and dangerous financial instruments, CFAs have become too smart for their own good.

Well, no, say many veteran CFAs. Yet there's some truth in both answers.

Michael Hlinka, who worked for investment dealers for 25 years before becoming a business instructor at Toronto's George Brown College, teaches CFA prep courses at night at the University of Toronto's School of Continuing Studies. The CFA designation has definitely raised the bar for analysts and money managers, says Mr. Hlinka, who describes the algorithm for investment decision-making until the 1980s as "seat of your pants," even in many large institutions.

The CFA exams have always been tough, and haven't gotten any easier in recent years. "When people ask me, I say that Level I is basically my entire undergraduate degree in finance and economics," says Blair Carey, vice-president of investments at Toronto-based private debt fund Third Eye Capital and a former chair of the Canadian CFA Advisory Council. Add in plenty of ethics, plus more advanced and more comprehensive portfolio analysis for Levels II and III.

True, there has been a stampede to write exams since the 1990s, but Messrs. Hlinka and Carey say the slackers get weeded out. The CFA Institute doesn't disclose what mark a candidate must achieve to pass, but in the 1960s, about three-quarters of applicants at all three levels made the grade. By fiscal 2008, the proportion of successful candidates had fallen to 35 per cent for Levels I, 46 per cent for Level II and 50 per cent for Level III. Along with passing Level III, you also need at least four years of relevant work experience to get your charter.

By fiscal 2008, the proportion of successful candidates had fallen to 35 per cent for Levels I, 46 per cent for Level II and 50 per cent for Level III. Along with passing Level III, you also need at least four years of relevant work experience to get your charter.

What do you get when you have your CFA? A designation that opens doors in financial capitals worldwide - from New York to Dusseldorf to Dubai and beyond. What don't you get? A foolproof method for analyzing investments, or making money, or avoiding disaster.

"The CFA is a great tool box, but it can't compensate for experience, and it can't change human nature," says Bill Webb, deputy chief investment officer of Gluskin Sheff + Associates in Toronto. "Manias, bubbles and panics have always existed, and they always will, due to economic and business cyclicality, and greed and fear. Financial innovation - what we call it politely - never stops either."

Yes, but expertise often accelerates innovation, and innovation definitely made the meltdown of 2008 the most complex and expensive one ever. Were CFAs part of that problem?

That's too much of a stretch, say Mr. Wells, Mr. Carey and others. CFAs certainly knew more than a lot of investors about mortgage-backed securities and other derivatives that have been around for a long time. And, yes, CFAs understood the broad patterns of financial disasters better than many in the industry. "There's the seduction of cheap credit and expensive assets," says Mr. Wells. "So people use more leverage to compound low returns. Ultimately, that credit bubble rolls over and the underlying assets deteriorate."

In recent years, however, a smorgasbord of new synthetic assets was introduced. "You start getting into things like CDOs and CLOs [collateralized debt and loan obligations]" says Mr. Wells. CFAs were familiar with the components of those assets, but couldn't predict how they would fare when bundled together. And, obviously, there was no historic data.

Trading strategies became vastly more complex as well. But again, CFAs say, you can't blame them. Mr. Carey notes that many of the algorithms were developed by specialists such as PhDs in mathematics, and were deployed by powerful executives who can be headstrong or impulsive. "It may surprise you that a lot of volatility in the market is not caused by execution by CFA charter holders," he says.

The CFA tool box won't be foolproof in the future, either. Even with a lot of the jerry-built instruments and the leverage gone from the game, the playing field is now completely different. "There's the complexity and scale of the policy responses," says Mr. Wells. "Zero interest rates, massive fiscal stimulus, massive monetary stimulus. There are no easy historic analogies."

It's a lot for any investment professional to chew on, no matter what letters appear after his or her name.