Selecting an Asset Manager

It is a fact that the Code of Ethics and Standards of Professional Conduct apply to all CFA stakeholders and that candidates hoping to pass the exams need to be well versed in the Ethics material. This Los provides a brief summary, which may be paired with the reading for a more concise understanding or may also be useful as an example of a potential case that could show up on the exam.

Background

This section of the curriculum presents an ethics case involving a university foundation. The case revolves around the foundation's search for external asset managers to oversee its endowment. One of the external managers is an alumna of the university who has made substantial donations to the institution since graduating. What complicates matters is that she is also a current member of the university's board of trustees, raising clear concerns about potential conflicts of interest.

The investment committee is also considering a proposal from another private equity firm, which lacks such apparent conflicts of interest. Under the pressure to select an external manager, not necessarily based on their qualifications but due to her ties to the university, a member of the investment committee is feeling compelled to report this situation to the university's board.

Proposals

The initial proposal from the alumni-run fund seems promising. However, it appears to be overly tailored to the university, raising concerns about how it acquired private university information. Additionally, the historical returns presented in the proposal show significantly higher performance than third-party database reports.

At this juncture, the investment committee member should have conducted a thorough investigation into the fund's performance and reported any discrepancies. Unfortunately, they fail to take these steps, committing ethical violations. Moreover, they should have reported the improper acquisition of university information to the board, but this crucial action was also neglected, resulting in another ethical lapse.

Research

The second fund option is a well-established firm with a reasonable track record. An external researcher is tasked with thoroughly evaluating both competing funds. The research suggests that the second fund might be a more suitable choice from an investment perspective. However, during the researcher's presentation, it becomes apparent that the first fund also presents a strong investment case, despite potential conflicts of interest. The first fund offers a fee discount, and the team decides to select it, as it is run by the university’s alumni.

In a surprising turn of events, it is discovered that the main researcher has family connections with the prominent alumni who won the initial proposal. This revelation raises questions about the validity of the research and subsequent presentations. The researcher claims he assumed everyone knew about these ties, but this assumption is an ethical violation, as he should not have presumed that his audience was aware of his relationships, which could impact his objectivity and independence.

Conclusion

Candidates need to become adept at reading a case and finding the potential harm in the actions of the individuals. These are not always obvious and can even be incredibly nuanced, but with practice, candidates can improve their Ethics section scores over time. A good sign is being able to read a case, spot the ethical dilemmas, and then label the (potential) violations with the appropriate parts of the Code of Ethics and Standards of Professional Conduct.

Question

The university president and treasurer, as a member of the University Board, had a duty to act in the best interest of the university by hiring the external investment managers most appropriate for managing the private equity portion of the university's endowment. Which of the following standards most appropriately pertains to this issue?

1. Standard of Professional Conduct IV Duties to Employers, (A) Loyalty.
2. Standard of Professional Conduct I Professionalism, (B) Independence and Objectivity.
3. Standard of Professional Conduct VII responsibilities as a CFA Institute Member or CFA Candidate A) Conduct as Participant in the CFA Institute Programs.

Solution

The correct answer is A.

Standard of Professional Conduct IV Duties to Employers, (A) Loyalty – In matters related to their employment, Members, and Candidates must act for the benefit of their employer and not deprive their employer of the advantage of their skills and abilities, divulge confidential information, or otherwise cause harm to their employer.

B is incorrect. It pertains more specifically to accepting gifts that affect recommendations.

C is incorrect. It pertains more specifically to outside conduct (non-financial or professional) that may reflect poorly on the CFA Institute.

Portfolio Management Pathway Volume 2: Learning Module 7: Case Study in Portfolio Management: Institutional; Los 7(d) Demonstrate the application of the Code of Ethics and Standards of Professional Conduct regarding the actions of individuals involved in manager selection