Members and Candidates must:<\/p>\n
The application of this Standard depends on the investment philosophy that the Member, Candidate, or firm follows, the role the Member or Candidate plays in the investment recommendation or decision process, and the resources and support offered by the Member or Candidates\u2019 employer. The factors highlighted will determine the rigor of research and the depth of due diligence required.<\/p>\n
Members and Candidates must make reasonable<\/em> efforts to consider all relevant information when arriving at investment recommendations. Members and Candidates may enhance transparency by providing supplementary information that supports their investment recommendations.<\/p>\n Clients rely on the expertise and knowledge of Members and Candidates to inform their investment decisions. Consequently, clients require assurance that Members and Candidates make the required effort to support any investment recommendations. Members and Candidates can provide greater transparency to their clients by communicating the breadth of information used and the considerations taken to arrive at investment recommendations.<\/p>\n Some<\/em> factors to consider while forming the basis of a recommendation include:<\/p>\n Members and Candidates are required to make a reasonable<\/em><\/strong> and diligent <\/em><\/strong>effort to determine the quality and soundness of external research.<\/p>\n Secondary research is defined as research conducted by someone who works at the same firm as the Member or Candidate. Third-party research is defined as research conducted by entities outside the firm, e.g., investment banks, brokerages.<\/p>\n Factors to consider while evaluating the basis of external research includes:<\/p>\n Members and Candidates should encourage the development and adoption of review policies of external research providers to ensure that the quality of the research is maintained at a high standard.<\/p>\n There has been an increase in the use of quantitative models to arrive at investment recommendations, stock selection, stock screening, and portfolio construction techniques. Members and Candidates are required to know the parameters, assumptions, and limitations of the models they use. In addition, Members and Candidates should incorporate a broad range of assumptions that capture the volatile nature of investments. The omission of negative outcomes or tail events may misrepresent the potential range of values that an investment can take.<\/p>\n Members and Candidates involved in the development or oversight of quantitative models must demonstrate a greater level of diligence than those who use the final model.<\/p>\n Members and Candidates involved in the creation of quantitative models must<\/em>:<\/p>\n Standard V(A) \u2013 Diligence and Reasonable Basis applies to the rigor of evaluation required when selecting an external manager or subadviser to manage a particular investment mandate.<\/p>\n Members and Candidates directly responsible for hiring or working with external managers should ensure that their firm has standardized criteria for reviewing external advisers.<\/p>\n Such criteria would include but are not limited to:<\/p>\n Members and Candidates will often be part of a team that is tasked with producing a research report or investment recommendation. The conclusions of a report may not reflect the sole opinion of a Member or Candidate, but their names would be included in the report.<\/p>\n If the Member or Candidate has a differing opinion from the consensus view but believes that the conclusions are based on a reasonable and adequate basis, the member does not<\/em><\/strong> need to dissociate from the report. If, however, the Member or Candidate believes that the conclusions are not founded on a reasonable basis, he or she should decline<\/em><\/strong> to have their name identified with the report.<\/p>\n Members and Candidates should encourage their firms to:<\/p>\n Calvin Samuelson is a junior fixed-income analyst at FreeHouse Securities. He is tasked with writing a report on the Fed interest rate expectations over the next two quarters. Samuelson completes his report and submits it to the investment review committee \u2013 as mandated by the firm\u2019s procedures.<\/p>\n An excerpt from the reports states:<\/p>\n \u201cWith the economic slowdown caused by the COVID-19 pandemic, we expect that the Fed will hold the Fed Funds rate steady at 0.25% over the next two quarters.\u201d<\/p>\n The majority of the investment committee does not agree with Samuelson\u2019s conclusions. The committee overwhelmingly believes that there will be a strong bounce back in economic activity and share concerns about unanticipated inflation. They believe the Fed will react by increasing the benchmark rate by 25bps over the next two quarters.<\/p>\n Samuelson does not agree with the consensus conclusion and believes that there is no reasonable and adequate basis for the committee\u2019s conclusions but proceeds to leave his name on the report.<\/p>\n Has Samuelson violated Standard V(A) \u2013 Diligence and Reasonable Basis?<\/p>\n \u00a0 \u00a0 \u00a0 A. Yes, because his report is supposed to reflect his views and conclusions.<\/p>\n \u00a0 \u00a0 \u00a0B. No, because the firm\u2019s internal policies require a consensus opinion.<\/p>\n \u00a0 \u00a0 \u00a0C. Yes, because he fails to dissociate from the report when he believes that there is no reasonable basis for the conclusions of the report.<\/p>\n The correct answer is C.<\/em><\/strong><\/p>\n Samuelson has violated Standard V(A) \u2013 Diligence and Reasonable Basis by failing to dissociate from the report. The conclusions of any<\/em><\/strong> research report or investment recommendation are inherently subjective.<\/p>\n In this case, the investment committee may have valid reasons for conclusions that differ from Samuelson\u2019s. The firm is permitted to publish a report that substantially different from Samuelson\u2019s findings, provided that there is a reasonable and adequate basis for its conclusions. If Samelson believes there is no reasonable basis for the conclusions, he should dissociate from the report \u2013 by declining to have his name on the published report.<\/p>\n Phillip Russo is the CEO of a mid-sized asset management firm. His firm relies heavily on external research to inform the firm\u2019s investment recommendations and actions. Russo\u2019s firm subscribes to a service from a reputable boutique research firm. The research firm has recently been awarded a prize for its stellar research coverage of the North American durable goods sector. Russo is confident in the rigor and quality of the research published by the firm and does not perform any independent due diligence to determine the quality and accuracy of data received. Russo always attributes the source of the research and explains this to his clients.<\/p>\n Which of Russo\u2019s actions are most <\/em>likely a violation of the CFA Institute\u2019s Standards?<\/p>\n \u00a0 \u00a0 \u00a0 \u00a0A. None of his actions violate any standards.<\/p>\n \u00a0 \u00a0 \u00a0 \u00a0B. His use of external research to inform the firm\u2019s investment actions.<\/p>\n \u00a0 \u00a0 \u00a0 \u00a0C. His failure to perform due diligence on external research.<\/p>\n The correct answer is C.<\/em><\/strong><\/p>\n Russo has violated Standard V(A) \u2013 Diligence and Reasonable Basis by failing to perform due diligence on external research. Russo is permitted to use external research, provided that he attributes the research to its original author or publishing entity.<\/p>\n Davidson Matthews is the head quantitative researcher at Core Technology Hedge Fund. Matthews is under increasing pressure to improve the firm\u2019s proprietary trading algorithms. The existing models have produced impressive results in a bull market but below average results in the current bear market.<\/p>\n Matthews reads several notable quantitative research blogs and publications. In one piece of literature, he identifies missing factors that would improve the firm\u2019s stock screening algorithm. He immediately incorporates the missing variables into the stock screening algorithm. Matthews shares the new algorithm with the firm\u2019s traders.<\/p>\n Has Matthews violated Standard V(A) \u2013 Diligence and Reasonable Basis?<\/p>\n \u00a0 \u00a0 \u00a0A. Yes, because he failed to diligently research the impact of introducing new factors into the model.<\/p>\n \u00a0 \u00a0 \u00a0B. No.<\/p>\n \u00a0 \u00a0 \u00a0C. Yes, because he is not allowed to draw inspiration from blog posts research publications.<\/p>\n The correct answer is A.<\/em><\/strong><\/p>\n Matthews has violated Standard V(A) \u2013 Diligence and Reasonable Basis by failing to diligently assess the impact of the addition of new variables into the existing model. Matthews is allowed to draw inspiration from blogs and research publications, but he needs to perform the necessary research to determine the effect of these changes on the stock screening algorithm.<\/p>\n<\/blockquote>\n LOS 2(a): Demonstrate a thorough knowledge of the CFA Institute Code of Ethics and Standards of Professional Conduct by applying the Code and Standards to specific situations. <\/p>\n LOS 2(b): Recommend practices and procedures designed to prevent violations of the Code and Standards. <\/p>\n","protected":false},"excerpt":{"rendered":" Standard V (A) \u2013 Diligence and Reasonable Basis Members and Candidates must: Exercise diligence, independence, and thoroughness in analyzing investments, making investment recommendations, and taking investment actions. Have a reasonable and adequate basis, supported by appropriate research and investigation, for…<\/p>\n","protected":false},"author":17,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[571],"tags":[],"class_list":["post-40885","post","type-post","status-publish","format-standard","hentry","category-cfa-level-iii","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"\nDefining Diligence and Reasonable Basis<\/h2>\n
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Secondary and Third-Party Research<\/h2>\n
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Quantitatively Oriented Research<\/h2>\n
Developing Quantitatively Oriented Techniques<\/h2>\n
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Selecting External Advisers and Sub-advisers<\/h2>\n
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Group Research and Decision Making<\/h2>\n
Compliance Recommendations<\/h2>\n
Recommendation for Members and Candidates<\/h3>\n
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Recommendation for Firms<\/h3>\n
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Application 1: Group Research Opinions<\/h3>\n
Solution<\/h4>\n
Application 2: Reliance on Third-Party Research<\/h3>\n
Solution<\/h4>\n
Application 3: Quantitative Model Diligence<\/h3>\n
Solution<\/h4>\n