The smart money has spoken

The smart money has spoken, and it believes that the UK and the US economies will be negatively affected by the global credit squeeze for more than a year before they can start to recover. Meanwhile the Brics will enjoy some fruits of economic decoupling – Brazil, Russia, India and China are all expected to recover from the negative effects of the credit crisis much more quickly.
The source of this wisdom? The delegates now massed in Vancouver for the annual conference of the CFA Institute, the organization that administers the CFA qualification and effectively functions as the world’s professional body for investors. Attendance is the biggest ever, from 70 different countries, and a poll of more than 400 attendees revealed the bearishness about the credit squeeze.
As the organizers also proudly proclaim that more than two thirds of their delegates have been managing money for a decade or more, and that two thirds work for companies with $50bn or more in assets under management, it seems that these people’s views are worth taking into account.
They are also bearish about America’s long-term position in the world, with 49 per cent of them predicting that the dollar will cease to be the world’s reserve currency within a decade. And they are bearish about the immediate prospects for equities, expecting the equity premium to widen.
However, the biggest question at this year’s conference may be more about whether the smart money is really so smart after all. The last 12 months have not been good for the public image of investment professionals. The disaster that befell structured credit, and the awful damage suffered by quant equity funds last summer, have made it suddenly fashionable to call into question the whole complicated theoretical architecture that the Institute’s members had spent decades developing.
Monday’s keynote speaker will be Nassim Nicholas Taleb, who has grown ever more vocal in his complaints that the most popular risk management systems were flawed in conception, and that the Black-Scholes options-pricing theory, bedrock for much quantitative finance, is fatally flawed.
Several other speakers will be backing the merits of behavioural finance. This is a separate debate that has sprung up within the investment management community, but it also calls some key assumptions into question. If the behaviouralists are right, then the assumption that people in markets behave rationally – a keystone of many economic models – needs to be jettisoned. Instead, models should incorporate the evidence from psychology that people are systematically irrational.
Meanwhile, quants will be expected to show that they have made some progress in working out what went wrong, and fixing it.
They are not about to go down without fighting: “100% Quant” T-shirts appear to be a popular conference item, and many presentations still feature intimidating long lists of Greek letters. But now that modern portfolio theory is coming under ever more public questioning, they will have to get much better at explaining themselves.
http://ftalphaville.ft.com/blog/2008/05/12/12946/the-smart-money-has-spoken/