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Morningstar’s Paul D. Kaplan, CFA to Receive Prestigious Financial Analysts Journal Graham and Dodd Award

 

Charlottesville, Va., March 9, 2009 − CFA Institute announced today that the Financial Analysts Journal’s Advisory Council and Editorial Board have awarded the annual Graham and Dodd Award to Paul D. Kaplan, CFA, vice president of quantitative research at Morningstar, Inc., in Chicago, for his article "Why Fundamental Indexation Might – or Might Not – Work." This article appeared in the January/February 2008 issue of FAJ.

 

The Graham and Dodd Award for excellence in research and financial writing is the Journal’s highest honor. The FAJ is published six times a year by CFA Institute, the worldwide association of 100,000 securities analysts, portfolio managers, strategists, consultants, and other investment specialists. The FAJ advances the knowledge and understanding of the practice of investment management through the publication of high-quality, practitioner-relevant research.  

 

The article demonstrates that, except in trivial cases, fundamental weights cannot be unbiased estimators of fair value weights with errors that are statistically independent of market values because the sources of those errors, risk and expected growth, are also determinants of market values. Kaplan also shows under what conditions fundamental weights are better than market value weights as estimators of fair value weights and under what conditions they are worse, concluding that the case for fundamental indexation is a conjecture about unobservable variables rather than a theory. Lastly, the author shows that fundamental weighting is inherently value biased. Hence in today’s market environment, with value strategies trailing the market, fundamentally weighted indexes are trailing their market-cap weighted counterparts. Kaplan concludes the article by discussing two approaches to combining fundamental data and market value data to form weights that yield better portfolios than could be obtained by using only one or the other.

 

The Graham and Dodd Award was created in 1960 to honor the enduring contributions of Benjamin Graham and David L. Dodd to the investment analysis field. Each year it is presented to the author or authors of the previous year’s most outstanding FAJ article. In 2008, Nobel laureate William F. Sharpe received the Award for his article "Expected Utility Asset Allocation," which appeared in the publication’s September/October 2007 issue.

 

The FAJ advisory council and editorial board also awarded four “Graham and Dodd Scroll Awards” to recognize additional outstanding articles published in 2008.

 

The four Scroll Award articles are:

 

• "Equity Returns at the Turn of the Month" (March/April), by John J. McConnell and Wei Xu. Summary: The turn-of-the-month effect in U.S. equities is found to be so powerful in the 1926–2005 period that, on average, investors received no reward for bearing market risk except at turns of the month. The effect is not confined to small-capitalization or low-price stocks, to calendar year-ends or quarter-ends, or to the U.S. This study finds that it occurs in 31 of the 35 countries examined.
• "Systemic Credit Risk: What Is the Market Telling Us?" (July/August) by Vineer Bhansali, Robert Gingrich, and Francis A. Longstaff, CFA. Summary: The ongoing subprime crisis raises many concerns about the possibility of even more widespread credit shocks. The authors describe a simple linear version of a sophisticated model that can be used to extract information about macroeconomic credit risk from the prices of tranches of liquid credit indices. The market appears to price three types of credit risk: idiosyncratic risk at the level of individual companies, sector-wide risk at the level of companies within an industry, and economy-wide or systemic risk. The authors applied the model to the recent behavior of tranches in the U.S. and European credit derivatives markets and show that the current crisis has more than twice the systemic risk of the automotive-downgrade credit crisis of May 2005.
• "Stock Repurchases and the EPS Enhancement Fallacy" (July/August) by Jacob Oded and Allen Michel. Summary: A common belief among practitioners and academics is that the increased EPS associated with a stock repurchase creates value for a firm’s shareholders. This belief is flawed. With the use of a numerical example and an analysis of ExxonMobil’s recent stock repurchases, this article demonstrates the magnitude of the distortion that arises from using EPS to make such repurchase decisions.
• "Saving Social Security: A Better Approach" (November/December) by Thomas K. Philips and Arun Muralidhar. Summary: This article argues that defined-benefit plans, such as the U.S. Social Security system, are fundamentally superior to defined-contribution plans and that the Social Security crisis is largely a crisis of demographics and funding. Social Security’s assets should be invested in a single portfolio that holds both stocks and bonds, and its risky return should be swapped for a fixed return to enable the provision of a DB. This proposal inexpensively affords insurance against a market decline and allows pensions of any kind to be made portable.

 

The Best Perspectives Award, which recognizes the timeliest and most thought-provoking opinion article, was presented to John C. Bogle, founder and former chief executive of the Vanguard Group and president of Vanguard’s Bogle Financial Markets Research Center, for his article "Black Monday and Black Swans" (March/April). The author writes that investors need to be aware that rare events with an extreme impact that, afterwards, we think we could have predicted − in short, black swans − happen in the markets. Those who are trying to measure risk in the financial markets need to carefully distinguish risk, with its probabilities, from uncertainty, which cannot be measured. Bogle argues that investors have become increasingly vulnerable to black swans because the financial economy has come to play an ever-larger role in productive economy.

 

Also, "The Market for Dividends and Related Investment Strategies" received the Graham and Dodd Readers Choice Award. This article, which appeared in the May/June 2008 issue, was written by Richard Manley, managing director at Goldman Sachs International in London, and Christian Mueller-Glissmann, an associate at Goldman Sachs International in London.

During 2009, all of the award-winning articles can be accessed online at no cost.

 

About CFA Institute

CFA Institute is the global association for investment professionals. It administers the CFA and CIPM curriculum and exam programs worldwide; publishes research; conducts professional development programs; and sets voluntary, ethics-based professional and performance-reporting standards for the investment industry. CFA Institute has nearly 100,000 members, who include the world’s 87,000 CFA charterholders, as well as 136 affiliated professional societies in 57 countries and territories. More information may be found at www.cfainstitute.org.