What is Standard V?
Investment Analysis, Recommendations, and Action
What are the subsections of Standard V?
There are three subsections:
V-A: Diligence and Reasonable Basis
V-B: Communication with Clients and Prospective Clients
V-C: Record Retention
What is Standard V-A?
“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 any investment analysis, recommendation or action.
How can you comply with V-A?
1: -The Security
2: -The Portfolio
3: -The Records - The importance of maintaining a complete track record of reasons for investment decisions is reinforced by the need to make this requirement a separate Standard in the revised list that becomes effective in 2006 (please refer to Standard V-C). Files can establish a paper trail and help protect the manager from accusations that a certain security (should it turn out badly) was not bought with an adequate basis and rationale.
1:-The Security
- Each research process is likely to be unique, but whatever the particular basis for a specific recommendation might be, it should generally be consistently applied to the company’s history of recommendations. Many research shops employ a general template of information that is always to be included with a recommendation (e.g. a summary of specific business factors, important financial statistics and ratios) to help guide compliance and ensure that the analyst employs a consistently diligent effort.
2:-The Portfolio
Is this security (and its expected level of risk) appropriate for all portfolios, or is it too risky for some, or perhaps not aggressive enough for others? CFA charterholders and candidates are obligated to examine the needs and circumstances of the clients on an ongoing basis, not just when the account opens. Portfolio theory emphasizes the need to diversify as a tool for reducing risk; thus any approach that concentrates a portfolio in just a couple of investments may not be in compliance.
3:-The Records
The importance of maintaining a complete track record of reasons for investment decisions is reinforced by the need to make this requirement a separate Standard in the revised list that becomes effective in 2006 (please refer to Standard V-C). Files can establish a paper trail and help protect the manager from accusations that a certain security (should it turn out badly) was not bought with an adequate basis and rationale.
What is Standard V-B?
“Communication with Client and Prospective Clients”
Members and Candidates must:
Standard V-B: Communication with Clients and Prospective Clients
Members and Candidates must:
- Disclose to clients and prospective clients the basic format and general principles of the investment processes used to analyze investments, select securities and construct portfolios, and must promptly disclose any changes that might materially affect those processes.
- Use reasonable judgment in identifying which factors are important to their investment analyses, recommendations or actions, and include those factors in communications with clients and prospective clients.
- Distinguish between fact and opinion in the presentation of investment analysis and recommendations.
What is a “research report” as it applies to V-B?
The term “research report”, as it applies to this Standard, is very broad and covers much more than the traditional research reports as defined above.
For example, any form of communication can potentially apply, including (but not limited to):
- face-to-face recommendation
- speech or panel discussion
- telephone conversation
- TV appearance
- internet webcast or blog
What are some questions to consider when addressing a hypotethical situation on the exam relating to V-B?
Are opinions and projections separated from factual information?
In the gathering of information on a company, has this information been reviewed for accuracy by a representative of that company?
Has a newsletter or watch list omitted too much relevant information?
Has a research report adequately outlined the risk factors, or failed to analyze less optimistic scenarios?
Does a research report omit the analyst’s real reason for making a specific recommendation?
How can you comply with V-B?
Each subsection of this Standard relates to a specific goal that needs to be addressed when preparing research reports for public distribution:
1: - Using Reasonable Judgment on Factors to Include/Exclude
2: -Distinguishing between Facts and Opinions
3: -Indicate Basic Characteristics - This goal in particular provides some indication of the degree of risk that an investor will assume. A star system (1 through 5 stars, with 5 being safest) or a letter grade (“A” being the safest) will accomplish the task in the least amount of space. Other summary reports specify low, medium, high or very high risk. These labels are often an invaluable guide to determine whether the research should be used.
1:- Using Reasonable Judgment on Factors to Include/Exclude
- This procedure is in many ways the most subjective requirement within this Standard, as it is largely a function of an analyst’s experience in preparing research reports and understanding what factors are of greatest importance to readers and users of the research. A specific checklist is not relevant to a standard of conduct where each case needs to be individually evaluated. As with the other Standards guiding the investment process, one would start by archiving all records relating to the report, so that conclusions can be explained and additional information can be supplied upon request.
2:-Distinguishing between Facts and Opinions
This goal avoids the most obvious violations of the Standard, but given that most reports use facts as the basis for investment opinions (i.e. all reports will have both), it’s important to make such distinctions in as clear a manner as possible. Moreover, any data presented as fact must be properly scrutinized for reliability and accuracy. Financial databases that cover hundreds of data points for thousands of companies may produce misleading data - for example, they may show a negative price-to-earnings (P/E) ratio on a cyclical company, which then draws down the average P/E of a portfolio. In such a case, an analyst must ensure that the data presented is processed in a manner that provides for such situations.
3:-Indicate Basic Characteristics
This goal in particular provides some indication of the degree of risk that an investor will assume. A star system (1 through 5 stars, with 5 being safest) or a letter grade (“A” being the safest) will accomplish the task in the least amount of space. Other summary reports specify low, medium, high or very high risk. These labels are often an invaluable guide to determine whether the research should be used.
