3.5) Investment Analysis, Recommendations and Actions V (A): Diligence and Reasonable Basis Flashcards
What is standard 5?
V. Investment Analysis,
Recommendations and Actions
What is substandard 5(A)?
Diligence and Reasonable Basis
How should diligence and reasonable basis be displayed? (2)
- Must exercise diligence, independence, and thoroughness in analysing investments, making recommendations, and taking actions.
- Must have a reasonable and adequate basis (supported by appropriate research and investigation), for any investment analysis, recommendation, or action.
How is diligence and reasonable basis implemented for members?
Diligence, independence and objectivity in analysis, recommendation and research.
Reasonable basis for conclusions based on proper __________ and investigation.
research
Is secondary and 3rd party research acceptable?
Secondary and 3 rd party research is acceptable but must be assessed thoroughly.
How is group research and decision making implemented for members?
- Group research and decision making: if you are not in agreement, you may disassociate from the decision, but you do not have to if you believe that the rest of the group used independent and informed judgement.
Example 38: Imran is working in the Corporate Finance Division of an investment bank. He is working on a possible IPO for Zebra Mining, a platinum exploration miner. Imran discusses the company’s prospects with its Chief Geologist and determines that Zebra expects to find platinum ore grade of between 5 g and 15 g/tonne. On the roadshow to prospective IPO investors, Imran states that Zebra Mining is expecting to find ore grades averaging 10 g/tonne. Is Khan in compliance with Standard V(A)?
Solution: He is in breach of Standard V(A). He was given a min and max expected grade (a range), but has no basis for claiming an average expected grade of 10g/tonne (the midpoint of the range is not the same as the average).
Example 39: Milo is tasked with analysing Marine King, a listed boat building company. He visits the factory and is very impressed with operations and new boat designs. He also reads several reports from reputable research houses that say that the global specialised boat market is likely to grow at over 20% per annum over the next five years. Based on the above, Milo writes a research
report in which he predicts that Marine King’s earnings will grow significantly over the next year. Is Milo in compliance with Standard V(A)?
Solution: Milo has a reasonable basis for expecting the global boat market to grow significantly, but even if Marine King has brilliant and impressive
operations, this will not necessarily translate into “significant earnings growth”. Milo is in breach of Standard V(A).
Example 40: Yuvraj Singh is a junior equity analyst at Wood McKenzie (WM). He has just written a research report on Better than Meat, in which he, based on
extensive research, concludes that Better than Meat’s earnings will increase substantially over the next 5 years. However, two members of WM’s Equities Committee have extensive knowledge of Better than Meat, and after a debate the committee votes to make several changes to Singh’s report, and to change his “Strong buy” recommendation to a “Hold” recommendation. Is Singh or the committee in breach of Standard V(A)?
Solution: Neither Singh nor the committee is in contravention of Standard V(A). It is quite possible that two different and well informed views can exist on an
issue. In other words, very different and reasonable conclusions can sometimes be drawn based on the same factual evidence. However, Singh can ask for his name to be removed from the final report should he strongly disagree with the revised findings.
