ACTIVE &

PASSIVE
INVESTING
Jerome Kerviel’ s Case
Objectives
I. Active and Passive Investing
Definition
Characteristics of Active and Passive Investing
Pros and Cons
Comparative Analysis (Risk and Return, Strengths and
Weaknesses)
Balancing Strategies

II. Rational Investors vs. Irrational Investors

Traits and Characteristics
Analysis of how these traits affect investment strategies

III. Risk Appetite

IV. Case Study: Jerome Kerviel: The Rogue Trader
V. Recommendations
VI. Conclusion
II. Active vs Passive Investing
Active

Active investing is a form of investment strategy

characterized by the continuous engagement of
the investor in frequent purchasing and selling
activities. Active investors engage in the
acquisition of investments and maintain a
constant vigilance over their performance in
order to capitalize on favorable circumstances.

Characteristics of Active Investing

Fundamental Analysis
Market Timing
Portfolio Turnover
Manager Expertise
PASSIVE

Passive investing is a strategic approach aimed at long-term wealth accumulation by the

acquisition of assets that replicate stock market indexes, which are thereafter retained for
an extended duration. Diversification can mitigate risk as it involves investing in a
diversified portfolio of asset classes and industries, rather than relying just on particular
stocks.

Characteristics of Passive Investing

Low Portfolio Turnover
Index Tracking
Diversification
The Efficient Market Hypothesis (EMH)
Long-Term Investor Suitability
Active investing
PROS

Potential for Outperformance

Adaptability
Risk Management
Expertise

CONS

Higher costs
Market Timing Challenges
Tax Inefficiency
Passive Investing

PROS

Low costs
Diversification
Simplicity
Long-Term Perspective

CONS

Limited Potential for Outperformance

No Active Risk Management
Index Limitations
III. Comparative Analysis
EVALUATION OF RISK AND RETURN IN PASSIVE INVESTING

MARKET RISK MARKET

RETURNS

TRACKING ERROR DIVERSIFICATION

SECTOR CONCENTRATION LOW COSTS

EVALUATION OF RISK AND RETURN IN ACTIVE INVESTING

POTENTIAL FOR
MARKET RISK OUTPERFORMANCE

MANAGERIAL RISK ADAPTABILITY

CONCENTRATION RISK
 IV.Balancing Strategies

A. Incorporating passive elements into active strategies

- A Hybrid Approach

- It refers to the use of both passive and active investment

approaches within a single investment strategy to create a well-
rounded and potentially more diversified portfolio.
 IV.Balancing Strategies
(continuation)
B. Mitigating risks associated with passive investing
Strategies to mitigate risks associated with passive investing:

Diversification: Risk Spread

To reduce concentration risk

Regular Rebalancing: Maintain Asset Allocation

To ensure that the asset allocation aligns with the long-term investment strategy.

Risk Monitoring: Monitor Market Risks

Stay informed about market conditions and potential risks.

Manage Liquidity Risk: Consider Trading Costs Assess the liquidity of the
underlying securities in the index.

Invest in Quality ETFs: Choose Reputable Funds

Look for ETFs with low tracking error and minimal bid-ask spreads.
 IV.Balancing Strategies
(continuation)
C. Finding a personalized balance based on investor goals

Assess Risk Tolerance: Risk Seeking or Risk Averse

Consider Time Horizon: Short-term or Long term
Diversify Strategically: Spread investments
Asset Allocation: Deciding what percentage
Stay Informed: Economic and market developments
Seek Professional Advice: Consulting with a financial advisor
Understand Investment Products: Choose products that suit your goals
and risk preferences
 V. Rational Investors vs. Irrational Investors
Characteristics of Rational Investors:
Objective Analysis: Rational investors Rational expectation: Rational investors
make investment decisions based on have realistic expectations about the
logical and objective analysis. returns they can achieve in the market.
They do not fall prey to unrealistic
Long-term perspective: Rational
promises or get-rich-quick schemes.
investors have a focus on the long term
and aim to build wealth steadily over
time.
Patience
Discipline

Diversification: Rational investors

understand the benefits of
diversification in managing risk.
V. Rational Investors vs. Irrational Investors

Characteristics of Irrational Investors:

Emotional decision-making: Irrational investors are
driven by emotions rather than logic when making
investment decisions.
Herd Mentality - follow the crowd
Fear and Greed

Cognitive biases:
Overconfidence Bias - overestimate their abilities
Availability Bias - readily available information
Loss Aversion - avoid losses over achieving
equivalent gains. “Disposition Effect”

Short-Term Focus: Irrational investors may have a

short-term focus and be overly influenced by recent
market trends or performance.
 V. Rational Investors vs. Irrational Investors

Analysis of how these traits affect investment strategies

Rational Investors: Irrational Investors:
Rational investors tend to adopt a Irrational investors, , may engage in
disciplined, long-term investment short-term, speculative trading,
approach. They focus on driven by emotions and influenced by
fundamental analysis, diversification, market trends.
and risk management.
Volatility
Stability and Consistency Herd Behavior Impact
Adaptability
 VI. Risk Appetite
(Risk Aversion, Risk Neutral, Risk Seeking)

RISK AVERSION RISK NEUTRAL RISK SEEKING

 Case study

Jerome KERVIEL:

tHE ROGUE TRADER

JEROME KERVIEL:
ROGUE TRADER

Who is Jerome
Kerviel?
Born: January 11,
1977
Former French
Trader at Societe
Generale, a major
French
Multinational
bank
Notorious as
being one of the
most significant
rogue trader
 A. Jerome Kerviel: The Rogue Trader

2 3 4 5 6

Why did Jerome Kerviel How did Jerome Kerviel

What is Societe When and Where Engage in Unauthorized Consequences
Execute the
Generale? did the Rogue Trading?
Unauthorized Trades? Losses of approx.
Trading Scandal Unauthorized €4.9 billion (7.1B
One of the oldest Attempt to conceal
Occur? speculative
losses resulting from usd) in January
and largest trading
January 2008 speculative trades 2008
financial Exceeded trading
Led to Massive Unauthorized and limits
One of the
Institutions in
Financial losses highly risky trading Fabricated Hedges largest trading
France.
strategies to offset losses losses in the
Established in
Societe False Hedging Engaged in history
1864
Generale’s positions to offset complex Increased
Universal Bank the risks associated
Trading office in transactions scrutiny of risk
Global presence with his
Paris France Knowledge of management
unauthorized trades Societe Generale’s
Delta One equity practices
Creating losing Risk Control
derivatives
trades Systems
division
 Investor's cognitive biases present

Overconfidence Loss Aversion Anchoring Bias Endowment Effect Confirmation Bias

Bias

Explanation: Explanation: Explanation: Explanation:

Explanation: Confirmation bias
Overconfidence bias Loss aversion is the Anchoring bias occurs The endowment effect involves favoring
refers to an individual's
tendency to prefer Accountingrely
when individuals is a cognitive bias that
tendency to information that confirms
avoiding losses over Records
too heavily on the first causes individuals to preexisting beliefs or
overestimate their own
abilities and believe they acquiring equivalent piece of information attribute greater worth decisions while ignoring
1 to 4
objects or
have more control over gains. encountered when or downplaying
events than they actually making decisions. possessions that they contradictory evidence.
do. already own.

Application: Application: Application: Application: Application:

Kerviel's engagement in Kerviel's actions, such as Kerviel may have Kerviel's evident Kerviel may have
unauthorized and highly hiding losses through anchored his trading emotional attachment selectively sought
risky trades, coupled with unauthorized trades, may information that
his attempts to
decisions on initial to his trading positions
reflect a strong aversion supported his risky trading
manipulate risk controls, to acknowledging and successes or perceived could have hindered
market trends, leading strategies, ignoring
suggests overconfidence realizing losses. his ability to promptly warning signs or contrary
in his trading skills and him to maintain his mitigate losses or evidence. This bias could
the belief that he could strategies even when understand the have contributed to his
navigate the market the market conditions inherent hazards continued engagement in
successfully. or risk factors changed. involved. high-risk activities.
C. Attributes of behavioral decision-making exhibited
(Rational and Irrational)

RATIONAL IRRATIONAL

Unauthorized
Financial Trading
Knowledge Risk-taking Behavior
Competence Concealing Trades
Overconfidence
Risk Lack of
Management Comunication
Failure to Admit
Profit Motive Mistakes
D. Advantages and Disadvantages of Being an Overconfident Investor

ADVANTAGES DISADVANTAGES

Excessive trading
Risk-Taker Under-
Confidence in diversification
Decision- Underestimating
Making risk
Persistence Ignoring
information
Positive Self-
Overestimation
Bias of Skill
E. How does this connect with Active Investing?
Jerome Kerviel's case is an intriguing example of the hazards and limitations of
active investing, particularly when individuals participate in restricted and high-
risk trading activities. Jerome Kerviel was a trader at the French bank Société
Générale, and his activities in 2008 resulted in one of the greatest trading losses
in history.

Here are some connections between Jerome Kerviel's case and active
investing:

Unauthorized Trading and Risk-Taking

Lack of Risk Management
Lack of Oversight and Controls
Regulatory Implications
Impact on Reputation
F. How does this connect with Passive Investing?
If Jerome Kerviel had pursued passive investment
strategy, the outcomes would be different:

1. Stability and lower risk

2. Lower Fees
3. Market Returns
4. Minimal involvement
5. Compliance with regulations
 G. How does this connect with Risk Aversion?

Jerome Kerviel’s investment strategy does not exhibit risk aversion

rather it exhibits risk seeking behavior.
Liquidity - low
Diversification - low
Risk tolerance - high

If Jerome Kerviel had been risk averse:

Liquidity - high
Diversification - high
Risk tolerance - low
 VIII. Case Study Conclusion
A. Recommendation for a balanced investment approach (Active and Passive)

ACTIVE INVESTORS PASSIVE INVESTORS HYBRID INVESTORS

Continuous monitoring
Compliance and Oversight Long-term perspective
Adaptability
Continuous education Risk tolerance assessment
Strategic Asset Allocation
Transparent communication Regular Portfolio Rebalancing
Risk Management
Performance monitoring
Investment Committee or
Risk Management
Advisor
Stay Informed
IX. Recommendations
A. Strategies for mitigating overconfidence in investment decisions
Diversifying Investments
Research and Due Diligence
Set Realistic Goals
Develop a Long term Investments
Consult with Financial Professionals

B. Importance of self-awareness in investment behavior

Risk Assessment
Emotional Intelligence
Regular Self-Reflection
Adaptability

C. Long-term considerations for individual investors

Time Horizon
Emergency Fund
Consistent Contributions
Risk Management
Review and Rebalance
Tax Efficiency
Balanced investment approach

Diversification and Adaptability

Active and Passive investments

Overconfidence
Final thoughts on the choice between active and
passive investing

FINANCIAL GOALS
RISK TOLERANCE
TIME COMMITMENT
INVESTMENT KNOWLEDGE
 Emphasizing the importance of understanding
behavioral aspects in investment

Diversifying investments, conducting thorough research, setting

realistic goals, and embracing long-term strategies are essential.

Jerome Kerviel's case underscores the importance of these

behavioral insights, emphasizing the need for prudence, self-
awareness, and a long-term perspective in navigating the
complexities of financial markets.
 Thank You
Presented by:

BERNARDO CAGUIOA CHUA FERNANDEZ PATRICIO PEÑAFIEL

References:
Ayoola. (2023, April 28). Passive Investing: What It Is and How It Works - NerdWallet. NerdWallet. Retrieved November 16,
2023, from https://www.nerdwallet.com/article/investing/passive-investing
Balmer, C. (2008, January 25). Rogue Societe Generale trader “a genius of fraud.” U.S.
https://www.reuters.com/article/idINIndia-31585220080125?
fbclid=IwAR16Y5p9gpwOj_o9elCV23cTyrDIAc62pXxyGgS87kXnt7fAuTwZQgnUksY
Battle. (2023, April 30). Risk Averse: What It Means, Investment Choices and Strategies. Investopedia. Retrieved
November 16, 2023, from https://www.investopedia.com/terms/r/riskaverse.asp
BBC News. (2014, September 8). Rogue trader Jerome Kerviel leaves French jail. BBC News.
https://www.bbc.com/news/world-europe-29106135?fbclid=IwAR0B7PIawxK9hujmYP5FBGv2AkxNqFJqjSJBddo3WoN-
mgWj-fSGaMuldYI
Catalano. (2022, May 4). What Is Risk Neutral? Definition, Reasons, and Vs. Risk Averse. Investopedia. Retrieved
November 16, 2023, from https://www.investopedia.com/terms/r/riskneutral.asp
Chen, J. (2022, June 26). Jerome Kerviel: History and Work with Derivatives. Investopedia.
https://www.investopedia.com/terms/j/jerome-kerveil.asp
Kerviel case - Société Générale. (2016, September 23). Société Générale.
https://www.societegenerale.com/en/news/newsroom/kerviel-case?
fbclid=IwAR3UL4UJdo3N04XoCV4KgOHX0ORFw1ZA15ElssUQWMbAx7cW-AcgtGoL2kQ#Q2
Pareto, C. (2022, July 30). Understanding investor behavior. Investopedia.
https://www.investopedia.com/articles/05/032905.asp
Scott. (2022, August 30). Active Investing: Overview, Benefits, Limitations. Investopedia. Retrieved November 16, 2023,
from https://www.investopedia.com/terms/a/activeinvesting.asp
Snelder, S. (2021, February 7). Are investors rational or irrational? https://www.linkedin.com/pulse/investors-rational-
irrational-simon-snelder/?fbclid=IwAR0FqiPGUdWYV4qJqBi93UkGyCpkrMRGYgyi7It28tTtknOg2ZMiJMEHZQ8
References:
Ayoola. (2023, April 28). Passive Investing: What It Is and How It Works - NerdWallet. NerdWallet. Retrieved November 16,
2023, from https://www.nerdwallet.com/article/investing/passive-investing
Balmer, C. (2008, January 25). Rogue Societe Generale trader “a genius of fraud.” U.S.
https://www.reuters.com/article/idINIndia-31585220080125?
fbclid=IwAR16Y5p9gpwOj_o9elCV23cTyrDIAc62pXxyGgS87kXnt7fAuTwZQgnUksY
Battle. (2023, April 30). Risk Averse: What It Means, Investment Choices and Strategies. Investopedia. Retrieved November
16, 2023, from https://www.investopedia.com/terms/r/riskaverse.asp
BBC News. (2014, September 8). Rogue trader Jerome Kerviel leaves French jail. BBC News.
https://www.bbc.com/news/world-europe-29106135?fbclid=IwAR0B7PIawxK9hujmYP5FBGv2AkxNqFJqjSJBddo3WoN-
mgWj-fSGaMuldYI
Catalano. (2022, May 4). What Is Risk Neutral? Definition, Reasons, and Vs. Risk Averse. Investopedia. Retrieved November
16, 2023, from https://www.investopedia.com/terms/r/riskneutral.asp
Chen, J. (2022, June 26). Jerome Kerviel: History and Work with Derivatives. Investopedia.
https://www.investopedia.com/terms/j/jerome-kerveil.asp
Kerviel case - Société Générale. (2016, September 23). Société Générale.
https://www.societegenerale.com/en/news/newsroom/kerviel-case?
fbclid=IwAR3UL4UJdo3N04XoCV4KgOHX0ORFw1ZA15ElssUQWMbAx7cW-AcgtGoL2kQ#Q2
Pareto, C. (2022, July 30). Understanding investor behavior. Investopedia.
https://www.investopedia.com/articles/05/032905.asp
Scott. (2022, August 30). Active Investing: Overview, Benefits, Limitations. Investopedia. Retrieved November 16, 2023,
from https://www.investopedia.com/terms/a/activeinvesting.asp
Snelder, S. (2021, February 7). Are investors rational or irrational? https://www.linkedin.com/pulse/investors-rational-
irrational-simon-snelder/?fbclid=IwAR0FqiPGUdWYV4qJqBi93UkGyCpkrMRGYgyi7It28tTtknOg2ZMiJMEHZQ8
Group Photo