Thursday, December 3, 2009

Dealing with breaks

A client recently asked about dealing with "breaks" in performance. First, what IS a break? We'd define it as a temporary loss of discretion over a client's assets, during which time no trading can be done. Breaks can be caused by changes in custodians as well as for other reasons. Another term for a "break" is a "gap." I opined on this topic a few years ago in our newsletter, regarding the calculation of returns (that is, can you link across gaps for returns). The client's question had to do with GIPS(R).

If you search the GIPS Q&A database you'll only find one item dealing with this topic, and it doesn't really address temporary breaks. I recall discussing this a few years back with a group and we couldn't arrive at any clear consensus. Some thought ANY break meant that performance stops, while others felt that there should be an assessment as to whether or not there would likely have been any trading during the break: if not, then what's the harm in linking across it?

I tend to be in the latter group's camp: that is, when one has a break, they should determine the likelihood of trading occurring. If, for example, the manager is very much a buy-and-hold manager, who trades infrequently, then a gap of even a few weeks might not cause a problem. However, if the manager trades almost daily, then even a short break would be problematic.

Ideally, the manager has other similar accounts that they can compare the account-with-the-break to, to determine if there truly was an absence of trading. This is where the verifier can come provide an additional degree of analysis.

It would be nice to see something formal regarding this topic, but for now there is little guidance. Hopefully mine won't conflict with anything that comes in an official capacity.


  1. Perhaps we do not have all the details from the summary provided, but an account could never have a gap in performance. If the account is open, even if there is no trading activity, its positions will change in value or there will be income and therefore, a return.
    If the reference to a gap refers to the account's membership in one or more composites, then the gap is appropriate. If it is the only account in the composite, then there will not be a return for the composite, otherwise, the composite return just will not include this account's contribution.
    The reference to a change in custodian causing a gap in performance is baffling. Changing a custodian should never cause such an event.

  2. Stephen Campisi, Intuitive Performance SolutionsDecember 5, 2009 at 1:31 PM

    Nancy Burges provides a concise and cogent analysis of the "issue" of gaps in performance. It seems to me that this is not really a legitimate issue, but more likely it is "much ado about nothing." Once again, it seems that hypothetical situations and odd exceptions are being used to establish the rules for how to handle the business of communicating performance accurately and fairly to prospects. Everyone who wants to opine about such one-off procedures should first demonstrate the business need and show that this is something that does occur in real life with enough frequency to make establishing an exceptional rule worthwhile.

    I think that another problem demonstrated here is the lack of focus on what question we are trying to answer and what use we will make of the information provided. We see mention of a lack of discretion being temporarily imposed on an account. That in itself is a rather odd situation; I've never encountered it, and I never recall anyone else mentioning it. If the question is how to assess the impact on the composite to which this account belongs, then Nancy's analysis covers this perfectly and completely. Simply stated, the portfolio is contained in a composite when the manager HAS discretion, and is removed while the manager DOES NOT HAVE discretion. After all, composites should only include accounts where the manager has full discretion, so that the performance record is a fair representation of the manager's skill. Seems that there is no real controversy here.

    If the question involves assessing the return on the individual portfolio, then "the return is the return." While it is true that the performance might have been different if the manager had not been denied discretion for a time, that fact does not change the return for the individual portfolio. If you want to know the impact of the client's decision to deny discretion, then that is a piece of additional INFORMATION that would have to be developed; it is distinct from the DATA regarding the portfolio's return. From the standpoint of communicating TO THE CLIENT who owns the portfolio, there is no problem with developing your own solution. No standard is needed, and in this context this is not a GIPS issue at all. After all, GIPS does not apply to existing clients, but rather it only applies to prospects.

    We will ignore for a moment the fiduciary issue that we owe a duty of loyalty to EXISTING clients, so that standards for presenting performance should be developed for clients FIRST, rather than being left unaddressed while we belabor arcane issues regarding how to support the firm's marketing department. Frankly, anyone with a first-hand relationship with clients would understand this and wonder why those clients whose fees pay our salaries are given such poor treatment. Perhaps THAT is a subject more worthy of discussion.

  3. Like it or not, gaps CAN occur.

    At the portfolio level: if a firm switches custodians there may be a period of time when the manager is asked not to do any trading; thus, they've lost temporary discretion over the account.

    At the composite level: when the last account in a strategy leaves or is temporarily removed from the composite (e.g., because the account fell below the composite's minimum or because of temporary loss of discretion, or because the last account left and some time goes by before a new account is added).

    At the asset class level: because a balanced manager decides to reduce his/her exposure to a particular asset class (or sector or some other sub-portfolio grouping)to zero for some period of time.

    Thus, we need rules or at least an indication in the firm's policies regarding how they'd handle such situations.


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