I'm still a bit befuddled by the GIPS(R) error correction guidance, which goes into effect in three weeks. I guess I'm relieved that I'm not alone, but I'd feel a lot better if it was crystal clear. The guidance provides for four levels of errors:- Non-material: ["Take no action"] error is so minor that no action is needed.
- Non-material: ["Correct the presentation with no disclosure of the change"] you'll (a) correct the error, but (b) not document it (i.e., disclose it in your GIPS presentation) nor (c) not tell anyone
- Non-material: ["Correct the compliant presentation with disclosure of the change and no distribution of the corrected presentation"] you'll (a) correct the error, (b) document it, but (c) not tell anyone
- Material: ["Correct the presentation with disclosure of the change and make every reasonable effort to provide a corrected presentation to all prospective clients and other parties that received the erroneous presentation"] you'll (a) correct it, (b) document it, and (c) tell anyone who got a copy of the previously erroneous copy that an error was corrected.
At last week's Performance Measurement Forum meeting in Orlando we discussed this issue at some length. It appears that you don't have to have rules for all four cases. My advice regarding the four levels (by level):
- Identify the kinds of errors that you'd not bother correcting (immediately spelling and grammatical errors come to mind; you get to decide what else)
- Identify the level that you feel needs to be fixed but is so minor that you don't need to tell anyone (an example here might be a correction that increases your return).
- I don't see a need for this level. I base this on the Q&A, which basically says you don't have to document the error unless you can't determine if you gave a prospect a copy of the prior version. If this is the sole condition, since this level doesn't require redistribution, why would you document it?
- I'd establish the rules that would cause this to happen, but ensure that I've got records of who gets copies of what presentations, so that if a material error IS discovered, I can get them a copy of the revised presentation, if appropriate.
I'm thinking that perhaps a relative rule might be workable. For example, a 5% error of the return itself (example: if the return was 2% and has been corrected to 1.89%, that's 11 bps, which is 11/200 = 5.5%, so it's material). Perhaps at returns > 10% I'd say the level is 10% (again, of the return itself; example: if my return was 12% but corrected to 10.78%, that's a 122 bp drop, and 122/1200 = 10.17%, so it's material).
This approach might be better than simply saying "100 bps" or "50 bps." I'm not saying to adopt these thresholds ... you decide what works for you. But perhaps this approach would provide the necessary flexibility so that the rules will make sense? Your thoughts are, as always, invited.
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ReplyDeleteDave Spaulding's guidance seems like a reasonable balance between exercising judgment while maintaining the spirit of the principles and rules around a fair representation of performance. No matter how many rules one makes, there is always a need to exercise judgment. And there will always be rascals who find a way to sidestep the rules. So, we also need judgment and discernment in the validation and interpretation of performance presentations.
ReplyDeleteAs someone who has followed the progression of the performance standards over the past two decades, I see a disturbing trend towards meaningless complexity without regard for relevance, materiality or cost. The GIPS are approaching the complexity and length of the tax code, without any balancing confidence in the results. Just look at the recent furor over verified firms that were either not in compliance or were outright fraudulent in their performance presentations. Does anyone still remember the illustration that was used when the standards were being introduced to demonstrate the need for performance standards? The firm in question had cherry picked an account, cherry picked the time period, used model performance, etc. I doubt that anyone today would consider such performance results credible and representative of a manager’s skill.
Clearly, the prevention of such potential manipulation could be accomplished with a single paragraph regarding the calculation of return. Along with reasonable guidance around composite construction we can eliminate the potential for all of the truly material manipulations and errors and have greater assurance that we are presenting performance that is a "fair representation and full disclosure of all material facts." And to the question: “What is material?” this is already settled. Just check the CFA Institute’s ethics guidance, which states that materiality is determined by whether the disclosure of this information would have an impact on an investor’s decision.
So, the calculation and interpretation of performance will always require judgment on the part of the investment managers, performance staff and clients. No amount of complexity will ever eliminate the need for exercising judgment. We see performance standards that are becoming more complex and costly without improving results. It may be that all this complexity will actually erode results. Additional complexity and cost must first be justified by a proportional increase in quality and reliability of results. I'll admit that all this complexity and detail is well intentioned. I also recall the saying that "the road to hell is paved with good intentions."