Someone suggested that GIPS(R) (Global Investment Performance Standards) verifiers should have the CIPM; this suggestion was trumped with the notion that verifiers should be CPAs. A few others agreed with this suggestion. And, you will probably guess that all who did support this idea happen to have CPAs ... a rather self-serving suggestion. A colleague of mine from Canada (aka, the 51st state) who happens to be a CA (Chartered Accountant) has made a similar suggestion; one that obviously I take exception to.
I know that we don't want to get into a debate on the practices of CPA firms and discuss some of the irregularities that have surfaced over the years. And I also don't want to discuss how a verification is quite different from a financial audit; granted, there are some similarities, but to suggest that one needs to have gone through audit training is a bit ludicrous.
Our firm has replaced several CPA firms for clients; in every case, the prior firm had made numerous errors in their reviews. One in particular, by a very well known accounting firm, had been verifying the client for ten years, and every year giving them a verification report, even though their client didn't even have GIPS presentations for their composites! Plus, they were missing several composites. So much for the CPA designation.
I find it offensive that CPAs would make such a suggestion. The question that was posed dealt with the CIPM. While I fully support the CIPM program I wouldn't want to see possessing it be mandatory for a verifier. I would, however, encourage verifiers to obtain the CIPM as it provides them with an extensive knowledge of performance measurement; granted, not accounting, but accounting isn't part of performance measurement.
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I agree with you one thousand percent. Hey wait a minute: you can't agree more than one hundred percent, right? (Says the accountant.) That's an example (although a trite one) of the difference between investments and accounting - this CIPM/GIPS compliance thing is a matter of perspective that comes from in-depth subject matter expertise, which comes from first hand experience with investments, not accounting.
ReplyDeleteThe significant problems that GIPS compliance and verification should identify and correct are rarely matters of accounting or mathematics. Rather, the errors that matter are sourced in the investment process that is supposed to be fairly measured and presented by the performance record. So, good verification is knowing what to look for, what to be skeptical about and having the gumption and the reasonable basis for "pushing back" on the investment client to validate the claims they make, and to justify claims that don't seem dubious. To do these things you need an understanding of the investment process, not an accounting credential.
Performance is an INVESTMENT function, not an ACCOUNTING function. We are not "advancing the ball" in getting the respect that performance deserves when we make the only recognized performance certification look more like accounting than investments. How about NOT acting like one's own worst enemy?
Steve, thanks for your excellent insights! Some great points.
ReplyDeleteHi Dave,
ReplyDeleteI disagree in part with your above comments. I don’t think Verifications and composite examinations are that different, conceptually, than financial statement audits and requiring audit-type training can be helpful.
Let's suppose we have two documents. One is a mutual fund financial statement for the XYZ mutual fund. The other is a composite performance presentation for the XYZ composite, which happens to have only one account at the moment - the XYZ mutual fund.
Are these similar? Are they really that different? Well, let's look at what the mutual fund's financial statement will contain. It will have a bunch of numbers and disclosures. The numbers on the income statement (P/L) will portray the performance of the fund in dollars. The balance sheet will give an indication of what's in the mutual fund and give a sense of size. The financial highlights will provide the performance of the fund in percentages. And the notes will provide information explaining the nature of the fund, how the numbers were gathered together, and so forth.
The composite performance presentation will have a bunch of numbers that also provide information on how the composite (in this case, just the fund) performed. In fact, the return numbers on the composite performance presentation should be the same as those on the mutual fund's financial statement financial highlights. And the composite performance presentation will also have total assets, which should be the same as the net assets on the mutual fund's financial statements. The composite performance presentation will also have notes explaining nature of the composite, how the numbers were gathered together, and so forth.
Conceptually, these documents seem very similar. Both present performance, asset size, and disclosures explaining key policies and how the numbers were put together.
As for errors - we've replace both CPA and non-CPA firms and found mistakes made by prior firms. Both types of firms make mistakes. So we agree that neither designation is fool proof.
In summary, I believe that, although we probably shouldn’t force people to become either CIPMs or CPAs, there is value to verifiers in learning audit-type topics such as risk assessment techniques, designing procedures to address risk, sampling methodology, sampling evaluation - projecting to populations, control testing methodologies, quality control procedures, and so forth.
-Tom
What happened to Tom's post? By the way, I AM SHOUTING.
ReplyDelete-Investment Performance Dork
Tom,
ReplyDeleteWhile examinations and financial audits no doubt have a lot in common, I believe that verifications are less so, though having such training as is common in the world of CPAs should, no doubt, equip a verifier to understand the procedures to follow. I'm unaware that CPAs learn about investment performance, however; and I believe that this knowledge is critically important, as well as concepts about how firms manage, portfolio accounting, etc.
If the AIPCA were to offer training, I would be interested in taking it as it's highly possible I would learn something; but, I would oppose any requirement for such training to occur.
Regarding examinations, we've been outspoken in our general opposition to having them done because we believe they have little value, in general. Research has shown that very few RFPs ask about such tests and the costs to firms can be quite high.
GIPS addresses aspects of the procedures verifies are to take; this can be learned. And I'm sure each firm approaches their work differently. The distinction should be the knowledge of GIPS and the thoroughness in which the work is done. As you know, some verifiers believe they can do an adequate job remotely; we don't believe this.
In no way are my views to be construed as not seeing value in having attained the CPA designation. I simply don't believe that it's a requirement for a verifier. The letters, be they CFA, CPA, or CIPM, don't guarantee a successful review, as I'm sure you'll agree. Each has value and should be respected.
In the spirit of transparency, please post your policy for posting or editing responses. Tom's comment and your response have been deleted and now re-posted, but edited.
ReplyDeleteNote: Tom's earlier post (and my response) were removed after Tom and I chatted. We agreed to resubmit our comments. Sorry for any confusion.
ReplyDeleteDave
Should not you actually have both the CPA and CIPM qualifications before making such judgements?
ReplyDeleteI was asked to post my policy on posting and editing comments. I generally post whatever is sent to me. Today, after I posted Tom's comment and followed with a response, I reached out and spoke with Tom. He volunteered to rework his response and I did the same, so I decided to pull the earlier responses. Had I reached out to Tom before posting his response, no one would have been the wiser. That would probably have been the better course of action. To my recollection, this is the first time I've withdrawn comments and expect that in the future this will be done on a case-by-case basis, depending on the circumstances. Therefore, my policy of generally posting whatever is sent will continue.
ReplyDeleteInteresting and fair point, but I believe that one doesn't need either designation to make such a judgment. Neither is required for one to become a verifier and the CIPM has only been in existence for a short time. I think people should be free to comment and offer their views regardless of the designations they've achieved.
ReplyDeleteHi Dave,
ReplyDeleteI have to disagree with you again. From an investor’s perspective, I believe that composite performance examinations are significantly more valuable than verifications.
Let’s suppose that I’m an institutional investor looking to put a $100 million allocation in ABC investment management firm’s large cap equity product. Here’s what I (as an institutional investor) am going to care about the most (from a GIPS perspective) before I plop my money down. I want to know that the returns I’m being shown for the specific composite I’m interested in are accurate. A composite performance examination get’s me there. I don’t care if the firm’s balanced composite is correct, or if the wrap performance related policies are in good order. I care about the accuracy of the numbers and disclosures that directly relate to the investment I’m considering.
Verification is not enough to get me comfortable on a specific composite performance presentation for me to have enough confidence to invest. A manager can have controls that are designed to get to compliant presentations, and still have screwed up a presentation. A verification is not aimed at providing any form of assurance on any specific composite performance presentation, which is exactly what I, as an institutional investor, would be looking for.
Let’s compare again to mutual funds. Suppose ABC investment management firm has a large cap equity mutual fund. Let’s further assume that the mutual fund is custodied at a well known, large, and respected custodian / administrator. The custodian has a SAS70 report which provides an opinion on the controls, but not on any specific numbers (such as the numbers on the financial statement of the large cap equity mutual). From an investor’s stand-point, do you think it’s wise to only rely on the SAS70, and not ask for audited statements of the large cap equity mutual fund? I would not just rely on the SAS70 without getting audited statements for the mutual fund because there's too many things that can go wrong along the way. Well designed controls don’t automatically equate to accurate financial statements.
As a side comment, I’m up to my eyeballs right now in mutual fund audits. Almost all of them are using large, well-known, custodians that have SAS70 control reports. And on several of them, we have adjustments that need to be made to the financial statements because errors happen. Well designed controls help, but they are not enough. That’s why funds get audited. As an investor, when I’m putting my money in a fund, I demand audited financial statements, or I would not invest – regardless of SAS70s or other control reports that may be available. There is no substitute for an audit.
It’s no different for composite performance presentations. A verification is definitely a good sign, but it’s not a substitute for an examined composite performance presentation. Well designed controls don’t automatically equate to accurate composite performance presentations.
-Tom
PS – I wonder how many other topics we can disagree on today!
PPS for Anonymous - The spirit of my original comments remains unchanged in the version Dave has on this blog. I simply toned down the language a notch.
Tom, Tom, Tom. We're making a habit of this (as you so accurately point out in your closing comments). I should get you to speak with Chuck Tschampion, former vice chair of the AIMR-PPS Implementation Committee on this (or, read his interview in the journal!).
ReplyDeleteExaminations, as you imply, check to make sure the numbers are right. Great! But this also suggests that there's possibly some chicanery going on. Most managers are honest individuals (at least all of our verification clients are). They don't need me to check their books to tell them if they've been cooked! They would surely know themselves if they have been. As part of the verification, we check to ensure the returns are calculated correctly; while we don't cross-check the portfolio returns with the custody statements, I believe that the SEC would in fact say that this isn't necessary, since (their dirty little secret) they don't require firms to have independently produced records! (this being said, if the manager receives custodial statements and trade tickets, they're required to maintain them).
You said to suggest that YOU are an institutional investor; okay, you are! So, when you're doing your search, ask for examinations on the composite(s) you're interested in. The reality is that, by far, most investors do NOT ask for examinations! And so, why make your client pay for something that no one is asking for?
Tom, in every case, when we've taken over a client from another firm that had previously had examinations done, they've stopped doing them! We simply ask: "why do you have examinations done?" And their answer is often "well, we don't actually know why; we just have always had them done" or "well, because our verifier recommended that we have them done." We then ask "well, if it's not benefiting you from a marketing perspective, why spend the money?
I don't believe it's appropriate to take money from a client if I don't see the value in it; and to me, the value has to be from a marketing perspective. You obviously see other value that I don't! And so, we disagree.
There's still time for us to disagree some more!
Dave, Dave, Dave.
ReplyDeleteI'm not implying that we need examinations because managers are dishonest and are employing chicanery. I'm stating that errors happen, even when controls are in place. As for crossing to custodial records, I think it's important to do so.
I don't agree with you're assertion that the SEC doesn't think comparing manager records to custodial records is necessary. The SEC recently released IA-2968 and IA-2969 which increase custody related requirements for investment managers and require more surprise custody audits where CPAs compare records of the manager to records of the custodian.
How would you like to be an investor looking to invest with either of the firms that were identified in the March 2009 Fund Fire articles. These managers were allegely committing fraud, which was not picked up because the verifier wasn't crossing manager records to custodial records. An integral part of our testing is crossing manager records to custodial records.
Our CPA training causes us to neither believe that the manager is doings things right, or doing things wrong, but to maintain professional skeptism throughout the engagement. Our CPA training also has taught us to seek external 3rd party evidence first, when testing something - rather than relying on internally generated data. That's not to say that internally generated data can't be used, but it is lower on the priority list.
Getting back to another one of your points, I think more investors are asking if composites have been examined than you might think. But the deeper issue here is, if they're not - they should be. Here's one topic that I think you and I would agree upon - many institutional investors don't understand GIPS well, and could benefit from learning a bit more.
I also believe that the concepts of verification and composite examination are not entirely clear to many investors, which is why we responded to the GIPS 2010 exposure draft asking that language be added to clearly explain what they are. You'll note this is the first point we raise in our letter.
http://www.gipsstandards.org/news/releases/2009/pdf/kreischer_miller_comment104.pdf
Alright, I gotta get back to work. Have a nice evening!
Tom
Tom, as for examinations and the frequency of asking in RFPs, a colleague checked 2,000 RFPs and only found one that made such a request. Perhaps this is a bit of an anomaly, but others have also said it's a rarity. You're comfortable doing them and your clients are okay paying you, fine! We're not and neither are ours. Managers are fully capable of checking their own math; they don't need to pay tens of thousands of dollars for someone else to. But, if they want to, fine. We always tell our clients that if they want an examination, we'll do it. We are a for-profit organization.
ReplyDeleteOriginally, examinations weren't even to be included in GIPS...I'm one who wishes they hadn't been. I know I'm in the minority, but that's my view.