Wednesday, April 20, 2011

Pension funds and GIPS

Of late there's been some discussion occurring regarding pension funds (and similar entities, such as endowments, foundations, and even central banks; i.e., "asset owners") becoming compliant with the Global Investment Performance Standards (GIPS®). I believe that I was the first person "on record" supporting such a step, as I commented on this topic in response to an article that harshly criticized the idea, in Pensions & Investments a few years ago (I have the letter somewhere if anyone is interested in seeing it).

I still believe that the idea has merit, though it's important to understand why such an organization would (or perhaps should) seek compliance and what their compliance would mean.

One cannot lose sight of the reason we have the standards in the first place: to provide an ethical framework for asset managers to provide their past performance to prospective clients. This clearly doesn't apply to pension funds. So why would anyone want to go through the time-consuming and costly exercise to achieve compliance if they don't market their services?

One reason is that it helps the firm get their shop in order. It requires the establishment of policies and procedures, and along with that controls. It forces individuals to think about how they organize themselves, what policies make sense, etc.

Would the plan have only one composite or multiple?

The plan might only have one portfolio,  per se, that is broken up across dozens or even hundreds of smaller subportfolios, each geared towards a specific market segment. There can be justification to create a single composite (for the entire portfolio) or multiple composites. If you go with multiple, where each aligns with a subportfolio, what do the numbers represent? The performance of the manager. Therefore, if an external manager is being used, it will be their performance; if it's an internal manager, it will be his or her performance. But not the plan's. And if the plan is set up as a single composite, then the return represents the performance of all the managers in aggregate. But again, not the plan's, because the plan's performance can only be measured in one way: using money-weighting.

The only concern that I have with pension funds, etc. embracing the GIPS standards and becoming compliant is that they will interpret them as being the most appropriate way to represent how they're doing, but this is about as far from the truth as one can get; it represents how their managers are doing. If anyone wants to know how the plan itself is doing, GIPS won't tell them. The Standards don't speak to this.

I have already had discussions on this topic with one pension fund and a central bank, both of whom claim compliance. I cheer them on for wanting to comply, but that is not sufficient as it fails to tell them what is most important: how THEY are doing. Yes, it's important to monitor the managers, but this can be done without the GIPS standards, and has been for many decades. "How are we (the plan) doing?" is a different question, and requires a different way of thinking and calculating returns.

Is a new standard needed?

May I be so bold as to suggest that this part of the market (pension funds, endowments, etc.) would be better served with a standard that is geared specifically to them. That would be preferable. With but one standard, that is the only place one looks for answers. But, it shouldn't be. Perhaps moving to GIPS is a good "first step" in the process; and hopefully at some point in the future we will see a standard that speaks to this market, providing a framework that will result in returns that answer the right questions.

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