A
letter I wrote appears in the most recent issue (May 30) of
Pensions & Investments, that's in response to a letter Jonathan Boersma wrote (April 18), which was in response to one I had written (February 21), in response to an earlier article (December 27, 2010), regarding pension funds and risk. I should mention that Steve Campisi also wrote a letter (May 16) in response to Jonathan's. Much of this dialogue deals with two primary topics or issues:
- Pension Funds (and other similar bodies) and their compliance with the Global Investment Performance Standards (GIPS(R))
- The use of money-, versus (or perhaps more accurately, in addition to) time-weighted returns.
Steve and I (along with a third colleague) are working on an article where we address the former in great detail. There are benefits to these institutions complying, though there are potential risks as well, given that the standards are intended for asset managers who sell their services to others, including these very plan sponsors (I use this term in a broader way then many, as I think it can apply to not only pension funds, but also endowments and foundations, as well as other similar organizations).
As for the second point, the argument is, perhaps to some, tiresome, while to others one that needs continuous, or at least frequent, attention (see, for example, the
Linkedin group dedicated to this topic). I won't repeat myself on this subject here, though this doesn't mean that I am one who has grown tiresome of the topic and its salient arguments.
Please take the time to review Jonathan's, Steve's, and my letters on this topic, as it's an important one, which perhaps needs greater attention and consideration.
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I think a thoughtful and thorough discussion on the use of time weighted vs money-weighted returns is really needed. That may sound like an odd statement, since we have had this topic discussed at many conferences, and there has been much written about this. So, why another discussion? The answer is simple: the conversations so far have been too narrowly focused, too detailed and frankly too partisan and opinionated. Before getting into the details and the mathematics, we need to identify the questions we are trying to answer. Unfortunately, the participants in this TWR vs MWR discussion have often approached the discussion from a single viewpoint, as though performance serves only a single purpose. In the end, a "debate" on this topic ends up sounding like a chorus of rather shrill harpies all vying for the spotlight.
ReplyDeleteIt would help if we first identify the use of TWR to evaluate the merits of a single product relative to its appropriate benchmark. There is little disagreement that a time weighted return is the right performance measure, since control of external cashflows distort the return, making it unrepresentative of the product manager's expertise. In this instance, control of the cashflows is an appropriate consideration.
However, this is not the only use of performance. Sometimes the appropriate question is this: "What was the return on the overall portfolio?" This is especially important in terms of a multi-asset class portfolio such as an endowment, foundation, pension plan or personal portfolio. And, this is crucial in determining whether the portfolio return was adequate in meeting the financial goals, which often involve the adequacy of withdrawals from the portfolio to fund those financial goals. Clearly, one cannot ignore the success of the portfolio in terms of this "spending" when calculating its return. And we cannot ignore whether the portfolio maintained its principal value so that it can support future payments from the portfolio. Which performance measure considers the client's financial goals and determines the return on the portfolio (as opposed to the return on the individual product managers?) It's the money weighted return. Different question, different return calculation.
We have all seen the benefit of comparing the MWR vs the TWR for individual investors' total portfolios. Often, the MWR is much lower than the TWR. This has shown the harmful effects of investors "chasing performance" by investing in sectors and/or product managers that recently performed well ("buying high") and exiting sectors and managers that recently underperformed ("selling low.")
So, we actually have some agreement on the use of MWR and TWR - at least in terms of "who controls the cashflows." The next consideration is that MWR is also appropriate even when the external cashflows are not controlled by the investor. This is the case for pensions, endowments, foundations and individuals (isn't that everyone?) The issue is not "who controls the cashflows" but rather that "the cashflows fund the financial goals." So, if we are to calculate a return that expresses the ability of the portfolio to fund the client's financial goals, the appropriate measure is the money weighted return.
What does all this mean for GIPS? I suggest that GIPS be expanded in its scope so that it serves not only PROSPECTIVE CLIENTS of a product fund manager. GIPS has the tremendous opportunity to also serve the EXISTING CLIENTS of those "client portfolio managers" or "fund of fund managers" or "plan sponsors." Essentially, GIPS can begin to help answer the most important question: "Is the portfolio meeting our financial goals?" That would be a great benefit to everyone.