Thursday, December 27, 2012

What to do with the cash that you just created for your client

We often get questions about a problem all asset managers face: a client requests you to sell some of his/her/their securities, to free up cash that they plan to withdraw. Between the time that the cash is created and it's finally taken by the client, it's sitting in the account, impacting the portfolio's return. What options does the manager have? There are a few:
  1. You can leave the cash there and accept the impact. When reporting to the client, you can explain that the cash diluted the return and that you would have invested it if you could have, but at the client's request, it was created for them.
  2. You can move the cash out immediately into a "temporary account." This account would be on YOUR system (i.e., the custodian doesn't know about it), and would segregate the cash you raised from the account and any other cash that may be there (i.e., cash you can invest).
  3. You can move the cash into a different cash "bucket" (or pseudo security), which you would flag as being "unmanaged," so that it isn't included in the returns.
Once the cash is created it's nondiscretionary, is it not? When it was invested it was under your control, but once you create it for the client, you cannot invest it, and so it should arguably be segregated. By moving it into a temporary account, you accomplish this. Also, if you can move it into a different security category and simply give it a different name ("non-discretionary cash") which you've flagged as unmanaged, your return calculation will exclude it.

Some of our clients raise cash for clients who say they'll take it immediately, only to find that the cash is still there weeks (or months) after it was raised. It's unfair for the cash to impact the return when the manager can't invest it. It's just like any other unmanaged or nondiscretionary asset: it should be excluded from the return. Have some other thoughts? Please share them.

Wednesday, December 26, 2012

Having a risk policy is only part of the solution

A recent WSJ headline referenced one major bank's problems as regulators challenge its risk management practices. This made me think of comments I usually make during our firm's Fundamentals of Performance Measurement course, when I touch on risk management: having a risk policy can be risky!

This comment is based on a consulting assignment we had several years ago, that involved a plan sponsor's challenge of one of its managers risk management policies. They felt that the manager had failed to live up to their documented control procedures, and we were asked to conduct an analysis to discover what we could regarding this matter.

Of course, a policy has to be sound and as complete as possible. The point here is that having one on paper but not in reality can be hugely problematic. Not having one is also a problem, as more and more clients expect to see some risk management in place. I recall a NYC asset manager client who contacted me one day about establishing one: their largest client had asked what their policy was, and the reality was that they didn't do any risk measurement or management.

Policies, procedures, and controls cannot reside only on paper; they must be exercised and validated occasionally, to ensure they are performing as expected, and from time to time enhanced, too.

Monday, December 24, 2012

Seasons' Greetings from The Spaulding Group

This has been quite a year. We've had our ups, and our downs, just like all years. Overall, The Spaulding Group had a great year. Our verification practice continues to grow, and our GIPS(R) verification clients now number more than 100. Our PMAR conferences both had record attendance, and our training numbers were on the rise. Our new software certification service has been well received, and we will shortly award certifications to two of our clients. We are grateful for those who have hired us to serve them, as well as our the many professionals we have the pleasure of working with. On a personal note, I am thankful for the team we've assembled.

A dear friend, who I met almost 50 years ago when, as young men, we were members of the Order of DeMolay, and who passed away 6+ years ago, told me how he always liked it when Chanukah and Christmas overlapped. While the holidays have nothing in common other than their proximity, I agreed that having them occur at roughly the same time was especially nice. This year they are separated quite a bit, and so our Jewish brethren have already exchanged their holiday gifts.

Our pastor's letter in this weekend's church bulletin referenced two events which have taken away from the holiday season for many of us: Hurricane Sandy, which smacked our region a few weeks back, and those horrific killings which struck a nearby Connecticut school 10 days ago.

Yesterday was the last Sunday of Advent, and just like the prior Sunday, the four candles in our Advent wreath were changed to black, as a sign of mourning for those who perished in Newtown. The song we began the mass with brought tears to my eyes, and the tears appeared again yesterday, as I reflected upon those candles. Our hearts continue to ache for those who perished and the loved ones they left behind.

Our family will celebrate Christmas tomorrow, though tonight we will go to church with our sons, our daughter-in-law, and our grandsons. We will also exchange gifts this evening, since this year our grandchildren (and their parents) will be "at the other grandparents" for Christmas day.

Despite the difficult times, we will try to focus on the happiness that the holiday brings. I am blessed that my wife of 40 years and I will share it with family.

We hope our Jewish friends and colleagues had an enjoyable Chanukah, and wish our Christian friends and colleagues a happy and blessed Christmas.

Friday, December 21, 2012

Spreadsheet-based systems: a case in point

The Spaulding Group's December newsletter deals with the use of spreadsheets, and their all too frequent use as "systems." I point out, as I've done countless times elsewhere, that they are:
  • time-consuming
  • error prone
  • cumbersome
  • not databases
and so should be avoided, if possible.

Earlier this year I was asked to develop an attribution model for a client that employs option writing along side its long stock positions. It's a global firm, so the model has to also be sensitive to currency movement, though since the client doesn't employ a hedging strategy, naive multi-currency attribution works.

I completed the assignment, and delivered the spreadsheet. Because of its complexity, the firm will most likely not employ it, which I can fully understand.

I do see the exercise as a way to prototype a model, so as to gain confidence in the approach, formulas, assumptions, etc. From such an effort a programmed system can be built.

This exercise will also likely result in an article for The Journal of Performance Measurement(R), to explain the model as well as to further support the use of spreadsheets to prototype models, but not to turn into "systems."

Wednesday, December 19, 2012

Attribution is part of our daily lives

When I teach our fundamentals of performance or attribution classes, I often mention how we adopt ideas from other segments of society. Measuring performance, for example, is found in many areas, with sports perhaps being the most thorough (with baseball leading the way).

Attribution, too, is found in many places. Police departments conduct attribution when attempting to ascertain the cause(s) of an accident, and fire departments do the same when investigating a fire.

The recent horrific massacre at the Sandy Hook Elementary School is causing a rash of attribution analysis, as the contributing causes are being analyzed. How much did mental illness play a part, should gun control laws be examined, does violence on television lead to violence in real life, etc.? And just as performance attribution is controversial, so are many of these discussions.

I'm conducting a study which demonstrates how some approaches to performance attribution or flawed, and can lead to incorrect conclusions (an article summarizing preliminary results will be published shortly). This, in spite of the fact that we're talking numerical attribution. In the case of analyzing a crime, much of the work will be subjective, which can be influenced by various factors, including political and public pressure. To avoid flaws in the results, objectivity must be complete and the evaluation unbiased.

David Kopel wrote an interesting piece in Monday's WSJ titled "Guns, Mental Illness, and Newton." He points out how we've seen a significant increase in random mass shootings over the past 30 years. Some are quick to "rush to judgement," while many admit they "haven't a clue." President Obama wants action taken to make these events an impossibility, which is admirable and something we all would support, though how realistic this goal is is yet to be determined.

My heart continues to ache for those who died and the loved ones they left behind. The attribution analysis has begun, and hopefully action can be taken to reduce the risks of similar attacks taking place.

Saturday, December 15, 2012

No answers for this one

Almost every day I receive questions from clients and others about various aspects of performance and risk. And for the most part I am able to respond, either with my opinion or an answer based on fact.

What occurred yesterday in Newtown, CT leaves me, and no doubt you, too, with no answers. How anyone could commit such a heinous crime baffles us to no end. How anyone can kill small, frail, innocent children, as well as innocent adults, is something that none of us can give a good reply to, other than perhaps madness. This young man was set on a journey of destruction; his motives or the basis for such action will probably never be known. Man's inhumanity to man is still shocking to me. But it's difficult to think of anything that can compare to this horror.

One of my friends expressed being somewhat at loss as to how to pray for the parents who lost their young children; I suggested that to pray that they be given peace and comfort is an okay thing to do. They will forever, probably every single day, be reminded of their loss. Nothing I can think of can compare to such a loss, especially at this time of year, as most of these young folks were awaiting the arrival of Santa in less than two weeks, and others just wrapping up the festival of lights, a time that no doubt brought them much joy.

Two weeks from yesterday is the Feast of the Holy Innocents, when we remember those victims of Herod's pursuit of the newborn Christ child. Those youngsters who died yesterday are holy innocents, too.

My heart aches as I think of what occurred. As a parent and grandparent, perhaps this event is more hurtful, though I don't believe we need to have any children to know how horrible this crime was.

I pray for the parents, family, and friends who suffered the loss of a child yesterday. And, I pray for the victims; it is my hope that they are at peace, resting in the arms of a loving God.

Friday, December 14, 2012

Getting control of ancillary systems

At this month's Fall (Autumn) Performance Measurement Forum meeting, which was held in one of my favorite cities (San Francisco), one member posed a question about ancillary systems (i.e., those systems that sit aside the packaged or programmed systems that most asset managers use, including manual and spreadsheet). The reality is that EVERY FIRM just about has at least one spreadsheet-based system to support their performance measurement needs. This discussion raised a question about "best practices" for such systems.

Interestingly, this past weekend's WSJ had an article ("Ex-Trader's Gambit Bites Goldman") which discusses how a former Goldman and Morgan Stanley trader "using a manual system typically for trades done over the counter or those handled by a floor broker, entered 60 false 'sell' trades to make it look as if he was reducing his position." Does this not speak to the need for some form of "best practices"?

At our Spring Forum meeting (which we expect to be held in Boston) we will address this subject. Here are a few quick thoughts (you're invited to chime in with your own):
  1. Avoid having manual or spreadsheet based systems when packaged software can accomplish what you require
  2. KNOW what systems exist within your organization. Construct an inventory of all systems, who built them, who's responsible for their maintenance, who uses them, and what they're used for
  3. Know what data is used by these systems and what data comes out of them, to be used by other systems
  4. Identify the controls that are in place to ensure integrity of the information
  5. Put in place a process by which such systems must go through a testing process before they can be implemented...
  6. ...also, for changes!
  7. Identify systems that are used as an alternative to programmed/packaged systems
Give me time, and I'll come up with a few more, but this is at least a start.

As you might expect, this is one of the areas we look at when we conduct our operational reviews. It's not uncommon to find spreadsheet based systems that pose huge threats to the integrity of the firm's data.

Thursday, December 13, 2012

Feeling lucky?

Jason Zweig often provides inspiration for a blog post, and his article in this past weekend's WSJ ("Are You Brilliant, or Lucky?") has done just that. The subject of luck versus skill has been one that academics, as well as practitioners, have wrestled with for decades, but this is not the time to try to address this in any detail.

What actually grabbed me was his opening statement: "Have investors finally learned that past performance doesn't guarantee future results?"

The answer, sadly, is NO!

We're approaching that time of year (January) when several magazines  (e.g., Money) will identify the "top money managers of 2012." And how will many investors react? They will flock to whoever holds the #1 spot.

My response: sorry, but you're a year late.

Often the #1 fund managers have a minimal amount under management, and perhaps are concentrated in a few stocks that simply performed in an OUTSTANDING fashion. But investors don't care...they'll be sending their money their way once the manager's been id'd.

Investing is clearly not the only industry that falls victim to this. We see it in sports all the time, do we not? Professional athletes often receive very lucrative signing or resigning contracts, because the GM (General Manager), manager/head coach, and/or owner(s) expect past performance to predict future results.

Of course, this begs the question, if past performance ISN'T an indication of future results, should it be banned from being reported?

The answer: no. Because, it still tell us how the manager did in the past, and this information can have value. To have no such track record would, I suspect, be MUCH worse.

Imagine, for example, me, David Spaulding, putting up a shingle on January 1 offering my investment management service with absolutely no track record, because past performance is no predictor of future results. I suspect that folks would want some indication as to my prior success, in spite of my inability to say that what I had done could be done again.

In whatever endeavor we choose, we cannot guarantee that our past accomplishments will be matched in the future. Fortunately, this some times works where the individual had previously failed multiple times but then succeeds (Abraham Lincoln comes to mind). Knowing about one's past should always be part of the evaluation.

Tuesday, December 11, 2012

GIPS Standards Handbook Now Available; The Spaulding Group to Provide Copies to GIPS Verification Clients

The long-awaited third edition of the Global Investment Performance Standards (GIPS(R)) Handbook is now available.

This book is a companion whenever I do a verification. I find it to be an invaluable compendium to the Standards, and a valuable resource that helps provide clarity to various aspects of the Standards.

The book is available as a PDF online for free. While I frequently use the PDF version of the Standards, I haven't taken advantage of this option with the handbook, but will give it a try. Hard copy versions are available for US$40.

The Spaulding Group feels that this book is so important that we are buying copies for all of our GIPS verification clients. Each client's verifier will provide a copy to them when we conduct their 2012 verification. A copy is also included in our GIPS Orientation Kit.

Monday, December 10, 2012

Getting our attribution right

In last Friday's WSJ, Cameron McWhirter had an article titled "To Quote Thomas Jefferson, 'I Never Actually Said That,'" in which he refutes many quotes that are incorrectly attributed to our America's third President (and one of our Founding Fathers, author of the Declaration of Independence, the country's first Secretary of State, and much more). He cites Anna Berkes, a librarian at the Monticello Jefferson Library who speaks of the "rampant misattribution" of such misassignment of quotes.

In performance attribution analysis, we must also be on the lookout for misattribution; what's the point of doing the analysis if it's going to result in figures pointing to the wrong cause?

For example, on a few occasions I've found global managers who fail to measure the impact of currency movement. This means that the selection effect is including it, and therefore possibly crediting selection decisions when the currency movement is the correct source.

I've written about the problems that holdings-based models can cause, especially when there's a fair amount of trading occurring within the portfolio: not only can we expect to see large single-period residuals (as opposed to multiple-period, that can result from the absence of a sound linking method), but also the misassignment of the effects (more to follow on this point).

The integrity of the attribution analysis depends on the model's alignment with the investment process, as well as the completeness and accuracy of the model's formulae.

Misattribution can result in giving credit where credit isn't due, failing to see problems that may exist within the investment process, and misleading clients and prospects about the sources of return. They can also call into question the value of the performance team. None of these are good things.

Saturday, December 8, 2012

The ever befuddling world of materiality

Today's post was inspired by an op-ed piece in this weekend's WSJ: "Madoff Got Away, But Netflix Won't," by Holman W. Jenkins, Jr.

Jenkins discusses how Netflix CEO Reed Hastings' Facebook post that the company's "customers had streamed a billion hours of video in the month of June" was determined to be worthy of scrutiny by the U.S. Securities & Exchange Commission. He suggests that one "ask just how crazy is the SEC in trying to extend its concept of 'materiality' to the news that Netflix actually disclosed."

In our industry, the Global Investment Performance Standards (GIPS(R)) calls for the disclosure of material items multiple times, including the requirement that firms define a level of materiality for a certain threshold of errors (which happen to be classified as "material").

Of all the things we wrestle with, defining materiality is probably one of the most challenging, because it is entirely subjective, and there is no real guidance or "best practices" to help.

My favorite word source,, offers definitions for "materiality" that refer to "material," which is of no real value, and so we're forced to check out what this latter term means. And while several definitions are offered, the one that applies here is "of substantial import; of much consequence; important." An example is included: Your support will make a material difference in the success of our program.

And so something is material when it's important and involves much consequence. Now, let's translate that into numbers; ah, there's the rub.

I tend to think that something is material if it causes us to look differently upon something than we would otherwise have.

An extreme example: Wilt Chamberlain, the late Hall of Fame National Basketball player claimed to have slept with 20,000 women; quite a tally. If we were to learn that the actual number was 19,000, or 21,000, would we think any differently about his achievements in this area? I think not. And yet, it would still be a 5% error over what he reported.

Interestingly, his actual height is unknown. He claimed to have been 7-foot tall, as I recall, but was apparently even taller (by a few inches, perhaps). Hardly a 5% difference from the actual height, but he was somewhat intimidated by his height and didn't want to share the actual figure, fearing, perhaps, that it might cause some embarrassment.

When trying to define rules for materiality, try to consider what others would consider a noticeable difference, which could cause them to rethink their prior conclusions based on the earlier result: would it cause someone to say something like "well, upon further reflection I must reconsider my earlier response"? If yes, then it's material.

As always, we're open to your thoughts and ideas on this subject.

Friday, December 7, 2012

Minimum requirements for Karnosky-Singer attribution

Many software vendors and custodians claim to offer the Karnosky-Singer multi-currency attribution model, but do they really?

The name has become synonymous with a robust approach to identifying the contributions from currency movements on a portfolio's excess return, and comes from the monograph Denis Karnosky and Brian Singer wrote for the CFA Institute. Though a relatively short piece (as monographs are intended to be), it covers a lot of ground. Carl Bacon has done an admirable job of describing the model in his books, which arguably should be considered a companion piece to the model, and present on all performance measurement professionals' bookshelves.

But when we speak of the K-S model, what do we mean? I discussed this recently with my colleagues John Simpson and Jed Schneider, and then confirmed our conclusions with Brian.

First, we expect to see currency's attribution effect bifurcated into two components (am I being redundant? how many components could BIfurcation create?):
  • the contribution that results from currency movement on the market; that is, as we take securities from the local to base currency, the change in value that's attributed to currency fluctuations
  • the contribution that comes from currency management; that is, the investments in currency futures in order to hedge the portfolio, or to expose the portfolio to other currency weights that differ from the portfolio's investments.
Second, that interest rates be broken away from the market side of attribution and included with the currency side, because, as Denis and Brian point out, interest rates have a direct bearing on currency movement.

We have observed some firms who claim to offer the K-S model, but who "lump" or combine the effects into a single value; i.e., the currency effect is shown as one, not two numbers. This fails to provide the highlights that the K-S model offers from an analytic perspective, robbing the recipient of knowing (a) how much was contributed from the currency movement across time on the underlying assets and (b) how much came from currency management (i.e., the hedging decisions that occurred). To lump them together converts the K-S model into a naive model, and should deprive the firm from claiming that they do, in fact, offer Karnosky-Singer attribution.

As always, your thoughts and insights are welcome.

Wednesday, December 5, 2012

Some portfolio managers are more erinaceous than others ... explained

One of the daily alerts I subscribe to is the "word of the day," from Many of the words are quite fascinating, and today's struck me as one that was worthy of being highlighted in a post. Chances are you've already guessed what the word is.

erinaceous \er-uh-NEY-shuhs\, adjective: Of the hedgehog kind or family.

Examples are offered, including "[Thoreau was] the most erinaceous of American writers. Ideas struck out from his writing like porcupine quills, guaranteed to prick the hide of even the most thick-skinned, reader."

You may recall that the late investor Barton Biggs brought us Hedgehogging, a book I enjoyed and have often recommended. And so, it was he that extended the term "hedgehogging" to the hedge fund industry, and thus it seems appropriate to carry this a bit further and suggest that those who take up this craft might therefore be thought of as being erinaceous. It seems to work, does it not?

Tuesday, December 4, 2012

Filling in the gaps of performance ... or not!

My son, Chris, and I had a preliminary meeting with someone who is looking to obtain compliance with the Global Investment Performance Standards (GIPS(R)). He left his prior firm and has recently created an account that is being managed in the same fashion as those he managed at the prior firm. The rules of portability apply. And so, he wishes to show a contiguous track record extending to performance he had at the prior firm.

The problem is that there is a two month gap between the time he stopped managing at the prior firm and began managing his new account. What can he do about it? Can he cross or fill in the gap?

Unfortunately, no; nothing can be done to link the two periods. He must show partial (aka "stub") period returns for the period leading up to the break (e.g., January-August, 2012) and the period since (e.g., November-December, 2012). The gap cannot be crossed.

Might he simulate the performance, by way of a benchmark's return, model performance, or backtesting? Nope!

I recognize that this is frustrating to those managers who have compiled a five or ten year track record, and wish to take advantage of and build upon it in their new endeavor. No doubt, they wish to report the return for the entire year they departed, as well as to link that year to prior and subsequent periods, so as to show rolling or fixed five and ten year cumulative and anualized returns. But when a gap occurs, it sadly cannot be crossed.

Individuals contemplating a departure from one firm to either start or join another, and who wish to continue their track record, must maintain at least one account in the same manner so as to avoid the creation of a gap. Of course, there are times when their departure is not of their own design but is forced upon them without notice. In these cases, nothing can be done. But, if someone anticipates a departure, willingly or otherwise, they can take steps to ensure their continuous and contiguous track record remains.

Have other thoughts? Please chime in!

Friday, November 30, 2012

Blending MWRR & TWRR

The same question has come up twice in the past week, so I thought it worth posting.

A manager manages several different accounts for the same client. Some returns are money-weighted (MWRR), some time (TWRR). The manager wishes to consolidate the accounts to present a single picture. How should they do this?

First, from what perspective are the returns being presented? That is, are you telling the client how THEY did, or how YOU, the manager did?

If the former, then I'd report everything as MWRR. In fact, I think that it might be reasonable to aggregate all the information and derive a single MWRR, although it might be better to asset weight the money-weighted returns; I'd want to spend more time on this before committing to one way or the other.

If the latter, then I think I'd asset weight the individual returns to derive the overall return. This means, asset weighting both the MWRR and the TWRR.

Can we mix MWRR and TWRR? Why not? In this context, each represents how the manager did. Asset weighting tells us overall  how the manager did.

Can we calculate MWRR for short time periods? Yes, as short as you would like.

I'll try to work up some examples.

Have some thoughts on this? Please offer your comments.

Thursday, November 29, 2012

At the risk of upsetting some GIPS folks, I offer the following thoughts ...

I participated in the rewriting of the wrap fee (aka SMA (Separately Managed Account)) guidance, as a member of the then AIMR-PPS(R) Implementation Committee. This was the rewrite of the earlier rewrite, that was handled by a single (un-named) member of this committee, which resulted in a then record number of negative responses from the industry when it was put out for public comment. The committee was broken into two subcommittees, and I chaired one. The rules were loosened a bit, allowing, for example, wrap fee managers to look upon the wrap fee sponsors as their clients. We thought this made perfect sense.

Now, for the opinions which I've held for well over a decade.

Why, dear reader, must a wrap fee manager who claims compliance with GIPS(R) (Global Investment Performance Standards) be required to put their wrap fee accounts into a composite?

Some key points to consider:
  1. It is my opinion (one that has been confirmed by more than a few wrap fee managers) that wrap fee sponsors rely primarily on the institutional composites to determine if they want to add the manager to their suite of managers
  2. The manager's "client" is the wrap fee sponsor. The individuals who do the investing are the clients of the sponsor. Okay, the manager signs up to be the discretionary manager, but rarely if ever actually meets with or speaks to the end client.
  3. The wrap fee sponsors are not "GIPS compliant." They are the ones who market their suite of managers to their clients, and use whatever performance materials they feel are appropriate (and that meet the requirements of the Securities & Exchange Commission (the SEC)). Yes, the manager is to encourage the sponsor to use their materials, but the sponsor is not required to.
It is quite a challenge, even given the revised guidance, for wrap fee managers to bring their wrap fee accounts into compliance and to maintain these records. The composites and presentations that are created serve little if any purpose.

My recommendation: Drop the requirement!

Make  it OPTIONAL for wrap fee managers to bring these accounts into compliance. If they feel that the composites have value, GREAT! But, in all likelihood, they will rely upon their institutional track record to be awarded the coveted role as a manager to be offered to a sponsor's clients. If no institutional composite exists, or if it has become inactive, then I'd favor the requirement for a composite, but otherwise think it should be optional.

I would treat this the same as non-fee paying accounts. They are not required to be in composites, but can be included if the manager wants to. Likewise, the wrap accounts wouldn't be required to be included in composites, but could be if the manager felt there was some value to do this. The verifier would be required to verify that the excluded accounts are, in fact, wrap fee, but beyond that, no additional work would be needed. Such a move would (a) save the manager lots and lots of time and expense to maintain these records and (b) save on their GIPS verification, as these wrap fee composites could be dropped.

Have a different view? Think this is silly, crazy, nonsense, or worse? Please chime in! I'm all ears.

My guess is that the GIPS Executive Committee (EC) is hard at work on GIPS 2015. Wouldn't this be a great time to remove this rule?

Tuesday, November 27, 2012

Bottom up attribution

A colleague asked me for some details on bottom up attribution. I then asked for the context in which he was speaking, since knowing the context is important.

If we're talking about a "bottom up" manager, who doesn't take allocation into consideration, one could argue that contribution is sufficient. However, there will still be allocation, though perhaps unintended, unless the manager is successful at being market neutral throughout (i.e., regular rebalancing to match the benchmark). Otherwise, "allocation risk" could occur, which could detract from the portfolio's performance. The "Brinson type" models will still be effective to evaluate a bottom up manager, by showing the unintended allocation effects, and should arguably be considered.

If we're speaking in the terms of "nested attribution," for example where we evaluate the portfolio at the asset class (equities, fixed income, cash) and styles (large cap growth, large cap value, etc.), then we're speaking of adding the lower level effects to arrive at the higher level ones. There ARE attribution systems that behave this way, but they're arguably flawed, as I've shown in the past: the results are sometimes simply nonsensical.

Steve Campisi wrote an article for The Journal of Performance Measurement ("Balanced Portfolio Attribution," Winter 2008/2009) where he provides an interesting way to handle nested attribution.

A colleague and I will discuss this topic at a webinar in early 2013; details to follow. With the absence of agreed upon "best practices," we are bound to have various approaches, some of which don't quite work as well as they should. Steve's does, and it will be presented during this webinar.

As an aside, I think there's a fundamental belief that some hold, that summing up from the bottom, be it for returns or attribution effects, yield a more precise number; I generally disagree. I'll try to take this up in greater depth at another time.

Sunday, November 25, 2012

A different kind of attribution

When I teach our Performance Fundamentals and Attribution classes, I often say how we frequently borrow concepts from other places: attribution is just one example. We didn't come up with the idea of attributing an event to a cause, or determining how various causes contributed to an outcome. 

Today's post deals with an attribution that has nothing to do with performance. It is also a bit of a delicate subject, so I hope it's okay.

The subject: prostate cancer.

I just turned 62. As I understand it, by my age roughly 60% of men have had prostate cancer. I had a physical recently, and I was told that the condition of my prostate is somewhat "unique." That is, it's in very good shape.

Unlike those men you see in some commercials, I don't find myself having to rush to the bathroom multiple times a day or throughout the night. I recall playing a round of golf with three much younger men. We all had plenty of fluids to drink during the first part of our round. When we got to a hole with a bathroom, the three young guys rushed to the bathroom while I stayed in the cart.

And so, what to attribute to my apparently quite healthy prostate? I've identified three possible causes.

#1 My morning smoothie drink. For more than 10 years (probably close to 15) I've prepared a smoothie when I'm at home, that consists of the following ingredients:
  • One serving of soy powder. I read something many years ago that suggested that the use of soy might help reduce the risk of prostate cancer. And so, I've been a devotee. I use Solgar Iso-Soy Soy Protein/Isoflavone Concentrated Powder Natural Vanilla Bean Flavor which you can get from Amazon
  • 1/2 tsp cinnamon. I had read that cinnamon is good for you, so I include a bit in my drink.
  • 1 tbsp EVOO (extra virgin olive oil). I understand that we are to consume at least some olive oil daily, and so by including it in my morning drink, I'm guaranteed having it.
  • 1 cup blueberries. I use Wyman's frozen wild blueberries. They're high in antioxidants. You can get them at BJs and Costco.
  • 3-4 frozen strawberries. Also high in antioxidants. Also taste good!
  • 1/2 cup orange juice
  • 1/2 cup grapefruit juice
  • 1 cup skim milk (a way to get calcium)
  • 1 banana (for potassium).
When I'm home, I start each day with this drink. It makes about 32 ounces, which I consume at one time. You could split it between two days, of course. It is, I think, fairly high in calories, so you might want to consider this. I happen to think they're very healthy calories.

#2 High consumption of fluids. Empirical evidence shows that I consume a much higher amount of fluids than most people. During the day I drink a lot of coffee (decaf; in the AM), water, and diet soda. Could this have anything to do with my healthy prostate? I have no idea, but looking for things that are obviously different suggests that it's a candidate.

#3 Heredity. It's possible that I have "good genes," though I don't have any easy way of finding out. My father died at 69 from pneumonia (he was a "recovered" alcoholic and heavy smoker; I don't know if he had prostate issues). His father was older when he died, but I have no evidence to suggest that he had a good or bad prostate. Details of my maternal grandfather's demise are unknown to me; I never met him, and his is an interesting story that I'll save for some other time.

There is, of course, a fourth possibility: unknown cause. I have faith in my daily drink, and believe that what I include is all healthy stuff, some of which reportedly combats cancer. While I've never heard anything about fluid consumption being good or bad for cancer prevention, knowing that my intake is higher than most suggests that it's at least a possibility.

When men turn 40 they begin to get tested for prostate cancer, and this continues for the rest of their lives. I now get annual physicals. Fortunately, my prostate is healthy. My only reason for sharing this today is because I am fully aware of the potential effects of a bad prostate. I have friends my age who often have to stop to rush to the bathroom. I don't. I sent my formula to one prostate cancer research facility, who didn't seem to be impressed, which is fine. And perhaps you won't be, either. But prevention is a good thing. And while I cannot guarantee that this drink is a good thing, it's a daily routine for me whenever I am home. My mother died of cancer when I was very young. I've had other relatives and friends who've died of cancer. And so, prevention and awareness is very important to me. Thus, this post. I hope it's well received.

A disclaimer: I am, of course, not a medical authority or practitioner. I am simply sharing something that I do. I cannot offer any guarantees whatsoever, or offer any further guidance. I have faith in it, thus my daily devotion and interest in sharing it with my readers.

Wednesday, November 21, 2012

Happy Thanksgiving

From all of us at The Spaulding Group
A Very Happy Thanksgiving

Getting the words right

My wife and I recently came across this sign on the front door of a medical facility where we had an appointment. If we are obligated to follow these instructions, we must attempt some other means to gain access to the building.

No doubt when the creator of the sign wrote it, they didn't think that the words "at all times" are an absolute, and leave no exceptions. In life we often encounter absolutes tossed about when they shouldn't be: "they always lose," "this always happens to me," "you're always late," "you never ..."

When we write instructions, we should be careful that the words reflect our intended meaning: that we don't say too much, nor too little.

The Global Investment Performance Standards (GIPS(R)) occasionally uses absolutes, when in reality they're not meant. For example, we know that "all actual, fee paying, discretionary portfolios must be included in at least one composite." But we also know that there are a few exceptions to this rule (e.g., portfolios that are excluded because of significant cash flows, because they've fallen below the minimum, because they haven't been managed long enough, because they're transitioning from one composite to another).

Almost 40 years ago, when I was stationed in Hawaii with the 25th Infantry Division, I had the "extra duty" of being our artillery battery's race relations officer. One of the things we would tackle was prejudice, which is typically built around absolutes: "all black people ...," all Jews ...," "all whites ...," "all Hispanics ..." In reality, we know that the "all" never applies to any group. There seems to be plenty of evidence to support avoiding absolutes, in just about all areas of our lives, unless they really apply ("never do illegal drugs" would be an example that I think does work).

The words we use count. My wife and I have become fans of The Big Bang Theory, and Sheldon is great at dissecting the words people use (I'll confess that I am sometimes guilty of this too; an example: when a waitress tells you, "if you need anything, my name is Mary," might cause one to ask, "what's your name if I don't need anything?").

After conducting verifications, I want to make sure my feedback is clear to our clients. Sometimes I find myself writing "you should ...," when "you must ..." is more correct. I generally refrain from telling someone things they must do, but the reality is that to avoid confusion, such wording is sometimes needed.

Someone once said that there's no such thing as writing, just rewriting. This applies to everything we write, whether it's emails, letters, reports, or the words that are to appear on signs. Even blog posts!

Monday, November 19, 2012

Alternative Investment Guidance Statement Explained

If your firm complies with the Global Investment Performance Standards (GIPS(R)), then you need to be familiar with the new guidance statement on alternative investments.

The Spaulding Group's Jed Schneider, CIPM, FRM will host a webinar tomorrow, Tuesday, November 20, to provide some insights into this important document.

To learn more about the webinar, please contact Jaime Puerschner.

Wednesday, November 14, 2012

Taking a week off (well, except for today, which is only for explanatory purposes)

My wife and I are on vacation this week in beautiful Aruba, to celebrate our 40th wedding anniversary. And so, rather than detract attention to the woman I love (save for this single post, while she's showering), I won't post again until next week. Hope you understand, dear reader. I have my priorities, and this week it's my wife.

Thursday, November 8, 2012

Next week is Risk Week ... still time to sign up!

The Spaulding Group will hold its second annual webinar conference next week, and the subject is RISK! Each day there will be a different topic and speaker.

Details can be found on our website.

This conference format (one topic/speaker per day for five days) provides a cost effective way to bring training to your firm. Everyone is concerned with risk, and there are no doubt topics you'll find of interest.

The response has been tremendous, but if you want to take advantage of this session, you should sign up by this Friday. Please call our offices (732-873-5700) or email Jaime Puerschner for more details or to sign up. You can also sign up on line. Don't miss out!

Monday, November 5, 2012

When short is too short

I have a confession to make: I used to be 6' 1/2" tall (I liked the 1/2", because it put me ABOVE 6'). My father was 6'6", my older brother roughly the same, and my younger brother is, I think, around 6'2". My two sons are both taller than I am. And so, I can be thought of as the (a) runt of the litter and (b) still the shortest guy in the family. (Okay, it's true that I am taller than my grandsons, but they aren't fully grown, yet).

Sadly, I am no longer 6' 1/2" tall. Gravity has set in (so they tell me) and I am now 5' 11"; i.e., LESS THAN 6'. Yes, I've needed therapy to deal with this, but I'm managing quite well, thank you.

And yes, I know that I am still taller than average, so have no complaints.

But in this post, I'm speaking about a different kind of short. I'm speaking of shortness in time.

John Simpson, CIPM recently conducted a webinar on the mathematics of multicurrency: a session that was very well attended. One participant raised a question regarding the possibility of instantaneous measures of change. If you have a mathematics or physics background, you can probably relate to this. I recall in calculus, where we're introduced to the idea of shortening the measurement period, so as to find the instantaneous changes.

The question: should we concern ourselves with instantaneous changes in returns, or perhaps more correctly, valuations?

My reaction is that this is of little value, and I would discourage doing or pursuing it. I have heard some folks ask for intraday returns (which isn't quite as short as instantaneous, but it's moving in that direction), and am concerned that this could be something we'd adopt.

Investing is supposed to be long term, is it not? Looking at short periods introduces noise and causes frustration.

This past summer we replaced the robot (vacuum) for our swimming pool. It was very different from the ones we previously had. Someone from the company urged me NOT to watch it as it worked, as it would cause frustration, as I'd see it miss things here or there, or fail to see it move into certain parts of the pool, and might wonder if it's working properly. Instead, I was advised to step away and look back after it's been given several hours to work.

There are, I believe, only four reasons to calculate performance within a month (i.e., to calculate daily performance; more correctly, value the portfolio so that we have a point in time to measure from):
  1. Because someone has asked "what's my month-to-date performance" or "MTD returns are included on a report (portfolio managers often want to see MTD results, and this is fine)
  2. To improve accuracy, by revaluing the portfolio for large or, better yet, all cash flows
  3. Because an account terminated, and we wish to calculate the return up to the point where management ceased
  4. It's a new account, and we want to start the valuation on the date it began being managed.
Disagree? Have other thoughts? Please chime in!

I should add: there is nothing to be gained from an accuracy perspective to move to instantaneous or daily valuations/calculations; cash flows are the primary delimiter for valuations (and period ends, of course). In addition, daily valuation is fine and becoming standard, and I support this.

Thursday, November 1, 2012

A crowded, but happy office

Hurricane Sandy left many of us without power; fortunately, our office has electricity. And so, we invited our employees to bring their spouses and/or children with them, to have a chance to warm up, relax, and even have a hot shower. Most took advantage of the offer, and so we had several extra folks in our offices these past couple days (and expect to still have a few tomorrow). While some of us now have electric back on at our homes, many still do not.

I consider it a blessing that our office had electricity and the other amenities, thus allowing for us to provide a respite for our colleagues' families. The children (numbering eight, I think, at our max) handled the situation quite well, hunkering down in our conference room, which has a TV, and a large table which allowed them to do various projects. The youngest members (our two grandsons) made the whole office their own, crawling (Caden, who will be one in less than three weeks) and walking (Brady, who turned three in August) around, visiting with everyone.

I guess it's called making the best of it, and I think we have and will continue to do so.

While the gasoline lines are quite long, and many remain without power (and of course too many suffered very badly), we will continue to count our blessings and be patient with those dedicated souls who are working to return our lives to normalcy.


Wednesday, October 31, 2012

When performance isn't so good

A year ago Monday, the Northeast part of the United States was greeted with a horrendous storm, which included a lot of snow and damaging wind. My wife and I that day went to a civil union ceremony, a trip that should have taken about an hour; instead, it took four.

Well, on this storm's (and the happy couple's) one-year anniversary we were visited by Sandy, a hurricane which has pelted us quite hard. Its performance was quite good, for a hurricane, but quite bad, for those of us who were recipients of its forces.

The NYSE closed for two days, as did our offices. Many, including almost everyone in our NJ offices, are without power. Our office, however, has power, so those of us who can are here.

Many roads remain closed, which can make travel quite difficult. While I had no problem making it in (I live less than 10 minutes away), it took Patrick Fowler three times as long as usual to get here, and others may not make it in.

Because of loss of power, many (most?) gas stations are closed; and those that are open are doing lots of business, as the lines extend for quite some distance (Chris counted 150 at one waiting for a single pump!).

Hurricanes have hit this area before; what made Sandy different?

I am not, of course, a meteorologist. But, from what I can gather, most hurricanes come ashore much farther south (e.g., in Florida), and then, if they so choose, work their way north along the coastal states, but inland, meaning their power is weakened as it moves northward. Sandy moved north in the ocean, and made land right along the New Jersey coast, with its width spreading north (to NYC, Long Island, and Connecticut) and south (to Philadelphia, Delaware, and Maryland). It caused extremely high waves, which pummeled the shoreline, flooding many towns and communities. Its winds, sometimes in excess of 100 mph, caused much destruction.

We're the lucky ones

Despite some of the damage that we've had, and our power issues, our troubles are not at all like those of many others, whose homes, cars, and property have been lost or severely damaged. Our thoughts are also with those who have died as a result of this devastation (55 so far), as well as their families that are left behind to mourn their passing.

Friday, October 26, 2012

You can pay me (annualize) now, or you can pay (annualize) me later

One of our clients introduced me to alternative ways to calculate two commonly used risk-adjusted return measures: information ratio and Sharpe ratio. Their immediate derivation is from Zephyr, and I am attempting to identify their origin. I confirmed that Morningstar also uses them.

In both cases, they annualize and then do the math, rather than do the math and then annualize. This calls to mind the associative property of mathematics, which says the order does not matter. While in addition, this holds (2 + 4 = 4 + 2 = 6, for example), it does not in these methods, as we get different results.

This also reminded me of how some attempted to derive my favorite risk-adjusted measure, Modigliani-Modigliani (annualize first or last?).

The information ratio differences:

And, the differences with Sharpe ratio:

This raises numerous questions. For example, is one approach superior to another? My suspicion is that most firms use what I refer to as the "typical" formulas. The reference materials I've checked only show these approaches. But clearly, some favor the alternative. The CFA Institute's CIPM(R) program, as I recall, also references the "typical" approach.
We know that there are multiple ways to derive various statistics, and here are just two more cases. As I learn more, I will share it with you. In the mean time, feel free to "chime in" with your thoughts. 

Tuesday, October 23, 2012

Working my way through the Alternative Investments GS

I have read through the new GIPS(R) (Global Investment Performance Standards) Alternative Investments Guidance Statement a few times, and frequently make what I think are interesting discoveries. Here's just one:

I have highlighted the part I find of interest (I hope it's readable). We see "firms may wish to present simulated, model, or back-tested hypothetical performance results due to the lack of an actual historical track record." [emphasis added] This further adds credibility to my prior suggestions that the Standards permit the use of non-real performance, which is, I think, quite a good thing. And so, for example, if a firm has a new strategy for which they only have simulated, model, or back-tested performance, they can use it (along with a disclosure that makes it evident that this isn't a real track record (i.e., against managed assets)).

However, when we continue to read we find that these same results "can be presented as Supplemental Information to a compliant presentation." [emphasis added] What compliant presentation?

I think this is where it can get interesting, and even confusing, but it shouldn't be.

First, we see the word "can," which isn't the same as "must." And so, in the absence of a track record for a strategy, a firm can use hypothetical results.

When would the "can" apply?

In a couple cases.

First, even though this sentence is in the same paragraph as the wording dealing with the absence of a track record, the hypothetical performance can be used even if there is a track record, to demonstrate performance for periods not covered by the real investments.

Second, just because a firm doesn't have a track record it can still have a presentation; I have long been an advocate of this. The firm would have all the necessary disclosures, but no performance. The performance would be the supplemental hypothetical.

Make sense?

We also see the same language that appears in the Supplemental Information guidance statement: that you can't link hypothetical and actual performance. By "link" we don't mean "geometrical linking," though this would also hold true, but rather "visual" linking, where by presenting hypothetical and actual on the same page, the reader might mistakenly think they're one and  the same (i.e., actual for the full period). And so, to avoid the potential confusion, you're required to have them on separate pages.

I'll have more to say about this GS in future posts.

Thursday, October 18, 2012

Did you hire a GIPS verifier or a cell phone provider?

If truth be told (and I am about to tell it), I do not know how common this practice is, but we have become aware of cases where GIPS(R) (Global Investment Performance Standards) verifiers require their clients to sign multi-year contracts. E.g., they will perform the verification for the period 2010-2012. Does this remind you of anything?

Cell phones come to mind.

AT&T, Verizon, etc. all do this: they require you to sign up for a multi-year contract.

Can you get out of them? Sure, if you want to pay them. But who does? Regardless of the quality of the phone or service, you're pretty much stuck.

The Spaulding Group has NEVER thought of doing this. Our view is, if you don't like our service, fire us! Our feelings won't be hurt (okay, maybe a little bit, but we'll get over it). While we always strive to deliver the highest degree of service, we don't want to require our clients to keep us if they don't want to.

Why would you want to require your clients to sign a multi-year contract?

Oh, I know why: for YOUR benefit! Now I get it. Lock the client in. Even if they discover a better option, you lock them in, so that they are forced to retain your services.

Our advice to firms looking for a verifier: if the firm you choose is making you sign a long-term agreement, just say "no!"

If you have confidence in what you deliver, you won't have such a practice. Have a different view? Chime in!

p.s., if you'd like to learn more about TSG's GIPS and non-GIPS verification service, go to our website; better yet, fill out a questionnaire and get a detailed no-obligation proposal, along with a surprise gift!

Tuesday, October 16, 2012

A new GIPS rule being introduced in a non-standard way

It came to my attention yesterday that a new GIPS(R) (Global Investment Performance Standards) rule is being introduced into the GIPS Handbook regarding the treatment of significant cash flows (SCF): compliant firms will no longer be able to use the "number of portfolios" as a factor to employ the firm's SCF policy.
Where did this new rule come from? And more importantly, why wasn't the public given a chance to comment? Would such a change not be better handled through a revision to the SCF guidance statement, with the traditional public comment period?
This change is no doubt being couched within a "Q&A," that was perhaps fabricated for the purpose of introducing it, but the Q&As were never intended to be the source of new rules but rather interpretation of existing rules. Was this a Question that was asked of and Answered by the GIPS Help Desk? I suspect not, since it's not listed in the Q&A section of the GIPS website. Was this rule vetted with the Interpretations subcommitte or the GIPS Executive Committee? Or, was it added as part of the last minute editing process, without the benefit of public discourse?
The irony here, as you will see, is that the earlier version of the guidance statement conflicts with what is now apparently a rule!

Here's what is being changed: Let's say you have an SCF policy that you employ firm wide, that says if there's a flow greater than 30%, you will remove the portfolio for one month. Great! BUT, you have a few small composites (small in number of portfolios) that could have "gaps" or breaks in performance if you ever employed the SCF rule here. And so, you want to condition your policy by having something like "if the composite has less than five accounts, the policy does not apply." I.e., you'd rather suffer from the impact of the flow rather than experience a break in your performance history.

Or, what if you want a policy that says that composites with ten or more accounts have a 30% threshold, while composites with 5-10 have 40%, and below five will not participate in the SCF policy, so as to avoid possible breaks; what is the harm with such a policy?

This new rule will prohibit firms from doing this. Why? What's the point? What is the harm with firms having such policies? I find the change unnecessary, but more important, the manner in which it is being done in total conflict with the traditional methods to introduce new rules. What happened to protocol?

I mentioned above that these new "rules" seem to conflict with language in the earlier version of the SGF guidance:

As you can see, the SCF guidance recognized that a firm could experience gaps if a composite had just a few accounts, and so it cautioned firms on applying the same rules across the firm, without any regard to the number of portfolios a composite might have. For an unknown reason, this wording was removed from the most recent version of this guidance. Are we now witnessing a total "180" regarding a firm's ability to have rules partly conditioned on the number of portfolios in a composite? Why?

Since this is clearly a rule change, why isn't there an effective date?

I find this frustrating, ridiculous, absurd, and senseless! What do you think?

By the way, firms can STILL accomplish having their policy sensitive to the number of portfolios in a composite; they will have to specifically identify those composites which will employ the SCF policy. It's a little more cumbersome, perhaps, but can still be done. There is no requirement that firms must have a single SCF policy that must apply to all composites (at least not yet!).

Also, one might wonder what other new rules are being introduced this way; I guess we'll find out soon.

Monday, October 15, 2012

TSG Hires Steve Sobhi to head up our western region sales

This was just released by The Spaulding Group:

One possible reason for the reluctance to hear different views

The weekend WSJ often provides fodder for this blog, though this is the first that I recall it came from Peggy Noonan. Her assessment of Thursday's Vice Presidential debate ("Confusing Strength With Aggression") in this past weekend's edition was quite insightful. But the source for today's post can be seen as independent of the debate critique. She offered the following:

"Age can seem reactionary, resistant to change in part because change carries a rebuke: You and your friends have been doing things wrong, we need a new approach." [emphasis added]

A few of the new ideas that I and others have championed have met with resistance from some in our industry. For example:
  • My call to eliminate the aggregate method to calculate composite returns (for the Global Investment Performance Standards (GIPS(R))
  • Our desire to see broader acceptance and employment of money-weighted  returns.
It had never occurred to me before that some may interpret these suggestions as rebukes, as this was never our intent. But surely we can rise above this, can we not?

The irony is Noonan's linking of the resistance to change to age, as if those who don't want it are older. In spite of my youthful appearance, the reality is that I am one of the oldest folks in our industry!Those who oppose the ideas put forward are in all cases younger than I am. Why must they be so wedded to their ideas that they resist being open to new ones? Can our industry advance when some (and sometimes those who hold positions of authority) refuse to even consider change?