Thursday, January 17, 2013

Outcome oriented / client centered investing

The concept of orienting your investing so that it's geared to the client's requirements is getting more attention of late. P&I had an article on this subject in their November 12, 2012 issue, and Steve Campisi, CFA has addressed this at several of The Spaulding Group events, including our Performance Measurement, Attribution & Risk (PMAR) conferences. Steve and I are in discussions with another colleague about giving this subject even greater attention and focus.

One of my concerns is the practicality of having each of a plan sponsor's managers sensitive to the same objective; oriented to the same goal(s). Does this make sense? Is this appropriate?

You may have heard of the "Myners Report" (aka, Myners Review) which was delivered by then Gartmore chairman Paul Myners back in 2001. The actual report is about 200 pages long; I recommend this, as well as my books, as effective insomnia cures.

I won't pretend that I've read the entire document, though I did review much of it when it was first published, and I recall strong support for the use of liability-related benchmarks.

The question, I think, should be to whom these benchmarks are used. I'd think the plan, itself. As for the managers, they should be selected as part of their (the plan's) overall strategy to meet or exceed their benchmark. However, judging these managers by this same benchmark seems incorrect to me. Your thoughts?


  1. I think that your insights on this topic are "spot on." In a nutshell, the traditional analysis of performance (individual fund portfolios against their respective asset benchmarks) is the right way to evaluate an individual fund manager. However, the goals-based approach (total portfolio against the expected stream of withdrawals and ending portfolio value) is required to evaluate whether the portfolio is achieving its purpose. From the fund manager's perspective, nothing changes. From the client's perspective, and additional area of analysis is required.

    Currently, there is nothing being done in this area as far as the "orthodoxy" of performance dictates. However, as we continue to introduce performance analysts to the client's needs and the opportunities this presents, I expect to see an increase in the trend toward goals-based performance analysis. It's encouraging to see certain consultants and even performance vendors beginning to take hold of this concept.

    From the client's perspective, this goals-based approach changes everything, because the typical performance information they receive only informs about the pieces of the portfolio; it's completely silent about whether the entire portfolio is meeting client goals. In fact, the cash flows that make up the goal (i.e. withdrawals to pay for living expenses, or pensioner retirement payments, or endowment needs, or foundation grant making) are actually EXCLUDED from the calculation of time-weighted returns, which have unfortunately become the ONLY performance measure that clients typically see.

    Imagine this: the very thing that makes up the client's goal is not only ignored, but is eliminated from the analysis of the return on the client's portfolio. It's a total disconnect between the client's portfolio and the goal that this portfolio is supposed to satisfy.

    The current crisis of underfunded pensions is a critical example of the problems that are created when investment managers only examine their own performance rather than understanding whether or not they are meeting client needs. We have to be reminded that "It's not about US; it's about THEM." For decades the pension investment industry focused on beating a theoretical return (i.e. 8%) and only looks at the risk of volatility of returns, rather then evaluating the ability of the assets to sustain required pension withdrawals and to maintain the portfolio value in the face of the true risk they faced: the effect of changes in interest rates on the value of the liabilities. So what happened? In recent years, equity values plunged and yields fell, causing liability values to risk while portfolio values fell. As a result, in the U.S. the typical corporate portfolio has only 70% of what they should have to pay their beneficiaries, while government plans have between 30% - 60 percent. Imagine that such a crisis was partially caused by the lack of relevant performance analytics, while everyone commended themselves on their individual performance against a meaningless asset benchmark and the "gold standard" of time-weighted returns.

    Clearly, there is a HUGE opportunity here for the performance industry. Hopefully, efforts to change the perspective will be helped along by discussions such as these.

  2. Steve, thanks for your comments, which, sadly, took a while for me to post (sad explanation: I don't always get messages that comments are waiting to be reviewed ... darn!). Great insights, as usual, and use, HUGE opportunities await us to develop this further; thanks!


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