Monday, July 29, 2013

You can't perform unless you try

This photo of one of the legends of sports, not just basketball, was recently posted on FaceBook. I thought it worthy to use as the basis for a blog post.

It made me think of two of my Spaulding Group colleagues who recently completed degrees part-time, which isn't an easy thing to do. It requires perseverance, drive, patience, a willingness to push forward, a commitment to spend time studying and attending classes rather than doing some fun things, the ability to keep motivated for a fairly long stretch of time, and the desire to succeed. Having earned two master's degrees (and now completing my doctorate) this way, I know first hand what it's about.

I congratulate my younger son, Douglas, who earned his MFA in Creative Writing from Farleigh Dickinson University and Jessica Laffey, who earned her Bachelor's in Criminal Justice from Caldwell College. Two great performances!

Sunday, July 28, 2013

A different kind of performance

When I teach our firm's Fundamentals of Performance Measurement class, I begin by saying how performance measurement isn't limited to investing. We encounter the opportunity to observe or participate in performances all the time. My friend, Herb Chain, is the President of the Queens (no, not Elizabeth, the NYC Borough) Symphony Orchestra, that holds performances regularly. They may get judged in a subjective way, based on how the audience feels they did.

Our younger son, Douglas (pictured above), is the artist in the family, given that he avoided sports throughout school (save for the few years he was in little league, youth soccer, and youth basketball), and concentrated on theater, instead (while his older brother, Chris, the athlete in the family, won the wrestling award as a senior, Doug won the theater award). Doug majored in theater and has worked for our firm for more than 10 years.

Well, a few years ago Doug took up a new pastime: obstacle courses. He has participated in several "Tough Mudders," as well as other events, including the one described in this video:

Thursday, July 25, 2013

Golf and performance measurement ... more in common than you might think

I'm teaching a Fundamentals of Performance Measurement class in Sydney this week, and it struck me how much we can use from golf that applies to performance measurement. For example:
  • Measuring performance: performance in golf is measured quantitatively (a player's score), just as we do with performance
  • Benchmarks: Here we have at least two standard methods:
    • An index: the course's par
    • A peer group: the field that the player is part of. E.g., Phil Mickelson just won "The Open" (aka, the British Open); anyone else playing in the tournament arguably had a chance to win.
  • Rules: performance measurement has the BAI standards, the ICAA standards, the GIPS(R) standards, while golf has the PGA standards
  • Risks: we have various risks that come into play in investing, such as market and idiosyncratic, while golf has bunkers, water hazards, woods.
Anything else come to mind?

Metaphors, analogies, etc., are very helpful ways to communicate ideas. It helps folks better to relate to concepts, and tying golf in (something many are familiar with) is just one example.

Tuesday, July 23, 2013

Which return is right?

I was recently asked to do some analysis on a firm's return calculation process; this request stemmed from the fact that they were getting different returns for the same period. I surprised them, I think, when I said that more than one return could be "right."

During a Fundamentals of Performance Measurement class I am teaching this week in Sydney (Australia), I mentioned this discussion. I also mentioned how once again, Bill Clinton's famous "it depends on what you mean by the word 'is,' is" came to mind. In this case, it's the word "right" that is interesting.

What is "right"? In performance measurement it's deriving a rate of return using an acceptable method. Historically, there have been more "acceptable" methods, but this number has dwindled in recent years, mainly because of the Global Investment Performance Standards (GIPS(R)), but also because of the industry's general interest in providing more accurate returns (in 1988 I attended an event sponsored by the ICAA (now the IAA), that addressed this very topic). Gone (so to speak) are the Original Dietz method (which treated flows as mid-period events), as well as Modified Dietz and Modified BAI (which day-weight cash flows), unless you revalue for "large cash flows."

And so, we have three or  more "acceptable" methods to choose from:
  • Modified Dietz (revalue for large cash flows)
  • Modified BAI (revalue for large cash flows)
  • Exact (revalue for all cash flows.
Does this mean that the most number of returns we might have is three? No, because we have to contend with the weighting method chosen; here we could have:
  • Start-of-day (for all cash flows)
  • End-of-day (for all cash flows)
  • Start-of-day (for inflows) and end-of-day (for outflows)
  • Start-of-day (for outflows) and end-of-day (for inflows)
  • Middle-of-day (something I'm not a fan of, but know that some folks like).
This suggests that we might have 15 different returns. But, when you consider that one vendor allows the weights to go from 0 (end of day) to 1 (start), with increments of 0.1 (i.e., 0.1, 0.2, ... 0.9), the number jumps even higher!

And this is only the time-weighted variety. What about the Internal Rate of Return (IRR) as a money-weighted return?  That is arguably "right," too! You could use the IRR (the exact money-weighted return) or Modified Dietz (as an approximation).

Perhaps the exact method is the most right return (nice choice of words!), but even here there might be at least four varieties, based on how we choose to handle the cash flows, and of course exact for TWRR and MWRR will be different returns showing different results (unless there are no cash flows).

You still have the opportunity to encounter "wrong" returns (e.g., returns based on settlement date accounting, that ignore large flows, that use erroneous data, based on faulty methods, that don't revalue at least monthly), but they are, in most case, clearly "wrong."

You obviously want to avoid reporting different returns to the same party (this only leads to confusion, concern, and credibility issues). In the case of our client, they were getting two different returns from their performance system, one which I determined to be wrong.

Most firms are familiar with the challenge of having to reconcile their return to the custodian's and/or client's consultant, all of which may be technically "right." This whole subject makes for interesting discussions, I think.

Friday, July 19, 2013

A performance measurement myth: rolling up is better

A common myth that I often run into is the one involving building up returns from the underlying assets. That is, the belief that if you calculate the returns at the security level and then "roll them up" to derive the portfolio return, that is somehow better.


It is better to calculate the portfolio return based on its beginning and ending market values, its cash flows, and ideally, its values when flows occur.

Building up from the securities can often create errors. Plus, as I've explained before, security level returns should be money-weighted, not time-weighted, thus their use for rolling up has to be wrong!

I just reviewed one client's system that calculated returns this way, and discovered that not only were the portfolio and asset class returns in error, so were the security returns themselves!

Let's put an end to this myth!

Tuesday, July 16, 2013

Should returns be net of inflation?

I had a discussion recently with a good friend and colleague, who suggested that when evaluating a manager's performance, returns should be net of inflation. I'm not so sure about this.

What are the "nets" we're familiar with:
  • Net-of-fees: most managers charge an advisory fee for their skill in investing their clients' assets. To report to their clients without the impact of fees is not showing the full picture. Yes, perhaps before the fees are removed (i.e., a gross-of-fee return) the manager did well, but the client wants to know the impact of the costs they incurred, which means transaction costs and management fees. Therefore, when reporting to clients, net-of-fee returns are, in my view, better than gross-of-fee.
  • Net-of-taxes: a few years back, reporting "after tax" returns was being encouraged quite a bit. This was perhaps stimulated by what appeared to be excessively high double- or triple-digit returns which managers were regularly producing. If a manager provided a +50% return (net-of-fees, of course), but taxes took a big chunk out of it, because of capital gains, how well did the client actually do? Thus, the encouragement to show after-tax returns. Even the AIMR-PPS(R) and GIPS(R) (Global Investment Performance Standards) had provisions for after-tax returns (since dropped from GIPS)). In my view, managers who claim to provide tax-efficient management are obligated to provide after-tax returns. Clients who want to see them should be given them, too. As for everyone else, I'm not sure, but it would be an interesting conversation to have. If the manager isn't making an attempt to avoid the impact of taxable events, should they be required or encouraged to report the impact their trading has? If a manager is extremely inefficient when it comes to managing vis-a-vis the impact of taxes, surely their clients (and the market) would want to know this. Again, could be fun to discuss.
  • Net-of-withholding taxes: When investing overseas, portions of income are withheld to pay local taxes. These funds may be recoverable. But until they are, should the returns reflect their impact? Probably, since the manager made the decision to invest in those countries and securities.
  • Net-of-risk: Risk-adjusted returns are, in reality, a return that has risk stripped away. Measures such as the Sharpe ratio, Treynor measure, Jensen's Alpha, and Information Ratio produce a form of risk-adjusted (i.e., net-of-risk) returns. My favorite risk-adjusted measure, as you may be aware, is Modigliani-Modigliani (aka, M-squared). Its use results in returns that are truly net-of-risk, which can be easily shown next to the portfolio's benchmark(s), to better judge how the manager performed.
To show returns to clients that are net of:
  • fees,
  • withholding taxes,
  • and risk
is, I believe ideal. To include taxes is also beneficial.

Okay, so what about net-of-inflation?

First, the manager obviously cannot control inflation. Inflation figures are reported ex post. And so, I don't know today what the inflation rate is; it's based on price changes over time. Can or should managers invest in a way to avoid or exploit inflation? Perhaps if they recognize that certain industries will benefit from inflation, they may invest in them, and industries that suffer, to avoid; is that reasonable? Do managers tout themselves as "inflation avoidance/efficient managers," as we have "tax avoidance/efficient managers? Not that I'm aware of, but clearly if someone does hold themselves out this way or employs such a strategy, then reporting net-of-inflation would seem to make sense.

We encourage managers to report the internal rate of return (IRR), or money-weighted return, to their clients, in order to represent how the client did. Should the manager judged on the IRR? In general, no, since the manager can't control the client's cash flow decisions, which may have a negative impact on performance. Perhaps net-of-inflation should fall under this idea, too; to show the client yet another net-of- figure, especially since their wealth is impacted by the effects of inflation. But, for the manager not to be judged. Again, an interesting question, worthy of some discussion.

Sunday, July 14, 2013

Don't confuse familiarity with understanding

I'll admit that it's a bit unusual that a sermon would be the inspiration for a blog post, but that's the genesis (pardon the pun) for this one.

At Church today, the Gospel was the well known (i.e., familiar) story of The Good Samaritan. Our pastor explained how most of the congregation could recite the story quite accurately. But he suggested that one shouldn't confuse familiarity with understanding, as the story's deeper meaning requires some effort to discern.

This made me think of many of the formulae and methods we employ in performance measurement. No doubt most performance measurement professionals are familiar with the idea of time-weighting, the Modified Dietz formula, some of the attribution models, many of the risk measures, etc. But, how many understand them?

In the case of The Good Samaritan, with each listening / reading, one has the opportunity to reflect more, or, if they're lucky, to be instructed by a knowledgeable theologian on some of the story's details, as well as background insights that aren't necessarily discussed in the parable. The same holds with the methods we employ on a regular basis to evaluate all aspects portfolio performance.

The Spaulding Group's training classes provide the opportunity to not only gain greater familiarity with many of the things we encounter, but also to expand one's understanding. I'll confess that my understanding continues to expand, as I spend more and more time reflecting on these materials.

I am excited that I will return to Sydney, Australia next week, to conduct both our Fundamentals and Attribution classes. While I've been there several times, it's been quite some time since I've been down under, and am looking forward to the trip. Sydney is one of the most beautiful cities I've visited. I enjoy the people and much of what the city offers. Hopefully, I'll be able to spend some time at the famous Opera House, too! If you know of someone who might wish to attend the training, please let us know, as there is still time to sign up!

Tuesday, July 9, 2013

With 10,000 in circulation, it's time for a 3rd edition!

The second edition of The Spaulding Group's very popular Formula Reference Guide is completely sold out.

What to do, what to do?

Well, we decided! We will publish a third edition, that will be revised and expanded. Plus, special attention will be given to formulas that are on the CFA Institute's CIPM examination.

Many, many folks have told us how valuable they find the guide to be. We frequently find it on our clients' desks or credenzas, for easy reference.

We have committed to have this new edition ready by year-end. We'll let you know more as we move forward.

Care to suggest a formula or two you think we should add? Let us know, but the deadline to do so is July 31!

p.s., We will soon announce a "pre-publication" offer that will make copies available at a significant discount, so stay tuned!

Monday, July 8, 2013

The use of words: taking a cue from President Clinton

You may recall President Clinton's statement that "it depends on what you mean by the word, 'is.'" I think Clinton made a good point, and I often find myself citing this line, as I think it has extensive relevance, given many words' or phrases' varied meanings. Knowing what is meant is key to understanding.

I recently opined on the Q&A-based allowance for GIPS(R) (Global Investment Performance Standards) compliant firms to remove certain disclosures from their presentations, if they are no longer meaningful or relevant. Coincidentally, we've recently seen in the press (e.g., in today's WSJ, in an article by Valentino-DeVries and Gorman, titled "Secret Court Ruling Expanded Spy Powers") the U.S. National Security Agency's expansion of getting phone records of its citizens, by redefining what the word "relevant" means.

While we might expect GIPS compliant firms to narrow its meaning, so as to avoid continuing the disclosure of certain information in their composite presentations (e.g., composite name changes), in the case of the NSA it appears that the term's meaning has been broadened. I won't comment any further on this subject, at least relative to the NSA.

We often have a difficult time defining what words or expressions mean. "Relevant" and "meaningful" will only join this list, which, for GIPS-compliant firms, includes "material." This doesn't mean firms can't use these words; just that they need to be circumspect, and document within their policies, as best as possible, what the words mean and how they're applied.

p.s., and a special thank you to Diana Merenda for providing the "word art" graphic which appears at the top of today's post.

Sunday, July 7, 2013

Enroll in Automobile University

The late motivational speaker and author, Zig Ziglar, coined the phrase "automobile university," to refer to the use of the time spent behind the wheel to expand one's education. He suggested that many drivers can increase their knowledge about a variety of subjects quite a lot during their drive time.

For close to 30 years I have been an active student in this university, initially taking advantage of the various cassettes (now CDs) from Nightingale-Conant. They offer a very wide variety of speakers and topics. In fact, it was from listening to one of these sets that I got the idea to go off on my own and start a company (The Spaulding Group), which has now been in business for 23 years.

In 2009, a friend and client turned me onto, which offers access to a tremendous number of books, covering all types of subjects and genres. A year or two before, I had begun to buy books on CD, as a way to expand my reading while listening (I still read a great deal the old fashioned way, but figured that by listening, too, I'd expand my reading experience even more). provides a more efficient, expansive, and less expensive way to do this.

I drive more than 20,000 miles a year, so the time available to listen to these books (which I download to my iPod) are extensive. While I could be listening to the radio or perhaps music, I generally prefer to spend the time listening to books. I feel that it's a much better use of my time. It allows me access to more information and education, as well as to books that I had never gotten around to reading before.

My taste in reading is quite varied, and this resource is quite helpful in allowing me to invest my time wisely. For example, I've listened to classics in literature (e.g., Dostoevsky's The Idiot and The Brothers Karamazov, F. Scott Fitzgerald's The Great Gatsby, Thoreau's Walden, Cervantes' Don Quixote, and Hugo's Les Miserable; business books such as Wessel's In Fed We Trust, Greenspan's The Age of Turbulence, Paulson's On the Brink, and Zuckerman's The Greatest Trade Ever Made; contemporary fiction, such as works by Baldacci (who I've come to like) and Howe's The Physick Book of Deliverance Dane; political books, such as Ayn Rand's Atlas Shrugged and Gibbs' The Presidents' Club; as well as autobiographies, such as Massie's Peter the Great and Catherine the Great. In all, around100 books. Some are fairly short (eight hours or less) while others can be quite long (e.g., Atlas Shrugged was 63 hours and Les Miserables was more than 60 hours). For the most part, the books are unabridged, so you're getting the full book.

In addition to listening while I drive, I also listen while I exercise, which I try to do several times a week (on an elliptical, for 45 minutes).

I strongly recommend that you consider enrolling in Automobile University. There are probably other resources than, though I find it ( to be reasonably priced (you pay a monthly fee, which allows you access to recorded books that would normally cost much more than the fee itself). You can also make additional purchases, which I've done a few times. Note that they offer discounted pricing for the first three months, which provides a great way to try it out. I suggest you do!

Thursday, July 4, 2013

Happy July 4th

The markets in the United States are closed today, in observance of July 4th.

July 4th has a special personal meaning for me, for that's the day in 1970 that I met the young lady who would (two years later) become my wife; we have been married for over 40 years and today celebrate the 43rd anniversary of meeting each other.

For our nation, it's recognizing the day that we declared our independence from Great Britain. Those individuals who signed the Declaration were, as some put it, signing their death sentence, for if we had lost the war, they surely would have lost their lives for treason. The bold steps they took have resulted in a great nation.

Happy July 4th!

Wednesday, July 3, 2013

CIPM Program: a way to benefit your colleagues, the industry, and yourself! (pretty cool)

The Spaulding Group remains big fans of the CIPM(R) program, and so, we are posting details that were recently sent out via an email from the CFA Institute.

Building a better investment industry starts with you. By referring a colleague
 to the newly enhanced CIPM Program, you’ll be helping to raise standards
in the industry. If you know someone whose role relates to investment
performance and risk evaluation, this is a great time to introduce or reintroduce
them to the CIPM Program. Registration for the October 2013 exam is open
through July 31.
The CIPM Program will help your colleagues:
  • Deliver more actionable investment insights
  • Improve manager search and selection
  • Provide feedback to maximize your firm's efficiency
  • Increase risk awareness
  • Produce comprehensive and transparent reports
As a thank you, we’re rewarding those who refer a colleague with a chance to
win an Amazon Kindle Fire HD. Participation in the contest is easy. Simply refer
the CIPM Program to your colleagues and direct them to register for the chance
to win. When your colleagues register for the contest and indicate that you
referred them, both you and your colleagues will be entered into a random
drawing for a chance to win an Amazon Kindle Fire HD. The complete Official
For further information about the enhanced CIPM Program, visit

Tuesday, July 2, 2013

Cash can be such a drag ...

A Spaulding Group verification client contacted me with a non-GIPS(R) (Global Investment Performance Standards) related question, which I want to share with you, as I think it has wide applicability.

They have a commingled vehicle that restricts cash flows to always occur on the first of the month. For contributions, this works quite well. However, they've discovered an issue with withdrawals.

One of their clients requested a sizable withdrawal last month. The money flowed out on July 1, which is fine and dandy. BUT, the money had to be raised during the month of June, meaning that for much of the month, their cash position was much higher than it should have been (it is typically close to zero, but was more than 10% as a result of the sale of assets to raise the requested cash). Consequently, the fund's return was much lower than it should have been, because of the cash drag.

A possible solution: once the cash was raised, it is no longer under the manager's discretion (i.e., they cannot invest it). And so, perhaps they should either (a) move the cash to a "temporary account" or (b) flag it as "un-managed."

Here's an example; hopefully it will help. It's in three parts.

Part #1: the portfolio as it would have looked at the beginning and end of the month, had there been no cash flow:

As you can see, we began with 100 million and ended with 105 million: a return of 5.00 percent.
Part #2: One client requested that 10 million be raised, and so, securities were sold mid-way through the month, in a proportionate manner, to raise the necessary cash, which remained in the portfolio until the end of the month [NOTE: if you have a hard time reading this graphic, just click on it to expand it]:
We see that the 10 million was raised halfway through the month and that it did not appreciate any further (we're assuming a 0% return for simplicity). Because the cash remained, its presence dragged down the return of the portfolio
Part #3: Finally, we see the case where we transfer the cash that was raised out (either to a temporary portfolio or to an un-managed status):

As you can see, by shifting the cash out, we are able to eliminate the impact it would have on the fund's return.
There are clearly some assumptions made here. One being that the manager has the ability to segregate the cash (which most accounting systems should be able to support), and provides returns to the fund's shareholders. Second, that the custodian's report won't cause any issues; it shouldn't, as the manager can explain the math behind his/her returns. And third, that the assets are liquid enough that mid-month valuations can be done, to support the bifurcating of the monthly return (prior to and after the transfer of cash).
If a firm does this, then it should document it and ensure that this approach is used consistently. It would seem to be applicable to hedge funds that might have to raise cash that they normally wouldn't have, and don't wish the cash to cause a drag on performance.
Note that the monthly return that is derived from the unit values (produced by the custodian) won't match what the manger provides; however, once we get past this month and calculate returns, the cash's impact should disappear. The only time it should have a lasting impression will be if this is done in December, in which case the manager's return will be the correct one; at least in my view. What's yours?
p.s., You may noticed that more than $10 million left; I show the full cash going out. We could have had just the $10 million go, leaving a small residual amount, but this would have been in the earlier case, too; the results won't really differ. I think the point is clear.

Monday, July 1, 2013

Relevant and meaningful sunset rules

As noted last week, firms that comply with the Global Investment Performance Standards (GIPS(R)) are now given the opportunity to no longer disclose composite name changes when they are deemed to be no longer "relevant and meaningful."

I think it's fair to interpret from this that such a test can be applied to other "required" disclosures, too. Although there is no conditioning language embedded within the Standards, given that such leeway has been permitted here, it seems to be a logical step to extend the same test to other disclosures; wouldn't you agree? And so, if a firm feels that the departure of the CIO (Chief Investment Officer) 13 months ago is no longer relevant and meaningful, they can stop disclosing it, as well as changes to the composite's strategy, and other things.

Despite the fact that these changes were introduced through a Q&A, I welcome them. It appears that the GIPS EC has decided that the sunset rules are flexible and in the hands of the firm. I think clear wording to this effect should be provided, to ensure that this interpretation is correct. Rather than stipulate that certain disclosures have to stay for one, two, five, ten years, by attaching the "relevant and meaningful" conditioning language, it appears that firms can choose when to discontinue their appearance. I believe that in addition, anytime a disclosure is removed, that its removal be documented, so that the verifier (and probably anyone else) can have a look.

Perhaps a Guidance Statement on Sunset Provisions would be a good idea ... I'd welcome that, too.