Wednesday, January 29, 2014

That which gets measured, gets improved ... or maybe not

I have to thank my lovely daughter-in-law, Monica, for providing this photo to me. 

Consider this, a "fun" post.

I was in the Army for almost five years, and stationed for 39 months with the 25th Infantry Division (Oahu, Hawaii; I was a Field Artillery officer). Granted, this tour was quite a hardship, but I managed to survive (along with my bride, Betty, who accompanied me). 

Shortly after we arrived, I met the "Fort DeRussey beach officer," another 2LT (second lieutenant). Ft. DeRussey is an "army beach," that occupies a great spot along Waikiki beach in Honolulu (shortly before we left the island, a beautiful high rise hotel was built; Betty and I stayed there our last few days). Ft. DeRussey is a beach where many a military person spent their "R&R" (rest and recuperation).

I thought "what a great job THAT would be!" Well, as it turned out, it wasn't such a good job, as this guy got passed over for 1LT (virtually unheard of; such a promotion is usually considered an "automatic!"). 

But when I saw this photo, I realized that THIS would be the career choice I would have made.

Okay, so perhaps I'm jesting ... just a bit. But it's interesting how we are prepared to measure just about anything.

Tuesday, January 28, 2014


Note: the following comes from this month's newsletters, but I wanted to get it out, given the urgency of registering!

The CFA Institute has made a huge commitment in our segment of the industry by creating, maintaining and administering the Certificate in Investment Performance Measurement Program. I am always excited when I see folks, both senior as well as relatively new, with the CIPM designation. But I’m also disappointed that more haven’t taken advantage of this opportunity. 

To me, there are two major reasons to do so:

1) For what it will do for you

The reality is that many fields have developed professional certifications. Clearly, there’s a recognition that there is value in being “certified.” The “CIPM” gives unbiased testimony to your skills and knowledge in the areas of performance and risk measurement. It says to your colleagues, your employer, as well as anyone else you come in contact with, that you know your stuff!

2) For what it will do for our segment of the industry

For those of us who have been in the industry for 20 years or longer, we’ve seen how the role of performance and risk measurement has grown into a highly respected and valued part of the world of investing. All areas of investment management have incorporated performance
reporting. The CIPM program is one way to give further credibility to the important role we play.

I’ll confess a degree of frustration and disappointment that more senior level performance measurement folks haven’t pursued the exam. Granted, many have built up a “resume” and reputation that speaks quite loudly that they have skills and experience.

However, by pursuing the exam they will set an example for others, and further add to the importance suggestive of the program. I know I’ll leave a lot of folks off, but will briefly list just a few of the senior investment professionals I know who have achieved this certification:

  • Carl Bacon 

  • Ann Putalaz
  • Douglas Lempereur 

  • John Simpson
  • Neil Riddles 

  • Jed Schneider
  • Debi Deyo Rossi 

  • Tim Ryan
  • Sandra Hahn Colbert 

  • Gerard van Breukelen
  • Annie Lo
NONE of these folks HAD TO get this designation. Each one had already established themselves as knowledgeable and experienced investment performance professionals. But they invested the time to accomplish this objective. While I can’t speak for any of them, I suspect that many did so, not so much for themselves, but for the industry.

The CFA Institute spent a great deal of time analyzing and revising the program, to make it even better. Isn’t it time YOU took it?

The next exam period is in April, but you only have until January 31 to register. 

Go to to register.Our firm offers training and study aids. To learn more, visit

Spaulding,..., David Spaulding

This year's Performance Measurement, Attribution & Risk (PMAR) conferences, like last year's, will have a theme. It started as "Casino Royale," but has been broadened to "Secret Agents," or more specifically, 

"Secret Agents of 
Performance Measurement."

As with last year's event, we will have caricatures done of the speakers, as well at the conference of those who successfully complete the mission of visiting all of the event's sponsors!

This "black tie optional" event will surely be one you won't want to miss. It'll be fun, informative, exciting, engaging, entertaining, and much more!!!  

Plus, you get two chances!

May 21-22, 2014 in Philadelphia, PA (USA)!
June 10-11, 2014 in London, England! (Home, as you may recall, of 007!).

We are proud to announce that the European event is being done in association with the CFA Institute ... not too shabby!

For more information, please visit our conference site.

Friday, January 24, 2014

10 Key points about rates of return

At the core of performance measurement is the rate of return. While we are often distracted by attribution, risk, and the Global Investment Performance Standards (GIPS(R)), the ROR is fundamental. And so, there are some key points we should agree on.

1. Use time-weighting to judge the manager only when the manager isn't controlling the cash flows. That's it! No other need for it. While it seems to be the virtual universal way, that's sadly just how it's worked out, but fortunately a lot of correcting is going on, and many are rethinking the universal application of a method that was only intended to serve a single purpose.

2.Use money-weighted returns to judge the manager when the  manager controls the cash flows. Regrettably, GIPS' narrow application of the requirement for money-weighting only does part of the job. The rules are more complex than they need to be, and are often confusing. The simplest rule: if the manager controls the flows, use money-weighting. Hopefully, that'll be adopted worldwide (even in GIPS!) some day.

3. Use money-weighting to show how the client did. Whether the client controls the flows or not, money-weighted returns are the way to show the return of the client. More and more are realizing this, including the GIPS Executive Committee (with the introduction of the guidance statement for plan sponsors (i.e., asset owners)), GASB (the U.S. Government Accounting Standards Board), Canadian regulators, and others. 
Let's keep it going!!!

4. Know when to aggregate and when not to. If you have several accounts and want to know how your managers (collectively) are doing, in theory you have two choices:
  • Provide a time-weighted return on the aggregation of assets
  • Asset-weight the individual account time-weighted returns.
I vote for the latter. Why? Because the aggregate isn't being managed by a portfolio manager. It's essentially the same argument I have against the aggregate method for composites: no one is MANAGING the composite! The return is meaningless.

AND, if these managers include ones that control the flows, I still vote that you asset-weight, but for those managers that have money-weighted returns, use the MW returns, don't switch to time-weighted. The result is how your managers are managing your portfolios ... this can have some value. The return of the aggregation is valueless (that's in addition to being meaningless (see above)).

If you have several accounts and want to know how you're doing (collectively), you have two options:
  • Provide a money-weighted return on the aggregation of assets
  • Asset-weight the individual account money-weighted returns.
I vote for the former. I think it will be a better representation, since it takes everything into consideration.

5. Shorts are special, they need their own linking method. If a portfolio holds short positions, the standard geometric linking won't work; there's a special adjustment to that approach which I've highlighted in the past, which should be used.

6. Speaking of shorts, don't net your longs and shorts. If a portfolio holds both long and short positions of the same stock, or periodically goes back-and-forth between long and short, keep them separated. While it IS possible to derive a return across the time period, it's better to segregate them so that you can show the return of each side, as they're intended to do completely different things and reflect differing views of the market.

7. Show returns to two decimal places. Two decimal places mean you're showing to the basis point (1/100th of a percentage point). To show to only one decimal place doesn't provide enough precision; to show to three is overly detailed and unwarranted. Are there exceptions? Yes, but they're rare.

8. Select the right time-weighted return formula. Ideally, use the exact method (aka "true daily" and "pure"). If you have to use an approximation method (e.g., Modified Dietz), revalue for large flows, and set your "large" threshold to no more than 10 percent. In addition, if you go with this latter approach, test flows against the  most recent revaluation point.

9. Select the right money-weighted return formula. We've helped firms implement money-weighted methods, and have done  so using Modified Dietz, as an "approximation" to the true, money-weighted return (aka, the internal rate of return (IRR)), but recognize that this is less than ideal. The preferred approach should be to use the IRR. While the Modified Dietz is often quite close, as with its ability to approximate the exact TWRR, it sometimes lacks the accuracy we'd like.

10. If you're not comfortable explaining why a client has a positive TWRR but lost money, figure it out. No, it's NOT wrong; no, it DOES make sense. You need to understand WHY the return is this way and be able to explain it in an intelligible way. Step one is to identify the cash flows (there has to be at least one) and step two is to look at the performance pre- and post-the flow(s). That's probably all you need to do; if you need help, contact me.

Wednesday, January 22, 2014

A case for a mixed cash flow treatment policy

Most of those who calculate rates of return have settled on either the end-of-day or start-of-day treatment for cash flows. Some time ago I arrived at the belief that a mixed treatment is better:
  • Inflows: start-of-day
  • Outflows: end-of-day.
While in bed one night, it hit me why this made perfect sense. Thinking I'd recall in the morning what I discovered that night, I didn't bother to write it down. Sadly, I didn't, and haven't been able to recall since.

But the other night, a set of examples came to mind, which seemed, though perhaps not as elegantly, to do a reasonable job justifying this belief. This time I rose from my bed and wrote them down! (The saying pale ink is better than the most retentive memory rules!).

By way of three examples I hope to justify this method, which I'll simply (for the first time) refer to as the "mixed cash flow treatment" approach. We'll use Modified Dietz as our daily return method, where our "weight" is zero, for end-of-day and one for start-of-day.

Gains (or losses) realized on investments made but not recognized until the end of the day.

We host a membership group called the Performance Measurement Forum, which meets twice a year in the States and twice a year in Europe. The subject of cash flow policy has come up a few times, and this example is one that we've discussed at some length.

Let's say your policy is to treat flows as "end-of-day" events; not uncommon. And let's make the example really simple: 
  • A portfolio starts the day holding 100 shares invested in a company valued at $10 per share, for a total of $1,000 starting value (there is nothing else in the account). 
  • A cash flow of $1,000 occurs and the manager invests it at the same $10 per share price (for simplicity, we'll ignore transaction costs). 
  • At the end of the day the stock has risen to $11 per share.
What's your gain?

Seriously, does this make sense? I think you'll agree that it does not. The portfolio is benefiting from the gain of a purchase it hasn't yet recognized. As you can imagine, the same problem can occur if a loss occurred. It's because of examples like this that I came to realize that inflows are start-of-day events. As you can see

it yields the correct result.

When a new account is opened.

A new account gets established with an inflow (e.g., money wired in); there is no starting value without a transaction to create it. 

For our example, let's say that $10,000 comes in to open a new account and that no trading is done, so it ends with the $10,000 it began with. What's the math?

As you'll recall, we cannot divide by zero, and 0/0 has been declared undefined / indeterminate by mathematicians. If you use the end-of-day (EOD) treatment for your inflows, this will occur. And even if the asset had grown during the day, the denominator would remain zero, which is a problem if we use the end-of-day approach. The start-of-day (SOD) method yields the correct result:  0.0 percent.

When an account is terminated.

Okay, perhaps we're not so concerned with getting the returns correct for someone who's leaving, but we at least need to understand the math. Let's assume here that you've adopted the "start-of-day" approach for all flows.

The portfolio begins the day with securities valued at $100,000. We sell them for $101,000 and immediately create a withdrawal in the account (we ignore the issue with settlement, since we're using trade date accounting). 

Clearly the start-of-day treatment fails miserably here, does it not? The end-of-day approach provides the correct return for the last day that we manage money for this client. 

It's my belief that if you use only start- or end-of-day treatment for your flows, your returns are often incorrect; perhaps by just a tad, but wrong, nevertheless. But, if you use the mixed approach as your default, you'll be right much more often. Are there times when this approach is incorrect? Yes, I believe there probably are, but far less than when it's correct. 

I'm happy to report that an increasing number of firms have adopted this approach!

Your thoughts, insights, objections?

Tuesday, January 21, 2014

Are big contributors always good to have in your portfolio?

Contribution, aka "absolute attribution," is a commonly used measure of performance. It's simply the return of whatever we're evaluating (securities, sectors, etc.) times its weight. We sum these values up, and they should equal the portfolio's total return, but may not, if transactions have occurred and you failed to compensate for them.

This produces our "winners" and "losers," often reported as "top 5" and "bottom 5" contributors. One might conclude that if a security is on the "top 5" list that they did well and that having them was a good thing, but not necessarily. Consider the following:
We see that the two main contributors both generated 20 basis points to the total return. One (Security 1) had a return (1.00%) that was significantly below the average and perhaps it was below the benchmark's average, too. And so, how did it end up being a top contributor? Because of the large weight it has (20%). But is such a weight justified given the low return? Security 3 also generated 20 basis points of contribution, and had the smallest allocation (1.20%), but had the highest return (17.00%). 

And so, we see that very large weights or returns can result in large contributions to the overall return. If you were to show these two securities in your "top 5" list, someone may inquire as to why such a (relatively) poor performing stock ended up being a big contributor; the answer is simple: you put a lot of your money there. In retrospect, perhaps you would have preferred to reverse the weights between Securities 1 and 3.

Of course, this is merely a snapshot for one particular period; perhaps over the long term, Security 1 has done extremely well, while 3 hasn't. But understanding how a security ends up on your "top 5" list is important.

Tuesday, January 14, 2014

Two things to remember about performance attribution

To see a World in a Grain of Sand, And a Heaven in a Wild Flower, Hold Infinity in the palm of your hand, And Eternity in an hour
William Blake

I believe there are two major things that performance measurement professionals need to know about attribution.

#1 Attribution is about insights.

The single word, "insights," says a lot.

Attribution provides insights into what has gone on;  what has occurred. Another word for this is perspectives. The more you twist and turn (i.e., slice and dice) the portfolio, the more insights or perspectives you can gain.

What is waiting to be discovered?

#2 Perhaps more than anything else we do, attribution greatly helps to elevate the role of the performance measure-
ment team.

It affords opportunities for the performance measure-
ment professionals to provide key information to the front office. It allows you the chance to provide guid-
ance, explain what has gone on, share the insights you gained, resolve issues, identify causes, and much more. It's something that should be grasped and championed.

There are times when you don't stop at giving the front office the reports; instead, find ways to provide helpful commentary; perhaps discover secrets that may not be clear; identify those key insights that the mangers may overlook.

Are you going to be a provider of reports or a provider of information? 

That's the challenge. That's the opportunity.

Thursday, January 9, 2014

Order dependence vs. independence

You may recall the commutative property of math-
ematics, which essentially speaks of changing the order in which we do the math. This property holds for addition and multiplication; for example:

You'll may also remember that it doesn't hold for all mathematical operations; for example:

Technically, there ARE times when these rules hold (e.g., when A and B are the same value), but these are exceptions.

I'm reviewing a client's performance attribution process, which includes their reporting of contribution (a.k.a. "absolute attribution"), and discovered that their method to link contribution effects over time is "order dependent." What I mean by this is that if we link January's contribution to February's, we get different answers than if we link February's to January's. 

This caused me to recall a rather lengthy series of discussions that occurred about 10 years ago, when we saw several attribution linking methods introduced. I have confirmed with a few folks that the concept of order independence is an important one; I agree.

What is particularly troubling to me is that this contribution linking method is WIDELY used within our industry. But just because everyone else does something doesn't make it right. 

I am going to pursue this matter further, and will offer further comments both here as well as in our newsletters. Any thoughts you have will be welcome.

Wednesday, January 8, 2014

10 Key points about performance attribution

While the role performance attribution has continued to grow within the investment industry, it is, in the words of "Brinson, Hood & Beebower," still evolving. And in its evolution, there remain areas that need to be re-explored, reconsidered, revisited, and rethought about (a lot of "re"s). Anyway, I thought it might be fun to identify some key points that firms should consider.

1. Contribution is a form of attribution. While there are some who will object to this, many of us believe that contribution is essentially "absolute" attribution, as it tell us how the various parts of a portfolio contributed to the total return. It is a commonly found statistic that often accompanies both client and prospect reports. Ideally, a "transaction" based approach should be used, to eliminate the presence of residuals and to ensure accuracy in the results. In addition, it's common to show the "top" and "bottom" five or ten; not typical to see all securities listed. In addition, it can be applied against sectors and virtually any other ways to carve up the portfolio, in order to provide valuable insights.

2. Get the model right -- it needs to align with the investment approach. Make sure the model you use ties into the investment approach, to ensure that the results can be aligned with the actual decisions being made.

3. But don't stop there, slice it up even further! To provide even more valuable insights, don't stop with the standard approach, but slice the portfolio up in additional ways, in order to gain more insights. For example, perhaps decisions aren't made based on style or market cap, but by running your attribution model against your portfolio broken up by large, mid, small cap within growth, core, and value, you can discover additional insights. We credit Ron Surz for this approach (in his words, "attribution with style"). There are many other ways to slice the portfolio up, too.

4. Speaking of which ... contribution of securities not held. An interesting twist to contribution is to run a form where you see what impact your decision NOT to hold certain benchmark securities had on your portfolio. Such information can be very helpful when communicating the reasons why you out- or underperformed the benchmark.

5. Have more information available when you underperform then when you outperform. If you can thoroughly and clearly identify the reason(s) why you underperformed, this will often satisfy your clients and prospects, as it shows that you have your "finger on the pulse," and can clearly articulate what occurred.

6. Don't ignore the currency effect. Too often we find firms that invest outside of their domestic market ignoring the currency effect; this is a huge problem, as it ignores a potential major contributor to performance. You can do well or poorly in the local market, and under or outperform the index because of how currency moved. It's the combination of what occurs in the local market to your securities, as well as the changes to exchange rates, that contribute to your performance. Don't ignore this effect.

7. Knowing when to use a sophisticated currency model. There is a fairly "naïve" currency model which gives just one figure. This approach is fine if you're not engaging in currency forwards, etc. I.e., if your portfolio is "naked" to the effect of currency movement. However, if you make currency bets or do any level of hedging, then you want a more sophisticated model (e.g., Karnosky-Singer) in order to bifurcate currency's effect into the change of the FX rates on your holdings as well as your use of derivatives.

8. If you're using a holdings-based model, seriously consider switching to a transaction-based one. Research I've done shows the ever presence of residuals when firms use holdings-based models. But worse, when using a holdings-based approach I found that frequently the signs of the effects will be opposite of what they should be (e.g., a negative selection effect when it should be positive). I plan to publish these details later this year, and believe it will add great credibility to abandoning the holdings-based methodology.

9. Treat the interaction effect with respect. While I realize that explaining what the interaction effect is can be a challenge, to simply place it with the selection effect is, in my view, improper, as it will occasionally give credit when credit belongs to allocation, or fault, when allocation is the cause. If you don't want to show interaction, then place it where it belongs. I wrote an article on this some time ago, and believe that such analysis can be easily incorporated into an attribution model.

10. If you're going to go below one level in your model, make sure you do your math correctly. Multi-level, multi-layer, nested attribution, if not implemented correctly, can either (a) result in incorrect results or (b) not have the sum of the parts equal the total. Steve Campisi, CFA developed a model that properly handles this type of analysis. He and I plan to do a follow up article, hopefully in the coming months, which will go into further detail on how to implement Steve's approach.

Tuesday, January 7, 2014

Not reporting the impact of currency fluctuations on mutual fund returns because (a) you don't have to and (b) because it can't be done ... considered

I often find the WSJ enlightening. Today provided a very insightful article by Chana R. Schoenberger ("Test Your Smarts ... on Currency Effects", page R5), where I learned that at least some fund analysts believe they cannot tell the impact of currency fluctuations on their returns. I was quite surprised to learn this. 

Ms. Schoenberger poses eight questions and provides the answers to each. And to the second ("How much do currency fluctuations contribute to mutual fund returns?") we learn "Funds do not have to report how much of their performance is due to currency effects, and we actually can't tell," as reported by a senior fund analyst at Morningstar. 

Not reporting the impact of currency movement on returns because we "do not have to" seems to missing a huge opportunity to provide investors (as well as prospective investors) details on the impact of how currency movements contributed or detracted from the fund's performance. To ignore this impact would suggest, perhaps, that the entire movement comes from the appreciation or depreciation of the underlying holdings (i.e., the stock picking and sector/country allocation skills of the investment team, which are typically assessed in the local market), which of course would be false. In addition, such reporting should benefit the firm's management, to understand the sources of return, so that individuals are properly rewarded and credited.

But to report that you "can't tell" seems to reflect a lack of awareness that there are methods available to separate the impact from currency movement. The Karnosky-Singer model, for example, bifurcates the currency effect into (1) the amount coming from the change in currency rates on the underlying securities and (2) the contribution from the use of currency forward contracts. A "naive" model is available that seems to work fine if the manager isn't engaging in the use of currency derivatives. 

I consulted with a client this week on their attribution system; since they're a global equity manager, they calculate currency effects. They very much wish to demonstrate the impact currency has on their client's returns; and, they can. 

Tomorrow I'll post some "key points" about attribution; one addresses this very topic.

Monday, January 6, 2014

10 Common GIPS non-fatal mistakes

The Global Investment Performance Standards (GIPS(R)) are complex and often confusing. And while we have identified common mistakes which can lead to non-compliance (recall that GIPS is very "black-and-white," with no "materiality" for compliance: you either are or are not), there are also mistakes we often see which, though not fatal (i.e., that won't cause the firm to be non-compliant; sorry for the bit of hyperbole), they are mistakes nonetheless.

1. Using the asset-weighted version of standard deviation for dispersion. The asset-weighted standard deviation was first introduced with the AIMR-PPS(R), and falls under that broad category of things that made sense at the time (like, for example, the brake light that U.S. cars must have in the center of their rear window and the lower urinals in men's bathrooms).

I love it when Carl Bacon, CIPM and I agree on anything, and we both agree that this approach is flawed. Unlike the equal-weighted (i.e., universally standard) method to derive standard deviation, the asset-weighted result is not interpretable.

We always recommend that our verification clients replace the asset-weighted version with equal-weighted. You'll note that GIPS, unlike the AIMR-PPS, does not encourage it, and we reject it. While using it isn't non-compliant, it is not a good approach.

2. Saying too much. By this I mean having disclosures that simply aren't needed. For example, "negative disclosures." For example, while GIPS requires firms to disclose the use, extent, etc. of leverage, derivatives, and shorts, if you don't use them you don't need to say anything. Some firms may have the philosophy that the more you disclose, the less likely the prospect will read, but that's an exception, I believe. Better to drop some of these unnecessary statements and enlarge the font size.

3. Showing both firm assets and composite percent of firm assets. I'll confess that this is a subset of #2, but it warrants its own recognition. GIPS 1999 required firms to disclose composite assets, as well as firm assets and composite percent of firm: the reality is that if you have any two of these, you can get to the third, so why require all three? The folks who worked on GIPS 2005 (I was one, by the way) wisely decided to drop the requirement for all three, and only require composite assets and EITHER firm or percent of firm. Why clutter the data columns; they're crowded enough?! We recommend showing firm assets because if you show percent, while you can get to firm it's only an approximation and can be off by a fair amount.

4. Not saying enough, by not including meaningful supplemental information. First, "supplemental information" is essentially anything related to returns or risk that isn't either required or recommended; for example, attribution results. Firms can take great advantage of supplemental information to go beyond the Standards and provide meaningful information to support the firm's performance. I'll probably do a piece on this later, as there are great opportunities here.

5. Not being verified. Granted, verification remains an option and we have come out strongly opposing it ever being mandated (and we believe this will never happen). That being said, there remain some firms who have chosen not to be verified; but why not? It's an investment, just like compliance. If you're not verified you're now required to state this (in the past, you didn't have to say anything about verification). We believe it's worth the investment.

6. Not being verified frequently enough, by not having it done annually. Okay, so you've decided to be verified but periodically skip a year, what's the harm in that? What this means is that you'll be at least a full year with what might be termed a "stale" verification. You're required to indicate the period for which you've been verified, meaning if you skip a year the reader will know this and may wonder why. We recommend doing annual.

7. Being verified too frequently, by having it done quarterly. Our surveys have consistently shown that most firms get verified annually; we recognize that a few verifiers encourage quarterly, with the argument that more up-to-date verifications are better. Better for whom? We believe the verifiers themselves, as it allows them to keep their folks busy all year. The ironic thing is that we often find firms that use such verifiers being several quarters behind, meaning they're showing, for example, that they were verified through two or three quarters ago: where's the benefit in that? To us, it's a waste of money (since quarterly will usually cost more), more disruptive (since you have to respond to verifier requests four times a year, not just one), and unnecessarily time consuming. But, if you like having quarterly done, fine; we are prepared  to do them for our clients, though none (even those who switched to us from quarterly-promoting-verifiers) do.

8. Getting examinations done, without ensuring the cost is justified. I know I've "harped" on this quite a bit, but this list wouldn't be complete without me including this item. While verifications are optional and recommended, performance examinations are merely optional. We have a few clients that have them done, because they believe they have value; however, most of our clients (something "north of" 95%) do not. If you feel they're justified, great! But, at least think about it. Better, ask your verifier why THEY think it's necessary.

9. Defining composites based on client strategy requests, rather than firm marketed strategies. While it's rare, some firms create new composites whenever a client requests a variation to a standard marketing strategy (e.g., you have an emerging market equity strategy, and a client asks for the strategy ex BRIC (Brazil, Russia, India, China) based companies). While the compliant firm may want to create such a composite for marketing reasons (i.e., if they believe other prospects may be interested in such a variation to their standard strategy), to automatically create composites for every client-defined / constrained strategy will result in way too many composites than the firm will likely need. Instead, defining strategies and then establishing a policy for discretion is, in my view, a better approach.

10. Failing to properly format the firm's policies & procedures document. We recently issued a white paper on the subject of policies and procedures; this document falls on the heels of one that was released by the GIPS Executive Committee; we believe both should be referenced to ensure the firm's documents are appropriate. Organizing the document into a logical collective of policies should make its implementation and use much easier. A very simple addition is to add page numbers. Any document greater than two pages should be numbered; actually, even numbering a two page document is perfectly fine (just don't number the first page). When we do verifications and get P&P that aren't numbered, it makes referencing our comments a bit more challenging. But meeting the needs of the verifier is hardly the reason to number pages: numbering should be a standard practice because it makes communication and referencing much simpler.

11. (Bonus!) Not being selective about which recommendations to employ. GIPS recommendations are boldly referred to as "best practice," something we often take exception to, as there are some recommendations we strongly oppose (the most noteworthy is that compliant firms should provide copies of composite presentations to clients on an annual basis, something I've commented on before). There are, however, many recommendations that are excellent, such as showing the equal-weighted composite return.

I happen to believe this is a far superior metric to the required asset-weighted composite return, as it provides an non-skewed report of averages. Too often, very large accounts pull the average in their direction, thus providing something other than the experience of the average investor. Granted, the required disclosures are extensive, so we understand why adding recommended ones may seem to overdue it, but many are worth incorporating.

A word of clarification. Most men don't know that the lower urinals that are typically found in men's bathrooms are not there for children, but rather handicapped: a case of "it seemed like a good idea at the time." The center brake lights we see in the USA are there so that you can see if the car in front of the car in front of you is braking, so that you have early warning. Just try to see if you can actually see these lights. Again, it seemed like a good idea.

Saturday, January 4, 2014

What kind of life do you wish to pursue?

Every once in awhile I want to read some poetry. Yesterday I turned to a book of John Keats’ work. In reading part of the introduction, I was motivated to read some of the letters that are included: it’s amazing how letter writing has become a "thing of the past.," which is sad.

In one letter he speaks of "the life I intend to pursue."

This phrase really struck me hard: who thinks about the life they intend to pursue? But shouldn’t we all? Sadly, we get started with living and don’t typically stop to think such things, but I believe it’s a worthwhile exercise. And, at 63 I don’t think it’s too late for me to reflect on this, though I would encourage younger folks to do this now, before they get too far along living.

This goes well beyond New Year’s resolutions; we’re talking about one’s life. Sadly, the very talented Keats died at a very young age (25), though he seems to have made much of the life he had.

Thursday, January 2, 2014

10 Performance Resolutions for 2014

I thought it fitting to offer some suggested resolutions for the coming year.

1. I resolve to become more educated about my profession by reading more about performance and risk measurement. There are countless resources available. The Journal of Performance Measurement(R) offers the most up-to-date thinking from the industry's leading experts. An annual subscription is quite reasonable, and the journal can be shared with your colleagues. There are also many books that have been published in recent years; it seems as if almost every year there's a new offering. The Spaulding Group has published several, with more planned.

2.  I resolve to get involved more with the industry. There are many ways to do this, including joining a local society and offering to serve on committees. GIPS(R)  (Global Investment Performance Standards) has many committees that are often looking for new recruits: considering putting your name forward. By participating you'll not only grow personally, but will help our industry. The Performance Measurement Forum is also a great way to interact with other performance measurement professionals, and a way to improve yourself as well as your firm.

3. I resolve to become certified. The CFA Institute's CIPM (Certificate in Investment Performance Measurement) program is a great way to become recognized for your expertise (as well as to strengthen it along the way). It also benefits the industry. By the way, The Spaulding Group offers training and other tools to help you be successful.

4. I resolve to get some training for me and my team. The Spaulding Group offers a variety of training classes. They are quite affordable, and are held in various locales. In addition, for firms that have several folks they want trained, we offer inhouse training, which is even more cost effective.

5. I resolve to get our firm compliant with GIPS. Granted, most institutional asset managers are claiming compliance, but there are many that still don't, as well as managers that serve other segments of the market. Plus, asset owners can now claim compliance, which is a worthy goal. Our firm can help.

6. I resolve to question why we spend so much money each year on GIPS examinations. Many firms habitually have their verifier conduct composite examinations, without ever stopping to ask "why do we do this?" I have written and spoken at length on this subject, and hold that while the money to achieve and maintain compliance, as well as to have verifications done are investments, the money spent on examinations are generally costs. Investment firms try to wisely invest their clients' money; why not do the same with your own money? Ask "why are we doing this?" A few of our clients have them done, and feel they have benefits, which is obviously great, but most do not. Try skipping a year and see what happens. If your verifier has never tried to talk you out of examinations, perhaps it's time to consider a change!

7. I resolve to ensure we're providing our clients with meaningful information. Is it time for an inventory or review of what you give to clients? I don't favor reporting standards, but do favor improving what can be improved. Most asset managers fail to provide their clients with money-weighted returns, to accompany their time-weighted ones; in addition, reports often include statistics that don't apply. Perhaps it's time for an independent review of what you're doing.

8. I resolve to attend at least one performance measurement conference in 2014. Great! And why not make it the industry's leading one? The Spaulding Group's Performance Measurement, Attribution & Risk (PMAR) conferences do something that no other industry conference does: offer its attendees a risk-free option. Because we're not a conference company hosting a performance conference, but rather a performance company hosting a conference, we know the topics that are most important and the speakers with the experience, expertise, enthusiasm, and energy to discuss them. Plus, we guarantee that not only will you learn a lot, you'll also have fun! Our North America conference is in Philadelphia, PA in May, while our European will be in London in June.

9. I resolve to improve our risk measurement and management. The greatest area of need in our industry today is risk measurement and management. What statistics do you provide? How do you calculate them? What else can you offer? Plus, what controls do you have in place for managing risk? The 2008 market downturn's poor returns are no longer part of your five-year numbers, but the lessons learned about risk can't be forgotten. What steps have been taken since then to ensure you're doing a better job?

10. I resolve to continue to find ways to improve myself, my department, my company, and what we do for our clients. In general, you should try to constantly improve; what some have called constant and never ending improvement. Reading, learning, experiencing, listening, getting input from others, and sometimes just spending quiet time in reflection can help.

11.* (a bonus) I resolve to ensure we spend our firm's money wisely. I mentioned above the notion of questioning having examinations done. But perhaps think about your verification in general: are you getting what you deserve? Do you have to deal with constant turnover over folks doing the verifications, individuals who are in need of training (which you get to provide), who can't answer your questions, and who seem to take forever to get the job done? Are you forced to repeat the same steps four times a year because your verifier insists upon quarterly? Does your verifier provide "value added" support, such as monthly webinars? If not, perhaps you should consider a change.

I hope you find these suggestions of value.
It's obvious that we offer many resources to help you achieve your goals for the year. Feel free to reach
out to us with any questions you have.
And, may you have a spectacular 2014!

Getting our attribution correct

In our classes I often comment how much of what we do in investment performance and risk is borrowed from other disciplines. For example, "attribution" is employed by many, to identify the source(s), cause(s) and/or contributor(s) of something.

In today's WSJ, Jason Zweig offered a brief commentary on "The Year Ahead" (page A8), where he quoted G.K. Chesterton: "Wisdom should reckon on the unforeseen." This pithy verse is one that could perhaps invoke multiple interpretations, and so I decided to "Google" it, to learn what others thought. This took me to an interesting page, where this very subject was taken up.

One contributor began with the following: "By way of explanation, the sentence makes sense when you know what Poes [sic] Paradox (and Poes [sic] Law) means." This is because Chesterton's line has been extracted from the following text: "As it has been well expressed in the paradox of Poe, wisdom should reckon on the unforeseen." [emphasis added] The contributor continues with an explanation of Poe's Law, which "was originally formulated by Nathan Poe in August 2005."

This struck me as a tad suspicious, because I thought that Chesterton had departed this earth long before 2005. However, several folks applauded this contributor's detailed and seemingly quite logical interpretation of the Chesterton verse. That is until we get to someone who posited that "Another take on this quote could be that it was made in reference to the author, Edgar Allan Poe. The quote comes from 'The Innocence of Father Brown,' by G.K. Chesterton (1874 – 1936)."

And so, if Chesterton died in 1936, how could he have been referring to Poe's Law, introduced by Nathan Poe in 2005? The attribution of the first contributor seems to be off the mark a bit.

Attribution is something that one must be cautious about, yes? A fundamental principle of investment performance attribution is to use the correct model (one that aligns with the investment approach); to do otherwise could lead to nonsensical results, as we discover above. Another fundamental component of the analysis should be, "does it make sense?" Something worth taking into consideration before reporting on one's findings.

Wednesday, January 1, 2014

Happy New Year

Hoping that 2014 is a grand year for you. My it prove to be a prosperous, healthy, rewarding, stimulating, challenging, enlightening, stupendous, exciting, fulfilling, and pretty much fabulous one!

The U.S. stock market had a great 2013; may this year be even better!