Investment Performance Guy

TSG in the media

2012-02-15T13:08:00.000-05:00

This has been a rather busy week for The Spaulding Group and the media.

On Monday, Chris Spaulding, a company SVP who heads sales and client relations, and Patrick Fowler, our firm's COO, were interviewed on WCTC Radio. They discussed sales and marketing techniques, and a venture they began that provides services to New Jersey businesses.

And last night I participated in a panel discussion titled "How to Win the Hearts and Minds of Consultants," which will be aired on Asset TV at the beginning of March, and emailed to their 30,000 plan sponsors and consultant viewers in the US, and added to Bloomberg's 140,000 terminal network in North America. Lillian Jones (Managing Director, Artemis Global Partners) moderated the panel, along with Anna Gilligan of Asset.TV. Joining me on the panel were Russell Kamp (Kamp Consulting Solutions) and Oscar Gil Vollmer (Appomattox Advisory). The session centered on hedge fund transparency and compliance, and as you might expect, my focus was on hedge funds and GIPS(R) (Global Investment Performance Standards).

We hope to provide links to both programs, so you can listen and/or watch!

Happy Valentine's Day!

2012-02-14T07:52:00.000-05:00

The spirit of the rules

2012-02-13T09:20:00.000-05:00

In a recent blog post I referenced the notion of taking into consideration the "spirit" of the GIPS(R) standards (Global Investment Performance Standards) to consider what would be permitted. Being ever mindful of the underlying "spirit" of the Standards, though often difficult to define, is critically important.

Some 35 years ago I worked for a software consulting firm, that was looking to hire new staff. And so, to encourage us to identify prospects, they rewarded anyone who provided management with names. Furthermore, if these folks got hired, the staff member would get an additional "bounty." One rather creative fellow decided to post a "help wanted" advertisement in the local paper, which resulted in quite a large number of resumes. Well, he was paid for each, but management quickly clarified that the idea was to refer people you knew, who you felt were (a) qualified and (b) would fit in with our culture. This fellow, while being industrious, perhaps, clearly went against the the spirit of the initial request; something anyone should have understood. Okay, and so the rules weren't as clearly defined as they might have been, but give me a break!

Twisting and turning rules to fit can justify almost any improper or inappropriate behavior. At dinner last night, with my wife, younger son and his friend, we briefly discussed the idea of someone qualifying why their actions might be acceptable; I'm sure that most thieves and rule breakers have somehow found justification for their actions. While on a recent flight, a fellow sitting next to me continued to have his cell phone on after the plane began to taxi. I suggested that perhaps he should turn it off. He was a bit offended by my request, but my belief is that if the airline bothers to tell us to turn these devices off, there must be a reason for it. He justified his action by saying that he was emailing his son, who has diabetes; I guess he wasn't able to do that until we were taxing. Oh, well.

And so, some things are clearly black and white, while there are other times when there may be gray areas, in which case being mindful of the spirit of the rules should help direct our choices.

Getting GIPS presentations to prospects

2012-02-09T07:41:00.000-05:00

The GIPS(R) Standards (Global Investment Performance Standards) require compliant firms to make every reasonable effort to provide prospects with a compliant presentation (¶ I.0.A.9); actually, not just any presentation, but the one(s) that aligns with the prospective client's objectives. The Standards are kind of silent as to the timing as to when the presentation needs to be provided.

The GIPS Guidance Statement on Supplemental Information states that "[it] does not prohibit firms from preparing and presenting information according to specific requests from prospective clients. However, firms are required to provide a compliant presentation prior to or accompanying any supplemental information." [emphasis added]

The GS defines "supplemental information" as "any performance-related information included as part of a compliant presentation that supplements or enhances the required and/or recommended provisions of the GIPS standards." [emphasis added]

This is almost circular logic is it not? By definition, supplemental information accompanies a presentation, so how could it be sent in advance? But does it therefore also mean that if a firm provides performance information, separate and apart from the GIPS presentation, along with the requested details from the prospect, by definition it cannot be "supplemental information," and is therefore permitted to be sent?

While I recognize that someone may suggest that I am merely being difficult, I do see a hole in this logic. And I realize that one must always be mindful "of the spirit" of the Standards. If a manager isn't quite sure which presentation to send, or if it's quarter- or year-end, and the most recent materials haven't yet been finalized, but the firm wishes to quickly respond to the RFP, and include some preliminary information, with the expectation that presentations will be sent shortly thereafter, is there a problem? I don't see one.

Bottom line, I see ambiguities in what exists today. I also believe that "the spirit" of the Standards is always something to be mindful of. I realize that many like the Standards to be "black and white" on all matters, but there is often some gray, meaning room for interpretation. At a minimum, the presentation(s) needs to be provided in advance of the prospect becoming a client. And, I would say should be provided once you know which presentation(s) are appropriate. The wording regarding it being sent in advance of or along with supplemental information is a bit confusing, however, and I think can be open to interpretation. What do you think?

René Descartes and client reporting

2012-02-08T08:24:00.000-05:00

Leave it to my friend, Philip Lawton, PhD, CFA, CIPM, to find a way to link a philosopher with client reporting. In a recent blog post, he did just that, commenting on the initiative spearheaded by Stefan Illmer, to develop client performance reporting standards for the CFA Institute.

I want to preface my remarks by saying that I love Stefan; he is truly a gift to our industry. He has served us all quite well, most notably in his work on the GIPS(R) (Global Investment Performance Standards) Executive Committee. He is a great leader, who is skilled at the art of compromise. Client reporting has been a passion of Stefan's for some time (he was involved in the development of guidance for the European Investment Performance Committee, several years back). You should also know that Stefan and I agree on many more things than we disagree on (for example, we are both passionate champions of money weighting). Stefan is apparently being assisted by Dmitri Senik, along with others from the industry. I also hold Dmitri in high regard, as well as those members of the committee who have been identified to me. Volunteers should always be honored, for their contributions to our industry are great.

In his post, Philip appears to favor the introduction of standards; I do not.
My issues include:

What problem are these standards to solve? You might ask, why must there be a problem, and you'd have a valid point; and so, why do we need them, then?
Has there been any evidence that the industry wants them? To the contrary, I've found that the industry clearly does not.
Many firms have custom reporting, and have little interest in adopting standards.
What impact will the standards have on asset managers? Plenty! Not only additional time and effort to comply, but also the cost of getting verified (as I understand it, Stefan's committee plans to include this as a recommendation). I often find myself having to remind folks that our firm, The Spaulding Group, actually is a "for profit" company. This isn't always so obvious, when I come out against GIPS performance examinations, and now reporting standards, which would surely bring additional revenue to our firm. But I do not want our verification clients to spend money they don't need to. I am doing a GIPS examination this week, so am clearly supportive of clients who find benefits in having them done; and, we will no doubt be ready-and-willing to verify clients' compliance with reporting standards. We just find the notion of such standards difficult to appreciate.

Let's face it: the CFA Institute has a great presence in our industry. Their contributions are exceptional. We fully support the CIPM program, recognize the value of the CFA, and obviously support GIPS. However, moving forward with this initiative, without first validating the need and desire for standards, is a problem, I believe. Will the reporting standards be implemented and introduced, regardless of what the majority of firms feel? If yes, it is likely that they will become de facto standards, requiring compliance.

We've taken this topic up at the Performance Measurement, Attribution & Risk (PMAR) conferences, meetings of the Performance Measurement Forum, and in conversations with clients, and find an overwhelming opposition to such standards. There is, however, interest in "guidance." Will Stefan and Dmitri's committee be willing to adjust what they're doing to introduce this softer item, or are they (and the CFA Institute) committed to standards? The CFA Institute has enough clout that the line from Field of Dreams will read "build it and they must come." Hopefully flexibility will be present, but only time will tell.

p.s., The Battle Royale at this year's PMAR conferences will deal with this topic. In London you'll be able to witness Stefan battle my colleague, John D. Simpson, CIPM. To avoid bias, Patrick Fowler will, as he always does, serve as moderator.

When random isn't so random

2012-02-07T05:57:00.000-05:00

In conducting research studies, we often want to introduce a degree of randomness, to avoid the potential bias that might creep in if we select our cases directly. There are random number generators available to assist us, although many of them have been challenged for their "true randomness." I know that in research I'm doing on transaction based attribution, I sometimes question whether the random number generator I've chosen is truly producing random results.

While sitting at the boarding area in Oslo, Norway this past Saturday, after conducting a GIPS(R) (Global Investment Performance Standards) verification for a client, one of the officials mentioned that there would be security checks done on a random basis. Well, I soon learned what random meant.

A young man, probably in his mid-to-late 20s, was the security person charged with "randomly" selecting passengers. I observed as he walked up and down the rows of passengers who were seated, awaiting word to board. A couple rows across from me was a very attractive young lady; and sure enough, she was his first "random" selection. While at first I thought this was humorous, when I observed that he was the one who carried out the full body search (and I want to emphasize the word "full"), I became a bit disturbed. But I became even more upset when I saw that his second "random" passenger was another young, attractive woman. This time the girl's father came rushing over, when he learned that she was to be screened. But this didn't deter the security man from once again carrying out the full body search.

Shortly thereafter we boarded, and this episode continued to bother me, to the point that I mentioned it to the attendant in charge, who suggested I contact United when I got home. Well, I decided to go up to some of the passengers who were forced to undergo what I saw as an embarrassing ordeal. I went first to the father of the young girl, who expressed his upset at what had occurred, and how he was reluctant to say much, fearing the result (thinking that he might even be arrested); i.e., he was intimidated by security. I ended up speaking with several of the young ladies (and there were several; all attractive) who were randomly picked. I wanted to see if I could get their contact information, in the event United wanted to speak with them.

Well, the compliant has been filed, and we'll see what becomes of it. But so much for randomness, right? What good is this extra level of security when most of those selected are young, attractive women (the heck with the older guy with explosives strapped to his body!).

Randomness: a great concept that offers much value, but only if it really is random.

p.s., In the unlikely event you're wondering what my issues were: first, it wasn't random, which defeats the purpose of the exercise; second, a woman should have done the body checks of women; third, when checking "private" areas, the back of the hand should be used, not the front. Need I say more?

What does Bill Sharpe have to say?

2012-02-06T12:01:00.000-05:00

Bill Sharpe read my recent blog post on addressing negative Sharpe ratios, and offered the following:

Your blog post seems fine.

About the only alternative I can offer is this:

The (original) Sharpe ratio in effect compares two alternative combinations of treasury bills and portfolios (funds). The one with the higher (ex post) ratio provided a better (or less bad) average return per unit of risk. Thus if portfolio A had a higher ratio than B, a combination of bills and A with the same risk as a combination of bills and B had better (or less bad) performance.

Unfortunately such comparisons are likely to common these days, so keep up your campaign.

I think sometimes think that they don't make sense, but deep down they do. I confess to falling into the belief that negative Sharpe ratios were a problem, but I've come to believe that they are correct. The same issue often happens with time-weighted returns that sometimes don't make sense at first glance, but in reality are perfectly correct.

M-squared's view of negative Sharpe ratios

2012-02-03T01:41:00.006-05:00

In The Spaulding Group's January newsletter, I expanded upon a recent blog post where I introduced a couple graphics in an attempt to "make sense out of" negative Sharpe ratios. Two pillars of the investment performance community, Carl Bacon and Steve Campisi, chimed in with comments, which will appear in the February newsletter. In the mean time, I will take this topic a bit further, with inspiration from both gentlemen.

Would it not be useful to see how the Modigliani-Modigliani risk-adjusted measure responds to negative Sharpes? I believe so. And in truthfulness and full disclosure, I will admit to being kept awake last night thinking about this (graphing it in my head), until I got up to put the materials together.

On the positive side. Let's begin by recalling how the M-squared looks when we're dealing with positive returns.

Recall that we first plot the benchmark (in the risk/return graph), and draw a line from the risk free rate and through it; this is the "market line." We can next plot the portfolio, and draw a similar line. Here I show a case where the portfolio and benchmark have identical returns, but the portfolio has taken on added risk. Note that its line falls below the benchmarks, meaning it will end up with a lower M-squared value.

The fundamental step in this method is to equalize the risks, and this is done graphically here, where we shift the portfolio's point to the left, so that it aligns with the benchmark's risk; and, as predicted, we have a lower return.

What happens on the negative side?

I again chose a case where the portfolio has the same return as the benchmark, and where it also has taken on greater risk. But notice that it plots above the line. We again adjust the portfolio's risk, so that it aligns with the benchmark's, and we see that it has a higher return.

This is what people find confusing: more risk, same negative return, why not a lower Sharpe ratio (risk-adjusted return)? Do the graphics help? Perhaps in some cases, but surely not all.

That's why I hold to the notion that we would expect that by taking on more risk, the portfolio should have a much lower return; however, it doesn't, and thus it gets rewarded. Perhaps if we inverse the thinking a bit: the benchmark took on less risk but did equally bad (i.e., it managed to do as badly as a portfolio that took on more risk, so it somehow captured even greater negativeness than one would have anticipated.

Please let me know your thoughts. I plan to tackle this subject from a beta perspective, too!

Inflating performance

2012-01-31T07:19:00.000-05:00

Excuse me for once again commenting on the subject of trust, but I just learned that Claremont Mckenna College, a prestigious California institution, has admitted to inflating SAT scores to improve it's ranking. There seems to be almost an epidemic in such shenanigans. It hasn't been that long since we learned of teachers in many public schools in the United States changing the answers on student exams, to improve rankings. Cheating has somehow become acceptable, at least in some sectors.

Such actions don't occur without a degree of conspiring on the parts of two or more individuals. How does this happen? Apparently, it isn't so difficult, at least from the rash of cases that have surfaced. Yes, we have our Bernie Madoff and others like him who was successful at getting individuals to work with them in order to do some pretty dishonest things. And yes, over the years we've seen some asset managers inflate their scores to improve their rankings. I find all of this quite disturbing.

And while we can feel good that these are "isolated incidents," when those we hold in the highest regard fail us, that surely impacts our comfort at trusting others, does it not? As a society, we should be concerned that such behavior seems to have almost no limits.

Dispersion relative to what, exactly?

2012-01-30T06:54:00.000-05:00

I participated in a panel discussion last week for the New York Society of Security Analysts (NYSSA). Questions arose regarding the use of standard deviation with GIPS(R) (Global Investment Performance Standards). I used my standard graphic, which distinguishes between this statistic being used as a risk measure (a longitudinal or across time view, looking at 36 months of composite returns) and as a measure of dispersion (for a single period, where we look at the returns of the accounts within the composite, to see how disparate they are).

One individual mentioned that as a dispersion measure, it measures the account returns relative to the composite's return. While this would be, I believe, the ideal, as one should want to know how returns vary relative to the composite, in reality, most firms measure dispersion relative to the average of the accounts that were present for the full period, and this can be quite a different number.

Consider this: We have a composite that begins with 30 accounts; during the year, 10 disappear, and 10 more are added, meaning 20 are present for the full year. The composite's return is derived on a monthly basis, from the accounts present each month; these returns are then linked to produce the composite's return for the year. If one runs standard deviation across the 20 accounts that were present all year, it won't consider the composite's return whatsoever; in order to bring that return into the mix, one must manually (i.e., employ a step-by-step approach) calculate standard deviation, using the composite's average as the average against which each account return is measured.

My suspicion is that few firms employ this more accurate approach. Is there much of a difference? Probably not. However, I think it unfortunate that we weren't clearer as to how this measure is to be derived. Perhaps we will in the future. I'll address this in greater detail in our February newsletter.

Is consistency overblown?

2012-01-27T07:47:00.000-05:00

We, that is, The Spaulding Group, are (or should it be, is?) wrestling with a situation where a client may not be consistent in their pre-2011 adoption of "stub periods" for their GIPS(R) (Global Investment Performance Standards) composites (recall that until 1 January 2011, showing stub period performance in your composite materials was an option; and some might argue, not even permitted!). And so this begs the question: "must they (be consistent, that is)?"

The standards expect consistency, but is this in everything a firm does? I would hope not. Surely asset managers should be granted some degree of flexibility, and not be castigated for an occasional, though intentional, lapse.

The Standards shouldn't be seen as constantly putting up challenges before firms that wish to comply. Surely, it must be challenging and demanding, but not in a silly, nonsensical, unnecessary way.

And while I am the first to criticize those verifiers who "work with their clients" in such a way that they ignore clearly articulated and defined rules (and as a result, put their clients at risk), where the rules haven't been overly prescriptive, let not the verifier be the one to introduce new and unnecessary hurdles. Your thoughts?

Let's take risk reporting to the next level

2012-01-25T09:29:00.000-05:00

The Global Investment Performance Standards (GIPS(R)) now require compliant firms to include the 3-year, annualized standard deviation for the composite and its benchmark. And while this was a somewhat controversial move, it's here, so we live with it. But, why stop there?

For example, while conducting a recent GIPS verification for Reams Asset Management, a division of Scout Investments, I found the following shown for their Unconstrained Fixed Income Composite:

What can we tell from this? Not much.

Okay, the composite had a significant out performance relative to the index (more than 200 bps); but, look at that standard deviation; looks like a lot of risk was taken! If one truly believes in the value of standard deviation, might it be a good idea to move to the next step? That is, to require a risk-adjusted measure, such as (what seems to be the logical choice in this case, given that the risk measure is standard deviation) the Sharpe ratio?

But also observe that we are showing a one-year return and a three-year standard deviation, meaning the match up isn't perfect (and is arguably misleading), and so, let's report what isn't required (but perhaps should also be?): that is, the three-year annualized returns!

A lot more insightful, right?

In this particular case, the benchmark is an absolute index, so the differences are a bit more pronounced than they might otherwise be. But the point is, I believe, still valid: to compare one-year returns with three-year risk statistics is, as we like to say, mixing apples and oranges. And, showing returns and a risk measure doesn't quite do the job.

And so, I encourage the GIPS Executive Committee to:

Require, in addition to the 3-year annualized standard deviations, the corresponding 3-year annualized returns
Require the Sharpe Ratio.

What do you think?

"Say again?"

2012-01-24T07:39:00.000-05:00

It wasn't long after I joined the Field Artillery that I learned that one did not say "repeat" over the radio, especially when speaking to anyone in an artillery battery, as this expression means to "fire again." Instead, one would simply speak the words "say again?" (You can often tell a former army guy, if they say this; you also know when they can spell phonetically (alpha, bravo, charlie, etc.)).

Well, sometimes one is tempted to ask the person one is speaking with to "say again?" when they hear something that is confusing, ambiguous, or unclear. This happened to me recently, when speaking with a client who was wondering about the proper treatment of fees, meaning custodial and management, for "SMA accounts." SMA stands for "separately managed account," and my initial question was "are you able to break the fees out?" Since this firm is a GIPS(R) (Global Investment Performance Standards) verification client of ours, I was a bit confused, since I didn't recall that they had any wrap accounts.

Well, there's the rub. You see, they don't have wrap accounts. The person asking the question is somewhat new to this side of the investment business, and was using the term "SMA" to represent, well, a separately managed account. Sadly, since the wrap fee industry adopted the term "SMA" to represent wrap accounts, confusion often arises; this isn't much different than when someone says "alpha," which can mean (a) excess return, (b) Jensen's alpha, and (c) other things, too! And so, one is forced to qualify what the speaker or writer means.

As I understand it, E.F. Hutton (you recall them, right? "When E.F. Hutton speaks ...") invented "wrap fee" accounts in the early/mid 1980s (an advisor I worked for in the mid 1980s considered introducing wrap fee accounts, too). These accounts "wrap" all the fees (commissions and other trading expenses, advisory fees, custodial fees, broker fees) together into a single fee (e.g., 2.00%; 2.50%), which the client pays. This way, the client doesn't worry about the advisor churning and burning them with lots of trades, which can turn into high commission expenses. My guess is that some in the industry felt that "wrap" didn't have quite the pizazz they wanted, and so the use of "SMA" began. It's probably too bad that no one said "sorry, that term is already in use; pick something else!"

Consequently, when we hear someone say "SMA" or even "separately managed account, qualification is in order. We should try to avoid reusing words and expressions, as this practice often leads to confusion.

The value (and necessity) of trust

2012-01-20T07:16:00.001-05:00

I recently listened to Stephen Covey (the son of Stephen Covey of the "7 Habits" fame) speak on trust. It truly resonated with me, and I'll share just a bit here and more in an upcoming newsletter.

Our industry has suffered from a loss of trust. A highly successful and revered leader, Bernie Madoff, turned out to be a charlatan and a crook. Former New Jersey Governor and Senator, and former Goldman Sachs CEO, Jon Corzine ran a company that appears to have misappropriated client segregated funds. If ever the need for trust was evident, it is today.

In our GIPS(R) (Global Investment Performance Standards) and non-GIPS verification, we must have trust in our clients: if we encounter someone who we don't trust; who we think will try to deceive us, then we won't take them as a client.

As Covey points out, there are two important aspects of trust: character and competence. To gain our full trust, one must have both. To have character without confidence, we know that the person will strive hard to do a good job, but won't fully know enough to be successful, and so will need our support, counsel, and guidance. If the person is highly competent but lacks character, then there is nothing we can for them.

But in a relationship such as this, we, too, must win the trust of our clients, by demonstrating our competence and character. We want them to have confidence in our counsel, and see us as a highly trusted advisor. This is critical to success.

Yes, trust is extremely important. And again, more to follow.

The many faces of standard deviation

2012-01-19T08:45:00.000-05:00

Confusion abounds when it comes to standard deviation. Some of the issues include:

Equal-weighted or asset-weighted?
Divide by "n" or "n-1"?
Is it a measure of variability, volatility, or dispersion?
Is it a measure of risk?
What's the best way to measure relative to the composite's average return?

I'll be brief, but promise to expound further upon this subject in this month's newsletter.

Equal or asset-weighted?

If you've been reading my stuff for any length of time, chances are you know the answer: EQUAL! Okay, so you're allowed to do asset-weighted, but why would you? What does the number mean or represent? This was an idea that some folks thought made sense almost 20 years ago ("since returns are asset-weighted, shouldn't standard deviation?"), but didn't and doesn't. But if you insist on doing asset-weighted, be my guest.

Divide by "n" or "n-1"?

By "n" we mean the number of accounts. I recall that the AIMR-PPS® flip flopped on this one (the first edition (1993) had one form, the second (1997) a different one [perhaps someone was planning to enter politics, and wanted practice]).

We're supposed to use "n" when we're measuring against the population, and "n-1" when against a sample. Dividing by "n" makes standard deviation a bit smaller. Most firms seem to use "n," so I say "why not join them?" We can debate which is appropriate, but why bother?

Is it a measure of variability, volatility or dispersion?

The short answer: yes!

Bill Sharpe, in his 1966 paper used the term "variability" to describe standard deviation (he referred to what we know as the "Sharpe Ratio" as the "reward to variability" (recall it has standard deviation in the denominator) and Jack Treynor's risk-adjusted measure as the "reward to volatility" (it has beta in the denominator)). However, in an email to me not long ago, he said using either the term "variability" or "volatility" is fine. Both of these are used in the context of standard deviation being a measure of risk; what some call "external dispersion."

As for "dispersion," I usually mean this in the same context as some do for "internal dispersion," meaning how the composite's returns compare / vary.

The GIPS® standards (Global Investment Performance Standards) now require both (a) a measure of dispersion (and standard deviation is just one way to accomplish this) and (b) the 36- month, annualized standard deviation for both the composite and benchmark. The former is for a single time period (standard deviation of annual portfolio returns for 2011, for example) and the other across time; a longitudinal measure, if you will (e.g., the 36-month standard deviation of the composite for the period ending 31 December 2011).

Is it a measure of risk?

It depends who you speak to. Since many consider risk to be either (a) the failure to meet the client's objective or (b) losing money, it wouldn't qualify, because it does neither. However, Spaulding Group research has shown that it's the most common measure of risk. And, the GIPS standards now require it (although they've shied away from calling it a "risk measure"). And so, regardless of its detractors, most folks do consider it a measure of risk.

What's the best way to measure relative to the composite's average return?

I saved the best for last. I am conducting a GIPS verification and was validating the client's measure of dispersion; in this case, equal-weighted standard deviation. Because I couldn't match what they had, I tried comparing it to the composite return; let me explain.

If you use Excel, for example, and run the "STDEVP" function against the returns of all account's present for the full year, you're measuring standard deviation against the average of these returns, which in almost all cases will not be the same as the composite's return, meaning it's telling us how disparate the returns are around this average, not the average reported in the presentation. I believe that ideally it should be run against the composite's return. However, this would require several more steps, and couldn't be invoked by simply running a similar function like STDEVP. Too bad.

--------------------------------------------------

And so, standard deviation isn't really so simple, is it?

Lessons from a former CEO, U.S. Senator, and Governor, on how to avoid risk hurdles

2012-01-18T08:58:00.000-05:00

In yesterday's WSJ we saw yet another article regarding MF Global Holdings and its former CEO, Jon Corzine ("MF Probe Targets Back-Office Unit") . This time we learn that just about everyone in the company has been interviewed by federal prosecutors, save for the Honorable former Governor of the great state of New Jersey, and a few other former seniors from the firm.

In the spirit of "full disclosure" I must confess that as a resident of the Garden State, I did not vote for Corzine when he ran for Senator or Governor, and my reasons aren't because he is a Democrat, as I have been known to vote for several Democrats, including the member of the House of Representatives (Rush Holt) who represents my district. It is one thing to persuade lots of people to make significant donations to your campaign, as Barack Obama and many others have done; it's another to spend millions of your own dollars to buy a Senate seat and Governor's position. Perhaps he was fired from Goldman Sachs for a reason. His performance as a U.S. Senator was one with no notable accomplishments, and as Governor, his performance was so bad that this predominantly Democratic state voted him out (something that rarely occurs).

It has been reported that Corzine, when confronted by MF Global's risk officer (who no doubt was paid a sizable amount to guard the firm against taking unnecessary risks) about his desire to invest so much of the company's funds in sovereign debt, said something to the effect of "if you won't let me do this, I'll quit!" At least somewhere in the WSJ I recall reading something to this effect, as incredulous as this may sound.

I am blessed with two beautiful grandsons. But I have confidence that their father (my older son) and their mother (my lovely daughter-in-law), if talked to in a similar fashion, wouldn't budge. But no; not in this case. A CEO who throws the equivalent of a tantrum is told "okay, go ahead."

Risk managers are hired and risk controls are implemented for very good reasons; and one would think that the CEO, who as spent decades on Wall Street, would know as much, respect them, and even serve perhaps as an example in honoring them (so much for the "honorable").

Risk remains a very difficult subject to get our arms around. Risk managers, risk officers, risk controls, risk management rules, etc. are necessary; they must be honored, respected, and ahered to.

Marrying Performance and Risk

2012-01-17T15:51:00.000-05:00

I have been invited to join the CFA Institute's Jonathan Boersma and Neuberger Berman's Leah Modigliani to speak on the subject of risk, at an evening event at the NYSSA (New York Society of Security Analysts). The program takes place at 6 o'clock on January 26.

I am particularly looking forward to this, simply to hear Leah once again discuss the risk-adjusted measure she and her Nobel Prize winning grandfather, the late Franco Modigliani, developed; to me, this alone, is "worth the price of admission." As I understand it, Jonathan will discuss GIPS' (Global Investment Performance Standards) new risk reporting requirement; I will briefly provide an overview of a variety of measures, and then Leah will discuss M-squared (I guess we could say that she's "one of the M's" in this model!).

Hope you can join us; I guarantee you'll benefit!

Can I be accused of caviling? Hopefully not.

2012-01-17T09:36:00.001-05:00

The editorial writers of The Wall Street Journal would make Bill Buckley proud, given the frequency in which they use words that are unfamiliar to many of us, thus providing the opportunity to strengthen our vocabulary. A weekend issue from last October was no exception.

In their "Killing Awlaki" piece, they mentioned how "The caviling over Awlaki's death began almost the moment the news was announced." This required me to turn to my trusty source for word meanings, dictionary.com, where I discovered that "cavil" means "to raise irritating and trivial objections; find fault with unnecessarily." Perhaps you were already familiar with this word; I was not (or if I was, I long ago forgot it; a "senior moment" perhaps).

Well, as one who has, on occasion, voiced opinions about such things as the Global Investment Performance Standards (GIPS(R)), I would hope that my comments have not been likened to caviling. And while some may be irritated by some of the points I have raised, I don't believe they have been trivial. Irritation, if there has been any, might stem from uninvited or unwelcome questioning, which I imagine can become tedious at times. But if we want our rules to be as good and valuable as possible, comments and challenges should be welcome, yes? I believe with confidence that for the most part, those who oversee the Standards are open to such comments. But if I ever do cavil, I hope someone will let me know!

Almost Everything We're Taught Is Wrong, well maybe not almost everything

2012-01-13T09:51:00.000-05:00

Last year John Stossel wrote a piece titled "Almost Everything We're Taught Is Wrong." When it comes to performance measurement, there's some truth to this, too. Sorrowfully, many refuse to be open to the possibility that the way they've been doing or promoting something is fundamentally wrong. Is it pride, a refusal to be objective, impatience or frustration with those of us who challenge the "conventional wisdom," a resolute commitment to the traditional methods, or some other reason?

I must confess I've been guilty of this, too. We learn something at an early age, and it gets reinforced along the way. Then, out of the blue, someone comes and says "no, there's a different way," or "no, what you're doing is wrong," or, "no, your understand is incorrect." How do we react? Our natural reaction is usually a defensive one: that is often the case with me. I have to learn to pause, listen, reflect, consider. A lot to ask, but really what's necessary.

Take Modified Dietz, for example. I was taught that it was a time-weighted rate of return: FULL STOP! That's it. And then I'm told (by my friend Carl Bacon and a few others) "no, actually it's a money-weighted rate of return." "WHAT!" And so, I turn to the literature, and nowhere do I read that this is true; on the contrary, everything points to it being a time-weighted rate of return. Carl is clearly mistaken.

Somewhere along the way I realized that (dare I say it?) Carl was correct. BUT, do I confess (mea culpa)? And, do I tell others? After all, just about everyone knows that Mod Dietz is time-weighted. By coming out with this revelation, won't confusion be rampant? Can the performance measurement industry stand such a jolt? Well, after much soul searching, I realized that regardless of the impact, the truth must be told: Modified Dietz is money-weighted ... unless, of course, you link it, and then it's an approximation to time-weighting (right, Steve?).

But there is so much more that we do that is simply wrong; for example:

using the aggregate method for GIPS(R) (Global Investment Performance Standards) compliance
relying so heavily on time-weighting, when money-weighting is a superior method
requiring asset-weighted composite returns rather than (or, at a minimum, along with) equal-weighted composite returns for GIPS compliance.

Opportunities still arise for change, however. And it will come, eventually.

Making sense of negative Sharpe ratios

2012-01-12T07:53:00.000-05:00

I'm teaching an in-house Fundamentals of Performance class this week in Canada, and, as usual, we touch upon the Sharpe ratio, and how negative Sharpe ratios can produce results which appear inconsistent with our expectations.

To help try to communicate what's going on, I constructed the following graphic:

What you're seeing are two different cases: one where we're dealing with a positive Sharpe ratio, and the other where we have a negative. In both cases, the portfolio's risk exceeds that of the benchmark, and in both cases the portfolio's return equals that of the benchmark. On the positive side, given the higher risk, we would expect a higher return for the portfolio; but because it failed to do that, we end up with a lower Sharpe ratio. On the negative side, we would expect to see a lower return, given the higher risk; but failing to see this occur, we are rewarded with a higher Sharpe ratio.

This may not be clear enough to comprehend, and I will take the subject up later this month, in our monthly newsletter. So, consider this a "warm up"!

PMAR IX Transcripts Published

2012-01-11T08:38:00.000-05:00

We're pleased to announce that the transcripts from last year's Performance Measurement, Attribution, and Risk (PMAR) conference has been published. Since The Spaulding Group began the conference ten years ago, we have gone to the expense of time and money to produce these reports, because of the valuable information that's shared at the events.

As Patrick Fowler stated in the press release which was published last week, there are several reasons we go to this expense: "our speakers and topics are very important, and we want to capture what is shared, as it often makes a profound impact on the industry. Second, we know that it's easy to forget some of what is shared during a talk, and these books allow attendees to review sessions to recall information, and perhaps gain additional insights. Third, we know that many who attend would like to share the information with others in their firm, but even the most gifted listener cannot record all the pertinent details of a speech. Fourth, our vendors are given the opportunity to place advertisements in these books, which is yet another way for them to communicate with our clients. And finally, we believe that the transcripts bring back great memories of the event, as we include many photos that our attendees can peruse. In addition to the transcripts, attendees receive audio CDs, which allow them to listen to the conference presentations, and share with their colleagues." All attendees of the conference receive complimentary copies of these materials.

The transcripts for last year's PMAR Europe III will be published shortly. Attendees of last year's event will be sent complimentary copies, along with audio CDs of the program.

PMAR North America X will be held at the Ritz-Carlton, Philadelphia on May 23 and 24. PMAR Europe III will be held at the America Square Conference Centre in London on June 12 and 13. To learn more about these conferences, please contact Christopher Spaulding or Patrick Fowler or visit TSG's website.

Who benefits from quarterly verifications?

2012-01-10T07:53:00.001-05:00

The Spaulding Group is sometimes asked if we do quarterly GIPS(R) (Global Investment Performance Standards) verifications. We would be happy to, but strongly recommend against it. And why is this?

Well, we firmly believe that the only one who benefits from quarterly is the verifier; and this is for two reasons:

They can charge more, because they increase the frequency of visits
It keeps their staff busy all year round!

We oppose it because:

It's disruptive to the client
It costs more
There are no added benefits from more frequent verifications

What benefit does it provide? Does the client really think that they are going to fall out of compliance within a quarter, or a few quarters? Recall that verification does two things; it "assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm’s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards." Even though the Standards encourage firms to reflect quarterly and/or monthly returns on their presentations (see ¶ I.5.B.2.c), we don't feel this means they need to immediately get those quarters verified.

As verifiers, we focus on the firm's policies and procedures, and its composite construction. Chances are the P&P won't change very much during the year, so that leaves the composite construction. Why must we monitor clients monthly? If we give interim reports rather than an annual, will it really help them?

During the year we often engage with our clients. Our clients frequently contact us with questions or seek advice. Our clients are invited to participate in our monthly webinars at no cost. And, we share information with them in other ways. And so, why bother them with quarterly visits?

Interestingly, of the numerous firms who have switched to The Spaulding Group from verifiers who required quarterly, none have continued at this frequency: all have been happy to move to annual.

Disagree? Think quarterly is a good idea? Let me know why! I'd love to hear your reasons. And the competing verifiers who read this blog are invited to chime in, too, but not anonymously, otherwise they won't be posted.

A year of epiphanies, perhaps?

2012-01-08T21:41:00.000-05:00

Today is the Feast of the Epiphany. At Church our pastor explained the meaning of the term:

capitalized, it refers to the manifestation of Christ to the gentiles in the persons of the Magi (three Kings)
lower case, it is a sudden, intuitive perception of or insight into the reality or essential meaning of something, usually initiated by some simple, homely, or commonplace occurrence or experience.

For our purposes, I'm referring to the latter. Surely you've encountered situations that you could describe as "epiphanies." Moments when all of a sudden something makes sense. This happens to me on a regular basis. And I often share these in this blog and/or our newsletter.

Epiphanies should be sought out, as they are ways for us to grow. To strive to make this a "year of epiphanies" is, I believe, a worthy objective. For me, I'd like every year to be one.

p.s., the definitions above, while consistent with what our priest stated, are actually from www.Dictionary.com.

How large is your stack of quotidian reports?

2012-01-07T17:06:00.000-05:00

If you're like me, the word "quotidian" is probably one you're not terribly familiar with. Perhaps you don't even see it in print regularly, though interestingly it appeared twice on page A15 of the July 26, 2011 edition of The Wall Street Journal, in both an article on the nutcase Anders Breivik and a book review of Rules of Civility, by Amor Towles (a book I happened to read, and found quite good).

Bret Stephens, the author of the first piece references the "quotidian details of [Breivik's] shooting," while Joanne Kaufman, who penned the book review, referenced the "quotidian pursuits like commerce."

So what does this word mean? My favorite source for word meanings offers the following:

adjective
1. daily: a quotidian report.
2. usual or customary; everyday: quotidian needs.
3. ordinary; commonplace: paintings of no more than quotidian artistry.
4. (of a fever, ague, etc.) characterized by paroxysms that recur daily.

noun
5. something recurring daily.
6. a quotidian fever or ague.

And thus the real reason for this post: your quotidian reports (or the ones you produce and give to various folks in your organization). When was the last time you did an inventory of them? Are they needed? Can they be improved? Might be a good new year's project!

Fun stuff!

2012-01-06T17:12:00.000-05:00

We got picked up in another blog; kind of cute, so sharing it here!

The "regulator's dilemma"

2012-01-05T10:50:00.001-05:00

I often save clippings from newspapers and magazines, to refer back to at a future date. I just discovered one from the August 12, 2011 issue of the WSJ: it's from their "op ed" section, titled "S&P 500 and the 'Regulator's Dilemma.'"

The article discusses the U.S. Senate Banking Committee's examination of Standard &Poor's decision to downgrade the long-term U.S. debt. The writer points out something ironic: "S&P's judgements carry such weight because Washington [i.e., the federal government, or perhaps more correctly, the United States Congress] told the markets to pay attention to them. Federal regulators have embedded credit ratings into countless financial rules." Not surprisingly, as a result of Congress' habit of excluding various parties from their regulations (even themselves, on occasion), Treasury debt was exempt.

The author points out that "a critical ingredient in the 2008 financial crisis was the encouragement that regulators gave banks to hold mortgage-backed securities rated by S&P, Moody's and Fitch – the government-created oligopoly of credit judges."

And while Dodd-Frank instructed bureaucrats to remove credit rating references from their rules, bank regulators resisted, because of their struggle to devise better standards to judge an asset's safety.

A key statement in this piece: "as counterintuitive as it may be to politicians, having no federal standard on risk is the best standard of all." [emphasis added]

Those interested in reviewing the article's points regarding banking regulations are welcome to do so. My reason for mentioning this piece is the reference to trying to "standardize risk." It's illusive, ambiguous, impossible to classify with any degree of agreement, and impossible to measure in a way that all would find acceptable.

In my recent post that highlighted the 10 things I like best about GIPS(R) (Global Investment Performance Standards), I (with some hesitation I might add) applauded the introduction of the requirement for a three-year annualized standard deviation. Not because I think it's an ideal measure, because I'm on record objecting to it. However, I also realize that there is no measure that all would agree with, and that this is a formula that is quite easy to calculate and interpret. Firms can include additional risk measures; the new requirement simply aims to have something that prospective clients can see.

In the Standards' 2010 edition exposure draft, the GIPS Executive Committee suggested mandating risk disclosures in composite presentations; this was objected to by most who took the time to comment, and the EC wisely withdrew it. Risk is SO difficult to get one's arms around. Trying to regulate it, much more than this simple requirement, would probably be unwise. And, create additional dilemmas we don't need.

Time and Money Weighting: making sense of the differences

2012-01-04T09:12:00.000-05:00

When teaching our Fundamentals of Investment Performance course, when writing my books, and often when simply having conversations with clients, I am often faced with the task of explaining, in as clear a manner as possible, the differences between time and money weighting. This topic is one of the most confusing in our industry. I've heard, on several occasions, performance measurement veterans misspeak when it comes to these matters.

At the core it all boils down to cash flows: whether to include them in the process, or eliminate (or at least reduce) their impact on the resulting return. And while a few folks suggest that their implementation has nothing to do with who controls the cash flows, the reality is that this is definitely the main reason behind deciding upon which to use (though there are times when we actually ignore this, in favor of the insights provided).

And it also boils down to linking. That is, the geometric linking of returns.

Time weighting comes in two forms: exact and approximate. Exact methods revalue the portfolio for all cash flows, and calculate returns between each of these revaluations. Approximation methods may revalue for large flows, but not all flows (or they'd be exact). And linking occurs at any point when the portfolio is revalued (either when large flows occur, or at month-ends).

We typically use either the Modified Dietz or Internal Rate of Return (IRR) formula in our approximation methods. Both of these formulas, by themselves, are actually money-weighted methods. We transform them into time-weighting when we employ geometric linking!

The following graphic contrasts money and time weighting:

As you can see, we are calculating returns in two ways: by time and money weighting. The essential difference is that with time-weighting, we value the portfolio multiple times during the period, and link the intermediate results, while for money weighting, we only value at the end points.

Can more be said on this topic? Yes! And more will be, so stay tuned.

Down with obfuscation!

2012-01-03T15:35:00.000-05:00

As we begin a new year (and one of the "leap" variety, at that!), I wish to share with you further commentary from Henry Hitchings' The Language Wars. Recall that I mentioned this book in a recent post. The reality is, there is much of what he's written which lends itself to issues we deal with.

He points out that "It is no fun to have to read twice a sentence which, on the second reading, we find we didn't even want to read once. Skillful handling of language will tend to reduce the amount of cognitive effort one's audience has to expend in getting at one's meaning. If my expression is confused and ambiguous, I risk losing your attention."

Surely you can relate to cases where clarity is hard to find, and information shared is unnecessarily obfuscated (but then again, is it ever necessary to introduce obfuscation?). At times it seems that some speakers and authors wish to go out of their way to make something more complicated than it needs to be.

Hitchings cites Noam Chomsky, who stated that "language's main purposes [are] to transmit information, establish relationships, express our thoughts or clarify them, pursue knowledge and understanding, exercise our minds creatively, and play. In all but the last two of these, lucidity is vital. Precise and conventional use of language averts painful misunderstandings."

I have been told that one of my gifts is the ability to communicate in a very lucid manner; this may be due to my need to be lucid for myself, let alone the audience, to ensure that I understand what I'm communicating! I first became aware of this skill when I taught a business mathematics course at the University of Baltimore, while pursuing my MBA, more than 30 years ago. It was essentially a survey course, which touched on many areas of math, including algebra and basic calculus. I didn't feel the need to impress the students with my knowledge, but rather to convey the knowledge to them so that they could understand it. I succeeded, and thus realized that I could, in fact, share complex material in a, well, lucid fashion!

A few years ago, at a Performance Measurement Forum meeting, we had a speaker explain a particular risk measure. While I cannot speak for my fellow attendees, I found the presentation difficult to understand. And so, I slowed the speaker down, and asked some very basic questions. As a result, I was able to grasp a much better understanding then I would otherwise have obtained. Meaning, sometimes it's up to the listener to ask for clarity.

Of what value is it to overly complicate information? An oft cited quote, attributed to Einstein, is to "make things as simple as possible, but not simpler." A good idea, I think!

"We are the agents of change"

2011-12-29T07:53:00.001-05:00

One of my Christmas presents this year was the book, The Language Wars, by Henry Hitchings. Not surprisingly, I have already discovered some great insights which translate well to our profession.

Hitchings quotes American linguist William Dwight Whitney: “‘Every existing form of human speech is a body of arbitrary and conventional signs...handed down by tradition.’ Crucially, therefore, change is ‘the fundamental fact upon which rests the whole method of linguistic study.’”

Hitchings points out how “we may experience a kind of amnesia about what the words we employ used to mean and where they came from.” Sound familiar? See any relevancy here?

“Change happens” Hitchings proclaims, and “We are the agents of change...Needs alter, values shift, and opportunities vary.”

To say that some of our rules are arbitrary would be inaccurate and unfair; but many are due to convention, and perhaps “handed down by tradition.” Why not open our eyes to the possibility that some changes are in order?

As to the book, if you’re an avid reader, writer, or merely interested in language, you are sure to find it of interest. It was reviewed in the WSJ recently, and placed on my list of books I’d like to receive, and my wife was kind enough to include it with my other gifts. I think you’ll like it!

New Year's Resolutions

2011-12-27T09:18:00.000-05:00

It's that time of year when folks begin to think about things they want to change come the new year.

It occurred to me that wisdom from one of the most renowned and powerful Jedi Masters, Yoda, might serve us well. After all, he was known for his legendary wisdom and mastery of the Force, not to mention his skills in lightsaber combat!

You must unlearn what you have learned

This is a tough one, I must confess. We tend to hold on to beliefs that we learned early on, without regarding the possibility that there could be any other way. And, I must confess that I have been guilty of this shortcoming too many times, myself.

I hardly expect that we will all agree on one set of beliefs, and there is always room for different approaches. But to at least be open to why one approach might be better than another would be wise. Here is an abbreviated list of areas where one might consider exploring the alternative(s):

Rates of return: be open to employing money-weighted returns. Why must time-weighting dominate?

Attribution: arithmetic versus geometric. Here is one area where I must try to see the benefit of geometric.

GIPS(R) (Global Investment Performance Standards): I invite others to see that the two broad approaches to derive composite returns (using beginning market values (with or without weighted flows) versus the aggregate method) yield two completely different results, meaning two different definitions for this value. In addition, for more PMPs (Performance Measurement Professionals) to see that equal-weighting is superior to asset-weighting.

Risk: be open to exploring alternative metrics, both ex post and ex ante.

Season's Greetings

2011-12-24T22:24:00.001-05:00

When I was 15 I met Ian Harvey when I joined the Order of DeMolay (a Masonic-sponsored group for young men). We became friends and remained very good friends until his death from cancer, five years ago. Ian was Jewish, and he said how he really liked it when Chanukah and Christmas overlapped. While they obviously don't always, they do this year.

And so, I wish my Jewish brothers and sisters, a very Happy Chanukah.

And, to my fellow Christian brothers and sisters, a very Merry Christmas.

And to all, a safe, happy, healthy, and prosperous New Year! May 2012 be a great one for us all. God bless.

The 10 Best Things About GIPS

2011-12-21T07:10:00.001-05:00

As I explained in yesterday's post, I would balance out my 10 "not so good things" about GIPS(R)" (Global Investment Performance Standards) with my "10 best."

--------------------

#10 3-year annualized standard deviation: Okay, so I'm not a huge fan of standard deviation as a risk measure, and voted against it in my comments on the 2010 exposure draft. But, I realize, too, that getting agreement on a risk measure is quite a challenge. And the need for a risk measure in the Standards justifies something, almost anything. Standard deviation is easy to calculate and understand. And firms can always augment it with other risk measures, and probably should.

#9 The GIPS Help Desk: Arguably, one could simply say the CFA Institute, but we'll just focus on the individuals who respond to questions that come in on "all things GIPS-related." They work very hard to respond quickly to requests, and attempt to be as clear as possible. No doubt they are often inundated with inquiries. Where would the Standards be without them?

#8 The GIPS Country Council: This group represents the 30+ countries who endorse the standards. And while they do not dedicate the same level of time as the EC, they are still extremely important, and worthy of our praise and thanks.

#7 The GIPS Executive Committee: Where would we be without this body, to manage the standards' development? Eight of its nine members are unpaid volunteers, who devote countless hours to the standards, on our behalf. We are in their debt and gratitude. While we may not always agree with them, we recognize that they do what they believe is best for the industry.

#6 Significant cash flows: I take pride in pushing the introduction of this provision, along with Neil Riddles and a few others, who felt that to force managers to keep accounts in their composites when they experienced very large flows made no sense. While many firms don't avail themselves of this option, many do, and at least firms have this opportunity.

#5 Verifier independence guidance: Having seen some verifiers go to great lengths to obliterate any semblance of independence, the introduction of a formal guidance statement on this matter was an important step, in at least memorializing some rules. Granted, some verifiers still manage to cross the boundaries, but at least we have rules.

#4 Dispersion: In 1970, Chevrolet introduced the Vega (I bought one (model year 1972) in November 1971: my first new car). It was a nice car for its time, but the initial edition (model year 1971) was missing something: a glove box! An acknowledged oversight which was quickly corrected with the 1972 version. Well, the initial version of the AIMR-PPS was missing something: dispersion! This was corrected in 1997, and provides a great deal of insight into a composite's management: a return by itself just doesn't say enough. Does the manager consistently apply the style across all clients, or are they "all over the map" with their investments? This is important information, which is a necessary and required disclosure in the Standards, by way of standard deviation (not to be confused with the required 3-year annualized, which is a risk measure; here, it's a measure of dispersion), high/low, range, or quartile dispersion, for any composite with six or more accounts present for the full period.

#3 The composite: To me, the bedrock of the standards is the composite. They're powerful, and yet flexible, too. Yes, they can be quite complicated, but at the heart, they're quite simple, at least to understand. They provide the prospective client with a thorough understanding as to how the manager managed the style/strategy they're interested in. What a concept!

#2 The globalization of the standard: AIMR, back in the mid 1990s, had the forethought to create a global committee, which ended up crafting GIPS. They could have allowed each country to "do their own thing" (as many began to do, following the introduction of the "PPS" in 1993) but they chose to be proactive, assemble a team of international performance professionals, and create what became a single global standard: what an accomplishment!

#1 The standards, in general: I believe we owe a huge debt of gratitude to the gentlemen who were on the "blue ribbon committee" back in the mid 1980s who crafted the first performance presentation standards: a great idea that has seen worldwide support. And the fact that this was taken up by AIMR (now the CFA Institute) is a huge commitment, responsibility, and service to the industry.

---------------------

Anyone involved with the Standards could obviously craft their own list. And I do not expect you to agree with everything I've written. If you have ideas, thoughts, reactions, please let me know! But reminder: please do not do it "anonymously," as it then won't appear in the blog.

The 10 "Not So Good" Things About GIPS

2011-12-20T07:37:00.000-05:00

Over the past several months, I've had conversations with other PMPs (Performance Measurement Professionals) about the GIPS(R) Standards (Global Investment Performance Standards). And while we are in agreement that the standards are exceptional, necessary, and highly successful, and something we all support, we're also in agreement that there are some shortcomings (as one might expect with such a complex document). And, of course, there are many things about these standards we like a lot. And so, I thought I'd put two lists together, representing both sides.

I first thought of referring to this first list as the "10 worst things" about GIPS, because I will identify the "10 best things" about the Standards tomorrow, but thanks to feedback from colleagues I decided that the word "worst" might engender some ill feelings among some folks (which is not my intent or desire), and perhaps sounds really negative. And so, what to call the list?, I wondered. Someone suggested making it like Santa's "naughty and nice" list, but I thought that didn't fit well. How about the "10 could be better" list?, but that wasn't very crisp. After much thought, I settled on this "euphemismistic" title: "The 10 'Not So Good' Things About GIPS."

And so, here is my list of the 10 "not so good" things about the standards, and in David Letterman style:

--------------------------

#10 Performance Examinations: The GIPS draft didn't include examinations, but somehow they were introduced when the first edition was published. They have virtually nothing to do with the standards, and cost managers tens (and in some cases, hundreds) of thousands of dollars a year. The Spaulding Group is happy to do them for our clients, as we are a for-profit company, but discourage our clients from having the expense (compliance is an investment; verification is an investment; examinations are usually an expense). And most of the clients we've won from other verifiers, who previously had them done, have ceased; and none of the clients we were the first verifier for have them done.

Are examinations necessarily a "bad" thing? No, perhaps not; perhaps they fulfill a need that some folks have, to undergo an independent review of the underlying data, to enhance the credibility of their presentation. But, I believe they're overdone, and that too many firms have ALL of their composites examined, or ALL of their "marketed" done, when this isn't really necessary.

#9 Model fees: GIPS 2010 introduced a term: "model fees." But, there is no definition for it! I've asked for one, but am still waiting. You would think that if a new term is introduced, it would have a definition, but this did not occur. Maybe we'll see one in the 2015 edition.

#8 The recommendation that compliant firms annually give their existing clients a copy of the composite(s) their account is in. This idea, when introduced in the 2010 Exposure Draft, was met with strong opposition. But rather than listen to those opinions, the EC decided to make this part of the standards: and since recommendations are, by definition, "best practice," someone thinks that all firms should do it.

I am curious to know how many members of the EC, who work for asset managers, send these reports to all of their clients annually; I suspect few, if any. Reporting to existing clients is arguably "out of scope" for GIPS. This was a bad idea, but unfortunately it's with us.

#7 Introducing a rule disallowing intra-month additions of accounts in a Q&A: There is no doubt that the recent addition of this rule was in response to my vocal opposition to the aggregate method, as several of my examples pointed out how the aggregate method could yield nonsensical results when accounts were added during the month. However, after further reflection, and the realization that the aggregate method, by definition, isn't supposed to look like the asset-weighted methods, since it's measuring something completely different, it turns out that intra-month additions for the aggregate method are perfectly fine; they shouldn't be allowed for asset-weighted methods. But more importantly, introducing a rule, in a Q&A, no basis for it, with no opportunity for public comment, and with no effective date? One might suggest (as a colleague did to me) that the concept is good, but it's lacking (a) a clear definition of the concept of a "performance measurement period," and (b) a basis for the Q&A in the existing provisions and guidance, which would justify the requirement. I recommend retracting the Q&A and treating this rule change as any other would be: by putting it out for public comment, with sufficient supporting language to make its application clear.

#6 No GIPS Handbook. We still do not have a GIPS Handbook, which is odd/unfortunate, because GIPS 2010 has been in effect for a full year, and so many rely on this important document. Having worked on the current handbook, when I was a member of the Investment Performance Council and Interpretations Subcommittee, I know how challenging revisions can be, especially following major changes to the Standards. But I also know how important the document is. We have had several inquiries from our clients about it, and its absence is a problem. Hopefully it will be here soon.

#5 Dropping after-tax. The 2005 edition of GIPS included after-tax provisions for the U.S. and Italy. It was decided to drop them completely from the 2010 edition, rather than (a) allow them to stay, (b) encourage other countries to offer rules, or (c) come up with generic rules. This has resulted in a great deal of confusion, at least here in the U.S. In addition, it has removed an important element: after-tax performance.

Perhaps the EC could have, and perhaps should have, made more of an effort to come up with something here. And perhaps a USA-bias was the problem, and a feeling that a global standard would need to be as specific as the existing U.S. guidance, causing people to think any global tax provisions would be bogged down with accounting details. But, the right answer may have been to become more principles-based (with the necessary disclosures) rather than rules-based, with respect to after-tax provisions and guidance. Perhaps something to take up with the 2015 version. My colleague, John Simpson, CIPM, has worked on these rules for many years, and would be a great candidate to lead such an effort. And, I will toss in Douglas Rogers' name, too, as he, like John, is a recognized expert on this subject, and could contribute greatly to the assembly of such a document.

#4 The Error Correction Guidance Statement: It would be a bit unfair (and not my intention) to label the entire GS as a bad idea, especially since I crafted the initial working draft several years ago (which was based on an article Stefan Illmer and I wrote). But the version that went into effect in January 2010 was poorly handled: it introduced several changes to the earlier draft (which had been approved by the IPC), including requirements, which arguably should have been put to the public for comment. Once the EC saw how the ideas were, received they were when made part of the standards (in the 2010 exposure draft), they (the EC) pulled them from the standards. But, since they were in the GS, they would still be required!

The most recent GS edition is much improved, save for the third level of the recommended error correction hierarchy, which is a requirement to disclose immaterial errors, for an indefinite period! There's a reason the public is asked to comment! Oh, and to clarify: the concept of the guidance is both great and necessary, and we fully support it (heck, it may have been my idea, come to think about it!); the problem is how it was introduced.

#3 The aggregate method for composite returns. I have commented on this before, but it's clearly in my top (I mean, bottom) list. The aggregate method tells us how the composite did: who cares? Who manages the composite? Why wouldn't we want to know how the average account did? Okay, while I'd prefer the equal-weighted average, I'll take the asset-weighted average any day over the composite's return, which I believe is useless information.

But perhaps more importantly, the GIPS EC needs to define what "composite definition" means, as I have suggested in the past, as the two broad calculation areas (asset-weighted methods vs. aggregate) produce two very different numbers, representing two very different things.

#2 The use of asset-weighting to measure performance. Back when the Association for Investment Management & Research (CFA Institute's former moniker) were crafting the AIMR-PPS(R), two groups (the ICAA (now the IAA) and IMCA) opposed the use of asset-weighting of portfolio returns, as it could skew the results in favor of the larger account(s). But AIMR refused to budge, and asset-weighting remains. Over the past year or so I've learned that they (the ICAA and IMCA) were right: equal-weighting is a much better way to assemble the returns. For example, a very large mutual fund's return can dwarf the returns of a few smaller accounts, such that the composite's return is essentially that of the mutual fund.

Perhaps the best solution is to require both asset- and equal-weighted composite returns. One could argue that prospects should have some sense of returns for larger versus smaller portfolios in the strategy.

#1 The decision to eliminate the opportunity for firms to allocate cash to carve-outs. Back when the earlier (2005) version of GIPS was being crafted, the rule change was already planned to occur in 2005. But the IPC (Investment Performance Council; the predecessor group to the GIPS EC (Executive Committee)) listened to the overwhelming opposition to the change, and agreed to push it back five years. But when the 2010 edition was being considered, rather than again open this point up for comment, the EC refused; how unfortunate. As a result, most firms that had been using carve-outs have had to stop, which was an unnecessary inconvenience; this isn't a desirable outcome.

--------------------------

Please do not get me wrong: there is SO much more good about the standards than bad (sorry, I mean not so good); and, with any such document, there is bound to be disagreement. And, being the somewhat opinionated person that I am, it's not surprising that I could craft such a list. To balance them out, I will post my "10 best things" tomorrow!

Oh, and if you (a) have your OWN list or (b) wish to comment on mine, please let us know!

Announcing a new service!

2011-12-19T09:39:00.003-05:00

We are very excited about a new service The Spaulding Group announced last week: "Software Certification."

While the type of work isn't new for us, as we've reviewed many firms' performance systems for close to 20 years, the formalizing of it is. We provide an independent review of a firm's performance system, addressing the system's:

Functionality
Calculations
Completeness
Screens/User Interfaces
Reports
Usability
Controls
Workflow.

Software products or areas that are eligible for certification include:

Rates of return
GIPS(R) "Basic"
GIPS Real Estate
GIPS Private Equity
Equity Attribution
Fixed Income Attribution
Risk, ex post

with other areas planned.

The review is intended for software vendors, custodians, and asset managers with internally developed systems. It is both rigorous and comprehensive. John Simpson, CIPM and I designed and developed the process we will use to evaluate systems. For firms to have their system declared "TSG Certified" it must meet the tests we've developed.

The certification

provides software vendors with a "competitive edge"
affirms the system's capabilities
gives the firm's clients and prospects greater confidence, reduces their concerns and risks, and increases the vendor's likelihood of a sale.

To learn more about the service, please contact Christopher Spaulding (732-873-5700).

Who to get net, who to get gross?

2011-12-16T07:41:00.000-05:00

Okay, so yesterday we touched on the calculations for gross- and net-of-fee returns. But who should get what?

Prospective clients should get gross-of-fee returns, unless the net-of-fee returns are net of the same fee. The problem with most net-of-fee returns is that they're net of a mix of fees: how can one easily understand what the number represents? If you're going to show net-of-fee, provide helpful information so that the reader can better interpret it. Under the "old" AIMR-PPS(R), firms were required to show their weighted average fee, which could be helpful to interpret the return; but this is neither required nor recommended in GIPS(R) (Global Investment Performance Standards). In some cases, regulators (think SEC) require net-of-fee under certain circumstances, so it becomes a requirement. To me, gross-of-fee should be a requirement for marketing to prospects. Showing both is probably the ideal, even given the NOF's shortcomings.

Existing clients should get net-of-fee reporting. This represents the manager's performance after the fee they're charging has been removed. This seems best for the client.

Arguably, both prospective and existing clients should also see net-of-taxes (i.e., after-tax) returns, too. And, net-of-risk (i.e. risk-adjusted) returns.

p.s., The 2010 edition of GIPS now requires firms to indicate whether their NOF returns are net of actual or "model" fees (see ¶ I.4.A.6.b).

Deriving net rates of return

2011-12-15T06:01:00.000-05:00

There has been a bit of a debate on one of the Linkedin groups lately, regarding the proper way to derive net-of-fee returns, when the fees come out of the corpus of the account. I happen to like this topic, and wrote an article on it for the CFA Institute some time ago.

To put it simply, fees are technically cash flows, but when it comes to calculating net- or gross-of-fee returns, we need rules on what to do with them. When we calculate gross-of-fee returns, we treat the fees as a flow; when we calculate net-of-fee return, they're ignored (i.e., they do not show up in our calculation at all).

The Linkedin question was simply whether one should always include the fee (as a cash flow) in the denominator, regardless of whether you're calculating a net or gross return. One individual suggested that since the manager controls the timing of the flows (recall that in the Modified Dietz formula, cash flows are weighted based on timing, and this weighting is done in the denominator), that they should always be included (sorry about the run-on sentence...quite a mouthful!). I failed to see the logic behind "controlling the timing" and whether to include them. My interpretation of the statement was that this "control" might be used to advantage them somehow, even though one never knows how the month will end, so why would this matter?

Anyway, I stick by my simple rule:

Gross-of-fee: treat fees as a cash flow (in the denominator AND numerator)
Net-of-fee: ignore everywhere.

This, of course, is for fees taken from the corpus; fees paid from outside the account are treated differently. We'll address this at another time.

Doing transaction-based attribution? Don't forget about the benchmark!

2011-12-14T06:40:00.000-05:00

I am working on a research project, where I am creating a variety of portfolios to compare the implementation of transaction-based attribution versus holdings-based. I began this study more than a year ago with my first test portfolio, and am now putting several more together. I chose the S&P 500 index for this project.

To avoid complicating the matter, I began by selecting months where the S&P 500's constituents saw no changes, as I didn't want to be bothered with worrying about capturing those transactions (one or more securities leaving during the month, and being replaced by other securities, possibly altering the weights of the various sectors). The problem is that it's often difficult to find such a month.

And so I decided to discard this requirement, and select any month, even if changes had taken place. The problem was that when I made this decision, I forgot about the need to capture the transactions on the index side.

Almost immediately residuals appeared when no portfolio transactions had occurred: they weren't terribly large (usually only one or two basis points), but when there is supposed to be no residual whatsoever, this posed a dilemma. At first I thought the fault lied with my spreadsheet somehow: that perhaps in loading the data, I had altered a cell's formula. But after some reflection it hit me: the benchmark's composition had changed, and I hadn't accounted for it (ironic, because my initial intention was to avoid this situation, but somehow forgot about it when I decided to forgo the original constraint). In other words, the benchmark sector weights used in the formulas were based solely on what they looked like at the start of the period, without accounting for the changes that occurred during the month. And so, the formula:

fails. And yet, the sector returns are the result of changes in their weights, which aren't captured here. The result: we have a residual.

The solution? Well, in "real life," one would want to make sure you captured the changes in the sector weights that resulted from securities leaving or entering the sector during the month. In my case, because I am evaluating changes to the portfolio, not the benchmark, I will simply alter the benchmark's overall return so that the formula is satisfied: something I have the luxury of doing in my analysis, and arguably a "must" to properly assess what the study is all about. Hopefully, you'll read more on this in an upcoming article.

My point? Make sure that your implementation of a transaction-based model properly captures the benchmark's changes, too; i.e., not just the ones to your portfolios!

More on Error Correction

2011-12-09T07:37:00.000-05:00

We held a webinar on Monday devoted to the GIPS(R) (Global Investment Performance Standards) Error Correction Guidance Statement. As I pointed out in the session, this GS is one of the most confusing that has been offered, though the newest version is definitely much improved of the prior edition.

A verification client sent me a question, which is one that perhaps is worth commenting on here:

The Guidance Statement on Error Correction indicates that disclosure of the change must be included In the respective compliant presentation for a minimum of 12 months following the correction of the compliant presentation. In what situations would the firm be required to continue to disclose the change to the erroneous presentation for a minimum of the following 12 months if the firm has already provided all persons that received the erroneous presentation with a corrected presentation that contains disclosure about of the change?

There are two possible scenarios when it comes to the disclosure of "material errors":

The firm has kept track of the recipients of their presentations
The firm has not kept track of the recipients of their presentations.

If the client has kept track, then this 12-month rule doesn't apply, since they will have two versions of their presentations (one with the disclosure, which they will give to those prospects who are (a) still active prospects or (b) have become clients in the interim; the second with no disclosure, which will be given to new prospects who didn't see the version with the error).

If the client failed to keep track, then they have a single version of the presentation, which will contain the disclosure, and which they will give to everyone (both new prospects as well as any prospects that saw the version which they know of).

Hope this makes sense!

Dealing with zero weights

2011-12-08T06:46:00.000-05:00

I got an email from a client recently, asking how one should treat the case where a manager has zero exposure to one of the sectors in the benchmark.

If you are using one of the Brinson models and simply use the formulas as written, you'll find that the interaction effect gets most of the credit (or blame) for the decision. But does this make any sense? No!

And so, you may want to shift the interaction results to one of the other effects: selection or allocation.

Now, which do you think it should be? [pause, to allow you to reflect a moment] I think allocation, since the manager made the decision to go void in the sector. Thus, I would move the entire interaction effect there.

I'll address this in greater detail in this month's newsletter.

What happens when our firm's name changes, and we're "GIPS compliant"?

2011-12-05T16:17:00.000-05:00

One of our GIPS(R) (Global Investment Performance Standards) verification clients may be changing their name soon. What is the requirement for dealing with this?

Well, technically there is nothing explicit that I have found which deals with this matter: a quick check of the Q&As turned up nothing, and the Firm Definition Guidance Statement only states that changes in the name alone do not qualify for a firm "redefinition" (which has its own required disclosures).

A name change falls under the broad category of a "significant event," and requires a disclosure (see ¶ I.4.A.14). Our advice: include the date and previous name in the Firm Definition paragraph of all presentations. For example, "Effective January 1, 2012, XYZ Investment Advisors changed its name to ABC Investment Management." If a merger or acquisition occurred which formed the basis for the name change, include a disclosure about this, too; for example, "Effective January 1, 2012, XYZ Investment Advisors changed its name to ABC Investment Management, as a result of the September 1, 2011 acquisition of XYZ by ABC."

How to implement transaction-based attribution

2011-12-01T05:05:00.000-05:00

I got an email from someone today asking how to calculate transaction-based attribution. I addressed this during our recent Attribution Week, but will touch on it briefly here, and in greater detail in this month's newsletter.

Recall that attribution relies on returns and weights.

The Weights

With a holdings-based appraoch we use the weight at the start of the period. For example, if the portfolio's initial value is 100,000, and Technology has 10,000 as its starting value, then its weight is 10% (10,000 / 100,000).

To have a transaction-based approach, we need to adjust the weight for any buys/sells/income that occur during the month. For example, if we bought another 2,000 at the middle of the month, then we weight the transaction the same way we do with Modified Dietz [(CD-D+1)/CD] and multiply this by the value (and so, 0.5 x 2,000 = 1,000). We add this to the starting value and get a revised weight [(10,000 + 1,000)/100,000 = 11%]
We use this weight in our formula.

The Returns

With holdings-based, we can simply account for the starting values to derive our returns. With transaction-based, I suggest you use Modified Dietz, so that you capture the activity that occurs. And so for our example above, if we ended with Technology being valued at 14,000, we'd have R = (VE-VB-CF)/(VB+w*CF)=(14,000-10,000-2,000)/(10,000+0.5*2,000).
[I'll let you do the math]

That's it! Again, I'll spend a bit more time on this in the newsletter.

A standard in name only?

2011-11-30T10:04:00.000-05:00

One of our clients sent us a note recently, which stated that one of their clients told them there is a "standard to report alternative investments as net-of-fee, and to combine these with gross-of-fee returns." This "standard" apparently is not in writing, so perhaps the term was being used a bit loosely? Perhaps "a common practice" (although how common this is is open to debate) or "best practice" (though I would think it's not "best") might have been a better choice of words. In general I think "standards" should be written down somewhere; this is an example of one that isn't, though it's still worth discussing.

Mixing assets with net-of-fee returns with assets with gross-of-fee returns is never a good idea: what do you end up with? A hybrid, where you cannot make much sense out of what is being shown. If there is a "standard" (though again, it's probably a "best practice") it would be to not combine net-of-fee return assets with gross-of-fee, unless you have no choice. An example of how this used to be the case: in the early days of the AIMR-PPS(R), many U.S. firms included mutual funds in their composite, where the funds had net-of-fee returns (because at that time, firms were prohibited from "grossing-up" the fund returns) and separate accounts had gross-of-fee returns. The result was a composite gross-of-fee return that was lower than it would have been (had the fund been grossed-up). In 1996, the SEC issued a "no-action letter" which allowed firms to gross-up fund returns, so this is no longer a problem.

There are loads of things that mix well together, but net- and gross-of-fee returns aren't two of them.

Our performance numbers don't agree!

2011-11-28T08:08:00.000-05:00

Last week I had a call from a client who said that the returns they calculate don't match those provided by the hedge fund. How can this be?

Hedge fund performance should be pretty easy to handle: once we have the monthly valuations, cash flows are typically restricted to being once a month (on the last or first day), so it's quite simple to do the math. And so, what might be going on?

Well, our client said that they recognize flows when they occur! This could be the problem, right?

In wanting to get the money to the hedge fund in time that it's available, many of their clients will wire funds a few days early, but the hedge fund pretty much (as I understand it) ignores the money; (i.e., just lets it sit outside the corpus of the fund), until they're ready to bring it in: as a partnership, they do partnership accounting, where they calculate an end-of-month NAV (net asset value), and then issue new shares based on this value and the money being deposited (or, in the case of withdrawals, reduce the number of shares). If our client treats a flow as an intra-month event, using either Modified Dietz or a daily measure (where they simply carry the fund value from the start of the month to every day in the month (since daily values won't usually be available)), differences can occur, yes? There can be other reasons for differences in returns, but this seems to be a likely candidate.

My advice: adopt the same method as the fund. For example, if a flow actually occurs on November 28, but the hedge fund won't recognize it until November 30, having the return reflect the flow on the 28th isn't going to help when trying to match up with the fund. The fund is not doing anything with this cash, so treat the flow as if it occurred on the 30th, just as the fund will. As with all of my posts, I welcome your thoughts.

"the sort of precision that gave one confidence"

2011-11-23T08:43:00.000-05:00

My son, Douglas, gave me Rules of Civility by Amor Towles for my birthday. And while I don't often read novels, the review in the WSJ painted it as a book I should read (it likened it to The Great Gatsby, and after finishing it I can see why). Given that performance measurement is our passion, it's not surprising that I found inspiration within this text for a post.

In describing how a waiter poured three martinis, such that there was just enough to fill each glass with great exactitude (with not a drop too much, or too little), the narrator remarked how "It was the sort of precision that gave one confidence."

This line reminded me of something Roger Lowenstein wrote in his best seller When Genius Failed, about Long-Term Capital Management: "Long-Term did not merely concede the possibility of loss, it calculated the supposed odds of it occurring, and to precise mathematical degrees...The point was, Long-Term predicted the odds with precision." (emphasis in original) And no doubt, this precision gave LTCM's investors confidence in those who managed their money.

When a pilot informs the passengers that he expects to land at "about 5:17," the mere fact that he didn't round to the nearest five (i.e., 5:15) suggests a high degree of confidence, in spite of the qualifier, "about."

Precision implies accuracy and confidence, which isn't always valid. One should think about how far they want to go with the precision of their reporting, if the numbers are based on approximations, estimates, preliminary information, etc. Sometimes qualifying language is in order, to guard against confidence that might be misplaced.

Wondering about your error correction policy?

2011-11-21T15:05:00.000-05:00

Here's an opportunity to gain some insights into the proper way to construct your policy. (If you claim compliance with the Global Investment Performance Standards (GIPS(R)), you are required to have a written policy!).

Join me on Monday, December 5, from 11 AM to 1 PM (EST), for our delayed November Webinar. We will go through the guidance statement, clarify some key points, and address:

Understanding the requirements
Common mistakes
Dealing with materiality

To register or for further information, please contact Jaime Puerschner or Patrick Fowler (732-881-5700).

Note that a modest site fee will be charged (and you can have as many people on the line as you'd like!), except for our verification clients and members of the Performance Measurement Forum (who can participate at no cost!).

Taking advantage of "senior moments"

2011-11-18T07:26:00.002-05:00

When I was an undergrad math major at Temple University, roughly 40 years ago, a professor, who was teaching a Numbers Theory course, mentioned that there were three things mathematicians should always remember: the Pythagorean Theorem, Fermat's Last Equation, and he said he couldn't recall the third.

I often cite this episode when teaching our Fundamentals of Performance Measurement course, when I suggest that there are three things performance measurement professionals should know (in my scenario, I recall all three).

I thought of my professor's admonition when I heard about one of the Republican candidates for U.S. President, who said there were three departments he would eliminate, but failed to recall the third. His apparent stumbling didn't go over well. It seems that he hasn't learned the art of self-effacing humor, and turning moments like this into something funny.

Now that I am in my 60s (you're shocked to hear this, I know; people tell me all the time I don't look that old), I have the benefit of referring to episodes of forgetfulness as being "senior moments," something that always results in a laugh. And while my age probably has little to do with temporary memory lapses (given that everyone is subject to them), it's a line that fits well (at least for folks my age). Had the candidate made a similar statement, perhaps he would have gotten by without the negativity that has resulted.

Humor works, but only if the speaker is adept at pulling it off. This topic came up at a conference I was at this week; many of the attendees liked the humor I interjected during the session I moderated. Later, during dinner, I discussed this with a fellow dinner guest, and said how there is an art to telling a joke, and mentioned the joke about the fellow who walks into a bar, sits down and orders a beer. A few minutes later someone calls out "52," and everyone there began to laugh. A few minutes after that, someone called out "67," and the same thing occurred. Next, someone yelled "18," and the crowd again laughed loudly.

Turning to the bartender the fellow asked what was going on, since he didn't see any humor in numbers being called out. The bartender explained, "we have had the same neighborhood folks come in here for many years. And as you might expect, the same jokes kept getting told, over and over again. So, we decided to number them."

Hearing this, the man called out "44." Silence. Again, "44!" And again, silence; no reaction at all.

And so, he turned to the bartender and asked, "is there a joke numbered 44?" and was told "yes, there is."

"Well, how come when I yelled it out, no one laughed?" The bartender's response: "some people don't know how to tell a joke."

Understanding the why

2011-11-16T07:29:00.000-05:00

While driving to Boston to moderate a panel on fixed income investing, my wife and I were listening to David Baldacci's latest book, Zero Day. Early in the book he explains why folks in the UK drive on the left-hand side of the road. It apparently dates back to the "jousting days," when knights typically approached their opponent on the left hand side, since most were right handed, and this would be a better way to attack.

The reason Americans drive on the right-hand side is, as I understand it, is attributable to an American Indian custom of approaching oncoming riders on the right, as a way to show that they came in peace. Funny how both are apparently due to horse riding, but for completely opposite reasons.

Understanding "the why" behind why we do things can be quite helpful.

I was engaged in a conversation with another verifier last week at our European Performance Measurement Forum meeting in Budapest, Hungary. The question we addressed: "why do firms in Europe not have GIPS(R) (Global Investment Performance Standards) performance examinations done, while they are quite common in the States? The "why" here is pretty clear: it dates back to the days of the AIMR-PPS(R), when large accounting firms wouldn't do a "Level I" ("verification" in today's terms) verification, but would do a "Level II" (equivalent to today's examinations). And so, for many years lots of U.S. firms were only having Level II (examinations) done. When GIPS was introduced, these same verifiers dropped the prior restriction. As a result, the firms that perhaps would have avoided Level IIs had their verifiers offered Level Is continued as they had been.

Understanding "the why" might cause us to reconsider some of the things we do, though I wouldn't hold my breadth on anyone shifting the side of the road they drive on any time soon.

Real Estate - is it leverage or not?

2011-11-15T09:17:00.000-05:00

The Global Investment Performance Standards (GIPS(R)) require compliant firms to make certain disclosures regarding the use and extent of leverage in their portfolios (See ¶ I.4.A.13).
Does this include real estate?

Answer: No!

Yes, real estate investing is a leveraged asset, but this isn't what the standards are referring to. Here we speak about things like options and margin accounts.

It therefore naturally follows that mortgage backed securities and asset backed securities are not leveraged assets, either! A verification client of ours was wrestling with this and fortunately called for clarity.
MBS and ABS in your portfolio? Fine; no need to disclose.

Seeing risk as an opportunity

2011-11-12T11:41:00.002-05:00

I'm sitting in the Lufthansa business class lounge, preparing to return home, after spending a few days in Budapest, Hungary, where we held our 51st meeting of The Performance Measurement Forum. The reading material includes the WSJ's European edition weekend edition, which doesn't "hold a candle" to the U.S. version, but at least provides me something to read. I was struck by a Dow Jones advertisement, with the heading "Risk is also an opportunity." One might think such a statement unnecessary, as one can't achieve rewards without taking some risk. Its opening sentence, "Protect your business from risk without hindering growth," does seem like a stretch, however. But perhaps I need to spend some time pursuing their website.

One of our presenters this week was Harry Kat, who has written for The Journal of Performance Measurement(R), as well as other publications. Harry's presentation on risk was interesting in its simplicity, and I'll have more to say about it in the coming days.

Back to the WSJ advertisement. Over the years I've collected a few such ads, as they can be quite interesting in how they portray risk. We rarely see anything addressing the flip side (performance, which some say, with risk are the two sides of the same coin). And yet risk continues to be quite a challenge, in understanding, measuring, and managing it. More to follow.

Overselling time-weighting

2011-11-10T02:15:00.000-05:00

Motivational speaker Zig Ziglar frequently interjects jokes into his presentations. One deals with a Roman Catholic girl who was asked by her Baptist boyfriend to marry him. This occurred many years ago, when such “mixed marriages” were often frowned upon. When the girl told her mother the news, her mother responded “Darling, you know you can’t marry a Baptist boy! We’re Catholics, and it just wouldn’t work out.” The girl replied: “I know, Mom, but we’re in love!”

The mother thought about it and offered a solution: “Why not take him to Church with you, and let him experience the beauty and power of a Catholic Mass. Perhaps you can convince him to convert.”

Well, the daughter did as instructed, and a few weeks later informed her mother that the boyfriend had agreed to become Catholic, so a date was set for the wedding.

But then a short time later, the girl came home crying, explaining that the wedding was off. “What happened?” asked her mother. “Did he decide not to become a Catholic?” “Worse,” explained the daughter. “I think I oversold him. He’s going to become a priest!”

Sadly, the investment industry has been oversold on time-weighting. Ironically, those who were doing the selling (e.g., Peter Dietz) never claimed that time-weighting was the universal way to measure performance, and often cited money-weighting as the preferred approach to evaluate performance from the client's perspective (that is, "how did my account do?," as opposed to "how did the manager do?").

I've been asked to write a brief article on this topic, and will provide a link to it shortly. Because of space limitations, I couldn't use Zig's joke in the article, so I decided to use it here; hope you liked it!

Who's the client? (revisited)

2011-11-09T10:37:00.001-05:00

One of our GIPS(R) (Global Investment Performance Standards) verification clients posed the following question: "We have had the question come up here as to whether a potential limited partner in a partnership that we manage (managed in a similar manner to a mutual fund) is required to receive a GIPS compliant presentation?"

This raises the question as to who the client is?, for GIPS purposes. Our client cited a post I did more than a year ago.

As with a mutual fund, I would argue that for GIPS purposes, the "client" is the partnership, not the investors in the partnership (for a mutual fund, the fund is the "client"). The prospective shareholder/limited partner isn't investing in the composite's strategy; they're investing in a particular product, which no doubt comes with loads of disclosures that will give them all the information they require.

Might it be a good idea to include the appropriate composite presentation(s)? I would say, "yes," though only if doing so doesn't conflict with local regulators, who might have rules that make this inappropriate. But in my opinion, it's not required.

There seems to be a "lacuna" in the justification that was offered

2011-11-07T07:52:00.001-05:00

I did not attend this year's annual GIPS(R) (Global Investment Performance Standards) conference in Chicago, though we sponsored it, and four of my colleagues were present. I learned that someone raised a question which I put forward here a few days ago, regarding the apparent introduction of a new rule, prohibiting the introduction of accounts within the month. An attendee apparently submitted a question on this item, and it was explained that it was believed that this was always the Standards' intent, or something to that effect.

Well, as this blog's title suggests, there seems to be a lacuna in this justification. And, if you're like me, you may find the term "lacuna" to be somewhat foreign to you. I learned of the word while reading Neal B. Freeman's piece in this past weekend's WSJ; the article marked the 50th anniversary of Bill Buckley's God and Man at Yale. And so, turning to one of my favorite websites, I discovered that it means "a gap or missing part, as in a manuscript, series, or logical argument." [emphasis added]

In this case, the missing part (or lacuna) seems to be the basis for this claim. Where in the Standards does one conclude that it was always the intent of the Standards? Surely there must be a paragraph that one can point us to. Absent that, my only conclusion must continue to be that this is a new rule, probably in response to some of my arguments challenging the aggregate method as a legitimate approach to measure a composite's average return.

p.s., While Freeman may not be quite the sesquipedalian (user of long words) that Buckley was, Bill would most likely still have been pleased with the article.

Bold predictions about the future can be haunting

2011-11-05T10:08:00.000-04:00

Dippin' Dots' claim of being the "ice cream of the future" appears to have been a bit aggressive, as it declared for bankruptcy.

Granted, this bold statement was merely their tag line, and perhaps some could foresee ice cream actually universally becoming like their product (I only tried it once, and that was enough for me), but it's still risky to be so confident about what lay ahead.

Perhaps this can serve as a metaphor for similar offerings of what tomorrow will bring.

Periodicity for risk statistics (and other measures)

2011-11-03T09:52:00.000-04:00

A client recently asked about the appropriateness of reporting volatility and tracking error, for one and three month time periods, based on daily values. In addition, whether the results should be annualized. He was curious about the "best practices" for reporting these values.

Volatility (presumably, standard deviation) requires at least 30 observations to have validity, and so a monthly statistic, based on the roughly 22 trading days in the month, wouldn't quite make it, but it's close; clearly the three-month period would. But, this begs a bigger question: the appropriateness of using daily values.

I would say that the "rule of thumb" is to only use monthly returns. And why is this? Because daily provide too much "noise." Just consider the past week's DJIA returns, where we've seen 100+ point movements up and down, allegedly in response to the economic crisis in Greece. Monthly returns smooth these gyrations out, into meaningful numbers. Quarterly would be arguably better, but to achieve the requisite 30 observations would require 7 1/2 years: a bit long for most folks.

As for annualizing the monthly or quarterly values, the "rule" is not to annualize returns for periods less than a year; I would think the same applies to risk stats. And, if your intent is to compare them to a monthly or quarterly return, why not have it represented in the same manner?

Disagree? Have different thoughts? Please chime in!

Best practice for composite construction

2011-11-01T07:25:00.000-04:00

One of our GIPS(R) (Global Investment Performance Standards) verification clients called to ask what's the best practice for composite construction. Interesting question, I think.

We first touched on the meaning of "best practice," as it relates to the Standards, which is arguably an unknown, though I have concluded that it's what the Executive Committee thinks is best, which is fine by me; it's just important to know the context of the term. In the case of our conversation, though, I suspect the client meant what the industry might deem best, or best for ones clients or prospects.

If we turn briefly to the Standards, we know there are a host of recommended criteria available in the Composite Definition Guidance Statement. In reality, the standards afford the firm a great deal of latitude when it comes to construction. As is often stated, one can define their composites broadly, which allows more accounts to be included, with the likely result being more dispersion, or narrowly, meaning fewer accounts, with the anticipation of tighter dispersion.

Let's consider a brief example. Let's say that you have a U.S. large cap growth strategy, which you implement in two ways: with separate securities for your larger accounts, and mutual funds for your smaller ones. The "instruments used" can be a criteria for composite construction, and so you could have two composites: USLCG with separate securities and USLCG mutual funds. Or, you could combine them and have a single composite.

The advantages of a single composite are (a) more assets and (b) having to deal with just the single composite from a maintenance perspective; it also probably means wider dispersion. Going the dual composite route means tighter dispersion; it also means you'll have lower assets and have to work with two composites. Which is best practice? Well, if we're speaking from the standpoint of the firm it really depends on what they wish to accomplish. If you are disappointed that you'll have lower assets if you go with two composites, you can still show prospects the other composite, too, in order to demonstrate that your presence in that strategy is broader than one might conclude by looking at the single composite. From the prospect's perspective, to me it's clear that the dual composite approach makes more sense, because it means that they will see the one that aligns more accurately with their objectives and what you'll be doing for them. In the end, though, it's up to the firm. If you decide to have one large composite, then its description needs to indicate that mutual funds or (or possibly, "and/or") separate securities may be employed.

There are always trade-offs, and the firm gets to decide how they wish to deal with them. I was pleased that our client takes this so seriously, and wishes to do what is best for their prospects. It may mean more work for them, but it will allow them to better represent their success. There is more to be said on this topic, and we'll likely take it up again in the future. Your thoughts, ideas, and reactions are always invited.

Controlling risks when we can

2011-10-31T06:08:00.001-04:00

This past Saturday, my wife and I were driving to a wedding in Hope, NJ, which is about 75 minutes from our home. As you may have heard, New Jersey, as much of the Northeast, received a rare and rather nasty snowstorm. We didn't know what we were in for.

After sitting in traffic on Route 206 for about 30 minutes, we learned that a tree had fallen up ahead, and was blocking the entire roadway; okay, so mystery solved. Our GPS detoured us to another route, which took us on to Schooleys Mountain Road; a road we were somewhat familiar with because it was how we got to the college our younger son, Douglas, went to as an undergrad (Centenary). We were about 15 minutes from our destination and a short distance from where we were to turn, when we encountered a freshly fallen tree, blocking our way (see first photo). So, we had to turn around and find another way (what did we do before the GPS?).

This time we were driving along Route 46, four tenths of a mile from where we were to turn, and again, less than 15 minutes from our destination. Now we were stopped for about 20 minutes and then learned that someone had driven into a utility pole, knocking it down, resulting in a roadblock which wouldn't clear for hours. And so, off again!

We were heading down a road when we found yet another tree blocking the road; not a terribly large one, and one I thought we could maneuver around. But before we had a chance to try, a truck came the other way (second photo). To make a long story short, the truck helped to make our path clearer, but also nearly hit us, as he fishtailed his way up the hill and inches away from our car. We eventually made it to the wedding, missing the ceremony: a trip that took us nearly four and a half hours.

Recognizing that the snow covered roadways required extra care, I, as well as just about every driver we encountered, drove much slower than normal. But there were still accidents and other mishaps. But, we could control much of the risks we encountered.

Contrast this with the 84 year old man from Pennsylvania, who was napping in his recliner at home. A tree fell down, onto his home, and killed him. A totally unanticipated event. We could think of the man's house as a AAA-rated structure, which wasn't able to withstand the onslaught of a tree, whose limbs were made more heavy by snow falling upon leaves, which normally are long gone before the first snow arrives.

Can we see a parallel between these two situations: driving through a snowstorm, and resting at home during a snowstorm? In the first, we can observe risks and take steps to reduce or try to avoid them. In the second, "out of left field" an event appears, one that we couldn't have expected; perhaps not unlike the mortgage crisis which rippled onto the stock market.

Bottom line: we can only do so much to avoid or control risks. We should try to identify the risks we face, and take the necessary steps to minimize them. However, we must also be aware that there are certain risks we cannot anticipate, and must respond to them, as best we can, if we are able to.

How to make your returns look better

2011-10-27T08:31:00.001-04:00

We've discovered a way to enhance performance, at least in the short term: if you have a portfolio begin late in the month, to make the monthly return look better, treat the return as if it was for the full month!

What do we mean by this? Well, consider the Modified Dietz formula for a second:

Let's say that we begin with zero invested, so our beginning value is zero. We have a cash flow of $100 occur on the 28th of a 30 day month. We end with $105. It is evident from the numbers that we have a 5% return, yes? But let's see what happens with Modified Dietz, if we calculate the weight for the 30 day period:

Now, let us plug this value into our formula:

Instead of the 5% we know we earned, we will see a 50% return! Quite impressive, yes? And so, what happened?

The problem is, as you hopefully can see, that we are trying to measure a monthly return for an asset that was held for just three days. The culprit is our weighting formula. Instead of our "CD" (number of calendar days) be three, which we know it is, we're using 30. And therefore, instead of the flow being present for the full time (of three days of a three day period), it is shown as being present but for a mere three days of a thirty day period, or 10% of the time. This causes our denominator to be smaller than it should be, resulting in a return that is much higher than it really is.

Does this mean that Modified Dietz cannot be used in cases like this? Well, no, it can be; you just have to get your weight right.

Now, when we use this weight in our formula, our return is:

Unfortunately, I've seen too many systems that do not test to see the true period an asset is held, and allow distorted returns to be reported. There is no legitimate explanation for allowing this to occur: the return is wrong. You cannot report a one month return for an asset that is held for less than a month; nor can you report a one-year return for an asset held less than a year. We designed a system for a client a few years ago, and made sure it was sensitive to cases like this, to avoid reporting misleading information. If you see very large returns, they may be attributable to this problem, not truly great performance.

Of course, if you have a bad three days, your negative return will be exploded, too, so this practice serves no valid purpose, and should be abandoned.

A new GIPS rule has been introduced

2011-10-25T06:01:00.000-04:00

The GIPS(R) (Global Investment Performance Standards) Q&A desk appears to have introduced a new rule:

Firms may not add new accounts within a month*

While I have no problem with this change, it would have been nice if it had been put forward for public comment, since it doesn't appear to be based on any language that is actually in the standards themselves; i.e., no paragraph is referenced to justify its introduction. This is arguably a change in the standards, which should (I believe) have been open to public comment. [Recall that GIPS-compliant firms must comply with Q&As and Guidance Statements, in addition to the standards themselves. Therefore, this Q&A applies to you.]

In this Q&A post we find the following: “When calculating composite returns for a specific period, only portfolios that are included in the composite for the entire performance measurement period are included in the calculation.” [emphasis added] We also find “When calculating a monthly composite return and the performance measurement period is defined as a month, a firm must not include in the composite calculation portfolios that were not managed for the full month and therefore do not have a full month of performance.” [again, emphasis added]

Consider the expression "performance measurement period." In the early days of the AIMR-PPS(R), we saw both this term and "performance reporting period" used. One might report quarterly but measure monthly.

While this new "rule" seems to prohibit monthly additions (or removals) of accounts to (from) a composite, it appears to be based solely on this concept of this undefined term: "performance measurement period." If I calculate the return for January, but revalue the portfolio for large cash flows, aren't I measuring performance across multiple performance measurement periods in order to arrive at my January return? Firms that do daily performance might say that their performance measurement periods are days, might they not? Would this therefore allow them the opportunity to include an account within a month (since the month isn't the performance measurement period; the subperiods of the month are)?

Let's return to the first sentence from this rule: "When calculating composite returns for a specific period, only portfolios that are included in the composite for the entire performance measurement period are included in the calculation.” I've now emphasized two terms: specific period and performance measurement period. Are they interchangeable? It's a bit confusing, I think.

If the intent of this rule was simply to say "you can't add or remove accounts within a month," why doesn't it say that? I firmly believe that this is what is intended, but again, from the standards perspective, I fail to see the justification for it; sorry.

I will confess that I was aware that this change was "coming down," and I am perhaps responsible for it, given my challenge of the aggregate method (many, though not all, of my examples of flaws were based on cases where accounts were added within the month). A colleague told me that firms cannot add accounts within the month. It probably won't surprise you to learn that I asked "what paragraph in the standards is this interpretation based on?," but I got no response. I think this Q&A is the response.

Again, I am fine with this change, but feel that it is based on nothing in the standards. There is a process and protocol to introduce changes to the standards; this wasn't followed here (unless someone can point out the chapter and verse that the Q&A's response is based on). The Q&A desk's role is to interpret questions relative to existing rules; no rule was cited as the basis for their response. In my view this constitutes a new rule, not an interpretation of an existing rule.

In addition, given that there ARE managers who (a) claim compliance with the standards and (b) HAVE been doing this in some cases for many years, does this mean that they aren't compliant, or that they have to recalculate their performance? More is needed, I believe. In my view, this is a new rule that should have an effective date, so as to avoid confusion (and again, should have been open for public review). There are composite software packages that permit their customers to add or remove accounts from composites within a month; I suspect that they should consider restricting it going forward, so as to avoid putting their customers at risk in violating the standards. This issue will not apply to the vast majority of compliant firms, who add accounts at month-end; however, it's still important to consider the process and how the change was introduced. Can we expect other changes to be introduced in this manner?

* Note: I don't want to confuse anyone; this isn't a quote from the Q&A; it's my interpretation of what the new rule is.

The Five Ways You May Be Wasting Money in Performance Measurement (#5)

2011-10-24T05:44:00.001-04:00

#5 Using the wrong approach to measure, analyze, and report performance and risk

The good news is that there are plenty of great software packages available today, to assist firms with all aspects of their performance and risk measurement. The bad news is that there is no one "best" system, nor is there a system that works well with every organization's needs. Consequently, investing money in a system that fails to do the right job is a waste, or at least a partial waste.

Too many firms use spreadsheets for "systems," and in general this is not a good idea: there are exceptions, but they are few.

Producing reports that fail to provide the information needed, or failing to take an inventory of what is being used and what isn't, is a waste of resources.

All firms should periodically assess where they stand, from a systems and operational perspective. Is the firm using the right measures? Do the reports contain the right information? Are the processes smooth, with the appropriate controls? Is there unnecessary redundancy, in processing or systems? Are there more efficient ways to operate?

Some firms have moved to or are considering outsourcing part or all of their performance and risk measurement process. One can debate the appropriateness of this, but the reality is that many firms find benefits in taking these steps. Even these, though, are worthy of occasional reviews to ensure they are meeting the firm's needs.

The Five Ways You May Be Wasting Money in Performance Measurement (#4)

2011-10-21T08:50:00.000-04:00

#4 GIPS Performance Examinations

We have always been big supporters of GIPS(R) (Global Investment Performance Standards) verifications: given the Standards' complexity, it is very easy for firms to make mistakes.

At one time it was expected that verifications would become mandatory, but this idea was met with much opposition and was (fortunately) derailed. However, the importance of verification has been heightened as a result of the rewording and expansion of the "claim of compliance" statement in composite presentations, and the market has, in fact, made it a de facto requirement.

Examinations are a totally different matter. They are GIPS' version of the AIMR-PPS' Level II Verification. The following schematic summarizes the history of these reviews:

Examinations test to see if the firm is "cooking its books," and has little to do with the standards themselves.

While it's true that firms (a) move to compliance and (b) undergo verifications primarily for marketing purposes, the rationale behind examinations is less clear, especially since most RFPs fail to ask about them. We believe that for many firms they are simply a continuation of their Level II verifications, that were done when many large verification firms wouldn't do Level I's. And while this is no longer the case (i.e., these same verifiers will do GIPS verifications), the practice has continued.

We discourage our verification clients from having them done, and very few do (even those who used to, have, for the most part, stopped). This has resulted in tens of thousands of dollars in savings each year for our clients.

If a firm IS going to have examinations done, they should only be for those composites for which they have seen interest in having them done by their prospective clients. We have seen cases where verifiers perform them for all of the firm's marketed AND non-marketed composites: the only one who benefits from this is the verifier.

If yours is like most firms, chances are you're spending a lot of money on examinations each year. Do yourself the favor of asking "why?"

The Five Ways You May Be Wasting Money in Performance Measurement (#3)

2011-10-20T07:12:00.002-04:00

#3 Not training your staff

Entrepreneur magazine cited lack of staff training as one of the top reasons companies fail.

As consultants to many types of firms (e.g., asset managers, custodians, software vendors, pension funds, endowments), we often encounter cases where improper decisions were made because of lack of training. Take GIPS(R) (Global Investment Performance Standards), for example. We strongly encourage our new GIPS verification clients to allow us to conduct a pre-verification in advance of the actual verification, to ensure that they are heading in the right direction. Part of this day is spent educating the client about the standards, to help them avoid making costly mistakes. Firms that fail to take advantage of training often make many errors as they move towards compliance, because of the Standards' complexity and many areas of confusion. We believe that moving towards GIPS compliance without proper training is usually a waste of time and money. [Reminder: The Spaulding Group is hosting a free GIPS webinar next Monday!]

Other aspects of performance also need to be addressed, such as performance attribution, rates of return, benchmarks, and risk. The lack of knowledge often leads to poor decisions being made. Having untrained individuals carry out performance and risk measurement related tasks is an expense that often results in a waste of money.

Investing in proper training is not only good for the firm, it's also very good for the team members. They recognize the organization's desire for them to grow and to enhance their ability to contribute. They appreciate their company's willingness to invest in them. It is a motivational factor that leads to more productive employees.

Training can take many forms, from formal class room programs, to conferences, and even reading industry publications, like The Journal of Performance Measurement(R).

Poorly or insufficiently trained staff can often result in a waste of money.

The Five Ways You May Be Wasting Money in Performance Measurement (#2)

2011-10-19T06:56:00.003-04:00

#2 Using spreadsheets to maintain your GIPS composites

The Spaulding Group began surveying the industry on the presentation standards (initially the AIMR-PPS(R); later GIPS(R) (Global Investment Performance Standards)) in 1994, and we've done it several times since then. We have always been struck by the large percentage of compliant firms who use spreadsheets to maintain their composites. And while we can understand why this was common in the early 1990s (given the dearth of software packages), this is no longer the case, and hasn't been for some time.

Years ago, when doing talks on the standards, I would tell participants that when they hear a voice in their head suggesting that they put their composites on a spreadsheet, that this was the voice of the devil. Spreadsheets are:

time-consuming
error prone
cumbersome
manually intensive
and not a data base.

It is virtually impossible to include the artificial intelligence-type logic in spreadsheets that can help firms tremendously to maintain their composites. In addition, it's typical for packaged software to produce presentations, saving users the trouble of gathering data from multiple sources, and using MS/Word or MS/Excel to put presentations together.

Okay, and so now I can hear you ask "you're suggesting that we SPEND money; how is this 'wasting money.'"

Good question. Because you're wasting money on the manpower that today must maintain these spreadsheets. These folks are usually highly trained and educated individuals whose time could probably be better spent (invested) in more analytical-type work. In addition, the potential errors that can arise from spreadsheet-based composites is huge.

So why bother? Make the investment of money in software, not people's time. Use these human resources in better ways, that will likely give them more job satisfaction and provide additional benefits to the firm.

p.s., Are there exceptions? Yes, of course! Many smaller firms cannot justify the expense of a packaged solution, and so spreadsheets may be their only option. Or, if the firm has but a few composites and a limited number of accounts, then spreadsheets may be okay. But in general, firms should seek out a packed solution.

p.p.s., In general, spreadsheets shouldn't be used for "systems." Especially when there are programmed systems available. This applies beyond the area of GIPS compliance.

p.p.p.s., Reminder: there's still time to sign up for next Monday's free webinar on the GIPS Standards. To register, please contact Jaime Puerschner or Patrick Fowler (001-732-873-5700).

The Five Ways You May Be Wasting Money in Performance Measurement

2011-10-18T07:52:00.004-04:00

Let's start with a joke: As a salesman approaches a farmhouse door, he notices a three-legged pig hobbling about on the front porch. The salesman knocks on the door and is greeted by the farmer. Before making his pitch he asks "what happened to this pig's leg."

The farmer responds "oh, this is Bessie. She's a marvelous pig. There was the time when a fire started in the house. Bessie saw it, came in to my room, and woke me up. I was able to put the fire out before it spread. If it hadn't been for her, the house would have burned down, and me and my family would have died!"

"Very interesting," says the salesman, "but what happened to her leg?"

The farmer continued: "then there was the time that our youngest daughter, Mary, fell into the pond. Bessie swam in and dragged her out. Mary would have drowned had it not been for Bessie."

"Wow, Bessie is quite an impressive pig. But I'm curious to know what happened to her leg" responded the salesman.

"Son, with a pig like Bessie, you can't eat it all at once!"

---------------------

Okay, so much for the joke. How does it relate to this topic? Well, with a title that begins "The Five Ways" I think it best that we don't discuss it all at once, but rather over a five day period.

#1 Not Being GIPS Compliant

You may be wondering what money you're wasting if you're not compliant with GIPS(R) (Global Investment Performance Standards), since it costs money to comply. Answer: much of the money you spend on marketing, sales, and responding to requests for proposal, because the failure to comply makes these efforts much more challenging, and much of your investment in selling is lost because of the inability to respond "yes" to the question "Are you compliant with the GIPS standards?" In the institutional space, lack of compliance places a firm at a marketing disadvantage, and therefore results in wasting money in pursuit of many prospects that are beyond your reach.

If your particular market isn't institutional, where compliance is a de facto standard, you're still wasting money, because you're competing on a level playing field with the other firms that aren't compliant. Why not make an investment in compliance, so that you obtain a marketing advantage!

p.s., Reminder: there's still time to sign up for next Monday's free webinar on the GIPS Standards. To register, contact Jaime Puerschner or Patrick Fowler.

Oldies ... so, do you want us or not?

2011-10-15T15:10:00.001-04:00

This weekend's WSJ has two stories, reflecting opposite views.

Michael M. Phillips' "The Old Soldier Who Didn't Fade Away" tells the story of a 59-year old U.S. Army staff sergeant who is currently deployed in Afghanistan. He has my admiration and appreciation for his dedication, patriotism, bravery, and sacrifice.

In the same section of the paper we find Joe Queenan's "Revenge of the 60-Year-Old Has-Beens," where he takes aim at Mitt Romney (who in Joe's eyes is "dull as dishwater," who "could be the first president that no one in this great country actually likes"), Bill Clinton (who "will not, will not shut his trap"), along with a host of other sexagenarians.

As one who has made it to the 60-year old level (coincidentally, eight days after Joe did), I prefer Phillips' story of someone who refuses to let age slow him down. And because the U.S. Army restricts enlisted men from serving in combat once they hit 60, he is now looking to get a commission, since officers have a higher age limit. Bravo!

In a sense, these stories speak of performance; granted, not performance in investing, but human performance nonetheless. Can "Has-Beens" continue to perform? Obviously the answer is "yes," and often better than the young folks. Granted, my body is a bit more creaky than it was a few decades ago: for example, unlike SSG Don Nicholas, who can run two miles under 12 minutes, my orthopedist will not allow me to run any more (and I'm not sure I could ever run two miles at such a pace); but, I have no intention of slowing down. Plus, I'm having too much fun!

Looking at age from multiple perspectives isn't much different than looking at risk or returns from multiple angles, too. We can learn a lot, and perhaps draw some great insights and conclusions.

Dispersion around what exactly?

2011-10-14T07:43:00.000-04:00

A verification client called me with the following question: they have historically calculated dispersion around the composite's return; however, their new GIPS(R) (Global Investment Performance Standards) system measures it around the average of the accounts that were present for the full year. Which is better?

To clarify: GIPS compliant firms are required to include a measure of dispersion (e.g., standard deviation, range, high/low, quartile) for each year, provided there were six or more accounts present for the full year (if there are less than six, then it's an option to include dispersion). The composite's annual return is based on the monthly returns, which are linked together. Each month can have a different mix of accounts, because, for example, accounts were removed because they: terminated, fell below the minimum, had a significant cash flow, had a change in strategy, or are now non-discretionary; or accounts were added because they are new, rose above the minimum, returned after removal because of a significant flow, are no longer non-discretionary, and so on.

The only accounts that are used for the dispersion measurement purpose will be those that were present for the full year. If we calculate standard deviation against these accounts themselves, without any reference to the composite's return, then dispersion will be measured against the average of these accounts, which may not (and probably will not) be the same as the composite's annual return. To measure standard deviation against the composite's return, one would have to manually, so to speak, step through the standard deviation formula, inserting the composite's average into the equation, rather then allow the formula (e.g., Excel's STDEVP) run by itself. This would require more effort. You can get differences in results, as you might expect. Here's a quick example:

And so, is either approach okay? Is one method preferred?

The standards do not speak specifically to this question. I would say that both approaches are acceptable. However, I believe dispersion is expected to be about the composite's average (we want to know how actual accounts varied relative to the reported return). But, I suspect that most systems measure dispersion relative to average of the account returns, not the composite's return. In the end, the differences are probably immaterial.

Risks in predicting the future

2011-10-12T07:24:00.000-04:00

Despite the criticisms that have been offered to anyone who wishes to make predictions, there is no limit to their presence. Who would want to see the end of weathermen (weather people?) telling us what tomorrow will look like, despite everyone knowing "no one can [accurately] predict the weather."

The accompanying chart shows the Obama administration's predictions for what the unemployment rate would be if (a) the stimulus package was implemented, (b) what it would be if it wasn't implemented, and (c) what it actually has been. The abject failure to be accurate in these predictions has resulted in strong criticism from the president's foes (and even some friends). But Obama isn't the first president to make predictions (or for that matter, promises) that didn't hold (recall, for example, "read my lips: no new taxes!").

Qualifying predictions is important. I recall a few years ago when a couple sports pundits didn't bother to offer their predictions for the first round of the baseball league playoffs, as it was "a given" as to what teams would prevail in the first round. Well, they were wrong. And yet, their pomposity and arrogance seemed to give their predictions undeserved credibility.

I have voiced my concerns with ex ante risk measures, but recognize that clients and managers still want to see them, which is fine, as long as they recognize the underlying assumptions and the qualifications of these predictions. To make bold statements about what will happen will usually lead to errors of one sort or another.

Is net of fee performance recommended?

2011-10-10T08:30:00.001-04:00

We received a question from a client recently, who cited the GIPS(R) (Global Investment Performance Standards) Fees Guidance Statement.

On page 5 we find the following:

Let's focus on the sentence that reads "In these situations, it is most appropriate to present the return net of all fees (e.g., including administrative fees) since all investors must pay these fees." Is the "most appropriate" contrasting different ways to calculate net-of-fees returns (i.e., to include all of the fees rather than only the fees the manager charges) or relative to showing gross-of-fee performance? I can see why one might be confused.

I do not interpret this to be "as opposed to gross-of-fee performance," since this entire guidance statement deals with fees; it is not positioning itself relative to gross-of-fee returns. This guidance statement (page 2) and the standards themselves (¶ I.5.B.1) recommend gross-of-fee returns. Therefore, my interpretation isn't that this is taking a new direction on the recommendations, but rather stating that if you're going to report net-of-fee, this is how you should in these cases. If I am mistaken, hopefully someone will correct me.

In and out of a bear market, or maybe not

2011-10-09T18:24:00.000-04:00

In this weekend's WSJ, Jason Zweig (in "If It Looks Like a Bear ...") begins with a brief retrospective on what appeared to be the market's recent entry into bear market territory (and quick departure from), but then touches on what is meant by a "bear market." It seems that "there is no such thing as an 'official' bear market, [though] for convenience...The Wall Street Journal and others define it as a 20% decline from a closing high to a closing low on the Dow or the S&P 500." This is apparently a new definition. He goes on to explain the source of the term, "bear" ("to sell the bear's skin before one has caught the bear"). This presentation should be of interest to anyone involved in the world of investing.

I found it quite interesting to learn that there is no official bear market definition. Who would have thunk! Surely a term that is bandied about would have a common meaning and interpretation, but this isn't the case.

And so, the fact that many of the terms we use in performance not having official meanings isn't unique. But it's important for us to know this, I believe, just as with Jason's insights. I won't restate some of the points I've referenced of late in this blog, as my readers are no doubt familiar with them. Being aware of what is defined or agreed to, versus terms that aren't, is important, so one isn't mislead or confused.

When aggregate makes sense

2011-10-06T07:02:00.000-04:00

Before you think "oh, here he goes again" please give me a second to explain. Okay, yes, it's true: I've been beating this to death (and will continue to, but not right now).

I was sent the following question from a client:

"How do you calculate performance for a composite that contains two or more funds? Do you combine multiple funds' cash flows and calculate an IRR [internal rate of return] using all the funds' contributions, distributions and residual values as if they were from a single fund?"

Some background: the writer is speaking about a client's account, where they are reporting to the client, and are using the concept of a "composite" to pool the client's accounts together.

In this case, unlike with time-weighting, we would aggregate the accounts (starting and ending market values, as well as cash flows). We then calculate an IRR across this aggregate account. I would not encourage asset weighting individual IRRs, though to confess I haven't played around with it; my "gut" is speaking here.

And so, there is a place for aggregation: for IRRs, when we are reporting to a client about their return!

Chief Ethics Officer named; Standards of Practice published

2011-10-05T06:34:00.003-04:00

The Spaulding Group, Inc. is pleased to announce that we've created two new positions: Chief Ethics Officer and Assistant Ethics Officer. In addition, we've published a Standards of Practice handbook for our staff.

John D. Simpson, CIPM has been appointed our firm's Chief Ethics Officer, and Jed M. Schneider, CIPM, FRM, is the Assistant.

Details can be found in our press release.

A free webcast on the GIPS standards!

2011-10-04T06:36:00.000-04:00

The Spaulding Group's official October webinar (yesterday's was actually for September; John Simpson had an extremely busy month, which included a trip to the Middle East to conduct training) will be GIPS(R) (Global Investment Performance Standards) fundamentals, that will highlight the "Five Key Components of GIPS." I will conduct this session, which will be on Monday, October 24, from 11 AM to 1 PM, EST.

And, it's free!

But if you want to participate, you'll have to sign up quickly, as space is limited. Only the first 100 to register will be able to do so for free. If you plan to have more than one listen in, you only need to register one time!

For more information, please contact Jaime Puerschner.

Potter Stewart and risk measurement

2011-10-03T06:35:00.003-04:00

When Herb Chain (of Deloitte), Matt Forstenhausler (of E&Y), and I used to regularly teach AIMR-PPS(R) and then GIPS(R) courses (first for AIMR, then for the CFA Institute), one thing we could be sure of: Herb would reference former U.S. Supreme Court Justice's famous line about not having a definition for pornography, but knowing what it was when he saw it. Over the years I, like Herb, have used this line metaphorically, as it fits a variety of situations.

Well, when it comes to risk measurement his line doesn't fit, as their are several definitions available. Leslie Rahl (of Capital Market Risk Advisers) has become somewhat famous for her long list of risks, which she further qualifies as being incomplete. There is no commonly used definition for risk, and perhaps this is how it should be. Risk is usually defined in four ways:

Volatility
Possibility of a loss
Possibility of not meeting the client's objective
Uncertainty.

Volatility probably has the most number of measures, with standard deviation being the most common, as well as the most frequently used measure overall. One cannot assume that because most firms use standard deviation that they therefore interpret risk to mean volatility; it's likely that they look at risk in a different way, but use standard deviation to try to assess risk in line with the other definition (which can be a challenge). Other measures include beta and tracking error.

The possibility of a loss and possibility of not meeting the objective can be measured using the same formula: Sortino ratio. We just adjust the absolute return in our equation, from zero (for a loss) to our goal, or minimal acceptable return (or, if you prefer, minimum funding ratio or liability related benchmark).

Uncertainty is difficult to measure. Scenario analysis can be used here, where we look at different possible future events to see how our portfolio would behave. Value at Risk and Liquidity Risk might also work, too.

Regardless of your definition, we see risk as something that needs to be "ganged up on." That is, approached from multiple angles to get a sense of what is really there. The old television game show, Concentration, might be a good metaphor for risk. We want to get a good look at what risk is, but must take several views to really understand it. But unlike the game show, it never fully reveals itself.

Risk management gone amuck

2011-09-30T06:34:00.000-04:00

By now you're aware of Washington's funding of Solyndra, the now bankrupt energy company that received something north of a half billion dollars in government loans. In Wednesday's WSJ, Deborah Solomon had an article ("Solyndra Said to Have Violated Terms of Loan") which included the following passage: "In a March 2011 report, [the Energy Department's inspector general, Gregory Friedman] said his office 'found that the Loan Guarantee Program could not always readily demonstrate, through systematically organized records, including contemporaneous notes, how it resolved or mitigated relevant risks prior to granting loan guarantees.'"

Interesting, isn't it, how the federal government, who readily criticized the investment industry's risk controls and management, was able to grant such a huge loan, shortly before the recipient declared bankruptcy? And while perhaps it may do our hearts good to see that "the shoe is on the other foot," or to feel better because "misery loves company," (sorry for the inclusion of overused cliches), the reality is that the millions of dollars given away belongs to the taxpayers, who lose in the end. And perhaps it's better to use this example as a way to reflect upon our own risk controls to ensure that they're sufficiently tight. While we may not all be in the business of granting loans (although anyone who buys bonds is, of course, doing just that), we all experience risks in our investments. Too many managers have no risk policies at all; surely something can be implemented to demonstrate an awareness of the risks being taken and the controls in place to minimize these risks.

It's not what you say,...

2011-09-29T06:05:00.005-04:00

Pollster and word guru Frank Luntz is known for his admonition, "it's not what you say; it's what people hear." This rang true for me this week.

I did a talk on Tuesday at the New York Society of Security Analysts (NYSSA) titled "Performance Measurement & Alternative Products: What's different?" As you might suspect, I addressed hedge funds, private equity, and real estate. I pointed out that for illiquid assets (e.g., private equity and real estate, though this can apply to certain hedge fund assets, too), valuations can be quite difficult, which calls into question the accuracy of the returns that depend on them.

One young woman mentioned something to the effect that private equity managers aren't "all cowboys" when it comes to pricing; that established rules are followed for pricing. I agreed, and cited the three-level hierarchy that the GIPS(R) (Global Investment Performance Standards) standards have for such pricing. But this doesn't mean that the valuations are solid.

Case in point (okay, a slight diversion, but hopefully you'll see the connection): in yesterday's WSJ, Joesph B. White and Nick Timiraos mentioned how Detroit is witnessing a jump in housing prices ("Housing Revs Up in Detroit.") The very last paragraph referenced a realtor who cited a house that had just gone under contract for $80,000, which was appraised at $30,000! In my talk I mentioned how (a) prices are often subjective, (b) appraisers can use different methods (thus could come up with different valuations), and (c) valuations are often done without the benefit of transactions. What better example? An asset undervalued by more than 50%!

I never intended (thus my Luntz quote) for anyone to take away that I was suggesting that pricing of private equity and real estate assets is anything but formal, standardized, and with the greatest care. But, we all know how pricing can be suspect. I'll try harder not to offend or mislead.

Taking the CIPM exam? Want some help?

2011-09-28T16:11:00.002-04:00

Our next webcast has been announced: John Simpson, CIPM will conduct a two-hour session to help test takers prepare for their upcoming CIPM (Certificate in Investment Performance Measurement) exam (whether you're taking the Principles or Expert level test).

It will be this coming Monday, October 3, from noon until 2 PM (EST). If (a) you attended one of John's prep classes, (b) your firm is a member of the Performance Measurement Forum, or (c) your firm is one of our verification clients, then it's free! For everyone else, our normal webinar fee has been reduced to make it easier for you to benefit from John's expertise. Not able to attend but still want to hear what's discussed? You can obtain a copy of the session!

Questions? Contact Patrick Fowler (732-873-5700).

John Simpson developed the class and has taught it numerous times. He also teaches our other courses, and is highly regarded for his teaching skills. We're sure you'll find this program of value. Stumped by something? Have some questions you'd like to pose? Or, just curious what others are thinking? You'll no doubt enjoy and benefit from this session.

More on composite returns

2011-09-28T06:42:00.001-04:00

Brian Chapman (of KPMG, London) reminded me that the AIMR-PPS(R)'s view of composite return is that it's "a single value that reflects the overall performance (the 'central tendency') of the set. The objective in reporting the returns of composites is to use a method for reporting the composite return that will give the same value achieved if the composite were treated as one master portfolio. That is, the value being calculated is the same value that would result if all of the assets and transactions of the individual portfolios/classes were combined and the return were computed using the procedures discussed earlier." [page 27 of the '93 version] Actually, I hadn't so much forgotten this, but rather was unable to locate a definition in the '93 or '97 editions of the AIMR-PPS (neither of their indexes provide easy passage to what Brian located, and I wasn't as diligent as he in trying to locate it).

When I taught classes for the CFA Institute (and prior to that, AIMR) on the standards (AIMR-PPS and GIPS(R)) the explanations regarding the math more often than not fell to me, and I would explain that asset weighting is used so that the return looks like it's coming from a single portfolio. I guess I hadn't really given this explanation a whole lot of thought: I had first heard it in 1992, when a debate was occurring on this subject, with the ICAA and IMCA challenging the approach that AIMR was implementing. The arguments against asset weighting were that it would cause larger accounts to overly influence the results; however, with the aggregate method we don't actually see this, since we end up with a mix of all accounts' holdings tossed together, with no reference or link to their source.

Further research is in order to understand "why" AIMR (and then the CFA Institute, and arguably now the GIPS Executive Committee, by default) would favor this approach. Is the blending of assets from a variety of accounts truly what we want?

It's somewhat ironic, I think, that the only method that AIMR came up with in their '93 edition fails at achieving the definition they laid out, as it provides an asset weighted average of returns (what IMCA and the ICAA objected to), not a result which truly represents the composite as if it was a single portfolio (though some would argue that it is an approximation of this).

If by now you're growing tired of this topic, I apologize. But I happen to find this somewhat fascinating.

Comment in a courteous manner, please...

2011-09-27T07:02:00.032-04:00

This blog has been around for more than two years, and I thank those who have taken the time to follow it, post comments and critiques, and contribute to its success. I always appreciate when someone takes the time to comment on the blog. Perhaps there haven’t been as many as I would have hoped for or expected, but still a fair number have come in.

Many have commented anonymously, which until recently has been fine. But over the past few weeks I’ve been sent a couple comments which either bordered on rudeness or were patronizing: they didn’t get posted. While I appreciate all comments submitted, I will not publish rude or arrogant ones. The blog is a medium for information and education for the industry. Critiques and comments are welcome when presented in a professional and respectful manner. While I embrace the new social media, and the freedom of information and voice it provides us, I am also a firm believer in professionalism, courtesy and etiquette.

Have an opinion that differs from mine? Think that I made an error or that I’m wrong? I am more than happy to post it. Case in point: Brian Chapman sent me a comment correcting something I had written relating to what the GIPS return means. It got posted, and I appreciated him sharing this. In fact, it resulted in another blog post.

Be professional and it will be posted. Going forward, I will avoid publishing anonymous submissions: please identify yourself. If you can’t do this for some reason, then send me an email along with the post, and I’ll consider releasing it. Thanks!

When the stats don't add up

2011-09-26T05:57:00.000-04:00

I am a very big fan of Michael Lewis, beginning with his best seller Liar's Poker. I was advised to read Moneyball, and as with his other books, found it very well written. And given my lifelong love of baseball, found it quite intriguing: the idea that the Oakland A's could assemble a team of low priced players and meet with great success. The book has been transformed into a movie, which opened this past Friday.

In last Thursday's Wall Street Journal Allen Barra wrote a piece titled "The 'Moneyball' Myth," which questions the conclusions drawn by Lewis and others, that by focusing on certain statistics rather than others, success could be realized; that teams didn't necessarily have to spend a bundle.

Thus, Barra was questioning Lewis' attribution analysis, was he not? Were the conclusions that were done, based upon the story that was told by the team's general manager, appropriate? Barra shares information that causes one to wonder.

Statistics are curious things, are they not? As the saying (credited to Britain's former Prime Minister Disraeli, and made famous by Mark Twain) goes, "there are lies, damn lies, and statistics." We can get statistics to prove or disprove just about anything. In the world of performance measurement, we have loads of measures, some that compete with one another (money- versus time-weighting; equal- versus asset weighting; geometric versus arithmetic), which produce differing results.

One must be sure that they are willing to step back and understand what the numbers are supposed to represent, to determine if they're appropriate, whether they're complete, and whether additional information is needed.

Baseball is perhaps the best example of statistics gone wild. For example, ESPN can tell us what the batter's chances are of getting a hit, with two on, facing a right handed pitcher, and with a ball and a strike. In the end, one is tempted to ask "do we care?" But with performance measurement, and the ability to understand what is working and what isn't, we surely do care. But having the skills and tools necessary isn't perhaps always so evident.

A performance measurement professional friend and veteran of our industry visited our offices last week to chat. We talked about the world in which we find ourselves, and what we like about it. For me, the dynamics are perhaps the best part: we don't know all the answers, and are continuing to question and learn. One cannot ever think that "it's done," 'cause it isn't.

The art of investing

2011-09-24T09:31:00.004-04:00

Since almost the beginning of this blog, I have incorporated clipart, to add color, effect, humor, and sometimes wonder (as you wonder what the heck it's there for). The selection has always followed the subject, until today.

Clipart has the word "art" in it. And while I deplore the notion that there is anything artful about graffiti (i.e., that those who display them are "graffiti artists"), clipart frequently exhibits art-like qualities. And for one who very much enjoys and appreciates art, being able to include pieces that somehow (though not always very clearly) tie into the post's theme is fun and sometimes challenging (I usually include clipart with my PowerPoint presentations, too). Speaking of art, I am one who believes that a bare wall borders on being sinful, and our home and office walls are replete with art and other pieces, that perhaps aren't always very artful, but at least add something to the rooms.

Charles Bragg is a very unique artist. Like many other painters (Vincent van Gogh comes to mind, for example), his style is easily recognizable. I recall the first time I saw his work: my wife and I attended an art auction at the Pearl Harbor Officers' Club (I was with the 25th Infantry Division a few miles north at Schoefield Barracks; Hawaii was hardly a "hardship tour"), where they exhibited about five of his paintings. I did not care for his art at all. However, within a few weeks it grew on me, and I decided that I actually liked it (and regretted not having arrived at this realization earlier, when we could have acquired one or two of his pieces at an attractive price). Much of his work deals with the medical or legal professions, though he has produced a few paintings that tie into investing. I have wanted to acquire a piece for a long time, but they were always outside my price range, or simply more than I cared to spend, until this week.

I happened to locate the piece shown above on eBay, and was quite pleased by my good fortune. It will arrive shortly and appear in our offices (hopefully my colleagues won't mind). My wife knows of my enjoyment of Bragg's work, and is pleased by my acquisition.

Many folks have done pieces that tie into what we do, often with a serious tone: there is rarely anything very serious about a Bragg. If you have a piece that you like (it doesn't have to be a Bragg), please send me a photo so I can include it here.

What does it mean?

2011-09-23T05:58:00.001-04:00

Earlier this month I posted a question regarding what the definition of "composite return" is. Given the importance of this value within the GIPS(R) standards (Global Investment Performance Standards), there should be an answer.

I promised to expand on this subject further, and have done so in this month's Spaulding Group newsletter. To me this is a fundamental issue. Please let me know if you disagree.

"A remedy in search of a problem"

2011-09-22T08:15:00.000-04:00

In last weekend's WSJ, Clint Bolick had a column dealing with Arizona's struggle with apparently unfair and unnecessary federal government interaction with much of their activities, especially regarding elections. In it he had a statement which hit me as being, at times, appropriate to the world of GIPS(R) (Global Investment Performance Standards"): "a remedy in search of a problem." Mr. Bolick does not deserve (nor I suspect does he seek) credit for coining this phrase (a Google search identified its use elsewhere), but its appropriateness in many areas of our lives is fitting.

The recently circulated revised guidance statement for examinations (whose comment period recently ended) included suggested language which would have required verifiers to go directly to custodians and brokers for records to support the asset manager's claims. I believe this was a case of a remedy looking for a problem. The inconvenience and added cost should have been obvious from the start. We do not yet know what will make it into the final version, but hopefully these requirements won't.

I'm on record as opposing examinations, though my firm (The Spaulding Group) is quite willing to perform them for our verification clients (the vast majority of whom have decided (as we have) that they are an unnecessary expense). We believe our clients (and for that matter, all firms) should spend their money efficiently. In most cases, examinations are remedies in search of a problem.

I would include in this group of "remedies" the decision to abolish the use of carve-outs, except where cash is managed separately. There was no documented problem necessitating this move. And the change has caused headaches for many firms who had been using them since the early 1990s.

One might expect that the GIPS Executive Committee will (if they haven't begun already) begin to consider what changes to make to GIPS; after all, the standards are to be reviewed every five years for potential changes. One would hope that if any are, that they will be minimal (the last round was quite extensive). Adding remedies in search of problems should be avoided.

When I was mayor of the Township of North Brunswick, our resident gadfly suggested that for each new law (actually, ordinances in the case of municipalities) we introduced, two should be struck from the books. Not a bad idea. As Thoreau recommended in Walden: simplify!

Where education is lacking

2011-09-21T16:21:00.000-04:00

Surely you're familiar with the George Santayana line about needing to recall the past to avoid repeating it. This speaks to history, yes?

In today's Wall Street Journal Norm Augustine discusses how history is a subject today's youth don't do too well with. As one who considered history as an undergrad pursuit (I chose math instead) and who still enjoys reading about history, I found the article of great interest. Augustine writes that studying history has benefits outside the knowledge it brings, as it "create[s] critical thinkers who can digest, analyze and synthesize information and articulate." Furthermore, and perhaps of greater importance, "These are skills needed across a broad range of subjects and disciplines." Can you, perchance, think of any area where such skills are necessary? Hopefully performance and risk analysis came to mind. He also points out the value of "the ability to think broadly and read and write clearly" as being key to advancement.

While I love American and World History, I am also a fan of Performance Measurement History; that is, to learn about what has transpired over the past 40 years or so in the world in which I've chosen to spend most of my time and build a career. Having been around "at the creation" of the FAF standards, and the AIMR-PPS(R), and its evolution into GIPS(R), I can relate how things were to how they are today, which often has value. The Spaulding Group's publication of Classics in Investment Performance Measurement was partly in response to my desire to capture some of the earlier works in our field.

I encourage you to study history in general, but also to be aware of our history. Who doesn't want their analytical skills improved and to advance further?

What are the risk statistics for IRR?

2011-09-19T06:21:00.000-04:00

Someone recently asked me what risk statistics should be used with the internal rate of return (IRR), (which, as any reader of this blog knows, is my preferred return measure). Sadly, I didn't have an immediate reply.

The plethora of risk statistics that are available for time-weighted rates of return (TWRR) use the intra-period returns. For example:

standard deviation (we can continue its appropriateness as a risk statistic)
beta
tracking error
downside deviation

as well as the multitude of risk-adjusted return measures that use these risk measures (such as Sharpe ratio).

Recall that the IRR measures the return for a single period; there is no linking. Comparing the portfolio's IRR with the benchmark's only serves the purpose of seeing how well the portfolio did. But how can we measure risk if we use the IRR?

Reflect on this for a bit; I will return to this matter soon, with some concrete ideas.

Knowing the risks one is taking

2011-09-16T13:47:00.000-04:00

By now you probably heard about a rogue trader who's cost his employer, UBS, some $2 billion. The bank's risk management is being questioned, and I won't say anymore about it at this time.

It so happens that another, perhaps more interesting, story has surfaced regarding a 20-year old Irish national who attempted to smuggle some $200,000 worth of cocaine out of Brazil. Apparently this young man failed to consider all of the risks he was taking, which would include detection (which would lead to a trial, and likely imprisonment) and that one or more of the bags might decide to open, which could lead to death.

In order to manage risk, one must know the risks they're taking, and decide if the action being considered is worth it. Too often this isn't the case, be it in investing or other pursuits. Why don't people consider the consequences of their actions? Not all risks can be properly evaluated, but some thought should go into what we do, yes?

p.s., as for the rather graphic photo, it’s a medical image that was released by the Brazilian Federal Police which shows cocaine-stuffed bags inside the gastrointestinal tract of the would-be smuggler. It's enough to cure me from taking up this profession.

Getting the basics right

2011-09-14T09:12:00.000-04:00

I stumbled upon an asset manager's website this week, which served as a good example of some of the problems that exist within the world of firms claiming compliance with GIPS(R) (Global Investment Performance Standards).

This firm apparently has undergone a recent verification; granted, not by a firm that many have heard of, but nevertheless, one that holds itself out as being capable and qualified to conduct verifications. Very quickly I identified three problems:

This was an SEC-registered firm, meaning that it must comply with the SEC's advertising rules. The SEC requires that net-of-fee be of equal or greater prominence to the gross-of-fee returns. They only reported gross-of-fee results. (Strike one)
Their website page announcing compliance failed to contain the GIPS required advertising disclosures. Granted, compliant firms aren't obligated to adhere to these guidelines unless they reference GIPS; but since this firm did, it was required to include them. It was missing virtually all of them. (Strike two)
Their site includes a composite presentation. This presentation was missing at least one required disclosure, and had other items which looked suspect. (Strike three).

Of these three items, the verifier is technically only responsible to look into the third; their apparent failure to catch the missing disclosure(s) is a problem. The verifier should also provide their client guidance on advertising (from both a GIPS as well as SEC perspective); this was clearly not done here. The verifier should educate their client so as to avoid actions which might put them at risk or negate their compliance. Bottom line: this firm is not compliant and part of the blame belongs with the verifier.

Nearly 20 years ago I encountered similar problems, and requested a mechanism to verify the verifiers (I believe I coined the phrase). This has been an ongoing theme for nearly two decades. I suspect that nothing will ever be done.

We all make mistakes; as the saying goes, "no one is perfect." But the gravity of these errors is of such a magnitude that their existence reflects serious problems. I am confident that this asset manager had no intention of being out of compliance. They are most likely quite proud that they "achieved compliance." It appears to me that they picked an unqualified verifier.

The requirements to be a verifier today are the same as they were roughly 20 years ago: call yourself a verifier. Technically, we and the standards would expect a lot more, but since there is no test, no oversight group, no verifier of verifiers, anyone wishing to can become a verifier in a matter of minutes. I think there's room for improvement.

Last week to participate!

2011-09-12T07:10:00.000-04:00

The Spaulding Group (TSG) has announced that this will be the final week to participate in its 4th survey on performance attribution. Joining in is quite simple, as the survey is online and easy to access; simply go to the firm's website and you'll be directed to the survey. You can also see details about the survey on the firm's site.

The survey covers all aspects of attribution. All participants will receive a complimentary copy of the results.

TSG has taken on six cosponsors: (DST Global Solutions, First Rate, StatPro, Morningstar, BI-SAM and VPD) for this research project. They will not receive details about the participants, as this information will remain confidential.

Please join in today!

9/11: A day to remember

2011-09-11T08:36:00.001-04:00

I don't read the comics, but my wife does. And she showed me this one. It fits my mood today quite well.

What's it all about?

2011-09-08T06:34:00.001-04:00

You may recall that I have opined in the past about the problems I've discovered with the aggregate method, both several times in this blog, as well as in our newsletter; I also wrote an article on this topic.

Some individuals who have read my materials argue that the aggregate method is, in fact, the superior method. They find that the case, for example, where all the composite's accounts have identical 4.00% returns, but where the composite has a different return, to be perfectly fine. In fact, that it is the correct return, and that the BMV+weighted cash flow approach to be the one in error (even though it matches the composite's).

I must confess that I found this all quite perplexing and, to some degree, shocking. However, while corresponding with some folks on this topic I had yet another epiphany. I believe there is something more foundational / fundamental going on here, which requires some thought. There is a point which is very important to consider: What is the composite return supposed to represent? I suggest that you take a moment to reflect on this before continuing to read this post.

If you want to check the definition that is in the GIPS® (Global Investment Performance Standards) glossary, you'll quickly discover something:

it's not there! In spite of the vast importance of the composite return, there is no definition for it. Perhaps there was an expectation that "of course everyone knows what it means or represents," but after some reflection, I don't believe this is true.

In reality, there are two different answers, depending upon which formula you use to calculate it:

if you use either the BMV or BMV+WCF approach, the composite return represents the asset-weighted average experience of the accounts that were present in the composite during the given time period. However,
if you use the aggregate method, the composite return represents the return of the composite, as if it was an account itself.

Therefore, if you believe that the return should treat the composite as a single account, then of course you would believe that the aggregate method is correct; but if, like me, you think it should represent the average experience of REAL accounts, then you would find its result to be a bit confusing at times.

Space doesn't permit me to go much further on this subject here, but I will comment at greater length later this month in our newsletter, so please stay tuned. I am of the firm believe that this is a fundamental issue with the standards, which has been overlooked by the GIPS Executive Committee, and its predecessor groups. I, too, hadn't really given it much thought until recently. But when someone firmly says, in response to my criticisms, that "no, the aggregate method is the most accurate method, and the BMV+WCF is actually inferior," I was forced to pause and reflect.

p.s., As you no doubt realize, the GIPS standards grew from the AIMR-PPS®. If you take a look at the first edition of the earlier standard you will only see one method to derive the composite return, and it is based solely on the beginning market value. The other two were added in the 1997 editions. I suspect that when this was done, no one on the AIMR-PPS Implementation Subcommittee realized that they were at that moment introducing a second definition or meaning for the composite's return. But they were.

The overwhelm effect

2011-09-06T10:03:00.000-04:00

In this past weekend's WSJ,Jonah Lehrer had an article titled "Learning How to Focus on Focus." He quotes psychologist Herbert Simon: "A wealth of information creates a poverty of attention." Lehrer tell us that a key is to strengthen our "executive function," which is " a collection of cognitive skills that allow us to exert control over our thoughts and impulses."

I couldn't help but think about the massive amount of data that we sometimes give to our portfolio managers and external clients. When they see pages upon pages of information, is the result an inability to properly focus on the most important things?

One of our neighbors has a front yard that is overrun with plants and shrubs. At one point I'm sure that it looked quite nice, but now it's difficult just to walk past their house, as the sidewalk is being partially blocked by some of this vegetation. Some trimming is definitely in order. Might the same be true for some of the information we give our clients?

Can we properly focus when we're bombarded with pages and pages of return, risk, attribution, etc. details? Our effort to, at times, impress others with what we can give them may result in a lack of good and solid information, that they can really find of value. Something to think about.

What is the "sell side"?

2011-08-31T08:20:00.000-04:00

We have been engaged in a research project for a client, who wanted information on "sell side fixed income attribution systems." This cause me to reflect a bit on the term "sell side."

You've no doubt run into the terms "buy side" and "sell side"; but do you know what the they mean? I used to always think of the sell side as the market that provides securities to asset managers, who in turn would represent the "buy side."

We might think of the sell side as those who sell from their own inventory (dealers), but this wouldn't be sufficient, would it, as brokers, too, make securities available to buyers. So to limit this to dealers is, I think, inappropriate. And of course, asset managers also sell, right? But to include them would result in no differentiation whatsoever.

During one of my doctoral finance courses, a professor offered a definition which I think is perhaps more accurate: the sell side sells liquidity. But even here, wouldn't asset managers sell liquidity, too? But to include asset managers is, I think, inappropriate, because once you do, then there is no need to differentiate between the two sides of the market. Yes, there are times when asset managers may provide liquidity, but in general, we're speaking of broker/dealers, yes?

Trusty Wikipedia offers the following: "It is a general term that indicates a firm that sells investment services to asset management firms." Investment services? Does not an asset manager sell investment services, too? But to avoid confusion, they add "These services encompass a broad range of activities, including broking/dealing [sic], investment banking, advisory functions, and investment research." It's interesting to note that this page states "This article needs attention from an expert on the subject." And the absence of references makes its information less valid. But who has written on this matter to any extent?

As always, your thoughts on this are welcome.

A challenging question: what to do with the money?

2011-08-30T09:03:00.000-04:00

A colleague recently passed me a question that was sent to him: what is the proper treatment of class action settlement proceeds from securities-related lawsuits or bankruptcies, which are then deposited into an investment portfolio.

You may have encountered this yourself. When a firm goes into default on their bonds, the bondholders are left wondering if they'll ever see any money flow their way again. And at times, lawsuits are filed. Sometimes it takes years before a payment arrives. But when it does, how do you treat it?

First, do you treat it as an accrual? No, since there was no anticipation of any payment. Accruals should only be applied when there is a high degree of confidence or probability that a payment will be made. Once a bond goes into default, "all bets are off."

Second, is it income or a cash flow? Here, I think the answer is an "it depends." Technically, it's income. However, what if the bond was purchased by a prior asset manager, and your firm had no involvement in it at all. Because it's the same custodian, the income comes in and gets passed to you. For you to treat it as income would, I believe, be improper; for you, it's a cash flow. But if you were the manager who made the decision to purchase the bonds, then it's your income.

I hope this makes sense. Please comment if you have further thoughts or ideas you wish to share.

Committers of fraud need not apply...

2011-08-28T11:48:00.001-04:00

You have perhaps heard that Abercrombie & Fitch is actually paying members of the reality show, Jersey Shore, money to not use their products; the individual known as "the situation" is one who has been particularly focused on. In this weekend's WSJ, Joe Queenan addresses the topic of hoping for certain individuals to avoid their products in "Please Don't Endorse Our Product."

This made me think of the case where a few firms embraced the Global Investment Performance Standards (GIPS(R)) who shouldn't have. The on-line publication Fundfire ran a few pieces on this, where they identified managers who were charged with fraud, who had not only claimed compliance but had also managed to get verified.

As I recently pointed out, the act of "claiming" compliance doesn't take much effort; anyone can do it. The real test is whether or not the firm actually is compliant. And while we expect verification to help determine this, it has been stated that this voluntary exercise isn't intended to identify fraud, and so the fact that a few tricksters were able to achieve a successful verification isn't necessarily a rap against this exercise.

But clearly, those of us who support the standards would prefer that firms that are less than ethical simply avoid claiming compliance; adding a fraudulent claim to their existing misdeeds might result in discrediting this important standard, which clearly we don't want to see.

Attribution survey ... please join in!

2011-08-26T07:53:00.004-04:00

The Spaulding Group has announced that it's conducting a survey on performance attribution.

The survey will address all aspects of attribution, including approaches, preferences, and systems. Five cosponsors: DST Global Solutions, First Rate Investment Systems, StatPro, Morningstar, and VPD have joined in so far for this research project. The cosponsors won't receive details about the participants - this information will remain confidential.

This is the fourth time the firm has surveyed asset managers on the use of attribution. The results are always well received, given the importance attribution has in the world of investing.

Please join in: all participants will receive a complimentary copy of the results.

p.s., less than a week after we announced the survey we're at more than 100 participants! Please join in and make this a phenomenal research effort. Reminder: all participants will receive a complimentary copy of the results. Thanks!

Beta ... what is 1.0?

2011-08-25T07:09:00.000-04:00

Beta is a risk statistic which tells us essentially how our portfolio behaves relative to the market. It is a derivative of Modern Portfolio Theory, and more specifically, the Capital Asset Pricing Model (CAPM). The purpose of this post isn't to address whether or not beta is dead; Fama & French can tackle that one. It's really a lot simpler than that.

The market gets 1.0; our portfolio's value is measured using the following formula:

We measure the covariance of the portfolio's return stream relative to the market's; that is, how they vary relative to one another. We then divide this value by the variance of the market.

One question that has held firm for CAPM is "what's the market?" Well, that's something that is taken up in the hallowed halls of academia; for our purposes, we have the same question, but not perhaps from such a purist perspective. We want to know what gets the "1.0."

Standard practice seems to be to assign the 1.0 to the portfolio's benchmark. In my opinion, to do anything but this can be of little value. For example, let's say that you use the S&P 500 to represent the broad market, and everything, including your portfolio's benchmark, relative to it. And let's say that as a U.S. small cap manager, your benchmark is the Russell 2000. And so, you first calculate the Russell 2000's beta, which you find to be (for exhibition purposes only; not in reality) 1.53. You next calculate your portfolio's beta relative to the S&P 500, and it turns out to be 1.61. This tells us that both the portfolio's index and the portfolio itself are more volatile than the S&P 500, meaning that they both exhibit more risk. So what? We're interested in the risk you've taken relative to the index your managing against, aren't we? And wouldn't it be more appropriate to set the Russell 2000 to 1.0, and measure the portfolio's beta in comparison to it? We should let the academics try to define "the market." But when we're measuring a portfolio's risk, its market is its benchmark, and risk should be compared against it. This holds for tracking error, information ratio, Jensen's alpha, Modigliani-Modigliani, and any other risk statistic that uses a benchmark in its formula.

p.s., There may be some value to measure a benchmark's beta relative to the S&P 500 (or some other "market"), to exhibit how each behaves relative to it, so I don't want to "pooh-pooh" the idea completely. But from a fundamental, foundational perspective, use the portfolio's benchmark when measuring risk. You're not managing against "the market," other than as represented by the associated benchmark.

Words matter

2011-08-24T06:12:00.002-04:00

In yesterday's WSJ, William McGurn wrote about adhering to codes of conduct, and began by citing West Point's code: "A cadet will not lie, cheat, steal or tolerate those who do." As a former Army officer who served with many "ring knockers," I was already familiar with this code. As McGurn points out, it's the last few words that may be the most difficult to uphold. He cites the recent University of Miami football scandal as an example of folks who prefer not to say anything, when they are aware of improper behavior. Bernie Madoff's firm might be the greatest example of individuals who knowingly allowed illegal, unethical, and improper behavior to occur in their midst, and even to be knowledgeable and willing participants.

Earlier this week I participated in a panel discussion regarding the GIPS(R) standards (Global Investment Performance Standards). Someone asked "what does it take to claim compliance." In reality, it doesn't take anything but a willingness to make such a claim; the important thing is what it takes to achieve and maintain compliance. I have witnessed cases where firms who claimed compliance when they knew that they weren't. On one occasion, I told a firm's chief compliance officer that her firm was not compliant, and said that they have two choices: continue to claim and hope that the SEC doesn't find out, or stop claiming and get their house in order, fully expecting that she would dismiss the first. But to my surprise, that was her choice. We dropped them as a client.

McGurn mentioned how Miami's code states that violations "should" be reported. As a former member of the GIPS Investment Performance Council and Interpretations Subcommittee, I know how word choices are important. There is a big difference between "should" and "must." Weighing our choice of words is important. But beyond the words is the character of the individual. We admire those individuals who, in the face of what appears to be acceptable (though in their eyes, poor) behavior, say "no."

The Spaulding Group is formalizing our standards of practice, to make it clear to our team what we expect. It is based on the CFA Institute's standards, which are arguably "best practice" for our industry. Perhaps codes of conduct shouldn't have to be written down, but at a minimum they convey our beliefs and rules. And not only won't we lie, cheat, or steal, we also won't tolerate those who do.

Math mistakes matter

2011-08-23T06:17:00.000-04:00

In this past weekend's Wall Street Journal, Carl Bialik's article, "Technology Can't Save Us From Math Mishaps, brought home the problems we face daily in trying to ensure a relatively high degree of accuracy in the information we report.

He cited S&P's $2 trillion error which didn't dissuade them from lowering the U.S.Government's coveted AAA rating. It is interesting how this "error" was characterized: "The Treasury Department claimed that S&P originally used the wrong number - projected gross domestic product growth instead of projected inflation - to calculate what U.S. government spending and total U.S. debt would be for the next 10 years. S&P spokesman John Piecuch says that the original number 'was not a mathematical error at all,' but instead based on a different assumption about spending...John Bellows, Treasury's acting assistant secretary for economic policy, called it a 'basic math error.'"

Bialik further pointed out that a common cause for many wrong numbers is "insufficient safeguards to catch errors before the numbers are released." Amen. But how does one come up with these "safeguards"? That's the challenge. Mathematician Thomas R. Nicely is quoted as saying "The best method of preventing [errors] is to have two or more independent procedures for determining [or checking] the same result." If we were to apply this in the world of returns, would it mean, for example, to use two formulas (Modified Dietz and daily, for example? That, to me, wouldn't work, since the underlying data would be the same, and that's usually the cause for the errors, is it not?

One of our consulting clients compared their client returns to the S&P 500, and if they were off by a certain amount they'd flag it for review. On the surface this might appear reasonable, but given that their clients are primarily retail, non-discretionary accounts, that (a) aren't investing relative to the S&P 500 and (b) may only have one or two securities in their portfolio, it isn't likely to be very helpful. If the manager (or investor) is managing relative to a particular index, such a check is probably quite reasonable.

It's relatively easy to establish wide ranges to use as tests (e.g., if the return is below -50% or above 50% for some given period). But what about the errors that aren't quite that large? Which aren't quite so obvious?

Getting the soundness of the formulas down shouldn't be a problem; it's the data, right? And this is where it gets difficult. Processing the corporate actions properly, accounting for trades, capturing the right prices, getting the exchange rates correct, etc. Data isn't a particularly "sexy" topic, is it (as opposed to returns, attribution, risk, and GIPS(R), that is)? But it's critical. And sadly, it's one of those areas that when everything goes well, the folks in charge probably don't hear very much; but when errors arise, they do.

Best practices in data management is a topic worthy of further discussion. If you have ideas you want to share, please pass them along. Thanks!

Netting same day flows...expanded commentary

2011-08-22T06:16:00.002-04:00

Earlier this month I commented briefly on the question of netting same day cash flows. And, as promised, I expanded this topic in this month's newsletter.

I must confess that the analysis helped me gain greater appreciation for the proper treatment of cash flow timing. Our training classes include examples which dramatically show how mistakes in timing can lead to huge errors. This month's newsletter provides a similar, though different perspective on this topic.

A lot of times it's these small details that can lead to huge errors; and even when the errors aren't "huge," they can be still cause problems. In fact, it's probably the not-so-huge errors that are more problematic, because they're more likely not to be discovered.

Have thoughts, comments, insights, or stories to share? Please chime in!

Performance measurement and alternative investments...

2011-08-20T06:28:00.001-04:00

I have spoken at several NYSSA events, and am very much looking forward to this one. Alternative investments seem scary, but are they? We'll discuss it on September 27; hope you can join in!

Should we blend?

2011-08-19T10:16:00.000-04:00

A client alerted me about a new Q&A that is on the GIPS(R) (Global Investment Performance Standards) website. I'll save you the trouble of looking it up, and provide the particulars here. First, the question:

"For one of our composites, we use a portfolio-weighted custom benchmark that is created monthly using the benchmarks of the individual portfolios in the composite. The GIPS standards require that if a firm changes the benchmark, the firm must disclose the date of, description of, and reason for the change. Given the nature of the benchmark, the benchmark is subject to change each month. What must be disclosed to satisfy this requirement?"

The response is interesting: "The GIPS standards require that if a custom benchmark or combination of multiple benchmarks is used, the firm must disclose the benchmark components, weights, and rebalancing process. In this example, the benchmark may change every month as part of the normal procedure. It is required in this instance to disclose that the benchmark is rebalanced monthly using the weighted average returns of the benchmarks of all of the portfolios included in the composite. A firm is not required to disclose how the underlying portfolio benchmarks and weights have changed each month. If the benchmark for the composite were to change from a portfolio-weighted custom benchmark created monthly using the benchmarks of the individual portfolios in the composite to a market index, this would be a benchmark change that must be disclosed

"In the spirit of full disclosure and fair representation, firms must disclose the components that comprise the portfolio-weighted custom benchmark, including the weights that each component represents, as of the most recent annual period end. Firms should also offer to provide this information for prior periods upon request.

"Sample disclosure: The Long US Government/Credit Custom Benchmark is calculated using the benchmarks of portfolios in the Composite. The benchmark is rebalanced monthly based on the beginning values of portfolios included in the composite. As of December 31, 2009, the breakdown of the benchmark is 88.2% Barclays Capital US Long Government/Credit Index and 11.8% Barclays Capital US Long Government/Credit A+ Index. The breakdown of the custom benchmark for different time periods is available upon request."

Our client, and we as well, found this approach to benchmarking quite unusual. Usually when we think of a custom benchmark it is constructed to align with a strategy for which a single benchmark doesn't work (e.g., a balanced approach, whereby we'd find an equity and fixed income component). Here, the manager has a composite where the underlying portfolios all align with different benchmarks. I would respond to the question with a series of questions.

Does the manager actually manage differently for each of the client benchmarks, or does the manager manage against a common benchmark? If it's a common benchmark, then it should be the one that's used. If the manager manages differently for each client, in accordance with their respective benchmark, then why aren't they using different composites, since benchmark is an acceptable criteria for composite construction?

If the manager feels that the differences between the portfolios is not material, then I would advise them to pick one of the benchmarks and use that. What value is a benchmark that reflects a dynamic mix of underlying benchmarks, each representing the strategy for of a different client? And asset-weighting them means that the larger account's benchmark rules, yes? But why? And don't forget, the firm can provide additional benchmarks for reference purposes, too!

I think this question calls into the issue of the role of the composite benchmark: is it not to provide a basis to compare the manager's successful implementation of their strategy? If the manager is managing across multiple benchmarks, they may have success with one and failure with another: combining them means what, then?

This is an interesting topic, I think, and one worthy of some reflection, too. Your thoughts are welcome.

What goes around, comes around

2011-08-18T08:25:00.000-04:00

The revelation that the U.S. Justice Department is now investigating S&P's ratings of pools of mortgage backed securities is perhaps totally unrelated to S&P' recent downgrading of the U.S. government's credit worthiness, but the timing does suggest otherwise. Assigning the coveted AAA ratings to pools with sub-prime mortgages (which individually would most likely have been below investment grade) provided many investors with confidence that was unfounded.

Sorry, but I liken S&P's recent actions to the SEC's, when their failure to catch Bernie resulted in them getting tough with the likes of Goldman Sachs.

Whether or not the government's investigations are in response to what S&P did, it's probably still justified and perhaps long overdue.