LeRoy Neiman's influence on performance measurement

More than 10 years ago we held a Performance Measurement Forum meeting at the W Hotel in Los Angeles. Our meeting room abutted the swimming pool, and I happened to notice famed artist LeRoy Neiman sitting in the pool area. I mentioned this in the meeting, and later that afternoon our then editor of The Journal of Performance Measurement(r) saw Mr. Neiman in the lobby. She took the opportunity to approach him and ask "Are you Leonard Nimoy?" As you might imagine, we had a good laugh over this, and she was a good sport about her error.

In today's WSJ there's an article that informs us of how the Mr. Neiman is seeking to inspire a new generation of artists. I was particularly struck by his suggestion that "all young artists need to be amused in a classroom to maintain interest."

I have felt this way about performance measurement. Thus my attempt (though sometimes lost on the students) to interject humor whenever possible; I do the same with my public speaking. I learned the value of humor in presentations close to 40 years ago, when, as a newly minted army second lieutenant, I attended a class on a rather boring subject during Field Artillery Officer's Basic at Ft. Sill, Oklahoma. The instructor would interject a joke roughly every 40 to 60 minutes. Not only did this make us laugh, it also raised our attention levels.

Granted, not everyone is good at telling jokes or using humor, but it's a skill that can be learned. I'm pleased that many speakers we invite to PMAR, such as Steve Campisi and Carl Bacon, strive to liven up their presentations with a bit of humor. Shocking as it may sound, to some performance measurement, risk, benchmarks, and the like can get a bit dry once in a while, and there's nothing like a good joke to help keep people awake.

p.s., LeRoy Neiman's image above comes directly from the WSJ article.

Tests: too hard, too easy, and the world of cheating

This past week saw a few articles appear dealing with test taking. The WSJ reported on teachers who cheat for their students, so that the students' scores on standardized tests are higher, presumably so that the teachers can qualify for monetary benefits (or perhaps to avoid being terminated). The article cited one student who refused to take the test, but somehow managed to pass! Sadly, even in the Garden State (New Jersey), home of some of the most corrupt politicians in the States, apparently is also home of some corrupt teachers, as we are seeing evidence of cheating, revealed in last Saturday's Home News Tribune.

At the other end of the spectrum we learned of EU Bank exams that are apparently so easy that too many banks refused to fail them, as reported in this past weekend's Wall Street Journal.

An exam that's near and dear to many of us in GIPS(R)-land (Global Investment Performance Standards) is the Performance Examination, which can be done alongside, or after a firm undergoes, a verification. The GIPS Executive Committee has presented us with a proposed revised version of the Examination Guidance that suggests that verifiers perhaps should get the required account details (holdings and transactions) from an independent external party (e.g., custodians or brokers), offering three levels for your consideration:

• “preferable” to obtain from independent external parties
• “must make every reasonable effort” to obtain from independent external parties
• “must” obtain from independent external parties.

I consider these rather extreme measures, that appear to be aimed at the likes of the currently incarcerated Bernard Madoff; must we all suffer as a result of his misbehavior?

In this month's soon-to-be-published newsletter, I go into some detail on the exposure draft (the draft is available for public comment until August 31). In addition, I will discuss performance examinations in general, as well as the exposure draft, at this month's webinar (Monday, July 25, @ 11:00 AM, EST). If you're interested in participating in the webinar, please contact Patrick Fowler. And please review the draft so that you can comment; this document affects both verifiers and asset managers.

Providing performance results in a "non-GIPS" world

We have been in discussions with a firm that doesn't claim compliance with GIPS(R) (Global Investment Performance Standards), but still wants their returns "verified." They wanted to know what they need and what their options are.

The introduction of GIPS doesn't mean that firms can't show prospects performance results; granted, GIPS is considered "best practice" within our industry, but there can be a variety of reasons why a firm isn't able to comply. And so, what can they do? Here are three approaches:

1. Hypothetical or model results. With this option, the firm doesn't use real portfolios but a model portfolio to represent their strategy. This would be the least attractive option, but is permitted. Adequate disclosures are needed. (Steve Stone and I wrote an article on this topic for the CFA Institute, which you might find of value).
2. A representative portfolio. This is probably more attractive than a model, but less attractive overall, because it suggests "cherry picking," and you'd also have to deal with cases where an account may terminate. However, it's an option nonetheless. It would require appropriate disclosures as to what the returns represent.
3. A composite of all accounts in the strategy. This could be just like what GIPS requires (e.g., asset-weighted returns) or not completely (e.g., to use equal-weighted returns). This is preferable to the other two options shown (but obviously not as preferable as GIPS compliance), and will require your rules for composite construction to be identified, and preferably written down. Some form of disclosures would be needed, but perhaps not as many as the other options.

We conduct "non-GIPS" verifications for several firms, and so this option (to get your returns verified by an independent, third party) exists in this arena, too. We obviously encourage all managers to comply, but recognize this isn't always possible. This doesn't mean you can't have your numbers reviewed.

Oh, and when it comes to firms that fall under their country's regulator(s) (e.g., the Securities and Exchange Commission (SEC)): you will want to ensure that your materials conform with their rules, just as GIPS requires.

What happens when benchmarks change?

I received some interesting questions this week from someone regarding changes to a client's benchmark, which I thought would be worth sharing here.

I am gathering views from respected performance measurement professionals on an issue that has arisen with regard to benchmark performance. Within the scenarieo whereby at some point within the measurement period of a client’s portfolio there has been a change of benchmark (for example due to a change in investment strategy) would you agree with the following statements:

1. A client would still be interested in the performance of their portfolio over the full period of of measurement of their portfolio, spanning the two benchmarks.

This can absolutely be done. And, expected. Why would a change in the client's benchmark result in a cessation of full-period reporting?

2.  The client would expect the benchmark returns to be linked together accordingly in their client report.
 
This makes sense and appropriate. The investor surely wants to see the management vis-a-vis the benchmark, even if and when it changes.And we would expect the linking to reflect the multitude of  benchmarks which may have been used over the period.

3.  It is industry standard functionality within performance measurement systems for benchmark returns, spanning a change in benchmark, to be linked when this information is retrieved from the system?

Yes. This is a requirement in GIPS(R) (Global Investment Performance Standards).

Benchmarks often change. To avoid problems we would expect the historical benchmark(s) to remain, for the periods they aligned with.

Yes, we're now tweeting...

Not me, but we (our firm, The Spaulding Group, that is), are tweeting away. We have decided to create a Twitter account, meaning that we will be tweeting news and informational items we feel have interest to our friends and colleagues. Dave Mory, our sales associate and resident social media overseer, has set this up for us.

But, we have to be careful; we don't want to be captured by Fox News tweeting some dumb things, such as:

• Jessica Biel on the Days of the Week: “I work out every day -- Monday to Saturday.”
• Bow Wow on the Meaning of Life: “Im getting an xbox controller tatted on my arm. they say tats post to be meaningful, thats apart of my life video gaming.”
• Paris Hilton's Geography Lesson: “No, no, I didn't go to England; I went to London.”
• Solange Knowles Knows Her Body: “My thumb itches and my armpits smell like spongebob fever.”
• Lady Gaga on Love and Construction Materials: “Love is like a brick. You can build a house, or you can sink a dead body.”
• Sean 'P Diddy' Combs' Multiple Personalities: “I Am Destiny To Do Something GREAT Today!!!”
• Mary J. Blige Addresses Her Detractors: “Why is that people always try to understand estimate my intelligents?! They should never do that!”
• Ashton Kutcher on World Affairs: “Watching these dictated countries implode is just crushing.”
• Alicia Machado on Asia Tensions (Tweeting about the tense situation between North and South Korea): “Tonight I want to ask you to join me in a prayer for peace, that these attacks between the Chinas do not make our situation worse.”

 Please sign up so you can follow us! Thanks!

Is compliance enough?

A firm we consulted to a few years ago responded to one of our marketing pieces about verification, wondering if they should make the investment to undergo this exercise. They have claimed compliance with the Global Investment Performance Standards (GIPS(R)) for some time, but have noticed that they aren't getting the business that they thought they'd get, especially their above average returns.

To put it simply, YES! Verification is not an expense but an investment, that serves multiple purposes.

Claiming compliance is critically important today, especially when marketing in the institutional space. However, these institutions want some assurance that your claim has a degree of validity, and verification does just that. Granted, contrary to common belief, verification doesn't verify compliance. Rather, as GIPS 2010 points out, "Verification 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." But for many this is seen as being tantamount to affirming, though not in so many words, that the firm's compliance is correct.

And given that both our research and experience have shown that most firms who have not undergone a verification but claim compliance are falling short of the requirements (i.e., not really complying), the claim without the verification doesn't carry a lot of weight.

Another advantage for SEC registered firms: while the SEC offers "free verifications," you don't want to fail them (i.e., you don't want them to be the ones to tell you that you're not actually in compliance). Therefore, isn't it better to make the investment to avoid having these problems?

How frequently should you have a verification done? We recommend annually; we don't in any way support quarterly. Not because we don't like to visit our clients, but because there is no benefit for this level of frequency, other than to keep the verifier's employees busy throughout the year. We believe that quarterly visits are also disruptive to the client. Granted, some of the firms that do these verifications don't actually visit their clients, but we do, and none of ours has the need for us to see them that often (unless, of course, we're engaged in some other work for them).

Our research has also shown that most firms that claim compliance do have verifications done. And so, firms like the one cited above are in the minority. Yes, it's nice to be able to "tick off" the box in the RFP (Request for Proposal) that asks "Do you claim compliance with the GIPS standards?" But if you can't also tick off the "Have you had a GIPS verification done?," then the likelihood of being hired, or even considered, is significantly reduced.

And so to these firms I have to ask: you made the investment to achieve compliance; isn't it worth the investment to undergo a verification, too? We (and most of the industry) would say "yes."

p.s., a point of clarification is in order. The SEC doesn't actually offer "free verifications." They do freely come in once in a while to check registered investment advisors out, and in the course of their work may conduct tests to validate a firm's compliance, but aren't in the business of conducting verifications. Please don't call them and say "Dave Spaulding said you offer free GIPS verifications and we'd like you to come in and conduct one for us." I have used this line about "free verifications" in a number of talks I've given, thinking that surely everyone understood it was meant as a joke, but apparently some in attendance believed me.

p.p.s., while the suggestion that verification become mandatory has died away, the new requirement (as part of the 2010 edition) to declare whether or not the firm has undergone verification should encourage more firms who haven't made the investment yet to do so. That's at least the expectation.

Tracking your performance

This weekend's WSJ has once again provided us with a topic to address, specifically from Jason Zweig's column, titled "Why We Can't Tell if the Market is Half Empty or Half Full." He points out that "For most investors, getting a clear picture of where your portfolio stands isn't easy." The key words here are "your portfolio."

He later quotes Tom Chubb, a retired marketing executive who said "What I want to be able to do is to look at those different locations where my nest egg is stored and try to determine whether my financial advisers are doing a good job." Here we want to evaluate the financial advisers.

Jason identifies a few sites that might help the investor, such as Moringstar's, which has a "performance tab" where an investor can compmare their stock or ETF (exchange-traded fund) against the S&P 500, with dividends included. But would we really want to look at single investments? This has some value, no doubt, but the portfolio view is probably what most want to see. And if these investments are purchased and sold at different times, or in pieces, such a review won't really do us much good.

Apparently Google Finance is considering a "total-return chart," but they don't have any plans to introduce one. Yahoo apparently has one "in the pipeline."

What is it the investors are interested in? We've been through this a few times, yes? It depends on the perspective from which the question is posed:

• How am I doing? We want a money-weighted result.
• How is my portfolio manager or financial advisor doing? We're talking time-weighting.

Modified Dietz isn't a difficult return to calculate, and I'll be happy to provide anyone who'd like it a basic spreadsheet that can be used to derive these returns. They can then be chain-linked to develop an approximation to the true, time-weighted return, which will no doubt suffice for most investors who want to gauge the performance of those they rely on for their investments. For their own performance (i.e., money-weighting), they can rely upon Excel's built-in IRR functionality. We can provide guidance on how to do this, too. It's not really that hard. 

Oh, and for Mr. Chubb and others like him, we are finding more and more broker/dealers (several of whom are our clients) providing their clients with rates of return. Granted, they're often only from one perspective, but this solves at least one of their needs. And many can consolidate the holdings from other managers, so that the investor sees a single report that covers all their investments.

It really shouldn't be that hard, should it? We don't think so.