Who benefits from quarterly verifications?

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:

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

We oppose it because:

1. It's disruptive to the client
2. It costs more
3. 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?

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?

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!

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

The "regulator's dilemma"

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

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!

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!