A crowded, but happy office

Hurricane Sandy left many of us without power; fortunately, our office has electricity. And so, we invited our employees to bring their spouses and/or children with them, to have a chance to warm up, relax, and even have a hot shower. Most took advantage of the offer, and so we had several extra folks in our offices these past couple days (and expect to still have a few tomorrow). While some of us now have electric back on at our homes, many still do not.

I consider it a blessing that our office had electricity and the other amenities, thus allowing for us to provide a respite for our colleagues' families. The children (numbering eight, I think, at our max) handled the situation quite well, hunkering down in our conference room, which has a TV, and a large table which allowed them to do various projects. The youngest members (our two grandsons) made the whole office their own, crawling (Caden, who will be one in less than three weeks) and walking (Brady, who turned three in August) around, visiting with everyone.

I guess it's called making the best of it, and I think we have and will continue to do so.

While the gasoline lines are quite long, and many remain without power (and of course too many suffered very badly), we will continue to count our blessings and be patient with those dedicated souls who are working to return our lives to normalcy.

 

 

 

 

When performance isn't so good

A year ago Monday, the Northeast part of the United States was greeted with a horrendous storm, which included a lot of snow and damaging wind. My wife and I that day went to a civil union ceremony, a trip that should have taken about an hour; instead, it took four.

Well, on this storm's (and the happy couple's) one-year anniversary we were visited by Sandy, a hurricane which has pelted us quite hard. Its performance was quite good, for a hurricane, but quite bad, for those of us who were recipients of its forces.

The NYSE closed for two days, as did our offices. Many, including almost everyone in our NJ offices, are without power. Our office, however, has power, so those of us who can are here.

Many roads remain closed, which can make travel quite difficult. While I had no problem making it in (I live less than 10 minutes away), it took Patrick Fowler three times as long as usual to get here, and others may not make it in.

Because of loss of power, many (most?) gas stations are closed; and those that are open are doing lots of business, as the lines extend for quite some distance (Chris counted 150 at one waiting for a single pump!).

Hurricanes have hit this area before; what made Sandy different?

I am not, of course, a meteorologist. But, from what I can gather, most hurricanes come ashore much farther south (e.g., in Florida), and then, if they so choose, work their way north along the coastal states, but inland, meaning their power is weakened as it moves northward. Sandy moved north in the ocean, and made land right along the New Jersey coast, with its width spreading north (to NYC, Long Island, and Connecticut) and south (to Philadelphia, Delaware, and Maryland). It caused extremely high waves, which pummeled the shoreline, flooding many towns and communities. Its winds, sometimes in excess of 100 mph, caused much destruction.

We're the lucky ones

Despite some of the damage that we've had, and our power issues, our troubles are not at all like those of many others, whose homes, cars, and property have been lost or severely damaged. Our thoughts are also with those who have died as a result of this devastation (55 so far), as well as their families that are left behind to mourn their passing.

You can pay me (annualize) now, or you can pay (annualize) me later

One of our clients introduced me to alternative ways to calculate two commonly used risk-adjusted return measures: information ratio and Sharpe ratio. Their immediate derivation is from Zephyr, and I am attempting to identify their origin. I confirmed that Morningstar also uses them.

In both cases, they annualize and then do the math, rather than do the math and then annualize. This calls to mind the associative property of mathematics, which says the order does not matter. While in addition, this holds (2 + 4 = 4 + 2 = 6, for example), it does not in these methods, as we get different results.

This also reminded me of how some attempted to derive my favorite risk-adjusted measure, Modigliani-Modigliani (annualize first or last?).

The information ratio differences:

And, the differences with Sharpe ratio:

 

This raises numerous questions. For example, is one approach superior to another? My suspicion is that most firms use what I refer to as the "typical" formulas. The reference materials I've checked only show these approaches. But clearly, some favor the alternative. The CFA Institute's CIPM(R) program, as I recall, also references the "typical" approach.

 

We know that there are multiple ways to derive various statistics, and here are just two more cases. As I learn more, I will share it with you. In the mean time, feel free to "chime in" with your thoughts. 

Working my way through the Alternative Investments GS

I have read through the new GIPS(R) (Global Investment Performance Standards) Alternative Investments Guidance Statement a few times, and frequently make what I think are interesting discoveries. Here's just one:

I have highlighted the part I find of interest (I hope it's readable). We see "firms may wish to present simulated, model, or back-tested hypothetical performance results due to the lack of an actual historical track record." [emphasis added] This further adds credibility to my prior suggestions that the Standards permit the use of non-real performance, which is, I think, quite a good thing. And so, for example, if a firm has a new strategy for which they only have simulated, model, or back-tested performance, they can use it (along with a disclosure that makes it evident that this isn't a real track record (i.e., against managed assets)).

However, when we continue to read we find that these same results "can be presented as Supplemental Information to a compliant presentation." [emphasis added] What compliant presentation?

I think this is where it can get interesting, and even confusing, but it shouldn't be.

First, we see the word "can," which isn't the same as "must." And so, in the absence of a track record for a strategy, a firm can use hypothetical results.

When would the "can" apply?

In a couple cases.

First, even though this sentence is in the same paragraph as the wording dealing with the absence of a track record, the hypothetical performance can be used even if there is a track record, to demonstrate performance for periods not covered by the real investments.

Second, just because a firm doesn't have a track record it can still have a presentation; I have long been an advocate of this. The firm would have all the necessary disclosures, but no performance. The performance would be the supplemental hypothetical.

Make sense?

We also see the same language that appears in the Supplemental Information guidance statement: that you can't link hypothetical and actual performance. By "link" we don't mean "geometrical linking," though this would also hold true, but rather "visual" linking, where by presenting hypothetical and actual on the same page, the reader might mistakenly think they're one and  the same (i.e., actual for the full period). And so, to avoid the potential confusion, you're required to have them on separate pages.

I'll have more to say about this GS in future posts.

Did you hire a GIPS verifier or a cell phone provider?

If truth be told (and I am about to tell it), I do not know how common this practice is, but we have become aware of cases where GIPS(R) (Global Investment Performance Standards) verifiers require their clients to sign multi-year contracts. E.g., they will perform the verification for the period 2010-2012. Does this remind you of anything?

Cell phones come to mind.

AT&T, Verizon, etc. all do this: they require you to sign up for a multi-year contract.

Can you get out of them? Sure, if you want to pay them. But who does? Regardless of the quality of the phone or service, you're pretty much stuck.

The Spaulding Group has NEVER thought of doing this. Our view is, if you don't like our service, fire us! Our feelings won't be hurt (okay, maybe a little bit, but we'll get over it). While we always strive to deliver the highest degree of service, we don't want to require our clients to keep us if they don't want to.

Why would you want to require your clients to sign a multi-year contract?

Oh, I know why: for YOUR benefit! Now I get it. Lock the client in. Even if they discover a better option, you lock them in, so that they are forced to retain your services.

Our advice to firms looking for a verifier: if the firm you choose is making you sign a long-term agreement, just say "no!"

If you have confidence in what you deliver, you won't have such a practice. Have a different view? Chime in!

p.s., if you'd like to learn more about TSG's GIPS and non-GIPS verification service, go to our website; better yet, fill out a questionnaire and get a detailed no-obligation proposal, along with a surprise gift!

A new GIPS rule being introduced in a non-standard way

It came to my attention yesterday that a new GIPS(R) (Global Investment Performance Standards) rule is being introduced into the GIPS Handbook regarding the treatment of significant cash flows (SCF): compliant firms will no longer be able to use the "number of portfolios" as a factor to employ the firm's SCF policy.

 

Where did this new rule come from? And more importantly, why wasn't the public given a chance to comment? Would such a change not be better handled through a revision to the SCF guidance statement, with the traditional public comment period?

 

This change is no doubt being couched within a "Q&A," that was perhaps fabricated for the purpose of introducing it, but the Q&As were never intended to be the source of new rules but rather interpretation of existing rules. Was this a Question that was asked of and Answered by the GIPS Help Desk? I suspect not, since it's not listed in the Q&A section of the GIPS website. Was this rule vetted with the Interpretations subcommitte or the GIPS Executive Committee? Or, was it added as part of the last minute editing process, without the benefit of public discourse?

 

The irony here, as you will see, is that the earlier version of the guidance statement conflicts with what is now apparently a rule!

Here's what is being changed: Let's say you have an SCF policy that you employ firm wide, that says if there's a flow greater than 30%, you will remove the portfolio for one month. Great! BUT, you have a few small composites (small in number of portfolios) that could have "gaps" or breaks in performance if you ever employed the SCF rule here. And so, you want to condition your policy by having something like "if the composite has less than five accounts, the policy does not apply." I.e., you'd rather suffer from the impact of the flow rather than experience a break in your performance history.

Or, what if you want a policy that says that composites with ten or more accounts have a 30% threshold, while composites with 5-10 have 40%, and below five will not participate in the SCF policy, so as to avoid possible breaks; what is the harm with such a policy?

This new rule will prohibit firms from doing this. Why? What's the point? What is the harm with firms having such policies? I find the change unnecessary, but more important, the manner in which it is being done in total conflict with the traditional methods to introduce new rules. What happened to protocol?

I mentioned above that these new "rules" seem to conflict with language in the earlier version of the SGF guidance:

 

As you can see, the SCF guidance recognized that a firm could experience gaps if a composite had just a few accounts, and so it cautioned firms on applying the same rules across the firm, without any regard to the number of portfolios a composite might have. For an unknown reason, this wording was removed from the most recent version of this guidance. Are we now witnessing a total "180" regarding a firm's ability to have rules partly conditioned on the number of portfolios in a composite? Why?

Since this is clearly a rule change, why isn't there an effective date?

I find this frustrating, ridiculous, absurd, and senseless! What do you think?

By the way, firms can STILL accomplish having their policy sensitive to the number of portfolios in a composite; they will have to specifically identify those composites which will employ the SCF policy. It's a little more cumbersome, perhaps, but can still be done. There is no requirement that firms must have a single SCF policy that must apply to all composites (at least not yet!).

Also, one might wonder what other new rules are being introduced this way; I guess we'll find out soon.

TSG Hires Steve Sobhi to head up our western region sales

This was just released by The Spaulding Group: