20 years and counting

Earlier this week my TSG colleagues and I went to lunch to celebrate our 20th anniversary in business. And, they presented me with a beautiful pen to commemorate this event.

Because we have a decimal (i.e., base 10) system of counting, we focus on years ending with zeroes and fives. And so it's natural that 20 years be celebrated (imagine what we'll do for 25!).

As we grow older we tend to focus more when we hit 30, 40, etc. and our wedding anniversaries get greater attention when they end with zeroes and fives (my wife and I went to Hawaii for our 35th and haven't gone anywhere for our last couple; and we exchanged nicer gifts for our 25th).

To let this anniversary go by without acknowledging a few people would be wrong, so I will do that here.

• Patrick Fowler is the #2 person in our firm. He has been with us for over 12 years. He essentially "runs" the firm, being responsible for just about all of our events and programs. I rely upon his advice and support immensely, and am so grateful that he's with us.
• Chris Spaulding, my older son, joined us almost eight years ago and is responsible for sales and customer service. He, too, has taken on a role of advisor. While having family members in a business can be a challenge, it hasn't been for us; it's been quite a joy.
• John Simpson rounds out the management team (that, if you haven't figured it out, includes Patrick & Chris) and recently celebrated his five year anniversary with our firm. We knew John from his prior role at IDS and were thrilled that we could persuade him to join  us and run our West Coast office. He provides depth that we sorely needed and has been a great asset.
• Doug Spaulding, my younger son, has been with the firm for seven years. He came on to be responsible for the production side of our publishing, and took on the role of editor last year. His love of writing makes him a perfect fit for this position, and I've been so proud to see him grow in this position.
• Jaime Puerschner joined the firm more than six years ago to be our event planner, though she does much more than that. Given the many programs we run we felt we needed someone dedicated to ensuring that our events go smoothly, and she has done a fantastic job at it. If, for example, you've attended PMAR you know good a job she does at organizing.
• Sue Kneller worked for our firm for ten years and recently retired. She was our VP of administration and made sure the office ran properly. She contributed to our success in so many ways.
• Betty Spaulding is my wife and carries the title ceremonial title of EVP, though has no official role with the firm. But, she has served as a counselor to me over these 20 years and has been such a tremendous source of support and encouragement that she warrants acknowledgment, too.

We didn't start out to be so focused on performance, but have no regret for this decision. We have been fortunate to meet and work with so many folks throughout the world. We consider our clients and colleagues to be our friends, and enjoy being with them. The Performance Measurement Forum has been an especially great group for us to be involved with. We thank our many clients for their support and the honor to serve them.

Our industry is an exciting one to be in. We really are passionate about performance measurement, and hope it shows.

MWRR @ subportfolio level

A brokerage client just mentioned that one of their reps wants money-weighted returns at the subportfolio level. And I was asked to contrast the advantages and disadvantages of time- versus money-weighting. Well, in one respect he came to the wrong guy, because there is no advantage to time-weighted subportfolio returns, with the only possible exception that someone might want to see how a security performed, irrespective of the flows that occurred, which might have some slight marginal value.

Who controls the flows at the subportfolio level? Well, if it's a managed account it's the portfolio manager...so why wouldn't you want to use money-weighting to capture these decisions? And if it's the client, then again, why wouldn't you want to capture the buy and sell activity?

Money-weighting is the way to go. [full stop!]

Advisory assets & GIPS(R) firm assets

The Global Investment Performance Standards (GIPS(R)) requires firms to report their "firm assets" as part of each composite presentation. But many people have advisory accounts...should these assets be included?

First, what are advisory accounts? They're essentially non-discretionary relationships (from a legal perspective) where the manager has no assurance that their investment decisions will be carried out. For example, perhaps you have a brokerage client that you alert to trades you plan to do, and suggest that they do the same. Or, you have a model which you've sold to a third party, who in turn markets to their clients. You can't be assured or don't know whether or not they take your advice, however.

These assets are not part of your "firm assets" and should not be included as such on your GIPS composite presentations. The basis for this position is shown in a table on page 67 of the 2006 edition of the GIPS handbook.

You can, of course, include a separate field if you wish, of "advisory assets," but this would be considered "supplemental information" and would have to be annotated accordingly.

A client reporting "no no"

It appears at times that reports are designed to convey how smart the sender is. And while this is perhaps not normally the intent, it can nevertheless be the message. Sending a client, for example, the results of a complicated fixed income attribution model, when we haven't conveyed in a clearly understandable manner the meaning of what's shown, serves no purpose.

Even sending what many might consider basic return or risk statistics, when they aren't necessarily appropriate, would fall into this category. Why, for example, would we send a brokerage client tracking error? Tracking error, if you recall, is the standard deviation of the excess return, which in turn is the portfolio return minus the benchmark. It basically tells us how closely our portfolio has tracked the index. But why would a retail client care about this? Are they managing their portfolio vis-a-vis an index? Okay, if they are then fine, send them tracking error. But if they're a fairly normal (whatever that means) brokerage account, why give them this statistic? It may confuse them but will most likely not enlighten them.

Let's not get carried away with our reporting. Just because we can send a client something doesn't mean we should.

"Audited performance figures are what I want" ... but can I get them?" cont'd

Earlier this month I posted about the issue of firms wanting their returns "audited" when they have a GIPS(R) (Global Investment Performance Standards) verification conducted. At that time I mentioned that I had asked a couple of CPA colleagues their thoughts on this. I mentioned at that time how the first responded; here's what the second wrote:

[Accounting firms] shouldn't let anyone say that they were "audited." No accounting firm would let someone present their performance as audited.  We do an examination.  When my clients ask me about this, I respond that they can say that their results were "EXAMINED."      
 
If you look at the opinion that the accounting firm renders, its heading is "Report of Independent Accountants."  It does not state "Report of Independent Auditors."
 
We can only call ourselves Independent Auditors when we conduct an audit.  An audit can only be conducted on a full set of financial statements (with a balance sheet, statement of Operations and Cash flows).  We can not (under our professional standards) audit part of financial statements or a performance presentation.

While it's common to hear our verification clients state that their "auditors are here" or that their numbers have been "audited," it's clear that this is technically incorrect. And, it's clear that it's incorrect for an accounting firm to try to distinguish themselves from non-accounting firms who perform verifications by suggesting that with them the client gets "audited returns."

Interesting, I think. Hope you agree.

Gaining clarity

I don't know about you, but I was a bit confused by the GIPS(R) (Global Investment Performance Standards) requirement that compliant firms must disclose that additional information regarding policies to calculate and report returns is available upon request (see ¶ 4.A.17 of the 2005 edition). What does "report" mean? Reporting to clients? Prospects?

Well, the 2010 edition makes this much clearer. Compliant firms will be required to disclose that their policies to value portfolios, calculate performance, and prepare compliant presentations are available upon request (see ¶ 4.A.12 of the 2010 edition). This means that  you need to have such policies, and so if you don't, it's time to begin to work on them!

"Logic does not require empirical verification"

The above quote comes from Nassim Taleb's Fooled by Randomness, which I started to read over the weekend while vacationing at the Jersey Shore (light reading). I'm finding that the book, as with his later Black Swans, has many interesting insights.

But this quote, to me, says a lot.

When, for example, I discuss the topic of money- vs. time-weighting, I often resort to logic (or at least to me it's logical). If we use time-weighting to eliminate the impact of cash flows because the client controls the flows, then wouldn't it seem logical that we would include the impact of cash flows when the client doesn't control the flows (i.e., when the manager does)? To some it apparently doesn't seem logical; in fact, some argue that you cannot use this form of logic. That yes, it is true that we use time-weighting to eliminate the impact of flows when the client controls them, but when the manager does we should still use time-weighting.

Sorry, this doesn't seem logical to me. If anything this counter argument screams the absence of any logic.

Fortunately, there's plenty of empirical evidence to demonstrate why money-weighting is the way to go when the manager controls the flows, but to some no amount of evidence will sway their view. Oh, well. You win some, you lose some. The reality is there are different views and everyone is entitled to theirs.

Performance and risk from a parallaxical perspective

I want to thank William McKibbin for introducing me to a new word: parallax. He used it in a response to one of my recent posts and I must admit that I was forced to look up its meaning, because it was new to me. Dr. McKibbin has a blog which I frequently visit, and so am pleased that he not only reads my blog but also occasionally offers commentary.

As per dictionary.com, parallax means "the apparent displacement of an observed object due to a change in the position of the observer." This word does fit quite well, does it not, when we speak about performance and risk? 


I have written about performance from a matter of perspective. That is, depending on one's perspective, you may see performance differently or more importantly, have different requirements when measuring performance. The same applies to risk. Parallax is yet another way to view these phenomena, where depending on where one is standing, they are seeing things differently. 




p.s., as for "parallaxical," I made that word up...but it works, does it not?

Bernie & GIPS

I received an interesting question from a Linkedin mate today regarding the Global Investment Performance Standards (GIPS(R)) and the impact that our friend Bernie Madoff may have had:

I was just curious about this and I figured you would be a good person to ask,

With all the scams (Madoff) and market meltdowns, has the amount of firms looking to become GIPS verified increased? Have they been feeling the pressure to get GIPS verified? I would think they would but it still seems there are a lot of firms out there that are not.

Any insight would be greatly appreciated.

We have definitely seen increased interest in compliance. Our verification business grew by more than 400% last year and this was partly due to firms becoming compliant for the first time. One might also attribute some of the growth to the market downturn, where firms are making the investment to comply in order to attract new business. And, we've seen increased interest in compliance (and verification) from the hedge fund community.

Yes, Bernie has been very good for GIPS!

Getting the dates straight

I've commented in the past how the new version of the Global Investment Performance Standards (GIPS(R)) can be a bit confusing. The "2010" in the title refers to the published date; the effective date is 2011 (actually, January 1, 2011). But when do firms have to begin to comply?

Well, the answer is "it depends." First, firms can comply early if they so choose. But when MUST GIPS-compliant firms comply with the new provisions. The simple answer: when they begin to reflect 2011 returns in their presentations.

So, for example, if you typically show quarterly returns in your presentations, then you'd comply when you show your 1Q2011 returns (probably around April of next year). But what if you only show annual returns? Then, you would comply when you show your 2011 annual returns...which might not happen until January 2012!

Whose risk is it anyway?

Last week I interviewed Northfield Information Services' founder and president, Dan diBartolomeo for The Journal of Performance Measurement(R). Dan shared many insights with me, and I'm sure our readers will find his thoughts and comments quite compelling.

One thing that struck me was the issue of risk from the standpoint of "whose risk are we measuring?" That is, are we looking at risk from the standpoint of the manager or the client? I've addressed this from the performance standpoint, but Dan was speaking of it from a risk point of view, which I found quite interesting.

There are loads of questions one might want to ask when it comes to risk, and they have different degrees of meaning depending on whether we're speaking of it from the manager's or client's perspective. For example:

• the risk of being fired
• the risk of losing our money
• the risk of uncertainty
• the risk of not being able to meet our objectives.

When it comes to risk management, the manager and client should be looking at risk from a variety of perspectives, yes? Just like performance measurement!

p.s., We are embarking on a research project this month to see how firms manage and measure risk. We've teamed up with Leslie Rahl and Capital Management Risk Advisors. In addition, we have several cosponsors supporting this effort. We will gain insights into how managers are measuring and  monitoring their risk.

p.p.s., Dan diBartolomeo recently conducted a webinar for our firm, where he shared details on the Bernie Madoff scandal. He is also featured in the August issue of Risk Professional Magazine.

p.p.p.s., Dan's interview will appear in the upcoming Summer issue of The Journal. 

Going back in time

An interesting question was posed to me recently; one that I hadn't previously thought about.

A client who wants to become compliant with the Global Investment Performance Standards (GIPS(R)) has three strategies, each of which has been in existence for 20 years, and each having its own composite. The firm wishes to have history for one going back the entire period, for 10 years for the second, and only the minimum five years for the third. Can they do this?

I thought this was a bit of a perplexing problem because a "firm" is compliant, not a "composite." And since the "firm" wouldn't have been "compliant" eight years ago, for example, if only two of the three composites had returns, would that therefore invalidate compliance for those dates? And yet, the standards only require five years (or to the date of the composite's creation, if shorter) of history. And although there's a recommendation that firms go back beyond the five year minimum, there is no stated requirement that firms must be consistent in doing this.

My conclusion was that "best practice" would be where the firm is consistent, but that they could do as they desired. But to be sure I contacted the GIPS help desk, and they confirmed that there was no prohibition on what the firm wanted to do and that they could, as they wished, establish history for different historical periods for the composites. Interesting, I thought; and glad that they concurred with me.

Getting rid of the cash

Let's say you have a client who asks you to raise a sum of money, which requires you to sell securities. At what point is this cash no longer yours? That is, at what point should the cash no longer be reflected in the portfolio as being under your discretion? Well, as we used to say in the military,

immediately, if not sooner.

A problem many asset managers face is that the client asks you to raise the money, but then takes days, weeks, or perhaps even months to wire the funds out, all the time the cash is sitting in the portfolio, but you can't touch it! And, its mere presence is impacting your return. This cash, once raised, is arguably non discretionary, and should be isolated.

GIPS(R) (Global Investment Performance Standards) permits firms to temporarily remove an account from its composite in the event of a large flow, but this only solves part of the problem: the portfolio's return will continue to reflect this cash. And, what if the cash is still present after the allotted removal time has expired?

A better solution is to use a temporary account. The problem is that this can be a challenge for many, especially when you have to reconcile with the custodian.Perhaps a better solution is to identify this cash as "unsupervised." This is an analogous approach. Some systems support this, and you should consider employing this technique, where applicable.

"Audited performance figures are what I want" ... but can I get them?

A hedge fund is considering us and a small CPA firm to do their GIPS(R) (Global Investment Performance Standards) verification and they also want an examination done. If they pass, they want to be able to say that their records "have been audited." We never use this expression, because I was concerned that the auditor community had an official "lock" on it. Perhaps by implication, the reader might interpret it to mean that an auditor did the work. If our client wants to say that their numbers "have been audited," can they?

Well, I passed this question along to a couple colleagues at very large CPA firms to get their thoughts. I mentioned that this may fall under the category of a "silly question," but I've been known to ask these and obviously have no shame. While both responded I'm only at liberty to share one at this time:

“Audit” does have a defined meaning for us in public accounting.  However, there is no ownership of the term of course.  IRS does “audits” – in the generic use of the word.  Anyone who does an “audit” is an “auditor” – nothing to do with a professional designation.

The CFA Institute did not use that term for the PPS and now GIPS, basically because our profession convinced them that it was the incorrect term for us when WE do the work, and we wouldn’t use it.  Nor do we, as our work is performed under the ATTESTATION standards, not AUDITING standards.

Wouldn’t their use of the term conflict with GIPS?

This raises at least two issues, does it not? First, if our competitor has suggested that they are doing an "audit" and that the client could state that their numbers "were audited" would conflict with the profession's governing body as well as GIPS, itself. Second, it appears that the common use of the term ("our numbers have been audited") is improper. Interesting, is it not? And perhaps not such a silly question, after all!

Karnosky-Singer attributes

Perhaps the best known model to reflect the attribution effects due to currency is the one developed by Denis Karnosky and Brian Singer, both formally of Brinson Partners. The fact that they worked with Gary Brinson is probably part of the reason for its tie in with the Brinson equity models. The K/S model is actually quite flexible and can be adapted to any attribution model, including fixed income models, though little has been written about this. This is "on my plate" to do in the near future.

Two important features of the K/S model should be emphasized. First, on the market side (where we look at the traditional effects one might find from a Brinson (e.g., Brinson-Fachler) model, for example) we use local return premiums rather than merely local returns. That is, we back out the risk-free rate from the returns, as this rate ends up on the currency side.

Second, we show two attribution effects for the currency side: the contribution from the underlying assets (that is, the impact simply due to changes in the FX rates on the assets in the portfolio over the period) and from currency forwards (that arise from our employment of various forward strategies). While one might want to lump these effects together, separating them provides the reader with a much better insight into what has occurred in the portfolio.

If, for example, we don't employ any hedging, then all of the effects would presumably come from the underlying assets. If, however, some hedging is taking place, then we would see how each is contributing to our excess return.

Attribution standards

Someone e-mailed me this week asking about the status of attribution standards. He cited my article, "A Case for Attribution Standards" (Journal of Performance Measurement, Winter 2002/2003) and wondered if any progress has been made. Sadly, no.

When the Performance Measurement Forum developed our draft standards close to a decade ago we hoped they would spur some interest and an endorsement, but this hasn't occurred.

Since the release of the article and the draft, a French group (GRAP) released guidelines for fixed income attribution and the European Investment Performance Council also provided guidelines.

There was much confusion when the subject of standards was first broached, with some interpreting the idea as defining what type of model, for example, one must use. But rather the idea is about disclosure: that is, for firms that employ attribution to disclose how they do it (e.g., arithmetic or geometric; holdings- or transaction-based; which model).

Perhaps this inquiry and some additional discussion might inject some renewed interest in this concept.

Confused?

We occasionally ask folks what they think is the most confusing aspect of the GIPS(R) (Global Investment Performance Standards), which typically results in a variety of responses. To me, the most confusing term is "discretionary account." Recall that compliant firms must place all actual, fee-paying, discretionary accounts into at least one composite. But most firms read "discretionary" and immediately take this to mean legal discretion; that is, does the firm have the authority to trade on behalf of the client.

But this isn't what the term means...it's dealing with discretion from a GIPS perspective. That is, has the client placed any restriction or requirement on the manager such that the result will not represent the manager's style? If "yes," then it's non-discretionary.

I was at a new client last week and they were putting every account into composites, even though they clearly had some flexibility at hand. For example, they had a new client which imposed a restriction which would have caused roughly 10% of their model's typical holdings to be excluded from this client account, which would have resulted in returns which wouldn't represent the composite. They were planning to create a whole new composite just for this account. And while they aren't prohibited from doing this, why do it if you can simply flag the account "non-discretionary"?

Discretion is a great tool that's available to all GIPS-compliant firms, but it must be used in a proper manner. Their rules for discretion must be documented in writing. And general rules such as "an account is deemed non-discretionary if the CIO (chief investment officer) feels the account has restrictions that impedes his ability to invest" don't work: we need clear cut rules; rules that can be tested by an independent party.

If you'd like to share what you think is confusing about the standards, feel free!