Inconvenient truths about "best practice"

The weekend Wall Street Journal rarely fails to provide me with ideas for this blog, and this past weekend was no exception, as Matt Ridley's article titled "Inconvenient Truths About 'Renewable' Energy" made me think about the issue of "best practice." And how was this? He begins with the question "What does the word 'renewable' mean?"  You may recall that I have asked this same question before regarding "best practice." The reality is that there are loads of different meanings, and so when it's used it's helpful to understand which definition the user is employing.

We know that the GIPS(R) (Global Investment Performance Standards) standards state that recommendations are "best practices," but fails to define what the term means. A colleague recently pointed out that the CIPM (Certificate in Investment Performance Measurement) program, too, uses this term; their website includes the following: "The CIPM program applies best practices in investment analysis techniques." (emphasis added)

And so, what is meant by this term? I will confess that I often use the term myself, but generally mean "in my opinion" or what I believe most performance measurement professionals would say or do.  I think it's helpful to understand what is meant when one uses such an expression, as it can be quite misleading without this clarification.

How linking turns money-weighted into time-weighted returns

When we link money-weighted returns we get time-weighted returns, or more precisely, approximations to time-weighted returns, as discussed in today's video.

Client reporting standards: a good idea?

I am in Philadelphia for a couple days, hosting PMAR IX. Yesterday we heard from Beth Kaiser about a CFA Institute initiative to possibly develop reporting standards for clients. I must confess that I have mixed feelings about this.

There are two main concerns that I have:

1. Where is the problem? The FAF standards, which became the AIMR-PPS(R) standards, and (arguably) the GIPS(R) standards, were developed to solve a problem and a need for improved and ethical representation of past performance for prospective clients. But where is the problem in client reporting? Granted, some firms often want ideas, but is this the way to provide solutions? Unclear to me.
2. Will this be GIPS II? By this I mean, will this be another standard that firms will be required to comply with, possibly meaning additional costs?

On the other hand, I have witnessed cases where some individuals want to see guidance, and so perhaps this idea might be a good one. I will keep an open mind, and encourage you to be mindful of what is occurring, as it will no doubt be of interest to all in our industry.

A few yeas ago, the EIPC (European Investment Performance Council) developed guidance for reporting, and this will no doubt be used during this process. If you are interested in seeing a copy of what they developed, please let me know, and I'll send it along.

By the way, we will address this topic again next month, at PMAR Europe II in London.

Subportfolio returns discussed in an animated way

Today we address subportfolio returns, and why money weighting is the appropriate way to measure them.

Equal-weighting ... can it be done?

I had a call yesterday with a client who wanted to know if they can show equal-weighted composites. Recall that GIPS(R) (Global Investment Performance Standards) requires composites to be asset-weighted (something which I have grown to consider perhaps not to be appropriate, but that will be taken up at length in an upcoming article). And so, is it permitted to show an equal-weighted composite?

Yes! Provided (a) you have an asset-weighted version which is your actual presentation, (b) that you don't use the equal-weighted version as the presentation, but rather, (c) label it as "supplemental information."

Firms can use supplemental information to go well beyond the requirements of GIPS. The rules deal with the materials GIPS requires, but not items outside of GIPS, other than provisions as outlined in the Supplemental Information Guidance Statement, which you should familiarize yourself with.

How to explain positive returns when losses occur

Today's animation discusses the fairly common situation, where a portfolio loses money but has a positive return.

Early adoption still befuddles me

If you recall, when we transitioned from the 1999 to the 2005 edition of GIPS(R) (Global Investment Performance Standards), firms were permitted to do so slowly if they wanted; that is, they could adopt parts of it in advance of adopting all of it. The standards had within them a statement encouraging early adoption. The move to the 2010 edition, however, hasn't been so smooth, at least in my view.

The 2010 edition has removed some parts of 2005; for example, the after-tax rules. This sparked some early questions as to whether firms could "early adopt" by no longer complying with them, but rather using some other method to calculate their after-tax returns; we were told "no," unless the firm fully adopted the requirements of 2010. The reason, as I recall, was to avoid having a firm be partly compliant with the 2005 edition, and partly compliant with the 2010 version, which would result in the firm being in between two versions, not comply fully with either. Okay, I accepted this and thought it made sense.

It therefore also made sense to me that if this was, in fact, the basis behind the prohibition to drop things from 2005, then surely it also applied to changes that might cause a similar problem. For example, if a firm adopts the new compliance language of GIPS 2010 without fully adopting the other provisions, then they would be out of compliance with the 2005 edition (because of the wording change), but not yet fully compliant with the 2010 edition. However, I was mistaken. A Q&A on the GIPS website which reads:

"We currently claim compliance with the GIPS standards (the 2005 edition). May we adopt selected portions of the 2010 edition of the GIPS standards before 1 January 2011 and not others?

"For periods prior to 1 January 2011, compliant firms may continue to claim compliance with the 2005 edition of the GIPS standards. Firms may choose to early adopt selected new or revised requirements of the 2010 edition of the GIPS standards. However, a firm must not stop adhering to selected requirements of the 2005 edition of the GIPS standards that have been removed in the 2010 edition without adopting all of the requirements of the 2010 edition."

The key wording here is the permission for firms to "early adopt selected new or revised requirements."

I cannot claim complete ignorance of this Q&A, as I believe I came across it some time ago, but failed to really pay it much attention. However, I am conducting a GIPS verification for a client who chose to adopt the new claim statement without adopting any of the other requirements, thus putting them in between two standards. I was prepared to say "sorry, but this isn't permitted" but decided to check the Q&A library and found the above language.

And so, the apparent early basis for denying a firm the ability to drop something that's required in 2005 (but no longer required in the 2010 edition) apparently doesn't rest on this issue of being "in between" two standards, which begs the question "why?" That is, why couldn't a firm have chosen to drop something in advance of fully complying? I guess we'll never know.

At this point very few of our clients have moved to the 2010 edition. And compliance with it isn't required until firms begin to report 2011 numbers, which for some won't occur until early 2012. And so, this issue still has relevance, at least for a few more months. And while I still remain somewhat confused about this topic, I think enough has probably been said about it.

Fixed income attribution ... trends & best practices

A client recently asked me what the trend is regarding "building" fixed income attribution systems and what some of the "best practices" are for these systems.

First, as to the trend, I would say it is to buy not build these systems, as there are many vendors who offer very good ons. That being said, we still see many firms who want to build them. We have and continue to work with firms who wish to do this.

And as for "best practices," I will offer two:

1. Strive to have the system match the investment process; this is a "universal rule" when it comes to attribution.
2. Employ two models: one for the managers (internal use) and one for the clients (external).

You may be curious about the second, so I will touch on this briefly. Many portfolio managers want their attribution sliced up into many effects, so they can fully and completely analyze what took place; however, such details can be overwhelming for the firm's clients, thus we recommend a broader, more intuitive model for them.

There continues to be discussion around the possibility of software vendors including one or two commonly accepted fixed income attribution models. I had posed this question several years ago, in discussions with vendors who participated in one of our surveys, asking if they expected to see a "Brinson-type" fixed income model; not that the model would be structured like the Brinson equity models, but rather models that would be found in every vendor's list. While there seemed to be little support for this, I expect this to occur at some point. As always, your thoughts are invited.

Performance through goal accomplishment

Today's post is different than usual, as it's a celebration of the accomplishment of a goal that America has unanimously supported.