10 Steps to GIPS Compliance

The Spaulding Group's latest book, The Spaulding Group's Guide to the Performance Presentation Standards (Spaulding, Simpson & Schneider) includes 10 steps for firms to achieve compliance with GIPS(R) (Global Investment Performance Standards). I thought I'd share them with you:

1. Read the book (the book being the Standards themselves, but our new book can't hurt, either!)
2. Assign responsibilities
3. Define the firm
4. Define the composites
5. Develop policies & procedures
6. Assign accounts to composites
7. Get your records in order
8. Put it all together
9. Prepare marketing materials / disclosures
10. Get checked out (both internally as well as with the help of an independent verifier (i.e., get a verification done!).

That's it! Can it be any simpler?  J

Of course, it's not simple, and for many firms, some steps may require a great deal of effort. We typically begin our verification assignments with a "pre-verification," which includes a "mini" GIPS class, to help orient the firm. We also provide them with our new "GIPS Orientation Kit™." For most firms, compliance is worth the investment!

Can you show two benchmarks in your GIPS presentation?

When you hear the same question multiple times in a short period, chances are it's a fairly common one, so I'll respond.

The question: Can a GIPS(R) (Global Investment Performance Standards) compliant firm show two (or more) benchmarks in a GIPS presentation?

The answer: Yes! However, if you're going to do this you need to identify which is the "primary" benchmark.

Some firms like to show the components of a blended benchmark, alongside the blend: that's fine! Others like to show something like the consumer price index; that's fine, too.

Just make sure you identify the primary; arguably the others appear for "reference" purposes.

What to attribute events to can be a challenge

At last week's North America Performance Measurement, Attribution & Risk (PMAR) conference, I provided an update on research I'm doing on holdings vs. transaction based attribution. Many investment professionals are aware that the holdings based approach typically results in residuals (i.e., unexplained differences between the sum of the attribution effects and the excess return). What isn't widely known is the mis-assignment of attribution effects, which can result in erroneous and misleading reports.

Yesterday we were hosting our immediate family for a picnic/pool party. As I walked outside to take bags of ice to our cooler, I tripped and fell. My wife responded by trying to come to my aid, only to stumble herself. And while I suffered no injury at all, she had a severe sprain. The cause of her injury? My falling, of course, for she wouldn't have fallen had I not done so myself.

Knowing where the blame or credit goes is important. What we don't need are reports that provide the wrong assessments.

Happy Memorial Day

Kind of odd, I think, to wish someone a "Happy Memorial Day," since the day's real purpose is to honor those American military men and women who "paid the ultimate sacrifice," by dying for their country in battle, to protect our freedom. I also realize that around most of the world today, the stock markets are open; but here in the U.S., it's a national holiday, so most of us have off (and our markets are closed).

Memorial Day serves as the "official start of summer," although summer doesn't technically begin for another three weeks. But many (like us) are having picnics and barbecues. Too few don't pause to reflect on what this day is all about.

We wish another a "Happy Memorial Day" in the hopes that it's an enjoyable one for them. But perhaps also we might pause, even for a brief moment, to reflect, to pray, to contemplate the sacrifices of others on our behalf.

As for today's picture, I took it from my friend Herb Chain's Facebook post.

UAPS vs. GIPS

Earlier this week we announced a new standard which The Spaulding Group and BrightScope are working on: the Universal Advisor Performance Standards or UAPS. At this week's North America Performance Measurement, Attribution & Risk (PMAR) conference in Philadelphia, a few folks inquired into how these standards related to GIPS(R).

I guess one might expect that this initiative would engender some confusion, since the Global Investment Performance Standards have been around for almost 13 years, and have gained a tremendous amount of well deserved support and attention. The distinction between GIPS and the UAPS is, I believe, fairly clear.

GIPS is for asset management who manage client money and who wish to present their past performance to prospective clients. We are dealing with legally discretionary assets (i.e., assets where the client has given the manager the right to trade on their behalf) that further meet the firm's "GIPS discretionary" rules (that is, where the client has not imposed a restriction or requirement that causes the resulting portfolio not to be representative of the manager's strategy).

UAPS is intended for the retail / high net worth / wealth management arenas, where we often find individual financial planners and advisors who may provide their non-discretionary clients with advice and recommendations or have independent responsibility to manage their discretionary clients' assets.

When a firm has thousands of financial planners, scattered throughout the country, each independently managing client assets, to attempt to bring that firm into compliance with GIPS is a virtual impossibility. And so, these investment professionals want some standard they can use to ensure their reporting is appropriate, and which they can claim compliance with.

Let me make my next point very clear: UAPS does not compete with GIPS. It does not intend to serve the same market. Using a Venn diagram, we have the following:

For several years I have witnessed the confusion that exists within, for example, the U.S. brokerage community, where registered reps, financial planners, and investment advisors frequently ask their firm "are we GIPS compliant?" or "are our reports GIPS compliant?" or "are our returns GIPS compliant?" Clearly, GIPS has a far reaching presence. Unfortunately, these are the wrong questions, because these firms cannot easily achieve GIPS compliance. But with only one standard to use, it is not surprising that this occurs.

Whenever I suggested that a new standard, designed specifically for this market, was needed, the response has been over-whelmingly positive. And although we have wanted to develop a standard for this market, for a variety of reasons we couldn't make progress. Until now.

Last Fall we learned about the fellows at BrightScope, and reached out to them to discuss our idea of a standard, and they were very enthusiastic and offered to help. And so, we began the journey to develop such a standard. We are pleased and enthused by the progress we've made in a fairly short time, and are now ready to move to the next step of vetting and enhancing the document with a group of investment and performance professionals.

If you have any questions about the standards, please reach out. Contact information is at our website, where you can also obtain a copy of our draft white paper.

ANNOUNCEMENT! New Performance Standard Proposed

BrightScope and The Spaulding Group, Inc. Release White Paper That Proposes a Universal Performance Standard for Financial Advisors

The Adoption of Universal Advisor Performance Standards Will Broaden the Base of Advisors Who Can Report Performance to Both Clients and Prospects

Somerset, NJ - May 22, 2012

Contact:

Jaime Puerschner

PR for The Spaulding Group

732-873-5700

JPuerschner@SpauldingGrp.com

Katie Carlson

Atomic PR for BrightScope

415-593-1400

katie@atomicpr.com

BrightScope, a leading provider of independent financial information and investment research, and The Spaulding Group, a global leader in investment performance measurement products and services, today jointly announced the release of a new white paper, "Universal Advisory Performance Standards," highlighting the need for an industry consensus performance standard for financial advisors. The free white paper can be downloaded at www.uapstandards.org.

Today’s technology allows consumers to quickly and easily search for and compare mutual funds, 401k plans, mortgages, and many other types of financial products online, but when it comes to financial advisors there is not an efficient way to select one based on performance.

"Over time, we envision that every financial advisor will want and need to disclose the performance of their investment selections on behalf of clients," said Mike Alfred, the CEO and co-founder of BrightScope. "As the leading performance measurement firm in the money management industry, The Spaulding Group’s expertise is perfectly complimentary to BrightScope’s vision, and together we’re confident we can unify the industry around this new standard."

Currently many advisors and broker-dealers do not calculate and do not disclose performance to the general public, making it difficult for prospects to select the right advisor and challenging for the best advisors to grow their practice. As a result, the act of selecting an advisor has been limited to personal recommendations, and what little information consumers can find on the SEC and FINRA websites.

"BrightScope Advisor Pages has done a good job to bring transparency into the marketplace, however since there is no clear guidance or industry standard, many advisors refrain from reporting performance out of fear they might run afoul of SEC and FINRA advertising regulations," said David Spaulding, President of The Spaulding Group, Inc."When there is a single standard created specifically for the money management industry, individuals will understandably assume that it applies to them, when it may not. As a result, there can be confusion as well as the use of something that is less than appropriate. By introducing a new standard, specifically designed for financial advisors, we should see increased reporting; it will also allow investors to make a more informed decision on which professional is best qualified to serve them."

To further support universal standards, BrightScope and The Spaulding Group have founded the Committee for a Universal Advisor Performance Standard. Inaugural advisors to the committee include John Rekenthaler, Vice President of Research at Morningstar; Ric Edelman, Chairman and CEO of Edelman Financial Services LLC; James Edmonds, Executive Director at Morgan Stanley Smith Barney; Joseph Klimas, Vice President of Portfolio Research & Consulting Group at Natixis; Franklin Tsung, President of Appcrown; Christopher L. Davis, President of Money Management Institute and Steven W. Stone, Partner at Morgan, Lewis & Bockius LLP. More information can be found at www.uapstandards.org.

###

About The Spaulding Group, Inc.

With offices in the New York City and Los Angeles metropolitan areas, The Spaulding Group, Inc. is the leader in investment performance measurement products and services. TSG provides consulting along with GIPS and non-GIPS verification services; offers a unique Software Certification service; publishes The Journal of Performance Measurement®, a quarterly publication launched in 1996; and hosts the Performance Measurement Forum. The firm also sponsors the annual Performance Measurement, Attribution and Risk (PMAR) conference and PMAR Europe, which have come to be recognized as the leading performance measurement conferences in the industry. TSG’s Institute of Performance Measurement offers performance measurement training, including a fundamental’s course on performance measurement, a course on performance attribution, and two CIPM exam preparation courses.

About BrightScope

BrightScope is a financial information company that brings transparency to opaque markets through independent research and analysis. Delivered through web-based software, BrightScope data drives better decision-making for individual investors, corporate plan sponsors, asset managers, broker-dealers, and financial advisors. The BrightScope Rating™, developed in partnership with leading independent 401k fiduciaries, reviews more than 200 unique data inputs per plan and calculates a single numerical score which defines plan quality at the company level. In April 2011, the company launched BrightScope Advisor Pages™, the first comprehensive and publicly available directory of financial advisors designed to help consumers discover information and conduct due diligence on wealth management professionals. BrightScope also markets a suite of data analytics software products to Fortune 1000 companies, asset managers, broker-dealers, financial advisors, and other market participants. Public ratings for more than 46,000 retirement plans as well as rating definitions, criteria and methodologies, and information on more than 575,000 financial advisors and 45,000 advisory firms are available for free at www.brightscope.com.

Clothing & Beta: is there a connection?

The Spaulding Group held its Spring North American Performance Measurement Forum meeting earlier this month in Atlanta, and during the session I had a thought about how the subjects of beta and Jensen's alpha can be related to clothing (being one who is always on the lookout for metaphors and analogies, this seemed to be a good one to share).

Jensen's alpha, as you may recall, is a risk-adjusted measure, that can be viewed as excess return that takes beta into consideration. The typical way we view excess return is:

Jensen's alpha looks a bit like this expression, but with a twist:

First, we're dealing with equity risk premiums (portfolio return minus the risk free rate). But, basic knowledge of algebra would make it clear that if this was the only difference, it would match our excess return. What's really different is the use of beta. Jensen's alpha takes the portfolio's beta and applies it to the benchmark (or more precisely, the benchmark's equity risk premium), essentially saying that THIS is what the portfolio's return WOULD be (net the risk free rate), if beta captured everything for the portfolio; that is, if beta was a perfect predictor of portfolio return. But, Jensen's alpha is usually not zero, based on the portfolio's idiosyncrasies.

And so, where does clothing come in? Well, the benchmark could be looked upon as a school uniform, which everyone is required to wear. Assuming students are required to keep them clean and pressed, there would be no differences. However, if there was some leeway in terms of the shoes a student could wear, whether they could have their uniform custom made, if they could substitute fancy socks, or perhaps (as my friend Steve Campisi likes to do) include a pocket handkerchief, they would be different.

The military doesn't permit much in the way of variation. But, when I was on active duty (with the Field Artillery branch of the U.S. Army) we had the option of substituting "airborne boots" for our standard issue ones; they looked much sharper, and many of us did (even if we weren't airborne!). And, one could buy their "dress blues" off the rack, or get them custom made. And so, even here we had the ability for some degree of idiosyncratic adjustments.

This difference is like what we see with the result from Jensen's alpha. When one speaks of "portable alpha," THIS is the "alpha" they are speaking of: the part of excess return that is completely attributable to the idiosyncrasies of the portfolio, with no baggage from the benchmark.

By the way, you are probably also noticing that we use the term "alpha" here, but in the "Jensen's alpha" context. Whenever anyone simply says "alpha," you should ask "what alpha are you referring to?" This isn't an offensive question, but rather an insightful one, because it reflects your awareness that there are at least two versions of alpha: basic alpha, which is derived from excess return, and Jensen's alpha.

Talk about performance!

Our younger son, Douglas, who is the editor of The Journal of Performance Measurement, has done the Tough Mudder four times (most recently a week ago in the Poconos, PA). Well this morning he (kind of) did it a 5th time, on Fox & Friends. He was interviewed, too!

What IS a model fee under GIPS?

The 2010 edition of GIPS(R) (Global Investment Performance Standards) introduced the term "model fee," but without any clarification as to what the term means. Consequently, we get questions like the following, which was sent by a verification client to me yesterday:

"Our composite net returns are based on the highest tier of our fee schedule. Does that then fall under 'Model Fees'? If there is some guidance on this subject can you please give me a reference."

The client was referencing the following provision:

Since the alternative to "model" is "actual," one might conclude that model referencing anything but actual. And so, I responded to the client that "yes, what they do falls within the realm of a 'model fee.'"

If you have any insights or thoughts, please offer your comment below.

New Standard Forthcoming

We cannot say much about this, yet, but since it appeared on the CNBC website yesterday, I'll share the brief info they have.

Yes, The Spaulding Group and Brightscope have some great news which will be released next week.

More details to follow.

Modified Dietz or BAI, which to choose?

I got an email this week from someone who wanted to know the difference between Modified Dietz and Modified BAI. Briefly:

1. They are both approximations to the true, time-weighted rate of return
2. They are both based on the concept of linking money-weighted returns to derive a time-weighted return
3. They should yield equivalent results.

Modified BAI is actually, in my view, a misnomer, or perhaps more precisely, the use of an inappropriate qualifier; I will explain below.

The Bank Administration Institute (BAI) developed the first performance measurement standards in 1968. In that document they offered three methods to calculate time-weighted returns:

1. The exact method, which requires revaluing the portfolio for all cash flows. The BAI recognized that it was unlikely that this could be accomplished very easily at that time, and so offered the other methods as alternatives.
2. The linked IRR (internal rate of return) involves calculating returns for subperiods (ideally, no longer than a month) and geometrically linking these returns to obtain approximations to the TWRR.
3. The third involves an alternative approach to geometric linking: "The time-weighted rate of return is ... the average of the rates for [the] subperiods with each rate being given a weight proportionate to the length of time in its subperiod." Suffice it to say, this approach has died away, though we retain the term, "time-weighting" (in spite of the fact that we do not weight time).

What we think of today as the "Modified BAI" is actually BAI's Linked IRR. We are not modifying anything; it is just one of the three methods. And so, we link subperiod internal rates of return to obtain an approximation to the true TWRR.

An unlinked Modified Dietz (MD) is an approximation to the IRR. And so, by linking subperiod MD returns (as we do with linking the IRR), we obtain an approximation to the true TWRR.

Which is better? I don't think it matters. Linking Modified Dietz returns is easier than linking internal rates of return, since the IRR is an iterative formula while Modified Dietz is solved directly. The results should be identical, or at least very close. Is one "more correct"? Not in my view.

Hope this helps! Please add your thoughts and comments below.

Discretion ... a definition

Recall that GIPS(R) (Global Investment Performance Standards) has a fundamental rule that states "all actual, fee paying, discretionary portfolios must be included in at least one composite." Much of this is pretty simple:

• "actual": a real account; exclude back-tested results, model portfolios, and hypothetical portfolios (you can show non-actual as supplemental information)
• "fee paying": an advisory fee is paid to the manager (you can include non-fee paying, with additional disclosures)

"Discretionary" is a difficult and oft confusing term.

Since we typically think of it in light of legal discretion, this is often where firms stop. However, we're talking beyond the realm of legal; legal is assumed (that is, the firm has the ability to execute trades on behalf of the client). We're talking "GIPS" discretion. And so, WHAT DOES THIS MEAN?

I am preparing for The Spaulding Group's upcoming GIPS Fundamentals workshops and have come up with the following:

• Portfolios for which the firm is able to execute their strategy
• Portfolios whose composition and returns are representative of the composite’s strategy
• Portfolios for which the clients have not imposed restrictions or requirements that impede the manager from fully executing their strategy, such that the results will be representative of the strategy

I think nondiscretion is easier to define:

• Portfolios that have restrictions such that the manager isn't able to fully execute their strategy
• Portfolios whose composition and returns are not representative of the given strategy.

They're essentially mirror images of one another, though I tend to feel more comfortable defining nondiscretion, though I think what I have offered here works. What do you think? Please comment below.

Does a hedge fund need a market index?

Note that the title of this post includes "market index," not "benchmark." The reason?  Benchmark can mean more than market indexes; for example, it includes absolute benchmarks, such as LIBOR or LIBOR + 1. These ARE appropriate for hedge funds, since hedge funds are typically absolute managers, that DO NOT MANAGE  against any particular market index.

I had a conversation a few years back with legendary investor Barton Biggs about the use of indexes with hedge funds. He said that they include them in their reporting, and I asked, "but do you manage against them?" He acknnowledged that they did not.

And so, market indexes typically only serve as references when it comes to hedge funds. That's why we often see a mix of indexes, which might include the Barclay's Agg, the S&P 500, and the DJIA.

Does a hedge fund need a market index? Yes, I'd say they should have them, but their role is different than what we typically find in long only space. Hope this makes sense. Please comment below with your thoughts.

New Spaulding Group Website Launched!

After several months of design, preparation, planning, review, etc., The Spaulding Group's new website has been officially launched!

Many thanks to Patrick Fowler and Chris Spaulding for heading up this effort: it looks great!

As you might expect, with the new site a number of our old links no longer work (sorry about that). I most likely won't go through all of my blog history to adjust, but will alert you that The Spaulding Group's upcoming PMAR Conferences have a new link!

Net-of-fee returns: what to do with the denominator

A colleague recently brought to my attention wording that appears in the 1993 edition of the Performance Presentation Standards, published by AIMR (Association for Investment Management and Research; the former name of the CFA Institute). On page 25, under a section titled "Net-of-Fee Calculation" we find: "In a net-of-fee calculation, when fees are paid from the corpus of the fund, the payments should be included as a withdrawal of capital in F (flows) and in FW (weighted flows). In addition, performance results are reduced by deducting fees as negative income [a positive number] in the numerator." The accompanying formula (that appears on 26) has the fees removed, separate from their treatment as a flow.

What this essentially means is that the fees cancel out in the numerator (which is the same as my recommendation to ignore them). The AIMR-PPS's denominator has them as a weighted flow; I recommend not doing this. Their result is a higher NOF return (since the denominator is reduced by the weighted flow). I believe ignoring the fees entirely is correct.

As I pointed out in an article for the CFA Institute, as well as in our firm's newsletter and this blog, we should completely ignore net-of-fee payments that come from the corpus of the account; we treat them as flows for gross-of-fee returns.

Note: this is MY (i.e., Dave Spaulding's) view on this matter, but I believe that logic and the results show that it makes sense. But chime in with your thoughts, by inserting a comment below! In reality, whether you treat them as a weighted flow or not, the difference is probably de minimis.

50 Rules on Ethics

A journey of a thousand miles must begin with a single step.

Confucius

At this year's CFA Institute Annual Conference, John Rogers, CFA, President and CEO, called for all investment professionals to restore trust in the investment industry. He presented the CFA Institute's "Integrity List," a collection of 50 steps investment professionals can take to restore trust in our industry. And these steps are:

1. Make ethics training a high priority for yourself, your colleagues, and your firm.

2. Recommend to clients the simple products with transparent payoffs, costs, and risks.

3. Name and shame unethical behavior.

4. Operate with a 100% conflict-free business model.

5. Take credit for successes – and be transparent about failures.

6. Advocate for stronger regulations that protect investors.

7. Never overlook unethical behavior because you’re better served by ignorance.

8. Act with integrity 24/7 – not just at the office.

9. Commit to a gold standard code of ethics and professional conduct.

10. Vocally demand that your firm does what is right for clients.

11. Encourage young professionals to have the courage to disagree.

12. Keep client fees low.

13. Act with fairness and prudence with every decision.

14. Present analysis based on facts and client needs.

15. Always be honest with clients.

16. Never engage in misleading sales promotions.

17. Always under-promise and over-deliver.

18. Align incentives and disincentives in favor of clients.

19. Disclose how you improve your level of competence.

20. Outline exactly how you are managing a client’s funds.

21. Disseminate transparent, accurate, and timely information.

22. Be clear about situational influences in your environment.

23. Place the client’s interests before your own.

24. Base investment recommendations on strong analysis.

25. Actively disclose all compensation arrangements to clients.

26. Adhere to high standards even if they are not required in your country.

27. Disclose information in ways your parents would understand.

28. Adopt Global Investment Performance Standards.

29. Maintain regular contact with clients.

30. Always share bad news with all who are affected.

31. Listen to clients’ concerns and fears.

32. Help clients focus on risk as much as they do on performance.

33. Create an ethical work culture that allows constructive criticism.

34. Bring an ethical dimension to discussions of business strategy.

35. Adopt the CFA Institute Asset Manager Code of Conduct.

36. Remind junior associates that reputations are hard earned and easily lost.

37. Lead by example.

38. Take responsibility for the actions of your team.

39. Mentor future investment industry professionals.

40. Use social media to comment about the values you uphold.

41. Write articles and speak publicly about ethics.

42. Act as an expert resource for journalists.

43. Refuse to associate with any brokers who take advantage of clients.

44. Bring to justice those who take part in irresponsible and illegal activities.

45. Recommend companies with fair practices and good corporate governance.

46. Never get involved with risky investments.

47. Advocate for technology that makes the industry more transparent.

48. Serve on committees that advocate for regulatory reform.

49. Engage and build relationships with local regulators and policy makers.

50. Become a member of CFA Institute and sign the required annual ethics statement.

Impressive! I am glad I wasn't asked to come up with 50 steps. While they may not all apply to you or your organization, many, no doubt, do. And so, consider which you can begin to work on.

Choirs and rating agencies: yes, they have something in common

It occurred to me that a choir might be a good metaphor for rating agencies;  at least to some extent.

Recall that certain rating agencies got blasted because they frequently awarded their highest ratings to pools of subprime mortgages, which on their own would have been rated much lower. Was the theory that by pooling them somehow the risks would cancel out?

Well,what if we took a group of mediocre (or poor) singers (some who were tone deaf, none who could read music, some who sang through their nose, some who couldn't enunciate) and pooled them together into a choir. Do you think that they'd be an A-list type choir once they were together (their poor qualities canceling out)? I guess this can be considered a rhetorical question, as we all know the answer.

And so, if a group of  poor singers together doesn't produce a highly rated singing group, why would a group of subprime mortgages?

Ethics in the news ... or at least Linkedin

I just checked in on Linkedin and discovered two of my connections posting  about ethics:

• Jay Abraham: "ETHICS: You have to distinguish yourself and operate at the highest level of ethics, of integrity, of veracity. If you lower yourself to the level of a lot of the people in the world today, you won’t be distinctive. You won’t be preeminent. You won’t standout. If you operate at this high level, you will win over people and they will stay with you when you have the right systems and strategy in place."
• Tom Robinson: "'Relativity applies to Physics, not Ethics. Ethics are absolute.' Einstein "

I cannot disagree with either gentlemen (who can?).

Tom, as the MD of Education for the CFA Institute, is attending the annual CFA conference; sadly, I am not there as I will be at a client conducting a GIPS(R) (Global Investment Performance Standards) verification instead. Jay is a marketing consultant we (The Spaulding Group) occasionally draw upon for advice.

Interesting coincidence that these posts appeared within inches of one another.

And  both of these statements are worthy of reflection on their own, with no additional commentary from me.

Cases of unintended consequences

We are witnessing a case, I believe, of unintended consequences in the world of American football (not to be confused with the rest of the world's view of football, which Americans call soccer). The fundamental question: do football helmets, which were intended to protect the head, actually cause more damage?

Hearken back to the pre-helmet days, when players had no protection at all. The first phase of protection was leather padding that merely sat against the head. This provided some degree of protection, no doubt. Over the years plastic helmets were introduced, with each version offering greater and greater protection.

But the consequence of these actions was that players were able to use their heads more aggressively, which has apparently caused too many cases of head trauma, in one form or another. [This relates to the theory that when more rules are introduced to enhance safety, individuals become more aggressive, thinking that given the added safety, they can take additional risks.]

The question: if players no longer had any helmets, or perhaps ones that were like the first variety, might they actually be better off? They wouldn't want to crash their bare (or barely protected) head into another player's midsection, for example.

Another example is boxing, where the likes of Mohammad Ali suffered from having their heads bashed against many times by opponents whose hands were protected by a well padded gloves.

I recall a movie that showed boxing around the turn of the last century, when bare-fisted boxing was forbidden, but occurred nevertheless. Gloves were being introduced and a boxer was asked something like "would you rather break your hand (without the use of gloves) or your jaw (as the result of an opponent using a glove)?" The boxer pointed out that he was quite fond of eating, so seemed to prefer the sans glove option.

If we were to make gloves illegal and require boxers to fight without them, their fists would no doubt be bloodied by the end of a match. But, would their heads be pummelled to the degree they are today? My guess is they would not.

These, I believe, are examples of ideas that had a great deal of merit at the time, but the consequences that resulted seem to have shown them to have made the situations worse.

Two other examples: in the U.S. cars are required to have break lights at the center of the back window. As I recall, the basis for this was so that if the driver in front of the car immediately in front of you was stopping, you would be alerted by seeing the lights brighten, through the windows of the car in front of you. This sounds like a good idea, until you realize that you do not see those lights (or rarely do). The idea simply doesn't work. And yet, millions of dollars were no doubt spent to retrofit or reengineer cars to accommodate them.

Another: again in the U.S. public men's bathrooms must have urinals that are set lower than normal. Most people believe this is to accommodate young boys; it isn't. It's for handicapped patrons. But, this idea simply doesn't work, and yet the laws remain.

In many cases it is very difficult to project what is going to be the result of our actions, so to criticize those who came up with these ideas would be improper. They made sense at the time. In the case of the sports examples, the intent was to protect the head (football) and hands (boxing); but as a result of the added protection, in both cases the head has suffered.

I have pointed out how the notion of asset-weighted composite returns (for GIPS(R) (Global Investment Performance Standards)) was introduced because it just seemed to make sense to those who framed the rules (in spite of the objections from various parties). But in retrospect, I, as well as many others, believe it's the wrong approach. There are other examples, too, but I won't bother to rehash items that I've previously addressed here on in The Spaulding Group newsletter.

How should you handle trade error payments?

Okay, so your client has a restriction against you buying tobacco stocks, but you accidentally did. You now have to sell this stock, but because the price has dropped, your client is out some money. And so, you decide to "make it right," and deposit company funds to make up for the difference.

Is this transaction a cash flow?

If it's a cash flow your performance suffers, but is that fair, because you sold the stock before you would have.

Regardless, I would say that you are essentially reversing the trade, which means you're restoring the account to the condition it was in before the trade was done (essentially acting as if the trade never occurred). I think that the funds are not to be treated as a cash flow. While you cannot alter the official books and records, your records should portray this as a "non event."

What do you think? Chime in, by commenting below.

p.s., Several years ago I advised a client to purchase a trade order management system; they held off on this roughly $100,000 purchase. A few months later they had a trade error that cost them more than $500,000.

p.p.s., We have received a few comments (see below) that you should read. Steve Campisi suggests that this may "bend the law." Derek points out that many firms move these trades into their error account. And Jed raises the question about the other side: if the stock's price goes up!

Benchmark Versus Portfolio Rebalancing: must or should they be the same?

A GIPS(R) (Global Investment Performance Standards) verification client was rebalancing their blended benchmark annually and their portfolio monthly. This sparked a whole long discussion with a few colleagues on the appropriate timing for rebalancing.

The basic question: must (or should) the portfolio and benchmark have identical balancing schedules?

The answer, I believe, has to be couched with a few key points:

• is the benchmark blended or a single market index?
• does the manager have control over the benchmark's rebalancing?
• does the manager's tactics require a balancing that is different than the benchmark's?

The first two points are related, though it's important that they be addressed separately.

If the benchmark is a blend of two or more market indices, then the manager clearly controls its timing. If the manager begins the year with the strategic balance established in the benchmark and portfolio, and the benchmark isn't rebalanced again for a year, but the portfolio is rebalanced monthly, then I think there's a problem. I would expect the timing to match.

If the benchmark is a market index, must the manager rebalance his/her portfolio to match that of the benchmark? I would say "no." We have a client that establishes its portfolio's allocations annually, and doesn't do much to the portfolio for the remainder of the year. The benchmark rebalances much more frequently. The portfolio manager's tactic is to let it ride. That is, not to make any adjustments once the allocations are established. I think this is perfectly fine. These details are disclosed as part of their marketing and GIPS materials.

There are no doubt other cases that could be considered, so there is probably not a "black-and-white" answer, though this may serve as at least the start of some guidance. Please let me know your thoughts by commenting below. Thanks!

Half of performance measurement book sale proceeds to go to Alex's Lemonade Stand

You may recall that in late March The Spaulding Group announced that it had discovered a printing error in my most recent book (Handbook of Investment Performance Measurement, 2nd edition), and decided to offer copies at a huge discount ($20 versus the normal $75). The response to this offer has been phenomenal. In addition to single copy sales, several folks have purchased multiple copies for their staff or clients.

During a staff retreat earlier this week, we were discussing this topic, and I suggested that perhaps we should do another announcement. Patrick Fowler, our firm's COO, suggested that  we say "The Lemonade Stand is Still Open," which I thought was catchy. Chris Spaulding, a company SVP, our head of sales and my older son, suggested that we donate a portion of the proceeds to Alex's Lemonade Stand. We all loved the idea, and so decided to donate 50% of the revenue to this very worthy cause.

Alex's Lemonade Stand Foundation (ALSF) emerged from the front yard lemonade stand of cancer patient Alexandra "Alex" Scott (1996-2004). In 2000, 4-year-old Alex announced that she wanted to hold a lemonade stand to raise money to help find a cure for all children with cancer. ALSF's mission is to raise money and awareness of childhood cancer causes, primarily research into new treatments and cures and to encourage and empower others, especially children, to get involved and make a difference for children with cancer.

And so, there are now at least two great reasons to take advantage of this offer. First, you get the book at a huge discount. Second, you will be contributing to a very worthy cause.

GIPS Portability: what does "one year" mean?

The Global Investment Performance Standards (GIPS(R)) have provisions to accommodate firms and individuals that move their skills from one place to another. For example, the emerging markets team from Firm A decides to either set up shop themselves or move in with Firm B. Or, if Firm X acquires or merges with Firm Y.

We find the following in ¶ I.5.A.8.b: "If a FIRM acquires another firm or affiliation, the FIRM has one year to bring any non-compliant assets into compliance." What does this mean?

One sentence just isn't enough to explain what a firm is obligated to do. I have had many discussions on this topic, and have found very different views. In April's newsletter (which is admittedly late ("my bad"), but will appear very shortly), I provide my views on this matter. I welcome your comments, be they in support, in opposition, or simply if you have further questions on this important matter. Please email them to me. Or, post a comment below! Thanks!

Oh, and this topic will also be the subject of The Spaulding Group's monthly webinar (date & time TBA!)