Can a GIPS-compliant firm show a "rep" portfolio? Should the UAPS permit them?

I had a recent conversation about the UAPS (Universal Advisor Performance Standards), which provides the ability for a compliant firm to show a representative ("rep") portfolio's performance. I mentioned that the white paper is a draft and subject to change. However, we recognize that it's possible some firms may want to show such information, and therefore feel we need to address it; at least at present.

Reference was then made to the Global Investment Performance Standards (GIPS(R)):

• Question: Can a GIPS-compliant firm show a rep account's performance?
• Answer: Yes! Nowhere in the Standards is this prohibited.

Why would a compliant firm choose to show a rep portfolio's information?

• To provide performance attribution results
• To show actual holdings and trading
• To provide additional insights they may feel would prove helpful to the prospect

I am also aware that investment consultants sometimes ask to see a rep account.

Such information should be considered "supplemental." In addition, it should include appropriate disclosures, to ensure the recipient understands what they're getting.

But rep portfolios not allowed? Of course they are!

While they aren't specifically PERMITTED (see below, they actually ARE addressed!), the fact that they are not explicitly PROHIBITED means that they can be employed. Clearly (a) best practice is ALWAYS the composite presentation, and (b) compliant firms are obligated to make every reasonable effort to provide the appropriate compliant composite presentation to the prospect. If they can give them a rep account's details, they shouldn't have any difficulty giving them the composite presentation, too! And (c), we would expect appropriate disclosures to be included with any rep portfolio details, to alert the reader of the possiblity that it was cherry-picked.

The Supplemental Information Guidance Statement actually makes reference to representative portfolio information being permitted:

Disagree? Have a different opinion, additional thoughts, or insights? Please share them below.

Documenting your risk measure

At The Spaulding Group's PMAR Europe conference earlier this month, one speaker suggested that Bill Sharpe's revised eponymously named risk-adjusted return is more typically employed than the original. While I don't have a lot in the way of empirical evidence, I believe it's the other way around. I suspect that most performance and risk measurement folks are unaware that the Nobel Prize winner made a revision.

Regardless, this suggests to me that some disclosures are in order, whenever such information is reported.

The reality is, there are multiple ways to derive MANY of the risk and risk-adjusted measures our industry employs, from standard deviation (do we divide by "n" or "n-1," for example) to M-squared (i.e., Modigliani-Modigliani) to Sharpe ratio. Even the simple use of the word "alpha" can conjur up multiple methods.

In next month's newsletter, I will opine at length on this matter, as I feel a healthy amount of disclosures are warranted, to ensure the recipient understands (or has the opportunity TO understand) what's being shown. The reality is that too many client reports carry misleading or inappropriate statistics. I suspect the intent is always honorable. It's just that we sometimes get carried away.

Making rules can be a challenge

"It's good to be king"

(King Louis XVI, from History of the World,
Part I)

Responsibility for crafting rules can be quite a challenge, hefty responsibility, and difficult undertaking. It's so easy for things not to work out as we'd like, for errors to be introduced, and for things to be left out. For our intention not be clear, or for many to misinterpret our meaning.

So often, after we're done our writing, we're given information from others, or make our own discoveries, that let us know that what was written wasn't what we wanted or intended.

Rule making is quite a challenge, regardless of the purpose of the rules. Having served on numerous (industry and non-industry) committees over the years that have crafted rules, I know how difficult it can be. Just like any form of writing, errors and unintended or ambiguous phrases can be introduced, which can cause confusion, concern, and complaints.

Any rule making organization should be given some leeway, knowing that the task is a difficult and challenging one.

Say What?

Surely I am not the only one whose reaction to this photo and caption on the front page of this weekend's WSJ was different than what was intended.

"Germany Celebrates Greek Exit"

?!?!?!

From what? The Euro?

Nah. From the European Cup. I was in Dublin Friday night and knew that they had won, but by Saturday afternoon, back in the U.S. and seeing this on the front page, my reaction was initially one of surprise, thinking something had happened on the "world scene" that I had missed. Oh, and congratulations to Germany.

Alternative Investments ... just scratching the surface

At this week's European Performance Measurement Forum meeting, we touched on the subject of alternative investments. We hear this term bandied about quite a bit; so much so, that it often causes one to grimace when they hear it, because of the fear it can invoke.

While this category can include credit default swaps, as well as other varieties of swaps and swaptions; futures, forwards, and options; along with commodities and fairly esoteric investments, such as guitars, watches, and artwork; it also is where we house [pardon the pun] real estate and private equity.

In the case of real estate and private equity, while we may not know all the answers, many of the rules are fairly well agreed upon. The GIPS(R) standards (Global Investment Performance Standards) after all includes rules specifically for these asset classes.

But there is a broad, make that very broad, collection of instruments for which the rules are less clear. And when we speak about rules, we must consider:

• Valuing the assets
• Deriving returns on the assets
• Measuring risk of the assets
• Determining how to handle them as part of our attribution
• and no doubt a lot more.

This is a topic that we will not attempt to address quickly, as much time is needed for it. Hopefully, we will be able to provide guidance on much of what is faced in the industry today. And so, stay tuned! In the mean time, if you have ideas or questions, please pass them along!

The CIPM isn’t just for junior level performance measurers

While a number of senior performance measurement professionals have taken and passed the CIPM® (Certificate in Investment Performance Measurement) exams (e.g., Carl Bacon, Sandra Hahn-Colbert, Douglas Lempereur, Annie Lo, Neil Riddles, Debi Rossi, Tim Ryan, Jed Schneider, John Simpson), there are countless more who haven't.

Most of the senior folks who took the exams didn't need to prove anything. I suspect many chose to in order to (a) show support for the program, (b) show support for the performance measurement industry, and (c) as an example to others.

I encourage others in our profession, who have nothing to prove,

to join us and take the exam

Why?

• As an example to your staff, associates, and colleagues
• To help foster and promote the program, which is an excellent one that anyone who considers themselves a performance measurement professional should support
• For our segment of the industry.

Are the exams difficult? Absolutely. You will need to review the material and study. But your success will be an achievement you’ll be proud of, and carrying the "CIPM" after your name will be a sign to others of your dedication and commitment for our profession, as well as your expertise.

Don't delay any longer; register for the October exam today!

Transaction-based attribution: daily or monthly? Does it really matter?

At this year's PMAR (Performance Measurement, Attribution & Risk) North America and PMAR Europe conferences, I provided an update on research I'm doing, contrasting the results by using monthly holdings-based attribution versus monthly transaction-based attribution. The differences can be quite huge, not only in the residual typically found with the holdings-based approach, but also with the misassignment of attribution effects. More details will follow.

I pointed out that I believe that there will be no difference if we move to daily processing for the transaction-based approach; I am now reconsidering this, and will opine further as I do some exploring. Today I'll briefly explain the basis for this "180."

For the monthly approach, I use Modified Dietz, which in this context produces a money-weighted return. There are several of us (including Steve Campisi, CFA and Stefan Illmer, PhD) who have argued for money-weighted attribution (because the manager controls the subportfolio cash flows (e.g., buys and sells) and is, by virtue of the securities selected, responsible for the remaining internal flows (e.g., corporate actions and income).

To move to a daily application would, I believe, move us to a time-weighted approach, given the daily revaluing of the portfolio and its constituents. And so, it should (a) produce a different set of results and (b) arguably the wrong set. Wrong, that is, in Steve, Stefan, and my opinions (as well as others who have "seen the light" as far as the use of money-weighting for attribution).

Please look forward to further discussion on this both here and The Spaulding Group's monthly newsletter.

Canadian Securities Administrators Favor Money-Weighted Returns

Thanks to Philip Lawton for posting this news. Make that, exciting news.

As Philip explained, the Canadian Securities Administrators have proposed amendments to the National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103 or the Rule) as well as Companion Policy 31-103CP Registration Requirements, Exemptions and Ongoing Registrant Obligations (the Companion Policy).

The introduction to the document states:

"The proposed amendments set out requirements for reporting to clients, relating to investment charges, investment performance and client statements. These requirements are relevant to all categories of registered dealer and registered adviser, with some application to investment fund managers.

"The proposed amendments would apply in all CSA jurisdictions, and we would expect the requirements for members of the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA) (together referred to as the self-regulatory organizations or SROs) to be materially harmonized."

The document includes the following:

"We are proposing to mandate that registrants use the dollar-weighted method in calculating the percentage return on a client’s account or portfolio, in order to promote consistency and comparability in investor reporting from one registrant to another.

"We had previously considered permitting registrants to choose between a time-weighted and dollar-weighted performance calculation method. We have decided to mandate the dollar-weighted method because it most accurately reflects the actual return of the client’s investments. This is in keeping with one of the main themes of the project – allowing investors to measure how their investments have performed.

"Time-weighted methods are generally used to evaluate the registrant’s performance in managing an account, as the returns are calculated without taking into consideration any external cash flows. These methods isolate the portion of an account’s return that is attributable solely to the registrant’s actions. The philosophy behind time-weighted methods is that a registrant’s performance should be measured."

This is exciting news to those of us who continue to champion the use of money-weighted returns.

I thank Philip for sharing this information; and look forward to reviewing the document in its entirety.

Congratulations to those who passed the CIPM Examinations!

The CFA Institute announced earlier this week that 46% of those who sat for the CIPM's Expert exam passed. Congratulations to these 98 performance measurement professionals who successfully demonstrated their expertise in the various areas of investment performance measurement. While the exams themselves are not sufficient to permit the use of the "CIPM" designation, it is a major step towards it.

Some background: CIPM stands for Certificate in Investment Performance Measurement. The Performance Measurement Forum initiated the idea several years ago. We created a "blue ribbon committee," and began working on the exam. About six months into the process, we learned that the CFA Institute had decided to offer a similar program, and so rather than compete, we turned our work product over to them, and have supported the program ever since. Todd Jankowski, CFA oversees the program, and he and his team work hard to promote and grow the certification. We believe that everyone in performance measurement should strongly consider pursuing the designation, to (a) demonstrate their own expertise and (b) help promote our segment of the industry.

I'll confess that I was quite nervous when I took the exam. My colleague, John Simpson, and I were among the first to attempt it. We were promoting and teaching prep courses for it, even though we had yet to see what the exam itself looked like (we only had the study materials provided by the CFA Institute). Had either of us failed, we would not have been very happy (to be honest, I think we would have been very embarrassed, given our presence and involvement in the industry). Fortunately, we succeeded.

A lot of senior folks in performance measurement have, I believe, hesitated to take the exam because they, too, would be embarrassed if they failed; but they really shouldn't be concerned. I think most folks who have been in performance for many years meet with success, though there are those who don't succeed, but this is usually because their work makes it difficult to devote the necessary time to properly prepare, or perhaps they underestimate the degree of difficulty of the exam itself.

The entire program is designed to be rigorous; if it was easy, it wouldn't mean anything, right? Granted today many of those who take the exam are more junior, thus (I believe) the reason for the lower pass rate.

To those who were not successful this time, I hope you'll make another attempt at it. Please don't give up.

The Spaulding Group offers both preparatory training courses and flash cards to help, so consider this.

I should also acknowledge those who successfully passed the Principles level; this too, is a great achievement. But, if you thought THIS exam was hard, just wait!

Again, to those who passed: CONGRATULATIONS!!!

Client Reporting: Needed or Not?

At yesterday's Spaulding Group PMAR Europe III in London, Stefan Illmer (for) battled John D. Simpson (opposed) on the subject of client reporting standards: Stefan was victorious.

Stefan's victory should not be interpreted as support for the standards, as the vote is intended to be on debating skills. After the "battle" we did a quick poll of the attendees, and it appeared to me that the group slightly opposed the idea of having such rules, though it was close. This marks about the fifth time we've surveyed a group on this subject, and on every occasion, the "nays" have out polled the "yeas." In the past the vote was very much against, but this time it was definitely closer.

This battle was a "redo" of one that occurred last month in Philadelphia, during PMAR North America X, when Neil Riddles (opposed) defeated Frances Barney (for). Clearly, there are many who support the idea of reporting standards, but I believe most folks, when asked, do not.

At last year's London conference, Stefan provided some details on the standards; he is the chair of  the committee (working group) that has been charged with developing these rules; the expected date of their arrival is year-end '12 or early '13.

Whether these will be

• Standards
• Guidelines
• or "Best Practices," whatever that means

is still to be determined. While I am okay with guidelines (as appear to be most folks we've surveyed), I oppose standards, for reasons which will be detailed in this month's newsletter.

The CFA Institute is sponsoring this effort, and their motives should always be viewed as admiral. But that being said, I question the need for this effort, since there are no common problems with client reporting. As Stefan mentioned yesterday, occasionally we hear of individuals who "need guidance," but there's quite a distance between "guidance" and "standards."

Once more we hear words which too often miscommunicate what is really being provided: "best practices." What this will no doubt be are the opinions of a select group of individuals, not the thoughts of the industry at large. And so, this should be (but probably won't be) stated as "the opinions of the working group as to what best practices are or should be."

Speaking of the working group, its makeup remains a secret, which I find curious and to an extent, troubling. We have made a few attempts to learn the identities of these individuals who were handpicked to participate in this effort, but the names have not been provided. Why not? It appears to resemble the Manhattan Project, as no clues have been forthcoming and may not be until the document is released.

While there are many things I look forward to, the delivery of these standards is not among them, as their arrival will be unwelcome by many, I am sure.

• reporting guidelines: yes;
• reporting standards: no.

It remains to be seen what arrives.

Client Focus is Key

The Spaulding Group's Performance Measurement, Attribution & Risk (PMAR) Europe III conference is this week in London, and yesterday was our first day of the program (we conclude the conference today).

In my opening remarks this morning I intend to comment that a common theme has been the client; that is, to be sensitive to the needs of the client.

While many managers no doubt believe they are, unless their reports include money-weighted returns, for example, they are falling short.

While for many this will, in reality, be a paradigm shift, it's worth the effort. More details to follow...

GIPS and "non-assets under management" scenarios: what's the proper treatment?

Recently, The Spaulding Group created a website specifically designed to field questions on the Global Investment Performance Standards (GIPS(R)): http://www.gipshelp.com/. It has already had several questions posted, and more are coming in on a fairly regular basis.

It would be redundant to comment here, as well, on questions that we've addressed on the help site.

That being said, I will occasionally post here, too, if the question is one that has a lot of interest or one that I feel needs additional attention.

Case in point; the following was just posted:

If a firm has a composite consisting partially or wholly of "notional" accounts run on lines of credit, is it appropriate to fulfill the Composite Total Assets requirement outlined in the GIPS Standards using the total notional value? Given the fact that compliant performance can be (and is) calculated based on notional values, and that one could potentially have a composite consisting of accounts run solely on lines of credit (i.e. $0 "GIPS" AUM), this would be in the spirit of full disclosure, would it not? It appears that it would be misleading and of little use to a potential client to see only the amount of collateral (if any) in a composite. However, the GIPS do not specifically address this, and many other situations unique to notional accounts.

There exists a Q&A regarding Overlay Strategies that concludes that for purposes of FIRM assets, notional amounts must not be included. However, there appears to be no definitive guidance when it comes to composite assets.

I do not know what Q&A the person who submitted this is referring to; possibly:
http://gipsstandards.org/programs/faqs/gipsresults.asp?Id=49,
though it does not explicitly prohibit the use of notional values.

I think this is a great topic, and worthy of further discussion. I had hoped that the GIPS Executive Committee would have included more on the subject in GIPS 2010, but I guess we'll have to wait for the 2015 edition for anything formal.

My opinion has been that notional values, in certain situations, are the appropriate details to provide. One can show the AUM (be it zero or some other value) and separately, as supplemental information, the notional value. The returns should be derived, in most cases, based on the notional values.

I believe that this is "in the spirit of the Standards."

What do YOU think? Please chime in by commenting below.

Have a GIPS question? Please visit the GIPSHelp.com website!

How to Win the Hearts and Minds of Consultants

I spoke earlier this year on Asset.TV, on a panel that addressed hedge funds, including compliance matters and the potential for them to comply with the Global Investment Performance Standards (GIPS(R)).

Lillian Jones, CEO of Jones Emerging Investment Advisors, Inc. chaired the panel. I was joined by Russell D. Kamp of Kamp Consulting Solutions, LLC and Oscar Gil Vollmer, CFO and COO of Appomattox Advisory.

As you might expect, my focus was on GIPS compliance. Our firm has encouraged the hedge fund community to embrace the Standards, as we believe they continue to offer "best practices" for the dissemination of past performance to prospective clients. In addition, compliance for hedge funds should be much simpler than for long-only managers.

The video can be viewed online, if you'd like to see what was shared.

A new risk: password security

The following was shared with me by my wife; this was passed along to her by an IT professional. I thought it worth sharing with you.

As you may or may not have heard, if you have a LinkedIn or eHarmony account, significant numbers of passwords were not only stolen, but were leaked out to the internet. The problem however, does not end there. These passwords were then posted on the internet along with identifying information.

The significance of this goes far beyond these two sites. Most people use the same password across many sites. It turns out that hackers are actively exploiting this to commit crimes.

If you have a LinkedIn or eHarmony account:

1. Reset your passwords to a completely different one immediately

2. If you use the same password on any other system (like a banking site, your email, or our computers, etc.), please change that password immediately

3. Be very careful if you receive emails related to changing your password that appear to be from these sites or other phishing emails. These email too can actually be more attacks. If you receive a password change notification in your email, do not click on the link, instead, go directly to the site yourself by typing in the name and change your password there.

Marrying Performance & Risk

Earlier this year I spoke at the New York Society of Security Analysts (NYSSA) on a panel with Leah Modigliani and Jonathan Boersma; our topic was "marrying performance and risk."

I think the highlight of the evening was the chance to hear the co-developer of the M-squared risk adjusted measure (Modigliani-Modigliani) discuss the method she developed with her grandfather, the late Nobel Prize winner, Franco Modigliani.

Leah has spoken at The Spaulding Group's PMAR (Performance Measurement, Attribution & Risk) conference, and is always well received. I enjoyed the opportunity to share my thoughts with the "SRO" (standing room only) audience.

Fortunately, NYSSA videotaped the session, so you can watch it, if you'd like by going either here or here.

Why security level attribution?

I am working on my doctoral dissertation (hoping to have it completed by the end of the year), and wanted to cite comments I've made regarding my questioning of the value of having security level attribution, but can't find anything in writing. This doesn't mean I haven't written on it; just that I can't find it. And so, I decided to briefly pen my thoughts as a start; more details will be presented in this month's newsletter.

Sector, industry, portfolio attribution I get: we want to capture our allocation and selection decisions (for the purpose of this post, I'm limiting my discussion to equity attribution, though similar arguments can also be made in other asset classes). The manager looks at the index and decides to overweight some sectors and underweight others; and so, we need to capture the impact of these decisions.

But how many managers actually allocate at the security level? Perhaps overweight within the portfolio, relative to other securities they hold, but relative to the index?

Let's say that the manager is using the S&P 500 where we find that the consumer discretionary sector has roughly 80 securities. Chances are the portfolio will hold much fewer securities in this sector. One of them is Best Buy, which is in the index, and it makes up 2.5% of the portfolio. It's about 0.15% of the index. Does this mean the manager overweighted Best Buy? No, it means that he has much fewer consumer discretionary stocks and stocks in total, and is therefore able to invest more in them than the index, which has 500 stocks. But if we run attribution at this level as we do at the sector, we'll get a contributor for the overweighting; does this make any sense?

Because the portfolio holds much fewer stocks than the index, it won't hold most of what the index has; does this mean the allocation is zero percent? Well, technically this may be, but isn't it really about selection?

PMAR X: A HUGE success

The Spaulding Group held its 10th annual North America Performance Measurement, Attribution & Risk Conference last month at the Ritz Carlton in Philadelphia; it was EXTREMELY well received, as evidenced by the comments made by both participants and cosponsors.

We had record attendance (more than 180 attendees in total), as well as a few surprises for everyone:

1) All attendees received a complimentary copy of our latest book, The Spaulding Group's Guide to the Performance Presentation Standards (Spaulding, Simpson & Schneider).

2) Participants also received a limited edition commemorative coffee mug, as well as the first ever PMAR football!

3) Two lucky attendees received Apple iPads, and several more received other great prizes for visiting sponsor booths.

4) Those we spent the night at the Ritz Carlton were greeted with some of Philadelphia's famous Tastykake Tandy Kakes!

Our Battle Royale pitted BNY Mellon's Frances Barney against Hansberger Global's Neil Riddles on the subject of Client Reporting Standards, and Neil (who opposes the standards) was victorious.

More details about the event will be forthcoming. In the mean time, if you missed out on attending, or want another "PMAR experience" and can't wait until next year, please join us in London June 12-13 for PMAR Europe III! As with the North American event, we are expecting record attendance, and lots of fun (of course, PMAR isn't just about having a good time; there's much to learn, too!).

Why I Oppose Mandatory GIPS Compliance

The May 31, 2012 issue of FundFire reported that the majority of participants of a recent poll support making compliance with the Global Investment Performance Standards (GIPS(R)) mandatory.

I object!

Actually,

I STRONGLY OBJECT!

I have never been a fan of being told what to do, at least as an adult. Granted, there have been and always will be exceptions. The military, for instance, isn't a democracy; one is expected to carry out legal orders made by their superiors. But for much of the other things we encounter in life, most people like to have the freedom to choose. Yes, of course we do what our bosses and clients tell us, but we aren't often in agreement with what our government tell us to do.

New York City's controversial and outspoken mayor, Michael Bloomberg recently proposed that the city ban soft drinks larger than 16 ounces to protect people who tend to consume large quantities of the non-diet varieties, that may contribute to obesity. Now, I'm no fan of obesity, but I am a fan of free choice. If a person wants to consume a 32 oz. or larger of their favorite sugary substance, it's their choice; we don't need "big brother" to decide for us or to tell us that we can't.

The same with GIPS compliance. The market directs our choices here, by its reception of firms that choose not to comply.

I felt the same way about mandatory verification. I strongly opposed this idea, and with the help and cooperation of folks like Stefan Illmer and Carl Bacon, succeeded in it not becoming a reality.

The Spaulding Group regularly surveys the industry on various performance and risk-related topics; we will conduct our eighth presentation standards survey later this year (prior surveys were conducted in 1993, 1995, 1997, 2000, 2002, 2005, and 2008; the first few dealt with the AIMR-PPS(R)). We probably won't ask if participants want compliance to be mandatory, as the idea is an abhorrent one to us and in the end it doesn't matter, for who would make it mandatory? We believe the market has made compliance (as well as verification) a de facto requirement, at least in the institutional space, but firms still have a choice.

We asked about mandatory verification at one time, because we wanted to take the pulse of the investment performance industry at a time when this was being considered (and we found strong opposition). Since the topic has been dropped, there is no point to bring the subject up again.

Adults can usually decide for themselves. If an investment firm wants to comply, it's their choice, and if they see no value in compliance, that's fine. And for verification, while we strongly support it (as well as compliance itself), it's their money. Oh, and by the way, I want to buy 32 ounce cups of my favorite soda, but it's the diet version, so Mayor Bloomberg, stop taking our freedom away!