Performance Holidays

A subject that has come up occasionally, but that has gotten little attention (and none formal), is the idea of "performance holidays."

These arise at times when a client makes a significant contribution to their portfolio, knowing that because of the nature of the strategy, asset class or market, it may take time to get the money invested, and the portfolio back to the point that it's representative of the strategy. Even though time-weighted returns eliminate (or reduce) the impact of cash flows, the cash that's sitting around waiting to be invested can still influence the portfolio's return. The "Performance Holiday" is a way to eliminate this problem.

Questions arise as to what the firm should do, and even perhaps, what is "best practice" to handle them?

First, I think it's important that the firm have a policy in place as to how they wish to handle performance holidays. Second, it's important (make that, necessary) that the client agree with the process. Third, make sure you document whenever performance holidays occur (when, what was done, who authorized it, etc.). And fourth, as with many things we do, consistency is important, so as to avoid the appearance of gaming situations to their advantage.

Performance Holidays & the Global Investment Performance Standards (GIPS(R))

Whatever holiday arrangement a manager has with his/her client has no effect on what they do with the portfolio's respective GIPS composite. If the firm has a significant cash flow policy and the portfolio's flow applies, it gets pulled for the predefined length of time. If not, it stays.

Options

As for the portfolio itself, there are a few options firms can consider.

 

The benchmark as a surrogate

 

First, use a benchmark return as the surrogate for the period. If the firm and  its client agree on such a benchmark return, that's fine; it's up to the firm and client (but again, this return won't be what the firm uses for the composite; the firm must use the portfolio's return).

 

Creating a "gap" (break) in performance

 

Second, the holiday may create a "break" or "gap" in the performance track record. This means you'd have a return UP TO the point of the flow, a break, and then a return AFTER the money has been invested. You could not link across this gap.

 

Temporary Account

 

Third, the firm could use a "temporary account" for the flow: that is, you'd move the cash into this temporary account and move the investments across as the money is invested (securities purchased).

 

This is probably the ideal approach, though it means there isn't a holiday, other than for the cash, which is sitting in the temporary account. Temporary accounts can be challenging to implement, so it's important that the accounting folks are "on board with this, too.

Use a return of zero

 

Fourth, you could set the account's return to zero percent. The problem with this approach is that zero is a return value. There are times when it would be higher that the manager would have obtained had there not been a contribution (in which case the firm is unfairly rewarded) or lower than what would have been experienced (in which case the firm is unfairly penalized).

 

Therefore, I'd  recommend against this option. It would be better to use the benchmark's return.

 

Bridge the gap!

 

Fifth, you could have a gap in performance, but agree to link across it (i.e., the gap disappears!). The problem here is that's equivalent to setting the portfolio's return to zero, so I'd argue against it.

Best practice?

 

I see three options: using an agreed upon benchmark, having a break, or using a temporary account. I'm sure there are other approaches, but you and your client need to be comfortable with whatever you choose.

Some “best practices” are probably in order. I've already identified a few, but further discussion and review is in order. To summarize:

 

1) Establish a written policy

2) Get the client's approval as to how their holiday(s) will work

3) Document performance holidays

4) Be consistent in implementing performance holidays

5) Ideally use a temporary account for the cash flow. If this can't be done, the second best approach is probably the use of the benchmark's return during the period.

 

Where to next?

 

First, if you have suggestions, ideas, insights you want to share, please send me a note.

 

Second, I may expand upon this further in our newsletter.

 

Third, we may get input from the Performance Measurement Forum on this topic; if we do, I'll pass it along.

Using past statistics to predict the future ...

Major League Baseball does this every year, one way or another.

That is, each year, based on a batter's great start in pounding out home runs, a pitcher's strikeout prowess, or another player's extraordinary early season feats, someone decides to annualize (or should I say, seasonalize) the partial period's results to predict the future; that is, how the player will do for the full season.

I recall a few years back when Alex Rodriguez (aka, A-Rod) belted out a lot of homeruns in April: someone figured out that if he maintained this pace he'd hit (as I recall) over 80 (he didn't!).

Well, last year's Triple Crown Winner, Miguel Cabrera, is being celebrated in a similar, though more extensive, way. Someone figured that he's on pace for a .388 batting average (last year he hit .330), will hit 49 home runs (vs. last year's 44), and be responsible for 201 runs batted in (vs. last year's 139).

Well, we'll see about this!

We will pick this up again at the end of the season, and see how well his season does turn out. We do, of course, hope that Miguel has a great season, and if he's able to match the predictions, that'd be phenomenal. But, (as they say) only time will tell. Perhaps the writer should be obligated to include "past performance is no indication of future results," though this would diminish from the story, so we'll skip this disclosure.

GIPS 2015 ... Not! BUT, what do YOU think?

Last week I mentioned that there will not be a 2015 edition of the Global Investment Performance Standards (GIPS(R)).

We're curious what you think about this. And so, please respond to our survey to share your thoughts. It is VERY brief:

Please join in. We'll publish the results in our newsletter, as well as in this blog.

If you'd like to send me comments, feel free; just let me know if (a) I can use them and (b) if I can cite you as the author; thanks!

Two things I learned at PMAR XI that I’m not happy about…

I recently shared some details about this year's PMAR XI. I touched on a fraction of our speakers and topics. Today, I want to candidly share with you two things I didn't like.

First, we learned that there will not be a GIPS 2015. I previously mentioned that I had heard a rumor to this effect, it was confirmed. I am very disappointed, as I firmly believe that a new edition is warranted and necessary.

Second, we learned that the reporting standards we've been hearing about these past couple years would soon be available on the CFA Institute's website.  Well, a colleague pointed out the location, so you can have a look yourself. They're titled Principles for Investment Reporting (first edition).

You'll quickly discover that it isn't a draft, as we've come to expect; rather, it's a final version. If you're like me, you'll have thoughts and opinions about this document. Please feel free to send them to me. I'll share them in our newsletter (just let me know if I can use your name).

In addition, we would like to hear whether you think there is a need for a GIPS 2015 edition. We will soon launch a short poll for you to express your opinion; we'll share these results in our newsletter.

PMAR Day 2

I'm a little late in posting, as PMAR Day 2 was last Friday, but I've been recovering from a busy and exciting event. I think there was little doubt that this year's program was the best, yet! It makes it difficult to continue our goal of always getting better, but we'll try.

This year's conference was held on a Thursday and Friday; in the past, it's been on a Wednesday and Thursday. The shift was done for me, as I "walked" at the Pace graduate-level degree class commencement at Radio City Music Hall (in NYC) Wednesday evening. While I haven't yet earned my doctorate, I was permitted to "walk," given that I anticipate defending my dissertation shortly and earning the degree in August. I had never participated in a college commencement before, even though I have three degrees (a bachelor's and two master's), so wanted to participate in the experience. Next year's PMAR will again be on a Wednesday and Thursday.

Now, back to PMAR. I will briefly comment on just a few of Friday's great speakers and topics.

Friday began with two professors from Rutgers University (New Jersey's state university): John Longo, PhD, CFA and Ben Sopranzetti, PhD. This was John's fourth appearance and Ben's second; both did an exceptional job.
 

Jose Menchero, PhD, CFA of Barra also joined us once again, to deliver a great talk dealing with risk and return attribution.

We announced the theme for 2014:

It will be labeled as "Casino Royale," and thus have a "James Bond" feel to it (black tie optional).

The feedback has been tremendous and we are very pleased with how everything turned out. Now, we are doing the final prep work for PMAR in London! Please join us if you can!

 

PMAR Day 1

Yesterday was the first day of the 11th annual Performance Measurement, Attribution & Risk Conference at the Ritz Carlton Hotel in Philadelphia. As expected, we had great speakers who provided a wealth of information and insights.

The session kicked off with our omnipresent Stephen Campisi, CFA, who continues to push us into thinking of better ways to provide information to our clients.

For me, the highlight of the day was Brian Singer, CFA, this year's recipient of The Journal of Performance Measurement's(R) annual Dietz Award, which is given to the top article of the year, as judged by the journal's advisory board. A well regarded industry veteran of roughly three decades, much of it with the legendary Gary Brinson, Brian shared not only key points from his article, but also his insights into how macro economics affects our capitalistic world, and thus our investments. His delivery, like Steve's, is one that not only keeps the attendees' attention, but also provides well timed levity.

We introduced, for the first time, Performance Jeopardy. Our contestants (Larry Campbell, Richard Mitchell, and Kathleen Seagle) competed for fame and fortune, and Richard, the former ball room dancing instructor, was victorious. It was a great way to end an exciting day and lead us to the awaiting cocktails.

Lots to celebrate!

Last night The Spaulding Group held a dinner, at which we celebrated anniversaries, accomplishments, and an announcement.

Chris Spaulding, my older son and our firm's EVP (Strategy & Business Development) has been with our firm for 10 years (as of last December; we're a bit tardy on recognizing this event); Douglas Spaulding, my younger son and a firm VP and Editor of The Journal of Performance Measurement(r) reached his 10 year mark this month; and Patrick Fowler, our firm's COO, will mark 15 years next month! 

As for accomplishments, Doug was recognized for earning his MFA in Creative Writing and Jessica Laffey, a Production Assistant, earned her Bachelors Degree. A surprise acknowledgement (for me) was that I was recognized for my earning my doctorate, which I will do in August (I "walk" tomorrow!).

Patrick, Chris and Jaime Puerschner (a company VP and our Event Coordinator) were recognized for the great job they've done in preparing for this year's PMAR Conferences, which will have record attendances. And Jaime was also recognized for coming up with the creative theme for next year's conferences ("Casino Royale").

Finally, the big news of the night was the elevation of Patrick Fowler to the position of President. As noted above, Patrick has been with our firm for 15 years. He was promoted to Chief Operating Officer two years ago. He has accomplished a great deal for our firm, is a huge contributor to our success, and is a dedicated member of our team; this promotion is well deserved. A press release will go out later today.

PMAR North America 2013 is NEXT WEEK!

I don't recall being as excited in the past for a conference as I am for this year's Performance Measurement, Attribution & Risk Conferences (PMAR), the first being next week in Philadelphia. The Superheroes are all ready to meet at the Ritz Carlton, and I wanted to share with you the welcome sign that will greet the attendees:

 

 

Now, can you see why I'm excited?

We're expecting around 200 folks to join us. If you haven't yet signed up, there's still time. And, of course there's always the 4th European event that will be in London in June.

Does the order matter?

In mathematics we are occasionally confronted with the questionable applicability of the commutative law. You'll recall that it basically states that you can move (as in commuting or moving about) values around in a mathematical expression without causing the result to change; e.g., A x B = B x A (just as A + B = B + A). This law doesn't always work, right? For example, with limited exceptions A - B ≠ B - A nor will A/B typically equal B/A.

Since the commutative law applies to multiplication, there's often an assumption that it always applies; but it doesn't. For example, some folks discover problems when using percentages; or, more correctly, when NOT using them when they should! We often see firms remove the percentage sign (%) from their reports (e.g., show 3.03 rather than 3.03%), which is fine, but knowing how the number is stored is important when attempting calculations. If you multiply percentages together AS percentages you'll get different results than if you multiply the values as if they weren't percentages (e.g., 3.03% x 2.14% ≠ 3.02 x 2.14). Whether multiplying or dividing, we can get problems (usually addition and subtraction are okay). For example, the Sharpe ratio, which involves division, will be a problem if you don't treat the values as percentages.

We occasionally discover other issues. I recently conducted a GIPS(R) (Global Investment Performance Standards) verification for a client who often uses blended benchmarks (that is, their benchmarks are made up of two or more indices). They chose to link the monthly returns of the individual indexes and then take the ratios, as defined for the benchmark allocation. However, this is incorrect. That is, the commutative law does not apply.

We can look at the math from two perspectives:

1) Link, THEN take the ratios
2) Take the ratios, THEN link.

We will get differences, and they can be material. You can try this yourself or wait until this month's newsletter, when I'll have more to say on this matter. The issue is partly attributable to the challenges we often face with compounding, which deserves a fair amount of treatment itself, which I hope to provide in the coming months.

Is it time for risk certification?

The question above might cause you to respond, "we already have certification programs for risk," and you would, of course, be correct. However, they're for a much broader view of risk than I have in mind. For example, the "FRM" covers much more than risk that those involved in investment management typically see.

During last month's Performance Measurement Forum meeting in Boston, I asked our members if having a certification for risk would be a good idea, and got very good response. The certification would cover:

• risk measures (e.g., standard deviation, beta, downside deviation, tracking error)
• risk-adjusted measures (e.g., Sharpe ratio, Treynor ratio, Information ratio, and Modigliani-Modigliani)
• risk-attribution (e.g., the work that Jose Menchero and Philippe Gregoire have done).

While the CIPM program includes risk, it doesn't to the extent that I'm suggesting.

Two names for the program have already been suggested: CRP (Certified Risk Professional) and CIRP (Certified Investment Risk Professional); others, perhaps more worthy, can be considered.

At this point we're merely floating the idea, to see what folks think.

There's no doubt that risk measurement's role has increased significantly. Many questions continue to surface as to what measures to use, how to calculate them, and how the risk team should be "married to" or "integrated with" the performance folks (or, for that matter, if they should BE the same folks).

Feel free to offer your thoughts.

An example of why I insist that those who comment identify themselves

Occasionally readers of this blog send me comments; and usually the writers identify themselves. My friend Steve Campisi has been the most frequent one to share his views, which often extend my thinking or offer alternative views, all of which are welcome. Contradictory thinking or opposing views are also invited.

But once in a while someone comments anonymously, and long ago I announced that these comments won't be posted. Very rarely, but on occasion, sarcastic remarks have been offered: it's a shame that these individuals won't identify themselves. And, on occasion the comment has value, but given my rule simply won't be posted. Today I received the following, regarding a post from February of this year. That post suggested that without knowing the rules, mistakes could be made and was inspired from something that had appeared on Facebook. This person offered the following:

I certainly wouldn't follow any of your 'Investment Performance' because your maths is flawed. The actual correct answer is -20.

The order of mathematical operands is:
Items in brackets or parentheses = ()
Other operands eg Indicies [sic] etc
Division = /
Multiplication = *
Addition = +
Subtraction = -
and if you are faced with multiples of the same operand then you must complete them from left to right.

Thus:
0+50*1-60-60*0+10=x
0 + 50*1 - 60 - 60*0 + 10 =x
0 + 50 - 60 - 0 + 10 =x
50 - 60 - 10 =x
-10 - 10 = -20

The mathematical problem that was posed was:

0 + 50 x 1 - 60 - 60 x 0 + 10 = ???

The writer is correct in the order, but somehow flipped a sign (note what I've shown in red above).

Given the writer's wording (the use of the word "maths") and notation (the use of the single quotation (') mark rather than the double (")), I'm guessing he or she is a "Brit," though I could, of course, be mistaken. The correct answer, as revealed in the blog post, is zero.

This anonymous person made a simple error, which we are all subject to. If they hold true to their threat, they will not see this post, which is fine, but at least I get to once again state that anonymous posts won't be shown ... oh, I guess I showed this one. Darn! Well, never again!!!

Say it aint so ...

I have been aware that there is no requirement for the Global Investment Performance Standards (GIPS(R)) to undergo a quinquennial revision; however, I believe there is an expectation for a review every five years in order to determine if a revision is in order. It appears that this may not be occurring this time.

It has been rumored that changes to the Standards will be introduced into guidance statements, which I find somewhat upsetting. I have opposed such acts, as they invariably lead to problems. Two cases in point:

1) The Significant Cash Flow guidance, which I worked on, introduced required disclosures, which were easy to overlook. Unfortunately, when the 2005 edition of the Standards was published, we overlooked these guidance statement-embedded required disclosures, making the job of the GIPS folks who took advantage of significant cash flows a bit cumbersome. It was just too easy to miss the required disclosures, which many firms did.

2) The Error Correction guidance introduced requirements which were not in the previously publicly reviewed version (I have previously offered my view that such major changes warranted the document going back out to the public). When GIPS 2010's draft was circulated, many of us saw for the first time these requirements; the public responded in opposition. And so, they were dropped from the Standards, but remained in the "GS," meaning they remained in effect. Much confusion resulted, which I think made the final hours of the 2010's birth overly challenging.

The intent of the GS is to offer guidance on the Standards, not to impart new rules. It's interesting to note that because of the Error Correction problem, guidance was needed on the guidance, which came in the form of a Q&A.

The 2010 edition was much more extensive than the 2005 version; perhaps one might suggest unnecessarily so. The Standards still warrant a five-year review and, if it's determined changes are needed, for it to be revised, not for them to be introduced via a backdoor approach (i.e., guidance statements). I do hope the rumor proves to be a false one, and that the GIPS Executive Committee will invest the time to revise the Standards and, if necessary, provide guidance on the rules, not impart new ones through guidance.