Performance reporting: setting high standards
Investors are keen to know how hard their investments are working for them. Every additional percentage point return can add up considerably to retirement funds if we factor in compounding returns.
Those building up a steady stream of passive income would want to know if they are any closer to financial freedom. Investors also compare. They want to know if their investment managers are underperforming or if there are better opportunities out in the market. Hence, investors examine performance metrics rather closely.
The report cards on investment performance are provided by investment managers at the close of the financial year. This duty to present a report card must be done in an appropriate manner given the importance of returns to investors. What are then some guiding principles behind this important reporting exercise?
The Performance Presentation Standard
CFA Institute is the global association of investment professionals that sets standards for professional excellence and credentials. As an asso-cation for professionals, the institute, under its Performance Presentation Standard, requires investment managers to make reasonable efforts to ensure that performance presentation is fair, accurate, and complete.
It is imperative to avoid misstating performance or misleading clients and prospective clients about the investment performance of investment firms. The standard covers any practice that would lead to misrepresentation of a firm’s performance record, whether the practice involves performance presentation or performance measurement.
Investment managers must also give a fair and complete presentation of performance information whenever communicating data with respect to the performance history of individual accounts, composites or groups of accounts, or composites of an analyst’s or firm’s performance results. Furthermore, investment managers should not state or imply that clients will obtain or benefit from a rate of return that was generated in the past.
Whenever an investment manager provides performance information for which the manager is claiming responsibility, such as for pooled funds, the history must be accurate. Research analysts promoting the success or accuracy of their recommendations must ensure that their claims are fair, accurate, and complete.
If the presentation is brief, the investment manager or research analyst must make available to clients and prospects, on request, the detailed information supporting that communication. Best practice dictates that brief presentations include a reference to the limited nature of the information provided.
Ethics in action: practise, practise, practise
Today’s case is based on and adapted from a CFA Institute Professional Conduct enforcement action. As a guide, the desired ethical behaviour required is based on the CFA Institute Code of Ethics and Standards of Professional Conduct (Code and Standards).
Case study: performance reporting
Yong is chief executive officer, portfolio manager, and sole owner of Singapore Investment Alliance (SIA), a registered investment adviser with more than $554 million assets under management and over 250 discretionary accounts. For several years, Yong has distributed marketing materials to clients and potential clients that contain gross-of-fee performance for returns on SIA’s managed portfolios.
Yong believes that gross-of-fee calculations are the most relevant because management fees are negotiable and can vary by client.
Yong includes a footnote at the end of the brochure disclosing that advisory fees would have to be netted out to show actual performance. The marketing material also includes a table that compares percentage increase in the S&P500 index with the percentage increases in SIA’s performance. SIA’s performance includes the reinvestment of dividends.
Yong believes that the S&P500 is the most appropriate and understandable benchmark because it is commonly reported in the financial press and recognisable by his clients.
Analysis: This case involves the presentation of performance history. The CFA institute Performance Presentation Standard states that “when communicating investment performance information, one must make reasonable efforts to ensure that it is fair, accurate and complete”. The goal is to provide credible performance efforts to clients and prospective clients and to avoid misstating performance or providing misleading performance information.
Absent legal or regulatory provisions prohibiting such conduct, presenting gross-of-fee performance is acceptable as long as there is clear disclosure that relevant fees must be deducted to get actual performance history.
It is unclear from the facts presented whether Yong’s footnote is prominent or clear enough to be sufficient to meet this standard. Best practice would be to present both gross- and net-of-fee performance history, or in some other way, prominently show the effect of the fees so that performance information meets the “fair, accur-ate, and complete” requirement of the standard.
Similarly, presenting a table that includes the S&P500 performance as a benchmark for returns may be appropriate under certain circumstances.
But when it is used as a benchmark for firm performance history that includes reinvested di-vidends, as in this case, it would not be an “apples-to-apples” comparison and would likely be misleading because the S&P500 performance history does not include reinvested dividends.
If Yong wants to use the commonly reported S&P500 returns over time as his benchmark, he should ensure SIA’s returns are calculated in a comparable way. At minimum, there should be prominent disclosures of any differences between the benchmark’s and the firm’s returns.
It is unclear from the facts presented whether Yong has made the necessary disclosures regarding the benchmark.
So, to judge whether there has been any misconduct, a thorough examination of the presentation material would be necessary to determine whether Yong is presenting performance that is fair, accurate and complete or whether his presentation misstates performance and is mis-leading.
This column has been adapted from content by CFA Institute and is printed here with permission from CA Institute
The writers are CFA charterholders who volunteer with the Singapore chapter on advocacy issues with a view towards promoting financial literacy among retail investors and improving overall standards and integrity in the industry. Comments and feedback can be sent to the CFA Society Singapore Advocacy Committee: [email protected]
Source: The Business Times