Pensions & Performance Measurement

Crisis Compels Economists To Reach for New Paradigm - WSJ.com#mod=todays_us_page_one: "The result was a new orthodoxy, known as 'rational expectations,' that still dominates, underpinning everything from the way pension funds invest to how financial analysts put values on securities."

In the same edition, some of the ways pension benefits can be manipulated was demonstrated along with the lead story about executive pensions rising in 2008 despite horrific company performance.

While pension calculations are not in the purview of today's performance measurement professionals, the idea of manipulating formulas is. Whether it is the underlying benchmark selection for attribution analysis or the choice of risk-free rates or pricing sources for securities, these inputs provide a substantial impact on the final product. The performance professional needs to be cognizant of the firmness of the foundations of his work before providing this data to the end user.

Taking Candy From A Baby

White House Tally Appears to Overstate Stimulus Jobs - WSJ.com: "Some Head Start preschool programs reported that stimulus money saved the job of every staff member who received a cost-of-living pay raise, according to their filings. Some colleges and universities counted every part-time student work-study position as a full-time job, according to their reports, which are published online at recovery.gov."

This really feels like piling on, but this measurement issues for the stimulus' effects offers an extreme example of what can happen when there are no performance standards involved. In an increasing quantitative world combined with demographic and fiscal inevitabilities, this may be the impetus to expand the expertise of performance measurement professionals from investment management to other less obvious fields.

Preaching To The Choir: Losses Are Harder To Recover

One Way to Dig Out of a Hole - WSJ.com: "If an investment declines 10%, it takes about an 11% gain to break even (assuming you don't pump in additional dollars). If the drop is 20%, you need a 25% gain to recover. A fall of one-third requires a rebound of 50%. And if your investment falls by half, 'you need a double,' or a 100% return, says Mr. Wiener, the New York-based editor of the Independent Adviser for Vanguard Investors. The recovery percentages grow exponentially because you have so few dollars working for you after a big loss."

This is the basic idea behind Nassim Taleb's Black Swan Theory. However, human nature is not wired to think about percentage gains and losses. One of the key areas performance measurement professionals can add value to the marketing process is working with the sales team to help them clearly demonstrate this.

Crying Out For GIPS

My Way News - Stimulus jobs overstated by thousands: "The AP review found some counts were more than 10 times as high as the actual number of jobs; some jobs credited to the stimulus program were counted two and sometimes more than four times; and other jobs were credited to stimulus spending when none was produced."

Performance Pet Peeve

Economics One: Despite claims, data continue to show small impact of stimulus:

"The table shows the latest Department of Commerce estimates of the contributions of consumption, investment, net exports, and government spending to the improvement in GDP growth from the first to second quarter. Growth improved by 5.7 percent (from -6.4 percent to -0.7 percent). Private investment was by far the major source. Government spending contributed 1.9 percentage points, but more than half of that was defense spending which was not part of the stimulus."

No, growth improved by 5.7 percentage points. Nevermind whether or not using percentages as ending and beginning values to calculate a percentage return is a proper way to express improvements.

GIPS Singapore Summary

GIPS Singapore Summary: "The GIPS Executive Committee (EC), the governing body for the Global Investment Performance Standards (GIPS), recently met in Singapore to review the comments received on the GIPS 2010 Exposure Draft and discuss proposed revisions."

Can Performance Presentation be Successfully Regulated Part II

From Trust and Delegation by Stephen Brown, William Goetzmann, Bing Liang, Christopher Schwarz First Draft: June 16, 2009

"Funds that strategically lie on their DD reports have higher performance than other funds after the DD report....perhaps these funds are better funds. However, since these managers appear to only strategically lie to the DD company, they may also choose to “game” the return data reported to investors, which causes these funds to appear superior to their peers.

We also find funds that have external pricing have lower performance than funds that price their own portfolios. Non-independent pricing allows the opportunity to inflate performance through “cherry picking” of model prices or outright fraud."

Operational definition of "strategic liar": managers who voluntarily disclosed past problems but Due Diligence firm found additional legal or regulatory problems that would have been expected to be disclosed.

Can Performance Presentation Be Successfully Regulated?

From Trust and Delegation by Stephen Brown, William Goetzmann, Bing Liang, Christopher Schwarz First Draft: June 16, 2009

"An event study shows that the DD reports are typically issued on high return funds three months after the historical performance has peaked. The DD reports are also issued at the point of highest investor flow into the fund. This pattern is consistent with return chasing behavior by institutional hedge fund investors. Brown et al. (2008) found no evidence that knowledge of operational risk in any way mediated the fund flow performance relation."

Would that be an investor behavior impervious to the most draconian regulation?

How To Abuse Carveouts

FT.com / Companies / Financial Services - Hedge funds misrepresent facts, says research:

"Managers most commonly misrepresented the amount of money they had entrusted to their funds...."

As previously mentioned, carveouts allow the presentation of a product AUM that is included in another product's AUM. Many people would simply add these product AUMs to get a firmwide AUM. Even with the firm AUM presented, summing the mandates will present a higher figure and sow confusion.

Cherry Picking

On the Internet, Everyone's a Critic But They're Not Very Critical - WSJ.com:

"Other critical reviewers say they get flak for their brutal honesty. Mark Nuckols, an American teaching finance in Moscow whose Amazon book ratings average a three, says he's concerned by what he senses is a practice of 'pre-emptive deletion.' When he posted a 'mildly critical review' of a recent children's book by Tom Tomorrow, it never surfaced. When he tried to post a review of another Tom Tomorrow book, it didn't show up, either."

Businesses whose revenue depend upon moving merchandise without a physical presence (e-tailers) need positive reviews of the items and have a conflict of interest when negative reviews appear. As a result, negative reviews are ripe for removal s Mr. Nukols discovered.

The Global Investment Performance Standards are designed to prevent this type of cherry-picking. Essentially, GIPS boils down to no cherry-picking of results. If it did not, then every asset manager would be look good.

One of the 2010 changes disallows carve outs that do not have its own cash. Previously, a firm could create a product from exisitng ones and claim it was representative of how the newly created product was actually managed. The simplest form was breaking a balanced account into its equity and fixed income components and marketing three products - the actual balanced one, an equity one and a fixed income one.

While that does not seem misleading, one already has a situation where the potential investor can no longer sum the AUM totals of the three products to get an idea of how much money and investment firm manages. Nevermind the deeper concern that the equity and fixed income carveouts are dependent on the balanced account guidelines for asset allocation decisions.

The more likely a practice can mislead a potential investor the more likely it will violate GIPS. Carveouts can certainly be one of those asset management practices.

What I'm Thinking About

Of Candor and Conflicts: What Were We Thinking? by Marianne M. Jennings, Professor of Legal and Ethical Studies at Arizona State University

"My intention, therefore, is to discuss three factors that are typical precursors to the ethical failings that lead to such scandals:

• pressure and myths about success
• conflicts, tone, and our resistance to
both
• gray areas that are not really gray."

Annualizing Partial Returns: The Case for Valuing Twitter at $2.7 Billion

A Case for Valuing Twitter at $2.7 Billion - Digits - WSJ

Quote:
'First, it is often difficult to come up with comparables (there has never been anything quite like Twitter) and the valuations often come before such important standards as, say, profits, so investors are left valuing a business based on such metrics as future revenue. "

First, Twitter is AOL Instant Messenger with Spamming Feature. Valuing Twitter is important only to the investment bankers would earn a commission and the early investors who will cash out.

That scathing assessment aside, the professor estimates Twitter going to have one billion users by 2013? Color me skeptical.

Whether it is the early estimates of internet growth or the estimates of the number of blogs in existence that inform my skepticism, I see a global population estimate of 7 billion people around 2013. Am I truly to believe that 1 in 7 people on Earth will be a Twitter user?

Just as projecting 20% growth per annum in perpetuity will lead to a company growing bigger than the economy, to project Twitter user growth to equal 1/7th of the world population in four years does not pass the sniff test.

GIPS disallows annualizing partial year performance for a similar reason. Prediciting the future is essentially a guessing game. Taking the best week of performance an asset manager had and annualizing provides such a large number that it too won't pass the sniff test.

Real Life Application of Rule of 72

Tom Daschle: Climbing the Hill on Health Care - WSJ.com:

"Failure to address ever-escalating health costs means that a typical family will see its annual cost of health insurance rise to $25,000 by 2025 from about $12,000 now."

While this is clearly a politician's appeal, I am going to stay away from the reasoning behind using a figure 16 years in the future without discounting it back to present value.

The Rule of 72 is a back of the envelope way of figuring out how long it will take something to double. Divide 72 by the expected growth rate to get the number of years to double. If the growth rate is 7.2%, then the amount doubles in 10 years.

The former Senator has given us the final value and the number of years. We need to figure out what the current cost of of health insurance for a "typical family" is. If one assumes that cost to be $12,500, then we know it will double over 16 years. That gives an approximate health insurance growth rate of 4.5%.

The National Coalition on Healthcare says, "The average employer-sponsored premium for a family of four costs close to $13,000 a year...". To explain further gets me into political commentary I rather not explore in this forum.

A More Investor-Friendly Performance Method?

Can Rally Run Without Revenue? - WSJ.com:

"In the short-term, earnings prospects may remain favorable for the market. Aggressive expense control and modest inventory restocking could boost third-quarter numbers, while the fourth quarter has easy comparisons against an awful 2008 that will give the appearance of healthy profit increases."

Instead of comparing current numbers against the previous year numberss, why not show one-year, two-year, three-year etc comparisons?

Is Performance Measurement Dying?

Fiduciary Duty Hits the Street -- Sort Of - WSJ.com:

"The changes could transform the brokerage industry by changing the way products are sold and marketed and even how brokers are paid. Requiring brokers to operate under the existing fiduciary standard could force them to recommend more investments that are less costly and more tax-efficient."

As a performance measurement professional, I can't help worrying this is going to lead to cuts in the support functions at financial firms. One such support function is performance measurement and presentation.

As a fledgling specialty, performance measurment can adapt as it can easily be folded into those areas which it supports i.e. marketing. The difficulty will come meshing the proclivites of those who currently enjoy performance calculations with those who enjoy marketing.

As holder of the CIPM designation and an individual with experience in sales and non-profit work, I can attest that the selling/service industry and attribution analysis/heavy spreadsheet work do not necessarily attract the same type of person.

Cash For Clunkers: Changing Benchmarks

'Clunkers' Lifts Foreign Cars - WSJ.com: "Transportation Secretary Ray LaHood said the program was 'wildly successful' at bringing 'moribund' car showrooms back to life."

I was under the impression that the cash for "clunkers" program was intended to help the automakers, specifically the US-based ones (GM, Ford and Chrysler). Secretary LaHood says otherwise.

It was the after-the-fact results that demonstrated the cash for clunkers program was an auto dealer bailout, and, judging from the Top 10 models sold, one for foreign car dealers.

The top 10 models purchased under the government's 'cash for clunkers' rebate
program:
1. Toyota Corolla
2. Honda Civic
3. Toyota Camry
4. Ford Focus FWD
5. Hyundai Elantra
6. Nissan Versa
7. Toyota Prius
8. Honda Accord
9. Honda Fit
10. Ford Escape FWD

What this does show is the importance of designating a benchmark before the results are in. Investment managers committed the GIPS know this. One can't simply get to month's end, see your performance results, then find a benchmark that works.

Code of Ethics

Goldman Sachs Trading Tips Reward Big Clients - WSJ.com:

"Mr. Canaday says analysts are told that any comment at a meeting that could result in a change in a rating, earnings estimate or stock-price target "must be published and disseminated broadly to all clients." He adds, however, that it is rare that tips arising from the meetings reach that threshold. He says ratings changes after the meetings also are rare."

As someone who has been involved with the professional designations available from the CFA Institute for the past seven years or so, I can't help thinking about the ethical codes those granted the right to use the designations must abide by. What the WSJ article describes sounds like front running, which would violate said code.

I am curious how the CFA Institute views Goldman Sachs practice as described in the front page article.

Importance of Benchmarks

Outplacement Firms Struggle to Do Job - WSJ.com:

"Chet Shubert, 53, arranged outplacement as a human-resource executive at Wyeth Pharmaceuticals and National Starch & Chemical Co. Last year, it was his turn, when he was laid off following a merger. He says he was offered several months of outplacement at Right's Management's Philadelphia office. In his first group meeting, he was surprised when a staff member said the firm didn't track how many clients get jobs."

This front page article is a lesson in the importance of benchmarks (or control groups for the more scientifically-inclined). Without them, there is no way to measure whether any outplacement firm is better than the other.

While benchmarking seems obvious to the investment management industry now, there was a time in our lifetime when benchmarks weren't considered vital either. Then came modern portfolio theory to usher in their importance.

Now proper benchmarking of investment products is a requirement for GIPS and a given in best practices.

Simple Prose On Seasonal Adjustments

WHAT THE GOVERNMENT REALLY SAID ABOUT US HOUSING - New York Post:

"A seasonally-adjusted house is one that exists only in the government's fertile statistical imagination.
And that imagination is spewing out a whole lot of deceptive economic numbers because normal seasonal adjustments are being thrown off by the abnormal nature of the current economy."

Seasonal adjustments assume what happened before happens again. A black swan would make these adjustments gibberish.

Mr. Crudele provides an easy to understand dismantling of the new residential starts figure.

Sometimes Exactitude Is Meaningless

New jobless claims rise unexpectedly to 576K - Yahoo! News:

"The number of people remaining on the benefit rolls dropped by 2,000 to 6.24 million."

With rounding, the "6.24 million" figure could range from 6,244,000 to 6,235,000 - of course rounded to the nearest thousand. I wonder whether reporting the 2,000 drop was an editiorial decision or oversight.

Seems insignificant with the rounding or too exact to be true.

Following Up On Yesterday's Orthodoxy in Investment Performance Measurement

Investment Performance Measurement:

"The fact that investment reporting often only reflects the asset manager’s perspective raises an obvious rhetorical question: Does investment reporting as currently practiced really meet the needs of clients? The next questions are not rhetorical: How will the investment industry close the expectations gap and give existing clients investment reports prepared from their perspective, and who will lead the effort?"

Re-Reading "U.S. Equity Styles Indexes" from The Research Foundation of AIMR

I was struck by this blurb within the discussion of the valuation effect on stock over- and under-performance:

"...the surprise registered by academic researchers in response to the discovery
of the value and size effects is hard to overstate. More than a decade of
efficient market and CAPM orthodoxy had convinced most that the cap-weighted
market portfolio could not be beaten, at least not with a simple, easy-to-follow
decision rule..."

The field of investment performance measurement could be said to be as young as the CAPM and efficient market theories were when Reinganum, Banz and Basu discovered the valuation effects. That could indicate there are accepted practices and methodologies within performance measurement and presentation that are currently viewed with similar orthodoxy as the CAPM and efficient market theory were in the late 70s.

More Regulation Is Coming

Obama pushes bill to crack down on hedge funds - Jul. 15, 2009:

"The bill, one of many Obama administration proposals to revamp financial regulation, would require all investment advisers with more than $30 million under management to register with the SEC and disclose key information about their funds to regulators and investors."

I wonder whether the CFA Institute would pro-actively get involved to be part of a solution in ways the healthcare industry has with heath care change.

Apples to Oranges.

How to understand the myriad jobless reports - Stocks & economy- msnbc.com:

"Q: What does the report on weekly jobless claims measure?
A: The report captures the number of people who file their first claim for unemployment insurance after being laid off.

This can be a good measure for how many jobs were cut the week before, but it doesn't capture the whole picture. For whatever reason, not everyone who loses their job ends up filing for unemployment insurance benefits, or at least they may not file right away. Still, the rough number can point to upward or downward trends in the labor market between monthly reports filed by the Bureau of Labor Statistics.

Q: What does the monthly unemployment report measure?
A: The monthly unemployment report is based on a Census Bureau survey of 60,000 U.S. households. The survey asks respondents several questions, including whether they have a job, are looking for a job, or are so discouraged that they have quit looking for work altogether.

The report lays out a whole range of unemployment rates. The most-cited rate only counts people actively looking for work; the latest unemployment report, released on May 8, calculated that rate as 8.9 percent. A much broader unemployment rate — 15.8 percent in the latest report — also includes everyone who has dropped out of the labor force or has been forced into part-time work."

This explains the conflicting recent news that the economy continued to lose jobs but the unemployment rate decreased. The two statistics aren't drawn from the same data. It's apple to oranges, sort of.

Drawing conclusions using those numbers provides conflicting conclusions. GIPS tries to prevent this by offering standards for performance presentation.

Spreadsheet Certainty

When Precision Is Only 92.11567% Accurate - WSJ.com:

"...decimal places lend the aura of authority and the veneer of verisimilitude. So the modern world is awash in squishy numbers wearing the many-figured garb of faux precision."

One would believe this does not really apply to investment performance measurement, but one would be incorrect. Think about what goes into the valuation of the numerous asset-backed securities and real estate.

Infrequent sales, illiquid markets, mark-to-model....All lay at the foundation of the values used to calculate security returns, which role-up into composite returns which are presented to the nearest basis point and provide a potential investor with "an aura of authority".

Interestingly, there was a book review in yesterday's WSJ that tapped into a similar vein. Philip Delves Broughton reviewed Matthew Stewart's polemic against management consulting "The Management Myth". According to Broughton, "Mr. Stewart argues that the profession is built on a science of management that is both narrow-minded and ­intellectually bogus....The business world...has become so obsessed with its own perverse value ­system and view of human nature that it is ­undermining the “commons” of society."

"Narrow-minded and intellectually bogus" are ways of describing foundational assumptions the author disagrees with. In the current environment of anger and disillusionment with Wall Street, the analogy to the assumptions underlying asset-backed securities could be described similarly.

Agree or disagree, and I am prone towards just the philosophical curiousity of the argument, what both do have in common is a foundation rooted in the "aura of authority and the veneer of verisimilitude" provided by the easy-to-read spreadsheet result.

How To Humble A Performance Measurement Expert

Why Toxic Assets Are So Hard to Clean Up - WSJ.com:

"The bulk of toxic assets are based on residential mortgage-backed securities (RMBS), in which thousands of mortgages were gathered into mortgage pools. The returns on these pools were then sliced into a hierarchy of 'tranches' that were sold to investors as separate classes of securities. The most senior tranches, rated AAA, received the lowest returns, and then they went down the line to lower ratings and finally to the unrated 'equity' tranches at the bottom.

But the process didn't stop there. Some of the tranches from one mortgage pool were combined with tranches from other mortgage pools, resulting in Collateralized Mortgage Obligations (CMO). Other tranches were combined with tranches from completely different types of pools, based on commercial mortgages, auto loans, student loans, credit card receivables, small business loans, and even corporate loans that had been combined into Collateralized Loan Obligations (CLO). The result was a highly heterogeneous mixture of debt securities called Collateralized Debt Obligations (CDO). The tranches of the CDOs could then be combined with other CDOs, resulting in CDO2.

Each time these tranches were mixed together with other tranches in a new pool, the securities became more complex. Assume a hypothetical CDO2 held 100 CLOs, each holding 250 corporate loans -- then we would need information on 25,000 underlying loans to determine the value of the security. But assume the CDO2 held 100 CDOs each holding 100 RMBS comprising a mere 2,000 mortgages -- the number now rises to 20 million!"

To quote Stan Lee, " 'nuff said."

I don't need to fly too close to the sun to know I couldn't do anything but accept the prices provided by a service or investment manager. Is this a short-coming of GIPS?

Calpers Has Worst Year, Off 23.4% - WSJ.com

Calpers Has Worst Year, Off 23.4% - WSJ.com:

"The California Public Employees' Retirement System, the nation's largest public pension fund, reported a preliminary decline of 23.4% for the fiscal year ending in June. The fund saw its value fall by $56 billion from the previous fiscal year to $180.9 billion."

Ending Market Value = $180.9 billion
Beginning Market Value = $180.9 billion plus $56 billion is $236.9 billion

EMV/BMV minus 1 = -23.6%

I have no qualms over the 0.2% difference given the possibility of rounding error in the original CaLPERS calculation. However, there is no cash flows components to the calculation if rounding is accepted as the reason for the difference.

Operational Definitions And Healthcare Costs

Economic Scene - Support for Health Reform Requires Facing Facts on Costs - NYTimes.com:

"The United States now devotes one-sixth of its economy to medicine. Divvy that up, and health care will cost the typical household roughly $15,000 this year, including the often-invisible contributions by employers. That is almost twice as much as two decades ago (adjusting for inflation). It’s about $6,500 more than in other rich countries, on average."

I want to figure out how Mr. Leonhardt calculated his $15,000 per "typical household" number. The U.S. economy was $14,264.6 trillion dollars at the end of 2008.

If medicine is 1/6th of the U.S. economy, then it represents $2,377.4 trillion dollars. To get the number of of households, this figure is by $15,000. Meaning there were 158 million households.

Of course, this calculation depends on the writer using the same operational definition for the U.S. economy that I did. I suspect he isn't doing so because the number of 2008 households in the U.S. is 116.8 million according to the U.S. Census Bureau. (Table AVG1)

Not Smelling Right: Auto Makers' Firmer Pricing Risks Denting Sector's Recovery

Auto Makers' Firmer Pricing Risks Denting Sector's Recovery - WSJ.com:

"Firm pricing may have worked for the auto industry when a sales level of 16 million cars and trucks a year in the U.S. was considered normal; now the annual-sales rate is less than 10 million."

A couple years ago, analysts assumed 16 million in annual auto sales was a legitmate number. Now that legitamte number is 10 million. A 37.5% drop points towards the annual sales rate as a figure that doesn't pass the smell test.

Adjustments for seasonality and annualizing one month rates are likely the two big factors that "offend" an investment performance measurement expert. Valuing portfolios for large cash flows covers the seasonality i.e. surges in assets under management due to IRA payments in April, and an outright ban on annulaizing returns less than one year covers the tricks on one-month sales' rates.

Rationalized or not, I can't shake the feeling the car and trucks annnual sales rate is too volatile to be accepted at face value.

Does Medical Care Have A GIPS?

In Massachusetts, a New Idea for How to Pay - WSJ.com:

"Under the new system, doctors and hospitals would be organized into groups responsible for all of a patient's health-care needs. The groups would receive a 'global payment' per patient, which could be adjusted with performance incentives based on the quality of care provided."

My question is a simple one - how will "quality of care" be measured? I see all sorts of difficulties in setting up performance measures. Two of the bigger ones are the presence of an indepedent standards-setting organization and a way to stave off the worst instincts of selection bias in choosing patients for the initial benchmark.

Investment performance measurement has the CFA Institute and the Global Investment Performance Standards to address the former and a set of requirements and recommendations to deal with the later i.e. inclusion/exclusion rules, specific ROR calculation methods, verification, etc. This framework provides investors with the confidence their potential asset manager is doing all it can to adhere to the highest standards in the investment industry.

Whether this model can be replicated within a universal healthcare coverage setting is debatable. To the extent it can be will determine the overall success of such a plan.

A Real Life Lesson In Operational Definitions

Small Business Faces Big Bite - WSJ.com:

"...employers with payrolls exceeding $400,000 a year would have to provide health insurance or pay the 8% penalty. Employers with payrolls between $250,000 and $400,000 a year would pay a smaller penalty, and those less than $250,000 would be exempt. Certain small firms would get tax credits to help buy coverage."

As the politicians go back and forth on trying to protect "small busineses" in the healthcare coverage debate, I sat and wondered what exactly a "small business" was. Was it a mom-and-pop store with a few full-time employees, typically family, and low-paid part-timers? Was it a 250-employee private asset management firm? Heck, was it a couple of guys teaming together to offer performance measurement and GIPS expertise?

Well, the House majority answered the question, and the POTUS supported it today in his public encouragement to pass the bill. A small business, operationally defined by the House of Representatives, is one with a payroll less than $250,000.

Looks like a mom-and-pop store can have 16.5 full-time employees at the soon-to-be minimum wage of $7.25. If it doesn't exist right now, it will soon - a way for the mom-and-pop owners to pay themselves minimum wage whilst reaping the reward for the risk-taking inherent in owning and operating a business.

As for the two-man team offering performance measurement and GIPS expertise....

Why Perfexc For Your Performance & GIPS Needs

Rising Health-Care Costs Are Pushing Entrepreneurs to the Limit - WSJ.com:

"At the same time, to keep costs in check, countless companies...Some are turning to freelancers...instead of hiring full-timers..."

Wow. That quote plus ellipses looks like a movie review. If this was a performance presentation and reporting topic, it could have been in the gray area of fair representation under the GIPS standards.

Losing Money Is Easier Than Making It Back

Small Investors Pile Into Funds Devoted to Riskier Investments - WSJ.com:

"Murray Schofield, a retired orthodontist in Arizona who sold most of his foreign investments in the second half of 2008, has been buying emerging-market funds, and funds dedicated to China and India, since March. He now has 23% of his portfolio in funds that invest in these stocks. “I have to recapture part of my losses,” says the 84-year-old. “Otherwise I’d be more conservative.” His portfolio is up 20.4% for this year, following a 44% loss in 2008, he says."

I have bolded the last sentence attributed to Mr. Schoefield because it demonstrates a natural flaw in people's thinking when it comes to percentage losses and gains towards recovering them. A common error is to see the 44% loss and the subsequent 20.4% gain and do a quick back of the envelope calcuation that he is down 23.6% now.

That is wrong. The back-of-the-envelope calculation is to take the 20.4% gain and multiply it by the 44% loss to see how much Mr. Schoefield has recovered - about 9%. That still leaves him down about 35% from start of 2008. (A performance measurement professional would say from 12/31/2007.)

To see how far he is actually down, assume $100 on 12/31/2007. A 44% loss in 2008 would leave him with $56. In the first half of 2009, he has gained 20.4%. $56 plus ($56*.204) equals $67.42. Or still down a cumulative 32.58%.

FWIW, Mr. Schoefield will need to see an additional 50+% return over the next six months to get his portfolio back to its 12/31/2007 value.

GIPS 2010 And Operational Definitions

Stan Liebowitz’ informative study, “New Evidence on the Foreclosure Crisis”, in Friday’s Wall Street Journal brought to mind one of the 2010 Global Investment Performance Standards (GIPS®) changes. The change is the requirement of firms claiming GIPS compliance to revalue its portfolios at every large cash flow.

Mr. Liebowtiz’ operational definition of sub-prime mortgage provides the basis of his study. He uses the technical one used by mortgage and lending professionals to show it isn’t sub-prime borrowers (FICO scores less than 620) that are the root of the foreclosure crisis, but those borrowers who have negative equity in their home.

He contrasts that with the operational definition politicians and ordinary people may be using for “sub-prime mortgage” – a loan to a person who cannot afford it. Whether this is an actual sub-prime loan or prime one or a liar loan or a 103% loan, these are mortgages taken out by borrowers, and granted by lenders, who would not have been expected to get one even 15 years ago.

Here is where the 2010 GIPS requirement to value portfolios at “large cash flows” runs into the issue of operational definitions. The CFA Institute is not providing a definition of what a “large cash flow” is. As a result, expect wide latitude in operational definitions of “large cash flow” amongst firms claiming GIPS compliance.

Why Annualizing Partial Returns Fails

Tilting at Windmill Jobs - WSJ.com:

"...it's worth recalling that Mr. Obama's economists predicted late last year that the stimulus would keep the jobless rate from exceeding 8%. That was a percentage point and a half ago."

The CFA Institute's Global Investment Performance Standards prohibits firms from annualizing return data for periods less than one year. One need only see a 1% weekly return presented as a potential 68% annual return to see why.

In the real world, annualizing returns for partial periods is no different than trying to predict the future. And no matter how smart a firm's investment team has demonstrated itself to be, nobody can predict the future with reliability.

Unfortunately for the real world, their are no GIPS reporting and presentation standards for politicans. I've often wondered though, whether a politican with a CFA needs to adhere to the Code of Ethics.

Using Averages

Big Pay Packages Return to Wall Street - WSJ.com

This above-linked WSJ article talks about the average compensation per employee at a few of the largest Wall Street firms. Saying the average pay at Goldman Sachs is $700,000 leaves the impression that every employee enjoys such opulent compensation.

I wonder what the median is or the quartiles. That type of information would be more informative. Otherwise I am left thinking about the old anecdote about Bill Gates and six people in a bar having an average salary amongst them of $170 million or however Gates's salary plus six $0 salaries average out.

GIPS 2010 - Valuation at Every "Large" Cash Flow

This morning's Wall Street Journal article on PPIP and its unpopularity drives home an upcoming difficulty in the GIPS 2010 changes. GIPS compliant firms will be required to value all portfolios on the date of large cash flows.

The banks are refusing to sell its toxic assets under the PPIP for fear of disclosing its market value and changing the values being shown on their books. Without the market, values for these securities is left to more subjective measures. Yes, even a discounted cash flow model is subjective thanks to the assumption the security will exist until maturity with principal repayment.

How will the GIPS compliant firm determine price in the event one of their portfolios has a large cash flow and these kinds of toxic debt?

How A GIPS Focused Person Reads The News

GIPS provides the industry standard for performance measurement, calculation and presentation. When one believes in the principles, he can't help those beliefs from framing his interpretation of the news.

Yesterday's Wall Street Journal had a small article on the decrease in assets of wealth-management firms. (Personal Finance, D4). To quote, "The 15 largest firms surveyed saw the dollars they manage fall by almost a quarter in 2008..."

As a performance professional and GIPS adherent, my first thought was those 15 need to increase assets under management by 33% to break even. The more important one, though, was to wonder how the calculation was made.

How were the cash flows, presumably negative thanks to client withdrawals, accounted for? How did a 25% decrease in AUM account for the market returns for 2008?

None of this is meant to claim Bank of America Corp.'s Merrill Lynch Global Wealth Management Group and Capgemini Group did not account for this concerns. It is just an example of how the belief in GIPS can inform one's understanding of the printed word.

Does The Health Care Industry Need a GIPS?

The referenced article shows the ways one industry cries out to be regulated - even if it doesn't realize that is what it is doing. GIPS performance standards fill that void for the investment community by providing a standard way to calculate and present performance.

One can't simply eliminate an account or two from a composite because its return was deemed an "outlier" (read: makes performance look bad) without justifiable, documented policies that are applied the same way to all accounts.

Senate Panel Says Health Insurers Underpay Claims - WSJ.com:

"Committee investigators found that Ingenix developed its payment models based on claims data provided by its customers, the insurance companies.

A committee aide said those companies sometimes would “scrub” the data sent to Ingenix—throwing out outlying high costs. Ingenix then would use questionable statistical models to come to its own rate estimates."

What would "Create and Save" Look Like Without GIPS?

Yesterday's Wall Street Journal had a brief article describing the states' instructions on how to count a job as "created or saved" under the stimulus bill. Basically, a state need only use its best judgment. Not exactly helpful for those states concerned about accurate measurement and a worry for those of a more cynical bent.

For those of us who live and breathe fair and accurate performance measurement, as laid out by the Global Investment Performance Standards (GIPS), this guidance on "created or saved" is almost heretical. An investment performance measurement equivalent would be arbitrary inception and closed dates, a whimsical inclusion/exclusion policy, and/or capricious cash flow accounting.

GIPS 2010

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