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.

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.

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.

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.

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?

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)

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.

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.

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.