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.
Friday, October 16, 2009
Thursday, October 15, 2009
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?
"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?
Wednesday, October 14, 2009
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.
"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.
Monday, October 5, 2009
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.
"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.
Monday, September 28, 2009
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:
"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."
Friday, September 18, 2009
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.
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.
Thursday, September 3, 2009
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.
"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.
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