UAPS vs. GIPS

Earlier this week we announced a new standard which The Spaulding Group and BrightScope are working on: the Universal Advisor Performance Standards or UAPS. At this week's North America Performance Measurement, Attribution & Risk (PMAR) conference in Philadelphia, a few folks inquired into how these standards related to GIPS(R).

I guess one might expect that this initiative would engender some confusion, since the Global Investment Performance Standards have been around for almost 13 years, and have gained a tremendous amount of well deserved support and attention. The distinction between GIPS and the UAPS is, I believe, fairly clear.

GIPS is for asset management who manage client money and who wish to present their past performance to prospective clients. We are dealing with legally discretionary assets (i.e., assets where the client has given the manager the right to trade on their behalf) that further meet the firm's "GIPS discretionary" rules (that is, where the client has not imposed a restriction or requirement that causes the resulting portfolio not to be representative of the manager's strategy).

UAPS is intended for the retail / high net worth / wealth management arenas, where we often find individual financial planners and advisors who may provide their non-discretionary clients with advice and recommendations or have independent responsibility to manage their discretionary clients' assets.

When a firm has thousands of financial planners, scattered throughout the country, each independently managing client assets, to attempt to bring that firm into compliance with GIPS is a virtual impossibility. And so, these investment professionals want some standard they can use to ensure their reporting is appropriate, and which they can claim compliance with.

Let me make my next point very clear: UAPS does not compete with GIPS. It does not intend to serve the same market. Using a Venn diagram, we have the following:

For several years I have witnessed the confusion that exists within, for example, the U.S. brokerage community, where registered reps, financial planners, and investment advisors frequently ask their firm "are we GIPS compliant?" or "are our reports GIPS compliant?" or "are our returns GIPS compliant?" Clearly, GIPS has a far reaching presence. Unfortunately, these are the wrong questions, because these firms cannot easily achieve GIPS compliance. But with only one standard to use, it is not surprising that this occurs.

Whenever I suggested that a new standard, designed specifically for this market, was needed, the response has been over-whelmingly positive. And although we have wanted to develop a standard for this market, for a variety of reasons we couldn't make progress. Until now.

Last Fall we learned about the fellows at BrightScope, and reached out to them to discuss our idea of a standard, and they were very enthusiastic and offered to help. And so, we began the journey to develop such a standard. We are pleased and enthused by the progress we've made in a fairly short time, and are now ready to move to the next step of vetting and enhancing the document with a group of investment and performance professionals.

If you have any questions about the standards, please reach out. Contact information is at our website, where you can also obtain a copy of our draft white paper.

ANNOUNCEMENT! New Performance Standard Proposed

BrightScope and The Spaulding Group, Inc. Release White Paper That Proposes a Universal Performance Standard for Financial Advisors

The Adoption of Universal Advisor Performance Standards Will Broaden the Base of Advisors Who Can Report Performance to Both Clients and Prospects

Somerset, NJ - May 22, 2012

Contact:

Jaime Puerschner

PR for The Spaulding Group

732-873-5700

JPuerschner@SpauldingGrp.com

Katie Carlson

Atomic PR for BrightScope

415-593-1400

katie@atomicpr.com

BrightScope, a leading provider of independent financial information and investment research, and The Spaulding Group, a global leader in investment performance measurement products and services, today jointly announced the release of a new white paper, "Universal Advisory Performance Standards," highlighting the need for an industry consensus performance standard for financial advisors. The free white paper can be downloaded at www.uapstandards.org.

Today’s technology allows consumers to quickly and easily search for and compare mutual funds, 401k plans, mortgages, and many other types of financial products online, but when it comes to financial advisors there is not an efficient way to select one based on performance.

"Over time, we envision that every financial advisor will want and need to disclose the performance of their investment selections on behalf of clients," said Mike Alfred, the CEO and co-founder of BrightScope. "As the leading performance measurement firm in the money management industry, The Spaulding Group’s expertise is perfectly complimentary to BrightScope’s vision, and together we’re confident we can unify the industry around this new standard."

Currently many advisors and broker-dealers do not calculate and do not disclose performance to the general public, making it difficult for prospects to select the right advisor and challenging for the best advisors to grow their practice. As a result, the act of selecting an advisor has been limited to personal recommendations, and what little information consumers can find on the SEC and FINRA websites.

"BrightScope Advisor Pages has done a good job to bring transparency into the marketplace, however since there is no clear guidance or industry standard, many advisors refrain from reporting performance out of fear they might run afoul of SEC and FINRA advertising regulations," said David Spaulding, President of The Spaulding Group, Inc."When there is a single standard created specifically for the money management industry, individuals will understandably assume that it applies to them, when it may not. As a result, there can be confusion as well as the use of something that is less than appropriate. By introducing a new standard, specifically designed for financial advisors, we should see increased reporting; it will also allow investors to make a more informed decision on which professional is best qualified to serve them."

To further support universal standards, BrightScope and The Spaulding Group have founded the Committee for a Universal Advisor Performance Standard. Inaugural advisors to the committee include John Rekenthaler, Vice President of Research at Morningstar; Ric Edelman, Chairman and CEO of Edelman Financial Services LLC; James Edmonds, Executive Director at Morgan Stanley Smith Barney; Joseph Klimas, Vice President of Portfolio Research & Consulting Group at Natixis; Franklin Tsung, President of Appcrown; Christopher L. Davis, President of Money Management Institute and Steven W. Stone, Partner at Morgan, Lewis & Bockius LLP. More information can be found at www.uapstandards.org.

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About The Spaulding Group, Inc.

With offices in the New York City and Los Angeles metropolitan areas, The Spaulding Group, Inc. is the leader in investment performance measurement products and services. TSG provides consulting along with GIPS and non-GIPS verification services; offers a unique Software Certification service; publishes The Journal of Performance Measurement®, a quarterly publication launched in 1996; and hosts the Performance Measurement Forum. The firm also sponsors the annual Performance Measurement, Attribution and Risk (PMAR) conference and PMAR Europe, which have come to be recognized as the leading performance measurement conferences in the industry. TSG’s Institute of Performance Measurement offers performance measurement training, including a fundamental’s course on performance measurement, a course on performance attribution, and two CIPM exam preparation courses.

About BrightScope

BrightScope is a financial information company that brings transparency to opaque markets through independent research and analysis. Delivered through web-based software, BrightScope data drives better decision-making for individual investors, corporate plan sponsors, asset managers, broker-dealers, and financial advisors. The BrightScope Rating™, developed in partnership with leading independent 401k fiduciaries, reviews more than 200 unique data inputs per plan and calculates a single numerical score which defines plan quality at the company level. In April 2011, the company launched BrightScope Advisor Pages™, the first comprehensive and publicly available directory of financial advisors designed to help consumers discover information and conduct due diligence on wealth management professionals. BrightScope also markets a suite of data analytics software products to Fortune 1000 companies, asset managers, broker-dealers, financial advisors, and other market participants. Public ratings for more than 46,000 retirement plans as well as rating definitions, criteria and methodologies, and information on more than 575,000 financial advisors and 45,000 advisory firms are available for free at www.brightscope.com.

Clothing & Beta: is there a connection?

The Spaulding Group held its Spring North American Performance Measurement Forum meeting earlier this month in Atlanta, and during the session I had a thought about how the subjects of beta and Jensen's alpha can be related to clothing (being one who is always on the lookout for metaphors and analogies, this seemed to be a good one to share).

Jensen's alpha, as you may recall, is a risk-adjusted measure, that can be viewed as excess return that takes beta into consideration. The typical way we view excess return is:

Jensen's alpha looks a bit like this expression, but with a twist:

First, we're dealing with equity risk premiums (portfolio return minus the risk free rate). But, basic knowledge of algebra would make it clear that if this was the only difference, it would match our excess return. What's really different is the use of beta. Jensen's alpha takes the portfolio's beta and applies it to the benchmark (or more precisely, the benchmark's equity risk premium), essentially saying that THIS is what the portfolio's return WOULD be (net the risk free rate), if beta captured everything for the portfolio; that is, if beta was a perfect predictor of portfolio return. But, Jensen's alpha is usually not zero, based on the portfolio's idiosyncrasies.

And so, where does clothing come in? Well, the benchmark could be looked upon as a school uniform, which everyone is required to wear. Assuming students are required to keep them clean and pressed, there would be no differences. However, if there was some leeway in terms of the shoes a student could wear, whether they could have their uniform custom made, if they could substitute fancy socks, or perhaps (as my friend Steve Campisi likes to do) include a pocket handkerchief, they would be different.

The military doesn't permit much in the way of variation. But, when I was on active duty (with the Field Artillery branch of the U.S. Army) we had the option of substituting "airborne boots" for our standard issue ones; they looked much sharper, and many of us did (even if we weren't airborne!). And, one could buy their "dress blues" off the rack, or get them custom made. And so, even here we had the ability for some degree of idiosyncratic adjustments.

This difference is like what we see with the result from Jensen's alpha. When one speaks of "portable alpha," THIS is the "alpha" they are speaking of: the part of excess return that is completely attributable to the idiosyncrasies of the portfolio, with no baggage from the benchmark.

By the way, you are probably also noticing that we use the term "alpha" here, but in the "Jensen's alpha" context. Whenever anyone simply says "alpha," you should ask "what alpha are you referring to?" This isn't an offensive question, but rather an insightful one, because it reflects your awareness that there are at least two versions of alpha: basic alpha, which is derived from excess return, and Jensen's alpha.

Talk about performance!

Our younger son, Douglas, who is the editor of The Journal of Performance Measurement, has done the Tough Mudder four times (most recently a week ago in the Poconos, PA). Well this morning he (kind of) did it a 5th time, on Fox & Friends. He was interviewed, too!

What IS a model fee under GIPS?

The 2010 edition of GIPS(R) (Global Investment Performance Standards) introduced the term "model fee," but without any clarification as to what the term means. Consequently, we get questions like the following, which was sent by a verification client to me yesterday:

"Our composite net returns are based on the highest tier of our fee schedule. Does that then fall under 'Model Fees'? If there is some guidance on this subject can you please give me a reference."

The client was referencing the following provision:

Since the alternative to "model" is "actual," one might conclude that model referencing anything but actual. And so, I responded to the client that "yes, what they do falls within the realm of a 'model fee.'"

If you have any insights or thoughts, please offer your comment below.

New Standard Forthcoming

We cannot say much about this, yet, but since it appeared on the CNBC website yesterday, I'll share the brief info they have.

Yes, The Spaulding Group and Brightscope have some great news which will be released next week.

More details to follow.

Modified Dietz or BAI, which to choose?

I got an email this week from someone who wanted to know the difference between Modified Dietz and Modified BAI. Briefly:

1. They are both approximations to the true, time-weighted rate of return
2. They are both based on the concept of linking money-weighted returns to derive a time-weighted return
3. They should yield equivalent results.

Modified BAI is actually, in my view, a misnomer, or perhaps more precisely, the use of an inappropriate qualifier; I will explain below.

The Bank Administration Institute (BAI) developed the first performance measurement standards in 1968. In that document they offered three methods to calculate time-weighted returns:

1. The exact method, which requires revaluing the portfolio for all cash flows. The BAI recognized that it was unlikely that this could be accomplished very easily at that time, and so offered the other methods as alternatives.
2. The linked IRR (internal rate of return) involves calculating returns for subperiods (ideally, no longer than a month) and geometrically linking these returns to obtain approximations to the TWRR.
3. The third involves an alternative approach to geometric linking: "The time-weighted rate of return is ... the average of the rates for [the] subperiods with each rate being given a weight proportionate to the length of time in its subperiod." Suffice it to say, this approach has died away, though we retain the term, "time-weighting" (in spite of the fact that we do not weight time).

What we think of today as the "Modified BAI" is actually BAI's Linked IRR. We are not modifying anything; it is just one of the three methods. And so, we link subperiod internal rates of return to obtain an approximation to the true TWRR.

An unlinked Modified Dietz (MD) is an approximation to the IRR. And so, by linking subperiod MD returns (as we do with linking the IRR), we obtain an approximation to the true TWRR.

Which is better? I don't think it matters. Linking Modified Dietz returns is easier than linking internal rates of return, since the IRR is an iterative formula while Modified Dietz is solved directly. The results should be identical, or at least very close. Is one "more correct"? Not in my view.

Hope this helps! Please add your thoughts and comments below.