Call For Another Uniform Performance Standard Misses The Point: Returns Are Usually Not The Best Measure Of Success For Advisor Clients Hot

While the existing standard for advisors, Global Investment Performance Standards (GIPS), is used by institutions, one aspect of the new proposal standard that would be beneficial is its focus on individual investors rather than institutional clients. Specifically, the new proposal addresses ways for advisors to standardize reports to all their clients, which is different from  GIPS focus on creating a composite. 

While creating a composite is necessary, it would also be beneficial to standardize the methodology used by all advisors in providing reports to clients. Implementing a normalized method and calculation for advisors to use would definitely help avoid confusion and allow investors to compare “apples to apples.”

At AssetBook, when we convert legacy data from other portfolio management systems, we usually find a difference in the return calculations of the legacy system from AssetBook.  The reason is that the returns are calculated in mathematically different ways from one portfolio management software (PMS) to the next.

Over a 10-year period, the difference could be as much as one-percentage point or two! It’s not that any of the PMS vendors are doing anything underhanded. It’s just different mathematical formulas are used. A normalized method would certainly be beneficial to iron out those deviations.

But focusing on these details means losing the forest for the trees.

Creating a new performance standard will not clear up the confusion investors face in choosing investment advisors.  If historical performance information led people to make good investment choices, then studies would not show that the vast majority of investors underperform the mutual funds in which they invest. It’s a behavioral finance issue!

Mutual funds with the best returns often get there by taking more risk. They can be as volatile on the downside as they are on the upside. And when they are volatile on the downside, many of their investors sell and are not there for the day when they swing back up.

Focusing on returns for advisors is not the solution. Putting returns in proper perspective to keep investors in the game is what makes clients and advisors winners.

While performance reporting is what I do for living and I am passionate about making the numbers accurate, those returns numbers should not be the center of attention. It is not the best measure of success for advisor clients.