certificate in investment performance measurement · 2015-06-23 · present performance results in...

Certificate in Investment Performance Measurement

Protecting Investors in the Good TimesPhilip Lawton, PhD, CFA, CMA, CIPM

1 © CFA Institute 2009

Agenda

ll k d h f h• Two Bull Markets and their Aftermath

• Manager Selection

• Manager Monitoring• Manager Monitoring


The Elements of Performance Evaluation

• Measurement:Wh t th t’ f ?• What was the account’s performance?

• Attribution:• Why did the account produce the observed

performance?

• Appraisal:• Was the account’s performance due to skill or luck?• Was the account s performance due to skill or luck?

• Or fraud?

• Performance evaluation techniques:• Are not designed to detect fraud

• But they may raise timely questions


S&P 500 Total Return Index Levels

2500

3000

2000

1000

1500

500

0


The Bezzle

• The inventory of undiscovered embezzlement—the “bezzle” is also cyclicalbezzle —is also cyclical.

• “Just as the boom accelerated the rate of growth, so theJust as the boom accelerated the rate of growth, so the crash enormously advanced the rate of discovery.”—John Kenneth Galbraith, The Great Crash: 1929


Shrinking the Bezzle

250

300

2500

3000

200

250

2000

2500

Sta

tem

ents

Leve

l

215

1501500

and P

ublic

S

500 I

ndex

L

50

100

500

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SEC

New

s

S&

P

76

0

50

0

500

Jul 04 Jul 05 Jul 06 Jul 07 Jul 08 Jul 09


Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09

Shrinking the Bezzle

Economic Downturn Accelerates Collapse of Ponzi SchemesEconomic Downturn Accelerates Collapse of Ponzi Schemes

By Del Quentin WilberWashington Post Staff Writer gFriday, June 12, 2009

…The FBI, which is handling about 20 such cases in the Washington region, has almost 500 open Ponzi investigations nationwide—up from about 300 in 2006, bureau officials said.


Headliners

• 1994–2002:

• Enron

• WorldCom Issuers

• HealthSouth….

• 2003–2009:

• Madoff

• Stanford

ll

Advisors

• Donnelly….


Manager Selection

• Analysis of Historical Returns

• Transparency and Investment Philosophy

• Independent Confirmation

• Risk Factors and Controls


Monthly Returns

15.00%

S&P 500 USD‐LIBOR Manager

5.00%

10.00%

‐5.00%

0.00%

‐15.00%

‐10.00%

‐20.00%


Descriptive Statistics

Mean Monthly Return

StandardDeviation Skewness KurtosisReturn Deviation Skewness Kurtosis

Manager 0.84% 0.71% 0.79 0.51

S&P 500 0.77% 4.12% –0.77 1.86

USD‐LIBOR 0.35% 0.13% –0.50 –0.95


S&P 500 Distribution

-0.0718 0.0742

5.0%3.7%

90.0%89.4%

5.0%6.8%

14

S&P 500 Total Return

12

14

8

10

Input

N l

4

6Normal

0

2

5 2 5 1 5 0 5 1 5

12

-0.2

5

-0.2

-0.1

5

-0.1

-0.0

5 0

0.05 0.1

0.15

© CFA Institute 2009

Manager Distribution

-0.60 21.40

5.0%10.1%

90.0%86.5%

5.0%3.4%

70

Manager

50

60

30

40

50

Input

Normal

10

20

30 Normal

0

10

-10 -5

1E-1

4 5 10 15 20 25 30 35

13

1

Values in Thousandths


Value‐Added PerformanceAnnual Returns

18%

20%

Value‐Added Manager USD‐LIBOR

14%.

16%

18%

10%

12%

4%

6%

8%

0%

2%

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007


1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Value‐Added Performance

Manager’s Returns minus USD‐LIBOR

From the Beginning ofTo the End of 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

2007 6.26 5.94 5.68 5.55 5.52 5.49 5.40 5.22 5.04 4.70 4.80 4.59 4.17 3.70 3.28 3.05 1.982006 6.53 6.21 5.94 5.83 5.82 5.82 5.75 5.58 5.43 5.09 5.26 5.11 4.72 4.26 3.94 4.132005 6.69 6.35 6.08 5.97 5.97 5.98 5.93 5.76 5.61 5.25 5.48 5.34 4.91 4.33 3.752004 6 91 6 56 6 28 6 17 6 20 6 24 6 20 6 05 5 92 5 55 5 92 5 87 5 48 4 902004 6.91 6.56 6.28 6.17 6.20 6.24 6.20 6.05 5.92 5.55 5.92 5.87 5.48 4.902003 7.07 6.70 6.41 6.30 6.35 6.41 6.40 6.25 6.13 5.72 6.26 6.36 6.072002 7.16 6.76 6.45 6.33 6.39 6.46 6.45 6.29 6.15 5.60 6.36 6.662001 7.20 6.77 6.42 6.29 6.34 6.42 6.41 6.19 5.97 5.05 6.052000 7.32 6.85 6.47 6.32 6.39 6.50 6.50 6.23 5.93 4.031999 7.69 7.21 6.81 6.70 6.87 7.12 7.33 7.34 7.841998 7 67 7 12 6 64 6 48 6 62 6 87 7 07 6 841998 7.67 7.12 6.64 6.48 6.62 6.87 7.07 6.841997 7.79 7.16 6.61 6.39 6.55 6.89 7.301996 7.87 7.13 6.43 6.08 6.18 6.491995 8.14 7.29 6.41 5.88 5.871994 8.71 7.76 6.68 5.891993 9.66 8.70 7.471992 10.79 9.951991 11.65


Ex Post Risk Measures

Manager S&P 500 USD‐LIBOR

Semideviation(Monthly Basis) 0 44% 3 16% 0 11%(Monthly Basis) 0.44% 3.16% 0.11%

AnnualizedTracking Error — 14.14% 2.39%

AnnualizedAnnualized Information Ratio — 0.06 1.99


Textbook Quality Control Chart (1)80% Confidence Interval80% Confidence Interval

Source: Jeffery V. Bailey, Thomas M. Richards, and David E. Tierney, “Evaluating Portfolio Performance,” Ch 1 i hili d dd k ki d f l i


Chapter 1 in Philip Lawton and Todd Jankowski, eds., Investment Performance Measurement: Evaluating and Presenting Results (CFA Institute, 2009).

Textbook Quality Control Chart (2)80% Confidence Interval80% Confidence Interval

Source: Bailey, Richards, and Tierney, “Evaluating Portfolio Performance” (CFA Institute, 2009)


Actual Quality Control Chart99% Confidence Interval99% Confidence Interval

15%

Manager Annual Excess Return Manager Cum. Annualized Excess Return

Upper Edge of Confidence Band Lower Edge of Confidence Band

10%

15%

eturn

5%

ualized

Excess Re

‐5%

0%

Cumulative An

n

‐10%

5 10 15December 1990—October 2008


Transparency

The Asset Manager Code of Conduct (2nd ed., 2009)

F. Disclosures

Managers must…

4. Disclose the following:c. The investment process, including information regarding lock‐up

periods strategies risk factors and use of derivatives and leverageperiods, strategies, risk factors, and use of derivatives and leverage.


Transparency

CFA Institute Standards of Professional Conduct

B. Communication with Clients and Prospective Clients.

Members and Candidates must…Members and Candidates must…

1. Disclose to clients and prospective clients the basic format and general principles of the investment processes used to analyze investments,principles of the investment processes used to analyze investments, select securities, and construct portfolios and must promptly disclose any changes that might materially affect those processes.


Transparency

“H i h i d ?”“How is the gain made?”

“To tell that would ruin me. That known, everyone would be going into h b i d i ld b d A ll I h dthe business, and it would be overdone. A secret, a mystery—all I have to do with you is to receive your confidence, and all you have to do with me is, in due time, to receive it back, thrice paid in trebling profits.”

Herman Melville, The Confidence‐Man: His Masquerade (1857)


An Investment Philosophy

A f b li f di h i i i h i d h i i• A set of beliefs regarding the security pricing mechanism and what it is about that mechanism that sometimes causes securities to be mispriced.

• A set of beliefs regarding the manager’s competitive advantage in• A set of beliefs regarding the manager s competitive advantage in exploiting these mispricings.

• A thesis about how these beliefs can be exploited to generate alpha (anA thesis about how these beliefs can be exploited to generate alpha (an “alpha thesis”).

Source: John R. Minahan, “The Role of Investment Philosophy in Evaluating Investment Managers: A Consultant’s Perspective on Distinguishing Alpha from Noise,” The Journal of Investing, Summer 2006, pp. 6–11.


The Investment Philosophy Test• What is the thesis (or theses) of how the product generates alpha?

• What is the conceptual basis of the alpha thesis?

• What is the manager’s view about the security pricing mechanism that underlies the thesis?

• What is the relationship of this view to capital market theory?

• What is the manager’s competitive advantage in executing the thesis?

• What is the evidence that alpha has been generated by successful execution of the alpha thesis and not a mismatched benchmark or luck? Ifexecution of the alpha thesis and not a mismatched benchmark or luck? If evidence is lacking, how does the manager convince him‐ or herself that the thesis is sound?

• How does the manager think about the possible need for the alpha thesis g p pto change over time?

Source: John R. Minahan, “The Role of Investment Philosophy in Evaluating Investment Managers: A , p y g gConsultant’s Perspective on Distinguishing Alpha from Noise,” The Journal of Investing, Summer 2006, pp. 6–11.


Passing the Investment Philosophy Test

“The investment philosophy test is not easy for a manager that doesn’t haveThe investment philosophy test is not easy for a manager that doesn t have answers. Even if a marketer were very creative in reverse engineering a story that seemed to answer the questions, it would be very unlikely for such a story to hold up under cross examination, especially if the evaluator cross‐references the story with analysis of the manager’s holdings.”

Source: John R. Minahan, “The Role of Investment Philosophy in Evaluating Investment Managers: A , p y g gConsultant’s Perspective on Distinguishing Alpha from Noise,” The Journal of Investing, Summer 2006, pp. 10.


Independent Confirmation


D Risk Management Compliance and SupportD. Risk Management, Compliance, and Support

Managers must…

3. Ensure that portfolio information provided to clients by the Manager is accurate and complete and arrange for independent third‐party confirmation or review of such information….p y



P bli A• Public Accountant

• Custodian

• Global Investment Performance Standards (GIPS®) Verifier



• GIPS Verification Tests:• Whether the firm has complied with all the composite construction

requirements of the GIPS standards on a firm‐wide basis, and

• Whether the firm’s processes and procedures are designed to calculate and present performance results in compliance with the GIPS standards.

• Verification does not guarantee that investment results are presented fairly, accurately, and completely.

• A Performance Examination of a specific composite performance presentation, conducted by a reputable verifier, gives prospective investors somewhat greater assurance about the reported returns.


Risk Factors and Controls


D. Risk Management, Compliance, and Support

Managers must…

6. Establish a business‐continuity plan to address disaster recovery or periodic disruptions of the financial markets.

7. Establish a firmwide risk management process that identifies, measures, and manages the risk position of the Manager and its investments, including the sources, nature, and degree of , g , , grisk exposure.


Monitoring and Review Process

YES

30

Source: Bailey, Richards, and Tierney, “Evaluating Portfolio Performance” (CFA Institute, 2009)


Performance Monitoring Case

Discriminant Asset Management manages an equity portfolio for a high‐net‐worth client. The portfolio is p g pbenchmarked 90% to a broad capital market index and 10% to cash. Discriminant uses equity futures contracts to adjust the portfolio’s overall market exposure inadjust the portfolio s overall market exposure in accordance with the firm’s near‐term asset class forecast. In the month of July 2009, the portfolio outperformed its b h k b 6 b i ibenchmark by 67 basis points:

Return

f lPortfolio 7.07%

Benchmark 6.40%

Value‐Added 0.67%


Equity Portfolio Characteristics Analysis

Physical Asset Class Portfolio Benchmark

Average Market Capitalization (Millions) 9,473.5 19,348.9

P/E Ratio* 22.3 31.4

P/B Ratio 1.1 1.8

Dividend Yield 4 17 3 42Dividend Yield 4.17 3.42

*Excludes negative earnings


Attribution AnalysisDiscriminant Asset Management—Month of July 2009

Portfolio Weight

%

Portfolio Return

%

Benchmark Weight

%

Benchmark Return

%Allocation Effect

Selection Effect% % % % Effect Effect

Physical Portfolio:Energy 9.72 3.48 11.29 4.55 0.03 ‐0.10Materials 3.35 14.08 3.31 13.10 0.00 0.03Industrials 8.14 10.78 9.06 9.43 ‐0.03 0.11Consumer Discretionary 14.42 6.29 8.39 9.85 0.21 ‐0.51Consumer Staples 15.43 7.81 9.77 5.78 ‐0.04 0.31Health Care 8.29 6.63 12.59 6.24 0.01 0.03Financials 10.02 9.47 11.89 7.82 ‐0.03 0.17Information Technology 18 42 11 24 17 42 7 14 0 01 0 76Information Technology 18.42 11.24 17.42 7.14 0.01 0.76Telecommunications 2.88 4.50 2.93 3.57 0.00 0.03Utilities 1.43 3.10 3.36 4.12 0.04 ‐0.01Total Stocks 92.11 8.19 90.00 7.11 0.21 0.80Cash 7.90 0.10 10.00 0.10 0.13 0.00Total Physical Portfolio 100.00 7.55 100.00 6.40 0.34 0.80Equity Futures Impact ‐5.92 8.19 0.00 7.11 ‐0.04 ‐0.06Cash Futures Impact 5.92 0.10 0.00 0.10 ‐0.37 0.00Total Portfolio 100.00 7.07 100.00 6.40 ‐0.07 0.74


*Totals may not add due to rounding.

Things to Watch

• Investment Policy Violations• Investment Policy Violations

• Organizational Changes

• Regulatory Actions

• Reconciliations

• Custodial Statements and Manager’s Holdings

• Returns Calculated by Manager and by Custodian or Consultant

• Portfolio Return vs. GIPS Composite Performance


Resources

• CFA Institute Centre Publications:

Asset Manager Code of Conduct, 2nd ed.g ,

CFA Institute Code of Ethics and Standards of Professional Conduct

Model Requests for Proposal: Templates for Small Institutional Investors—Equity; Fixed Income; Real EstateInvestors Equity; Fixed Income; Real Estate

U.S. Financial Regulatory Reform: The Investors’ Perspective; A Report by the Investors’ Working Group, An Independent Taskforce Sponsored by CFA Institute Centre for Financial Market Integrity and Council ofby CFA Institute Centre for Financial Market Integrity and Council of Institutional Investors (July 2009)

• “CFA Institute Offers 10 Tips on Avoiding Investment Fraud,” 21 January 2009 (press release)2009 (press release)

• Global Investment Performance Standards (GIPS®): Please visit www.gipsstandards.org


Certificate in Investment Performance Measurement

Learn about the CIPM® study and exam program at www.cfainstitute.org/cipm

Philip Lawton, PhD, CFA, CMA, CIPMHead, CIPM ProgramE il hili l t @ f i tit t


E‐mail: [email protected]

certificate in investment performance measurement · 2015-06-23 · present performance results in...

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