There's Safety In Them Thar Gold Standards
By: J. Michael Lowry
The new gold standard for the ethical presentation of investment performance is the Global Investment Performance Standards, commonly known by its acronym GIPS. North American investment management firms, prior to 2006, were guided by its predecessor, the Association for Investment Management and Research – Performance Presentation Standards, or AIMR-PPS. Over the past few years, it has converged, along with other country versions of GIPS, into the newer, more inclusive, Global Investment Performance Standards. As of January 1, 2006, GIPS became the single global ‘gold’ standard.
The call for global standards was triggered by:
- Globalization of markets and industries
- Growing demand for a single standard for full disclosure and fair representation of a manager’s performance track record (one solution for the industry)
- Buttressing investor confidence Like the move to build free trade agreements or adopt international accounting standards, the benefits of GIPS could be enormous for all interested parties.
And a growing number of investment management firms have decided to ‘get on board’ and adopt these voluntary standards as a best practice. Many of my clients have told me that the GIPS standards are becoming a business imperative for managers providing services to the institutional market in Canada.
Who Do These Standards Benefit And How?
Obviously, lots of red tape is avoided when investors, investment managers, and the search firms all recognize and play by one set of rules. We know what it’s like having securities commissions in every province, all with different rules and forms versus a single national securities regulator.
Secondly, a single set of standards, if widely adopted, would help weed out the ‘bad actors’ in the investment industry, they include:
- Cherry-picking: A practice where a manager markets the performance of his best performing accounts and says it is representative of how everyone has done.
- Selective Time Periods: This includes presenting only periods where the manager has outperformed, and not being forthcoming about periods where the manager has underperformed.
- Survivorship Bias: This is where the investment manager simply drops records for terminated accounts (which are often those with poor performance) so what’s left are records that include only accounts where the manager has done well.
- Comparability to Benchmark: This involves an investment manager purposefully selecting a benchmark of the index that they compare favourably to and not necessarily an appropriate one. You may be wondering, why should I care?
Doesn’t every manager have the right to put their best foot forward? After all, we know that investors are motivated by two basic emotions – fear and greed. For investment managers, we can add temptation and envy to this list.
Predictably, investors flock to ‘miracle investment securities.’ The temptation to exaggerate and cut corners on a full, fair investment performance presentation is enormous. Publishing an exceptional performance record in the national newspapers will certainly get the phone ringing and investors interested. Managers see that this advertising apparently works and envy the firm that successfully gathers assets using them. But can they believe it’s an honest, representative performance record?
Without safeguards to protect investors from the shenanigans of those investment managers who play fast and loose with the rules, investors are sitting ducks. They are susceptible to glib promises, vague explanations, and apparent extraordinary performance claims.
Without clear standards to guide managers and the recognition by all sides in the industry that these are achievable best practices, the temptation will remain. And so we shall continue to read about the occasional ‘bad actors’ getting caught for presenting false and misleading investment performance information in their marketing materials. Last year’s OSC sweep of investment counsel/portfolio management firms, as usual, cited all kinds of serious deficiencies in this area.
Regulators south of the border take a stronger view on fraud and misrepresentation. Investment management firms and their agents risk serious peril if they make misleading claims and misrepresentations in print or on their website. Recent high profile prosecutions in the U.S. have been a timely reminder that the Securities Exchange Commission has teeth as do the state attorneys.
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