Investment advisers who manage money for pension funds, trust accounts, endowments and wealthy individuals often tell gentlemanly horror stories about their less-honest peers:
– Reporting extraordinary investment results for a 10-year period without mentioning that hypothetical figures were concocted for part of that period when managed accounts were dormant.
– Forming a fund to buy first-time issues of stock in a hot market for initial public offerings, then using the almost inevitably bullish short-term results of the IPO fund to represent overall investment skill.
– Improving historical investment performance figures by deleting the dismal results achieved for a client who had withdrawn his money;
alternatively, representing new-account dollars as investment returns.
– Promoting superior results in a bond portfolio, despite a disastrous year in the bond market, by including results from a money market fund used to park cash from a separate stock portfolio.
– Touting the investment acumen of a new money manager based on the results of his previous firm, even though he had played no role in that firm`s investment decisions; alternatively, deleting from historical results the poor performance of a manager who leaves.
Such abuses, only a handful of which are ever caught by the Securities and Exchange Commission, occur frequently in what San Francisco investment adviser Claude N. Rosenberg Jr. calls the ”inner sanctum” of an outwardly respectable profession: managing other people`s money. It`s a business that, according to one estimate, involves $7 trillion in the United States alone.
Studies show that track records of money managers are useless in predicting future performance; but whether a manager is able at least to keep up with his peers and with widely watched market indices is important.
This year, for the first time, an organization of investment advisers is urging all professional money managers voluntarily to adopt a reporting code to bring basic uniformity to investment performance reports and to explain clearly whenever reports deviate from the standard.
The organization is the 23,000-member Association of Investment Management and Research (AIMR), based in Charlottesville, Va., and formed in 1990 through a merger of the Institute of Chartered Financial Analysts and the Financial Analysts Federation. There are about 15,000 Chartered Financial Analysts (CFAs) here and abroad who have passed a three-part test and worked at least three years as professional investment managers.
The AIMR believes its new performance reporting standards, drafted by a committee headed by Rosenberg, will come to be recognized as a hallmark of integrity among investment advisers.
Not all money managers are pleased. AIMR officials have fielded complaints from small investment advisory firms who say the new standards favor big firms that can afford the costly computer resources to prepare ongoing reports and reconstruct historical data required by the standards.
That complaint rings hollow to advocates of the standards.
”I`m quite adamant in saying, `Look, this business has a cost of entry, and if someone isn`t willing to incur these costs, then we don`t want you in the business,` ” says Gary P. Brinson, head of Brinson Partners Inc. in Chicago.
Increasingly, the wealth of America is being placed in hands of pension and profit-sharing funds, mutual funds, insurance annuities, trust accounts, personal asset accounts, endowments and foundations. The fiduciaries and beneficiaries of these funds, in turn, have hired in-house or independent investment advisers to safeguard the money and, hopefully, earn a return commensurate with the investment risks they chose to take.
Money managers are supposed to register with the SEC, and they often tout themselves as being ”registered investment advisers,” although that designation may be obtained simply by filing an application and paying a one- time $150 fee.
Until now, there have been no generally accepted standards for reporting the batting averages of the almost 20,000 investment professionals in the United States, many of whom solicit aggressively for dollars to manage.
Regarding investment performance reporting, the SEC focuses its limited staff almost exclusively on investment performance advertising by widely marketed funds, such as listed mutual funds, sold to the public.
However, much more money is in the hands of trustees of pension funds and other non-public pools of money. They are deemed to be more sophisticated than the public in distinguishing honest investment advisers from charlatans. Also, they, unlike the investing public, often employ independent consultants who rank money managers according to investment performance and sell themselves as being able to pick top-quality investment advisers.
Yet misrepresentations, fraud and simple fudging of numbers continue to confound the most sophisticated attempts to compare one money manager`s performance with another`s.
”Whenever you get into a competition for some new business, there`s a tendency to find that all the competitors are in the top quartile (the top 25 percent of a performance ranking),” said Michael McCowin, a portfolio manager for Harris Investment Management Inc., a unit of Harris Bankcorp, and chairman of the Institute of Chartered Financial Analysts. ”They all find a way to pick the right starting point or ending point (for their past performance) or the right account so they look good,” he said.
Among the key elements of the AIMR performance reporting standards is an insistence that an adviser report the results of all dollars under management. Segregating results by type of account-such as stock funds, bond funds, small- company stock funds, taxable funds, nondiscretionary funds-is acceptable if the adviser makes clear what proportion of the total assets under management is represented by the particular fund cited.
Also, results should be calculated at least quarterly on a ”time-weighted” basis, which eliminates the impact of cash flows into and out of the accounts for reasons other than investment results. Investment results in a given asset class, such as a stock fund, must include the effects of leaving part of that fund in a so-called cash equivalent, such as a money market fund. Historical results should extend back at least 10 years, if possible, and include the growth in total funds under management. Success in managing small funds does not foretell success in managing large funds. Fees should be disclosed, although investment results for non-public funds need not be reported on an after-fee basis. Reporting performance volatility is encouraged, but not required.
”We`re trying to have a level playing field” so that individuals and institutions can better evaluate and compare investment adviser performance, said Rosenberg.
