We were pleased to have the chance to respond to a recent letter in Pensions & Investments suggesting that pension plan sponsors should calculate their plan-level performance using internal rates of return. The thinking was that, whereas individual money managers’ performance shouldn’t be penalized or rewarded for timing of cash flows that was beyond their control, plan sponsors could take a larger view of things. So, if Manager A has money taken away from her to fund benefit payments on the third day of the new month, less money is exposed to that month’s bull market through no fault of her own, and the performance calculation methodology (“time-weighting”) should neutralize that effect.
Our point was that pension plan sponsors are also subject to cash flows that are beyond their control; for example: allocations of funding from legislatures or corporate treasury staff that occur on less than precise timetables. When it comes time to assess the effectiveness of management of the pension plan, why penalize (or reward) plan managers for these accidents of timing by using internal rates of return? Time-weighting makes as much sense at the plan level as it does for individual managers. Of course, internal rates of return are the measure of choice for assets for which pricing is hard to come by (private equity and some real estate, for example).
Beyond the technical issue at hand is the observation that the GIPS standards increasingly aren’t just useful for standardized fair presentations of performance for prospective clients. Existing clients, pooled funds, and plan sponsors may all find benefit to applying the performance measurement principles created and refined over the years by practitioners. Everyone’s performance gets measured, and the temptation is to present it in the best light possible. The GIPS standards are the industry standard that heads off confusion — no matter the underlying asset class. New guidance just issued for comment addresses applying the GIPS standards to hedge funds and other alternative assets.
It isn’t all that often that issues like performance measurement get much play in the industry press, so we’re glad that P&I recognized the value of the issue. Interest among practitioners remains high as well, judging by the attendance at our GIPS standards conferences and the devotion of time and effort by the many volunteers who work to ensure the standards remain current and relevant for the investment performance industry. It’s not surprising that raising industry standards of practice to a common, comparable level is a priority in an environment in which investors have put a premium on trust.