Views on improving the integrity of global capital markets
20 April 2011

Weight a Minute!

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.

About the Author(s)
Jonathan Boersma, CFA

Jonathan Boersma, CFA, is the former head of Professional Standards and former executive director of the GIPS standards at CFA Institute. He was responsible for developing, maintaining, and promoting the GIPS standards, Code of Ethics and Standards of Professional Conduct, and other CFA Institute standards of practice.

3 thoughts on “Weight a Minute!”

  1. David Spaulding says:

    We should not lose sight of what a pension fund should be concerned with: not only the performance of their managers, but THEIR performance, too, and this can only be done using money-weighting. Unfortunately, I think that this response to my letter to P&I muddies the water a bit, and may confuse folks. To suggest that time-weighting is all that a pension fund needs to use is inappropriate, misleading, ill advised, and incorrect. It demonstrates a lack of appreciation for the value of money-weighting and its role in this part of our market.While GIPS might have some value for institutions such as pension funds, given that it was designed for sellers of asset management services, there is only so much that fits here. As I suggested in my blog today, a standard unique to these institutions would be preferred, I believe, over the GIPS standards.

  2. Jonathan Boersma, CFA says:

    Thank you, David, for your comments. Many pension plans, sovereign wealth funds, etc. comply or have expressed interest in complying with the GIPS standards. They do so not because they are interested in marketing their products, but because it is good governance and the boards of these institutions take comfort that the information being presented adheres to an ethical standard that is recognized around the world. The internal rate of return has its place, but one must be clear about the question they are trying to answer before assuming the measure, and the assumptions related to the measure (e.g., control of the cash flows) is correct. I look forward to hearing thoughts from others on this topic.

  3. David Spaulding says:

    I guess I don’t follow the “good governance,” as the information that is presented from a compliant presentation says what, exactly? If it’s time-weighted it doesn’t provide the board, trustees, shareholders, citizens, or anyone else any insights into what the fund did. And while I am pleased that you say that the IRR “has its place,” you fail to identify what that might be. You correctly reference the “question they are trying to answer,” thus my point about the question that compliance with GIPS answers. It fails to answer anything about how the FUND is doing; this should be the chief interest of the parties I referenced above. I, too, look forward to hearing thoughts from others. And, I would respectively inquire into what you believe the IRRs role might be in a pension fund, endowment, etc., or if you feel there is no place. But if you think there’s one, what is it?

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