Académique Documents
Professionnel Documents
Culture Documents
Table of Contents
Vol. 15, #2 - Winter 2010/2011
Letter from the Editor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 4
Letter from the Publisher . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Page 6
Beyond Brinson: Establishing the Link between Sector and Factor Models
Ben Davis, Ph.D., MSCI and
Jose Menchero, Ph.D., CFA, MSCI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 8
The sector-based Brinson model is widely used in the investment management community. In this paper, we show that the
Brinson model represents a special kind of factor model, which we term the Brinson-replicating factor model. We then
demonstrate how this factor model can be augmented with other factors, such as styles, to gain insight that would not be possible under the simple Brinson framework. We also discuss how to attribute risk to the same underlying set of decision variables.
Getting to the Heart of Investing - Financial Stewardship That Meets Client Objectives
Patrick Fowler, The Spaulding Group
and Stephen Campisi, CFA, Intuitive Performance Solutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page 21
The purpose of this article is to introduce (or perhaps to reintroduce) a philosophy and structure of performance and financial
stewardship that puts the interests of the clients funding goals at the forefront of investment decisions. As our performance
metrics become more complex and we dive down deeper and deeper into the accuracy of returns, the availability of data, and
the automation of numbers, it is important to take a step back and reflect on what it is we are trying to accomplish. Each of
us has a fiduciary duty of loyalty, prudence, and diligence which we owe to the clients who entrust their financial assets to
our care.
This article has been reprinted with the permission of The Journal of Performance Measurement.
Winter 2011. For more information on this publication or to become a subscriber, visit
www.SpauldingGrp.com or contact Christopher Spaulding at
(732)873-5700 or CSpaulding@SpauldingGrp.com.
With offices in the New York City and Los Angeles metropolitan areas, The Spaulding Group, Inc is the
leader in investment performance measurement products and services. TSG offers consulting services;
publishes The Journal of Performance Measurement, a quarterly publication we launched in 1996; and
hosts the Performance Measurement Forum. The firm also sponsors the annual Performance Measurement, Attribution and Risk (PMAR) conference and PMAR Europe which have come to be recognized
as the leading performance measurement conferences in the industry. TSGs Institute of Performance
Measurement offers performance measurement training, including a fundamentals course on performance
measurement, a course on performance attribution, and two CIPM exam preparation courses. Additional
details about TSGs services may be found on our website www.SpauldingGrp.com.
Getting to the Heart of Investing Financial Stewardship That Meets Client Objectives
It takes a strong man to stand up for himself, a stronger man to stand up for others.
Excerpt from the movie Barnyard
The purpose of this article is to introduce (or perhaps to reintroduce) a philosophy and structure of performance
and financial stewardship that puts the interests of the clients funding goals at the forefront of investment decisions.
As our performance metrics become more complex and we dive down deeper and deeper into the accuracy of returns, the availability of data, and the automation of numbers, it is important to take a step back and reflect on
what it is we are trying to accomplish. Each of us has a fiduciary duty of loyalty, prudence, and diligence which
we owe to the clients who entrust their financial assets to our care. This is true for both investment managers and
performance measurement staff. The focus of performance professionals has traditionally been on individual products and funds. We receive very little training in the total portfolio and relatively little training in methods to evaluate our success in meeting our clients financial goals. We are advocating that performance professionals develop
a broader perspective than just the individual products. This may not fall on one performance professionals shoulders but the collective team to be aware of the ultimate client goals.
Patrick Fowler
is the Chief Operating Officer for The Spaulding Group, where he has been for the past twelve years. Patrick oversees the firms research efforts, training programs and conferences, the Performance Measurement Forum, as well
as other operational areas. Mr. Fowler is also the Director of PerformanceJobs.com, a career resource for investment performance professionals, is Managing Editor of The Journal of Performance Measurement, and is a partner
with Edge Financial Group. Patrick received his Bachelors Degree in Communication from Cook College, Rutgers
University in 1998. He also completed the Rutgers Mini MBA Program for Business Essentials in 2004.
Stephen Campisi, CFA
is a practicing portfolio manager for endowments, foundations, and pension plans and serves as a consultant to
institutional portfolio managers in the areas of asset allocation, risk management, manager selection, and performance measurement. He is also Principal of Intuitive Performance Solutions, a consulting firm specializing in
performance analysis and investment education. He has over twenty-five years of investment experience including
eight years as a bond portfolio manager within the insurance industry. He spent fifteen years as Adjunct Professor
of Finance for the Graduate School of Business of Western New England College, and for more than the past
decade he has taught CFA Review classes for the Hartford CFA Society, for which he is a past president. He is a
frequent speaker at investment conferences and a current participant in the CFA Institutes Speaker Retainer Program, addressing CFA Societies throughout the United States. He is a member of the Advisory Board of The Journal
of Performance Measurement, which published several of his articles including Primer on Fixed Income Performance Attribution and Long Term Risk Adjusted Performance Attribution which won the Peter Dietz award.
He holds an MBA from the University of Connecticut and an MA in Music from Montclair State University.
INTRODUCTION
Performance professionals have been called the geeks
in the corner, back-office number crunchers, and
performance nerds. But the title we need to hold above
all others is fiduciary. This is a steward with responsi-
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landscape. Evaluate the pension funds overall liabilities, along with its funding and operational requirements. Begin with these amounts and then match them
with risk-free bonds (i.e., Treasury zeros). By defeasing
these liabilities you have successfully eliminated risk
from the portfolio, ensuring a return that meets this
funds objectives. We manage the assets to increase the
certainty of meeting the clients objectives; in this case,
to fund the pension liabilities. Now take the surpluses
and manage them actively, providing your portable
alpha2 (transfer of excess return above the objectives
(read liabilities)). The alpha portfolio is invested in
higher-returning equities, and the beta portfolio is invested in bonds which match the liabilities. The job of
the alpha portfolio is to beat liabilities and to grow a
surplus of money, not to beat a benchmark return. Returns dont matter in respect to a benchmark; the only
thing that matters is generating alpha in excess of the liabilities. As Ron explains: The person that wins the
game is not the person that beats the benchmark; you
can beat the benchmark and still lose the game because
you are not meeting your liabilities. For example, we
observed a manager investing in a typical 70% equity
and 30% bond portfolio for a pension plan. He outperformed his asset benchmark by 300 bps in 2008, losing
only 22% instead of 25 percent. However, the pension
liabilities declined by only 8% over that time period.
So, was the manager 300 bps ahead or 1,400 bps behind? In this case, managing to the benchmark rather
than to the clients goals (the liabilities) produced a 14%
funding deficit for the pension plans beneficiaries.
Managing to the wrong objectives is not stewardship,
and no one benefits.
PROOF IS IN THE PUDDING
Some recent research by SEI suggests that pension
funds are moving in this direction of Liability Driven
Investing (LDI.) Their November 2009 Quick Poll
shows that the percentage of pensions employing a Liability Driven Investing strategy has nearly tripled over
the past three years from 20% in 2007 to 54% in 2009.
The poll also revealed that 90% of respondents felt that
controlling year-to-year volatility of funded status is
the primary objective of LDI. Absolute return seems to
also be on the decline as the benchmark of choice, as
the poll stated that in 2007 absolute return was the
highest ranked benchmark by 28% of poll participants.
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$43.3 Million
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really give you the full picture here of the story of surplus (29%) versus a deficit (12%)? The story of a $14
million difference in portfolio values? The story of gaining 3% net of payments versus losing 30 percent? What
about the story of risks? Would it guide you as to where
you would want your money invested?
Charities and Public Foundations
As performance professionals, we have to know the right
questions to ask in order to give the client the information relevant to them. In almost every meeting, conference, or forum we have attended, someone has brought
up the issue of educating the client or something to the
fact that I put all these reports together and have to explain them each time to the client. In the argument for
time-weighted return vs. money-weighted returns it is
often claimed that it doesnt matter as it is too complicated to explain the difference to the client. Why is
this the case? Are we reporting the right information
based on the clients requirements? We know in the case
of endowments and charitable organizations that their
goals (liabilities/objectives) are to fund their operational
expenses or to spend 5% a year giving back to the communities in which they serve, while making enough to
keep up with inflation. The goal for these organizations
is not to beat a benchmark; it is to sustain their existence
(maintaining principal adjusted for inflation) and provide
a service in both good times and bad. In short, these organizations exist to spend money, and their performance metric should not be a return comparison to a
benchmark or peer group. Instead, it should be the assurance to their constituents that they continue to support
their mission, especially in down markets and poor
economies when the need is greatest. In Steve Campisis
presentation at PMAR VII on Goal Centered Performance Analysis, he commented:
What is wrong with the traditional approach is that it
has nothing to do with measuring our ability to meet the
clients goals of spending adequacy and principal
preservation. And, they are not considering the clients
view of risk, which is a shortfall of spending and losing
principal value. That is what risk means to your client
in real terms. Standard performance techniques are
measuring the wrong things. They are doing it with great
precision, I will give them that, but I think that answering
the wrong questions precisely is not accuracy; it is precise, but precisely wrong. In the end, people dont want
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Return
Before Inflation
After Inflation
Risk
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Return
Before Taxes
After Taxes
Risk
Return
Risk
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SUMMARY
As performance professionals, our presence in the financial organization has increased considerably over the
past two decades. The performance and investment function go hand-in-hand when telling a story to a client.
That story must show our clients how their investment
portfolio performed (did they or didnt they meet their
goals/liabilities/minimum funding requirements), where
they came from, and where they are headed. We cannot
continue to present misleading or confusing information
to clients. We must manage to their goals. As an industry,
we are marred by a damaging public relations black eye.
As an industry, as a community, as a country, and as a
global village, we owe it to ourselves to change the way
we manage money (invest to meet client goals), the way
we benchmark results (adapt custom liability indexes
and money based benchmarks), and the way we report
results (use money values and internal rate of return to
complement time-weighted returns). We need to incorporate a stewardship mindset that truly puts our client
first.
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