A Challenge To Performance Standards

By Cyril Tuohy

InsuranceNewsNet

A pair of respected financial advisory consultancies has proposed new performance-reporting standards tailored to retail advisors, raising questions about the long-standing metrics used by the CFA Institute.

At issue is whether the CFA Institute’s Global Investment Performance Standards (GIPS) still serve the needs of retail investors who are in the market for a financial advisor, according to a white paper released by BrightScope and The Spaulding Group.

GIPS, a set of ethical principles, don’t do enough to disclose the performance of investment selections made by an advisor on behalf of investors, BrightScope and Spaulding contend, because the GIPS framework is based on the performance of discretionary accounts under the control of brokers and advisors.

GIPS is better suited to institutional asset managers who have full discretion over client assets and who primarily serve the needs of pension funds, endowments, foundations and other large institutions. In the retail and high-net worth sector, brokers and advisors often are responsible for non-discretionary accounts over which they have only partial control.

“Our belief still remains strong that every financial advisor will want to and should need to disclose the performance of their investment selections on behalf of clients,” said Mike Alfred, chief executive officer and co-founder of BrightScope, a provider of financial information and investment research.

BrightScope and Spaulding are seeking support for Universal Advisory Performance Standards (UAPS), their version of an “ethics manifesto” for prospective and current advisor clients. Advisors are welcome to download the white paper at www.uapstandards.org.

The two firms are welcoming comments from the advisor community through Oct. 18, and comments may be e-mailed to [email protected].

The new UAPS standard is better suited to retail financial advisors because they would be able to use representative and model portfolios, and hypothetical performance incorporating non-discretionary accounts to reveal performance to clients and prospects, the authors of the white paper maintain.

“UAPS provides ‘best practices’ for both client and prospect reporting of performance risk,” David Spaulding, founder and chief executive officer of The Spaulding Group, said in a statement.

But Jonathan A. Boersma, executive director of GIPS at the CFA Institute, said there was no need for a UAPS standard. GIPS standards, he said, already address nearly all the issues that UAPS seek to address.

For financial advisors and brokers to be using non-discretionary accounts — accounts over which they do not have complete control — isn’t representative of the advisor’s or the broker’s performance, so why include those accounts in the performance equation, he asked.

“My concern about that is, why would they be presenting that performance to anyone,” Boersma said in an interview with InsuranceNewsNet. “It's certainly not representing their skills and abilities, if clients have the discretion about what they want to do or how to decide [where to invest].”

A cursory search of the 75-page 2010 edition of GIPS reveals numerous procedures with regard to reporting discretionary and non-discretionary assets, and mixing discretionary and non-discretionary accounts is exactly what GIPS is designed to prevent so as to make broker and advisor performance transparent, he said.

GIPS, introduced in 1999, are “universal voluntary standards to be used by investment managers for qualifying and presenting investment performance that ensure fair representation, full disclosure and apples-to-apples comparisons,” according to a GIPS fact sheet.

But in an age when the responsibilities of financial advisors, registered investment advisors and broker-dealers often bleed into one another, achieving GIPS compliance has become impossible, BrightScope and Spaulding maintain.

The blurring of the lines as to what constitutes advice and how advisors can and should calculate and disclose performance “has made it difficult for brokers or those advisors who offer advisory accounts and brokerage accounts to effectively report performance,” the white paper states.

How is it that investors can easily compare the performance of mutual funds and insurance policies, for example, but when it comes to their financial advisor investors are “frequently unable” to evaluate the advisor’s performance before hiring them?

Fee-based brokerage accounts which are nearly identical to advisory accounts and the use of titles such as “investment advisor,” or “wealth manager” by brokers has made the distinction between the two even harder for consumers to understand, according to the white paper.

Many “independent” investment advisors are registered representatives of broker-dealers and agents of insurance companies, the white paper also notes. “So while they may at times don the ‘hat’ of an investment advisor and act as a fiduciary to a client, they may also don the broker ‘hat’ and offer the same client other financial products for a commission.”

These new realities of the brokerage and advisory marketplace show that the time has come for new performance standards, according to BrightScope and Spaulding.

Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. He can be reached at [email protected].

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Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. He can be reached at [email protected].