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The Investor’s Guide to GIPS® Standards

Global Investment Performance Standards:  What Do You Need to Know?

If you have money with a financial advisor or wealth manager, you need to know how well it is managed.  GIPS® standards for investors can help.  Learn how the Global Investment Performance Standards (GIPS®) by the nonprofit CFA Institute can help you take the mystery out of overseeing your investments.

 

Why Do You Need Global Investment Performance Standards?

When you hire someone as a financial advisor to help manage your money, how much do you really know about their investing prowess?

  • What type of returns do they generate for their clients?
  • Are they able to effectively protect and grow wealth?
  • How well have they navigated difficult markets in the past?

It sounds elementary, but according to a Wall Street Journal article entitled “Financial Advisors, Show Us Your Numbers,” many financial advisors simply don’t disclose their investment results. Or they talk about it verbally but offer no written record. So sadly, most investors are forced to trust this important role to someone they can’t properly evaluate.

Bull markets confuse the issue further. There’s an old market adage that “everyone’s a genius in a bull market.” During long-rising markets, it’s easy for financial advisors to point to strong returns and take credit. However, in most cases, these broad bull markets make almost everyone, professional or everyday investor, look smart.

Fortunately, there is a tool that can help you quickly evaluate and compare financial advisors.  It’s called the Global Investment Performance Standards, or GIPS® standards for short.

“Trust, but verify.”

— Russian proverb

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Why Evaluate Your Financial Advisor’s Investment Performance?

Some things in life are difficult to quantify, but investment returns are not one of them. Just type in the name of any mutual fund or ETF online.  You can quickly find information on how well the fund managers did this year, last year, last decade, and even longer.

So why is it that most financial advisors don’t provide similar reporting?  Aren’t clients demanding it?

It’s not even on their radar, according to Charles Rotblut, Vice President at AAII (the American Association of Individual Investors).

“I have to think investors would want to know that, but I don’t know how many are actually asking for it,” he said.

That’s very different from the institutional world.  When any institution, such as a corporation, pension fund or nonprofit entity, gets investment help, reporting is expected and commonplace. If you’re the Chief Financial Officer responsible for the assets of a large organization, you simply have no choice but to be thorough.  So these clients demand accountability in the form of performance reports prepared in an industry-standard manner.  And the financial advisors to these entities generally must provide this information to stay competitive.

But that’s not what you find with the retail side of the wealth management industry.  Financial advisors who serve individual investors don’t commonly disclose this information.

When your retirement savings is at stake, you have to get past the awkwardness and ask. And get it in writing, too. Promises made in an initial meeting may sound good at the time, but what happens when the actual services delivered don’t match the glowing sales pitch?

That’s why you need to demand more.  Instead of just assuming, it’s wise to ask, “Can I see your GIPS® compliant investment results?”

And you don’t want just any numbers, because, as you are probably aware, there are many ways to “fudge” measurements.

So how can you trust the numbers?

 

What are the Global Investment Performance Standards (GIPS®)?

The Global Investment Performance Standards, or GIPS® standard, is a worldwide format for reporting investment results created and maintained by the nonprofit CFA Institute.

Those firms who voluntarily comply agree to:

  • Measure their investment performance results in a very specific way
  • Have those results verified by an independent third party firm to ensure compliance to the standards

What does this mean to you?

GIPS® standards give you the transparency you need to evaluate and compare investment managers.

Sadly, the vast majority of investment and financial advisory firms don’t use these standards. According to the CFA Institute, only about 1,700 firms worldwide claim GIPS® compliance.[i]

Or, some firms may provide their own version of performance reports. These can easily be manipulated to look more favorable than they really are.  This can be done by excluding expenses or by cherry-picking certain periods and not including others. Most of these practices are prohibited by regulators, but unfortunately, that doesn’t mean these techniques are never used.

Bottom line? If a firm doesn’t provide performance reports that comply with GIPS® standards, there is not enough information for an investor to adequately assess their performance. They may still be competent, of course, but may not be as committed to transparency as you may prefer.

 

The Issue of Financial Advisor Transparency

It would seem highly counterproductive for a firm serious about serving individuals not to provide these numbers. Regardless, the vast majority of firms that serve individuals still do not provide industry-standard investment reporting. i

Investing is not easy. Emotions or bad decisions can trip up investors, and even professionals are not immune to mistakes. Fortunately, in today’s world, some investing is handled by computer models. But still, things need to be executed properly using disciplined systems.

Those who don’t publish GIPS® compliant results may be good investors, but the problem is you can’t properly evaluate their records.

Bottom line if you are going to trust your money to someone, make sure they are good at their job. Just like with selecting a surgeon, skill and experience matter. Until there’s a better way to measure, GIPS® standards are the best standard out there to help you make informed decisions.

“Many pros who assemble fund portfolios for clients don’t offer performance numbers. Potential clients should ask.”

— Jaime Levy Pessin

(Source:  Wall Street Journal: Advisers’ Little Secret: Their Past Results) [ii]

 

Is your Financial Advisor an Experienced Investor or a “Relationship Manager”?

Many times, it’s not even a matter of whether your financial advisor is a good investor. Because at many firms, especially the larger brand-name Wall Street firms, they may not even handle the investing.

Instead of you working with the people who manage your money, you may work with a ‘relationship manager.’ Then the actual management of your money may be outsourced to other firms or handled in different departments.

What’s the problem with this?

  • Those who manage your money may never talk directly to you to learn about your needs, goals, ability to take risk, and preferences.
  • Your financial advisor at these firms probably does not talk to the people managing your money, either.
  • This can be very good for the investment firm, as they can save money and outsource this specialized expertise, but it’s not usually good for you since you don’t get personalized risk management

Instead, you’re likely pooled in with others with generally the same needs as you. That’s, unfortunately, not very precise.

 

What Should You Look for in a Financial Advisor?

Will this model work for some? Yes, it certainly can, especially for younger investors who have decades to recover.  However, many may be disappointed with the results they get from firms who handle their investments that way.

As many people found in previous bear markets, a lot of investment managers had people taking far too much risk. If they had been meeting with investors consistently and having the honest conversations needed to find out their real capacity to accept losses, they probably would not have invested as aggressively.

Yes, that may mean that you don’t capture the sky-high returns since you usually have to give up a portion of the upside to protect from the big losses. But as many found out after big bear markets, it’s what you keep that is most important.

This is where being able to factually evaluate the investment manager is vital. Ask to see their GIPS®-compliant investment returns, and ask these questions:

  • Who will make the day-to-day investment decisions on my accounts?
  • What is your investment philosophy?
  • How will you manage risk for me?

Then, don’t look at just a year or two of performance.  Evaluate their numbers for multiple years to make sure their results are reasonably consistent through various market cycles and economic conditions.

 

Always Look for a Long-Term Performance Record

What if a financial advisor hasn’t been in the market for very long?  While that might be fine for younger investors with less to lose, you probably don’t want to be part of anyone’s learning curve.

That’s why it is wise to make sure your financial advisor has invested successfully through bull markets, bear markets, and all kinds of economic and geopolitical environments.

Your future is too important. Take care to make sure you are hiring someone who has the knowledge and experience to keep your money safe.

 

Beware of Unrealistic Promises

Conversely, there’s another danger:  the financial advisor who overpromises, or promises something that should be impossible. Or who gets caught up in a bull market frenzy and swings for the fences with your money.

When it comes to the financial world, some dynamics cannot be avoided. If you want to seek outsize returns on your money, you have to take more risk. And if you take more risk, you then have a greater chance of bigger losses.

A quality advisor will work with you to set realistic goals and expectations. It is not reasonable to expect to generate high rates of return every year. There will be years when the market is down. During those times, you can expect to focus on the preservation of capital instead of striving for returns.

Bottom line…beware of advisors who attempt to paint a rosier picture of what’s possible with your money.

This, again, is the value of GIPS® standards.  These standards were created by the nonprofit CFA board to help provide objective reporting.  Use of these practices helps ensure a broad, standard reporting approach that investors can rely on.

Just be sure to focus your attention on the advisor’s long-term performance, not just results over any short-term period. Short term, advisors can ride trends. Long term, their systems and discipline are put to the test.  They are forced to navigate changing market conditions and make adjustments.

Regardless, getting an accounting of your financial advisor’s investment performance shouldn’t be optional. If your advisor doesn’t supply it, perhaps it indicates they don’t monitor their own performance closely enough.  Or it may mean they tend to focus more on their bottom line than yours.

 

Always Insist on a Financial Advisor Who Acts as Your Fiduciary

A fiduciary relationship is one where a professional is required to put your interests before their own at all times. Believe it or not, not all people who give financial advice are required to act as your fiduciary.

Financial advisors that are “Registered Investment Advisors” or “Investment Advisor Representatives” are fiduciaries. This means they are held to the highest ethical standard in the financial service industry. They must put your financial interests (strive to achieve your goals) ahead of their own (to make money from the relationship).

Other advisors, such as those who hold Series 6 and Series 7 licenses are not fiduciaries. They are held to a lower ethical standard that is called suitability. So Series 6 and 7 licensed advisors simply have to recommend something suitable for you… even if what they are recommending is a more expensive mutual fund that pays them a bigger commission.

The best thing to do is ask any financial advisor you’re working with or considering working with to acknowledge that they will act as your fiduciary at all times.  And ask them to put it in writing.

 

What are the Best Credentials for a Financial Advisor?

As we’ve discussed earlier, results over a long span of time are what is most important.  You want to see that the individuals and firms charged with managing your life savings know how to preserve and grow wealth. Not just over a year or two.  You want cumulative experience that spans long periods of time.

Investing, however, is just one piece of the puzzle to achieving your financial goals and future lifestyle. In addition, you want those helping you to have expertise in financial planning.

Look for the CFP® designation, which stands for CERTIFIED FINANCIAL PLANNER™.  This is a credential with many requirements, including years of experience, completing an extensive course of study, and passing a rigorous exam.  In addition, they must keep current with continuing education and agree to uphold ethical requirements.

Other credentials of value can be a CPA, who can help on the tax side, as well as the CFA, a Certified Financial Analyst. These are all extensive programs that are difficult to pass.

Be warned, however, that there are many “junk” credentials out there as well. Some are simply offered for a fee and have minimal requirements.  A financial advisor may only need to attend a few webinars and pass a simple multiple-choice exam, for example, to obtain a certain credential. So don’t just assume a bunch of letters after someone’s name is meaningful. If in doubt, look it up and see if it’s known to be a real credential or if someone can just pay money to get the right to use that title.

You can look up a professional certification using this online tool from FINRA.

 

Ask What Custodian Will Safeguard Your Money

When you hire a financial advisor, you don’t give them your money. Instead, your money is handled by a “custodian.” The custodian is usually a large organization with a brand name that you’ve likely heard of. The custodian firm uses bank-level security and is in the business of managing billions or trillions of dollars of assets.

The custodian is then legally responsible for holding your investments and keeping them safe. Custodians also collect all your dividends and interest accrued on your investments and provide reporting to you on the status.

Having a financial advisor who does not have custody of your assets gives you an extra layer of accountability and oversight. You will receive a set of statements both from your advisor and from the custodian, allowing you to double-check what your advisor is telling you. Being defrauded is much less likely when you are receiving independent statements.

The custodian also prices your investments, ensuring that everything is really worth what your advisor says it is. When advisors provide their own valuations, they might use the opportunity to manipulate client investments.

So always ask a financial advisor you’re thinking of working with, “What custodian do you use?”

What you want to hear: A large name-brand custodian that has been in business for many years. Some of these are TD Ameritrade, Schwab, and Fidelity. If you’re working with a brand name advisor, however, they may have their own in-house custodian firm—for example, LPL or Wells Fargo. Regardless, the custodian should be a name brand you’ve heard of or one you can easily confirm online.

 

Your Next Steps

By now, you probably see that there’s more to getting the right financial advice than just hiring your friend’s advisor. Unfortunately, most people don’t know what to ask and simply hire someone they like or someone their friend or family recommends. Given the potential impact on your future, you can’t afford to take shortcuts.

So please refer to this Guide when you research and interview advisors to make sure you only consider those who are fully transparent with investment results and meet all of these other basic requirements.

One last tip: Once you hire someone, don’t just assume you can now put it on autopilot. Instead:

  • Stay Involved
  • Always review your statements.
  • Ask a lot of questions.
  • Fully involve your spouse or partner.

Are your investments aligned with your goals?

Wondering if you are properly invested to achieve your goals? We offer a confidential, no-pressure, Second Opinion on your investments.

Request a Free Second Opinion

 

At Arroyo Investment Group, we offer GIPS® compliant investing and financial planning for individuals.  View our GIPS® compliant investment results.

 

[i] https://www.gipsstandards.org/

[ii] https://www.wsj.com/articles/SB10001424052702304259304576375861063201854

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