Some things are hard to quantify, but investment returns are not one of them. Look at any mutual fund and you can quickly find its performance numbers telling you how the fund managers performed year-to-date, last year, last decade, and even longer.
So why is it that most investment managers and financial advisors don’t do something similar? According to Charles Rotblut of the American Association of Individual Investors, it may be something investors are simply not requesting.
“I have to think investors would want to know that, but I don’t know how many are actually asking for it,” he said.
Investment reporting is commonplace and expected in the corporate and institutional investment world. If you’re the person responsible for investing the assets of a large organization, you’ve got to do your homework. So financial advisors to these groups generally provide performance numbers—their institutional clients demand it.
But most financial advisors who work with individuals and families don’t commonly disclose this.
Don’t Be Afraid to Ask
When your money is at stake, you can’t just assume that the person you are considering hiring will do a great job with it. Instead, it’s best to see actual data on their track record. Verbal promises are not enough. Things said in a sales meeting may sound good at the time, but countless investors have been burned when the services delivered didn’t match the glowing sales pitch.
As an investor, you should always ask a prospective financial advisor, “Can I see your historical investment performance numbers?”
And you don’t want just any numbers, because as you are probably aware, there are ways to “fudge” the numbers by changing assumptions or cherry-picking good results.
So how can you trust the numbers?
Meet GIPS® Standards, an Investor’s Best Friend
GIPS® stands for Global Investment Performance Standards. GIPS® is a worldwide standard of reporting investment results created and maintained by the CFA Institute.
The CFA Institute is a global association of investment professionals. The organization is responsible for the testing and credentialing of investment professionals all over the world.
Those firms who comply with the CFA Institute’s Global Investment Performance standards agree to measure investment performance according to specific rules. Then they also agree to have their results reviewed by an independent third party to ensure they are complying.
With GIPS® standards, you get the transparency you need to compare and evaluate financial advisors.
In other words, this allows you to compare apples to apples.
Sadly, the vast majority of financial advisors don’t use these standards. In fact, only about 1,600 firms worldwide claim GIPS® compliance.*
Of these firms, most serve corporations and institutions, not individuals.
Out of the very biggest asset managers in the world, based on assets managed, 85% are GIPS-compliant, according to the CFA institute.*
Of course, some firms may provide their own version of performance numbers. These can easily be manipulated to look favorable by not including expenses, or by including certain periods and excluding others. Most of these practices are not allowed by the agencies that regulate advisors, but unfortunately, that doesn’t mean these techniques are never used.
If a firm doesn’t provide independently verified performance numbers (GIPS® standard), there is not enough information for you to assess their results. They may still be competent, of course, but may not be as committed to transparency as most investors may prefer.
Understanding GIPS® reporting
So now you’ve done your homework and are ready to compare advisors based on their GIPS® compliant results. Unless you’re a trained finance person, the numbers themselves may not mean much. How do you interpret them?
Look at the following:
- How do they perform relative to the entire market in rising markets?
- How do they perform relative to the entire market in falling markets?
- For best diversification, investment managers will usually need to invest internationally so the average you should compare to should be a global one (like the ACWI, the All Country World Index)
Don’t look at just a year or two. Evaluate their numbers for at least several years.
When it sounds too good to be true
On the other side of the coin, there’s another danger. The financial advisor who promises too much. Or who gets caught up in a bull market and forgoes discipline in the hopes of obtaining higher returns for his or her clients.
In the real world, certain rules are never broken. If you want to get higher returns on your money, you have to take higher risks. And if you take higher risks, you then have a greater chance of higher loss.
The best financial advisors help you set realistic expectations. We cannot expect to get high rates of return every year. There will be years when the market is down. During those times, you can expect to focus on preservation of capital, instead of focusing on high returns.
Beware of advisors who attempt to paint a rosier picture. There are some red flags to watch out for:
- Promising fixed or high returns every year (like Bernie Madoff, promising approx. 20% returns every year)
- Focusing on short-term performance
- Focusing on returns prior to subtracting out all fees and expenses
This is the value of GIPS-compliant results: these are based on standards created by the CFA board to ensure a broad, standard reporting that investors can rely on.
Be sure to focus on the advisor’s long-term performance, not just short-term. Shorter term, advisors can ride trends. Long term, they are forced to navigate changing markets, economic conditions, and trends.
Getting an accurate accounting of your advisor’s past investment performance shouldn’t be optional. If your advisor can’t or won’t supply it, perhaps it means they don’t monitor themselves closely enough, or they focus more on their bottom line than yours.
Until there’s a better way to measure, GIPS® is the best standard out there to allow you to make your decisions based on facts, not sales promises.
*As of Feb. 6, 2017, Source: the CFA Institute; https://blogs.cfainstitute.org/marketintegrity/2017/02/06/out-of-top-100-asset-management-firms-globally-85-claim-gips-compliance/.
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John Odell, CFP® is CEO of Arroyo Investment Group, LLC, a fee-only financial planning and investment management firm based in Pasadena, California. As a GIPS®-compliant firm, we bring institutional quality, high performance investment management and comprehensive financial planning to individuals and families. Together with Capital Research + Consulting, our sister firm, we collectively manage over $4 billion of assets for individuals and retirement plans. Visit us at www.arroyoinvestmentgroup.com.