Don’t confuse a bull market for brains

by Amy Parvaneh, 01/20/2015

“Don’t confuse a bull market for brains.” - Humphrey B. Neill
Because it’s easy to do so—especially when a general lack of transparency in the investment industry renders it difficult for investors to determine exactly from where their returns are coming.
Integrity and trust have always been key principles in the investment industry, but they’ve become even more poignant issues following the financial crisis as investor confidence largely gave way. Along the same line, the need for investment managers to apply consistent return calculations and provide accurate performance information has also become increasingly crucial.
Questions remain regarding the degree to which investment firms are making efforts to calculate their returns and publicly report their numbers. Certain legal regulations exist, but how widely and sincerely is self-reporting practiced and appreciated in the industry today?
Taylor Frigon Capital Management LLC tells of its commitment to being transparent with its investing strategy and performance results. The boutique wealth manager based in San Luis Obispo, Calif. serves private clients and institutions throughout the U.S. It claims compliance with the Global Investment Performance Standards and is independently verified by Ashland Partners & Co. for GIPS compliance reporting.
“We’ve been doing this compliance from the get go,” said President and Chief Investment Officer Gerry Frigon, who founded the firm in 2007 after more than 20 years of investment strategy, planning and management for private and institutional clients.
“GIPS reporting is a lot of extra work, it’s expensive, and we’ve gone back and forth at times about our decision to report and be verified,” he said. “But transparency is the point we want to drive home. We have taken the initiative to show our performance. We’re not going to run from our performance no matter what it is. We’ve been through some periods of really good outperformance and sometimes underperformance. But over time, if you have a disciplined strategy, we know that it will work.”
Frigon spoke of what he has observed during the three decades of his investment management experience.
“I grew up in a world over the last 30 years where, frankly, the typical investment adviser wants to run away from performance, not embrace it,” he said. “I think we knew that was a problem in the industry. But somehow, the industry has succeeded in pulling the wool over the eyes of the investor. You’re fighting a battle of firms that have gotten used to saying, ‘Performance doesn’t matter; all clients care about is service.’”
There is no official set of data to tell exactly how many investment firms pursue transparency at what levels. But the Global Investment Performance Standards, created by CFA Institute, is becoming more and more widely accepted as a universal language for presentation of investment performance.
“The GIPS standards represent an important part of our effort to restore public trust in our industry,” wrote Annie Lo, director of GIPS Asia Pacific at CFA Institute and Trevor Persaud, managing director for ASEAN and Taiwan at Russell Investments, in a 2013 issueof the CFA Institute Magazine.
“By choosing to comply with the Standards, investment management firms assure prospective clients that the historical ‘track record’ they report is both complete and fairly presented,” the article said. “GIPS compliance allows firms to expand their business territories and to participate in competitive bids against other compliant firms globally.”
Institutional investment data research firm eVestment recently published its 2014 study of the value of GIPS compliance. Analysis was based on survey responses of 101 participants and on the firm’s internal database of individual managers. The survey primarily included advisers managing institutional funds and likely does not represent the trend among advisers who oversee portfolios of individual investors.
Data showed that about 74% of the eVestment database population claims compliance with GIPS, and 82% of those that are in compliance receive verification of their reporting.
About 65% of consultants and investors exclude managers from consideration “some or all the time” if they do not claim compliance with GIPS.
Qualitative survey responses about GIPS included thoughts that compliance is “demanded by international markets,” and that the standards serve as “a scorecard” and “a tool” to evaluate managers. Some said that although the standards “aren’t perfect,” they do provide a certain guideline.
Frigon pointed to the general lack of understanding in the investment industry, even among portfolio managers, regarding their performance.

“The typical adviser has no idea why his or her portfolio has been performing OK,” he said. “If the average investor were to ask his or her manager, ‘What are the business reasons that this or that has happened in my portfolio?’ the manager doesn’t know. It’s possible that the manager is in such a broad index strategy that the performance is kind of accidental. Don’t confuse a bull market for brains.”

He added that there’s been a gradual but clear change in the investment industry over the past few decades.

“It used to be that a stock broker would actually get to know the companies first, and then they would go out to sell the stock to their clients,” he said. “That’s the traditional stockbroker. Some of the best money managers ever were the ‘old’ kind of stockbrokers. They understood how to analyze the company. But we’ve gotten so far from that. That art has been completely thrown out the window for the most part. The money manager types now are in mutual funds, and it’s become a quarter-to-quarter numbers game instead of understanding the companies within them.”

Frigon said Taylor Frigon as a firm hopes to see a shift in the lack of adviser knowledge and value.
“Our clients know that we are ridiculously transparent and that we adhere to a strict set of standards,” he said. “And we tell our clients that there may be periods where the performance might not make sense immediately. That’s because we’re not making our investment decisions based on the whims of the market. We’re doing so based on the businesses we’re buying and based on the things happening inside the businesses. Those things don’t necessarily happen in line with the market.”
“Overall, the issue becomes one of investor trust and manager integrity, and GIPS could be a useful tool to bring about a restoration of those principles in the investment industry,” Frigon said.
“I think being GIPS-compliant is like the cherry on top at this point,” he said. “Most advisers are not even reporting any kind of performance. They are dancing around it, and that’s what I think is shocking. That’s what I think needs to be exposed. Our clients are used to getting those performance reports. It’s standard for them.”
Jonathan Boersma, head of professional standards at CFA Institute, said that he thinks the “biggest challenge [that asset managers face today] is the lack of integrity in the industry that has led to investors’ lack of trust and a collapse in investor confidence.”

Even as the details of the GIPS standards have and will continue to evolve to fit the complex needs of the financial industry, the core objectives of the GIPS standards “remain unchanged [which is] to support fair competition and to promote comparability through consistent calculation and presentation of investment performance information,” he said. “The GIPS standards address some of [today’s challenges] because they are ethical standards that focus on fairness and improving transparency, which can help restore trust.”
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Investment Climate, January 2015

Here is our latest quarterly investment climate report: "An Energized West." Follow the link to access the full commentary, as well as links to previous investment climate commentaries.
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