Comparing Performances Will Be Easier Soon
The era of monkey business may be drawing to a close in the money-management business.
New standards that take effect Jan. 1 will likely lead to greater uniformity in the way performance is calculated and presented on privately run investment accounts.
Money managers can now tout their results using different methods, which makes comparisons difficult. Ultimately, the new guidelines might help answer the question of whether private accounts are really any better than mutual funds.
Stockbrokers and financial planners who steer wealthier clients into “wrap-fee” arrangements and other individual accounts argue that this is the way to go for people with the minimum $100,000 or more needed to get such personal financial attention.
But any arguments flaunting the superiority of private management over mutual funds couldn’t be proved.
That’s because private money managers haven’t had to calculate or portray their investment results according to any industrywide standards, as mutual funds have had to do for decades.
“All money managers seem to have great numbers,” says Daniel R. Bott, a vice president for Shearson Lehman Bros. in Scottsdale, Ariz.
The new standards will pressure managers to compute their returns according to a common methodology, and they will have to make certain disclosures to prospective clients.
There’s no law forcing adherence to the new standards, but there is pressure. At investment firms that don’t comply, money managers who have earned the chartered financial analyst--or CFA--designation could be stripped of the certification, says Craig Hobbs, president of Composite Research & Management in Seattle, one of many companies that have endorsed the new standards.
The standards, five years in the making, are a set of ethical principles intended to promote full disclosure and fair representation in the reporting of investment results.
They’re the product of the Assn. for Investment Management and Research, an 18,000-member group based in Charlottesville, Va., that administers the CFA program.
The standards aim to end a variety of money-manager abuses. For example, some firms show prospective clients the results only from their best-performing accounts, while others don’t subtract fees when presenting returns. And even when there aren’t any intentional deceptions, managers can come up with different numbers depending on how they handle assumptions involving dividends, account size, trade dates and more.
It will take a while for the new standards to become meaningful, however, since managers aren’t required to recalculate their performance prior to Jan. 1, 1993. But they must note any previous results that aren’t in compliance with the new standards.
The guidelines will put mutual funds and privately managed accounts on a more even playing field, although the former will still have an ethical edge, Hobbs says. That’s because mutual fund results must be audited by a certified public accounting firm, while there’s no such requirement on private accounts.
“I’m willing to bet that even some firms with CFAs may fudge,” says Bott, who monitors private money managers.
Still, Bott calls the standards a “first step” that will make it easier for investors and brokers to evaluate different management companies.
In addition to supposedly better performance, clients in privately run accounts can look forward to more individualized attention, proponents say. For example, portfolios can be tailored to each person’s risk tolerance, tax situation and the like.
And unlike mutual fund shareholders, individual clients aren’t affected by other investors’ cash flow. This can be important if a fund is losing investors and has to sell stocks or bonds at inopportune times--a development that would tend to hurt the remaining shareholders.
But mutual funds have certain advantages too. Most funds are much more diversified than smaller individual accounts, and the vast majority will accept shareholders with only $1,000 or so to invest.
As noted, private managers will typically close their doors to anybody with less than $100,000. Some require $1 million or more.
Also, the 2.5% to 3% annual fees that are standard on “wrap-fee” products--an increasingly popular type of private account--are much higher than the combined expenses that you would normally pay on most funds.
“Mutual funds have lower minimums and, typically, lower expense levels,” says Alan Cohn, a principal at Sage Financial Group in Bala Cynwyd, Pa. He recommends the fund approach for people with less than $500,000 to invest.
Fund proponents point out that many of the management companies that handle private accounts also run mutual funds--often with the same manager wearing both hats.
In this respect, investors who buy mutual funds aren’t necessarily giving up anything in the way of managerial talent.
* Setting the Standards
Managers of privately run investment accounts will come under pressure to compute and present their results in a prescribed manner starting Jan. 1, bringing them closer in line with performance standards that long have applied to mutual funds. Here are highlights of the new rules: Investment returns must be calculated using accrual accounting, which recognizes income when it’s earned rather than received. A manager’s overall or composite returns must be size-weighted, giving big accounts a greater impact than smaller ones. Managers can compile different composites for different types of accounts. All actual, fee-paying accounts must be included in a composite. This standard applies only to discretionary accounts--where the client hasn’t restricted the manager from buying certain securities. The firm must include returns for all years, and it must disclose any past results that aren’t in compliance with the new guidelines. Cash holdings must be figured into the results. Failure to do so would tend to boost returns in up markets. Prospective clients must be told that a list of the firm’s composite accounts is available. For each composite, the manager must disclose the number of accounts and amount of assets, along with the percentage of total assets represented by that composite. The manager must say whether or not fees have been subtracted in calculating the performance results. Either way, fees must be disclosed. The firm must say whether leverage (borrowed money) has been used in an attempt to boost returns.
