LONDON - European investment performance records are vulnerable to abuse with the introduction of a single European currency.
Introduction of the euro has significant implications for all money managers in developing composite performance data for their portfolios being marketed on the Continent.
The European Federation of Financial Analyst Societies, in conjunction with the U.K.'s National Association of Pension Funds, is examining the issues with the aim of providing guidelines by April, said Dugald Eadie, chairman of the analysts' federation's Permanent Commission on Performance Measurement.
But observers note the federation doesn't have policing powers. And while the institutional market is more sophisticated, individual investors can be misled much more easily, said David Hobbs, director at PDFM Ltd., London.
Still, problems exist in continental European institutional markets, where performance measurement is a relatively new issue. What's more, there is enormous apprehension in some continental pension markets that Anglo-Saxon managers will pick off prized accounts. Some U.S. and U.K. managers fear continental managers will be tempted to manipulate their data.
Because single-country European portfolios are being converted into pan-European portfolios, the opportunity for abuse by enterprising money managers is greatest there.
For example, a Belgian equity manager might shift a portfolio's mandate to all countries expected to participate in European economic and monetary union. That's fine by itself, but if the manager presents his historic Belgian stock-only performance as a pan-European track record, that would raise hackles among performance measurers.
Some don't think abuse will be likely. "I think this (misrepresentation) would be spotted very quickly," said John Williams, director of The WM Co., Edinburgh.
But others think opportunities for distorting data are abundant. Unfair competition among managers "could easily happen," Mr. Eadie said.
Industry experts are just starting to cope with how managers should represent historic performance for periods up to Jan. 1, 1999, the scheduled startup date for the euro.
The difficulty is that historic performance can easily be distorted without adequate self-regulation.
For example, an Italian bond manager that restates its historic performance in euros likely would outshine a bond manager based in Germany, where yields historically have been lower.
Industry experts add managers cannot construct a hypothetical euro for pre-1999 periods, because there's no way of knowing how the currency would have performed.
"The basic issue," said PDFM's Mr. Hobbs, who represents the U.K.'s Institutional Fund Managers Association on the NAPF's monitoring group, "is you can't reconstruct something that didn't exist before."
Nor can the European currency unit or other baskets of European currencies be used as a proxy for the euro, because all of the countries included in the ECU will not be included in the European monetary union. There also are problems in how to treat the cash portion of any portfolio, because varying interest rates would have affected domestic currencies, said John Stannard, managing director of Frank Russell Co.'s U.K. office.
"The bottom line," Mr. Stannard said, "is it doesn't make a great deal of sense to re-create a notional track record in euros before Jan. 1, 1999."
The question is whether historic performance data still will be relevant once most European Union nations' currencies are merged into the euro. David Puddle, senior vice president at Putnam Investments, London, said "old performance records will no longer mean anything."
But most experts said money managers and consultants would be unwilling to discard historic performance records. Instead, the federation's working group is trying to devise a way managers can link their historic performance with post-1999 returns. Such linkage would have to be disclosed.
No one thinks it's going to be easy. It will be an accommodation to the real world. "How to convert performance into euros retrospectively when euros didn't exist is going to be very difficult," said Mike Anthony, director-marketing, Julius Baer Investments Ltd., London.
While guidelines are being devised, Mr. Eadie, who also is chief executive of Henderson Investors, London, said consensus exists on two key principles.
First, portfolios that were comparable before EMU should remain so afterward. Second, portfolios that were not comparable before the euro's introduction should be evaluated separately.
Thus, pre-1999 track records for a stock fund denominated in French francs and one in deutsche marks should not be compared because they have different benchmarks and base currencies.
One problem is that some single-country stock portfolios are being converted into pan-European equity portfolios, as European investors broaden their horizons.
Those funds could be comparable from the onset of the euro, but historic performance could not be compared.
The transition period - until managers build up adequate track records - has industry officials most concerned, Mr. Eadie said.
The hope is that money managers will police themselves, along with the help of consultants. Eventually, regulators might get involved, but they are not yet focused on such issues, he added.
Other issues also will affect performance measurement. For example, the emergence of a Eurobond market creates new credit quality issues. While in the past an individual country could print money to pay off its outstanding bonds, establishment of a central European bank will eliminate that possibility, thus creating a default risk, Mr. Stannard said.