With regard to Mr. Grossman's commentary on the AIMR Performance Presentation Standards, we would like to clarify a few points and respond to some of his constructive comments. Most importantly, we would like to assure him that AIMR has continually devoted significant resources (both of staff and volunteers) to the gradual evolution of the AIMR-PPS standards over the 10 years since their original publication.
We would agree "it is not too early to improve the AIMR-PPS standards." In fact, they have already been "improved" in the form of formally published revisions three times and are continually open to further interpretation in the form of questions and answers published bimonthly in the AIMR Standards Reporter newsletter. The AIMR board appreciates the role the standards play in the investment industry, and has tentatively endorsed committing additional resources to further strengthen, enhance and support these important initiatives.
Support is growing
Mr. Grossman rightfully asks whether a "standard" can be worthy of that designation if more managers than not either ignore it, misuse it, or claim lip-service compliance. Several organizations, including The Spaulding Group and Evaluation Associates, have conducted surveys of both managers and consultants to determine the current acceptance level. Investment managers either claim to be already in compliance or to be actively taking steps to come into compliance.
The predominant reason they give for making these efforts is that the market demands it. AIMR has always felt that the acceptance of any performance standard would have to be market driven.
We certainly support Mr. Grossman in his suggestion that consultants should take the AIMR-PPS standards more seriously. We have even drafted a sample request-for-proposal questionnaire, which many consultants and their clients are starting to use for exactly the reasons Mr. Grossman suggests.
Enforcement is growing
As an independent association of individuals, with the primary goals of education and standard setting, AIMR has never chosen to be a self-regulatory organization. From the beginning in 1986, the original AIMR-PPS Committee made clear that the AIMR-PPS standards represented a set of ethical principles, not a cookbook of precise rules. However, the Securities and Exchange Commission has recently provided a much stronger enforcement capability than AIMR could ever muster. The SEC has concluded that a claim of compliance with the AIMR-PPS standards is a marketing claim. Like any marketing claim, it must be substantiated.
Thus, although the SEC takes no stand on whether the AIMR-PPS standards are required or even useful, they are increasingly policing those organizations who make the claim without really understanding its implications. We suspect that over the next few years, there will be much less concern about the lack of enforcement and more about educating compliance officers and verifiers so that they can properly fulfill their roles of keeping investment managers out of trouble.
Cash allocation
Mr. Grossman devotes several paragraphs to the potential incompatibilities which may arise from different managers' interpretations of the requirement to consistently allocate cash when separating a balanced portfolio into single asset composites.
Basically, there are three acceptable alternatives (but not those Grossman lists):
(1) Treat cash as a separate asset and list performance separately in the same chart for stocks, bonds, and cash. This allows a manager to avoid the allocation problem but provides the prospective client full disclosure because the manager must also show his allocation to each asset class. Single asset performance from this type of table cannot be combined with other single asset portfolios because cash has not been included.
(2) Allocate cash to each asset class in separate "pools" according to the way the equity and bond managers actually made their decisions. This works very well for firms which make a single stock/bond asset allocation decision and then manage each asset with its own cash position.
(3) Allocate cash pro rata to each asset class (Grossman's third option). Admittedly, this third option may not be ideal but it certainly provides more comparable and realistic data than allowing managers to ignore cash entirely and use asset-only performance, which would imply results that none of their clients ever actually achieved.
Risk-adjusted returns
Mr. Grossman makes a strong case for requiring more consistent (and comparable) composites and the inclusion of some form of risk-adjusted performance. The AIMR-PPS Implementation Committee is actively researching various alternatives. Although there is far from unanimous agreement on what constitutes risk, even in terms of the definitions of beta for stock portfolios or duration for bonds, it is very likely that a future version of the AIMR-PPS standards will include exactly the type of requirements Grossman suggests.
In fact, an AIMR-PPS subcommittee is pursuing a better calculation and disclosure procedure for leverage, either directly or via derivatives, in portfolios.
Also, another subcommittee is looking into a benchmark requirement as well as standards for undertaking performance attribution.
