Achieving Best Practice in Performance Measurement and Analysis

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14 October 2014

Achieving Best Practice in Performance Measurement and Analysis

To paraphrase the renowned Irish physicist Lord Kelvin: “If you cannot measure it, you cannot improve it.”

The concept behind Lord Kelvin’s statement is one familiar to the asset management industry. Huge resources are devoted to measuring and analysing investment performance to establish:

  1. Whether or not the level of performance being achieved is acceptable.
  2. If not, the corrective action that should be taken.

Best practices in the performance industry?

Although we apply Kelvin’s concept to the results calculated by performance teams, we do not apply it to the business processes that generate those results. The industry lacks a robust best practice framework and no objective benchmarks exist against which the ‘quality’ of business processes can be assessed. The situation is made worse by the fact that there are different ways to calculate the same performance metrics, and different opinions about the right and wrong ways to do it.

Over the past five years, we have seen an increasing amount of regulation entering the asset management industry. One perspective on regulation is that it imposes constraints on the creativity and flexibility of businesses, blunting their commercial edge. Another is that it provides a framework that guides businesses towards commercial and operational best practices.

The main regulation that applies to performance teams is the GIPS standards. So, can we look to the GIPS standards as a best practice framework for performance measurement and analysis?

The answer is “not really”. The GIPS standards were designed to ensure the fair and full presentation of composite performance in sales and marketing materials. A best practice framework for performance measurement and analysis needs to cover more than the calculation methods used to present information about composite performance.

At BI-SAM we believe this is a significant issue for the industry:

  • How do you know your performance function is operating at the right service level?
  • How do you know it is delivering value for money?
  • Is your performance function far behind or way ahead of industry practice?

These problems have never been more pronounced than today because performance teams are in a state of transition, moving from an old world to a brave new one.

Evolving investors’ requirements for performance reporting

It used to be the case that performance teams struggled to calculate basic performance metrics in a consistent way across all portfolios using repeatable processes. But this is no longer the case because the widespread use of Excel as a calculation ‘platform’ has been superseded by the use of specialist calculation systems. Consequently, calculating basic performance metrics has become a commoditised process.

Over the past five years, there has been an increase in the demand from investors for:

  • More detailed and transparent information about investment performance.
  • More explanation and evidence of the value delivered by investment processes.
  • More customised presentation of information to be provided in less time.

For these reasons, performance information now plays a central role in winning and retaining business. It provides the evidence managers need to show prospective clients how they can add value. And it provides the transparency and explanation that is vital for enriching the client experience.

So, today the challenge no longer centres on calculating basic performance metrics. Performance teams have to:

  • Calculate more sophisticated performance metrics.
  • Provide more detail about how portfolios have performed and why they have performed like that.
  • Distribute performance results and supporting data to more people, in more customised formats, via a broader range of distribution channels.

All of this means that performance teams need strategies that extend across the end-to-end processes of efficiently calculating and distributing performance results, and supporting data, to all the people inside and outside their firms who want to see them.

The elements of a best practice framework for performance measurement and analysis

Historically, performance teams have measured their capability in relatively simplistic ways, namely in terms of the calculation methods they use. But as we have explained above, over the past five years the demands and expectations of their internal and external clients have changed significantly.

A best practice framework for performance needs to focus on four key operational areas:

  1. The calculation of performance and risk results (returns, attribution, ex-post risk).
  2. How those results are distributed to internal and external clients.
  3. How well the performance team is integrated with upstream business teams and processes.
  4. The strength of the operating platform and of the governance and management controls used by the performance team.

Three benchmarks should then be used to assess the capability of performance teams in each area:

  • Standard Practice – the minimum service level performance teams should achieve.
  • Best Practice – the best level of service that should be expected in the industry.
  • Market Practice – the average level of service that is delivered by performance teams operating in a specific sector (e.g. institutional, wealth) and a specific region.

A best practice framework such as this will provide performance teams with independent guidance on whether or not methods, procedures and processes need to be enhanced. And if they do need to be enhanced, the specific areas where attention should be focused.

This will deliver value to the business as a whole:

  • It will instil confidence in their client base that service levels are aligned with, or are higher than, industry practice.
  • It can be used to gain acceptance from their client base that a good overall service is being provided.
  • It will focus effort in the right places when it becomes clear that there is a need to enhance service capability.

The ideas above have been expanded further in a white paper: “Achieving Best Practice in Performance Measurement & Analysis”. This white paper is part of BI-SAM’s thought leadership programme and can be downloaded at www.bi-sam.com.

Conclusion

Investors, regulators and investment managers all suffer from the industry’s lack of a reliable best practice framework for performance measurement and analysis. At BI-SAM we believe that the adoption of such a best practice framework is long overdue.