• No results found

Performance Reporting What s Behind the Numbers?

N/A
N/A
Protected

Academic year: 2021

Share "Performance Reporting What s Behind the Numbers?"

Copied!
7
0
0

Loading.... (view fulltext now)

Full text

(1)

Performance Reporting—What’s Behind the Numbers?

We have made several changes to the Morningstar ETF Managed Portfolios database to better align our data set with our vision of best-practice standards pertaining to the reporting of exchange-traded fund managed portfolios’ returns. To start, we have added numerical identifiers to distinguish between the various types of reported returns to the Landscape report. While ETF managed portfolios first emerged within the domain of traditional separate accounts, the use of ETFs has fostered new forms of collaboration among asset management firms, UMA platforms, and mutual fund companies. Because of the relatively small number of holdings and quantitatively driven investment processes utilized by many strategies, a significant portion of assets have grown via means of model delivery through multiple nondiscretionary sources—namely platforms such as Envestnet and AssetMark, or even other third-party Registered Investment Advisors. In addition, to add another layer of due diligence and validity, we have also added the source of any reported nondiscretionary returns. Given the dispersion of returns between discretionary and nondiscretionary accounts caused by differences in portfolio implementation and construction, knowing the source of reported returns will help investors to ask the right questions when parsing performance disclosures as they conduct due diligence.

Not All Strategies Are Made the Same

Within the realm of ETF managed portfolios, models are typically rules-based, quantitatively driven blueprints designed to guide the investment of assets according to a given philosophy. They are the preliminary investment framework utilized by a manager but not necessarily a mandate. There are several factors such as client constraints, the timing of trades, and manager discretion that can cause the returns of a model to differ from those of the final product. The end product, also known as the strategy, can be viewed as an interpretation of the model after portfolio construction and implementation (the actual use of assets) have taken place.

It should be noted that when an ETF asset manager lists a product on a platform, such as Envestnet or AssetMark, the manager is essentially offering a delivery of the investment model to the platform—specifying which ETFs to trade and the quantities involved. The platform is then responsible for implementing the model and executing the trades in the underlying client accounts. As such, the asset manager no longer has discretion or control over the portfolio implementation aspect of the investment process. This means that the returns of a strategy offered through a platform will typically deviate from the returns of the same strategy offered through a traditional separate account, where the manager has direct discretion over the assets. Because of this disconnect, it is important to note the specific source of returns being reported by the manager and how this implementation might differ from the avenue through which an investor intends to invest in a particular strategy. By identifying these differences, essential due-diligence questions immediately surface, which will be addressed in more detail later.

The Return-Type Identifiers

Given the importance of understanding the source of reported returns, Morningstar has introduced 12 May 2015

Ling-Wei Hew, CFA Analyst

ETF Managed Portfolios Research

ling-wei.hew@morningstar.com

1 312 348-2721 Perspective

(2)

Return Type Performance Construction

1 Performance is a composite of live discretionary accounts. 2 Performance is a composite of live nondiscretionary accounts.

3 Performance is from one nondiscretionary source (Envestnet, for example) and is used as a representative return stream for the entire model.

4

Performance is hypothetical based on a model’s positions. The model is being used to manage live assets, but the returns reported are not from the nondiscretionary source. The model used to calculate returns is identical to what is being delivered to third parties and not altered with the advantage of hindsight.

It should be noted that a strategy’s return-type classification simply details the source of a strategy’s returns as reported by the firm. The returns reported are in many cases a representation of the strategy’s overall performance and do not encompass all of a strategy’s distribution channels. For example, if a strategy’s returns fall under RT-1, it simply means that the manager is using the returns from a composite of discretionary accounts to represent all assets invested according to that particular investment mandate. It does not imply that the strategy is offered exclusively through a traditional separate account; the strategy may also be available through several nondiscretionary sources.

We make this distinction between discretionary and nondiscretionary assets in Morningstar’s database by offering two sets of assets—one at the strategy level and another at the vehicle level.

Strategy assets include both discretionary and nondiscretionary assets invested according to that

particular investment mandate. Vehicle assets include only the strategy’s discretionary assets and are a subset of any strategy assets listed. Therefore, if a manager were to list a strategy’s return stream under RT-1, those returns would be entirely applicable to any vehicle assets reported, provided all discretionary accounts are included in the composite as required by the Global Investment Performance Standards. It does not, however, necessarily mean that the RT-1 identifier is applicable to all strategy assets.

Inception Date

Morningstar defines the inception dateof an ETF managed portfolio strategy as the time it was first funded with live assets. By defining the inception date this way, back-tested returns are inherently barred from being included in the database. This differs from the commonly used definition that indicates when a strategy was first launched and made available to investors. The strategy according to this definition does not necessarily need to be funded at that time.

(3)

Return-Source Diagrams

To provide a clearer picture of each return type, the following diagrams illustrate the flow of information and what is and is not being reported:

Return Type 1 (RT-1): Performance is a composite of live discretionary accounts.

This return type is most relevant to a strategy offered as a traditional separate account. It is the cleanest source of returns being reported as it is a composite of underlying accounts managed with full discretion. However, there are many different ways a composite can be calculated and several factors to consider that could potentially bias the aggregate performance of a composite such as which accounts are included, how the assets are weighted, and how significant cash flows are treated.

The methodology used by a particular firm should be described in its performance disclosures section and viewed with reference to the GIPS guidance statements on calculation methodology and composite construction for further analysis. For example, according to the GIPS, all discretionary fee-paying accounts that follow the strategy’s investment mandate must be included in the same composite to prevent managers from cherry-picking their best-performing accounts. If a manager fails to include any discretionary accounts that follow the strategy’s investment mandate, further questions should be raised as to why those accounts were excluded and whether this was done to advantageously modify the performance of the composite.

If a strategy is offered as a traditional separate account and also through model delivery, it is likely that the asset manager will report returns using RT-1 since the performance from discretionary assets will be the most straightforward to obtain. Returns for those accounts invested through model delivery will need to be gathered from the relevant platforms or third parties managing the assets, representing an additional administrative hurdle for the manager.

(4)

Return Type 2 (RT-2):Performance is a composite of live nondiscretionary accounts.

Similar to RT-1, returns falling under RT-2 are also from a composite of underlying accounts. However, in this case, the underlying accounts are nondiscretionary, making this type of reporting administratively taxing and rare. The returns from all underlying accounts at each third-party, nondiscretionary source first need to be consolidated, and then all the nondiscretionary sources need to be aggregated to form a composite.

While GIPS only pertains to discretionary accounts, the same rationale behind many of the standards can be applied to the construction and calculation of composites for nondiscretionary accounts.

1. ETF Asset Manager sends investment model to third parties (platforms such as Envestnet and AssetMark) for implementation.

2. Platforms make portfolio changes in underlying accounts and returns are consolidated at each platform. 3. Each platform reports their returns to the asset manager.

4. The manager then consolidates returns across multiple platforms to create a composite. The composite’s return is reported.

(5)

Return Type 3 (RT-3): Performance is from a single nondiscretionary source (for example, Envestnet) and is used as a representative return stream for the entire model.

The distribution of a strategy in this case is similar to that of RT-2, except that the manager is not reporting a composite of all nondiscretionary accounts. Here, the manager is reporting the returns from a single nondiscretionary source and using those returns to represent the strategy’s overall performance.

The nondiscretionary source should remain constant so that managers are not advantageously selecting the source with the highest returns at any given reporting period. Although there may be instances that warrant a change in source (for example, if the strategy were to no longer be listed on a particular platform) this should not occur often and there should be a reasonable explanation behind the switch.

1. ETF Asset Manager sends investment model to third parties (platforms such as Envestnet and AssetMark) for implementation.

2. Platforms make portfolio changes in underlying accounts and returns are consolidated at each platform. 3. The manager uses the returns from a single third party as a representative stream of returns for the

(6)

Return Type 4 (RT-4): Performance is hypothetical, based on a model’s positions. The model is being used to manage live assets, but the returns reported are not from any of the nondiscretionary sources.

For a strategy offered exclusively through model delivery, this is the least administratively taxing way to report returns and likely to be the most common. Returns reported are not based on the performance of any underlying accounts. Instead, the returns are generated internally using a model identical to the one being delivered to manage the strategy’s nondiscretionary assets.

While we continue to caution against the use of back-tested returns, as they can be easily modified with the benefit of hindsight, the key distinction for RT-4 is that the returns are generated by the same model being delivered to third parties and used to invest live assets. Although the returns are not directly from the assets themselves, because the model is being used to guide the investment of live assets, that performance can be used as a point of comparison to the model’s internally generated returns. This provides a way to evaluate whether the model has been opportunistically modified along the way. There are many reasons why returns may differ, but a large enough gap between the internally generated model returns and those of the live assets should raise a red flag and warrants further investigation. Many platforms perform this type of due diligence themselves, assessing the difference between their own internal composites and those being reported by the manager.

1. ETF Asset Manager sends investment model to third parties (platforms such as Envestnet and AssetMark) for implementation.

2. Platforms make portfolio changes in underlying accounts and returns are consolidated at each platform. 3. The manager uses the returns generated from the original investment model delivered in step 1 as a

(7)

The Bottom Line

The growth of investment outsourcing through model delivery has made it increasingly difficult to keep track of what is going on behind the scenes of a managed portfolio. Raw performance numbers remain the focal point for most investors, making the transparency around the sources of those returns of supreme importance.

The returns that ultimately make it on paper are an abridged version of a larger story and typically the summary of a long trail of information. The addition of return-type identifiers provides greater transparency and outlines the flow of information between the various third parties involved. This lays the groundwork for understanding where various investment decisions are being made and provides investors with an additional tool for their due-diligence process.

References

Related documents

Questions were asked on whether they were satisfied with the health care facilities in their own country/place of stay; whether they have medical insurance; whether

Lemma 13 From initial asymmetric Nash equilibrium minimum standards a lump-sum transfer from the high quality to the low quality exporting country can ensure mutual gains from

Speaking of music, September brings us a Corey Harris Concert, as well as the Irish Traditional Music Sessions, the Sunnyside Singers sessions in Queens, the Folk Open

The report includes basic salary, bonus levels and benefits individually reported by level of seniority across the management consultancy profession, with break-out data

Although discovery of the tyrosine kinase inhibitor (TKI) imatinib mesylate has significantly improved the prognosis of chronic myeloid leukemia (CML) patients, a rare population of

The findings were cross-tabulated to establish whether the small manufacturing companies were held responsible for poor quality garments produced as a result of poor quality

Concur: The peer review process has been strengthened to ensure documentation of corrective action completion is included in the Peer Review Committee minutes. We recommended

motivation and positively predict controlled motivation and amotivation (H2).. well-being) and negatively predict exhaustion (an indicator of ill-being), whereas 1..