By Vidhu Shekhar, CFA
The investment industry employs many different types of professionals. They work in a variety of roles, ranging from individuals advising a few clients to large financial institutions employing thousands of employees. The investment industry has become more complex over time and has developed a complex value chain of services.
At one end of this chain are the investment advisers whose job is to understand the needs of their customers and to help them decide how they should invest their savings. Typically, these savings are invested in products like mutual funds, insurance plans, and pension schemes.
These advisers are sometimes called asset allocators, as their main function is to create and manage the right mix, or allocation, of stocks, bonds and other financial assets that will meet the long-term needs of their customers. These allocators can range from those who serve individual investors to large asset owners
Once asset owners have decided the asset allocation, they select asset managers best suited to manage different parts of their clients portfolio. Depending on the size of the portfolio, this could be a simple choice of mutual funds, or a complex exercise involving request for proposals (RFP) from multiple asset management companies.
The process, known as manager selection, involves studying the managers performance track record to determine how she can be expected to perform. Finding the right asset managers involves analysing both quantitative and qualitative factors. It is important to separate skill from luck when evaluating past performance. This is done through a process called attribution analysis. What risks did the asset manager take in order to achieve the returns? Did she underperform or outperform other managers who had similar mandates? What was the reason for the difference? Did she take too many risks?
Asset owners and consultants look at many such questions and produce detailed analysis of the returns as well as risk.
This analysis is only as good as the data on which it is based. If asset owners do not have reliable data, they will not be able to perform the right analysis and may end up choosing the wrong managers. In the 1980s and 1990s, large asset owners used to struggle with these tasks, because they neither had the right data nor the right tools to analyse it. They had no standard way to of comparing performance across asset managers.
How do you know whether what is being claimed is true? How do you measure performance when you cannot be sure that the asset managers are not cherry picking, i.e. including only their best portfolios in their presentations and leaving out the underperforming ones?
The GIPS® Standards, was created as a standard for investment performance for answering these and other questions that asset owners ask when selecting managers and monitoring manager performance.
Asset owners are considered fiduciaries, i.e. they are expected to act in the best interests of their customers. This is true for India as much as it is true for other mature markets. Leading asset management firms in India are recognising this and we are starting to see interest in adoption of GIPS by local firms.
Around two-thirds of global financial assets are managed by GIPS compliant firms. In India, the journey has just started.
(Vidhu Shekhar, CFA, is the country head of CFA Institute in India. Views are his own)