When communicating investment performance information, Members or Candidates must make reasonable efforts to ensure the information is fair, accurate and complete.

Reasoning behind Standard III-D
This Standard applies the guiding ethical principles of fair representation and full disclosure to the measurement and presentation of investment performance information. Much of the negative stigma associated with the money management business has to do with the marketing of performance returns in an effort to capture attention (e.g. "We returned 46% last year, and the market only did 11%! Sign up with us!"). Prospective clients and the investing public at large don't know what to think. Are these numbers a fair indication of what they can legitimately expect or a sleight-of-hand magic trick that may or may not be a total fabrication?

Misrepresenting Performance Records - Some of the Tricks

  • Selective Account - Take our previous example, where the manager wishes to promote the fact that the company returned 46%. Let's assume this manager has 500 accounts, yet one and only one of them did indeed happen to return 46% because (for tax purposes) it retained a 25% stake in one stock that tripled in price last year (these things do happen - even amateur stock pickers can end up with a three or four bagger!). However, most of the accounts under his umbrella were market performers at best. The manager figures that 46% was an audited, actual performance number, and he'd prefer to promote his best work.
  • Survivorship Bias - Say this manager took similar chances in other accounts (i.e. retained a large investment position in one stock), but the results were not quite as favorable. For one group of accounts, the manager added a penny stock at $0.31 a share, thinking that $2 was a virtual lock once the firm emerged from bankruptcy. Instead, a new class of equity shares was created and the old shares became worthless. A group of accounts with this stock experienced -8% to -14% overall returns, and the clients all terminated in disgust. However, these accounts are not current accounts and the manager excluded them from any representation of performance.
  • Portable Record - Say that Firm A claims to have a 10-year track record averaging 14% a year. In actuality, that 14% track record was produced by the management style of a competing firm. So that Firm A could make the claim, one of the members of the research team at the competing firm was hired away and made director of research. While this new hire did have a role in the decision-making process that produced the 14%, he was not the lead manager. In addition, in order to comply with the Standard, all decision makers within that competing firm would have had to been hired away. Due to these restrictions, in most cases, a firm will be unable to claim the same performance record as the new hire.
  • Selective Time Frame - The 46% return from last year was done in an account that, for the four years prior to that year, produced an average annualized return of -19%. In other words, much of the 46% represented a mere recovery from a previous sharp decline.
  • Simulated Numbers - To start a second product line, the manager engages in a lengthy exercise in data mining with his financial software, during which he discovers a screening model that, when applied to foreign small-cap stocks, appears to be capable of producing a 31% annualized performance number over a 10-year period. The marketing materials created to promote this discovery show the stellar 10-year track record but conveniently leave out the fact that these numbers are based on a simulation and not on actual invested assets.

In our earlier discussion of Standard I-C, which deals with misrepresentation, we noted the tendency for some practitioners to guarantee a future outcome based upon historical information. The tricks described above show that there are many creative ways to represent a performance outcome without actually making guarantees. In establishing Standard III-D, the CFA Institute is carrying this same caution against misrepresentation (as a general guiding principle) and applying it to the practice of developing performance information that describes the actual investment experience of a typical client.

PPS-GIPS
In addition to the stated requirements of Standard III-D (which primarily focus on the ethics of fair representation and full disclosure), a higher purpose of the CFA Institute is to (1) facilitate comparability of performance records while (2) improving professionalism of the industry and (3) bolstering its purpose as a self-regulating body.

The CFA Institute aims to achieve these goals by applying a common standard by which all managers will calculate and present their investment performance. To help develop this common standard, it first established Performance Presentation Standards (PPS), which are applicable to North American firms. More recently it has branched out globally with the Global Investment Performance Standards (GIPS), which it hopes to implement worldwide.

The PPS and GIPS are voluntary.
Members are not required to
adopt them, and a failure to do so is not a violation of Standard III-D. Members are encouraged, if not strongly encouraged, to adopt the standards. There are many worthwhile reasons to adopt the GIPS, but there are also many unique issues that make implementation more challenging for some firms (particularly smaller firms and those without sufficient records). At this time, an industry-wide requirement is seen as discrimination in favor of the big institutions, which can devote greater resources to performance-measurement issues.

In a later section, we will address the requirements of the GIPS in much greater detail. The CFA Institute is in the process of eliminating the old CFA Institute PPS, which are North American standards (the PPS is now regarded as a CVG, or a country version of the GIPS). Some firms would prefer to promote compliance with the more stringent set of standards, which is the PPS. As they are now, the PPS and GIPS are only modestly different, the main distinction being that the GIPS have relaxed the time requirement of the historical track record (PPS - 10 years, GIPS - five years) and eliminated requirements for alternative asset classes. For the CFA exam, the GIPS are the applicable standards that will be tested.

Applying Standard III-D

  • Know that compliance with PPS and GIPS is voluntary, and not required to comply with Standard III-D. However, it is a violation of the Standard to claim compliance with GIPS, in a case where the firm chooses to deviate from GIPS. For example, GIPS requires all fee-paying discretionary portfolios to be included in at least one composite. If a firm holds itself out as GIPS compliant, yet it eliminates outliers in calculating composite performance (as it feels the outliers skew that data and make it less representative), then it is not fully compliant with the GIPS and it is misrepresenting itself by stating that it is. If, however, this same firm eliminates GIPS compliant from its literature, it would not be violating Standard III-D.
  • A failure to disclose pertinent facts is likely to be a violation. However, including appropriate disclosures in the presentation of performance data will frequently avoid violations of this Standard. Let's return to our earlier examples of violations of Standard III-D: the issue of portability of investment results (advertising a manager's track record from a previous affiliation) is seen as misleading for the client. However, if a previous track record is displayed clearly as such (it is labeled as applying to a previous affiliation), with the appropriate disclosures intended to clarify the issue for the client, then the CFA member has complied with the intent of the Standard and would not be in violation. Likewise, simulated returns are permissible for marketing purposes but only if the appropriate disclosures are included, such as the summary of how the model was developed and the fact that the results being displayed are being applied retroactively.
  • The key words in applying this Standard can be found in its final sentence: "fair, accurate and complete". Determining whether a violation has occurred is sometimes a bit subjective, but by using the spirit of "fair, accurate and complete", you can handle situations presented on the CFA exam.

How to Comply

  • Adopt the GIPS Guidelines - Or, more accurately, encourage your firm to adopt them. Doing so would be the best procedure to avoid any violations. However, full compliance with the GIPS is not absolutely required, and in the absence of full compliance, adopting certain aspects of the GIPS is likely to be beneficial.
  • Add appropriate disclosures - This can help clarify and explain what a prospective client sees (e.g. what do "simulated" and "portable from a previous manager" mean?)
  • Consider the Knowledge of the Audience - Some presentations will necessitate additional explanation.
  • Present performance of Similar Portfolios - This avoids presenting a single portfolio as representative of likely results.
  • Maintain records - These will clarify how performance was determined. It's wise to anticipate that full adoption of the GIPS may be the direction in which the industry is headed, and the records will help any needed conversion.


Standard III-E: Preservation Of Confidentiality

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