Centre Main

28 October 2003

 

Ms. Natalie Barton
Retail Projects Department
Financial Services Authority
25 The North Colonnade
Canary Wharf
London E14 5HS
United Kingdom

 

Re: Consultation Paper 183 - "Standardising Past Performance" (Ref. FSA CP183)

 

Dear Ms. Barton:

 

The European Advocacy Committee ("EAC" or the "Committee") of the Association for Investment Management and Research ("AIMR")1 is pleased to comment on the Financial Services Authority's ("FSA" or the "Authority") consultation paper, Standardising Past Performance ("CP 183" or the "Paper"). The EAC is a standing committee of AIMR charged with reviewing and responding to major new regulatory, legislative, and other developments that may affect investors, the investment profession, and the efficiency and integrity of European financial markets. The Committee has 15 investment professionals volunteering from throughout Europe, providing a variety of viewpoints that are based on members' market experience and expertise and drawing upon the collective knowledge of AIMR's global network of investment professionals.

 

General Comments

 

The Committee strongly supports the FSA's desire to require investment firms marketing their fund and unit trust products in the U.K. to use a standardised format for presenting past performance. As the Paper indicates, without such a model, firms are free to artificially inflate the performance of the products by selecting strong periods, failing to include assets such as cash in their calculations or by using other distorting methods. Adopting a universal standard will not only ensure that firms are put on an equal footing when it comes to marketing their services, but will also reduce the likelihood that investors will make investment decisions based on faulty or incomplete information.

 

Such considerations first led AIMR and its predecessor organizations in 1987 to create the AIMR Performance Presentation Standards ("AIMR-PPS®") for firms in the U.S. and Canadian markets. Recognising the need for one global solution in 1999 AIMR used the AIMR-PPS standards as a basis for the new Global Investment Performance Standards ("GIPS®"). The GIPS standards were adopted in the United Kingdom as the United Kingdom Investment Performance Standards ("UKIPS" or the "Standards") in 2001 by the UK Investment Performance Committee (the "UKIPC"). The UKIPC sits on a quarterly basis and seeks to ensure that all relevant UK firms are UKIPS compliant.

 

The Council comprises representatives of the Investment Management Association (the "IMA"), the Association of British Insurers (the "ABI"), the National Association of Pension Funds (the "NAPF"), the UK Society of Investment Professionals (UKSIP), the AIMR itself, and a variety of other associations and firms. An FSA official acted as observer to the adoption of UKIPS, and the FSA has a regular observer seat on the Council. Another FSA official observes the global Investment Performance Council ("IPC") subcommittee on advertising. The NAPF provides for the UKIPC secretariat, and some members of the Council, to attend the European Investment Performance Committee meetings, of which the UKIPC forms part.

 

Use of UKIPS for the purpose of standardising performance presentations for collective investment schemes and unit-linked products would have the following advantages over an FSA-developed standard:

 

Global Best Practices

 

  • UKIPS are an accepted industry-created standard that represents global best practices for measuring investment performance
  • UKIPS draw upon the cumulative and collective experience of a global committee of seasoned investment professionals working 16 years to develop and enhance this standard
  • Competitive pressures resulting from increased awareness of UKIPS will encourage more fund managers and institutions to become compliant

 

Self Regulatory Solution

 

  • UKIPS require verification of compliance with policies and procedures by independent third-party firms adding to their own credibility
  • Continuing false claims of GIPS compliance in other markets are often seen as fraudulent advertising
  • UKIPS are an effective self-regulatory response to the need for improved performance presentation standards
  • UKIPS allow regulators to focus on fair disclosure of information rather than on performance measurement
  • Companies are bound to only promote use of UKIPS if the entire firm is compliant, thereby freeing the FSA to monitor other financial promotion issues

 

Ease of Understanding

 

  • UKIPS utilize effective performance measurement methods that also are easy to understand
  • Investors will be able to compare the performance of their pension fund interests with those of their personal investment funds
  • UKIPS require measurement against a comparable benchmark, that is representative of the fund advertised, to help investors assess the effectiveness of the investment strategy
  • By requiring companies claiming compliance to present at least five years, (or from date of fund inception, if less) and up to 10 years worth of annual return information, the format provides a good long-term indication of achieved return and volatility

 

Accuracy of Calculations

 

  • Firms with multiple products with similar investment strategies and objectives are required to make available the performance of all such funds to provide an indication of the overall management ability and volatility of the firm's management style
  • Monthly returns are geometrically linked to produce more accurate annual return calculations
  • Because a firm's funds that have similar management styles and objectives are grouped for presentation purposes, firms can legitimately promote past performance on new funds

 

Cost Effectiveness

 

  • UKIPS are already an existing standard in the U.K. and is endorsed, sponsored and recommended for use by members of the Association of British Insurers, the Association of Consulting Actuaries, the Investment Management Association, the National Association of Pension Funds, the Society of Pensions Consultants and the UK Society of Investment Professionals
  • According to a 2002 survey, The Spaulding Group estimated that 56% of U.K.-based money managers were already compliant with UKIPS
  • Because many of the firms targeted by these proposals already follow UKIPS or are seeking to comply with them, the time and cost required for implementation of performance presentation standards by adopting UKIPS are reduced
  • Firms that already use UKIPS for managing pension funds will not need to have two different sets of performance presentation requirements - UKIPS for pension funds and an FSA standard for other funds - which should result in even wider acceptance of performance transparency that will benefit the investing public

 

Universal Usage - Local GIPS versions are followed by firms in

 

  • Commonwealth countries - United Kingdom, Canada, Australia and New Zealand
  • Current or accession EU and EEA countries - United Kingdom, Austria, Denmark, France, Hungary, Ireland, Italy, Luxembourg, Netherlands, Norway, Poland, Portugal and Switzerland; Belgium, Germany and Spain are waiting IPC approval of their submissions to adopt GIPS
  • Largest financial markets in the world - United Kingdom, United States, Switzerland and Japan

 

It is on the basis of these benefits that the Committee recommends to the FSA that it encourage the use of UKIPS as a self-regulatory solution for standardising past investment performance rather than creating its own standard for collective investments and unit-linked policies. Furthermore, the Committee's responses below to the specific questions raised by the FSA in the Paper are based on the standards created by UKIPS and the advantages stated above.

 

Specific Remarks

 

Question 1: Do you agree with our chosen style of presentation for standardised past performance information?
 The style chosen by the FSA for collective investment schemes and unit-linked life products contains the following characteristics:

 

  • Simple return calculations
  • No benchmarks
  • Discrete annual returns presented as annual percentage changes over five years

 

The Committee does not agree with the style proposed or with the characteristics of the proposal.

 

One objection to the proposed presentation method (the "Proposal") is that it does not include comparative benchmarks which are readily available for most if not all retail products. [Absolute-return products are more difficult to benchmark because they do not use such comparisons. However, these funds represent a small, yet growing, portion of the investment universe for retail investors.] The Authority notes in the Paper that it decided against using benchmarks in part because of the problems associated with comparing an equity-based product with a deposit account. While the Committee agrees that such comparisons are irrelevant and might give investors misleading impressions about fund performance and that the findings of the FSA's market research highlight potential problems, the Committee is concerned that presenting performance information without also providing a point of reference will not help investors make informed decisions about their investment options.

 

Another concern is that the Proposal's use of simple return calculations over a five-year period would require investors to base their decisions on potentially incomplete information. The Authority points out that its decision to use this method was based on the ease with which consumers could use and understand the information, and the ease of calculation for firms. However, the Committee is concerned that this type of calculation will not provide an accurate assessment of true performance over a given period. Where investors' protection is involved, accuracy of essential disclosures should not be sacrificed for the ease and convenience of preparers of the disclosures.

 

Finally, the Authority's Proposal to present performance data for a five-year period may also fail to give potential investors an accurate picture of the investment manager's abilities to weather economic storms. For example, a presentation made in early 2000 would have included, to a very large extent, information from bull-market phases during which many funds generated strong returns.

 

UKIPS overcome all of these problems. On the matter of benchmarks, the Standards provide investors with relevant comparisons between, for example, equity funds designed for long-term capital appreciation and other funds with similar characteristics. Such comparisons will give investors a relevant point of reference that can help them make better investment decisions.

 

Likewise, adoption of UKIPS would eliminate the Committee's concerns over return calculations by providing a geometric linking of monthly returns over the course of a year. In time, the Standards will require firms to calculate these returns based on more frequent increments. This accomplishes the same purpose that daily compounding of interest does for deposit accounts.

 

Finally, by requiring firms to present performance data for up to 10 years, UKIPS give investors information that will cover a wide range of economic situations and market environments. In turn, this gives investors an idea of which firms have a steady track record and which merely benefited from the market's growth.

 

As a result of these reasons, together with those listed above in the "General Comments" section, the Committee reiterates its recommendation that the FSA encourage the use of UKIPS as a self-regulatory solution to standardising presentations of past investment performance.

 

Question 2: Do you agree with the distinction we draw between the different classes of product?
 The Committee had no opinion on the distinction of product classes.

 

Question 3: Do you agree that firms should be advised to refrain from using monetary terms to present past performance information in advertisements directed at the mass market?
 In the Paper, the Authority noted consumer research that indicated that financial promotions that put performance into monetary terms are more effective at swaying investor views about the relative performance of an investment scheme. In light of this, the FSA Proposal would prohibit the use of monetary terms in promotions for retail investors.

 

The Committee concurs with the Authority in its concern about the possible manipulation that might occur from the use of monetary terms in financial promotions. Again, the UKIPS call on users to present past returns as percentage gains and losses rather than as monetary gains and losses. As such, they achieve the FSA's goal in this instance.

 

Moreover, as stated above, UKIPS create competitive pressures on investment managers to come into compliance with these voluntary Standards or face a loss of business opportunities. In part, this is because investors, both institutional and retail, have become increasingly aware of the Standards and what they represent, even though many do not understand fully how they are calculated. As a result, through voluntary compliance the Authority could avoid having to set limits on what firms cannot say in their financial promotions.

 

To achieve this status, though, consumers must become aware of the Standards. Given that these Standards are promoted by a self-regulatory organization - the UKIPC - on which the FSA has an observer seat, the Authority could request and have some say in industry assistance in promoting the value of UKIPS to investors.

 

Question 4: Do you consider the rolling years approach to be the most appropriate?
 The Committee does not believe the rolling-years approach is the most appropriate, in part because it provides firms with an opportunity to advertise those periods that put their performance in the most favorable light. For example, a firm that has done poorly in recent months might choose to present information up to the most recent quarter's end rather than up to the most recent period.

 

UKIPS, on the other hand, require all compliant firms to present performance numbers on an annual basis for funds in existence for more than one year, and year-to-date actual performance for funds with less than one year of experience. The result is that investors can determine how one investment performed vis-à-vis another during the same period and reduces the temptation for firms to "work" with the return figures.

 

Question 5: Do you agree that firms should be required to show at least one 12-month period of standardized information?
 The Committee does not agree with the Authority's proposal and points to UKIPS as a way to handle interim periods for new investment funds. Under these Standards, firms can advertise performance data for funds with fewer than 12 months of experience so long as they provide non-annualized returns. For new funds that are managed in the same way and with the same objectives as funds already managed by the same firm, the firm can and in most cases is required to consolidate the performance data of all of those similarly managed funds to present an overall picture of the firm's competence.

 

Furthermore, firms in both situations must provide, among other things, the following:

 

  • A description of the firm
  • How an interested party can obtain a presentation that complies with the requirements of the Standards and/or a list and description of all firm funds that claim compliance
  • A description of the strategy of the fund being advertised
  • Whether performance is shown before or after the deduction of investment management fees
  • The total return of an appropriate benchmark for the same period for which the fund return is presented, including the name and a description of the benchmark
  • The currency used to express performance
  • Whether derivatives and leverage are used as an active part of the investment strategy and, if they are, a description of their use and the extent of such use

 

Question 6: Do you agree that firms should not be allowed to mention past performance in relation to a product with less than 12 months' performance data?
 As noted in its answer to Question 5 above, the Committee believes firms should have the ability to mention past performance relating to a product with fewer than 12 months' performance data. To do so under UKIPS, however, they must abide by the calculation and disclosure requirements of the Standards.

 

Question 7: Do you agree that the standardised data should be given no less prominence than any other piece of information about past performance?
 The Committee agrees that firms should give equal or greater prominence to standardised data as is given to other promotional material. However, given that firms complying with UKIPS are required to present up to 10 years' of performance data, it is likely that firms wishing to advertise their products will have little incentive to make other promotions more prominent as a result of the potential costs these may impose on them.

 

Question 8: Do you agree with our estimate of the costs and analysis of the benefits of these proposals?
 The Committee agrees with the Authority's assessment of the benefits resulting from the presentation of standardised investment performance data. As for the estimated costs, the Committee, as stated in the General Comments section of this letter, believes that a more cost-effective approach to achieving the FSA's goals would be to encourage the industry to adopt UKIPS as the standard by which firms offering collective investment schemes and unit-linked products market themselves.

 

Such a decision would not only achieve the goals of the Authority's proposals - namely an improvement in the quality of products offered and sold and an improvement in competition - but would also reduce the costs to both the FSA itself and the firms offering these products.

 

Closing Remarks

 

The EAC appreciates the opportunity to comment on the FSA discussion paper 183 on Standardising Past Performance. If you or your staff have questions or seek amplification of our views, please feel free to contact James C. Allen, CFA, by phone at +1.434.951.5558 or by e-mail at james.allen@cfainstitute.org.

 

Sincerely,

 

Frederic P. Lebel, CFA
Chair
European Advocacy Committee 		James C. Allen, CFA
Associate,
AIMR Professional Standards & Advocacy

 

1 With headquarters in Charlottesville, VA and regional offices in Hong Kong and London, the Association for Investment Management and Research® is a non-profit professional association of more than 65,000 financial analysts, portfolio managers, and other investment professionals in 116 countries of which 50,439 are holders of the Chartered Financial Analyst® (CFA®) designation. AIMR's membership also includes 127 Member Societies and Chapters in 46 countries.