(Photo: iStock)
(Photo: iStock)

Opinion | Returns from PMS, AIFs tell only half the story, thanks to poor disclosure

Standardized, comprehensive performance disclosures are a fundamental necessity

Asset management companies (AMCs) prominently display scheme returns. Scheme return advertisements, also known as performance disclosures, are often standardized through regulation. Many of the disclosures contain multiple pieces of information, but investors choose to focus on return numbers and then select investment schemes. Screening investment schemes based on just returns can lead to disappointment.

The first reason for potential grief is that returns never tell the complete story, not even half the story. The bigger reason, at least in India’s PMS (portfolio management services) and AIF (alternative investment fund) space, is that fund managers may advertise returns in ways that suit them the best. Managers may even misrepresent their real performance.

PMS assets, excluding pension money, are at more than $50 billion now. This is big enough to impact markets should something go wrong. Performance disclosure standards for PMS and AIFs are currently almost non-existent. Standardization gaps in performance disclosures have let inefficient and rogue fund managers survive in the system.

The Securities and Exchange Board of India (Sebi) recently published draft guidelines on PMS performance disclosures. The regulator’s attempt to provide better information clarity is a step forward in stopping the misselling of PMS schemes.

Performance misselling 101

One of the easiest misselling tricks unregulated fund managers use is to advertise model performance instead of real performance. A prospective client who buys a scheme based on model performance assumes that the model performance is what the client will get. Nice upward graphs on glossy sheets can easily lead the client astray. The other commonly used sleight is to showcase performance of winning schemes. A manager could be managing five schemes, with one winner and four losers. Will you want to invest your money with this manager? Using “easy to beat" benchmarks and calculating returns in ways that window-dress true performance are other common ploys managers use to misrepresent their true abilities.

Just a few years ago, not just PMS managers but mutual fund managers too compared their investment scheme returns with “easy to beat" price return benchmarks, which reflect underlying asset appreciation (stocks in the case of Nifty or Sensex). They do not include the dividends that stocks give. The return of a price return benchmark is, therefore, always lower than the return of a “total return" (price plus dividend) benchmark. This makes price return benchmarks easier to “beat". Not many investors, including some sophisticated practitioners, understood or raised their voice against this mischief. Last year, Sebi published amendments to mutual fund performance disclosure standards mandating AMCs to compare their schemes with total return benchmarks. Although many PMS and AIF managers have now started using total return benchmarks, explicit regulation will bring much needed clarity.

It is hard to say which of the frequently used “return" ploys investors will fall prey to. In any case, investors really need manager skill and an industrious investment team that can deliver on their needs. Selecting the right investment manager for managing one’s goals comes through research. Performance returns are an important starting point, but there are other factors that need careful consideration. Fund manager discipline, investment process, style, portfolio characteristics are among the many aspects that facilitate superior fund manager or scheme selection. Large institutional wealth advisors have the capacity to understand the sophistication that manager selection demands. The retail investor, including segments of high net-worth individuals and their advisers, are not in the know. The knowledge is not rocket science, but practitioners need to update themselves. Most learning resources on performance reporting are an internet search away.

Best practices and a history snapshot

Problems we are facing have been encountered by other investors around the world. Manager selection and performance reporting know-how has been evolving for some time. Peter Dietz’s 1966 work on measuring investment performance is where it all began. Over time, litigation, consumer awareness, regulatory measures (including industry self-regulation) and investor demand helped start the GIPS (Global Investment Performance Standards) movement in 1987. The GIPS standards are voluntary and now have over 30 years of developmental learning. The standards cover 46 markets and 24 of the world’s top 25 asset managers. Importantly, the standards have come to represent the collective wisdom and needs of a very large and diverse group of financial services experts.

End note

Standardized but comprehensive performance disclosures are a fundamental necessity. Learning from global standards is an opportunity to quickly bridge our own evolution gaps. In many ways, especially in performance disclosures, we seem to be converging to global learning outcomes. It may, therefore, be useful to proactively embrace best practices that have evolved around the world. Why reinvent wheels?

Shreenivas Kunte, CFA, CIPM, is director, content and advocacy, CFA Institute

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