Tag: performance advertising

Restructuring and Adviser Performance Track Record

The Securities and Exchange Commission has been skeptical of registered investment advisers using advertisements. The default position is always that it’s likely to be fraudulent, deceptive or manipulative and therefore a violation of Section 206 of the Investment Advisers Act. The level of skepticism has been even higher for performance advertisements and even higher for performance advertisement of a predecessor.

That has lead to the problem of an investment adviser carrying over his or her performance when joining a new firm. Since this happens often, the industry has been able to get the SEC to commit to some clear standards.

The SEC has laid out a five part test for an advertisement that includes prior performance results of accounts managed by a predecessor entity

  1. The person or persons who manage accounts at the adviser were also those primarily responsible for achieving the prior performance results
  2. The accounts managed at the predecessor entity are so similar to the accounts currently under management that the performance results would provide relevant information to prospective clients
  3. All accounts that were managed in a substantially similar manner are advertised unless the exclusion of any such account would not result in materially higher performance,
  4. the advertisement is consistent with staff interpretations with respect to the advertisement of performance results, and
  5. the advertisement includes all relevant disclosures, including that the performance results were from accounts managed at another entity.

The latest guidance from the SEC on this involves a restructuring of an investment adviser firm. South State Bank owned South State Advisory and Minis & Co., each of which were separately registered as investment advisers. The Bank wants to merge Minis and South State Advisory together for some operational efficiency. This triggers the performance advertisement from a predecessor entity concerns.

The Bank proposed that Minis would merge into the other advisor, but operate as a division within it. The SEC said it was okay to keep the performance track record based on the facts.

  1. the Minis Division will operate in the same manner and under the same brand name as Minis
  2. the Minis investment personnel, as well as the management, culture, and processes that helped to give rise to Minis’ track record, will continue after the merger
  3. The same management team that currently manages Minis would manage the Minis Division
  4. the Minis investment committee would continue to have responsibility for the Minis Division’s investment decisions and recommendations
  5. Minis’ performance track record by the Minis Division would be accompanied by appropriate disclosure

Minis pointed out the obvious flaw in the SEC position with the performance track record.  Personnel, management, culture and processes will evolve over time at any firm. Minis merely point out that none of those things are happening immediately as part of the restructuring.

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Best Practices for Presenting Model and Hypothetical Performance

These are my notes from an ACA Compliance Webcast on this subject. I’m sure you can find a replay on the ACA website.

There were three great presenters:

  • Alicia Hyde, Partner, ACA Performance Services
  • Mike Sonnenburg, CIPM, Managing Director, ACA Performance Services
  • Kim Daly, Managing Director, ACA Compliance Group

Definitions

The first topic was what these terms mean:

Model–A list of investments and transactions for an investment strategy that are not actually held by the portfolio but can be backtested over historical periods and/or run contemporaneously. Model portfolios are typically constructed using individual securities (stocks and bonds), ETFs, pooled funds, or other investment products. Also known as a paper portfolio, a policy portfolio, or a target portfolio.

Hypothetical–Performance of a model or synthetic portfolio (i.e., non-actual performance). Hypothetical performance can be ex-post and/or ex-ante.

Backtested–Ex-post testing of an investment model to see how it would have performed historically. Backtesting attempts to demonstrate how an investment strategy, constructed with the benefit of hindsight, would have performed as if it had been implemented historically.

Simulated –Same as backtested; non-actual performance and can be ex-post or ex-ante.

Theoretical–Same as backtested; non-actual performance and can be ex-post or ex-ante.

Ex-ante–Projected future performance. Ex-ante performance is non-actual and, as such, is hypothetical.

Ex-post –Performance over historic (after the fact)periods. Ex-post may be non-actual or actual performance.

Contemporaneous (Live) Model–Performance derived from a live, or contemporaneous model, where investment decisions occur in real time. Live model performance is still considered non-actual.

Synthetic Portfolio–The ex-post combination of actual portfolio returns. For example, taking an actual equity portfolio and combining it with an actual fixed income portfolio to create a synthetic balanced portfolio. The underlying performance is that of actual portfolios, but they are synthetically combined according to a prescribed asset allocation. Synthetic performance is considered to be hypothetical performance.

The Law

The main limitation is section 206 that prohibits you from being fraudulent, deceptive or manipulative. That has been further extrapolated by the SEC in Rule 206(4)-1, the advertising rule. That rule has been further elaborated in the Clover No Action Letter.

All of this has been heightened by the F-Squared cases that failed to properly disclose that the adviser and the firms that used its services were not based on actual performance.

Presenting Model Performance

  1. Model portfolio performance must not be presented in a false or misleading manner.
  2. Model performance should not be linked to actual performance.
  3. ‘White-labeling’ third party model performance requires sufficient due diligence.
  4. Model portfolio performance must include specific, accurate, and robust disclosures.

Model Performance Disclosures

Disclosures should address these items:

  • The limitations inherent in model results,particularly the fact that such results do not represent actual trading and that they may not reflect the impact that material economic and market factors might have had on the adviser’s decision-making if the adviser were actually managing clients’ money
  • Any material changes to the conditions, objectives, or investment strategies of the model portfolio during the time period portrayed and, if so, the effect of any such change on the results portrayed
  • As applicable, that the adviser’s clients had investment results materially different from the results portrayed in the model

Include the following disclosures:

  1. The results do not represent the results of actual trading using client assets but were achieved by means of the retroactive application of a model that was designed with the benefit of hindsight.
  2. The returns should not be considered indicative of the skill of the adviser
  3. The client may experience a loss.
  4. The results may not reflect the impact that any material market or economic factors might have had on the adviser’s use of the back-tested model if the model had been used during the period to actually manage client assets.
  5. The adviser, during the period in question, was not managing money at all, or according to the strategy depicted.
  6. The back-testing is for a strategy that the client accounts will follow or, if not, what difference there will be.

You can show projected returns

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