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Hypothetical and Unaudited Returns: Challenges and Acceptance in the Marketplace August 31, 2010.

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Presentation on theme: "Hypothetical and Unaudited Returns: Challenges and Acceptance in the Marketplace August 31, 2010."— Presentation transcript:

1 Hypothetical and Unaudited Returns: Challenges and Acceptance in the Marketplace August 31, 2010

2 Today’s Presentation GIPS: Distinguishing between Supplemental, Additional, and Model Common Applications: Inception of a Strategy Portable Strategies UMA Strategies FINRA Rule 2210 and SEC Rule 482 Q&A

3 The presentation will cover both RIA and B/D regulations/best practices. Audited/Unaudited is consultant terminology, not CPA terminology Consultant terminology: audited/ unaudited returns CPA terminology: performance examination, review, compliance attestation

4 Supplemental Information GIPS: Firms are “encouraged to present all relevant information beyond that required and recommended” –Fair representation and full disclosure –Cannot contradict compliant information Supplemental information: –Performance-related –Part of a compliant presentation –Supplements or enhances required/recommended provisions –Clearly labeled –Not examined by independent verifier as part of verification GIPS Guidance Statement: Use of Supplemental Information

5 Supplemental Information What is NOT supplemental: (no need for label) –Additional information: Additional benchmarks, added disclosure, monthly updates to the annual presentation –Non-Performance Related information: general information regarding the firm, strategy or details about the process –Misleading information: linking model, backtested results or non-portable performance to actual, ongoing performance results

6 Supplemental Information Examples of Supplemental Information Supplemental information must relate directly to the compliant presentation. Examples of supplemental information include, but are not limited to: Carve out returns that exclude cash Non-portable returns Model, hypothetical, backtested, or simulated returns Representative account information, such as: Portfolio-level country weightings Portfolio-level sector weightings Portfolio-level risk measures Attribution Composite or portfolio-level specific holdings Peer group comparisons Risk-adjusted performance

7 Supplemental Information You may prepare and present information according to specific requests from prospective clients. You may present compliant and noncompliant information on the same page. –When in doubt: separate. –If presented separately, relate it to the compliant presentation. Compliant firms: must provide fully compliant presentation prior to or accompanying supplemental information.

8 Inception of a Strategy During the initial 18-month period of building a performance record, investors are more understandable of unaudited returns More scrutiny is placed on risk management, infrastructure and operational due-diligence After this “grace period” unaudited returns send up a red-flag, and place you at a competitive disadvantage

9 Inception of a Strategy Paradigm Shift post Power lies with the investors Institutional Program Check-list: - Will ask for the scheduled delivery timeframe for audited results Audited returns suggest professionalism, transparency, and fund quality Provides data accuracy Investor Sentiment

10 Inception of Strategy Sample of seeded track record

11 Inception of Strategy Sample of paper track record

12 Inception of a Strategy Paper portfolios vs Seed money –Does it add credibility to have a paper portfolio audited? No. Size –How much does size of inception portfolio matter? Time Period –Length of time before it’s marketable? Consultants View

13 Portable Strategies a. Performance track records of a past firm or affiliation must be linked to or used to represent the historical record of a new firm or new affiliation if: –i. Substantially all the investment decision-makers are employed by the new firm (i.e., research department, portfolio managers, and other relevant staff), –ii. The staff and decision-making process remain substantially intact and independent within the new firm, and –iii. The new firm has records that document and support the reported performance. b. The new firm must disclose that the performance results from the past firm are linked to the performance record of the new firm, c. In addition to 5.A.4.(a) and 5.A.4.(b), when one firm joins an existing firm, performance of composites from both firms must be linked to the ongoing returns if substantially all the assets from the past firm’s composite transfer to the new firm. d. If a compliant firm acquires or is acquired by a noncompliant firm, the firms have one year to bring the noncompliant assets into compliance. GIPS Guidance Statement on Performance Record Portability

14 Portable Strategies Other “fair representation and full disclosure” considerations: M&A: Determining/disclosing assets under management M&A: Determining a “surviving” composite –link to the ongoing performance of the merged composite –recommend that the performance of the “non-surviving” composite be made available as supplemental information upon request Events that impact the firm’s operations and/or investment process (for example, change in ownership, merger or acquisition, departure of key investment professional, etc.) must be disclosed.

15 Portable Strategies

16 Presentational Linking: Could be misleading

17 Portable Strategies A Quick Solution

18 Portable Strategies Non-portable track records are not considered during the investment selection process: 3(c)1 Funds: –Limited to 100 investors –Must all be Qualified Clients to charge performance fee –Manager cannot use previous track record from another fund 3(c)7 Funds: –Limited to 499 investors –Must all be Qualified Purchasers –Manager is able to market previous performance Portable vs. Non-portable

19 UMA Strategies Unified Managed Accounts – combine a diversified portfolio of multiple instruments and managers into one account with a single registration, largely through the use of model arrangements –Advisory firms don’t have trading discretion –Assets through UMA or other agreements where there is no discretionary portfolio management responsibility are: –NOT part of a composite –NOT part of the GIPS firm assets –NOT included in ADV assets

20 UMA Strategies Could UMA assets be included as Supplemental Information? As of 2005, composite assets are $238 million and an additional $24 million employ the strategy through a model unified managed accounts program not included in XYZ assets. [If on a separate page, state: This is supplemental information. Please see full disclosure presentation located….]

21 UMA Strategies As of 2005, firm assets are $462 million, which includes $260 million in equity investments and $102 million invested in fixed income and cash equivalents. The firm also has model advisory contracts for $69 million, which we have no trading discretion for and do not include in firm assets. [If on a separate page, state: This is supplemental information. Please see full disclosure presentation located….] NOTE: Nowhere does the presentation add together firm assets and model UMA assets, which could be misleading. Firm assets: $462

22 FINRA Rule 2210 Prohibits funds from referencing hypothetical performance returns in any written sales literature What it does permit: (1) Hypothetical illustration of a mathematical principle (2) A verbal discussion of the performance that would have been achieved, so long as it is not in any written format or on any leave behind material Hypothetical Returns

23 FINRA Rule 2210 Prevents funds from excluding material information, if such information would cause the communication to be misleading Prevents “cherry picking” and presenting specific years’ performance or investment ideas, without representing the whole For any performance or benchmark information presented, the method of calculation and benchmark comparison must be explicitly stated Performance Standards

24 SEC Rule 482 Overlap with FINRA Rule 2210 –Require standardized performance information –Prohibits the exclusion of materially relevant information Addition to FINRA Rule 2210 –Claims that “boilerplate disclaimers” are insufficient to avoid misleading investors –Must adhere to federal antifraud securities provisions Performance Standards

25 In Summary The capital raising environment is more competitive than ever $9.2 BB of the $9.7BB allocated to hedge funds in Q2, went to funds >$5BB AUM Movement towards a regulated environment Adherence to institutional standards and compliance is of paramount importance Treat your fund as a business Put forth best practices Investor flight to quality

26 Q&A David T. Rondeau, Sean Long PrincipalsKim Cash, Partner Southport Harbor AssociatesAshland Partners & Company David direct: Cell: Sean direct: Contact info:


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