Heads I Win, Tails You Lose. Best Practices in Investment Reporting By: Gabriel PotterMBA, AIFA® 2013.03.05

Since the ERISA 408(b)2 rules took effect, retirement plans in the US committed themselves to ensure that the fees were being charged were assessed and evaluated for reasonableness.  ERISA specifically applies to retirement plans, but we consider this a best practice which should be followed by institutions of all types as well as individual investors.  For our clients, benchmarking is a given.  Still, we have been honestly a little surprised by the reticence of other financial services firms to assess and report their own fee structure for all of their clients – retirement plan, institution or individual.  There is not always a direct financial incentive for any firm to check their own costs, but the laws of competition applies equally to the financial services market.   Besides, how much loyalty does a client lose when they have to ask why they are paying so much when there are less expensive options available for identical services?

A contract is defined as a “meeting of the minds”; we find it worrying when the true costs are simply not understood by all the parties involved.  For instance, some investors believe that they are paying a nominal hard dollar fee for their advisor, but simply were unaware about how the fees embedded within revenue sharing, soft dollar arrangements, and so forth.  Some investors believe they have received investment returns net-of-investment-fees, when they actually have gross-of-investment-fees performance. 

Finally, the investment returns presented to investors must be compared to a relevant benchmark or target.  Imagine a hypothetical large cap blend mutual fund.  In the year 2008, the fund suffered an annual loss of -39%.  Naturally, their fund commentary highlights the difficulty affecting the entire market and their peers.  Fortunately for this mutual fund, they substantially recovered in 2009 & 2010 with annual gains of 24% & 13%, respectively.  For these recovery years, their annual fund commentaries highlight the incredible absolute returns the fund earned.

So, is this large cap fund performing well? 

Savvy investors will note that the losses and gains posited are always 2% behind the relevant benchmark – the S&P 500 – during the up-years and the down-years.  The fund commentary doesn’t reflect this reality; the commentary highlights their positives and takes advantages of the negatives.  Similarly, a portfolio may be sold with unearned “spin” by highlighting positive-alpha managers, and ignoring those who have fallen behind.  A relevant benchmark provides a fair source of comparison to judge the investment.  Investors should be wary of a “heads I win; tails you lose” scenario, if they accept performance without appropriate benchmarks.

Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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