Performance Measurement  For Trustees

by Stuart Fraser
Director, Investment Management Division, Williams de Broë
(From Issue 5,July 1998)

Trustees have both a duty and a fiduciary responsibility to ensure that Trust monies are not only invested in accordance with the objects of the Trust but that they are also being managed effectively.  As a generalisation 1 believe that, outside the institutional arena, Trustees have little concept of the issues involved in benchmarking portfolio performance.  In consequence they either ignore the whole subject or are easily deflected when challenging apparent poor performance by their investment manager/advisor.

Performance measurement against either standard industry or tailored benchmarks has been established for over a decade in the institutional market.  Virtually every Trustee of a Pension Fund and the larger Charities are well aware of the performance of their investments, over many years, as many, if not all, subscribe to one of the recognised performance measurers, Combined Actuarial Performance Services (CAPS) or World Markets (WM).

However, in the Private Client and Trust market benchmarks have not existed until the introduction of two new measurement services provided by  WM and The Association of Private Client Investment Managers (APCIMS) in February 1997. WM have named their service `Private Client Indicators` and APCIMS ` Private Client Indices`.

For the professional and/or conscientious Trustee, these two sets of `measurement tools` are clearly welcome and provide a framework around which portfolio performance can be assessed.  It is therefore important to understand what they measure, how they are constructed, how they should be applied and their limitations.

Both sets measure the performance of theoretical portfolios comprised entirely of stock exchange indices.

They are compiled from the result of regular surveys of asset allocation models.  APCIMS survey over sixty investment managers, including solicitors and accountants, responsible in aggregate for over fifty thousand discretionary client portfolios.  WM survey twenty-six leading investment managers responsible for over forty thousand discretionary portfolios.

In both cases the survey asks for asset allocation percentages across ten asset classes for three different types of portfolios classified under SFA regulations as Growth, Income and Balanced. Again both firms make six calculations to produce both capital and total returns for each of the portfolios.

However, in the calculation of performance there is a marked difference between the two.  WM use a relevant index for each of the ten asset classes and calculate using the `average` percentage for each class.  WM use only three indices, FTA All Share for UK equities, FTA World Ex UK for Overseas equities and FT Government All Stocks for Bonds and cash. Also they filter the response through an Investment Committee which meets every six months.  Although potentially the disparity between the two could be very wide due to the different methods used in calculations, to date the two have performed similarly, producing a total return, for Growth portfolios, of around thirty per cent for the year to the 5th April 1998.

In using these benchmarks Trustees should bear in mind that given the size of most Trust portfolios, they are likely to show a much greater divergence from trend than with say a large Pension Fund.  The Benchmarks are aimed at UK residents where capital taxes and dealing limitations are not a factor. Benchmarks do not suffer dealing or management costs so that also has to be borne in mind when comparing against real portfolios.

There are many Trustees, and even more Investment Managers, who believe that the whole concept of benchmarking using indices is seriously flawed.  I can understand the latter group as given the choice on being tested or not most would vote for the easy life.  In the case of the Trustees, I often find that objections centre around the “individuality` of Private Client portfolio requirement, the lack of balance within indices and a wish to avoid the apparent short-term performance testing evident in the institutional field.

Taking the points in reverse order.  It is Trustees who set the period over which investment managers are to be judged against their benchmarks.  In the Private Client field this should be at least three years and preferably five  Adopting benchmarking does not lead to short term investment management.

Indices are generally recognised as very imperfect, having heavy weightings in only a few sectors. Also the lack of depth and liquidity in markets can exaggerate trends or create very volatile conditions.  This has been very evident in recent months in the UK following the introduction of SETS.  Despite these imperfections indices are the only measure we have and are used across the institutional market to judge the performance of investment managers.  Obviously tax is a major differentiation but that does not excuse the proper measurement of portfolio performance.

Although clients are individuals, their investment requirements are often very similar. Most will fall into the standard categories of Growth, Balanced and Income. Some however may have unique or different requirements.  Perhaps they are non-UK residents, highly risk averse, require an exceptionally high income or wish to construct their own asset allocation guidelines.  In these cases standard industry benchmarks may not be appropriate but it is relatively easy to construct personalised or tailored benchmarks in these situations.

Perhaps the one major obstacle to benchmarking is the tax position within individual portfolios, particularly the accumulation of gains over a number of years.  Clearly it may not be in the clients’ best interests to realise those gains immediately, and this restraint would clearly hamper an investment manager in repositioning the portfolio for changing conditions and opportunities.  Without this flexibility the manager would be ill-advised to take on the rigours of benchmarking.  However, the Trustee can still use the standard indices as a benchmark to measure how much the policy of tax retention is costing in terms of lost opportunity.

As this is addressed to Trustees, it is, perhaps, worth making the point that imposing conditions on investment managers, either through insisting on tailored benchmarks or limiting tax liabilities, is effectively overriding the fund manager and is, therefore, clearly an “investment decision`.  Under these circumstances the Trustee then becomes accountable, and perhaps potentially liable, for the performance of the portfolio.

Performance measurement and benchmarking is here to stay.  WM and APCIMS will no doubt refine their products, but I believe they will become the recognised industry standards.  Trustees who ignore them and allow their investment managers to continue producing meaningless statistics, can only hold themselves to blame if they and themselves having to answer embarrassing questions from those for whom they act.

© Stuart Fraser 1998