Justifying the Cost of Performance

Over the last decade, investors have taken a more active interest in portfolio-specific rates of return. Investors commonly require investment advisers and portfolio managers to provide performance analysis reflective of all cash flows and transactions within each portfolio they manage. This analysis is a tangible demonstration of the value of their services, and is the foundation for communicating with investors.

While most investment firms understand how to calculate rates of return, few comprehend the true value that this data can provide. Most don't recognize the resources required to calculate accurate transaction-based portfolio analysis for large numbers of accounts. The industry continues to move from monthly to daily rate-of-return calculations, with daily calculations inevitable as industry regulatory bodies are expected to mandate them by 2010.

CONSIDER MORE THAN THE MATH
A good performance-analysis solution can dramatically improve efficiency and lower overhead costs associated with mundane tasks beyond simple mathematical calculations. Consider the time and expense spent compiling rates of returns for new business RFP responses and consultant databases, client communications, and Association for Investment Management and Research (AIMRTM) compliance composites.

When evaluating a performance solution, consider your firm's current processes and the costs associated with the following four responsibilities:

(1) Accurate Returns: Data inaccuracy is unavoidable. Whether a trade is missed, contributions are not reported, or a security is incorrectly priced, the result is an inaccurate performance return. A performance-measurement solution should aggressively identify these errors and either automate the correction process, or minimize the keystrokes required to make a correction.

The ideal system will perform automated-verification procedures that mimic the manual processes recommended by the firm's compliance officer. Powerful editing tools, along with automated audits and verification processes, will dramatically reduce resources while improving accuracy and lowering the risk of delivering inaccurate and potentially embarrassing rates of return. (2) Explaining Source of Returns: A performance solution with limited analysis capabilities causes additional work for investment advisers. How much time does your staff invest in explaining how a number was calculated? Consider the required effort if a client asks your investment manager to recalculate a performance return without a specific asset or industry group. Provoking potentially difficult questions such as these often is the reason that investment advisers are reluctant to discuss rates of returns with clients. Make sure that your solution provides easy access to returns and analysis that address the requests your clients or investment advisers will encounter. Performance analysis should convey your firm's investment philosophy and, if used properly, can be a compelling demonstration of the value that this philosophy adds for clients.

(3) Portfolio Aggregation: Between AIMR compliance and client demand for comprehensive wealth-management reporting, combining portfolios to calculate rates of return can be an exhaustive effort. Consider the processes currently in place to create composites that allow your firm to respond to new business proposals, consultant questionnaires and to fulfill AIMR Performance Presentation Standards (AIMR PPSTM) compliance issues.

An ideal performance solution capitalizes on the firm's existing composite-building approach, and provides analysis of the different rates of return and statistics required for each composite.

(4) Distribution: Every performance solution has two types of output " onscreen and printed. Evaluate your firm's requirements for online and printed output independently.

--Onscreen reporting decentralizes client-presentation creation and expedites rate-of-return delivery. Many performance systems also provide drill-down access to source data for calculated returns, which permits managers to verify data and gain comfort with the numbers before client meetings.

--For printed materials, an automated process that compiles client presentations can reduce preparation time by hundreds, or even thousands, of hours annually. Look for a solution that is customizable, creates cover pages and tables-of-contents easily, numbers pages, and combines performance reports with other types of documents, such as economic-outlook commentary, a mutual-fund prospectus, or AIMR PPS disclaimers.

AVOIDED COSTS ALSO PART OF THE EQUATION
A 2002 survey conducted by The Spaulding Group indicates that almost 50 percent of all investment advisers rely on spreadsheets to calculate and report rates of return. Even though they may recognize the need, most firms are reluctant to purchase a specific performance-analysis solution because of the cost.

When comparing the cost of an automated solution versus the cost of a spreadsheet application, consider the time administrative personnel spend copying data from spreadsheets to presentation software, adding page numbers to documents, and manually collating presentation books for every client presentation. Add up the hours investment advisers spend tracking down the source of a rogue rate of return, then explaining the error to the client.

A well-designed performance-measurement solution that automatically creates client presentations can be less expensive than dedicated resources supporting the current performance-reporting process. In addition, your firm should see fewer errors, expedited-delivery schedules for verified returns, and more time for investment professionals to focus on future opportunities " not past performance.

THE VALUE PROPOSITION
Analyze your current cost to calculate, maintain, and report performance before looking at a new performance solution. Base this on the number of times per year you analyze each portfolio and the portfolio count that you hope to achieve in the next two to three years.

Don't forget to include costs such as performance-calculation training, data maintenance, employee turnover, overtime and administrative support for graphic design and collating. This can often double or triple your costs.

Finally, identify if you are leveraging the calculated returns to benefit you and your clients. How would clients react if your firm stopped providing performance? What is the impact of reporting inaccurate rates of return that require restating? How is your firm leveraging this service to distinguish your managers and investment style from your competitors?

SIDEBAR:

SOFTWARE SHOULD ADAPT TO YOU
Integrating a performance-measurement solution into your current processes is key to leveraging the investment, and the best solutions will adapt to you. Following these steps will help ensure that you get maximum value from your performance-analysis solution investment.

How to calculate your current portfolio analysis costs:

1) Document your steps for calculating and reporting rates of return. Consider the time required for each step of the process including gathering data for rates of return calculations, calculating, auditing and verifying the rates of return, creating presentations containing these returns, and compiling each element of the final client presentation.

2) Multiply this number by the portfolio count that you hope to achieve in the next two to three years.

3) Then multiply that total by how many times per year the analyses are completed (usually quarterly or monthly) to learn how much time employees will spend annually developing client performance analysis presentations.

4) Multiply this by the average full time employee salary to find out your average annual cost for providing performance analysis.

5) Add other overhead costs including data maintenance costs and employee costs for graphic design services, training, turnover and overtime.