Resources/Facts: Advisor Track Records

Advisor Track Records

Money managers have track records because they have discretion over client assets and they provide the same service to multiple clients. For example, a mutual fund is a money manager that pools investor assets. There are also money managers who keep investor assets in separate accounts. But, they deliver the same money management service to the separate accounts.

Discretion means advisors can make investment decisions without client approval in advance.  A mutual fund or separate account manager does not call you for approval when it sells or buys a security for your portfolio.

Financial advisors do not have track records. They say that is because each of their clients is different. Advice varies by age and circumstance. For example, investing for a 35 year old couple is much different than investing for a 75 year-old couple.

The Hot Fund

Watch out for advisors who manufacture fake track records. They may show you the performance of a hot mutual fund – there are 15,000, so a few are always hot. They try to convince you the fund represents their track record on the basis they selected it before the performance occurred.

You have no way of validating this undocumented sales claim so you should disregard it. There are 98% odds the advisor selected the fund after the performance occurred – anyone can do that.

Model Portfolios

Most advisors use model portfolios that reflect the needs of investors with similar goals and risk tolerances. For example, one model has high-risk exposure and performance for younger investors. Another model has low-risk exposure and reduced performance for older investors. Most advisor clients fall into four or five categories that are represented by model portfolios.

Models portfolios could have track records as long as investors hold the same investments.

Performance Benchmarks

How do investors evaluate the quality of their investment performance? They compare their results to Paladin Performance Benchmarks. There five benchmarks for investors who have a range of performance requirements and tolerances for risk.

Global Investment Performance Standards (GIPS)

There are a number of ways to calculate investment performance. Some of the methods are very misleading. The track records may have extensive disclosures that are so full of jargon that they are difficult to read and understand.

GIPS is an international standard that is used for the calculation of track records. The formula recognizes transactions, income, and cash flows. Financial advisors should use this standard when they calculate performance that they use to produce track records.

Audited Track Records

The next issue is who prepares the track record using the GIPS formula and standards? It should be an independent firm that is not affiliated with the financial services firm. The ideal preparer would be a brand name accounting firm that has substantial experience auditing firm track records.

Remember Bernie Madoff? He used a small three-person accounting firm on Long Island that was easy to manipulate. No audited track record and small firms should be considered major warning signs of fake track records.

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