Investment Performance Measurement – Introduction and Importance

Investment Performance Measurement is a series of modern day application of classical statistics to investment related data, so as to differentiate investment manager’s success from failure on a macro level. On a micro level it is used to determine the success or failure of a particular portfolio’s performance too.

Investors, be it individual or institutional, create their investment portfolio which consists of various investment assets that are traded over several stock exchanges like NASDAQ or NYSE and many more. Such trading does affect the rates of returns of individual securities. If an investment asset in a portfolio brings in more return, it consequently increases the overall rate of return of the portfolio.

Investment managers are approached by the investors to strategically design their portfolios. Depending upon their reputation in the market such Investment Managers charge hefty commission or fees to the investors to chalk out value based asset allocation thereby predicting / targeting increased portfolio returns. Of-course, apart from targeting returns, the investment managers also consider various risks and time frames. If the portfolio fetches returns above predictions / targets, the investment manager is considered to be successful in strategizing asset allocation and would add feathers in his cap of success.

Many reputed companies in the United States like JP Morgan, Goldman Sachs, Mellon, Wachovia Corp., Morgan Stanley, Smith Barney etc., do performance measurement and evaluations to analyze the performance of their client portfolios and success of their investment managers. Of-course, there are other companies too, which might not be so very popular, but are actively involved in this foray of business. Such companies would be Ortec-Pearl, Base-Two Investments, Wilshire, First Rate, Sungard, and Wilmington Trust and so on and so froth.

Each portfolio is evaluated against certain guidelines and parameters (such as duration or weight by sector, free inflows & outflows, quality rating, country or region) that are established before the launch of the portfolio. Often portfolios are measured against established benchmarks like S&P 500, Russell 1000 or Dow-Jones Industrial Average. While investment manager makes trading decisions within the scope of each portfolio, how well he has executed these decisions is determined through the portfolio’s return and performance against its benchmark. Investment Performance Measurement clarifies whether the trades executed in a portfolio have been profitable and whether the bets (over-weights and under-weights) made in the portfolio have been paid off.

Being in the business of Investment Performance Measurement does not mean that anyone can change or invent his / her methodology for evaluating performances. This domain of business is tightly griped by the established Global Investment Performance Standards (GIPS). Companies involved in this business have to adhere to the guidelines governed by the GIPS, for calculating and reporting investment related whitepapers and analysis. These standards provide requirements and guidance for calculations, frequency of measurement, composite architecture and disclosure of methodologies and anomalies in the presentation of performance related data.

In developing countries like India, Investment Performance Measurement is a domain which is less explored and is still in a very nascent stage. The fact that there is not even a single Indian authored book written on this subject and that educational institutes have still not identified it as a discipline, shows us the virginity of this investment science at-least in India. Till date CIPM remains the only acceptable designation globally in the field of investment performance measurement, and is awarded by the CFA Institute in the US.

I am totally thrilled and excited to demystify whether the portfolio’s return is attributable to the investment manager’s skills or just luck and whether the portfolio is being managed to the style identified in the investment management agreement. If you are also equally thrilled and excited as I am, then don’t forget to check this blog-page in future for more detailed information around this subject. Your feedback and suggestions would definitely help and would be embraced with both my hands.