On 31 March 2013, the Canadian Securities Administrators (CSA) published a notice outlining the amendments made to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103). Among other changes, the CSA has mandated the use of money-weighted returns on client statements because the CSA “have concluded it is the better choice for investors.” Due to harmonization efforts, these changes will also apply to members of the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA). In a nutshell, firms will be required to report one-, three-, five-, and 10-year performance results, as well as performance since inception, using a money-weighted performance methodology. Here is the Canadian Investment Performance Council’s take on the good, the bad, and the ugly with regard to the performance-related amendments to NI 31-103.

The Good

The performance-related amendments will come into force on July 15, 2015, and firms are not required to reverse engineer a performance track record. In other words, one-year money-weighted performance would not have to be reported until 2016, three-year performance would not have to be reported until 2018, and so forth.

There is nothing in the amendments to prevent asset management firms from also displaying time-weighted performance, but the onus will be on the firm to explain to clients the difference between the two sets of performance results.

The Bad

The CSA has stated that they chose money-weighted returns, in part, to “promote consistency and comparability in investor reporting from one registrant to another.” With the money-weighted return methodology, while the mathematical calculations used from firm to firm will be comparable, the returns will not. There are many cases where clients have investments across different managers or advisors. How do these clients figure out which part of their performance returns was due to timing of cash flows and which part was due to manager skill? How many clients are going to make an incorrect decision to move money from one manager to another based on money-weighted returns?

As index returns are time-weighted, another major drawback of the money-weighted methodology is the lack of comparability of client performance results to an index. How will a client determine if a manager is adding value? Clients often compare their results to an index as a double-check on manager performance.

The CSA stated that one of the reasons for choosing money-weighted returns is because it “is useful to a client as a measure of their progress toward their investing goals.” However, sometimes sophisticated clients explicitly state that their investment goal is for the manager to beat the return of a particular index. In such cases, the use of money-weighted returns is clearly not appropriate. Additionally, most clients have multiple assets (house, rental properties, cash, bullion, art, vacation property, and so forth) all of which could be used to meet their investment goals, so the inclusion of money-weighted returns on a client report doesn’t provide much information about how close a client is to reaching their overall investment goal. Finally, many clients have goals that involve saving enough money to create a targeted cash flow, often to fund retirement living. In these cases, neither rate-of-return methodology will tell them how close they are to reaching their cash flow goals.

In each of the above examples, time-weighted returns would be more valuable to clients because it would at least enable them to monitor manager performance and, if necessary, aid them in selecting a new manager.

The Ugly

Perhaps the biggest drawback of the amendments is the failure to require the reporting of any sort of risk metrics. Risk and return go hand in hand, and while requiring firms to report returns is generally a positive step, it is disappointing that the CSA didn’t require firms to display some sort of risk metric alongside the returns.

Canadian Investment Performance Council

The Canadian Investment Performance Council (CIP C) is recognized by the Global Investment Performance Standards (GIPS) Executive Committee as the official sponsor of the GIP S Standards for the Canadian market. The objective of the CIP C is to promote and advance the GIP S Standards in Canada and to support their promotion internationally. Some of the CIP C’s activities include reviewing guidance statements issued by CFA Institute, obtaining feedback from the Canadian marketplace, and forwarding submissions to the performance standards bodies, including the GIP S Executive Committee. Find out more about us at www.cfa.org.