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Home > Library > Stable Times > Volume 3, Issue 1
The quarterly publication of the Stable Value Investment Association
First Quarter 1999 • Volume 3 Issue 1
Task Force Issues Report on Performance Measurement
Recommends Reporting "Fair Value" Total Returns in Addition to Book Value
By Allan Fen
In the fall of 1997, the Stable Value Investment Association created the
Task Force on Performance Measurement. The Association's charge to the Task
Force was to develop a practical framework for performance analysis of stable
value funds. The Task Force's primary focus was on addressing the major
deficiency in stable value performance reporting - consistent portfolio
return calculations, which are comparable across portfolios and with benchmarks.
Without this, performance analysis for stable value funds can never be as
thorough, objective and useful as it is with other asset classes.
The task force issued an exposure draft in March of last year. A number
of comments were received and this final report reflects changes made as
a result of these comments. The report was recently distributed to the membership
to begin the process of debate, discussion, testing and implementation throughout
the industry.
Performance analysis for any asset class has many components, including
returns, risk measures such as duration, credit quality, and volatility,
and for stable value funds, additional factors such as par/non-par allocation
and market/book ratios. But in the absence of consistent return numbers
across portfolios, performance analysis is seriously deficient. Book value
accounting is the foundation of stable value, but it poses serious obstacles
to meaningful return comparisons between funds and with benchmarks.
In order to have consistent and comparable return information, the task
force advocates the disclosure of returns based on "fair value,"
in addition to book value. Fair value return numbers overcome the comparability
issues posed by book value, making possible consistent comparisons across
stable value funds and with common benchmarks. Fair value is generally estimated
using market value for publicly traded assets, and for non-marketable assets,
some other reasonable and consistent estimation method is used. This approach
is already used for "Managed Synthetics," where the total return
based on market values is an essential part of any performance reporting.
In general, the task force looked first at approaches already developed
and accepted in other asset classes, particularly fixed income, and adapted
them to stable value, rather than blazing a new trail. These approaches
have withstood the test of time and are widely understood by investment
professionals.
Not only is the ability to have consistent return calculations important
in and of itself, it also opens up the stable value world to a host of other
performance analysis tools - benchmarks, composites, attribution, risk measurement,
etc. - which are meaningful only with consistent return numbers. With this
problem resolved, plan sponsors, investment managers and consultants can
evaluate performance of these funds with the same level of confidence that
exists with other asset classes. Compliance with AIMR presentation standards
would be a possibility. And most importantly, this will bring more accountability
into the investment and oversight process, which will ultimately benefit
stable value investors.
While the report focuses primarily on providing consistent performance comparisons
between funds for use by plan fiduciaries, investment managers and consultants,
other types of performance reporting should also be mentioned. The importance
of performance reporting to participants needs no elaboration, and for this
purpose, book value returns alone are the appropriate reporting basis. In
addition, book value is also the appropriate format for measuring returns
and return volatility when comparing risk/reward characteristics with other
asset classes in an asset allocation analysis. In this type of presentation,
book value is appropriate for the stable value asset class because, over
the long time periods involved, typically 10-15 years or more, the limitations
of using book value returns tend to diminish. But for comparisons between
stable value funds and with benchmarks, this is much too long.
The report is about six pages including a one and a half page overview at
the beginning. It discusses in detail the shortcoming of using only book
value when comparing stable value funds and gives examples of the cash flow
effects and the delayed gain loss recognition problems. It then discusses
how fair value addresses these issues and how it might be calculated for
illiquid assets such as GICs. There is a discussion on valuing the benefit
responsive option and of how the ability to present consistent return numbers
could lead to a comprehensive performance analysis framework, including
the possibility of AIMR compliance. The appendices have some additional
detail including performance simulations using both book and fair value,
AIMR compliance issues, and addressing the concerns raised by the membership
after the publication of the exposure draft.
Consistent, objective performance measurement is an integral part of investment
management in almost all other asset classes. It provides essential information
to plan fiduciaries, consultants, and fund managers needed to carry out
their responsibilities. It brings real accountability to the investment
process, which ultimately benefits participants. By addressing a major deficiency
in stable value performance reporting with the disclosure of fair value
return information, one can envision stable value performance analysis being
as useful and thorough as it is with any other asset class, and the industry
will benefit as a result.
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