An Interview with CFA Institute’s Jonathan Boersma
A new risk reporting standard is ready for hedge funds and other alternative investment vehicles. Those that adopt it are more likely to attract institutional money.
Jonathan Boersma has been working hard to standardize the quantification of investment risk as the chief overseer of the CFA Institute’s Global Investment Performance Standards — voluntary ethical principles known as GIPS. His next task: getting investment firms to start reporting it. And not just traditional asset managers, mind you; Boersma is also taking on the trickier challenge of getting hedge fund, private equity and real estate firms to adopt the reporting standard.
Boersma shepherded the creation of new risk standards last year. But they are only now coming onto the radar of investment firms, as they complete their annual GIPS compliance exercise — preparing standardized reporting documents for dissemination to institutional investors and investment consultants.
Between 85 percent and 95 percent of investment firms across the globe use GIPS, first developed 25 years ago, to report on their investment activities. Alternative investment managers have been slower to take them up. That is changing, says Boersma, as hedge funds and others look to make themselves more attractive to pension fund and other big investors.
Boersma visited Institutional Investor’s offices last week to speak with Senior Writer Frances Denmark about his efforts to get hedge funds, private equity and real estate investors on board with risk reporting according to GIPS.
Institutional Investor: Why risk reporting now?
Boersma: We view performance as a combination of risk and return. You can’t look at them independently. Historically the performance standards have focused on return elements. It’s much easier to standardize calculations and how performance is generated. We’ve recently been trying to address how risk is quantified. [We’re also working on] qualitative measures through certain disclosures.
How did you arrive at a standard risk measure for investment managers?
Risk is very difficult to get your hands around. Getting a common definition is difficult. Some view it as variability of returns. Others believe that a beta greater than one is somehow riskier. Others view risk in terms of bets. For example, a portfolio that is overinvested in technology stocks. Still others see risk as the possibility of losing money or not making money. It’s difficult to create a single definition that encompasses all of those elements, difficult to come up with a measure. The purpose of our standards is to provide comparability.
What risk measurement did you arrive at?
Countless numbers of groups have tried to standardize risk. At the end of the day they just gave up. They end up saying, pick one measure and show that. But that flies in the face of comparability. So we’ve had to start at a very basic level, and introduce a measure of three-year standard deviation of returns.
What has been the reaction to this choice?
Some people will argue that it isn’t a risk measure, especially managers with more esoteric strategies like hedge funds. It gets to be a theological argument. I don’t care what you call it, it’s a statistical measure of variability. It’s not a perfect measure but it’s well known. Every Morningstar report has standard deviation; anyone can calculate it with Microsoft Excel. It’s a good place to start.
What method did you use to reach consensus on this risk standard?
We followed a similar practice to regulators. We put out a proposal to all CFAs and the GIPS community and asked for comments.
Do you think investment managers will use the new risk standard?
One of the games managers played in the past was, “Let’s show whatever risk measurement that puts me in the best light.” It’s now [part] of our GIPS standards. Any firm that complies with GIPS has to use that measure. Some firms argue that it’s not relevant. But it indicates how your returns have varied over time. You show it and can also show other risk measurements you think are appropriate.
Why do you believe hedge funds and other alternative managers will comply with GIPS?
It’s a new era of transparency for hedge funds. There’s been tremendous scrutiny of the industry and attempts to regulate them and shine a little sunlight on them. GIPS standards are a great way hedge funds can address some of those issues. There’s nothing in GIPS that requires revealing their proprietary information, such as top holdings.
Also, institutional investors are demanding compliance with GIPS. For example, CalPERS and Norges Bank, the Norwegian sovereign wealth fund, have adapted GIPS in presenting performance reports to their boards. And large investment consultants like Towers Watson and Mercer will say to asset managers, “Don’t waste our time if you’re not compliant with GIPS.” It provides a framework to present a composite of multiple portfolios.
What has been the response from regulators?
The SEC has been advocating that hedge funds adopt GIPS. Fairness, transparency and integrity — GIPS is all about that. Those have all been sore spots over the past few years. Specific guidance on hedge funds is coming this summer.
How have hedge fund managers reacted to the new risk standard?
This is industry-driven. We have participants from all segments of the industry that helped develop these standards. It’s a universally held belief that an industry-developed solution is preferable to a regulatory, mandated one.