If you are an investor, you are likely to employ the services of a financial advisor at some point in your life. With tens of thousands of investment professionals out there, how do you find a skilled one? After all, you want someone with the proven ability and discipline to help you conservatively grow your assets through all phases of the market cycle.
Many investment managers hold credentials like the CFA (Chartered Financial Analyst) and the Certified Financial Planner (CFP). Does that mean they are an effective investment manager? Not necessarily.
So how can you evaluate a financial advisor’s investment performance?
You could rely on verbal descriptions of results. Things might be said in sales meetings to get you to on board. However, what is said verbally won’t help you if actual performance doesn’t match up.
Instead you want actual numbers, in writing. And not just for one year or a few years…you want to see a track record of several years. You want to see someone who has helped grow and protect investor money in both bull and bear markets.
Home-Made Investment Track Records
Some firms do publish their investment results, but in a format they develop. Unfortunately without any framework for comparison, these reports can be made to look more favorable than they are.
This is done in a variety of ways:
- manipulating time frames
- excluding certain items
- excluding fees and expenses
- choosing another benchmark to compare results against.
These types of practices are prohibited by industry regulations, but of course that does not mean they are not in use.
Unless a firm complies with some type of industry-wide standard, you won’t have the information you need to assess a firm’s performance. Of course, that doesn’t mean they are not competent. You just don’t have the information to determine that.
Fortunately there is a better way.
GIPS® (Global Investment Performance Standards)
The term GIPS® is short for Global Investment Performance Standards. These standards are produced by the Chartered Financial Analyst (CFA) Institute, a non-profit investment management association. The CFA institute handles testing and credential programs for investment professionals worldwide.The GIPS® standards are written in plain language that is designed to be understood by lay people. (Learn more about GIPS® standards.)
Compliance with these standards is purely voluntary. Those firms that do choose to comply with GIPS® standards are required to do the following:
- Measure their investment results in a specific way
- Have an independent third party verify those results to ensure compliance to the standards
GIPS® compliance is known as a best practice in the industry. Per the CFA Institute, as of last year, 85 of 100 of the top firms worldwide claim compliance with GIPS® standards.
Most importantly for you, a GIPS® compliant firm won’t be able to engage in those performance-inflating practices that can make an investment track record look better than it really is.
GIPS® compliance gives you the information you need to evaluate investment managers. To put it another way, you get an ‘apples to apples’ comparison.
You also find out exactly how committed a firm is to transparency. While many financial advisors and firms say they are dedicated to being transparent to benefit their clients, the large majority of firms don’t comply with these standards.
According the CFA Institute, only a small fraction (about 1,600) of firms globally are GIPS® compliant (as of Feb. 6, 2017: Source: the CFA Institute; https://blogs.cfainstitute.org/marketintegrity/2017/02/06/out-of-top-100-asset-management-firms-globally-85-claim-gips-compliance/.)
Before you hire a financial advisor, remember that getting the information you need to assess their investing results shouldn’t be optional. If an advisor will not provide it, that might mean they don’t monitor their own performance closely enough. Or, that they pay more attention to their profitability than yours.
Whatever the reason, limiting yourself to GIPS® compliant advisors allows you to make decisions based on facts, not verbal sales promises.
John Odell, CFP® is CEO of Arroyo Investment Group, LLC, a fee-only financial planning and investment management firm based in Pasadena, California, but serving investors nationwide. As a GIPS®-compliant firm, we bring institutional quality, high performance investment management to individuals and families. Together with Capital Research + Consulting, our sister firm, we collectively manage over $4 billion of assets for individuals and retirement plans.