In Thinking Fast & Slow, Daniel Kahneman discusses the notion of evaluating items separately (single) versus in comparison with others (joint). You are no doubt familiar with the importance of having returns and risk measures of a portfolio, for example, shown along with similar statistics for a benchmark, in order to gain greater insight into what occurred. To learn that Manager A’s performance in 2011 was 4.58% means nothing in isolation; it is only when we have something to compare it to are we able to judge whether this is a good or not so good result.
This section of Kahneman’s book reminded me of the difficulty presented with GIPS(R) (Global Investment Performance Standards) composite returns, as they are currently derived. Today, only asset-weighting is required; and although equal-weighting is recommended, it is rare to see it shown. But if one really understands what the details are that comprise a manager’s results, might they opt to see the other metric?
For example, if showing a prospect your composite, and its return for 2011 is 4.58% vs. the benchmark of 4.18%, you have demonstrated, at least for last year, superior skill. But if it turned out that the composite has five accounts, one huge mutual fund which had a return last year of 4.59%, and three smaller separate accounts, whose returns fell below 4.18%, but because of the fund’s size, the composite return was skewed, might these facts prove helpful? If the equal-weighted average is below the benchmark, we draw a completely different conclusion, do we not?
As I have stated before, I have become a non-fan of asset-weighted returns, and don’t see any value in them. Equal-weighting should reign; but, I am perfectly content with seeing both required. And why not? Might the mere insights provided by such information be worth the additional column?