A standard language must be developed when reporting investment performance as words used by fund managers are unregulated and can be very manipulative and powerful.
Speaking at the Portfolio Construction Forum, Platinum Asset Management investment specialist, Douglas Isles, said not regulating user specific words could be a compliance loophole.
He said words used by fund managers such as “strong” lacked a clear definition given returns ranging between 8% to 35% could be described as “strong”.
Isles noted with superannuation funds the words conservative, balanced, or growth were not consistent across products from the largest super funds nor were the target returns.
“There are conservative funds which categorise themselves as SRM [standard risk measure] four or medium risk. But this overlaps with balanced funds and it turns out some balanced funds classify themselves as risker than some growth funds,” he said.
“This is not consistent, nor are the target returns, nor are the exposures to equities. So, it remains subjective, like hot or cold.
“A big loophole that exists within the tightly regulated investment communication and that loophole is a disconnect between the free use or potential misuse of language and very tight rules around the use of the presentation of numbers.”
Isle proposed the “Isle Scale” that only had seven words to describe investment returns of markets and funds. The words were strong, excellent, good, average, soft, disappointing, and weak.
Each word represented a return scale between 5%.
“For example, a manager might be allowed to say something like ‘over the last year our fund delivered strong returns against the backdrop of a good market environment’. While it might make performance commentary more bland it would certainly remove the risk of manipulating performance messages,” he said.
“Fund managers might differentiate their communications by their anecdotes, their insights, and the lessons around their philosophies. Clients with over time become more familiar with standard terms and perhaps become better calibrated to market moves.”
Isle noted the scale was open to refinement through user testing give there were differing ideas as to where “strong” and “excellent” sat on the scale.
The proposed Isle scale applicable to equity markets
Source: Douglas Isle
