Return gaps can often occur. And so, there are times when we might want to be able to “cross” them: that is, to extend performance across this gap, so that we have a continuous return. However, there are times when the manager may not want to cross it, but the client does: should the manager comply with the client’s request?
Case in point: a good example for crossing return gaps
I had a conversation with a client last week, which is the genesis for this post. It seems that there are times when a client might change their strategy, which can cause an interruption in performance. A “performance holiday” occurs, during which time the manager does not have control/discretion over the assets. This results in a break or gap in performance. The manager, it seems, would prefer not to cross the gap, since they did not have responsibility for the portfolio during this period. Furthermore, the strategy before the gap is different than the strategy after. But the client wants to see the manager’s performance for the full period. Should this be permitted?
Why not? Cross the return gap!
I see nothing wrong with this. Return gaps are, at times, worthy of being crossed: that is, to link the two periods.
You should use a return of 0.00% for the portfolio, as well as the benchmark, for this gap period. Further, include a footnote or disclosure with the report to indicate what the return represents, as well as that a gap of [period length] was crossed. What’s the harm?
The manager can still, and probably should, provide performance for the non-continuous periods. But showing the performance across the gap can have meaning to the client. And, with the appropriate disclosure(s), the performance is qualified.
Should the performance that was earned during the gap be included?
During the break in performance there might actually be a non-zero return that has been earned, perhaps through the custodian. Should this performance be used instead of the suggested 0.00% return?
In the case of this particular client, it wouldn’t have made much of a difference, since the client who asked for the gap to be crossed has been their client for more than ten years. And so, one short period’s performance won’t make a material difference.
If you find that the performance for the gap would be material, you might want to use the 0.00% return. If the client wants the return that was actually used to be included, then do so, and make a note that it was employed. You could also show the performance with both the 0.00% return and the other return. This information can have meaning, yes?
Clients don’t always make silly requests
There are times when managers may think that a client’s request is silly or inappropriate. And, there are probably times when they are. But, in most cases the requests are probably quite legitimate and reasonable. This one seems to be to me one that should be honored. I hope you agree.
Does your software allow for it?
When we conduct our software certifications for portfolio rates of return functionality, we typically check to see if the system permits the crossing of gaps. In my opinion, the system should be flexible, allowing the user to decide if they want to cross gaps.
This isn’t the first time I’ve addressed this topic. I believe the first may have been in our April 2005 newsletter, so it’s been awhile, though the topic still has interest. And, there are different types of gaps (the earlier post dealt with one such alternative). Sometimes gaps should be crossed, sometimes they should not. Making the distinction is important.
Please let me know your thoughts!