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Client GoalBased Performance Analysis

Stephen Campisi, CFA Director of Institutional Investments Bank of America Merrill Lynch Hartford, Connecticut
Successful portfolio management is often determined and presented according to detailed and sophisticated performance measurement methods. Clients financial goals, however, are more straightforward: generate money to spend and preserve principal. Presenting performance in a manner that addresses clients true goals can strengthen the managerclient relationship and benefit both parties.

y goal is to challenge you to look at performance from a new perspective, one that can benefit you as well as your team, your firm, and most importantly, your clients. For performance professionals, this approach is an opportunity to become a meaningful partner in the investment process. I will demonstrate how to use clients goals to determine the investment process and how to communicate success to clients. The emphasis needs to be taken off of us, our firms, and our products and put on our clients and their goals. Instead of focusing on returns and the complexities and details of calculating returns, we should emphasize the income that the portfolio will provide to the clients for their goals. Additionally, clients are more likely to value you when your product is presented as an integral part of their overall portfolio strategy and not simply as an isolated product.

Clients and Their Financial Goals


First and foremost, our responsibility to our clients requires a commitment to ethics. As fiduciaries, we must maintain loyalty to our clients and act in a prudent and diligent manner. Our first responsibility in adhering to this loyalty standard is to understand our clients financial goals and act in a way that helps them meet those goals. We need to move away from simply looking at asset-based benchmarks as the measure of success and start looking at the clients goals as the measure of success. This approach is not meant to replace traditional portfolio management and measurement but to complement it. To meet clients goals, we must first understand our clients. There are essentially five types of clients. Individual or high-net-worth clients are those who rely on their investment portfolio to be a provision
This presentation comes from the GIPS Standards Annual Conference held in San Francisco on 2930 September 2010.

of living expenses, savings for their childrens college tuition or for retirement, or an inheritance or a charitable donation. Institutional clients include insurance companies, pension funds, and charitable organizations. Insurance companies collect premiums, invest them in a portfolio, and then spend money from that portfolio to pay benefits or annuities. Pension funds withdraw money regularly and pay it to the retirees who are living on that money. Charitable clients include endowments and foundations. Endowments tend to be not-for-profit organizations with a pool of money devoted to one beneficiary, such as a hospital or college. They spend routinely from the portfolio to help cover operating expenses. Foundations are not-for-profit organizations that make grants. They withdraw money from their portfolios and use it to fund such worthy causes as education and health care. These clients are vastly different from one another, but they have one thing in common: They all spend money from their portfolio. Benjamin Franklin once said, The value of money is its usefulness. Portfolios are not ends in themselves but means to an end. Our job is to help accomplish that end with our clients through our investment practices. Although cash distribution is a primary focus for clients, standard financial theory assumes that money is never taken out of a portfolio and that all proceeds are reinvested in the portfolio. Financial theory assumes a single, long-term holding period, and meanvariance optimization relies on this assumption. But correlations do not remain constant, variance does not stay the same, and clients do withdraw money from their portfolios, period over period. That spending changes everything for portfolio managers. Cash flows are usually viewed as having a negative effect when evaluating portfolio performance. For clients, however, the portfolio exists to meet their first goal, which is the ability to withdraw cash and

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use it purposefully. Portfolio spending can be viewed as a liability, a stream of payments that may be estimated in terms of amount and timing. Additionally, portfolio spending must keep up with inflation. The second client goal is that the portfolio continues to perform well, year after year, generation after generation. Meeting this goal means that at a minimum, the original principal value should be preserved net of spending and inflation. Endowments, foundations, and other institutions generally have a perpetual time horizon. Individuals can also have long investment horizons; income beneficiaries rely on spending from the portfolio, and heirs or remainder beneficiaries rely on principal preservation or growth.

The portfolio is now worth $65. Although it seems a return of about 50 percent is needed to break even, two years of inflation must be factored in to recoup the original portfolio value in real terms. A return of 63 percentalmost twice as much as in the original exampleis actually needed when accounting for spending and inflation. The Order of Returns. Spending is also significantly affected by the order in which portfolio gains and losses occur. Consider three annual returns of plus 10 percent and three annual returns of minus 10 percent, and factor in spending of 5 percent each year. In Scenario A, the positive returns come first and are followed by the negative returns. In Scenario B, the negative returns come first, followed by the positive returns. In both cases, $100, net of spending, becomes $70. But in Scenario B, spending is 25 percent less than in Scenario A. The order of returns does not matter when money is not spent from a portfolio, but it does matter when spending is the goal. Performance Analysis. Performance measurement began with simple absolute return methods. It evolved into relative return analysis when portfolio returns were compared with market benchmarks, peer groups, or style-based benchmarks. Today, returns are often adjusted for various types of risk, such as volatility risk, market risk, or more complicated risk measures (e.g., downside risk relative to a target return of the client). Attribution analysis details why a portfolio outperformed its benchmark. Following is a review of a portfolio using some traditional methods of performance analysis. Table 1 presents the return results of a real portfolio according to traditional quantitative performance analysis. The benchmark returned an annualized 7.98 percent. The portfolio earned 8.05 percentan excess return of 7 bps with slightly lower volatility. The portfolio and market returns are highly correlated at 0.97, and the beta of the portfolio is 0.93, which means the portfolio has 7 percent less market risk than the benchmark portfolio. Adjusting Table 1. Quantitative Performance Analysis for 19922009 of the Sample Portfolio vs. a Benchmark
Portfolio 8.05 10.82 0.97 0.93 0.38 0.40 0.38 Benchmark 7.98 11.26

Rethinking Portfolio Management and Measurement


All clients have in common the two goals mentioned earlier: to withdraw money from the portfolio and to preserve the principal. These goals thus need to become the new metrics for measuring success. A clients true goal is not an 8 percent return or beating a 60/40 benchmark. Although he or she may think that supports the goal, level of return is not really the main goal. Yet the performance measurement information shown to clients is often limited to returns and comparisons with benchmarks and peer groups. A disconnect exists between the clients true goal and how portfolio success is measured. Focusing on a clients true goal creates new challenges for portfolio managers. Volatility. Volatility is a challenge to portfolio management, and portfolio spending will make volatility an even greater challenge. Consider a simple example that illustrates the asymmetry between gains and losses. If a $100 portfolio loses 50 percent after one year, then $50 remains. If the portfolio regains 50 percent the next year, the investor will have $75. A return of 33 percent is still necessary to regain the original investment value. But when spending and the effect of inflation are factored in, a much higher return is actually needed. Consider the effects of a constant 5 percent spending objective and inflation of 3 percent a year on the above example. Five dollars is spent the first year, based on the original portfolio value. The $100 portfolio has lost 50 percent and spent $5. It is now worth $45. With a gain of 50 percent, the portfolio is worth about two-thirds of its beginning value instead of three-quarters. But spending in year two has fallen to $2.25. Volatility has reduced spending by more than half. Spending money in down markets increases the risk of a spending shortfall and principal loss.

Measures Traditional (time-weighted return) Risk Correlation with benchmark Beta to benchmark Alpha Sharpe ratio

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the alpha for market risk gives 38 bps of riskadjusted excess return. The Sharpe ratio confirms a better payoff for the risk assumed. This state-of-the-art performance analysis suggests that the portfolios performance has been adequate. Yet, when performance is viewed in terms of the clients spending and principal preservation goals, this portfolio performed exceptionally well. The reason for this disconnect is because traditional analysis fails to measure the clients goals or consider the clients definition of risk. Performance Returns. Two types of performance methods are generally used to measure client returns: the time-weighted return and the internal rate of return (IRR). The time-weighted return, often considered the gold standard in performance returns, measures the return on a single sum invested for the entire performance period. It does not account for cash contributions or distributions; it simply links returns together, whether the returns were based on a large asset base or a small one. It is the perfect method for measuring the return on an individual product, but it is not good for measuring the return on a portfolio with a spending objective. The internal rate of return, or money-weighted return, reconciles the beginning portfolio value and any cash flows with the ending portfolio value. It is useful for measuring an actual portfolio return, but it is still incomplete because it does not measure how much money the portfolio generated relative to how much money the client needed.

Case Study: Measuring the Money


For an analysis of performance based on clients goals, the actual money earned and spent are what need to be measured. The following case study is based on a large community foundation that is one of my clients. The foundations portfolio is invested globally in a mix of 70 percent equity/30 percent fixed-income investments and has quarterly return data from 1992 through 2009. The foundation had a spending rate of 5.5 percent through mid-2003, when it was lowered to a more sustainable rate of 5 percent. Clients typically base expenditures on the average of the portfolio market values over the past three to five years in order to stabilize the amount of spending over time. This client wisely chose a spending policy based on the average of the last five years. Traditional Results. The foundations portfolio earned an annualized time-weighted rate of return of 8.05 percent compared with the annualized return of the targetinflation plus spending

of 8.04 percent. The portfolio had 1 bp of excess return. But the portfolio did not simply meet its goal; it actually exceeded its goal. By examining the cumulative amount of spending planned versus the actual amount of spending achieved, the result is that for every $100 the client hoped to spend, it spent $113. And the principal grew by more than 5 percent. The 1 bp of outperformance shown by the time-weighted return ignores the spending success. Figure 1 shows the rolling seven-year returns of the foundations portfolio. The dotted line that hovers around 8 percent is the target return, which is the amount needed to cover annual inflation as measured by the Consumer Price Index (CPI) plus 5 percent spending. The black line is the portfolios returns. From mid-2002 through 2009, there was no period in which the portfolio came anywhere close to meeting its target return, yet this period is when the portfolio had its greatest success as measured by the amount of spending. Table 2 shows the portfolios returns on an annual basis. Years 19921999 are what I call the fat years, in which the returns are generally substantially higher than the target returns. Years 2000 2009 are what I call the lean years, in which the returns are devastatingly below the target returns. For 20002002, the cumulative return of the target was nearly 27 percent; during this period, the portfolio lost 7 percent. In 2008, portfolio performance was even worse and lagged the target by more than 3,400 bps. How was the great success possible during this time period? Goal-Based Results. During those fat years, the portfolio was generating extra money that was reinvested in the portfolio to expand the asset base and earn even higher returns. By the time the leanyear period began, the portfolio had a surplus of 50 percent in dollars accumulated that sustained portfolio spending through periods of great stress. To review the methodology behind this performance, the target portfolio begins with $1 million and grows with inflation. The spending target is 5 percent, growing with inflation. The portfolio begins with $1 million as well. In each period, the portfolio and the target will generate a return and use it to spend from, and the remaining value will earn the next periods return. Any contributions or excess spending by the client is ignored so success can be evaluated based only on the ability of the initial capital to meet the stated goals. Figures 2 and 3 show the results.

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Figure 1.

Rolling Seven-Year Returns of a 70/30 Portfolio vs. CPI plus Spending, December 1998December 2009

Percent 16 14 12 10 8 6 4 2 0 12/98 12/99 12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09 Target Return Portfolio Return

Table 2.
Year Fat years 1992 1993 1994 1995 1996 1997 1998 1999 Lean years 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Returns for the Sample Portfolio vs. the Target Returns, 19922009
Portfolio 12.00% 9.84 0.78 27.47 14.03 18.67 10.94 11.59 4.09% 1.15 9.77 22.60 12.42 6.51 12.88 9.97 29.2 27.24 Target 8.64% 8.48 8.40 8.26 9.08 7.39 7.29 8.41 9.14% 7.23 8.09 7.31 8.47 8.64 8.14 8.83 5.16 7.79

Figure 3 shows the growth over 18 years of the original $1 million principal value to about $1.5 million as a result of the effects of 2.5 percent inflation. The surplus grew, and then two market downturns occurred. The first was the bursting of the technology bubble. The second was the leverage-induced downturn of 2008. During the latter period, the portfolios value fell significantly below the target value for the first time. But at that point, I was able to meet with the foundation and show it that it could continue spending through the crisis and that it was likely to recover its losses in time. It was subsequently able to profit from the spectacular rally of 2009, which brought them back to a surplus state. The information I communicated to the client was meaningful, but it was not complex. The client saw that the portfolio was above the target values and that it was likely to stay above by continuing the cycle of building a surplus and spending it when necessary. The Virtuous Cycle. Several factors contributed to the portfolios outperformance: a solid investment strategy with reasonable return expectations, a reasonable spending policy that allowed for building a surplus, and the investment discipline to maintain the strategy. But the most important reason for the outperformance is that these combined factors allowed for the portfolio to be managed according to a virtuous cycle of building a surplus in the fat years to sustain the lean years. Figure 4 combines the portfolios spending success and principal preservation success into one chart. The black line represents the increase in portfolio value, and the gray line represents the increase in spending. From 1994 through 2000, portfolio value increased at a dramatic rate because

Note: Target return is CPI plus 5.5 percent from 19922002 and 5 percent thereafter.

The dotted line in Figure 2 is the target spending goal, growing with inflation. It shows when the client reduced spending from 5.5 percent to 5 percent. The black line is the actual spending results. Portfolio spending closely tracked target spending initially. Once the surplus is recognized, portfolio spending is persistently above target spending. The spending is also relatively smooth, despite the historic volatility in the markets during this time period.

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Figure 2.

Actual Spending vs. Target Spending for Sample Portfolio, March 1992December 2009

U.S. Dollars 25,000 Portfolio Spending 20,000 15,000 10,000 5,000 0 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 Target Spending

Note: Spending is per $1 million invested.

Figure 3.

Actual Portfolio Value vs. the Target Value, December 1991 December 2009

U.S. Dollars (thousands) 2,500

2,000

Portfolio Value

1,500

1,000

Target Value

500

0 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

the market returns were so strong. But because spending is based on smoothing the market values over five years, spending increased at a much slower rate, allowing a surplus to build. Figure 4 also shows how the surplus sustained spending during the lean years. In 2000, the market value of the portfolio dropped but spending increased. An even more dramatic downturn occurred in 2008. Once again, portfolio spending was maintained and even grew during this period of economic weakness and greatest need. In the aftermath of 2008, many noteworthy endowments and foundations cut their spending

and fell short of their mission. The foundation in this case study was essentially aided in its fundraising efforts because it could demonstrate to potential donors that it is a responsible steward of contributions. It was able to show potential donors that even during extreme market conditions, the foundation has a proven track record of continuing to provide such community services as lunch programs for children or transportation for the disabled. This information is much more beneficial to clients than demonstrating that the portfolio outperformed its peer group or its benchmark.

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Figure 4. Combined View of Portfolio Spending and Value vs. Target Spending and Value, December 1991December 2009
U.S. Dollars (thousands) 2,500 U.S. Dollars 25,000

2,000

20,000

1,500

15,000

1,000

10,000

500

5,000

0 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 Portfolio Value (left scale) Portfolio Spending (right scale) Target Value (left scale) Target Spending (right scale)

Communicating Results
To evaluate performance, the contributions from both active management and strategy need to be considered. Portfolio strategy provides the majority of good results, as Figure 5 demonstrates. The gray line is what the performance would have been if the portfolio from the foundation in the case study had simply been invested passively in benchmarks; the black line is the actual performance. Clearly, most of the success comes from strategy. The majority of communication to clients, however, is usually focused on the active effects. The opportunity for portfolio managers is to focus on the value that the portfolio strategy brings. Let me describe how results can be effectively and creatively communicated to clients using performance analysis that is based on clients goals. Money and Returns. Table 3 shows performance results in terms of dollars and returns for the foundations portfolio in the case study. The portfolio value at inception is $1 million, and the target value indexed for inflation is $1.56 million. If invested in the benchmark, the portfolio would have grown to $1.62 million. The portfolio actually grew to $1.65 million. The excess return over the target per million invested is about $84,000, of

which about $60,000 comes from the strategy and about $24,000 comes from active management. The spending objective was to begin with a $1 million portfolio in 1992 and spend a cumulative $1.2 million over the course of 18 years. The actual spending is $1.37 million, an excess of $165,000. The majority of this surplus, again, comes from the strategy. The combined principal and spending target is $2.76 million over 18 years. The portfolio value is $3 million, generating about $250,000 of cumulative excess per $1 million invested. This information is easily understandable as well as relevant and meaningful to the client. The concept of total return still has value, however, and Table 3 also shows the internal rate of return. This method is used because it recognizes the spending success as well as the principal growth. The portfolio achieved an annualized 8.86 percent internal rate of return compared with the 8.08 percent return of the target, an excess return of 77 bps. The 77 bps can be broken down into 62 bps from strategy and 16 bps from active implementation. The effect of the extra 77 bps on the clients goals is that about two-thirds of it went to spending and the remainder went to principal and growth. This approach links the returns to the initial capital and helps explain and attribute it in terms of source and benefit to the client.

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Figure 5.

Performance of the Portfolio, Benchmark Portfolio, and Target, December 1991December 2009

U.S. Dollars (thousands) 2,500

2,000

1,500

1,000

500

0 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 Portfolio Value Target Value Benchmark Portfolio

Table 3.

Nominal Values and IRR of the Sample Portfolio, Benchmark Portfolio, and Target for 19922009
Principal $1,562,327 1,623,123 1,646,722 84,395 60,796 23,599 IRR Cumulative Spending $1,205,825 1,343,335 1,371,362 165,536 137,510 28,026 Total $2,768,153 2,966,458 3,018,084 249,931 198,306 51,626

Portfolio Target Benchmark Portfolio Excess total From strategy From active

on a relative basis. Yet because of the surplus, the portfolio still spent above its target and the portfolio value remained 5 percent above target. Expressed in dollars, the excess over the target per $1 million for 20082009 was $70,000, most of which was in principal preservation. The dramatic plunge in the S&P 500 was an extreme event for the market, but it was not an extreme event for our client. It was reassured that even in extreme market conditions, its goals were being met and there was no need to alter its investment policy. Real Cumulative Dollar Results. Performance results based on a clients goals can also be shown in real dollar terms. The spending goal was $947,877, or about 95 percent, of the initial $1 million. The actual amount spent is 107 percent. The goal for the principal was to maintain $1 million in real terms; the actual amount is $1,054,019. These numbers can be shown as returns on a relative basis. They can also be shown in a cumulative attribution analysis relative to the target. The total excess over goal is 9.01 percent, 7.17 percent of which is from strategy and 1.85 percent of which is from active management. This percentage can be further broken down by benefit to the clients in terms of spending and principal. Current Values. Rather than showing the client all of these perspectives, I recommend reviewing the portfolio in terms of current values as shown in Table 4. The portfolio represented is worth $450 million; the target is worth $426 million. The $23 million of excess value contributed $1.2 million a

Portfolio Benchmark Target

8.86% 8.70 8.08

Note: Nominal values are per $1 million.

Real Annual Dollar Results. Another way to present these results is to compare the actual portfolio values and spending on an annual basis with the targeted values and spending. When viewed this way, the foundation portfolio outperformed almost 90 percent of the time, or 16 out of 18 years. On a total return basis compared with the benchmark or the target, the portfolio outperformed twothirds of the time. It is worth revisiting what happened to the portfolio during 2008, when the S&P 500 Index plummeted 37 percent. From 2008 through the end of 2009, the portfolio lost nearly a quarter of its value

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Table 4.

A Sample Portfolios Current Values, Surplus Value, and Surplus Annual Spending
Value $450,000,000 443,551,036 426,937,370

Conclusion
Presenting portfolio results in a goal-based manner can help reshape a clients perspective from focusing on individual investments and market fluctuations to evaluating the success of the entire portfolio on a long-term basis. The client is free to concentrate on being a steward of the assets instead of micromanaging the investment process and the manager. Reviewing portfolio results in this context also helps reshape the investment process. Our portfolio managers at Bank of America Merrill Lynch are focusing on being good risk managers in the context of the client. We have become goal-based managers instead of benchmark-driven managers. As a result, we are gathering more assets, managing them more effectively, and retaining more clients. It is my strong belief that performance analysis based on clients goals provides an exceptional opportunity for differentiation and a competitive advantage for investment firms.
This article qualifies for 0.5 CE credits.

Items Current values Portfolio Benchmark Target Surplus value From policy From active Total Surplus annual spending From benchmark From active

$ 16,613,666 6,448,964 $ 23,062,630

$830,683 322,448

year to additional grant making. The value of active management is $6 million more than if the portfolio had been managed passively. That difference supports more than $300,000 in additional grants. Which results would you prefer to communicate to a client: these results, or one extra basis point of time-weighted return?

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Question and Answer Session


Stephen Campisi, CFA
Question: How can investment managers take a macro view with their clients if they are only one of many managers and do not know about a portfolios entire structure? Campisi: I believe the best way to build client loyalty is to show the clients that your product is an integral part of the set of products they own. It is helpful to find out what they own. The assets of charitable organizations are generally publicly available. Perhaps your salespeople could simply ask your clients what their portfolios currently look like, explaining that the knowledge will help your firm show the clients how your products can complement their other investments. You may also want to partner with a few popular managers and determine how your product can best complement theirs. You may find other managers that have a little higher return than you have, but perhaps overall risk is not managed as well when products are combined with these managers as opposed to your product. Your correlation with the other assets may be much lower, which can reduce volatility and increase returns. Question: Is the methodology still effective when client spending is volatile and erratic or when the client does not have a spending plan at all? Campisi: The method is essential in these situations. The most difficult clients are those who spend too much. Spending rates around 5 percent are sustainable given an appropriate investment strategy, but spending that approaches 6 percent starts to become completely unsustainable regardless of investment strategy. Erratic spending is simply very hard to manage. I just did an analysis for a serial overspending client, and the conclusion was that if the client had spent the 5 percent we recommended over the past 10 years, he would have had 27 percent more in assets than he currently has. Similar to the importance of performance analysis and analytics during down times, this type of analysis is important with down clients. Why blame the manager for the actions of the client? Question: If surplus is lost in earlier lean years, does that make it difficult to build surplus in later fat years? Campisi: Yes. In the case study I presented earlier, we had the advantage of starting at a benign time during a positive-return period. For those clients that began investing in the year 2000, we can show them how much the portfolio value went down because of the market and how much it went down because of spending. We can show them that spending affects the portfolio value and that portfolio losses are not completely the investment managers fault. In some cases, managers could ask clients for some control over spending to enable them to spend less until a surplus is built. (In the case of private foundations in the United States, a minimum spending rate is required.) Spending is the most important investment decision. Even the best strategy, perfectly executed, will lead to bankruptcy if too much is spent. Question: Should spending be adjusted in the event of deflation or significant disinflation? Campisi: When inflation is negative, nominal spending will have greater value in real terms. If inflation is negative, it means the economy is weak and returns are low. An inflation-adjusted decrease in spending might help to prevent real overspending and thereby preserve the portfolios real value. Question: In the wake of the financial crisis, are companies more interested in preserving capital? Campisi: From our industry surveys and significant client experience, we find two things happening. Some clients, because they have lost value, have become more risk seeking. They are turning to exotic investments with potentially high returns in hopes of recouping their losses. Some other clients have become very risk averse and have revised their asset allocations toward principal protection rather than growth. Those who became risk averse at the end of 2008 missed the subsequent market recovery. It is in situations like the crisis when an analysis based on clients goals is helpful. You can show them that although they are down from the peak, they are still ahead of their target and maintaining their position might provide a chance of recovery. For both types of clients, I think an informed analysis is beneficial. Question: Do you think that we need to better explain to our clients the effect that spending has on a return? Campisi: Clearly, we need to better explain all of these things, and we need to do it in an intuitive way. I think the trends are more easily understood graphically. I have found that clients

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are able to understand these concepts because they are common sense. Most people understand that spending less than they earn allows them to save for the unexpected. Question: How can firms meet the goal of foundations that are looking for real returns of inflation plus 5 percent? Campisi: There are three ways to meet that goal over time. The first is with the right asset allocation; a simple U.S.-only, 60/40 strategy is not likely to work. The consensus view on U.S. returns in the future is that they will be more modest than historical returns. As an example, compound returns to U.S. large-cap equity were previously around 10 percent but are now forecast to be around 8 percent200 bps lower. So, consider asset classes that have higher returns and the possibility of better diversification to lower volatility, such as small caps and emerging market equity. An investor who can bear the illiquidity of private equity might earn 5 percentage points over large-cap equities to compensate for increased risk and illiquidity. The second way is through active management, which should be viewed as a risk management

tool. The real risk is not earning enough return to support spending. Increasing the active return provides another potential source of return enhancement and safety. The third way is to spend at a reasonable rate and smooth the market values over a multiyear period. The difference between smoothing for three years and five years is equivalent to about a 10 bp adjustment in the effective spending rate. The longer the time period that is smoothed, the more effectively is spending lowered. It actually produces more cumulative spending because a bigger surplus is being built. Those are three strategies to meet the goal: allocate appropriately, take active positions that you believe will help, and spend the right amount based on smoothed market values. Question: Should clients be presented with time-weighted return and internal rate of return measures or just internal rate of return along with the methodology you presented? Campisi: Both are necessary. Measuring by internal rate of return answers the question of how the portfolio capital gained or lost value. Measuring by timeweighted return answers the ques-

tion of whether the individual managers are really adding value. Question: Do you think clients will show loyalty to firms that demonstrate ethics, integrity, fair representation, and full disclosure? Campisi: I do. The essence of a fiduciary relationship is trust, and trust is rooted in ethical behavior. Striving to be ethical begins with the fiduciary duty of loyalty, which encourages managers to seek to meet clients goals and build a relationship with them that puts clients first. The question is, Will you retain clients longer when they truly understand the value you provide? I believe the answer is yes. If I were able to tell my clients that I not only met their goals but also exceeded their goals in all types of markets, rather than telling them that I outperformed by 1 bp, I believe they would choose to stay with me. Fewer reasons exist to leave this type of result because clients can see the big picture in the context of their goals. More reasons exist to leave if a manager looks just as good as everyone else based on his or her product in isolation.

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