F-Squared Enforcement by the Securities & Exchange Commission
Perhaps you’ve never heard of F-Squared. The only reason I knew the name was because a few years ago, we were asked by a new advisor to help them become GIPS® compliant. They were going to use F-Squared’s models in their offerings to prospects. We worked with this firm (not F-Squared) for a few months, mainly through phone calls, but also a one or two day visit to their offices. In the end, they opted not to move forward with their plans. Unfortunately, they also didn’t bother to pay for our services. Oh, well. I guess their ethics went about as far as, well, F-Squared’s?
It seems that what F-Squared’s presented as its real, historical track record was, in reality, only back-tested performance that turned out to be substantially inflated.
The problem goes beyond F-Squared
The act of presenting hypothetical, back-tested results as real is nothing new. What’s interesting in this case is that several other investment advisors were using those same numbers in their advertisements! The SEC penalized these advisors between $100,000 and $500,000 each! To see some details about this, please go here.
The “wake up call” this enforcement brings is that firms who use the returns of others need some degree of due diligence to ensure those numbers are actual.
Is GIPS the answer?
Compliance with the GIPS standards can definitely help, though it’s not necessarily a requirement.
While we conduct quite a lot of GIPS verifications, we are also often asked to conduct non-GIPS verifications. Not everyone is able to or chooses to comply with the Standards. But, they want to provide some assurance to their clients and prospects that their numbers are real and legitimate, so they ask us to conduct a review.
This issue extends to the wrap fee (aka, “SMA” or separately managed account) sector of our industry, where managers provide sponsors with their returns.
Доверяй, но проверяй (Doveryai, no proveryai)
Perhaps America’s 40th president, Ronald Reagan, can provide some assistance here.
You may recall him referencing a Russian phrase (shown above; in English here): “trust, but verify.”
Managers who rely on performance results of other parties need to spend some time ensuring that these numbers are what they claim to be. It could save you some serious money down the road!