NOTE: today’s post is from a guest blogger, Marshall Smith, CIPM. Marshall is the Chief Product Officer at First Rate. It originally appeared on LinkedIn, and we were so impressed with it that we asked Marshall if we could post it here, as well. He graciously agreed.

We talk to wealth managers on a regular basis that don’t trust their performance. It’s not because they have the wrong formula or are using the wrong method. It’s not because they have “old technology” either. I wrote about the top reasons why inaccurate performance returns are calculated a few months ago, see Four Reasons Why Your Performance Returns are Wrong.

In our experience, firms will have varying success in eliminating bad or inconsistent data, which is typically the underlying cause of the issue, but they will never be able to fully automate this process.   The best practice to achieving maximum accuracy is having a good process to review, reconcile and audit your data that produces your performance.

The reality is that most firms and most vendors have little to no process to review performance numbers. The following are three best practices that will help improve your firms performance results:

1. Accounting Checks. This is the most basic reconciliation of cash and share balances. The purpose of this check is to answer the question, does the transaction activity balance the cash and shares/units of my holdings from one point in time to another. If the answer to this is “no”, you are guaranteed to have accuracy issues. Many firms rely on their investment operations group to handle this but unfortunately their concern is typically making sure these checks are passed from an accounting perspective (dollars and cents) but can still leave issues with performance calculation.
2. Data Checks. While your cash and shares might balance, are you missing accruals, prices, security demographics such as coupon dates, ex-div dates, TIPS factors and more. In addition, are free receipts/deliveries valued correctly, have corporate actions been investigated to ensure the proper performance impact is occurring? Most firms completely miss these types of checks, instead relying on their operations teams to “reconcile” the numbers. These secondary data checks are key to producing accurate results.
3. Return Checks. Once Accounting Checks and Secondary Data Checks have been completed, it’s time to look at the returns. It is critical that this step is performed after all other checks are completed or you can be inundated with return noise caused by accounting or secondary data issues. Return checks should include two types of checks, Top-Down and Bottom Up. Top-Down checks should discover return outliers as compared to an appropriate benchmark that the portfolio, asset class, or segment being calculated should be similar to. Once the outliers are found, an analyst (yep, robots won’t cut it), must use their experience, intuition and performance detective skills to sniff out issues that may not have been caught by all previous checks. Typically these outliers are due to a lack of diversification but occasionally a unique situation related to transaction timing, an account closing with some remaining activity or other unique scenarios may present an issue that can be resolved. Finally, a Bottom-Up check should be performed comparing the security level returns of all securities to their peers (i.e. comparing Microsoft’s return as experienced in every account to the price/income return of Microsoft). Strangely, this too can identify issues impacting certain accounts that may not have been identified earlier or caused a significant enough issue to bubble up elsewhere.

Benjamin Franklin is famous for saying “If you fail to plan, you are planning to fail”. In the Investment Performance world, if you fail to have a mature, repeatable and adaptable process to identify inaccurate performance results, you will be consistently frustrated by inaccurate performance.”