Journal of Performance Measurement Interview of IAC

Journal of Performance Measurement:
The Journal Interview - Summer 2008

The Journal of Performance Measurement is an industry-leading quarterly publication covering performance measurement and other related topics, and is published by The Spaulding Group. The Summer 2008 edition contained an interview with the J.P. Morgan Investment Analytics & Consulting group.

David Spaulding (The Spaulding Group): Craig, we always begin the interview by asking the person to provide some background, so if you could tell us a little bit about yourself.

Craig Heatter (Global Executive for Investment Analytics & Consulting): I have been in the industry since 1976. I started as a plan sponsor at the Chicago Transit Authority, and spent six years as the superintendent of pensions. I was in charge of the investments as well as the administration of the Fund. From there, I was recruited to the City of Dallas. I was the Administrator of the Plan, and similar to my position at the CTA, was in charge of the investments and the administration. I then moved to the pension consulting firm Lowry, Raclin, Harrell, and Howerdd. I started as a consultant and was later promoted to a senior vice president. I was in charge of consulting operations and had the opportunity to work with top-tier corporate and public pension funds. After that, I moved to Financial Control Systems, a firm that provided both accounting and performance measurement, and served as a second set of books for a number of large and mid-sized pension funds. In 1990, I was recruited to Chase Manhattan Bank. I was a senior consultant for two years and then appointed to lead what was then called the Performance Measurement group, and is now known as the J.P. Morgan Investment Analytics and Consulting group. I have been here 18 years. I am responsible for our global business, comprised of 200-plus clients and approximately $2 trillion dollars in assets under measurement. We provide a full range of investment analytics with a consulting overlay.

DS: Okay. When it comes to your custodian services and performance measurement, what has the biggest change been in the world of custody services, when it comes to providing performance measurement?

CH: The large global custodians are now more than capable and competent to provide top-tier performance measurement and analytics. Client expectations are that we can and will deliver daily security-level, multi-currency performance measurement and analytics supported by a global platform. Multinationals are insisting that we consolidate performance analytics on all their plans around the world. They want to see reporting from a corporate headquarters perspective that brings all their global plan information into a centralized data depository, and they want to monitor and report performance results, how managers are doing relative to benchmarks and peer groups, funded status and cash flows, and benefit disbursements. As a result, custodians are becoming a more investment and information-centric business, supported by investment intellect and thought leadership.

DS: When we talk about custodian services in general, there are a lot of things, a lot of services that you provide to your clients. Where would you say performance measurement fits? How important is it as a service relative to everything else that the client is expecting?

CH: It will depend upon the client, although for a pension fund, it has become a key differentiator. Most pension funds will subscribe to a custodian’s performance measurement service and will look for extensions of standard service to empower them to make more informed investment decisions. Also, many institutional managers, in my view, are becoming comfortable that their custodians can provide a high quality service. Demand is going to dramatically increase as more and more firms entertain outsourcing of the middle and front office up to a point. They may keep their proprietary attribution models and some reporting that differentiates them in a marketing presentation, but they will be looking for us to be more and more supportive in helping them get insight into their competitiveness and what is going on in the front office.

DS: I want to talk more about this issue of outsourcing, but before we do, I am curious, of the 225 clients that you have, what percentage are expecting to receive performance measurement reports? You mentioned that you do daily, but do you provide performance rating reporting to all of them?

John Thomas (Product Manager): We have 225 clients, representing approximately 7,000 portfolios and $2 trillion in assets under measurement. Ninety-nine percent of our clients receive performance measurement reporting, with a subset receiving analytics, attribution, manager analysis, risk management, asset allocation analysis, and/or asset liability analysis. I would say that approximately 15 to 20 percent of our clients are receiving daily performance, although they tend to be some of our larger institutional clients globally. We are currently providing daily performance on $750 billion in assets, representing two to three thousand portfolios.

DS: What do you find that your clients and prospects are most confused about when it comes to performance measurement? For example, I have heard that many firms ask if the custodian is compliant with the GIPS standards. I am curious about whether you are asked that question, and, since GIPS does not even speak to the issue of custodians, does it really have no value? Are there other areas of confusion, or do you think your clients are pretty comfortable with everything involved with performance?

Karl Mergenthaler (Senior Consultant): Clients do bring up the question of whether we are compliant with GIPS, and the performance measurement reporting that we provide is consistent with the GIPS standards methodologies that are recommended by the CFA Institute. I would say that the biggest confusion that comes up with current clients today is how you integrate alternative investments and derivatives into the overall reporting package. That involves reporting time-weighted returns and money-weighted returns, and how we provide analysis that makes sense in that context.

DS: I imagine that some of your clients receive performance reports from other sources as well…possibly their consultant, their manager, and perhaps even an internal system. Do you ever find yourself having to justify why the numbers are different?

Mark Huamani (Executive Director): That is an excellent question, David. We do have many situations where we are one of multiple providers of performance reporting, and we have been asked to do reconciliations for discrepancies among the different data reported, which is similar to the process we go through to reconcile our returns with the investment managers. For clients such as pension funds, on a systematic basis we will capture the investment manager returns online: market values, cash flows, and cash flow base, and really try to explain the differences. That is not to necessarily say that one party is right or wrong when it comes to specific pricing that will lead to market value differences, but reconciliation is a big part of the process of providing performance measurement reporting. We are focused on high quality information.

David Remstein (Chief Operations Officer): We have seen a trend where institutional clients are looking to minimize the number of providers of performance information. As clients have built more confidence in custodians and in J.P. Morgan in particular, for many cases we are now the official supplier of performance numbers for the Plans. As you know, we have come a long way, and now custodians are top-tier providers with industrial-strength controls around reporting.

CH: To reiterate what Mark and David indicated, we are now asked to develop Service Level Agreements mandating that the custodian will be the books and records for the client. This involves a process in which the investment manager records are reconciled with the custodian’s records. In order to automate to this scale and be successful as a performance measurement provider, we have developed the aforementioned online reconciliation process, which results in full disclosure on any variance between the custodian and the manager. Clients and external auditors find it to be an excellent risk control.

DS: What are some of the biggest demands that your clients are making today?

MH: The question we are asked most frequently now is, “What are new ways to look at performance in a risk context?” Providing extensions of traditional performance measurement is key. We need to be able to analyze risk-adjusted returns and provide detailed security-level risk analysis that offers deeper and deeper information beyond just standard performance reporting.

JT: One other area in the pension space would be liability analysis, especially with recent U.S. regulations like the Pension Protection Act. Pension plans are looking for better understanding of where their pensions are from an asset-liability matching standpoint. How does their funded status look today? How is it projected to look 10 to 20 years from now? How does the duration of the assets match up with the duration of the liabilities? To respond to that need, we have created new reporting that integrates both the asset side and the liability side.

CH: More and more clients are viewing us as one of their trusted partners. They are asking us our views regarding asset allocation, manager selection, risk analysis, risk budgeting, and portfolio optimization. I learned a long time ago that no one can predict the future, although I believe that the analysis of past results can provide insight into making future decisions. We are becoming more savvy in developing technology that enables our clients to think through their decisions utilizing multiple “what if” scenarios. Ultimately, we listen to our clients, try to understand their needs, and then partner with them to empower them in the investment decision-making process. It’s challenging but also stimulating because my team is able to fully use their talents and intellect.

DS: You mentioned outsourcing previously; what are some of the benefits that outsourcing provides and how extensive are the services that you are offering?

DR: In terms of outsourcing, there are a lot of different definitions and models. In the past, we delivered our product only to clients who subscribed to our accounting services. We had been reluctant to provide performance using third-party, non-J.P. Morgan accounting based on previous experience with the lack of quality accounting and poor reconciliation procedures in outside accounting shops. But then we were approached by one of the largest U.S. insurance companies, which had a sizable fund accounting operation. They wanted to retain their accounting records on site while also receiving the features and benefits of our performance measurement application. We built a feed from their accounting system, and working in partnership with their team, we successfully implemented a top-tier solution for their complex and customized needs, including security-level returns, security-level characteristics, cost analysis reports, and a wide range of attribution reporting. This was a big success and now has positioned us to extend this outsourcing model to other clients.

CH: The performance measurement teams of custodians are best-in-class and continue to focus on improvements. They have an accountability that is unsurpassed in the industry. For example, one client we work with indicated that anything less than 100-percent accuracy is an F. We are held to a very high standard to provide high quality performance and analytics, and must also demonstrate intellect to translate the investment results and communicate to all levels of a client, including their Boards. Firms are recognizing that J.P. Morgan is able to understand their needs as well as think outside the box to provide thought leadership in optimizing both operations and investment competitiveness.

JT: And to your point, Craig, I think institutions see several benefits to potential outsourcing, the first of which is that you can outsource the intellectual capital. It is very difficult to build an in-house performance team and to retain those employees, so that is one aspect you can outsource. The second is technology. It is expensive to build robust technology platforms and upgrade them year after year as investment strategies become more and more complex. It is potentially more cost effective to outsource to a provider like J.P. Morgan.

CH: Our technology is scaling better than ever and has put us in a position to work with our clients to quickly build fundamental and sophisticated reports, to help firms understand the data, enhance operations and decision making, and differentiate themselves to their bosses or to their clients. We are continually enhancing our data through outside partnerships. For example, we have integrated BlackRock fixed income characteristics into our application. In addition, we have two Ph.D.s on our team to further help us provide thought leadership to the market.

DS: I am curious, given J.P. Morgan’s recent acquisition of Bear Stearns, has that had any impact on your part of the business?

JT: We are working closely with our new partners – in particular, the Measurisk group, which provides best-in-class security-level risk management solutions for all asset classes. Measurisk is definitely the industry leader in the hedge fund arena and can service the diversified portfolio of any institutional client, including investment managers and pension funds. Clients want to understand the risks of their entire portfolio, and we will be working with Measurisk to provide joint reporting to address this need.

DS: Where do you see performance measurement heading?

CH: I think it will be a key differentiator in understanding the investment business and making the decision to hire a particular custodian. As we continue to build our reputation, a big part of the custody selection decision will be intellectual prowess around investment analytics, especially in the investment manager space. This will be our biggest growth opportunity because people are seeing, to John’s point, that they cannot retain people with this skill set and that the technology is expensive. To build a true daily multi-currency performance measurement system to support multinational clients and investment managers is extremely onerous, expensive, and, if not done correctly, difficult to scale. In addition, maintaining intellectual capital is an ongoing challenge for all firms.

DS: Do you have any other comments you want to make?

KM: To sum up our view, clients will continue to ask for higher levels of service and information. The expectation is for performance measurement reporting to be high quality, and that is our number one job. Beyond that, we look to provide higher level analysis of client portfolios through risk management services such as value-at-risk, stress testing, and risk budgeting, analytics, and attribution services for equity, fixed income, and non-traditional asset classes. Finally, as was mentioned earlier, asset liability analysis is a key topic for our clients, so providing analysis with respect to the liability streams and the funded status of the pension plan will continue to be of importance. So, our view would be that performance measurement is certainly a key aspect of what we provide, but we need to go beyond that to provide higher levels of intellect and value-added services.

CH: The challenges on the horizon include higher quality data on all instruments, including derivatives, and the ability to provide timely and accurate performance, analytics, and risk management across all asset classes, including private equity, hedge funds, and real estate. We will need to provide holistic analysis and insight into the risks and rewards of the entire plan or fund.

JT: At the end of the day, institutions are coming to us more and more for the information and tools to help them achieve greater risk-adjusted returns. So we’ve tried to build a one-stop shop for information services that will help them meet their investment goals.