Creating performance metrics that are genuinely comparable

Published on August 19, 2019

As scrutiny into self-reported investment performance increases it is worth exploring the associated benefit of third party verified performance – namely comparability. In fact, whilst having a third party verify performance brings huge reassurance, it is the comparability that creates the real value. This is because the investment process, from due diligence to risk management, is in essence an exercise in comparison. At the due diligence phase, for example, investors need to understand, on an apples to apples basis, what is the risk adjusted return of one origination stream versus another. And so it continues throughout the investment process with comparisons being made to derive valuations and to monitor and manage both risk and performance. 

But as so often in finance the devil is in the detail. Effective comparison can only be made if performance measures are like for like comparable. And achieving genuine comparability is the hard part. 

 

Independent interpretation of default and loss given default

 
At Brismo we have built a process that ensures that the metrics we provide are like for like comparable. To do this we add what we call ’the extra step’. The extra step involves us independently interpreting when a loan needs to be impaired, and independently assessing the appropriate level of impairment. By working with bank statement level cash flow data we independently verify the status of the loan. This means that we do not rely on the originators own assessment of ‘default’ timing, or of the appropriate impairment amount. We will default a non-performing loan according to our own interpretation and we will write-down defaulted loans according to our own expectation of recovery. This may result in metrics that differ subtly from an originators own assessment. In fact, Brismo’s metrics will tend to be more conservative given that all subjectivity has been removed. But this is the price of true comparability, a price that is worth paying to achieve outputs that inspire confidence and bring real efficiency to the investment process. 
 
The ‘extra step’
 
Without this ‘extra step’ it is still possible to draw lines on a chart. But like for like comparability of those lines will be impossible, indeed any attempt at comparison could be misleading. Beyond the problems of comparison, investors will also soon realise that the metrics they are relying upon have not been verified, and are simply an aggregation of the originators own view with the application of some consistent definitions. The reality is that there are gradations of standardisation and without this ‘extra step’, we could not apply the description ’standardised and verified’ which gives investors confidence that they are basing their decisions on reliable metrics.