Hypothetical Performance

Actual Performance

Actual results experienced by a single client (account performance) or the aggregate results of a group of clients (composite performance) whose accounts are within a stated criteria such as being similarly managed.

Hypothetical Performance

Represents results that were not actually achieved by a portfolio under the management or advisement. These returns are theoretical and do not reflect actual client experience. Multiple types of hypothetical performance exist including Back-Tested, Model and Projected.

Model performance

Model performance represents the results of a model investment portfolio, and includes performance results generated by a model portfolio managed with the same investment philosophy used by the adviser for actual client accounts and consisting of the same securities recommended by the adviser to clients during the same time period. This type of performance is hypothetical because although the model consists of the same securities held in client accounts, the asset allocation process results in performance results that were not actually achieved by any client. Models are often designed to represent the appropriate balance of securities for a client’s portfolio based on defined investment objectives and risk tolerance.

This type of performance was originally described in the Clover Capital No Action Letter.

Backtested Performance

Back-tested performance uses a hypothetical portfolio of investments and retroactively applies market data from periods when the strategy was not actually used. It is important to understand that back-tested performance is not a forward-looking application of stated investment methods or criteria and does not reflect investment decisions made in real time with actual financial risk. In other words, back-tested performance shows how a portfolio may have performed during a time period in the past with the benefit of hindsight. The model is based on a current investment allocation and applied to time periods when the strategy was not yet offered to clients.

The returns shown are theoretical and do not reflect actual client experience.

Targeted and Projected Performance

Targeted or Projected performance reflects an advisor’s aspirational performance goals. These returns reflect an advisor’s performance estimates, often based on historical data and assumptions. Projections of general market performance or economic conditions are not subject to the provision on presentation of hypothetical performance.

Do not consider hypothetical performance as an indication of the skill of a financial advisor. Remember that it is based on assumed investment allocations for the reported time period and has been achieved with the benefit of hindsight. The investment holdings underlying a hypothetical performance report may differ from those of an actual client due to the client’s unique investment objectives, preferences and risk tolerance.

In general, retroactively-adjusted performance reports are subject to the fact that a financial advisor or other professional investment manager designed a strategy with the benefit of hindsight, including knowledge of the performance of the underlying investments. The performance of the hypothetical portfolio may be significantly different than the performance of actual client accounts managed with the same strategy. Investments may have generated greater or lesser returns than other investments during certain periods.

Hypothetical performance results do not include the effects that actual trading, market or economic conditions would have on a financial advisor’s decisionmaking. Since trades have not actually been placed, the investment results do not reflect how a financial advisor may have under- or overcompensated for the impact of economic or market events, or other factors such as a lack of liquidity.

It is assumed that all of the securities used in the hypothetical back-tested results were available for purchase or sale during the time period presented and the markets were sufficiently liquid to permit the types of trading used. In addition, back-testing assumes purchase and sale prices believed to be attainable.  Trades for the hypothetical returns were not actually executed. In actual trading, the prices attained may or may not be the same as the assumed order prices due to differences in the time the trades were executed and other factors.

Back-tested screening performance does not represent the impact of technical factors, such as: 1) changes in signals as a result of changes in market data that occur after the cutoff time for trading and 2) the inability to execute trades when desired.  In addition, performance results for clients that invest in the strategies will vary from the back-tested screening performance due to, for example, investment cash flows, frequency and precision of rebalancing and tax-management strategies.

The results do not represent the impact that material economic and market factors might have on an investment adviser's decision-making process if the adviser were actually managing client money. Accordingly, the results may have over or under compensated for the impact, if any, of certain market factors such as lack of liquidity, money flow and other factors.

When reviewing Hypothetical performance returns, the following items must be considered:

• The description of the model or strategy, assumptions, inputs and quantitative parameters necessary to interpret the theoretical results (e.g. all securities shown were available for the full time period; model assumes markets were sufficiently liquid to accommodate the model’s trades etc.). This information is typically included in the advertisement itself, within the body of the communication or disclosed through footnotes.

• The results are theoretical and do not reflect the performance of actual client accounts.

• Determinations on whether advisory fees, trading costs, or other fees were deducted from the performance figures.

• Assumptions regarding cash balances and external cash flows.

• The treatment of reinvestment of income, capital gains, and withholding taxes.

• The dates over which the theoretical performance applies.

• Whether backtested data covers reasonable time periods and varying market conditions (both good and bad).

• Targets and projections are hypothetical in nature and should not raise unrealistic performance expectations.

• The hypothetical performance results do not represent the impact that material economic and market factors might have on the adviser’s decision making process if the adviser were actually managing client money.

• Future market or economic conditions can adversely affect the returns.

• Hypothetical backtested characteristics related to positions (e.g., volatility and cost), position sizes and sector weights might differ materially from actual client portfolio(s).

Effective November 4, 2022, the U.S. Securities and Exchange Commission (“SEC”) prohibits investment advisers from showing (SEC Marketing Rule) hypothetical performance unless it is relevant to your likely financial situation and investment objectives, provides sufficient information to enable you to understand the criteria used and assumptions made when calculating such hypothetical performance, and provides sufficient information to you to understand the risks and limitations of using such hypothetical performance in making investment decisions.

Further, investment advisers must ensure that when receiving hypothetical performance materials, you have access to the resources necessary to independently analyze hypothetical performance and document thoroughly.

In late 2023, the Securities and Exchange Commission announced charges against nine registered investment advisers for advertising hypothetical performance to the general public on their websites without adopting and/or implementing policies and procedures required by the Marketing Rule. All nine firms have agreed to settle the SEC’s charges and to pay $850,000 in combined penalties.

Advisers can continue to show hypothetical performance to a “particular intended audience” (as opposed to a mass audience) so long as the adviser has adopted and implemented the required policies and procedures governing the distribution of hypothetical performance. However, this is still a high bar that requires consideration of whether the particular intended audience has access to the resources to independently analyze this information and has the financial expertise to understand the risks and limitations of hypothetical performance.

Hypothetical performance should always be labeled appropriately, and advisers should consider the proximity and prominence of disclosure about the methodology, risks, and limitations of hypothetical performance.

Advisers should make sure they satisfy the additional requirements to provide sufficient information about: (i) the criteria used and the assumptions made in calculating the hypothetical performance, and (ii) the risks and limitations of using the hypothetical performance in making investment decisions.

The SEC’s Marketing Rule’s general prohibitions and the requirements around the presentation of gross and net performance continue to apply to hypothetical performance.

If advisers are planning to show hypothetical performance in a more limited manner, they should define the intended audience and memorialize their determination that the hypothetical performance is relevant to the likely financial situation and investment objective of the intended audience.

Advisers may look to various factors in making this determination, including the following:

• The nature of the hypothetical performance that is shown (e.g., is it limited to blended performance based on actual returns of underlying investments, or is it more complex based on a range of different assumptions).

• The rationale for showing hypothetical performance to the intended audience (e.g., to demonstrate a particular investment strategy or illustrate the performance of a particular investment manager that the adviser is recommending).

• Whether the hypothetical performance is provided by a representative or consultant who can explain the hypothetical performance presentation and answer any client questions.

• Whether the adviser has implemented training for its sales personnel around the use and limitations of hypothetical performance and how to present it to clients.

• Whether the adviser has developed any educational materials that describe the use and limitations of hypothetical performance to clients.