We recently rolled out a risk-adjusted performance measurement application developed in response to a perceived lack of breadth and scope in the data being provided to participants in stock lending programmes. Agent lenders have historically provided their clients with varying degrees of performance reporting, with only modest disclosure of the embedded risks, and have not created the important analytical link between the two. In the absence of such a construct, the lender cannot definitively demonstrate to a plan sponsor that securities lending adds incremental value to its investment programme.

Recognising that some level of standardisation in performance evaluation needed to be achieved, many within the industry have supported the creation of a set of benchmarks" through which an agent's performance would be ranked on such measures as percentage on loan or average spread earned on a particular security type. Benchmarks must be universally achievable or replicable to be of value. For securities lending this is highly problematic because of the wide variation in lendable assets, collateral restrictions and acceptable counterparts, to name a few. Without the existence of a publicly quoted market, the pricing of loans is not transparent.

These comparability issues aside, this approach focuses on comparative performance against the universe of programme participants and creates only a limited context through which to evaluate the specific performance-related parameters inherent in one's particular programme. It fails to provide significant insight into some of the basic questions that programme participants ask. These include:

q How much risk is the plan taking to generate the level of returns it is receiving?

q Is the plan being adequately compensated for the level of risk being taken?

q How does the risk and return compare with that of the plan's underlying asset allocation activity?

q What alternative management strategies could be employed that would result in increased returns for the same level of risk or a lower level of risk for the same return?

It is our view that evaluating performance on a risk-adjusted basis can provide the information necessary to gain insight into these basic questions and at the same time ultimately account for differences in programme parameters and management styles between vendors. The quantitatively based nature of such an approach allows for consistency in the analysis of individual risks, their comparative weight, and correlation. This is powerful in that the relative risk/return trade-offs between various programme parameter options can be analysed with the goal of achieving optimum performance.

Having said this, while a quantitatively based decision-support system can provide the participant with objective comparative data, the acceptability of the performance outcome in the context of the associated risks is a function of one's unique risk/return tolerance. Locating the point on the risk/return spectrum at which one derives maximum utility, particularly in the context of a non-intuitive product such as securities lending, is not something that is arrived at immediately but rather is the result of a longer-term discovery process. In this process, the agent empowers the participant by creating a baseline through which to understand the various risk-based determinants of performance unique to that participant. With this in place, variations in any of the relevant factors can be readily identified and put back to the lender for clarification or possible adjustment. Increased accountability and ultimately a programme management "partnership" between lender and participant results.

Concerns expressed about risk-adjusted performance management and reporting have centered largely on implementation issues and not on the concept itself. We acknowledge that different risk measurement methodologies, assumptions and data set options can impact calculated results and that industry standardisation in likely to be a long way off. However, these issues exist in the mainstream investment process and are not unique to securities lending. In the long run, alternative approaches will serve to add depth to the common body of knowledge and ultimately benefit the industry.

The risk-adjusted performance construct should be viewed as a tool to better manage the product and augment communication. It is not intended to replace established risk management practices but rather to enhance them.

Ultimately, decision-support product offerings such as ours will serve to provide clients with meaningful and insightful information, truly enhancing the overall management and evaluation processes.

Jeffrey Trencher is vice president, risk and A/L management, global securities lending, with State Street in Boston"