Recently, a large value fund managing about $10 billion dollars in assets decided to close its operation. It was just one of numerous value funds, managing trillions of dollars, that have seen their worst performance in the last 200 years. Those aren’t just any dollars either — they include pension and retirement funds and lifetime savings. So why are these value funds closing en masse? To do our analysis of this question, we reviewed our research and revisited our earlier HBR article, “Why Financial Statements Don’t Work for Digital Companies,” to explain these new developments. But more importantly, we believe these closures make reforming financial reporting even more urgent. Without such reform, investors will continue to create their own, half-baked solutions, which harm their cause more than help it.
U.S. Financial Reporting Is Stuck in the 20th Century
One of the most important uses of financial statements is to enable investors to make timely decisions about buying and selling stocks. In the simplest analysis, an investor makes money by buying shares cheap and selling when it becomes overpriced. Value investors rely on multiple, often complicated, methods to make trading decisions. One way relies on income statement (profits) and balance sheets (assets) to identify cheap or expensive stocks. But current accounting rules require that funds companies spend on innovation, product development, information technology and other investments in the future should not be reported as assets and must be treated as costs in calculation of profits. The current system is causing confusion among investors and may even lead to misallocation of investment capital. It’s time to make concrete revisions to what must be reported in financial reports.