GIPS 2020: Everything you need to know

By Carl Bacon, CIPM, chief advisor, StatPro

13 August 2019

Global Investment Performance Standards (GIPS) are voluntary, ethical standards based on the fundamental principles of full disclosure and fair representation of investment performance.

As investor expectations increase and product innovation develops, the standards are evolving to remain relevant and maintain their core purpose: ensuring performance transparency and comparability.

The 2020 version of the standards is a key milestone and marks the biggest change in the standards since their introduction in 1999. The GIPS standards are governed on behalf of the CFA Institute by the GIPS Executive Committee (GIPS EC).

The mission of the GIPS EC is to promote ethics and integrity and instill trust through the use of the Global Investment Performance Standards by achieving:

  • Universal demand for compliance by asset owners
  • Universal adoption by asset managers, and
  • Universal support from regulators for the ultimate benefit of the global investment community

GIPS update: direction and next steps

To achieve this mission, the GIPS standards must be applicable to all types of asset managers regardless of structure, client type, asset class or investment strategy.

Although incredibly successful (41 countries have endorsed the standards, 1700+ firms from 40 countries have notified the CFA of their claim of compliance including GIPS defined firms within 86 of the largest 100 asset managers1), the standards are not universal. There has not been widespread adoption among alternative asset managers, private wealth managers, managers of pooled funds and perhaps not sufficient understanding of the benefits of GIPS amongst asset owners. The GIPS EC realised that the current 2010 version of the standards needed to be improved.

Therefore, in May 2017, the GIPS EC released a consultative document for public comment to help develop their thinking for the 2020 edition of GIPS. Comments received, generally supportive, taken together with public comments on various guidance statements then in progress, helped inform the overall direction for the next step; an exposure draft of the 2020 edition. This exposure draft was made available for public comment between September 1, 2018 and December 31, 2018.

The objectives of the GIPS EC were:

  • To simplify the standards as much as possible (but not too simple)
  • Retain the integrity of the standards
  • Remove any unnecessary complexity and barrier to entry
  • Expand the scope of GIPS to all types of assets and asset managers.

The GIPS EC received more than 5,200 comments from more than 120 organisations, another indicator of the success and importance of the standards.

The objectives of the GIPS standards are:

  • Promote investor interests and instill investor confidence
  • Ensure accurate and consistent data
  • Obtain worldwide acceptance of a single standard for calculating and presenting performance
  • Promote fair, global competition amongst investment firms
  • Promote industry self-regulation on a global basis

Three chapters: asset managers, asset owners and verifiers

The 2010 edition of GIPS focused solely on asset managers (or investment firms), although both asset managers and asset owners are able to comply with GIPS.

With the 2020 edition of GIPS the EC took the opportunity to create provisions specific to asset owners. In the exposure draft sections one to seven covered firms, eight to 12 asset owners and section 13 covered GIPS Advertising Guidelines for both asset managers and asset owners. To avoid repetition, an overly large document and frankly unnecessary complication the final version is split into three separate documents (chapters), one for firms, one for asset owners and one for verifiers combining existing verification and performance examination guidance into a separate document for verifiers:

  1. GIPS Standards for Firms (Asset Managers)
  2. GIPS Standards for Asset Owners
  3. GIPS Standards for Verifiers

Organisations that compete for business (Investment firms, asset managers and importantly asset owners that compete for business) must comply with the GIPS standards for Firms.

The GIPS Standards for Firms are divided into the following eight sections:

  1. Fundamentals of compliance: Several core principles create the foundation for the GIPS standards, including properly defining the firm, providing GIPS Reports to all prospective clients and prospective pooled fund investors, adhering to applicable laws and regulations, and ensuring that information presented is not false or misleading. Two important issues that a firm must consider when becoming compliant with the GIPS standards are the definition of the firm and the firm’s definition of discretion. The definition of the firm is the foundation for firm-wide compliance and creates defined boundaries whereby total firm assets can be determined. The firm’s definition of discretion establishes criteria to judge which portfolios must be included in a composite and is based on the firm’s ability to implement its investment strategies
  2. Input data and calculation methodology: Consistency of input data used to calculate performance is critical to effective compliance with the GIPS standards and establishes the foundation for full, fair, and comparable investment performance presentations. Achieving comparability among investment management firms’ performance presentations requires uniformity in methods used to calculate returns. The GIPS standards mandate the use of certain calculation methodologies to facilitate comparability.
  3. Composite and pooled fund maintenance: A composite is an aggregation of one or more portfolios managed according to a similar investment mandate, objective, or strategy. The composite return is the asset-weighted average of the performance of all portfolios in the composite. Creating meaningful composites is essential to the fair presentation, consistency, and comparability of performance over time and among firms. Pooled funds must be included in composites if they meet a composite definition.

Reporting sections: These four sections detail the requirements and recommendations for reporting the following types of returns:

  1. Composite Time-Weighted Return Report
  2. Composite Money-Weighted Return Report
  3. Pooled Fund Time-Weighted Return Report
  4. Pooled Fund Money-Weighted Return Report

One of the essential disclosures for every firm is the claim of compliance. Once a firm meets all the applicable requirements of the GIPS standards, it must appropriately use the claim of compliance to indicate compliance with the GIPS standards. Firms are also required to submit a GIPS Compliance Notification Form to CFA Institute when they initially claim compliance and on an annual basis thereafter.

  1. GIPS Advertising Guidelines: Firms are not required to follow the GIPS Advertising Guidelines when creating an advertisement, but if they would like to claim compliance with the GIPS standards in an advertisement, they must adhere to the GIPS Advertising Guidelines or include a GIPS Report.

The GIPS Standards for Asset Owners are for asset owners that do not compete for business and that report their performance to an oversight body. Asset owners that compete for business must comply with the GIPS Standards for Firms. Although GIPS for asset owners is aimed at asset owners reporting to their own oversight body, hopefully this extra focus will encourage all asset owners to require all their asset managers (including those managing alternative assets) to be GIPS compliant.

Effective date and preparation

This revised structure might seem like a big change but in truth if you are an asset manager already in compliance there are no fundamental changes that should cause major difficulties.

There are a few changes to disclosures such as the claim of compliance, the controversial reintroduction of carve-outs and additional opportunities in terms of the treatment of pooled funds and alternative assets that might tempt asset managers to broaden their current definition of firm. Even the effective date is relatively relaxed. The effective date is January 1, 2020, but this means that GIPS Reports that include performance for periods ending on or after December 31, 2020 must be prepared in accordance with the 2020 edition of GIPS. Even GIPS reports that include returns for periods ending prior to December 31, 2020 (eg year-to-date returns through September 30, 2020) may be prepared in accordance with the 2010 edition of the GIPS standards.

Firms will be required to make a new disclosure, not necessarily linked to the claim of compliance: “GIPS is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organisation nor does it warrant the accuracy or quality of the content contained herein.”

Firms that offer pooled funds must be able to correctly classify their pooled funds as either Broad Distribution Pooled Funds (BDPF) or Limited Distribution Pooled Funds to determine the relevance to their firm of various provisions pertaining to pooled funds.

A Broad Distribution Pooled Fund (BDPF) is a pooled fund that is regulated under a framework that would permit the general public to purchase or hold the pooled fund’s shares and is not exclusively offered in one-on-one presentations.

A Limited Distribution Pooled Fund (LDPF) is any pooled fund that is not a Broad Distribution Pooled Fund.

Pooled funds

In the 2010 edition of GIPS, firms are required to include all discretionary, fee-paying portfolios in a composite.

For some firms this means creating many composites that include only one pooled fund whose strategy was not managed for or offered as a segregated account. Firms will no longer be required to include such funds in a composite. This rule together with the GIPS advertising guidelines and clarity that firms are not required to provide GIPS Reports to prospective broad distribution fund prospective investors should encourage more pooled fund managers to become compliant. In a change to the exposure draft firms will be allowed to present gross or net returns in a GIPS Pooled Fund Report. Firms will be required to include benchmarks in their advertisements if they want to comply with the GIPS Advertising guidelines. Firms that do not comply with the GIPS Advertising guidelines are not required to do so.

In the 2020 Exposure Draft the private equity and real-estate provisions were removed in favor of more generic provisions that apply to all private market investments, including real assets, private equity, and similar instruments that are illiquid, not publicly traded, and not traded on an exchange. In the exposure draft the GIPS EC proposed all private market investments to have an external valuation, a valuation review, or be subject to a financial audit at least once every 12 months. Not all feedback was positive, in response the GIPS EC included a specific real-estate requirement for independent valuation but only recommended independent valuation for non-real estate private market investments.

In the 2010 edition of GIPS, firms are required to present time-weighted returns for all classes with the exception of private equity. Responding to the requirements of managers of alternative assets firms are now allowed to present money-weighted returns for those composite and pooled funds for which firms have control over external cash flows and that have at least one of the following characteristics:

  1. Closed-end
  2. Fixed life
  3. Fixed commitment, or
  4. Illiquid

The purpose of these extra characteristics is to ensure that money-weighted returns are only used when time-weighted is not appropriate. Only time-weighted returns are truly comparable. Note only the annualised since inception money-weighted return through the most recent annual period end is required. Both IRR and modified Dietz methods are acceptable.

Conclusion

With overlay asset managers in mind firms will be able to present total firm assets or total firm overlay exposure in GIPS Composite Reports for overlay strategies.

The GIPS EC concluded that allowing firms to include carve-outs with allocated cash would result in a greater number of private wealth managers and managers of private market investments coming into compliance. That said, firms must create and maintain composites that include standalone portfolios managed in the same strategy as the carve-outs with allocated cash. The returns and composite assets from the stand-alone composite must be included in the GIPS Report of the carve-out with allocated cash. Any major difference between these returns should be a red flag for any prospective client.

My advice is to stay well clear of carve-outs, they are required to be representative of the stand-alone strategy, the cash allocation calculations are onerous, it’s difficult to ensure you’ve included all relevant carve-outs in the composite and the stand-alone numbers must be shown – it’s a non-compliance trap that many innocents may fall into.

 

The 2020 edition of GIPS is a major step forward, broadening the relevance of the standards to alternative assets, pooled fund managers, private wealth managers and asset owners. It’s also an opportunity to emphasise the success of the standards to date and to re-energise the promotion of the standards to a much broader audience in terms of manager type, asset type and geographically. The evidence, so far, is that the CFA Institute has grasped this opportunity with both hands.

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