How to Update your GIPS Policies & Procedures for GIPS 2020

If you are an investment firm or asset owner that complies with the GIPS standards you are required to make some modifications to your GIPS policies and procedures (“P&P”) to address changes made to the 2020 edition of the Standards. The extent of these updates depends on:

  1. whether your organization plans to adopt any new optional policies,
  2. whether you have pooled funds to add to the current list of composites, or
  3. if your organization plans to change any calculation methodologies now allowed under the new standards.

Like other GIPS requirements, consistent application and adequate documentation are critical to ensuring these updates and changes are applied correctly and consistently.

GIPS 2020: Minimum Requirements for all GIPS Compliant Organizations

There are some required GIPS policies & procedure updates that will impact all organizations claiming compliance. At a minimum, all firms and asset owners must address the following in their P&P:

Terminology

What was previously called “Compliant Presentations” are now called “GIPS Reports” in the 2020 GIPS standards. Likely, the term “Compliant Presentations” is used throughout your P&P, which needs to be replaced with “GIPS Reports” to be in sync with the language of the updated standards.

Demonstrate that GIPS Reports are Distributed

It has always been a good idea to maintain a log documenting the distribution of GIPS Reports to help support that your firm met the requirement of providing them to prospective clients; however, it was not previously required. The 2020 edition of the GIPS standards now requires firms to demonstrate how it made every reasonable effort to provide a GIPS Report to prospective clients that are required to receive one.

The most common way to do this is by maintaining a log of the distribution in a spreadsheet or by noting the distribution in your firm’s CRM system. If noting distribution in your CRM, it is important to populate this in a way that can easily be extracted into a report. Your GIPS verifier is now required to test this so you will need to be able to produce a report demonstrating that your firm is distributing GIPS Reports to prospective clients.

In addition, you must now update your P&P to document the process for how this is maintained. Although each firm will need to document this differently to accurately describe their process (i.e., the system in which it is maintained and who is responsible for maintaining it), below is an example of how this may be documented:

Each time a GIPS Report is distributed, the firm’s Sales Associate is responsible for logging the distribution on the firm’s CRM system. This documentation will include who received the GIPS Report, the version of the GIPS Report they received, the method of delivery, and the date it was delivered. This information may be extracted from the CRM system by the Sales Associate if requested by a verifier, regulator, or if needed internally.

Error Correction Procedures

In the 2010 edition of the GIPS standards, if a material error was discovered in a compliant presentation, correction and redistribution was required with a disclosure of the change to “all prospective clients and other parties that received the erroneous compliant presentation.” In addition to these, the 2020 GIPS standards specifically call out providing corrected GIPS Reports to your current GIPS verifier as well as any former verifier or current client that received the GIPS Report containing the material error.

Currently, most firms’ policies relating to material errors are likely limited to the action they take to redistribute to current prospective clients. We recommend updating this language to specifically address the need to provide the corrected presentation to verifiers and clients who received the erroneous presentation as well. An example of how this may be documented is provided below:

Our firm will determine an identified error is material if the error exceeds the materiality thresholds stated in the Error Correction Policy: Materiality Grid. If this occurs, we will correct all affected GIPS Reports, include a disclosure of the change, and make every reasonable effort to provide a corrected GIPS Report to:

    • Prospective clients that received the GIPS Report that had the material error;
    • Clients and any former verifiers that received the GIPS Report that had the material error; and
    • Current GIPS verifier.

Verifier Independence

Verifiers are prohibited from testing their own work and, therefore, cannot help their clients by writing policies, calculating performance, creating GIPS Reports, etc. To help ensure this independence is maintained, firms that are verified are now required to gain an understanding of their verifier’s policies for maintaining independence and to consider their verifier’s assessment of independence to ensure there are no conflicts.

To comply with this, firms must request that their verifier provide documentation describing the measures they take during the verification process to ensure independence is maintained. The procedures for requesting and assessing this needs to be described in the firm’s GIPS policies & procedures. Below is an example of what this might look like:

Our firm has engaged XYZ Verification Firm as an independent third-party verification firm to verify our claim of compliance. Each year, prior to the start of the annual verification, we request the independence policy statement from the verification firm.  If there are no changes from the prior year, this confirmation is requested in writing.  Any potential threats to independence, either in fact or in appearance, are discussed with the verifier to resolve immediately.

GIPS Report Updates

We will discuss all the changes relating to GIPS Reports in a separate blog; however, some of those changes will require updates to your firm’s GIPS policies and procedures, which we do want to discuss here. Presenting annual internal dispersion and three-year annualized ex post standard deviation is not new; however, it is new that firms are required to disclose whether gross-of-fee or net-of-fee returns are used in these calculations. We recommend adding language to your P&P that makes it clear whether you will use gross-of-fee or net-of-fee returns. Including this in your P&P will help you ensure the calculation is consistent with the disclosure you will be adding to your GIPS Reports. An example of how this could be worded is as follows:

Composite internal dispersion is measured using the asset-weighted standard deviation of annual gross-of-fee returns of those portfolios included in the composite for the full year. The three-year annualized ex post standard deviation measures the variability of the composite gross-of-fee returns and benchmark returns over the preceding 36-month period.

While either gross-of-fee or net-of-fee returns are acceptable, at Longs Peak we generally recommend that our clients use gross-of-fee returns so the presented volatility relates specifically to the implementation of the strategy and is not affected by management fees (which may differ by account, be paid at different times, etc).

Additionally, there is a new requirement to update GIPS Reports with the prior year’s information within 12 months of the period ending. In other words, statistics for the period ending December 31, 2020 must be added to your GIPS Reports by December 31, 2021.That will be plenty of time for most firms, but to ensure this is done, we recommend adding a procedure to your P&P document simply explaining that the reports must be updated within 12 months after the end of each annual period.

GIPS 2020: Changes for Firms with Pooled Funds

Firms that have pooled funds will have a few additional changes to make to their GIPS policies & procedures.

Terminology

Most firms will have language in their P&P referring to “prospective clients.” In the 2020 GIPS standards, the term prospective client refers specifically to a prospective separate account investor while the term “prospective investor” is used when referring to a prospective pooled fund investor.  Firms need to review their P&P language and make updates to define both terms and ensure they are using the appropriate term depending on the context of what is being described.

List of Pooled Funds

Firms have always been required to maintain a list of composite descriptions, but now the same is needed for each pooled fund the firm manages. For each limited distribution pooled fund, a description needs to be included (similar to what was done historically for composites). Broad distribution pooled funds need to be listed, but no description is required.

If you are unsure whether a pooled fund is considered broad distribution or limited, broad distribution pooled funds are defined in the glossary of the 2020 GIPS standards as “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. Limited distribution pooled funds are simply defined as any pooled fund that does not meet the definition of a broad distribution pooled fund.

Pooled Fund Inception Date

Pooled fund performance must be reported back to the pooled fund’s inception date. How the inception date was determined must be documented in the firm’s GIPS policies & procedures. Inception date could be based on when investment management fees are first charged, when the first investment-related cash flow takes place, when the first capital call is made, or when committed capital is closed and legally binding. Whatever criteria is used to determine the inception date must be clearly described in the P&P to ensure an appropriate inception date is used for each pooled fund managed by the firm.

Error Correction Thresholds

If language used to document error correction materiality thresholds is specific to composites, this will need to be modified to incorporate thresholds for statistics reported in GIPS Pooled Fund Reports as well. If the same thresholds are appropriate for both composites and pooled funds (e.g. composite and pooled fund performance can have the same threshold and composite and pooled fund assets can have the same threshold) then this may be as simple as changing “Composite” to “Composite/Pooled Fund” throughout this section.

Additionally, if your firm is now presenting money-weighted returns and other related multiples for closed-end funds, you will need to add thresholds to your policy for these statistics as well.

Changes for other Optional Policies

The 2020 GIPS standards offer some more flexibility to ensure they are as meaningful and useful as possible to all types of investment firms and asset owners. If any of these policies are utilized, additional changes will be required to describe their use in your firm’s GIPS policies & procedures. Examples of these optional policies include, but are not limited to:

Carve-Outs

If a firm decides to utilize carve-outs with allocated cash, the new carve-out composite will need to be documented in the current list of composites. In addition, the firm will need to implement policies and procedures as to how they allocate cash, how they identify appropriate asset buckets to carve-out from existing accounts, which accounts have asset groups that need to be carved-out to meet the new composite definition, and document other composite related policies applied to the carve-out composite.

Portability

Historically, GIPS compliant firms meeting the portability requirements were required to link the historical performance record to the ongoing performance. The 2020 GIPS standards change this to make linking optional. When portable track records exist, firms need to document in their P&P 1) whether the historical track record meets the GIPS portability requirements and 2) whether they are electing to link the historical performance record or choosing to not link it.

Estimated Transaction Costs

The GIPS standards define “gross-of-fees” as the return on investments reduced by transaction costs. Historically, firms complying with the GIPS standards were prohibited from estimating transaction costs; the use of actual transaction costs was required. The 2020 GIPS standards now allow estimated transaction costs to be used in cases where actual transaction costs are not known.

Using actual transaction costs is straightforward for traditional portfolios that pay transaction costs in the form of commissions on each trade. The issue most commonly arises with wrap accounts that pay transaction costs as part of a bundled fee.

Historically, firms were not able to present returns gross-of-fees for their composites containing wrap accounts because they were unable to determine the actual transaction costs. Most firms instead present “pure gross” returns, which are gross of the entire wrap fee and are required to be labelled as supplemental information.

Allowing estimated transaction costs will give firms managing wrap accounts the option to estimate the portion of the wrap fee that is for transaction costs and reduce returns by this estimated figure.

If estimated transaction costs are utilized, the firm must disclose in their GIPS Reports how these estimated transaction costs are determined. Similarly, the process used to determine the estimated transaction costs and the methodology utilized to reduce the returns by the estimated transaction costs needs to be documented in the firm’s P&P.

Model Management Fees

Previously, GIPS compliant firms using model investment management fees (rather than actual fees) to determine net-of-fee results were required to use the highest investment management fee. This was generally interpreted as the highest fee from the composite’s fee schedule or the highest fee-paying portfolio in the composite, whichever was higher. In the 2020 GIPS standards, firms using model management fees are required to use a fee that is “appropriate” to the prospective client. While the model fee doesn’t specifically have to be the highest fee, the resulting returns still need to be equal to or lower than the results that would be calculated if actual management fees were used.

If your P&P already describes using the highest management fee and you will continue to use the highest fee then no change is needed. If you will implement a new process other than highest fee, then it is important to update your P&P to describe how the model fee will be determined and applied. This description needs to include how you will confirm that the net-of-fee returns using the model fee are not higher than they would be if the actual investment management fees were used.

Presenting Advisory-Only Assets

Firms that have Unified Managed Accounts (“UMA Accounts”) or other similar arrangements where they are simply providing a model to be implemented by another party generally are not able to include these accounts in their total firm assets. These accounts are considered “advisory-only” because the manager is only providing the model and has no responsibility to implement the strategy or monitor the portfolios on an ongoing basis.

This type of arrangement has become increasingly popular over the last decade. Given the popularity of these relationships, many firms now have a large amount of advisory-only assets that they would like to report. Because of this demand, the 2020 GIPS standards have provided guidance outlining the proper way for firms to present these assets separate from their total firm assets. Firms electing to present these assets must make it clear how they intend to report them in their GIPS Reports.

Historically, many firms documented in their P&P something like, “all accounts deemed to be advisory-only, hypothetical, or model in nature are excluded from total firm assets” to make it clear that they were not including anything in total firm assets that was prohibited. Firms now electing to separately present advisory-only assets must add an additional statement describing how they will be presented. For example, “Some of the firm’s strategies are offered through UMA platforms on an advisory-only basis. These assets are presented separately from the firm’s composite assets and total firm assets and will be labelled ‘Advisory-Only Assets’.”

Presenting Money-Weighted Returns

Historically, time-weighted returns were required with two specific asset class exceptions: Private Equity and Real Estate (when Real Estate was managed in a Private Equity-like fund). The 2020 GIPS standards have now removed the asset-class specific requirements. Instead, firms may now present money-weighted returns for any asset class as long as the firm has control over the external cash flows and the composite or pooled fund has at least one of the following characteristics:

  • Closed-end
  • Fixed life
  • Fixed commitment
  • Illiquid investments are significant portion of strategy.

For firms meeting this criteria and electing to present money-weighted returns, the P&P must be updated to 1) note that the criteria was met, 2) indicate the election to present money-weighted returns, and 3) outline the methodology utilized to calculate the money-weighted return and other related multiples that must be presented in conjunction with the money-weighted return.

Other Considerations for GIPS Policies & Procedures

When going through your firm’s GIPS policies & procedures to make the required changes for the 2020 GIPS standards, this is a great opportunity to review the document as a whole to ensure everything is still relevant, applicable and accurate. One of the most common deficiencies regulators write in examinations is that policy and procedure documents do not reflect actual practices of the firm. We recommend a comprehensive review be conducted annually. Check out GIPS Compliance Actions for the New Year for a step-by-step guide to this review.

Questions?

If you have a situation that we didn’t cover here that is specific to your firm or for more information on GIPS Policies and Procedures, the changes to the GIPS standards for 2020, or GIPS compliance in general, contact Matt Deatherage at matt@longspeakadvisory.com or Sean Gilligan at sean@longspeakadvisory.com.

How to Comply with the 2020 GIPS Standards

A new decade is upon us and with the new decade comes a series of new requirements in terms of investment performance reporting for firms and asset owners that elect to claim compliance with the GIPS standards.

Many organizations have elected to adopt the 2020 edition of the GIPS standards early and have already put a solid foundation in place for the updated requirements; however, many organizations have not. The adoption deadline for all compliant organizations is rapidly approaching, so if your organization has not begun this conversion, now is the time to get started.

What is Changing and Why

It has been over a decade since the last edition of the GIPS standards was released, and quite frankly, the industry has changed since 2010. As the industry has evolved, CFA Institute has released a number of Q&A’s, guidance statements, and interpretations on how the changes in the industry impact the standards.

Ten years of updates have resulted in a vast repository of information needed to obtain the guidance required to comply. Having so many different resources for guidance (the 2010 GIPS Handbook, separate guidance statements, the Q&A database, and the GIPS Help Desk) has made managing the requirements of GIPS a pretty daunting task; thus, one of the goals of the 2020 standards is to centralize all of the updates that have come out over the past ten years. The 2020 GIPS standards consolidates many of the concepts previously addressed in guidance statements and Q&A’s, allowing the new provisions and explanation of the provisions to serve as the primary source that firms, asset owners, verifiers, and consultants can look to for guidance.

Additionally, the 2010 standards were heavily focused on composites and the traditional definition of prospective clients. Using this as the main framework is not always applicable to organizations that primarily manage pooled funds or asset owners that do not compete for business or report performance to prospective clients. To address this, CFA Institute set out to make this new edition of the standards more applicable to pooled fund managers and asset owners. These updates were designed to make claiming compliance easier and more relevant for these types of managers, while not creating additional burdens on organizations that are already compliant with GIPS. This goal is evident in the new format of the provisions, which separately focuses on requirements for investment firms, asset owners, and verifiers.

In addition to the separation of pooled funds and composites, the guidance is broader on when organizations may present money-weighted returns instead of time-weighted returns. This change now allows the decision to be based on the investment vehicle structure and who controls the timing and amount of external cash flows, rather than limiting money-weighted returns to certain asset classes. This is a welcomed update in the industry as many organizations were frustrated by requirements to calculate and present time-weighted returns when this type of return was not the most meaningful representation of how they managed their investment strategies.

How the 2020 GIPS Standards are Organized

For ease of use and navigation, the 2020 GIPS standards is broken out into three different groups of tailored provisions – firms, asset owners, and verifiers. Each containing specific requirements and recommendations applicable for that type of organization.

As an organization claiming compliance or working to become compliant for the first time, you will need to determine whether the set of requirements for firms or assets owners is applicable to your claim of compliance. The primary distinguishing factor is whether your organization competes for business and manages external money, or reports to an oversight board and manages internal money. The answer to this determines which set of tailored provisions should be followed and sets the framework for how the standards will apply. 

Where to Start – GIPS Compliance Updates

Regardless of whether you are excited for the updates to the standards, they are coming and will be required for all firms and asset owners claiming compliance with GIPS. The new requirements take effect once your GIPS Reports (formerly called Compliant Presentations) present performance information that is inclusive of the period 31 December 2020.

There is a lot of information available and dissecting everything that has been released can be overwhelming. For organizations that have never claimed compliance, the good news is that the new standards are more applicable and easier to adopt than they were previously.

For most organizations currently claiming compliance, what’s great is that the new standards do not require a lot of changes, rather they mostly provide optional procedures that you may choose to adopt if you find it beneficial to do so. However, some firms will require more work.

At Longs Peak, we have created the following questionnaire designed to help you determine if converting to the 2020 GIPS standards will require more than a few minor tweaks. This list does not include all changes, but includes the top ten material changes that may require a project plan to implement the required changes by the effective date of the 2020 GIPS standards.

Answering “Yes” to any of the following questions means your organization may require more than a few quick tweaks to implement the 2020 changes:

GIPS 2020 Checklist

  1. Does your firm have limited distribution pooled funds (i.e., private funds that are not regulated under a framework that would permit the general public to purchase shares in the fund without a one-on-one presentation)?
  2. Has your firm created single account composites for pooled funds solely for the purpose of meeting the GIPS requirement of having every discretionary, fee-paying portfolio in at least one composite?
  3. Does your firm have multi-strategy portfolios (e.g., balanced portfolios where the equity and fixed income segments each could be represented as standalone strategies) where you would like to carve-out the individual strategies into their own composites?
  4. Does your firm have portfolios where actual transaction costs are unavailable (e.g., wrap accounts or other bundled fee arrangements) and you would like to estimate transaction costs to show gross-of-fee returns without labeling the returns as supplemental information?
  5. Does your firm have portfolios where your firm controls the amount and timing of external cash flows (other than for private equity or real estate) and you would like to present money-weighted returns rather than time-weighted returns?
  6. Does your firm have real estate or private equity composites?
  7. Does your firm include theoretical performance (e.g., model performance) as part of a GIPS report?
  8. Does your firm follow the Advertising Guidelines to claim compliance with the GIPS standards outside of your GIPS Reports?
  9. Does your firm currently update your GIPS compliant presentations more than 12 months after the year ends?
  10. Does your firm have advisory-only assets or uncalled committed capital you wish to present in your GIPS Report?

Although the intent is for the adoption of the standards to be more relevant, many organizations find themselves asking “where do I even begin?” The great news is that you don’t have to figure this all out on your own.

At Longs Peak, we have spent countless hours familiarizing ourselves with the new standards and have helped all of our clients begin to adopt the changes. We know what issues come up and how to navigate the changes required.

As a consultant, we do not have independence requirements like your verifier, so we can actually help you implement many of the 2020 changes required for your organization. If you do not already work with a GIPS consultant, now may be a good time to consider hiring one, especially if you lack the resources needed to get this done by the deadline to convert to the 2020 GIPS standards.

Contact us if you do not wish to read through all of the requirements and recommendations to identify what actions are required for your organization.

Finally, if you would like to read more about what changed and why, we have summarized the main changes to the GIPS standards in GIPS 2020 What’s Changing and What you Should Do.