Are fee-related admin issues causing errors in your investment performance?

Sean P. Gilligan

Author

November 5, 2015

15 min

Are fee-related admin issues causing errors in your investment performance?

Calculating gross and net investment performance should be simple, right? Yes, however, firms often face fee-related portfolio accounting or administrative issues that cause complications, resulting in inaccurate performance. It is essential that all types of fees are accounted for correctly to ensure reported performance can be relied upon for evaluation by clients and prospective investors.

Which Fees and Expenses Reduce Investment Performance?

Gross-of-fee performance represents a portfolio’s return net of transaction costs only. Net-of-fee performance is net of transaction costs and investment management fees, so the only difference between gross and net performance is the investment management fee. According to the Global Investment Performance Standards (GIPS®), investment management fees are defined to include both asset-based and performance-based fees that are earned for managing a portfolio.

If your firm is GIPS compliant, it is important to reduce performance by both types of fees when calculating net-of-fee performance. For non-GIPS compliant firms, this is still considered best practice; however, it is common for firms with both types of fees to report performance reduced only by the asset-based fee as “Net” and performance reduced by both the asset-based fee and performance-based fee as “Net Net.”

Administrative fees, such as custody fees, do not reduce performance. This is the typical practice because clients have some control over selecting a custodian and, therefore, the administrative fees charged to their portfolio. For this reason, administrative fees are excluded from performance calculations and instead are treated like external cash flows that do not reduce their return.

The most common exception to this is net performance reported for mutual funds, which is typically calculated based on the change in the fund’s net asset value (NAV), resulting in performance that is net of all fees and expenses. Mutual fund investors do not have control over the custodian used or administrative fees charged (i.e., the manager selects the custodian), so these fees do reduce performance when calculating net returns for mutual funds.

What Are the Most Common Fee-Related Administrative Issues and How Can They Be Addressed?

The most common administrative issues that affect performance results usually are derived from:

Clients paying their management fee by check or from another outside source
Accounts with bundled fee structures (e.g., wrap accounts)
Accounts paying asset-based fees for transactions in lieu of per-trade commissions

We will examine each of these issues below.

1. Clients Paying Their Management Fee by Check or from Another Outside Source

In an ideal world all clients would have their management fees directly debited from the account that earned the fee; however, this is not always the case. Some clients prefer to pay their management fees by check or out of one of their multiple accounts managed by your firm. Since many firms record their accounts receivable in an accounting system separate from their portfolio accounting system (which calculates performance), a matching entry must be added to the portfolio accounting system when fees are paid. If this fee is not recorded in the portfolio accounting system, the client’s gross and net returns will be equal (neither being reduced by the management fee), which is inaccurate.

How to Add Adjusting Accounting Entries to Ensure Net-of-Fee Performance Is Accurate

When a client pays their fee by check, to correctly record this, two entries are needed in the portfolio accounting system:

An external cash inflow matching the management fees paid by check.
A management fee expense for the same amount.

After these two transactions are made, the portfolio’s market value will be the same as it was before entering these transactions since the two transactions offset each other. While these entries do not change the value of the portfolio, an expense is recorded that will allow the system to report the correct net-of-fee performance for the period.

Similarly, when the management fee is directly debited from another account, adjustments need to be made to both the account that paid the fee and the account that earned the fee. The account that paid the management fee will need two accounting entries:

A negative management fee expense for fees paid on behalf of a different account.
An external cash outflow for the same amount.

The account that earned the management fee will also need two accounting entries (note that these are the same as the entries when paid by check):

An external cash inflow matching the fees paid by the other account.
A management fee expense for the same amount.

Again, these transactions will not change the market value of any account as these entries simultaneously adjust cash and management fee expense by the same amount. While this has no effect on the total portfolio’s market value, it will allow net-of fee performance to be accurately reported, regardless of the source or method of the actual payment.

Forgetting to make these adjustments is very common and often leads to erroneously overstating net-of-fee performance for clients paying their fees from an outside source. It will also result in an overstatement of net-of-fee performance for any composite that includes these accounts. To avoid regulatory deficiencies or non-compliance with GIPS requirements, it is best to look into whether your firm has accounts paying management fees from outside sources and ensure proper adjustments are made.

2. Accounts with Bundled Fee Structures, Such as Wrap Accounts

As previously discussed, gross-of-fee performance is reduced by transaction costs and net-of-fee performance is reduced by transaction costs and management fees. This can become complicated when fees and expenses are bundled together and accounted for as one bundled fee.

What to Do If Fees and Expenses Are Bundled Together and Cannot Be Separated

If fees and expenses cannot be separated, gross-of-fee performance is calculated by reducing performance by transaction costs and any fees or expenses that cannot be separated from those transaction costs. Net-of-fee performance is then calculated by reducing performance by transaction costs and management fees, as well as any fees or expenses that cannot be separated from the transaction costs or management fees. This often results in identical gross-of fee and net-of-fee performance, as both performance measures are reduced by the entire bundled fee.

This most commonly occurs with wrap accounts, where the client pays one bundled fee and the individual fees for transaction costs, management fees, etc. cannot be separately determined. When this occurs, disclosures should be included with the performance to clarify if any fees other than transaction costs and management fees have been used to reduce performance.

Alternative Presentation Options for Gross-of-Fee and Net-of-Fee Performance With Bundled Fees

Instead of presenting gross-of-fee performance that is equal to net-of-fee performance, firms often only include net returns as their official performance, but then also present “pure gross” returns as supplemental information. Pure gross returns are gross of all fees and expenses and must be disclosed as such.

3. Accounts That Pay Asset-Based Fees for Transactions in Lieu of Per-Trade Commissions

As discussed earlier, gross-of-fee performance is reduced by transaction costs. Typically these transaction costs are the commissions tied to each executed trade; however, there has been a trend towards using asset-based fee structures for transaction costs, instead of per-trade commissions.

If an account is actively managed and trades frequently enough that an asset-based fee structure results in lower expenses than paying commissions on each trade, an asset-based fee structure may be a good option for your client. However, properly accounting for this kind of fee structure in your portfolio accounting system may be challenging, as many portfolio accounting systems have not caught up with this trend, leading to errors in the client’s reported performance.

With a commission-based structure, portfolio accounting systems typically account for each trade net of commissions, which ensures that gross-of-fee performance is net of transaction costs. All other fees and expenses are recorded as separate line items that are coded as either “performance affecting” (e.g., management fees, which reduce performance to arrive at net-of fee-returns), or “non-performance affecting” (e.g., administrative fees, which are treated as external cash flows that do not have an effect on performance).

When asset-based fee structures replace per-trade commissions, the asset-based fee is commonly accounted for as a line item, similar to management fees or other administrative expenses. The problem with this is that neither of the two options available (“performance-affecting” or “non-performance-affecting”) reduce gross-of-fee performance to account for trading costs. Instead, these options were only designed to reduce net-of-fee performance or reduce neither performance measure (i.e., there is often no transaction code that only reduces gross-of-fee performance).

How to Make Adjustments to Properly Account for Asset-Based Transaction Costs

Many systems have not created a solution for asset-based transaction costs, leaving firms to develop their own workarounds to reduce gross-of-fee returns. One example of a workaround that firms use is to record these fees as negative dividends, which results in the desired effect of reducing gross-of-fee performance. While this approach works, it is not ideal since the dividend transaction code is not intended to be used for this purpose, and should only be used as a short-term solution until your portfolio accounting system provider can offer an appropriate transaction code that will properly account for this type of fee.

Firms that have accounts with this type of fee structure for transaction costs should check with their portfolio accounting system provider to confirm if there is a way to ensure these fees are accounted for properly. Ideally, this should be addressed with a system developer or senior representative from your system provider, as this question is likely beyond the knowledge of a typical helpdesk associate, and may not be addressed in the reference materials they have available to them.

While this post is focused on fee-related administrative issues that affect performance, there are many other fee-related issues that firms face in reporting investment performance. We intend to cover additional fee-related topics in future posts, including: determining whether to use cash basis or accrual accounting for management fees, and considerations for determining when it is appropriate to use hypothetical or model management fees instead of actual management fees to calculate net-of-fee performance. If you would like to receive periodic information on these kinds of topics, please subscribe to our blog by submitting your email at the bottom of the webpage or check back frequently for new posts.

For more information on fee-related administrative issues or to discuss other investment performance or GIPS® topics, please contact Sean Gilligan at sean@longspeakadvisory.com.

Calculation Methodology, Books & Records, Composite Definitions & Rules, and Error Correction Policies

As discussed in Part 1 of this two part series, GIPS compliant firms are required to document how they comply with the GIPS requirements as well as any recommendations that the firm chooses to follow. This document acts as the firm’s internal representation of their GIPS compliance, and is intended to state the firm’s policies and describe the procedures the firm follows to maintain its compliance.

In Part 1 of this two part series we covered Firm Definition and Definition of Discretion. Now, in Part 2 we will cover calculation methodology, books and records, composite definitions and rules, as well as error correction policies.

https://www.youtube.com/watch?v=UhaTy-4c-EM&feature=emb_logo

Calculation Methodology

While GIPS provides a framework for how to calculate performance, firms may have different methods for handling external cash flows, asset-weighting portfolios, calculating dispersion, etc. The specifics of the methods used must be documented in the firm’s GIPS P&P. This section is typically broken down to separately discuss portfolio-level calculation methodology and composite-level calculation methodology.

The main consideration when establishing your firm’s portfolio-level methodology is the treatment of external cash flows. Since the start of 2010, GIPS requires firms to revalue for all “large” cash flows. It is up to your firm to define the term “large,” but it should be defined based on when your firm feels that estimation methods, such as Modified Dietz, lose their accuracy. Most portfolio accounting systems either value portfolios daily (essentially defining “large” as 0%) or value portfolios for all cash flows 10% or greater. Firms without a portfolio accounting system that are calculating their portfolio-level performance more manually (e.g., in Excel) frequently use 20%, but higher than that is less common.

With regard to composite-level performance, the most important information to document is the method used to asset-weight the portfolio returns to get the composite-level performance results. This is typically achieved through one of the following three methods:

Asset-weight each individual portfolio’s return for the month based on each portfolio’s beginning market value and then sum the portfolios’ weighted returns to get the composite return for the month.
Asset-weight each individual portfolio’s return for the month based on each portfolio’s beginning market value plus weighted cash flows and then sum the portfolios’ weighted returns to get the composite return for the month.
Aggregate the underlying data of all portfolios in the composite and then calculate the performance for each month as if all of the aggregated data is for one large portfolio.

This section should also include information regarding how the other required GIPS statistics are calculated, such as dispersion and 3-year annualized ex post standard deviation. Here, it is important to note whether these statistics are calculated based on gross or net-of-fee returns, whether calculated by your portfolio accounting system or outside the system, (e.g., in Excel) and the specific standard deviation formula used to do the calculation (e.g., a population or sample based formula).

Policies Regarding Books and Records

Firms must be able to support all information included in GIPS compliant presentations as well as support that their client assets are real. This section of your GIPS P&P can outline the types of records that are maintained and in what format/location they are stored. Specifically, firms typically outline the types of documents they have (e.g., custodial statements, records maintained within a portfolio accounting system, printed records from a former portfolio accounting system such as holdings reports, transaction summaries, etc.). In this section, it is also important to mention whether files are hardcopy or electronic, whether they are maintained onsite or offsite, and if there is a limit to the amount of time they are saved.

Composite Definitions and Rules

irms must create policies to ensure that portfolios are placed in the appropriate composite for the correct time period. The timing of portfolio movement in or out of composites must be based on objective criteria that is outlined in this section of the firm’s GIPS P&P. For example, firms typically either set a policy based on the amount of time passed since discretion was granted or based on when the portfolio becomes “fully invested” – which must be clearly defined.

For example, if based on time, the policy may be written as, “portfolios are included in the composite at the start of the first full month under management.” If based on when the portfolio becomes fully invested, the policy may be written to state, “portfolios are included in the composite at the start of the first full month after the portfolio is at least 90% invested in line with the strategy.” The percentage set can be whatever your firm feels is appropriate, but you want to establish a clear threshold that can be followed. Simply stating “fully invested” is subjective and difficult to follow consistently.

Other rules can also be documented in this section such as minimum asset levels and significant cash flow thresholds, to keep portfolios out of composites during periods where the intended strategy cannot be fully implemented. Minimum asset levels set for GIPS composite purposes are different than minimums your firm may set for marketing purposes. While your firm can state any marketing minimum you wish based on the size portfolios you hope to attract, the minimum set for composite inclusion must be based on the minimum amount needed to fully implement that strategy. For example, even if your firm states that your strategy has a $1M minimum, portfolios accepted below this threshold must still be included in the composite if they can be managed the same as the portfolios over $1M. In this example, if you determine that below $500k you can no longer diversify the same way as you do for your larger portfolios, then $500k would be an appropriate minimum to set for composite inclusion purposes.

A significant cash flow policy can be established if your firm is concerned with very large cash flows moving in or out of a portfolio. Often these cash flows affect the portfolio’s performance and could distort the composite’s statistics. Firms wishing to implement a significant cash flow policy establish a threshold for the size of a cash flow (typically based on the percentage of the portfolio’s beginning of month market value) that would trigger the temporary removal of the portfolio from the composite while trading takes place to accommodate the cash flow.

This “significant” cash flow threshold is different than the “large” cash flow threshold discussed in the calculation methodology section. While the “large” cash flow threshold is set to improve the mathematical accuracy of the performance calculation, the “significant” cash flow threshold is based on the size of a cash flow that disrupts the actual management of the portfolio. Significant cash flows often lead to distorted performance figures that were out of the portfolio manager’s control in terms of timing or amount.

Error Correction Policies

Firms must create materiality thresholds that pre-determine the action required if errors occur in a compliant presentation. This section should include thresholds for all statistics as well as criteria for determining when errors in disclosures are material. Defining materiality thresholds can be difficult, but CFA Institute, in conjunction with the United States Investment Performance Committee (USIPC), conducted a GIPS error correction survey seeking information regarding the typical materiality thresholds used by GIPS compliant firms. We recommend reviewing the Executive Summary of this survey’s results to get an idea of the thresholds that have been set by your peers.

Typically, thresholds are set that define the level when an error becomes a material error. Anything above the threshold would require the firm to redistribute an amended GIPS compliant presentation to any prospective client or clients that relied on the erroneous presentation. This amended GIPS compliant presentation would also need to include a disclosure that explains the correction. Anything below the materiality threshold will only trigger a correction for future distributions, but no disclosure or redistribution of previously circulated presentations.

Updates for GIPS 2020

The GIPS standards were updated in 2020. Check out our post How to Update Your GIPS P&P for GIPS 2020 to make sure your P&Ps are consistent with these changes.

Want to Learn More?

If you have any questions about the GIPS Standards, we would love to help. Longs Peak’s professionals have extensive experience helping firms become GIPS compliant as well as helping them maintain compliance with the GIPS Standards on an ongoing basis.

GIPS Compliance Actions for the New Year 2020

January 9, 2022

15 min

Your firm works hard to comply with the Global Investment Performance Standards (GIPS®) and likely expects the benefits of GIPS to far outweigh any burden associated with maintaining compliance. Most of the policies and procedures your firm set when first becoming compliant will never need to change; however, as both the standards and your firm evolves, it is beneficial to conduct a high-level review of your GIPS compliance each year. This high-level review will help ensure that you continually refine your processes and policies to maximize the benefits of claiming compliance with GIPS year after year.

This year, conducting a review of your firm’s GIPS compliance is especially important because of the 2020 Edition of the GIPS Standards that was published in mid-2019. For information specific to the 2020 changes, please check out 2020 GIPS Standards: Prepare for the Changes.

Even without the release of a new edition of the standards, each year you should conduct a review. In the review, you should first make sure you have the right people involved. One person or department may be responsible for managing the day-to-day tasks that maintain your GIPS compliance; however, high-level oversight from a larger group should take place to help ensure that any decisions made or policies set will integrate well with your firm’s other strategic initiatives. This larger group, often called a GIPS Committee, typically consists of representatives from compliance, marketing, portfolio management, operations/performance, and senior management.

Not everyone on the committee needs to be an expert in the GIPS standards. In fact, many will not be. What they will need is to be available to share their opinions and represent their department’s interests when establishing or changing key policies for your firm. Your GIPS compliance expert/manager can set the agenda for your meeting and can provide any background on the requirements that will be part of the discussion. If you do not have a GIPS expert internally, or need independent advice about your policies and procedures, a GIPS consultant can be hired to help.

High-Level GIPS Topics to Consider Annually

Once you select the right group to represent each major area of your firm, the following high-level questions can help determine if any action is necessary to improve your GIPS compliance this year:

Have there been any changes to the GIPS standards?
Have there been any material changes to your firm or strategies?
Do your composites meaningfully represent your strategies or should their structure and descriptions be reconsidered?
Are the materiality thresholds stated in your error correction policy appropriate for the type of strategies you manage and are they consistent with the thresholds set by similar firms?
Are you satisfied with the service received from your GIPS verifier for the fee that is paid?
Is there any due diligence you need to conduct on your verification firm?

Changes to the GIPS Standards

It is important to consider whether there have been any changes to the GIPS standards since last year that would require your firm to take action. For example, if a new requirement is adopted, you should consider if any changes to your firm’s policies and procedures or GIPS Reports are needed.

Keep in mind that GIPS compliant firms must comply with all requirements of the GIPS standards including any updates that may be published in the form of Guidance Statements, Questions & Answers (Q&As), or other written interpretations.

If your firm is verified or works with a GIPS consultant, these GIPS experts are likely keeping you informed of any changes to the standards. The best way to check for changes yourself is to visit the “Standards & Guidance” section of www.gipstandards.org. Specifically, you should check the “GIPS Q&A Database” where you can enter the effective date range of the previous year to see every Q&A published during this period. You should also check the “Guidance Statements” section. The guidance statements are organized by year published, so it is easy to see when new statements are added.

With the new 2020 Edition of the GIPS Standards, a review of the changes to determine how they affect your firm is especially important this year. These changes must be fully adopted before presenting returns in your GIPS reports for periods ending on 31 December 2020 or later.

Changes to Your Firm or Strategies

Similar to changes in the standards, it is important to also consider whether any changes to your firm or its strategies would require you to take action. Examples include, material changes in the way a strategy is managed, a new strategy that was launched, an existing strategy that closed, mergers or acquisitions, or anything else that would be considered a material event for your firm.

Even if no changes were made this year, you should still read your entire policies and procedures document at least annually to make sure it adequately and accurately describes the actual practices followed by your firm. Regulators, such as the Securities and Exchange Commission (SEC), commonly review firms’ policies and procedures to ensure 1) that the document includes actual procedures and is not simply a list of policies and 2) that the stated procedures truly represent the procedures followed by the firm. Many firms have created their policies and procedures document based on template language, so tweaks may be necessary to customize the document for your firm.

Meaningful Composite Structure

The section of your GIPS policies and procedures requiring the most frequent adjustment is your firm’s list of composite descriptions, as you must make changes each time a new composite is added or if a composite closes. However, even without adding new strategies or closing older strategies, the list of composite descriptions should be reviewed at least annually to ensure they are defined in a manner that best represents the strategies as you manage them today.

Since your firm’s prospects will compare your composite results to those of similar firms, it is important that your composites provide a meaningful representation of your strategies and are easily comparable to similar composites managed by your competitors. If a review of your current list of composite descriptions leads you to realize that your strategies are defined too broadly, too narrowly, or in a way that no longer accurately describes the strategy, changes can be made (with disclosure).

Keep in mind that changes should not be made frequently and cannot be made for the purpose of making your performance appear better. Changing your composite structure for the purpose of improving your performance results, as opposed to improving the composite’s representation of your strategy, would be considered “cherry picking.”

Two examples of cases that may require a change in your composites include:

A strategy has evolved and certain aspects of the way the strategy was managed and defined in the past are different from today. This can be addressed by redefining the composite. Redefining the composite requires you to disclose the date and description of the change. This disclosure will help prospects understand how the strategy was managed for each time period presented and when the shift in strategy took place. Changes like this should be made to your composite descriptions at the time of the change, but an annual review can help you address any items that may have been overlooked when the change occurred.
A composite is defined broadly to include all large capitalization accounts. Within this large capitalization composite, there are accounts with a growth focus and others with a value focus. If your closest competitors are separately presenting large capitalization growth and large capitalization value composites, your broadly defined large capitalization composite may be difficult for prospects to meaningfully compare to your competitors. To address this, you can create new, more narrowly defined composites to separate the accounts with the growth and value mandates. In this case, the full history will be separated and the composite creation date disclosed for these new composites will be the date you make the change. Note that this will demonstrate to prospective clients that you had the benefit of hindsight when determining the definition.

Materiality Thresholds Stated in Your Error Correction Policy

Another section of your firm’s GIPS policies and procedures that should be reviewed in detail is your error correction policy. Your error correction policy includes thresholds that pre-determine which errors (of those that may occur in your GIPS Reports) are considered material versus those deemed immaterial. These thresholds cannot be changed upon finding an error; however, they can be updated prospectively if you feel a change would improve your policy.

Many firms had a difficult time setting these thresholds when this requirement first went into effect back at the start of 2011. Now that much more information is available to help you determine these thresholds, such as the GIPS Error Correction Survey, you may want to revisit your policy to ensure it is adequate.

Setting and approving materiality thresholds that determine material versus immaterial errors is a task best suited for your firm’s GIPS committee rather than your GIPS department or manager. The reason for this is that opinions of what constitutes a material error will vary from one department to another. Your committee can help find a balance between those with a more conservative approach and those with a more aggressive approach to ensure the thresholds selected are appropriate.

GIPS Verifier Selection and Due Diligence

If your firm is verified, it is important to periodically evaluate whether you are satisfied with the quality of the service received for the fees paid. You may also want to consider whether you need to conduct any periodic due diligence on your verification firm with respect to data security or other concerns important to your firm.

With several mergers, acquisitions, and start-ups in the verification community over the last few years, you may need to do some research to ensure you are familiar with what your options are when selecting a verification firm.

All verifiers have the same general objective: to test and opine on 1) whether your firm has complied with all of the composite construction requirements of the GIPS standards and 2) whether your firm’s GIPS processes and procedures are designed to calculate and present performance in compliance with GIPS. Where they differ is in the fees charged and process followed to complete the verification.

With regard to fees, much of the difference between verifiers is based on their level of brand recognition rather than differences in the quality of their service. For example, smaller firms specialized in GIPS verification may have more experience with the intricacies of GIPS compliance than a global accounting firm; yet, a global accounting firm will likely charge a higher fee. When selecting a higher fee firm, it is important to consider whether the higher fee is offset by the benefit your firm receives when listing their brand name as your verifier in RFPs you complete.

With regard to process, the primary difference between verification firms is whether the verification testing is done onsite or remotely. There are pros and cons to both methods and it is important for your firm to consider which works best for the team that is fielding the verification document requests. The onsite approach may result in finishing the verification in a shorter period, but may be disruptive to your other responsibilities while the verification team is in your office. The remote approach may be less disruptive to your other responsibilities, but likely will take longer to complete and may be less efficient as documents are exchanged back and forth over an extended period of time. Another difference is how the engagement team is structured, whether you can expect to work with the same team each year, and how much experience your main contact has.

Regardless of whether the verification is conducted onsite or remotely, be sure to ask any verifier how your proprietary information and confidential client data is protected. If the work is done remotely, how are sensitive documents transferred between your firm and the verifier (e.g., is it through email or a secure portal) and once received by the verifier, do they have strong controls in place to ensure your data is not breached.

If the work is done onsite, it is important to ask what documents (or copies of documents), if any, the verifier will be taking with them when they leave, and whether these documents are saved in a secure manner. Documents saved locally on a laptop are at higher risk of being compromised.

Questions?

For more information on how to maximize the benefits your firm receives from being GIPS compliant or for other investment performance and GIPS compliance information, contact Sean Gilligan at sean@longspeakadvisory.com.

How to Become GIPS Compliant

May 24, 2017

15 min

Many firms are interested in becoming GIPS compliant, but are intimidated by the initial process of bringing their firm into compliance. As long as you know the steps to become GIPS compliant and understand the options you have to complete each step, this process is very manageable. The information provided here is intended to provide you with a high-level overview of the steps you must complete to become GIPS compliant.

https://www.youtube.com/watch?v=E6zBnbW_OMU&feature=emb_logo

Before holding your firm out to the public as a GIPS compliant firm, there are three main steps that must first be completed. Firms must:

Document GIPS policies and procedures
Construct composites that consistently follow these policies and procedures
Create compliant presentations to show the results of each composite

Document GIPS Policies and Procedures

Firms are required to document how they comply with the GIPS requirements as well as any recommendations that the firm chooses to follow in a document known as the firm’s GIPS Policies and Procedures (“GIPS P&P”). This document acts as the firm’s internal representation of their GIPS compliance, and is intended to state the firm’s GIPS policies as well as describe the procedures the firm follows to maintain their compliance. Examples of items typically found in this document include:

Firm Definition – GIPS is applied to your firm as a whole, not to a single product or strategy you manage. How your firm is defined for GIPS purposes is primarily based on how the firm is held out to the public, which may differ from the legal structure of your firm.
Definition of Discretion –Discretion is defined differently for GIPS than it typically is for legal or regulatory purposes. You may have a discretionary contract for an account that you deem to be non-discretionary for GIPS purposes because of restrictions the client places on the implementation of the strategy. The “Definition of Discretion” section of your firm’s GIPS P&P should outline objective criteria for determining the discretionary status of accounts.
Policies Regarding Books and Records – Firms must be able to support all information included in compliant presentations as well as support that their client assets are real. This section of your P&P can outline the types of records that are maintained and in what format/location they are stored.
Calculation Methodology – While GIPS provides a framework for how to calculate performance, firms may have different methods for handling external cash flows, asset-weighting accounts, calculating dispersion, etc. The specifics of the methods used must be documented in the firm’s GIPS P&P.
Composite Definitions and Rules – Firms must create policies to ensure that accounts are placed in the appropriate composite for the correct time period. The timing of the movement of accounts in or out of composites must be based on objective criteria that is outlined in this section of the firm’s GIPS P&P. Other optional rules, such as minimum account sizes and significant cash flow thresholds can also be documented here to keep accounts out of composites during periods where the intended strategy cannot be fully implemented.
Error Correction Policies – Firms must create materiality thresholds that pre-determine the action required if errors occur in a compliant presentation. This section should include thresholds for all statistics as well as criteria for determining when errors in disclosures are material.

Construct Composites

After the GIPS P&P is created, firms can use these policies to construct the composites defined in the policy document. To do this, firms must:

Identify all of the accounts that meet the definition of a composite. In other words, group all accounts by strategy, but then remove accounts that do not meet the firm’s definition of discretion or that do not meet a composite-specific rule, such as a minimum account size.
Determine the correct time to include each account as well as remove any account that closed, changed strategies, or otherwise caused you to lose discretion. Portfolios must only be included in composites for periods in which they were considered discretionary for GIPS purposes. This helps ensure that the composite results accurately represent the firm’s management of the composite’s strategy and does not include outside noise created from client-requested restrictions.
Asset-weight the monthly account-level results for each account included in the composite to calculate the composite-level performance results.
Calculate all required composite-level statistics (see the list below) that must be included in the composite’s compliant presentation.

Create Compliant Presentations

Compliant presentations act as the firm’s external representation of their GIPS compliance and must be provided to all prospective clients. Each composite has a separate presentation that includes all of the required statistics as well as the required disclosures. Statistics included in compliant presentations include:

Annual composite performance (gross and/or net)
Annual benchmark performance
Number of accounts in the composite as of each year-end
Total assets in the composite as of each year-end
Total assets of the GIPS firm as of each year-end
A measure of internal dispersion for each annual period
Three year annualized ex-post standard deviation of both the composite and the benchmark based on monthly returns

Other statistics may also be required such as the percentage of non-fee paying accounts or the percentage of bundled fee paying accounts as of each year-end, where applicable.

Want to Learn More?

If you have any questions about how to become GIPS Compliant, we would love to help. Longs Peak’s professionals have extensive experience helping firms become GIPS compliant as well as helping them maintain compliance with the GIPS Standards on an ongoing basis.

How to Comply with the 2020 GIPS Standards

April 23, 2020

15 min

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

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)?
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?
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?
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?
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?
Does your firm have real estate or private equity composites?
Does your firm include theoretical performance (e.g., model performance) as part of a GIPS report?
Does your firm follow the Advertising Guidelines to claim compliance with the GIPS standards outside of your GIPS Reports?
Does your firm currently update your GIPS compliant presentations more than 12 months after the year ends?
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.

About ColoradoBiz’s Top 25 Young Professionals

The 13th annual Gen XYZ awards is open to those under 40 who live and work in Colorado — numbered in the hundreds, making for difficult decisions and conversations among judges, as always. Applications were judged by our editorial board based on career achievement, community engagement and their stories of how they got to where they are now.

About Longs Peak

Longs Peak is a purpose and values-driven company. It is our mission to make investment performance information more transparent and reliable—empowering investors to make better, more informed investment decisions.

At the onset, we were looking to help smaller investment managers by giving them access to professional performance experts and tools typically only available to very large firms. We know that our work enables emerging managers to compete with the big guys and helps facilitate their growth. We strive to be our clients’ most valued outsource partner and to be known for our exceptional client service. We know that providing exceptional client service means that we must first create a culture that lives by the ideals we are trying to create for our clients. A place where incredibly talented individuals are empowered to put their best work into the hands of clients that truly value what we do. As a firm, we recognize that our greatest asset is people – both those we work with and those we work for. We continue to evolve into something that represents the needs of both of these groups and hope someday a GIPS Report is provided to every prospective investor in the world.

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SEC Clarifies Marketing Rule: Gross-of-Fee Returns Allowed Under Certain Conditions

The investment management industry has spent significant time grappling with the SEC’s Marketing Rule and the question of whether gross-of-fee returns can be presented without corresponding net-of-fee returns in certain cases. Many firms have invested resources in trying to allocate fees to individual securities and sectors in an effort to comply. However, the SEC has now issued two FAQs (March 19, 2025) that provide much appreciated clarity on extracted performance and portfolio characteristics. The key takeaway? It is possible to present gross-of-fee returns without net-of-fee returns—if certain conditions are met.

March 27, 2025

15 min

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Extracted Performance: Gross Returns Can Stand Alone Under Specific Criteria

Investment advisers often present the performance of a single investment or a subset of a portfolio (“extracted performance”) in marketing materials. Historically, the SEC required both gross and net performance to be shown for such extracts. The new guidance provides a pathway for firms to display only gross-of-fee extracted performance, provided the following conditions are met:

The extracted performance must be clearly identified as gross performance.
The advertisement must also present the total portfolio’s gross and net performance in a manner consistent with SEC requirements.
The total portfolio’s performance must be given at least equal prominence to, and facilitate comparison with, the extracted performance.
The total portfolio’s performance must be calculated over a period that includes the entire period of the extracted performance.

If these conditions are satisfied, the SEC staff has indicated they will not recommend enforcement action, even if the extracted performance is presented without corresponding net returns. This is a notable shift, as it allows firms to avoid the complex and often impractical task of allocating fees at the investment or sector level.

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Portfolio and Investment Characteristics: Net-of-Fee Not Always Required

Another common industry question has been whether certain portfolio or investment characteristics—such as yield, volatility, Sharpe ratio, sector returns, or attribution analysis—constitute “performance” under the marketing rule, and if so, whether they must be presented net of fees.

The SEC’s latest guidance acknowledges that calculating these characteristics net of fees can be difficult and, in some cases, may lead to misleading results. As a result, the staff has confirmed that firms may present gross characteristics alone, without net characteristics, if they meet the following criteria:

The characteristic must be clearly identified as calculated without the deduction of fees and expenses.
The advertisement must also present the total portfolio’s gross and net performance in a manner consistent with SEC requirements.
The total portfolio’s performance must be given at least equal prominence to, and facilitate comparison with, the gross characteristic.
The total portfolio’s performance must be calculated over a period that includes the entire period of the characteristic being presented.

As with extracted performance, these conditions help ensure that the presentation is not misleading, reducing the risk of enforcement action.

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Bottom Line: A Practical Path Forward

This updated SEC guidance provides much-needed flexibility for investment managers, allowing for the presentation of gross-of-fee returns in a compliant manner. Firms that clearly disclose their approach and follow the specified conditions can reduce compliance burdens while still meeting investor protection standards. While this does not eliminate all complexities of the Marketing Rule, it does offer a practical solution that allows for more straightforward and meaningful performance reporting.

For firms navigating these changes, ensuring clear disclosures and maintaining compliance with the general prohibitions of the rule remains critical. Those who align their advertising materials with these guidelines can now confidently use gross-of-fee performance in a way that is both transparent and in compliance with regulatory requirements.

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Questions?

If you have questions about calculating or presenting investment performance in a manner that complies with regulatory requirements or industry best practices, we would love to talk to you. Please feel free to email us at hello@longspeakadvisory.com.

New GIPS Standards Guidance for OCIOs: What You Need to Know

The Global Investment Performance Standards (GIPS®) have released a new Guidance Statement for OCIO Portfolios, bringing greater transparency and consistency to the way Outsourced Chief Investment Officers (OCIOs) report performance. This update is a significant milestone for firms managing OCIO Portfolios and asset owners looking to evaluate their OCIO providers.

February 3, 2025

15 min

What is an OCIO?

An Outsourced Chief Investment Officer (OCIO) is a third-party fiduciary that provides both strategic investment advice and investment management services to institutional investors such as pension funds, endowments, and foundations. Instead of building an in-house investment team, asset owners delegate investment decisions to an OCIO, which handles everything from strategic planning to portfolio management.

Who Does the New Guidance Apply To?

The Guidance Statement for OCIO Portfolios applies when a firm provides both:

Strategic investment advice, including developing or assessing an asset owner’s strategic asset allocation and investment policy statement.
Investment management services, such as portfolio construction, fund and manager selection, and ongoing management.

This ensures that firms managing OCIO Portfolios follow standardized performance reporting, making it easier for prospective clients to compare OCIO providers.

Who is Exempt from the OCIO Guidance?

The guidance does not apply in the following scenarios:

Investment management without strategic advice – If a firm only manages investments without advising on asset allocation or investment policy.
Strategic advice without investment management – If a firm provides recommendations but does not manage the portfolio.
Partial OCIO portfolios – If a firm only manages a portion of a portfolio, rather than the full OCIO mandate.
Retail client portfolios – The guidance is specific to institutional OCIO Portfolios and does not apply to retail investors including larger wealth management portfolios.

Key Change: Required OCIO Composites

Previously, OCIO firms had flexibility in defining their performance composites. Now, the GIPS Standards introduce Required OCIO Composites, which categorize portfolios based on strategic asset allocation.

Types of Required OCIO Composites

Liability-Focused Composites – Designed for portfolios aiming to meet specific liability streams, such as corporate pensions.
Total Return Composites – Focused on capital appreciation, commonly used by endowments and foundations.

Firms must classify OCIO Portfolios based on their strategic allocation, not short-term tactical shifts. This standardization enhances comparability across OCIO providers. The specific allocation ranges for the required composites are as follows:

Required OCIO Composites for OCIO Portfolios

Performance Calculation & Reporting

To ensure transparency, firms must follow specific rules for return calculations and fee disclosures:

Time-weighted returns (TWR) are required, even for portfolios with private equity or real estate holdings.
Both gross and net-of-fee returns must be presented to clarify the true cost of OCIO management.
Fee schedule disclosures must include all investment management fees, including fees from proprietary funds and third-party placements.

Enhanced Transparency in GIPS Reports

The new guidance also requires OCIO firms to disclose additional portfolio details, such as:

Annual asset allocation breakdowns (e.g., growth vs. liability-hedging assets).
Private market investment and hedge fund exposures.
Portfolio characteristics, such as funding ratios and duration for liability-focused portfolios.

By providing these details, OCIO firms enable prospective clients to make better-informed decisions when selecting an investment partner.

When Do These Changes Take Effect?

The Guidance Statement for OCIO Portfolios is effective December 31, 2025. From this date forward, GIPS Reports for Required OCIO Composites must follow the new standards. However, firms are encouraged to adopt the guidance earlier to improve transparency and reporting consistency.

Why This Matters

With OCIO services growing in popularity, this new guidance ensures that firms adhere to best practices in performance reporting. By establishing clear rules for composite classification, return calculation, and fee disclosure, the guidance empowers asset owners to compare OCIO providers with confidence.

As the December 31, 2025 deadline approaches, OCIO firms should begin aligning their reporting practices with this new guidance to stay ahead of the curve.

Don’t miss CFA Institute’s webinar scheduled for this Thursday February 6, 2025 to hear more on this guidance statement.

Questions?

If you have questions about the Guidance Statement for OCIO Portfolios or the Standards in general, we would love to talk to you. Longs Peak’s professionals have extensive experience helping firms become GIPS compliant as well as helping firms maintain their compliance with the GIPS Standards on an ongoing basis. Please feel free to email us at hello@longspeakadvisory.com.

Are fee-related admin issues causing errors in your investment performance?

Which Fees and Expenses Reduce Investment Performance?

What Are the Most Common Fee-Related Administrative Issues and How Can They Be Addressed?

1. Clients Paying Their Management Fee by Check or from Another Outside Source

How to Add Adjusting Accounting Entries to Ensure Net-of-Fee Performance Is Accurate

2. Accounts with Bundled Fee Structures, Such as Wrap Accounts

What to Do If Fees and Expenses Are Bundled Together and Cannot Be Separated

Alternative Presentation Options for Gross-of-Fee and Net-of-Fee Performance With Bundled Fees

3. Accounts That Pay Asset-Based Fees for Transactions in Lieu of Per-Trade Commissions

How to Make Adjustments to Properly Account for Asset-Based Transaction Costs

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SEC Clarifies Marketing Rule: Gross-of-Fee Returns Allowed Under Certain Conditions

Extracted Performance: Gross Returns Can Stand Alone Under Specific Criteria

Portfolio and Investment Characteristics: Net-of-Fee Not Always Required

Bottom Line: A Practical Path Forward

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New GIPS Standards Guidance for OCIOs: What You Need to Know

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Who Does the New Guidance Apply To?

Who is Exempt from the OCIO Guidance?

Key Change: Required OCIO Composites

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Required OCIO Composites for OCIO Portfolios

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Simplify Performance. Amplify Impact.