Part 2: Creating GIPS Policies and Procedures

Sean P. Gilligan
Author
June 22, 2017
15 min
Part 2: Creating GIPS Policies and Procedures

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:

  1. 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.
  2. 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.
  3. 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. 

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Longs Peak is pleased to announce that Partner and Co-Founder, Jocelyn Gilligan has been named a GenXYZ Top Young Professional by ColoradoBiz Magazine. As ColoradoBiz states, “They’re uncommon achievers, whether as entrepreneurs, CEOs, nonprofit leaders, visionaries critical to their companies’ success or, in some cases, all of those roles. This year’s Top 25 Young Professionals figure to continue making a difference professionally and in their communities for years to come.”
March 14, 2023
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Longs Peak is pleased to announce that Partner and Co-Founder, Jocelyn Gilligan has been named a GenXYZ Top Young Professional by ColoradoBiz Magazine.

As ColoradoBiz states, “They’re uncommon achievers, whether as entrepreneurs, CEOs, nonprofit leaders, visionaries critical to their companies’ success or, in some cases, all of those roles. This year’s Top 25 Young Professionals figure to continue making a difference professionally and in their communities for years to come.”

Jocelyn grew up in Boulder, CO and graduated from the University of Colorado. She started her career at Ernst & Young in New York City where she worked on their Financial Services Transfer Pricing Team. She transferred with EY to their office in Shanghai and then eventually to Hong Kong. Jocelyn left EY as a Manager and relocated back to Colorado where she and her husband started a family. Soon thereafter, Jocelyn and Sean founded Longs Peak out of a small one-car garage in their home in Longmont, CO. Now running a thriving team of 14, Jocelyn has weathered the ups and downs of entrepreneurship. She credits a lot of their success to their amazing team and the community of entrepreneurs they live near and network with (Longs Peak is an active member of EO (Entrepreneurs Organization)).

Jocelyn is a voting member of the PTO at her children’s school and a member of Women in Investment Performance Measurement, a group recently founded to support women in the investment performance industry.

Please join us in celebrating this year’s ColoradoBiz Top Young Professionals nominees. You can view the complete list of nominees here

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.

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.
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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.

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:

  1. The extracted performance must be clearly identified as gross performance.
  2. The advertisement must also present the total portfolio’s gross and net performance in a manner consistent with SEC requirements.
  3. The total portfolio’s performance must be given at least equal prominence to, and facilitate comparison with, the extracted performance.
  4. 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.

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:

  1. The characteristic must be clearly identified as calculated without the deduction of fees and expenses.
  2. The advertisement must also present the total portfolio’s gross and net performance in a manner consistent with SEC requirements.
  3. The total portfolio’s performance must be given at least equal prominence to, and facilitate comparison with, the gross characteristic.
  4. 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.

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.

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.
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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.

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:

  1. Strategic investment advice, including developing or assessing an asset owner’s strategic asset allocation and investment policy statement.
  2. 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

  1. Liability-Focused Composites – Designed for portfolios aiming to meet specific liability streams, such as corporate pensions.
  2. 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

Required OCIO Composites
Source: Guidance Statement 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.