GIPS 2020: What’s Changing and What You Should Do (Updated July 2019)

It has been a busy couple of weeks for GIPS! On August 31st, the Exposure Draft of the 2020 Global Investment Performance Standards (GIPS®) was released for public comment and last week (September 14th and 15th) was the GIPS conference. With this exposure draft being released only two weeks before the conference, the forthcoming changes to the GIPS standards were the highlight of the event.

UPDATE: Notes have been added in red to clarify what has been adopted or modified now that the 2020 GIPS standards have been published.


Why are changes to the GIPS standards necessary?

The three primary reasons GIPS standards are being revised is to make them:

  1. Easier to understand: GIPS compliant firms are required to comply with all of the requirements of GIPS, including issues addressed in Guidance Statements and Q&A’s. Since the 2010 Standards were published, there have been several new Guidance Statements and many Q&A’s issued, which can be difficult for firms to follow. The GIPS 2020 re-write of the Standards is reorganized to avoid having to refer to several different sources to understand what is required.
  2. More relevant for different types of investors: GIPS was intended to be a global standard that is applicable to any type of investment manager, regardless of location or type of investment strategy managed. Despite this intention, GIPS has historically been focused on presenting composite performance, which is only really relevant when marketing a strategy to prospective segregated account investors. GIPS 2020 differentiates between marketing a strategy to potential segregated account investors versus marketing an established pooled fund to prospective fund investors. It also separates out the requirements for Asset Owners who present performance to their oversight board instead of prospective investors.
  3. More consistent across asset classes: In some cases, the Standards have been overly focused on asset class in specifying calculation methodology and valuation requirements where investment vehicle structure and external cash flow control are perhaps more important than the underlying investments. By removing asset class specific requirements for private equity and real estate, the Standards can be applied more appropriately and in a more consistent manner.


What is changing with GIPS?

To be clear, nothing is changing yet. The purpose of the exposure draft is to introduce proposed changes. We are all invited to provide comments during the public comment period (open through December 31, 2018) to ensure our voices are heard before any of these proposed changes become official. Below are some highlights of the most significant proposed changes:

Asset Owners 

While this is largely just a formatting change, the reorganization of how the requirements for Asset Owners are documented will make it significantly easier for Asset Owners to understand and apply GIPS to their organizations. Specifically, GIPS 2020 separates the requirements for Investment Management Firms and Asset Owners, allowing each type of firm to review the provisions applicable to them and see all requirements in one place. Since there are many redundancies between the two sections, this makes the Standards much longer, but easier to read since only the sections of the provisions applicable to them needs to be reviewed. Previously, Asset Owners were required to start with the Standards that were written for investment managers and then remove or adjust the requirements that were not applicable for them. It is now easier for Asset Owners to understand what applies.

UPDATE: This change was adopted as part of the 2020 GIPS standards.

Managers of Pooled Funds 

Previously, GIPS compliant firms were required to create composites for pooled funds even if the pooled fund would be the only constituent of the composite. GIPS 2020 no longer requires these composites to be created. Managers of limited distribution pooled funds will instead create a GIPS Pooled Fund Report that presents the information of the fund itself for prospective investors together with required GIPS disclosures for this type of report. Managers of broadly distributed pooled funds are not required to create a special report for GIPS. This will save managers of pooled funds a lot of time and effort and will allow them to create meaningful presentations focused on the funds themselves rather than creating composites that would likely never be used.

UPDATE: This change was adopted as part of the 2020 GIPS standards.

Option to present MWR

Previously, only Private Equity funds presented Money-Weighted Returns (“MWR”) (a.k.a. Internal Rates of Return (“IRR”)). GIPS 2020 removes all asset class specific rules and focuses more on the structure of cash flows and the type of vehicle used. For example, under GIPS 2020, if a firm manages a closed end fund where they control the external cash flows, they will have the option to present MWR instead of TWR, regardless of the type of underlying investments being made. In cases where the manager controls the timing and amount of the cash flows rather than the client, MWR is likely a more meaningful performance measure since it does not remove the effect of the cash flows the way TWR does.

UPDATE: This change was adopted as part of the 2020 GIPS standards.

Valuation Requirements

Previously only the Real Estate provisions included a requirement for external valuations. Since all asset class specific rules have been removed, the external valuation requirement now applies to all private market investments. To make this manageable, what is accepted as an “external valuation” has been loosened to include annual financial statement audits. This means that as long as the fund is audited, no separate external valuation should be required.

UPDATE: This was NOT fully adopted. Private market investments are now RECOMMENDED to have an external valuation at least every 12 months; however, real estate investments included in a real estate open-end fund are still required to have external valuations at least every 12 months. Real estate investments that are not included in real estate open-end funds are required to have an external valuation at least every 12 months unless the client agrees to a less frequent external valuation (minimum of every 36 months) OR, instead of the external valuation, the real estate investment can be subject to an annual financial statement audit.

Carve-outs

That’s right, carve-outs are back! Firms that spent a lot of time and money revising their composites when carve-outs were disallowed in 2010 may not be happy to hear this, but this is likely good news for wealth management firms with balanced accounts that want to market asset class specific strategies. It is not yet clear whether carve-outs can be built historically covering the period they were disallowed (2010 – 2020), but this was discussed at the GIPS conference and we expect it to be clarified.

UPDATE: This change was adopted as part of the 2020 GIPS standards and updates can be made for historical periods once the firm has adopted the 2020 GIPS standards.

Portability

Under the current Standards, GIPS requires firms to link prior track records to ongoing performance if all of the portability requirements are met. GIPS 2020 proposes to make the linking of historical performance optional.

UPDATE: This change was adopted as part of the 2020 GIPS standards.

Advisory-Only Assets

Firms are required to report total firm assets that include the assets of both discretionary and non-discretionary portfolios. GIPS 2020 clarifies that advisory-only assets cannot be presented as a part of total firm assets, but may be presented separately. With the growth of Unified Managed Account (UMA) platforms, many firms’ assets are shifting to the “advisory-only” category. Although presented separately from total firm assets, being able to present these advisory-only assets will allow firms with a large UMA business to demonstrate the amount of assets invested in their models.

UPDATE: This change was adopted as part of the 2020 GIPS standards.

Deadline to Update GIPS Presentations

GIPS Composite Reports (formerly known as Compliant Presentations) will need to be updated with the latest annual statistics within 6 months after the annual period ends. This won’t be an issue for most firms, but firms who prefer to have their verification complete prior to updating their presentations may struggle to get this updated in time.

UPDATE: A deadline to update GIPS Reports was adopted as part of the 2020 GIPS standards; however, a more reasonable 12 months after the annual period ends was set instead of the proposed 6 month deadline.

Sunset Provisions for Select Disclosures

GIPS 2020 will allow some disclosures, such as disclosures of benchmark changes or material events to be removed when they are no longer relevant for current prospects.

UPDATE: This change was adopted as part of the 2020 GIPS standards.

Additional Statistic in GIPS Presentations

GIPS 2020 will require a 3-year annualized return to be presented for both the composite and benchmark. GIPS already requires the 3-year annualized ex post standard deviation to be presented for the composite and benchmark, so this provides the return that matches the periods included in the standard deviation calculation.

UPDATE: This change was NOT adopted as a requirement of the 2020 GIPS standards, but was instead adopted as a recommendation.

Estimated Transaction Costs

Previously, the use of estimated transaction costs was prohibited. Because of this, many wrap managers, or managers of accounts with asset-based transaction fees that do not reduce gross-of-fee returns, are required to present their gross-of-fee returns as supplemental information. As long as these firms are able to estimate the transaction costs and support that the estimated costs result in gross-of-fee performance that is lower than when using actual transaction costs, these managers will be able to present gross-of-fee returns without the supplemental disclosures under GIPS 2020.

UPDATE: This change was adopted as part of the 2020 GIPS standards; however, the requirement for calculating returns that are more conservative when using estimated transaction costs was removed because it may be too difficult to prove. It was clarified that estimated transaction costs may only be used when actual transaction costs are unknown. Guidance on how to determine estimated transaction costs will be included in the Handbook, which is expected to be published by the end of 2019.

Revised Advertising Guidelines

GIPS 2020 takes a broader approach to the Advertising Guidelines to include advertisements to Pooled Fund Investors and Asset Owners rather than only for composites intended for Segregated Account Investors. Additionally, the requirements were loosened by changing some of the previously required disclosures to recommendations and by increasing the options for performance periods presented.

UPDATE: This change was adopted as part of the 2020 GIPS standards.

What action should be taken now?

 

UPDATE: The 2020 GIPS standards are now published. Please see our latest blog “2020 GIPS Standards: Prepare for the Changes to help your firm determine what steps you need to take to comply with the 2020 edition of the GIPS Standards.

The changes listed above are a sample of the most significant changes. If you are concerned about the changes, I would strongly encourage you to review the full exposure draft and provide comments to the GIPS Executive Committee. Read the full Exposure draft and provide any comments to the following email: standards@cfainstitute.org. Comments must be submitted by December 31, 2018.

Please note that the exposure draft contains 47 specific questions that the GIPS Executive Committee would like feedback on prior to finalizing the changes. You can provide comments on as many or as few of those questions as you like. Additionally, you can feel free to provide comments on any aspect of the Standards even if not related to one of the questions posed. Keep in mind that providing positive responses to what you do like is as important as providing critical feedback. If only critical feedback is provided, there is the risk that changes could be made based on the critical responses received that actually represent a minority of the stakeholders’ opinions since they did not hear the positive support for the change.

Questions?

If you have questions about GIPS 2020 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 GIPS on an ongoing basis. Please feel free to email Sean Gilligan directly at sean@longspeakadvisory.com.

How to Advertise as a GIPS Compliant Firm

Most GIPS compliant firms are aware of the requirement to provide their compliant presentations to prospective clients, but it can be a little confusing how to reference GIPS in other materials.

It is important to remember that you should never just casually reference your firm’s GIPS compliance without considering what disclosures are required to accompany that claim of compliance. Specifically, if you are creating an advertisement (any material meant for a broad audience, generally designed to attract people to become prospective clients of your firm), you have the following three options:

  • Don’t mention GIPS at all.
  • Mention GIPS and include a compliant presentation with all required GIPS disclosures.
  • Mention GIPS and follow the more abbreviated requirements of the GIPS Advertising Guidelines.

Why do some GIPS Compliant firms avoid mentioning GIPS?

One reason firms choose not to mention GIPS in an advertisement is due to space constraints or the logistics of fitting the required disclosures without looking awkward. For example, firms often try to keep factsheets to one page. If including the claim of GIPS compliance and related disclosures would push the presentation to a second page then the firm may elect not to mention GIPS.

Unfortunately, another common reason GIPS compliant firms choose not to mention GIPS in advertisements is out of fear of doing it wrong. After all the hard work you put in to become GIPS compliant, you should definitely be able to reference GIPS in your advertisements without fear! The information provided below explains how you can confidently make reference to your firm’s GIPS compliance in advertisements.


The Two Options When Mentioning GIPS

Option 1: Include a Compliant Presentation

Compliant presentations include all statistics and disclosures for a composite that are required to be provided to your firm’s prospective clients. While this document is most often used in a one-on-one setting with prospective clients, it can be attached to advertisements that mention GIPS as well.

In some cases, it can be easier to attach the compliant presentation rather than trying to incorporate the advertising disclosures directly into the advertisement. For example, if emailing a newsletter (considered a type of advertisement) and your firm wants to mention GIPS in the letter, you could include the compliant presentation as an attachment to the email rather than trying to fit the advertising disclosures into the newsletter itself. Making a reference to the attached GIPS compliant presentation may be cleaner than adding disclosures directly into the newsletter itself.

Also, many firms looking to add a reference to their GIPS compliance on their website (also considered a type of advertisement) will simply add a link to their compliant presentations rather than putting the advertising disclosures directly on the website. This way, you can simply add a link to the detailed information for each composite rather than adding disclosures referencing who to contact to receive a copy of the disclosures, etc., which is required by the GIPS Advertising Guidelines.


Option 2: Follow the GIPS Advertising Guidelines

Following the GIPS Advertising Guidelines allows a firm to mention GIPS in an advertisement with a more abbreviated set of disclosures than what is required for a compliant presentation. This is the most common option firms follow when they want to mention GIPS in a print ad or press release where attaching a compliant presentation would not be feasible.

The disclosures required by the GIPS Advertising Guidelines are different depending on whether performance is included in the advertisement or not. If you elect to follow the GIPS Advertising Guidelines, we recommend that you use our Required Disclosures for GIPS Compliant Advertisements checklist. This list can greatly assist in helping your firm confidently reference GIPS compliance in all of your advertisements.


Want to learn more?

If you have questions about the GIPS standards, we would be 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 GIPS on an ongoing basis. Please contact us or email Sean Gilligan directly at sean@longspeakadvisory.com.

Creating GIPS Compliant Presentations

Firms that are GIPS compliant are required to provide all prospective clients with a GIPS compliant presentation. Typically, each composite has its own separate one-page sheet that includes all the statistics and disclosures required for that composite. This one-page sheet can be attached as an appendix to your firm’s pitchbooks and other marketing materials to properly represent your firm to the public as a GIPS compliant firm.

Not all compliant presentations are the same. Your firm’s required statistics and disclosures will depend on your firm’s strategies and policies. In this article, we discuss the required statistics and disclosures applicable to most GIPS compliant firms. In addition, we provide information on common issues firms face when creating compliant presentations and what you might be able to do to avoid them.


Required GIPS Statistics

Although additional statistics may be required, the following are the most common statistics that GIPS compliant firms are required to present in their compliant presentations:

  • Annual composite time-weighted returns (gross and/or net) – GIPS recommends the use of gross-of-fee returns; however, at least in the United States, it is most common to include both gross and net-of-fee returns. Net returns can be based on actual management fees or a model fee. As discussed in a previous post titled “Are fee-related administrative issues causing errors in your investment performance?” using a model fee instead of actual fees may be necessary when you have clients that pay fees from an outside source (e.g., by check or from another account your firm manages for them).
  • Annual benchmark returns – GIPS requires the use of a benchmark unless you are able to disclose a reason why no meaningful benchmark is available. Even if your strategy is benchmark agnostic, most firms choose to include the most relevant benchmark available and then disclose any material differences between the benchmark and the strategy.
  • Number of portfolios in the composite as of each year-end – This is simply the number of portfolios that are included in the composite as of 31 December each year.
  • Total assets in the composite as of each year-end – This is simply the sum of the composite assets as of 31 December each year.
  • Total assets of the GIPS firm as of each year-end – This is the sum of all discretionary and non-discretionary portfolio assets that are included in the firm definition as of 31 December each year.
  • A measure of internal dispersion for each annual period – Internal dispersion is a measure used to give the user of the performance report an indication as to how tightly the strategy is managed. In other words, if you are reporting that the composite return was 10% for the most recent annual period, a low internal dispersion figure will tell the user that most portfolios in the composite returned approximately 10%. High dispersion would indicate that the portfolios in the composite had a more diverse set of returns (e.g., perhaps some returned 5% while others returned 15%). Typically, firms use standard deviation to present this, which can either be calculated on an equal-weighted or asset-weighted basis.
  • Three-year annualized ex-post standard deviation of both the composite and the benchmark based on monthly returns – This is a measure of risk. The standard deviation of the composite’s monthly returns and the benchmark’s monthly returns provides the user of the performance report an idea of the level of risk taken compared to the benchmark. Ideally, you want higher annual returns and lower annualized standard deviation compared to the composite’s benchmark. That would indicate that you were able to outperform while taking less risk. For composites where a different measure of risk would be more meaningful than standard deviation, firms may present an additional risk measure with an explanation as to why that measure is more relevant, but the annualized standard deviation must still be included.

Other statistics may also be required if, for example, your firm manages non-fee-paying or bundled-fee accounts. Firms with these types of accounts must show the percentage of the composite they represent as of each year-end. Firms with private equity or real estate composites also require different statistics which can be found in the Real Estate and Private Equity provisions of the GIPS Standards.


Required Disclosures

When reviewing compliant presentations before distribution, many firms focus purely on the statistics presented to ensure material errors do not exist. This is often done without realizing that missing or incorrect disclosures can also be considered a material error. Thus, you’ll want to make sure your review process incorporates an evaluation of both.

The disclosures that must be included in a GIPS compliant presentation will differ by firm and by composite. Rather than listing all of them here, we have compiled a checklist of required GIPS disclosures which can be used as part of your firm’s marketing material review process. This checklist can be used to help you incorporate the proper disclosures for each compliant presentation prior to approving them for external use.

When reviewing the disclosures included in your firm’s GIPS compliant presentations, it is important to ensure:

  1. No required disclosures are missing.
  2. The disclosures are consistent with the policies documented in your GIPS Policies and Procedures document (“GIPS P&P”), including any recent changes to policies. For example, if a minimum asset level is changed for a composite, it is important to ensure that this change is consistently:
    1. documented in your firm’s GIPS P&P,
    2. implemented in the actual composite construction, and
    3. disclosed in the GIPS compliant presentation.
  3. Any disclosures (such as the claim of compliance) that are required to be written word-for-word as stated in the standards, are not modified in any way.

Common Issues

Firms that do not have composite maintenance software or an external GIPS consultant to create their GIPS compliant presentations often create them manually. When creating and updating compliant presentations yourself, it is important to avoid theses common mistakes:

  1. Don’t double count assets. For example, if the same portfolio is included in more than one composite you will not be able to sum your composite assets to get to your total GIPS firm assets. Additionally, if you manage a fund and then some of the separate accounts you manage invest in that fund as part of their portfolio, you need to ensure you do not count those assets both as part of the fund and again as part of the separate accounts. It is also important to ensure that only actual accounts are included. Models and anything that is considered “advisory-only” should be excluded from your calculation.
  2. Ensure that the number of portfolios reported is the total number of portfolios included in the composite as of 31 December of that year. Since internal dispersion is calculated based on only the portfolios that were in the composite for the full year, some firms make the mistake of reporting their number of portfolios as just the number of portfolios that were included for the full year. This is not correct as this statistic is intended to be the total number of portfolios in the composite as of each year-end.
  3. When partial-year performance is presented, it is important to:
    1. Clearly label the period for which performance is presented.
    2. Match the benchmark period to the period presented for the composite.
  4. Keep your presentations up-to-date. This means:
    1. Updating presentations with corrected statistics if corrections are made to the composite’s data. For example, firms may make updates to transactions for reconciliation purposes, such as backdating dividends. If this results in a change to composite-level statistics, then the compliant presentations must be updated accordingly. It is important to consistently follow your firm’s GIPS error correction policy. Typically, immaterial changes to the statistics are updated for future use even if the changes are not large enough to trigger redistribution of the presentation.
    2. Updating presentations with the most recent year’s statistics as soon as they become available. It is not necessary to wait for the verification to be complete before adding and presenting updated statistics. For example, if your annual GIPS verification for calendar year 2017 will not be complete until mid-2018, you do not need to wait until the verification is complete to present the 2017 statistics in your compliant presentation. You just cannot update the date your firm is verified through until the verification report is issued (i.e., you can present unverified statistics for the 2017 period, but the date range of your verification will still be disclosed as ending 31 December 2016). This lets the user of your compliant presentation have the latest statistics while letting them know that the verification for the latest period is pending.
  5. Ensure there are no typos if you are manually entering the statistics into a table. Typos can easily cause material errors that would trigger the need for redistribution of the presentation with disclosure of the error. Establishing a simple review process can help your firm avoid this headache.
  6. Make sure the information for each composite is entered into the correct compliant presentation (i.e., ensure you do not enter the statistics for Composite A into the presentation for Composite B). Seems obvious, but you’d be surprise how often this mistake is made. Again, a reliable review process can help your firm avoid these mistakes.

Want to Learn More?

If you have any questions about creating compliant presentations or any GIPS statistics or disclosures, 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. Contact us to learn how we can help.

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.



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.


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 20/20 Consultation Paper

The GIPS Executive Committee (“EC”) is preparing for a full re-write of the GIPS standards, which they are referring to as GIPS 20/20. It is referred to as GIPS 20/20 as it is a “vision” for the future of the standards and because it also is intended to be rolled out in the year 2020.

The EC has never put out a consultation paper of this kind before; typically the only opportunity to comment is after new guidance is already drafted. This is your opportunity to help shape the future of the standards by submitting your comments in response to the questions they pose in the consultation paper. To provide feedback, please send your comments to standards@cfainstitute.org by 16 July 2017.

The full GIPS 20/20 Consultation Paper is available on the GIPS Standards website. The areas of focus include:

  • The structure of the standards to ensure they are applicable to all types of investment managers as well as to asset owners
  • Specific treatment of pooled funds, to build on the Guidance Statement on Broadly Distributed Pooled Funds currently in place
  • Adjustments to the way asset-class specific guidance is structured in the standards (e.g., guidance specific to private equity and real estate)
  • Expanded use of internal rates of return (IRR) where appropriate
  • The frequency at which portfolios are required to be valued
  • Providing compliant presentations to existing clients and pooled fund investors
  • Options for reporting “advisory-only” assets (e.g., UMA) that do not currently fit within a firm’s assets under management (AUM)
  • The inclusion of non-fee paying portfolios in composites
  • References to the firm’s claim of GIPS compliance
  • Timeliness and frequency for updating compliant presentations
  • The use of estimated trading expenses
  • Whether any required statistics or disclosures can be removed as well as if any statistics or disclosures not currently required should be added

Whether you agree or disagree with the potential changes discussed, the EC greatly appreciates any feedback provided. If you only have an opinion on some of the topics, it is okay to respond to the portions you wish. Your response does not need to be formal and could even be a simple email.

We are in the process of composing our comments and strongly encourage you to do the same. If there are any aspects of the consultation paper you do not understand, feel free to contact us and we can help give you context or clarify the concerns involved.

Part 1: Creating GIPS Policies and Procedures

Firm Definition and Definition of Discretion

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.



Many firms create their GIPS policies and procedures (“GIPS P&P”) from a template; however, unless this template is customized to address the unique circumstances of the firm, it will not sufficiently describe the firm’s actual practices in place to adhere to the GIPS requirements. Given that every firm has their own unique set of circumstances, we cannot cover every detail that your GIPS P&P should include, but we will cover the most important parts that every firm is required to document. Within Part 1 of this two part series we will focus on Firm Definition and Definition of Discretion. In Part 2 we will cover calculation methodology, books and records, composite definition, and error correction.


Firm Definition

The GIPS standards must be 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.

Most small and mid-sized investment managers define their firm for GIPS purposes the same as they are defined for legal and regulatory purposes. If you choose to define your firm more narrowly than the legal entity, it is important to ensure that you will be able to clearly and consistently hold yourself out to the public based on this more narrow definition. Most importantly, you must never imply that any part of your firm that falls outside of your GIPS Firm Definition is GIPS compliant.

Your GIPS P&P must include a written definition of your firm. This definition will then be provided as a disclosure in each of your firm’s GIPS compliant presentations. The following are a couple examples of how one might define their firm:

Example 1 – Firm Definition Matches Firm’s Regulatory Registration

ABC Asset Management, LLC is a registered investment advisor with the United States Securities and Exchange Commission in accordance with the Investment Advisors Act of 1940. ABC Asset Management, LLC manages equity and fixed income strategies for institutions and high net worth individuals.

Example 2 – Firm Defined More Narrowly than the Firm’s Regulatory Registration

ABC – Institutional is the Institutional Division of ABC Asset Management, LLC, which manages equity and fixed income strategies for institutional investors. ABC Asset Management, LLC is a registered investment adviser with the United States Securities and Exchange Commission in accordance with the Investment Advisers Act of 1940. ABC Asset Management, LLC also includes a wealth management division focused on managing customized portfolios for high net worth individuals. The institutional and wealth management divisions are held out to the public as separate entities and only the institutional division complies with the GIPS standards.


Definition of Discretion

One of the benefits of GIPS is that it helps your firm demonstrate its ability to manage each strategy that it offers. To ensure that your composite results truly reflect your portfolio manager’s decision-making process, it is important to include only the accounts that are free of material, client-mandated restrictions in your composites.

GIPS requires all discretionary, fee-paying portfolios to be included in at least one composite, while non-discretionary portfolios are excluded from composites. Within your GIPS P&P you can define how to determine the discretionary status of each account.

The term “discretion” is defined differently for GIPS than it typically is for legal or regulatory purposes. For example, 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.

This section typically includes the types of restrictions that would cause an account to be deemed non-discretionary for GIPS purposes. Ideally, firms should include thresholds to ensure the policy can be followed consistently. For example:

  • Custom allocation requests that cause the portfolio’s asset allocation to deviate by more than 10% from the strategy’s target allocation.
  • Restricting the purchase or sale of certain securities that affects more than 10% of the portfolio.
  • Requests to hold cash at a level more than 5% above the current cash target.
  • Monthly, recurring cash flows regardless of size.
  • The use of margin, regardless of amount used.

As far as determining the thresholds to set, firms that manage their strategies very strictly to a model will typically have very low thresholds or even a 0% tolerance for deviations from their model. These deviations would trigger the portfolio to be deemed non-discretionary and excluded from the composite. Firms that allow for greater customization in their portfolio construction will typically have a higher tolerance for deviations.

When setting the criteria for determining discretion you’ll want to consider the following:

  1. A greater tolerance for deviations from the strategy’s holdings/allocation, will result in more portfolios in the composite (higher disclosed composite size), but dispersion (differences in performance between portfolios in the same composite) will also be higher.
  2. A lower tolerance for deviations results in tighter dispersion, but composite assets will be smaller and your firm’s number of non-discretionary accounts will be larger.

Your firm should find a balance that results in composite performance that meaningfully reflects the size and dispersion of your strategies.


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. 

How to Become GIPS Compliant

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.



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:

  1. Document GIPS policies and procedures
  2. Construct composites that consistently follow these policies and procedures
  3. 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:

  1. 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.
  2. 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.
  3. Asset-weight the monthly account-level results for each account included in the composite to calculate the composite-level performance results.
  4. 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. 

GIPS Compliance Actions for the New Year

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.

Before getting into the specific aspects to 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 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 compliant presentations 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.

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 composites, as you must make changes each time a new composite is added or a composite closes. However, even without adding new strategies or closing older strategies, the list of composites and their 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 composites 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:

  1. 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, reason, and nature of 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.
  2. 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 compliant presentations) 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.

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 the highest 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.

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