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. 

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.