How to Survive a GIPS Verification Part 2: Kick-off and Initial Data Request

This article is part two of a three-part series on how to survive a GIPS verification. If you haven’t had a chance to read part one, we recommend going back and reading the first part of this series, which covers tips and tricks for setting up your verification for success. In this article, we cover recommendations for kicking off the verification and then provide some context around responding to the initial request made by the verifier. Understanding what the verifier is requesting and why they need it will help streamline the response and allow you to send only the information that is necessary.

Kicking off the Verification

Many firms are eager to quickly get through their verification. One way to help promote efficiency is to schedule a call with your verifier before they even send their initial request. The kick-off call will help ensure everyone is on the same page – especially if it is your first verification or if your firm and strategies have changed since the last verification was completed. For first-time verifications, this time should be used to communicate unique aspects of your firm, discuss the timeline, and introduce key members of your project team.

Most verifications are completed annually. A lot can change over the course of a year that may impact your compliance with the GIPS standards. The kickoff call will initiate these discussions at the onset so surprises don’t delay your ability to complete the verification. The following are some items to consider discussing during a kick off call:

• Any changes to the definition of your firm for GIPS purposes – such as acquisitions, mergers, portfolios moving to/from model-based platforms (e.g., UMA)
• Any new or closed composites or pooled funds
• Any material changes to your GIPS policies and procedures
• Any personnel changes at the firm – especially with individuals that are involved in the verification project
• Any upcoming deadlines that impact the timing of the verification

What to expect with the Initial Data Request

Once all parties are ready to begin the verification, your verifier will provide their initial data request, which lists all items the verifier needs to get the verification process started. After these items are received and reviewed, additional samples will be requested for the verifier to complete more detailed testing. These follow-up testing items are discussed in part three of this series. The most common items requested in this initial data request include:

• GIPS Policies & Procedures
• List of Composites and/or Pooled Funds
• Portfolio and Composite Performance
• Composite Membership Change List
• Assets Under Management (“AUM”) Report
• List of Non-Discretionary Portfolios
• GIPS Reports
• GIPS Report Distribution Log
• Marketing Materials
• CFA Notification Form
• Other miscellaneous items such as (where applicable):
  • Regulatory Correspondence
  • Changes to your Portfolio Accounting System
  • Error(s) Since the Last Verification
  • Incentive Fees Charged

The following sections discuss each of these commonly requested items in more detail.

Policies and Procedures

GIPS policies and procedures are one of the most important documents the verifier needs to get the verification started. The end goal of verification is the opinion letter that attests to “whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis.”

In other words, your firm’s GIPS policies and procedures document is used throughout the verification process to ensure that the policies and procedures are 1) adequate and 2) have been applied consistently across your firm. Your verifier will use your GIPS policies and procedures as the backbone for the entire project, and as a guide for how to test various aspects of your firm’s GIPS compliance.

The GIPS standards offer flexibility in many areas and, therefore, not all firms use the exact same calculation methodology, definition of discretion, timing for composite inclusion/exclusion, etc. Because of this, it is critical for the verifier to have a strong understanding of how these policies and procedures are applied at your firm.

If changes are made to composite policies, composite inclusion rules, or if a calculation methodology changed because of a conversion to a new portfolio accounting system, etc., it is essential that these changes are clearly recorded in the policies and procedures document before the verification begins. If the document is not kept up-to-date, the verifier will find inconsistencies between the policy documentation and the actual practices of your firm. This will stall the verification process.

List of Composites and/or Pooled Funds

If not already included in your GIPS policies and procedures, the verifier will request a current list of all active pooled funds and composites, including any composites that have terminated within the last five years.

This list commonly includes composite or pooled-fund-specific policies. This is an important piece of information to help the verifier understand what policies are applied to a given composite/pooled fund and ensure that they are selecting a meaningful sample.

Based on this list, a sample of composites/pooled funds will be selected for more detailed testing. This testing generally includes the recalculation of performance results presented in the corresponding GIPS Reports. The verifier will use the rules and methodologies outlined in the GIPS Report and composite definitions to gain confidence that the policies were consistently applied.

It is important that any new composites/pooled funds are added to this list and any that are terminated are labelled as such. Since this impacts the sample selection for the testing, the verifier needs to have a fully updated list to avoid having to modify samples and change testing procedures later in the process.

Portfolio and Composite Performance

Based on your firm’s list of composites and pooled funds, the verifier will select a sample to review in more detail. Often, verifiers focus on the main marketed composites, but they will also rotate through others to ensure all are being maintained as described in your GIPS policies and procedures.

For the selected composites, most verifiers will have you provide monthly portfolio-level market values and returns as well as monthly composite returns. With this information they will reconstruct the composites using the rules and calculation methodology described in your GIPS policies and procedures. As they do this, they will focus on the following:

1. Can they use the portfolio-level data to calculate the same composite returns you provided by following the calculation methodology outlined in your GIPS policies and procedures?
2. If a composite has a minimum asset level or significant cash flow policy, do they see portfolios in the composite breaking these rules?
3. How does the dispersion look on a monthly basis? Is it consistent month to month or are there months with large spikes? What outlier performers are driving this dispersion?

The information gleaned from this composite reconstruction and review drives the sample selection for the next phase of testing. Specifically, portfolios appearing to break established rules as well as a sample of performance outliers will be selected for further testing. These testing items are discussed in detail in part three of this three-part series.

Because the results of this initial screen drives the sample selected for further verification testing, it is important that the data is free of errors and has been constructed in a manner that is consistent with your documented policies. To gain comfort, a review of all portfolios should be conducted prior to providing the data to the verifier – either on your own or with the help of a GIPS consultant. These checks should confirm that:

1. Policies such as minimum asset levels and significant cash flows have been applied consistently and in line with how they are described in your GIPS policies and procedures.
2. Outlier performers within the composite are not caused by material, client-driven restrictions as defined in your firm’s definition of discretion.
3. Any portfolios added or removed from the composites during the period were done so in a manner consistent with the rules outlined in your GIPS policies and procedures.
4. There are no portfolios currently excluded from the composite that should have been included based on your firm’s GIPS policies and procedures.

If you do not have a way to test this internally, we strongly encourage you to reach out to Longs Peak for outlier testing. We can save you the headache of multiple rounds of testing with your verifier.

Composite Membership Change List

The Composite Membership Change List should include all portfolios entering or exiting your composites during the period under review. This is generally listed by composite and provides the portfolio name or number that entered or exited and the date of the change.

This list allows the verifier to select a sample of portfolios and test whether they are entering/exiting the correct composite at the correct time, based on your firm’s policies and procedures.

While the verifier is selecting only a sample of composites and/or pooled funds, they will likely want to gain an understanding for composite membership changes across the entire firm. Again, although the focus is primarily on portfolios within the selected sample described earlier, they may broaden their sample for this testing item. This is most common when there are material changes for composites not originally selected for testing or if the sample composites selected did not have enough changes to meet the sample size requirements set for your firm’s verification.

Beyond selecting samples, the verifier will also compare the composite membership changes on the list to the data provided to ensure they are in sync. They will do this comparison to ensure that any noted membership change is reflected in the performance data.

For example, if the Membership Change List documents that portfolio ABC exited the composite at the end of the month, but this change is not reflected in the raw performance data, the verifier will likely come back with questions.

Assets Under Management Report

Verifiers generally want to see an Assets Under Management Report that breaks the assets out by portfolio and clearly labels each portfolio as discretionary or non-discretionary and, if discretionary, what composite the portfolio is included in.

The verification is conducted at the firm level and this report will give the verifier a clear picture of the full scope of the GIPS firm. Specifically, it will help the verifier:

1. Gain comfort that the total firm assets reported in the GIPS Reports is accurate
2. Assess what percentage of the firm assets are discretionary versus non-discretionary
3. Confirm if there is any risk of double counting assets (usually caused by portfolios included in more than one composite or segregated portfolios investing in pooled funds managed by the firm)
4. Ensure none of the assets included appear to be advisory-only or model assets
5. Test that composite assets match the assets in the supporting information provided as well as what is reported in the firm’s GIPS Reports
6. Compare the total AUM to regulatory filings (such as your ADV) to ensure any material differences are understood and align with how the firm is defined for GIPS purposes

The verifier will likely test some of the assets in this report by selecting a sample of portfolios and requesting that independent support for the valuation be provided (e.g., custodial statements). Since a sample of these values will be tested for consistency with the GIPS Reports, it is important that this document is clean, accurate, and presented in a manner that is easy for the verifier to understand.

List of Non-Discretionary Portfolios

If the AUM Report has non-discretionary portfolios clearly labelled then this separate list may not be needed. Either way, it is best if each non-discretionary portfolio listed includes an explanation for why it is deemed non-discretionary for GIPS purposes. Including comments about why the portfolios are non-discretionary will help the verifier understand why each portfolio is excluded from the composites, and help ensure the testing goes smoothly.

Verifiers will select a sample of these portfolios to ensure there is a valid reason for them to be non-discretionary and excluded from your composites. It is important that this list is accurate and up-to-date so the verifier can select appropriate samples and test portfolios without finding errors in classification.

GIPS Reports

GIPS Reports act as your firm’s external representation of your GIPS compliance. Since you are required to provide GIPS Reports to prospective clients, verifiers will test that the presented statistics can be supported and that all required disclosures are included. It is important to have a quality control process in place to check that all required statistics and disclosures are included prior to distributing the GIPS Reports to prospects or verifiers. This checklist can be used to aid in this review.

If not already provided as part of other testing requests, the verifier will likely require that you provide support for the statistics presented. This may include support for:

• Composite assets
• Number of portfolios
• Total firm assets
• Composite returns
• Benchmark returns
• Composite dispersion
• Composite external standard deviation
• Benchmark external standard deviation
• Percent bundled fee portfolios (if applicable)
• Percent non-fee-paying portfolios (if applicable)
• Any supplemental information presented (if applicable)

GIPS Report Distribution Log

The 2020 GIPS standards now require firms to demonstrate that they made every reasonable effort to provide GIPS Reports to their prospective clients. Additionally, verifiers are also required to test that the firms they verify have done this. Generally, this is achieved by documenting each distribution in a log that can be provided to the verifier. Some firms document this in their CRM while others log it in a spreadsheet (here’s a sample). If doing this in a CRM, it is critical that a report can be exported to fulfill the request made by the verifier to confirm distribution. For more information on GIPS Report Distribution Logs, check out this article.

Marketing Materials

GIPS Reports are the only document that must be provided to prospective clients for GIPS purposes. However, your verifier is also likely to review your website and ask for a sample of other factsheets and pitchbooks – regardless of whether GIPS is mentioned in these materials. The purpose of this is to test that:

• Wherever GIPS is mentioned, all required disclosures accompany your claim of compliance
• The way you hold your firm out to the public is in sync with how your firm is defined for GIPS purposes
• Information presented is not false, misleading, or contradictory to what has been presented in your firm’s GIPS Reports

If no marketing materials are available outside of the GIPS Reports, that is perfectly fine. A simple confirmation of this scenario will suffice for the verification.

CFA Notification Form

All GIPS compliant firms are required to file a form with CFA Institute notifying them of their claim of compliance with the GIPS standards. This is completed once the firm is ready to claim compliance for the first time and then must be repeated prior to June 30^th each year.

Verifiers are required to confirm that this has been completed as part of their verification. This is generally tested by saving the confirmation email provided when completing the notification form and providing a copy of this confirmation to the verifier when requested. So, save those emails!

Miscellaneous GIPS Data Requests

Outside of the primary initial requests we have already discussed, the verifier may have some other miscellaneous items included in their initial data request. Most of these items help the verifier better understand your firm or ensure changes to policies and/or GIPS Reports are captured in the documents provided. The following are some common miscellaneous items we see verifiers request.

Regulatory Correspondence – The verifier may ask if your firm has had any recent regulatory correspondence other than standard filings. If you have had an examination resulting in a deficiency letter, they will want to review this letter as well as your response. The purpose of this is to help the verifier assess the risk of the engagement and to help them tailor their testing to risk areas already identified. This is especially important if any deficiencies resulted from your firm’s GIPS compliance or the calculation and presentation of investment performance.

Changes to the Portfolio Accounting System – If changes have been made to system settings since the last verification, especially if they impact calculation methodology, composite membership, etc., the verifier will want to know about it. This will help them ensure their testing is in sync with your actual current practices, documented policies, and disclosures in your GIPS Reports.

Errors Since the Last Verification – Unfortunately errors happen and verifiers want to know about them. They are not looking to penalize you for having errors, but rather need to confirm that the appropriate action was taken to rectify the error if/when it occurs. It is important that when errors arise, your firm consistently follows your firm’s error correction policy. It is also helpful to maintain an error log. Maintaining an error log will help your firm document changes to your GIPS Reports resulting from errors and actions taken to address them. Providing this log to the verifier will help demonstrate that your error correction policy was consistently applied.

Incentive Fees – Verifiers often ask if incentive or performance-based-fees were charged to any portfolios during the verification period. GIPS requires net-of-fee returns to be reduced by incentive fees. Thus, if your firm charges incentive fees and actual fees are used to calculate performance, your verifier will want to confirm that net-of-fee returns have been reduced by the incentive fee.

If model fees are used, your verifier will test to ensure that the model fee is high enough to result in net-of-fee returns that are equal to or lower than what the results would have been if actual investment management fees (including any incentive fees) had been used. If no incentive fees were charged, then simply notifying the verifier that this is not applicable for your firm is sufficient.

Verifier Independence – While this might not be a “request,” your firm is required to gain an understanding of your verifier’s policies and procedures to ensure they remain independent throughout the course of the verification project. If your verifier does not provide you with a copy of their independence statement at the start of the verification, you should be proactive and request it. Save this document to support that your firm meets this requirement and is aware of the steps your verifier takes to ensure they remain independent.

Prioritizing What You Provide

In a perfect world, every initial document requested by the verifier is available and ready to provide in your first data submission. However, that is rarely the case. If everything is not available right away, the question becomes – what do you prioritize to make sure the verification progresses forward? If you have to send the initial request in stages, we recommend focusing on requests that allow the verifier to select their portfolio-level samples.

Depending on the size of your firm and composites, the portfolio-level testing phase of the verification can have many follow up requests and typically is the most time-consuming part of the verification. Therefore, it is best to get that phase of the verification kicked off as soon as possible. The items that allow a verifier to select their portfolio-level testing samples include:

1. GIPS Policies and Procedures
2. Portfolio and Composite-Level data
3. Membership Change List
4. Non-Discretionary Portfolio List

The remainder of the initial request documents can be provided as they become available. They will be needed to complete the verification, but the above listed documents should be the first priority to allow the verifier to select their portfolio-level samples.

Conclusion

The documentation provided for the initial request helps set the stage for the next round of testing. The cleaner and more organized the initial data, the better off you will be for the rest of the verification. Providing clean data in this sense means that you are confident performance data and disclosures are error free and outliers have been reviewed and deemed appropriate. If the verifier is able to move through these initial documents efficiently, it will set you up for success for the remainder of the project.

For more information on verification testing, check out part three of this three-part series where we dive into portfolio-level testing. We’ll cover the types of documentation requested and help you understand what your verifier is looking for. If you have any questions about GIPS or investment performance, check out or website or reach out to matt@longspeakadvisory.com or sean@longspeakadvisory.com for more information.