How to Update your GIPS Policies & Procedures for GIPS 2020
Sean P. Gilligan, CFA, CPA, CIPM & Matt Deatherage, CFA
May 20, 2020
If you are an investment firm or asset owner that complies with the GIPS standards you are required to make some modifications to your GIPS policies and procedures (“P&P”) to address changes made to the 2020 edition of the Standards. The extent of these updates depends on:
- whether your organization plans to adopt any new optional policies,
- whether you have pooled funds to add to the current list of composites, or
- if your organization plans to change any calculation methodologies now allowed under the new standards.
Like other GIPS requirements, consistent application and adequate documentation are critical to ensuring these updates and changes are applied correctly and consistently.
GIPS 2020: Minimum Requirements for all GIPS Compliant Organizations
There are some required GIPS policies & procedure updates that will impact all organizations claiming compliance. At a minimum, all firms and asset owners must address the following in their P&P:
What was previously called “Compliant Presentations” are now called “GIPS Reports” in the 2020 GIPS standards. Likely, the term “Compliant Presentations” is used throughout your P&P, which needs to be replaced with “GIPS Reports” to be in sync with the language of the updated standards.
Demonstrate that GIPS Reports are Distributed
It has always been a good idea to maintain a log documenting the distribution of GIPS Reports to help support that your firm met the requirement of providing them to prospective clients; however, it was not previously required. The 2020 edition of the GIPS standards now requires firms to demonstrate how it made every reasonable effort to provide a GIPS Report to prospective clients that are required to receive one.
The most common way to do this is by maintaining a log of the distribution in a spreadsheet or by noting the distribution in your firm’s CRM system. If noting distribution in your CRM, it is important to populate this in a way that can easily be extracted into a report. Your GIPS verifier is now required to test this so you will need to be able to produce a report demonstrating that your firm is distributing GIPS Reports to prospective clients.
In addition, you must now update your P&P to document the process for how this is maintained. Although each firm will need to document this differently to accurately describe their process (i.e., the system in which it is maintained and who is responsible for maintaining it), below is an example of how this may be documented:
Each time a GIPS Report is distributed, the firm’s Sales Associate is responsible for logging the distribution on the firm’s CRM system. This documentation will include who received the GIPS Report, the version of the GIPS Report they received, the method of delivery, and the date it was delivered. This information may be extracted from the CRM system by the Sales Associate if requested by a verifier, regulator, or if needed internally.
Error Correction Procedures
In the 2010 edition of the GIPS standards, if a material error was discovered in a compliant presentation, correction and redistribution was required with a disclosure of the change to “all prospective clients and other parties that received the erroneous compliant presentation.” In addition to these, the 2020 GIPS standards specifically call out providing corrected GIPS Reports to your current GIPS verifier as well as any former verifier or current client that received the GIPS Report containing the material error.
Currently, most firms’ policies relating to material errors are likely limited to the action they take to redistribute to current prospective clients. We recommend updating this language to specifically address the need to provide the corrected presentation to verifiers and clients who received the erroneous presentation as well. An example of how this may be documented is provided below:
Our firm will determine an identified error is material if the error exceeds the materiality thresholds stated in the Error Correction Policy: Materiality Grid. If this occurs, we will correct all affected GIPS Reports, include a disclosure of the change, and make every reasonable effort to provide a corrected GIPS Report to:
- Prospective clients that received the GIPS Report
that had the material error;
- Clients and any former verifiers that received the GIPS Report that had the material error; and
- Current GIPS verifier.
Verifiers are prohibited from testing their own work and, therefore, cannot help their clients by writing policies, calculating performance, creating GIPS Reports, etc. To help ensure this independence is maintained, firms that are verified are now required to gain an understanding of their verifier’s policies for maintaining independence and to consider their verifier’s assessment of independence to ensure there are no conflicts.
To comply with this, firms must request that their verifier provide documentation describing the measures they take during the verification process to ensure independence is maintained. The procedures for requesting and assessing this needs to be described in the firm’s GIPS policies & procedures. Below is an example of what this might look like:
Our firm has engaged XYZ Verification Firm as an independent third-party verification firm to verify our claim of compliance. Each year, prior to the start of the annual verification, we request the independence policy statement from the verification firm. If there are no changes from the prior year, this confirmation is requested in writing. Any potential threats to independence, either in fact or in appearance, are discussed with the verifier to resolve immediately.
GIPS Report Updates
We will discuss all the changes relating to GIPS Reports in a separate blog; however, some of those changes will require updates to your firm’s GIPS policies and procedures, which we do want to discuss here. Presenting annual internal dispersion and three-year annualized ex post standard deviation is not new; however, it is new that firms are required to disclose whether gross-of-fee or net-of-fee returns are used in these calculations. We recommend adding language to your P&P that makes it clear whether you will use gross-of-fee or net-of-fee returns. Including this in your P&P will help you ensure the calculation is consistent with the disclosure you will be adding to your GIPS Reports. An example of how this could be worded is as follows:
Composite internal dispersion is measured using the asset-weighted standard deviation of annual gross-of-fee returns of those portfolios included in the composite for the full year. The three-year annualized ex post standard deviation measures the variability of the composite gross-of-fee returns and benchmark returns over the preceding 36-month period.
While either gross-of-fee or net-of-fee returns are acceptable, at Longs Peak we generally recommend that our clients use gross-of-fee returns so the presented volatility relates specifically to the implementation of the strategy and is not affected by management fees (which may differ by account, be paid at different times, etc).
Additionally, there is a new requirement to update GIPS Reports with the prior year’s information within 12 months of the period ending. In other words, statistics for the period ending December 31, 2020 must be added to your GIPS Reports by December 31, 2021.That will be plenty of time for most firms, but to ensure this is done, we recommend adding a procedure to your P&P document simply explaining that the reports must be updated within 12 months after the end of each annual period.
GIPS 2020: Changes for Firms with Pooled Funds
Firms that have pooled funds will have a few additional changes to make to their GIPS policies & procedures.
Most firms will have language in their P&P referring to “prospective clients.” In the 2020 GIPS standards, the term prospective client refers specifically to a prospective separate account investor while the term “prospective investor” is used when referring to a prospective pooled fund investor. Firms need to review their P&P language and make updates to define both terms and ensure they are using the appropriate term depending on the context of what is being described.
List of Pooled Funds
Firms have always been required to maintain a list of composite descriptions, but now the same is needed for each pooled fund the firm manages. For each limited distribution pooled fund, a description needs to be included (similar to what was done historically for composites). Broad distribution pooled funds need to be listed, but no description is required.
If you are unsure whether a pooled fund is considered broad distribution or limited, broad distribution pooled funds are defined in the glossary of the 2020 GIPS standards as “A pooled fund that is regulated under a framework that would permit the general public to purchase or hold the pooled fund’s shares and is not exclusively offered in one-on-one presentations. Limited distribution pooled funds are simply defined as any pooled fund that does not meet the definition of a broad distribution pooled fund.
Pooled Fund Inception Date
Pooled fund performance must be reported back to the pooled fund’s inception date. How the inception date was determined must be documented in the firm’s GIPS policies & procedures. Inception date could be based on when investment management fees are first charged, when the first investment-related cash flow takes place, when the first capital call is made, or when committed capital is closed and legally binding. Whatever criteria is used to determine the inception date must be clearly described in the P&P to ensure an appropriate inception date is used for each pooled fund managed by the firm.
Error Correction Thresholds
If language used to document error correction materiality thresholds is specific to composites, this will need to be modified to incorporate thresholds for statistics reported in GIPS Pooled Fund Reports as well. If the same thresholds are appropriate for both composites and pooled funds (e.g. composite and pooled fund performance can have the same threshold and composite and pooled fund assets can have the same threshold) then this may be as simple as changing “Composite” to “Composite/Pooled Fund” throughout this section.
Additionally, if your firm is now presenting money-weighted returns and other related multiples for closed-end funds, you will need to add thresholds to your policy for these statistics as well.
Changes for other Optional Policies
The 2020 GIPS standards offer some more flexibility to ensure they are as meaningful and useful as possible to all types of investment firms and asset owners. If any of these policies are utilized, additional changes will be required to describe their use in your firm’s GIPS policies & procedures. Examples of these optional policies include, but are not limited to:
If a firm decides to utilize carve-outs with allocated cash, the new carve-out composite will need to be documented in the current list of composites. In addition, the firm will need to implement policies and procedures as to how they allocate cash, how they identify appropriate asset buckets to carve-out from existing accounts, which accounts have asset groups that need to be carved-out to meet the new composite definition, and document other composite related policies applied to the carve-out composite.
Historically, GIPS compliant firms meeting the portability requirements were required to link the historical performance record to the ongoing performance. The 2020 GIPS standards change this to make linking optional. When portable track records exist, firms need to document in their P&P 1) whether the historical track record meets the GIPS portability requirements and 2) whether they are electing to link the historical performance record or choosing to not link it.
Estimated Transaction Costs
The GIPS standards define “gross-of-fees” as the return on investments reduced by transaction costs. Historically, firms complying with the GIPS standards were prohibited from estimating transaction costs; the use of actual transaction costs was required. The 2020 GIPS standards now allow estimated transaction costs to be used in cases where actual transaction costs are not known.
Using actual transaction costs is straightforward for traditional portfolios that pay transaction costs in the form of commissions on each trade. The issue most commonly arises with wrap accounts that pay transaction costs as part of a bundled fee.
Historically, firms were not able to present returns gross-of-fees for their composites containing wrap accounts because they were unable to determine the actual transaction costs. Most firms instead present “pure gross” returns, which are gross of the entire wrap fee and are required to be labelled as supplemental information.
Allowing estimated transaction costs will give firms managing wrap accounts the option to estimate the portion of the wrap fee that is for transaction costs and reduce returns by this estimated figure.
If estimated transaction costs are utilized, the firm must disclose in their GIPS Reports how these estimated transaction costs are determined. Similarly, the process used to determine the estimated transaction costs and the methodology utilized to reduce the returns by the estimated transaction costs needs to be documented in the firm’s P&P.
Model Management Fees
Previously, GIPS compliant firms using model investment management fees (rather than actual fees) to determine net-of-fee results were required to use the highest investment management fee. This was generally interpreted as the highest fee from the composite’s fee schedule or the highest fee-paying portfolio in the composite, whichever was higher. In the 2020 GIPS standards, firms using model management fees are required to use a fee that is “appropriate” to the prospective client. While the model fee doesn’t specifically have to be the highest fee, the resulting returns still need to be equal to or lower than the results that would be calculated if actual management fees were used.
If your P&P already describes using the highest management fee and you will continue to use the highest fee then no change is needed. If you will implement a new process other than highest fee, then it is important to update your P&P to describe how the model fee will be determined and applied. This description needs to include how you will confirm that the net-of-fee returns using the model fee are not higher than they would be if the actual investment management fees were used.
Presenting Advisory-Only Assets
Firms that have Unified Managed Accounts (“UMA Accounts”) or other similar arrangements where they are simply providing a model to be implemented by another party generally are not able to include these accounts in their total firm assets. These accounts are considered “advisory-only” because the manager is only providing the model and has no responsibility to implement the strategy or monitor the portfolios on an ongoing basis.
This type of arrangement has become increasingly popular over the last decade. Given the popularity of these relationships, many firms now have a large amount of advisory-only assets that they would like to report. Because of this demand, the 2020 GIPS standards have provided guidance outlining the proper way for firms to present these assets separate from their total firm assets. Firms electing to present these assets must make it clear how they intend to report them in their GIPS Reports.
Historically, many firms documented in their P&P something like, “all accounts deemed to be advisory-only, hypothetical, or model in nature are excluded from total firm assets” to make it clear that they were not including anything in total firm assets that was prohibited. Firms now electing to separately present advisory-only assets must add an additional statement describing how they will be presented. For example, “Some of the firm’s strategies are offered through UMA platforms on an advisory-only basis. These assets are presented separately from the firm’s composite assets and total firm assets and will be labelled ‘Advisory-Only Assets’.”
Presenting Money-Weighted Returns
Historically, time-weighted returns were required with two specific asset class exceptions: Private Equity and Real Estate (when Real Estate was managed in a Private Equity-like fund). The 2020 GIPS standards have now removed the asset-class specific requirements. Instead, firms may now present money-weighted returns for any asset class as long as the firm has control over the external cash flows and the composite or pooled fund has at least one of the following characteristics:
- Fixed life
- Fixed commitment
- Illiquid investments are significant portion of strategy.
For firms meeting this criteria and electing to present money-weighted returns, the P&P must be updated to 1) note that the criteria was met, 2) indicate the election to present money-weighted returns, and 3) outline the methodology utilized to calculate the money-weighted return and other related multiples that must be presented in conjunction with the money-weighted return.
Other Considerations for GIPS Policies & Procedures
When going through your firm’s GIPS policies & procedures to make the required changes for the 2020 GIPS standards, this is a great opportunity to review the document as a whole to ensure everything is still relevant, applicable and accurate. One of the most common deficiencies regulators write in examinations is that policy and procedure documents do not reflect actual practices of the firm. We recommend a comprehensive review be conducted annually. Check out GIPS Compliance Actions for the New Year for a step-by-step guide to this review .
If you have a situation that we didn’t cover here that is specific to your firm or for more information on GIPS Policies and Procedures, the changes to the GIPS standards for 2020, or GIPS compliance in general, contact Matt Deatherage at firstname.lastname@example.org or Sean Gilligan at email@example.com.