Key Takeaways from the 2022 GIPS® Standards Conference

CFA Institute hosted the 26th annual GIPS Standards Conference on October 25^th – 26^th 2022 in Boston, Massachusetts. This was the first time the GIPS Standards Conference was hosted in-person since the 2019 conference in Scottsdale, Arizona. It was great to be back together with so many familiar faces.

With the SEC Marketing Rule taking effect shortly after the conference, the hottest topic of this year’s conference was the two-hour session on this topic. Other topics included best practices for the implementation of the GIPS standards, information on ESG attribution, data visualization, practical advice for IRR calculations, OCIO performance issues, model portfolio programs and general updates on the GIPS standards.

SEC Marketing Rule

Michael McGrath, CFA, Partner with K&L Gates and Christine Schleppegrell, Acting Branch Chief with the Securities and Exchange Commission (“SEC”) did an excellent job addressing some of the grey areas relating to the presentation of performance in advertising.

Schleppegrell emphasized that the guidance is intended to be principles-based so there are not always back and white answers to these grey areas. Most important is that firms always consider if their advertisement is “fair and balanced” and appropriate/meaningful for the intended audience.

McGrath was able to share some more opinions on how firms can address some of the grey areas. Below are some key items worth highlighting:

Gross vs. Net for “Performance-Related” Statistics

The rule is clear that gross performance cannot be shown unless net performance is also shown. But for many trying to interpret this guidance it begs the question, what is “performance”? Is performance limited to only the actual returns of the strategy or are other risk measures and attribution considered “performance” as well?

A key distinction that was made is that performance demonstrates what the investors “actually took home.” So, charts that show the growth of a dollar would likely be considered “performance” and need to show net returns. On the other hand, a risk measure like standard deviation that indicates volatility, but does not actually tell us what the investor took home would likely not be considered “performance” and, therefore, can be shown based on gross returns without also showing net.

Performance appraisal measures like Sharpe ratio are a little closer to showing what an investor took home but are still just “performance-related” rather than “performance.” Attribution also likely fits into this “performance-related” category where it is likely okay to show based on gross data; however, for any of these performance-related measures, if choosing to show based on gross data rather than net you should:

1. Document internally why you feel it is more appropriate/meaningful to use gross data for these measures, so you are prepared to justify its use if questioned by an examiner; and
2. Present net performance (i.e., net time-weighted returns) for the strategy in conjunction with these other “performance-related” figures that are presented using gross performance data.

Calculating Net Performance

Calculating net performance for a composite can get tricky when a composite includes non-fee-paying accounts, accounts with greatly reduced fees, accounts that pay their fee by check, or accounts that pay their fees from other accounts managed by the same manager (we’ve written a separate post on how to account for these fees here). Firms presenting net performance based on actual fees must ensure fees are applied to every account in the composite even if some are non-fee-paying. While the GIPS standards allow firms to exclude non-fee-paying accounts from composites, the SEC Marketing Rule does not specifically allow this. If excluding non-fee-paying accounts, you will need to ensure that excluding them does not make your composite performance materially better. While a model fee can be applied to each non-fee-paying account, the easiest, and most conservative approach is simply to apply a model fee at the composite level.

Even when all accounts in the composite are fee-paying, if using actual fees to calculate net performance you should consider if the results are meaningful for your current prospects. For example, if historically you charged 75bps, but your current fee schedule for new prospects is 1.5%, it could be considered misleading to use net performance based on actual fees. It is considered more appropriate to apply a model fee based on the highest fee a prospective client would pay.

Materiality was also discussed with regards to non-fee-paying accounts in composites. Specifically, a question was asked regarding the need to adjust for non-fee-paying accounts in composites when the amount of non-fee-paying accounts in the composite is very small. It was confirmed that materiality can be considered, and no adjustment is needed if the impact is immaterial. Of course, materiality can be difficult to define so if your firm is electing to not adjust performance for the non-fee-paying accounts in the composite, you should document your justification for this. This documented justification should make it clear why the results are meaningful and appropriate for your intended audience without any adjustment.

Using Representative Accounts for Attribution

Many firms are accustomed to using representative accounts for attribution rather than using a composite for attribution. This may continue to be okay if the firm can demonstrate that the results for the representative account are not better than the composite and also that the account has attributes that truly are representative of the strategy. Generally, this attribution would be shown in conjunction with composite performance, so the representative account is only used for “performance-related” statistics and not for the performance itself.

Customized Requests for Prospects

If a prospect requests a customized report of information that typically would not be allowed in an advertisement, it may be okay to provide this information to meet their specific customized request. However, if you have a report saved with this type of information that you provide to more than one prospect when requested, this may no longer be considered customized and may then be considered an advertisement.

For example, if you create a report of gross equity returns extracted from a balanced strategy to provide upon request, this may be deemed an advertisement if you provide the same report to multiple prospects. In other words, it needs to be custom tailored each time to meet the unique request of a prospect to fall outside of the Marketing Rule. When in doubt, it is safest to assume it will be considered an advertisement and include all required statistics and disclosures.

GIPS Standards Implementation

I had the pleasure of speaking on this panel together with two other industry experts with experience in GIPS standards verification and consulting. Together, we emphasized the importance of ensuring GIPS compliant firms take the time to customize their policies and procedures to be meaningful for their firm. Often firms create their policies and procedures using a template when first becoming GIPS compliant. It can be hard to include detailed procedures at that stage because it is all so new. A key takeaway from this session was to go back to your policies and procedures and take a fresh look to consider if they are clear and complete or if more detailed procedures should be added now. If you would like some additional guidance, we have summarized a list of the main topics to consider updating in a previous post here.

Involvement from key stakeholders in your firms GIPS compliance was also discussed. Whether it be for determining error correction materiality thresholds, defining composites, or other important decisions for your GIPS compliance, it is important to include stakeholders from around your firm. Specifically, members of your firm from performance, operations, compliance, portfolio management, sales & marketing, and executive management should be consulted to help create robust policies that consider different facets of your business. Often, firms create a GIPS Standards Oversight Committee with members from each of these areas to help facilitate effective internal communication between departments regarding the implementation of the firm’s GIPS compliance.

Detailed composite construction policies were also discussed such as minimum asset levels and significant cash flow policies. The key takeaway from this was to ensure you are not over complicating policies. Implementing composite minimums and significant cash flow policies can be beneficial in some cases, but if you do not have a system to help automate the monitoring and implementation of these policies, the risk these policies add may outweigh the benefit. Depending on the size of the composite, these policies may only have an immaterial impact on the composite results. Since implementing policies like this (especially when not automated) increases risk of errors in composite membership, it is important to consider the potential administrative burden when determining whether you want to have these optional policies for your composites.

OCIOs and GIPS Compliance

Many OCIOs (Outsourced Chief Investment Officers) are currently working toward GIPS compliance. With the way these firms operate with heavily customized portfolios, defining discretion and constructing composites can be very challenging. With this in mind, additional guidance for OCIOs claiming compliance with the GIPS standards is in the works. An initial consultation paper is expected mid-2023 that will be open for public comment. Finalized guidance for OCIOs will be available after there has been time to consider the feedback received from the public.

Conclusion

This year’s speakers did a great job providing clarification on the SEC Marketing Rule and other relevant topics that impact GIPS compliance and investment performance.

We were happy to be back in-person to attend the conference in Boston and look forward to hearing where next year’s conference will be!

If you have any questions about the 2022 GIPS Standards Conference topics or GIPS and performance in general, please contact us.