GIPS – Study Notes

GLOBAL INVESTMENT PRESENTATION STANDARDS (GIPS)

Why GIPS were created?

The GIPS standards were created to provide a minimum standard for creation and presentation of comparable performance numbers of any compliant investment management firm regardless of the geographic location of the firm or the prospective client.

OBJECTIVES of GIPS (p.14, GIPS Handbook)

  1. To obtain worldwide acceptance of a standard of the calculation and presentation of investment performance in a fair, comparable format that provides full disclosure.
  2. To ensure accurate and consistent investment performance data for reporting, record keeping, marketing, and presentation.
  3. To promote fair, global competition among investment firms for all markets without creating barriers to entry for new firms.
  4. To foster the notion of industry self-regulation on a global basis.

Parties affected by GIPS (p.4, GIPS Handbook)

The GIPS standards have 2 constituencies:

a)Investment management firms, and

b)Their clients and prospective clients.

Investment firms claiming GIPS compliance provide investors with assurance that performance is reported completely and fairly.

Prospective clients will have a greater level of confidence in the integrity of performance presentations prepared by compliant firms.

Current clients attempting to evaluate their managers’ performance also benefit by being able to compare their actual results to the firm’s analogous product “average” as defined by the Standards.

country versions of GIPS

AIMR established the Investment Performance Council (IPC) in 2000, with the primary objective of having all countries adopt the GIPS as the standard for investment firms seeking to present historical investment performance. Recognizing that local regulations and well established practices will call for many countries to adopt requirements beyond those specified by the GIPS; the IPS adopted a Country Version of GIPS (CVG) approach.

Under the CVG approach, countries with existing standards may adopt the GIPS as their core standard, and supplement this core with local requirements and established practices that go beyond the requirements of the GIPS. However, the differences between the CVG and the GIPS must be minimal.

Translation of GIPS. If a country does not wish to adopt the English version of the GIPS, they may translate it into the local language and adopt a Translation of GIPS (TG) to improve local acceptance of the standards. Prior to the IPS’s endorsement, TG submissions are scrutinized to assure that nothing in the original version of the GIPS is lost in the translation. If a discrepancy arises between the different versions of standards, the English version of GIPS is controlling.

DEFINITION OF FIRM (p.32, GIPS Handbook)

The definition of a firm is the foundation for firm-wide compliance and creates defined boundaries for firm assets and the universe of “all” portfolios that must be included in at least one composite.

Guiding principle: It is recommended that firms adopt the broadest, most meaningful definition of the firm.

For the purpose of complying with the GIPS standards, a firm may define itself using one of following 3 options:

  1. Defined according to Regulatory Registration - An entity registered with the appropriate national regulatory authority overseeing the entity’s investment management activities.
  2. Defined according to Distinct Business Entity held out to the Public - An investment firm, subsidiary, or division held out to clients or potential clients as a distinct business unit. This means that a subsidiary or division of a firm can claim compliance with the GIPS even if the parent company is not GIPS compliant.
  3. Defined according to Base Currency - All assets managed to one or more base currencies. (After Jan 1 2005, firm will no longer be able to be defined by base currency and required to redefined according to one of the other acceptable definitions.)

Sub-Advisor – If a firm has discretion over the selection of the sub-advisor (i.e., can hire and / or fire), the firm must claim the sub-advisor’s performance as part of its performance history and include the assets in the firm’s total assets.

Multiple Defined Firms – If a parent company contains multiple defined firms, it is recommended that each firm within the parent company disclose a list of the other firms contained within the parent company. That is, to disclose all other related firms claiming compliance with GIPS standards (e.g. the parent organization and each of the other offices/branches/subsidiaries that are registered with the appropriate national registry as separate entities.)

HISTORICAL PERFORMANCE RECORD

In order to claim GIPS compliance, a firm has to present at least 5yrs of annual investment performance that complies with GIPS. If the firm has not been managing funds for 5yrs, the performance since the inception of the firm or composite must be presented.

After 5yrs of compliant history has been achieved, it must add one year to its historical performance record every year until it is presenting 10yr performance record of GIPS compliant history.

A firm may link a non-GIPS-compliant performance record to their compliant history so long as nonon-compliant performance is presented for periods after Jan 1, 2000, and the firm discloses the periods of non-compliance and explains how the presentation is not in compliance with GIPS.

For those firms having a longer history than 5yrs, it has 3 options to presenting its performance history for the period prior to the last 5yrs.

  1. Retroactively comply for the period prior to the last 5yrs in accordance with GIPS requirements, giving the firm a 10-yr GIPS compliant performance history.
  2. Not retroactively comply, but include its non-GIPS-compliant performance over the period prior to the last 5yr, along with the required last 5yrs of GIPS compliant performance results. Under this option, the firm must disclose why the non-GIPS-compliant yrs are not in compliance.
  3. Present only the last 5yrs GIPS compliant performance history and ignore the prior history..

Time-weighted Rates of Return

TWRR that adjust for Cash Flows – Permitted until Jan 1, 2005

Original Dietz Method

TWRR that adjust for Daily-weighted Cash Flows – Required after Jan 1, 2005

Modified Dietz Method

Modified IRR Method

TWRR that uses actual valuations at the time of External Cash Flows – Likely required beginningJan 1, 2010

Daily Valuation Method

MEASURE OF THE DISPERSION OF PORTFOLIO RETURNS (p.11, GIPS Level 3 Workbook)

A measure of the dispersion of individual component portfolio returns around the aggregate composite return (Presentation requirements – Standard 5..A. 1 d).

Internal Dispersion – Internal dispersion is a measure of the range of returns for only those portfolios that are included in the composite for the entire period. Portfolios added to or removed from a composite during the period are not included in that period’s calculation of internal dispersion.

Which internal dispersion measures can be used? The GIPS handbook (pp.96-98) identifies acceptable methods of calculation as follows:

  1. the range of annual returns
  2. the high and low annual returns
  3. the standard deviation of equal-weighted annual returns
  4. the asset-weighted standard deviation annual returns

PERFORMANCE RESULTS OF A PAST FIRM OR AFFILATION (p.12, GIPS Level 3 Workbook)

When a manager, group of manager, or an entire firm joins a new firm, a composite’s past performance may be linked with the ongoing results of the new firm only if ALL of the following conditions are true for that composite:

  1. Substantially all the investment decision makers are employed by the new firm (e.g. research dept, portfolio managers, and other relevant staff).
  2. The staff and decision-making process remain intact and independent within the new firm.
  3. The new firm discloses that the performance results from the old firm are linked to the performance record of the new firm.
  4. The new firm has records that document and support the reported performance.

In addition to the above four rules, when one firm (e.g. Firm A) joins an existing firm (Firm B), performance form one of the Firm A’s composites can be linked to the ongoing results of Firm B only if the following condition exists:

Substantially all the assets from Firm A’s composite transfer over to Firm B.

COMPOSITION CONSTRUCTION

A composite is an aggregation of discretionary portfolios into a single group that represents a particular investment objective or strategy. Composites are the primary vehicle for presenting performance to a prospective client.

The firm must include all fee-paying discretionary portfolios in at least one composite. In this way, firms cannot “cherry-pick” their best performing portfolios to present to prospective clients.

Non-fee-paying portfolios may be included in the firm’s composites; however, firms are required to disclose the percentage of composite assets represented by non-fee-paying portfolios.

Minimum Asset Level - If a firm sets a minimum asset level for portfolios to be included in a composite, no portfolios below that asst level can be included in the composite.

Portfolios must not be moved into and out of composites except in the case of valid, documented client-driven changes in investment objectives or guidelines or in the case of the redefinition of the composite.

Composite Definition Criteria – Factors that significantly impact/impede the implementation of the intended investment strategy.

VERIFICATION (p.13, GIPS Level 3 workbook)

Once a firm claims compliance with the Standards, it may voluntarily hire an independent third party to verify its claim of compliance to increase the level of confidence in the firm’s claim of compliance.

What is verification? The primary purpose of verification is to provide assurance that a firm claiming compliance with the GIPS standards has adhered to the GIPS standards on a firm-wide basis. Verification is performed with respect to an entire firm, not on specific composites.

Verification Tests:

Whether the investment firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis, and

Whether the firm’s processes and procedures are designed to calculate and present performance results in compliance with the GIPS standards.

Who can perform verification? Any independent third party can perform the verification. A firm cannot perform its own verification.

Why should firms consider undertaking verification? Third-party verification brings creditability to a firm’s claim of compliance. A verified firm may provide a prospective client with greater assurance about its claim of compliance with the GIPS standards. Additionally, a firm may improve its internal policies and procedures with regard to all aspects of complying with the GIPS standards.

Is verification required? NO. Verification is not a requirement for GIPS compliance, but it is strongly recommended.

Can a composite be GIPS verified? No, a composite cannot be verified. A single verification report is issued to the entire firm; GIPS verification cannot be carried out for a single composite. Separately, and following a firm-wide verification, a focused examination of a specific composite presentation may be conducted. This detailed composite testing is properly referred to as a performance audit or performance examination.

COLUMN HEADINGS THAT ARE REQUIRED IN A GIPS COMPLIANT PRESENTATION

Year / Total
Return
(%) / Benchmark
Return / No.
of Portfolios / Composite
Dispersion
(%) / Total
Assets at
End of
Peiod
(currency) / % of
Firm
Assets / Total
Firm
Assets
(currency)

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