Objective and Scope of the GIPS Standards

The Global Investment Performance Standards (GIPS)^® are designed to promote honesty and accuracy in reporting investment performance. GIPS aims to eliminate deceptive practices in investment reporting and presentation, including:

• Misrepresenting expertise: Presenting returns of top portfolios as if they represent the firm’s expertise in a particular strategy or style.
• Unsubstantiated valuations: Using unsupported estimates of asset prices for portfolio valuation.
• Inflated returns: Annualizing returns to artificially boost performance figures.
• Selective measurement periods: Cherry-picking favorable time frames for performance reporting.
• Simulated returns: Presenting simulated returns as actual investment returns.
• Retrospective benchmarking: Choosing benchmarks retroactively to make portfolio performance appear better.
• Asset growth distortion: Masking differences between investment returns and client contributions by emphasizing asset growth.
• Misleading graphics: Using design tactics to downplay unfavorable performance data and highlight persuasive elements in presentations.

Understanding these practices helps candidates grasp the types of activities GIPS aims to eliminate. The GIPS standards provide reassurance to investors regarding compliant firms’ integrity in reporting investment performance, especially when verified by independent third parties. Verification involves an external assessment of a firm’s performance measurement policies and procedures, enhancing the credibility of GIPS compliance claims.

Scope of the GIPS Standards

Firms eligible for GIPS compliance are those that manage assets on a discretionary basis and compete for business.

All or Nothing Compliance

Compliance is firm-wide only; no ‘partial’ compliance may claim. This precludes compliance from specific departments, certain portfolios, etc.

Compliance Meaning

When a firm claims compliance, it means that the following aspects adhere to the specified guidelines:

• Performance measurement data inputs.
• Processes.
• Return calculation methodology.

Compliance also means that:

• All the firm’s fee-paying discretionary segregated accounts have been assigned to at least one composite.
• All limited distribution pooled funds meeting a composite definition are properly included in the appropriate composites.

Other Important Vocabulary

Composite. A composite is an aggregation of one or more portfolios that are managed according to a similar investment mandate, objective, or strategy.

Segregated Account. A segregated account is a portfolio owned by a single client, sometimes referred to in practice as a separately managed account (SMA).

Pooled Fund. A pooled fund can also be known as a portfolio.

Pooled funds are further distinguished between limited distribution and broad distribution pooled funds. A broad distribution pooled fund is a pooled fund that is regulated under a framework that would permit the public to purchase the pooled fund’s shares and is not exclusively offered in one-on-one presentations. A limited distribution pooled fund is any pooled fund that is not a broad distribution pooled fund.

Examples of limited distribution pooled funds:

Private equity or hedge funds.

Examples of broad distribution pooled funds:

UCITs, Mutual funds.

Overview of the GIPS Standards

The following GIPS sections will be covered in this summary:

1. Fundamentals of Compliance.
2. Input Data and Calculation Methodology.
3. Composite and Pooled Fund Maintenance.
4. Composite Time-Weighted Return Report.
5. Composite Money-Weighted Return Report.
6. Pooled Fund Time-Weighted Return Report.
7. Pooled Fund Money-Weighted Return Report.
8. GIPS Advertising Guidelines.

Question

A composite can best be defined as?

1. An aggregation of one or more portfolios that are managed according to a similar investment mandate, objective, or strategy.
2. A portfolio owned by a single client, sometimes referred to in practice as a separately managed account (SMA).
3. Can also simply be known as a portfolio.

Solution

The correct answer is A.

A composite is indeed an aggregation of one or more portfolios that are managed according to a similar investment mandate, objective, or strategy. It is a way to group together portfolios that have common characteristics for the purpose of performance measurement and reporting.

B is incorrect. A composite is not a single portfolio owned by a single client. Instead, it is a grouping or aggregation of portfolios, as mentioned in option A. An SMA is a different concept, referring to an individual portfolio or account managed for a specific client’s needs.

C is incorrect. A composite is a distinct concept from a single portfolio. While a portfolio is an individual investment account or collection of assets, a composite is a grouping of multiple portfolios that share similar investment characteristics and objectives. Using the term “composite” interchangeably with “portfolio” would not be accurate in the context of performance measurement and reporting in the investment industry.

Fundamentals of Compliance

Definition of the Firm

For a firm to claim compliance, it must first meet specific criteria. It should be officially recognized as an investment firm, subsidiary, or division, and it must be presented to the public as a separate and distinct business entity.

A distinct business entity, in this context, refers to a unit, division, department, or office that is both organizationally and functionally isolated from other units, divisions, departments, or offices. It should retain the authority to make discretionary decisions about the assets it manages and have the independence to make investment decisions.

There are various criteria that can help identify a distinct business entity. This may include the entity being a legally separate organization, serving a unique market or client type, or employing a distinct and separate investment process. These criteria ensure that the claim of compliance is applied appropriately, taking into account the firm’s structure and operations.

Other Vocabulary

The term “total firm assets” pertains to the overall fair value of all assets under a firm’s management, including both discretionary and fee-paying assets. This encompasses assets that the firm is responsible for managing, even if they are delegated to sub-advisors. However, it does not encompass assets for which the firm provides advisory services only, nor does it include uncalled committed capital.

Reasons Behind the Impetus to “Define the Firm”

Within the GIPS framework, firms are mandated to proactively establish a clear definition of themselves. This serves the crucial purpose of ensuring that their reported investment performance is both accurate and truthful. This proactive approach helps prevent potential misrepresentations in performance reporting, such as:

• Portraying returns exclusively for top-performing portfolios as if they represent the firm’s overall expertise in a specific strategy or style.
• Selectively choosing favorable measurement periods for reporting purposes.

Candidates are strongly encouraged to revisit the list of potential abuses mentioned in the initial LOS summary. By doing so, they can gain insight into the underlying reasons for the specific details outlined in the GIPS standards. This understanding equips candidates to identify potential violations in real-world scenarios and on the exam.

Definition of Discretion

In essence, a portfolio is considered discretionary when the manager possesses the authority to execute the planned investment strategy. While both discretionary and non-discretionary portfolios contribute to the calculation of total firm assets, only discretionary portfolios are factored into composites. When a client imposes constraints on the manager’s ability to make independent investment decisions, including the buying, holding, and selling of securities necessary to execute the investment strategy and meet the portfolio’s financial goals, the portfolio is likely categorized as non-discretionary. In such instances, it is not appropriate to include the portfolio within a composite.

Other Fundamentals of Compliance

In Section 1, Fundamentals of Compliance, there are various other requirements that can be broadly categorized as follows:

• Initial Compliance Period: This relates to the minimum number of years a firm must adhere to the GIPS standards to be eligible to claim compliance.
• Documentation: Firms are required to document policies and procedures related to GIPS compliance.
• Legal Compliance: Compliance with relevant laws and regulations is essential.
• Accuracy: Firms must avoid providing false or misleading performance-related information.
• Report Distribution: There are specific requirements for distributing GIPS Reports and lists of firm composites and pooled funds.
• Benchmark Selection: The use of total return benchmarks that align with the investment strategy is mandated.
• Error Correction: Firms must rectify material errors in GIPS Reports and redistribute them to the appropriate parties.
• Data Maintenance: Firms are required to maintain data and information supporting the elements of GIPS Reports.
• Performance Linking: Conditions under which a firm’s performance may be used or linked to another firm’s performance are outlined.

Question

Which of the following is least likely a possible criterion for identifying a separate business entity within a firm?

1. The organization being a legal entity.
2. Having a distinct market or client type.
3. Using a similar investment process.

Solution:

The correct answer is C.

Answer choice C should read:

“using a separate and distinct investment process”.

Since the goal is to identify distinct business entities within the firm, readers should be looking for entities that stand alone, not those that mirror or favor each other.

Both A and B are correct.

Performance Measurement: Learning Module 3: Overview of Global Investment Performance Standards; Los 3(a) Discuss the objectives and scope of the GIPS standards and their benefits to prospective clients and investors, as well as investment managers