Investment Planning and Capital Suffic ...
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Firms aiming for GIPS compliance should make a reasonable effort to furnish a GIPS Report to potential clients and investors in limited distribution pooled funds. The report should accurately represent the investment strategy being promoted to these prospective clients.
There are two types of GIPS Reports:
The GIPS standards dictate that GIPS Composite Reports displaying time-weighted returns should exhibit a minimum of 5 years of annual performance. However, if the composite hasn’t been around for 5 years yet, returns since inception can be presented instead. Furthermore, firms must continue to extend the GIPS-compliant performance record each year until at least 10 years of performance data are provided.
The core elements of a GIPS Composite Report that presents a time-weighted return include the following:
The GIPS standards mandate the presentation of a measure of internal dispersion of returns for each annual period within a composite. This measure reveals how consistently the firm applies its strategy across individual portfolios. If there’s a significant range in results, it prompts users to investigate why there’s variability in returns among portfolios that should follow the same strategy.
The dispersion of annual returns for individual portfolios within a composite can be measured in various ways.
The table below displays the initial dollar values and annual returns of portfolios in the Example equity composite for the entire year 2032. The portfolios are arranged in descending order based on their returns, from highest to lowest.
$$ \begin{array}{c|c|c}
\textbf{Beginning} & \bf{2032} & \bf{(In \ \$)} \\ \hline
\textbf{Portfolio} & \textbf{Value} & \textbf{Return} \\ \hline
A & 122,517 & 4.02\% \\ \hline
B & 81,878 & 3.99\% \\ \hline
C & 121,586 & 3.57\% \\ \hline
D & 86,998 & 3.53\% \\ \hline
E & 114,900 & 3.51\% \\ \hline
F & 112,100 & 3.46\% \\ \hline
G & 98,692 & 3.41\% \\ \hline
H & 191,045 & 3.36\% \\ \hline
I & 107,791 & 3.31\% \\ \hline
J & 96,595 & 3.24\% \\ \hline
K & 75,900 & 3.19\% \\ \hline
L & 77,407 & 3.09\% \\ \hline
M & 31,300 & 2.50\% \\ \hline
N & 84,556 & 1.98\%
\end{array} $$
Internal dispersion, as defined by the GIPS Standards for Firms, measures how individual portfolio returns within a composite vary. Acceptable measures include high/low, range, and standard deviation of portfolio returns, whether equal-weighted or asset-weighted. The sample data will illustrate these methods.
Using the “Highest Lowest Method” for the Example equity composite, the highest return was 4.02% and the lowest was 1.98%. An alternative is the high/low range, which is the difference between the highest and lowest return, equaling 2.04% in this case.
While the high/low method is easy to grasp, it can be affected by outliers – portfolios with exceptionally high or low returns – leading to a less representative measure of dispersion. Other, more complex dispersion measures may provide a better understanding of return distribution.
The standard deviation is an approved measure of internal dispersion for portfolios within the composite. It gauges the variation of returns among the included portfolios for the entire year. Here’s the formula for population standard deviation:
$$
\sigma = \sqrt { \frac {\sum ( X_i – X )^2 }{ N}} $$
Where:
\(\sigma\) = Population standard deviation.
\(X_i\) = Each value from population.
\(X\) = Population mean.
\(N\) = Number of observations.
Candidates can utilize CFA-approved calculators during the exam to compute standard deviation. However, understanding the formula is beneficial for a deeper grasp of the material. In the table example above, the standard deviation would be 0.510%. Candidates should practice this calculation for both the GIPS section and potential quantitative methods questions.
The issue of “portability” regarding past performance is intricate. Performance from a prior firm or association can be connected to the new or acquiring firm if specific conditions are met on a composite-specific basis:
If there’s a break in the track record but the first three conditions are met, the past performance can represent the historical performance of the new firm, but the two records cannot be linked. When a GIPS-compliant firm acquires another firm, it has a one-year “grace period” to bring non-compliant assets into compliance for future reporting periods.
Question
Based on the presented returns, which of the following is most likely a GIPS® compliant return dispersion calculation?
$$ \begin{array}{c|c|c}
\textbf{Beginning} & \bf{20XX} & \bf{(In \ \$)} \\ \hline
\textbf{Portfolio} & \textbf{Value} & \textbf{Return} \\ \hline
A & 12,395 & 1.14\% \\ \hline
B & 4,506 & 11.0\% \\ \hline
C & 2,632 & 2.17\% \\ \hline
D & 11,764 & 3.70\%
\end{array} $$
- The fund experienced returns within a range of 9.86% over the period.
- The fund averaged a 4.5% standard deviation.
- The fund experienced a 10.2% return over the period.
Solution:
The correct answer is A.
Answer choice A uses the high-low method. This method takes the highest return and subtracts the lowest return (11.0% – 1.14%) to demonstrate a range of returns experienced by the fund.
B is incorrect. It uses a simple average, and purports to be a standard deviation, which would be a compliant method if it were properly calculated.
C is incorrect. It is neither properly labeled, not properly calculated.
Performance Measurement: Learning Module 3: Global Investment Performance Standards; Los 3(h) Explain requirements of the GIPS standards with respect to presentation and reporting