The Global Investment Performance Standards are universal, voluntary standards used by investment management firms for calculating and presenting investment performance and are based on the principles of fair representation and full disclosure. By choosing to comply with the GIPS standards, investment management firms assure investors that their reported historical track record is both complete and fairly represented. Globally recognized as best practice for the calculation and reporting of investment performance, the GIPS standards create a level playing field for competition between firms and allow investors to better compare the performance of one manager against another. Both the UK Hedge Fund Working Group and the US President’s Working Group recommend investment firms comply with the GIPS standards and encourage investors to require compliance with the Standards when hiring managers.
In order to keep the GIPS standards current with a dynamic marketplace, the CFA Institute periodically proposes revisions to the Standards. The current set of proposed revisions, available for public comment through 1 July 2009, will be finalized in 2010 with an effective date of 1 January 2011.
The following are some of the more significant proposed changes:
1. Fair Value – Firms will be required to value all portfolios at fair value. The proposed GIPS Valuation Guidelines describe fair value at length and provide guidance as to what is expected of firms with regard to valuation. The GIPS standards currently require the use of market values and the shift to fair value is to recognize, as has been seen over the past year, that occasionally liquidity dries up and the market disappears. The change from market value to fair value will also increase the accuracy, transparency, and reliability of the valuations used to calculate performance when compared to market values that may no longer be reflective of the true value of the investment. This movement is consistent with financial reporting standards set by the International Accounting Standards Board and the Financial Accounting Standards Board.
2. Non-Fee-Paying Portfolios – Currently firms are permitted to choose if they want to include non-fee-paying portfolios in any of the firm’s composites. The proposal includes a requirement that firms include all discretionary non-fee-paying portfolios in at least one composite.
3. Risk Disclosure – Firms must disclose the composite description, which must include the salient features of the composite strategy. The proposal requires firms to include, as part of the composite description, sufficient information to allow a prospective client to understand the relevant risks of the composite strategy. The intent is not to require a laundry list of all potential risks as are typically outlined in the prospectus or offering document, but rather to provide investors with insight as to the risks of the strategy or investments that was actually employed.
4. Standard Deviation – Firms will be required to disclose the three year annualized ex-post standard deviation of the composite and benchmark. It is recognized that standard deviation is not the most sophisticated risk measure and may not be the most appropriate metric for every investment strategy. Disclosure of additional risk measures is recommended. Standard deviation, however, is a widely understood measure and is relatively easy to calculate. Requiring a specific risk measure allows for baseline comparability between strategies and firms.
5. Proprietary Assets – Firms will be required to disclose the percentage of composite assets composed of proprietary assets (e.g., “seed” capital or “house” money). This disclosure allows investors to understand if the firm has invested its own capital in the strategyand if the firm’s investment represents a large or small percentage of the composite assets.
6. Real Estate External Valuation – Currently firms are required to obtain an independent external appraisal of real estate assets once every 36 months. The proposal increases that frequency to once every 12 months. While 12 month intervals are the norm in some markets, this is a significant change for others. Unlike some of the other proposed changes, increasing the frequency of external appraisals involves a considerable expense for some firms, and this expense is often passed along to the firm’s clients. There is a clear need to balance the value of improved accuracy with the associated cost.
7. Closed-End Real Estate Funds – The proposal includes new provisions for closed-end real estate funds, which generally have characteristics that are similar to private equity funds. These include a requirement to present an annualized since inception internal rate of return for each year since composite inception. The additional provisions are generally similar to those required and recommended under the private equity provisions.
8. Verification – Firms that claim compliance with the GIPS standards may also elect to have an independent third party verification. A verification tests if a firm has followed the composite construction requirements of the Standards as well as if the firm’s policies and procedures are designed to calculate and present performance results in compliance with the Standards. There has been much discussion and expectation that verification would become mandatory. Rather than requiring that firms be verified, the proposal includes changes to the GIPS compliance statement. As part of the compliance statement, firms will be required to disclose if they have or have not been verified and for which periods the firm has been verified. This change stresses the importance of the verification and may increase competitive pressures on firms to become verified.
While the Standards can currently be applied to hedge funds, there are issues and structures that are unique to this segment of the market that warrants further guidance. Master-feeder structures, for example, pose a challenge to managers when presenting performance and firms must determine which level is the most representative of the returns investors experienced. Side pockets are also an area that merit guidance. Should a firm include the side pockets when presenting historical performance? Should they be presented separately? Additional guidance will be issued to address these and other issues specific to hedge funds.
Compliance with the GIPS standards indicates a commitment to integrity and ethical practice and is critical to meeting investors’ needs and building trust. For more information on the GIPS standards and the public consultation, please visit the GIPS website at www.gipsstandards.org.
Jonathan Boersma holds a Bachelor of Science degree in economics from the University of Wisconsin and is a CFA charterholder