The Future of GIPS® Series – Part #2
The Four Toughest Questions Facing the Evolution of the GIPS Standards
The Four Toughest Questions Facing the Evolution of the GIPS Standards “In its lifetime the GIPS standards have been updated two times, the last official update was in 2010, although we have released new and updated guidance statements more frequently. The mission of the GIPS standards is to gain universal demand by asset owners, universal compliance by asset managers, and universal support from regulators” Jonathan Boersma, CFA
Despite the high acceptance and compliance rate globally, the GIPS Standards still require a lot more to remove all barriers towards the universal adoption target. The GIPS 2020 project is geared towards the elimination of such obstacles identified.
In this second post in the series, we discuss some of the key obstacles identified and what the likely solution may look like.
Obstacle 1 – Asset Class and One-on-One Account Structures
The GIPS Standards were originally structured around the two widely used asset classes of equity and fixed income, managed in Separate Accounts and traded in highly liquid markets. Later additions included the expansion to private equity and real estate asset classes. This structure has served to portray the standards as been only applicable to managers in this particular space. This was an unintended consequence and has been progressively corrected with Guidance Statements that expand or clarify their use with regards to real estate, private equity and alternative assets and strategies. But more needs to be done if universal adoption by all managers is to be achieved.
Likely Solution: The proposed changes will expand coverage to include other accounts, management and product structures used by the universe of managers and asset owners. Some work has already been done with the release of the Asset Owner and Pooled Funds Guidance Statements. Additional areas under consideration are structured products and overlay strategies under the proposed three-pronged compliance approach for determining total firm assets. This new hierarchy is covered in our next post.
Obstacle 2 – Composites for Presentation Vs Pooled FundsStructures
A key provision of GIPS for the presentation of investment performance information is the requirement to aggregate portfolios into composites as the unit for presentation of performance information about a particular style or strategy; and the requirement that all discretionary, fee-paying portfolios must be included in at least one composite defined by such style or strategy.
The problem with this is that pooled fund managers, especially regulated ones as well as those not covered explicitly under either the Private Equity or Real Estate provisions have found it challenging to comply with the standards because they do not easily fit into a composite structure as it is difficult to bundle them with other portfolios due to the peculiarity of certain regulatory requirements and management practices. The current workaround has been the use of single portfolio composite for each such fund or account. This has the consequence of not being very informative and may require additional steps especially on the part of regulated funds to shift between regulatory requirements and the GIPS Standards.
Likely Solution: The proposed changes include, the change in the compliance hierarchy to include a section dedicated to pooled fund structures and other product-oriented management structures as well and the consolidation with the existing Private Equity and Real Estate sections of the Standards. We discuss this proposed hierarchical change in the next post.
Obstacle 3 – Risk Considerations
When it comes to Investment Performance Evaluation, both return and risk information are equally important. The rate of return measurement, however, seems sufficiently covered, barring certain situations regarding the choice of use of either money-weighted return measures or time-weighted return measures as discussed below. With regards to risk, the GIPS currently requires compliant firms to disclose three-year annualised ex-post standard deviation for portfolio and benchmark and additional risk measure if it determines that this measure is not appropriate. Firms must also disclose extent and use of leverage, derivatives and short positions in a particular composite strategy if material. Many practitioners, however, believe the risk aspect of performance measurement is not adequately covered under the current standards.
With regards to risk, the GIPS currently requires compliant firms to disclose three-year annualised ex-post standard deviation for portfolio and benchmark and additional risk measures if the compliant firm determines that this measure is not appropriate. Firms must also disclose extent and use of leverage, derivatives and short positions in a particular composite strategy if material. Many practitioners, however, believe that these do not sufficiently provide enough coverage about the risk element and have advocated for a more comprehensive coverage under the revised standards.
Likely Solution: The committee will discuss the need for inclusion of additional measures and the form, applicability and accompanying disclosures that may be needed.
Obstacle 4 – Treatment of Proprietary Assets
The structure of the Standards provides the option for compliant firms to decide whether to include proprietary portfolios in an applicable composite and to disclose such inclusion if they do. It didn’t however, consider proprietary management situations where the entire operation of the ‘firm’ is the management of proprietary assets only, as in the case of asset owners that manage portfolios in-house and have no clients but do have interested stakeholders.
Likely Solution: The Asset Owner Guidance Statement was drafted to cater for this particular deficiency and now affords Asset Owners the opportunity to claim compliance with the Standards, independent of whatever outsourced management relationship they may have. This forms part of the three branched compliance hierarchy proposed under the new Standards that we discuss in our next post.
Obstacle 5 – Measurement Issues – IRR vs TWR
The requirement for the use of Time-Weighted Rate of Return (TWRR) Vs Money-Weighted Rate of Return (MWR) has also been a bone of contention with regards to certain management structures like closed-end private equity and real estate funds where the norm has been the use of the MWR measures rather than the GIPS recommended TWRR.
Likely Solution: Under the proposed changes, managers will determine the applicable rate of return methodology for Pooled funds, for instance, based on the Fund types of either Close-end or Open-end as shown in the image below. This will lead to the elimination of separate Real Estate and Private Equity provisions and their consolidation and expansion to all other pooled fund structures regardless of their regulatory status.
Obstacle 6 – Treatment of Alternative Assets & Strategies –Overlays
The adoption rate of the GIPS among hedge funds and other alternative strategies and structures managers have historically been lower than the rest of the industry due to perceived peculiar issues related to their practices that were not specifically addressed by the Standards. The Alternative Assets Guidance Statement sought to bring clarity to the application to these groups of managers.
Likely Solution: Specific attention will be paid to clarifying the application of the GIPS in these situations under the revised Standards by expanding the content and application of the Alternative Asset and Strategies guidance.
Obstacle 7 – Ex-ante vs Ex-post Performance Information
The GIPS are based on ex-post or actual rather than ex-ante or forecasted information, but ex-ante information is frequently provided to prospective clients and may be a source of misinformation especially if they lack reasonable and adequate basis.
But should there be specific standards governing the distribution of ex-ante risk and return information shared with prospective clients? What should be contained in such presentations? These are other areas of consideration under the revised standards.
A great starting point for Standards in this area may be the section of the CFA Institute Code of Ethics and Standards of Professional Conduct, particularly the Section V concerning practices related to Investment Analysis, Recommendations and Actions.
Obstacle 8: Outsourced CIO or Fiduciary Structures
In the current content of the Standards, outsourced relationships are dealt with at the determination of total assets of the firm by evaluating whether the outsourcing relationship results in the manager having control over the actual implementation of the strategy (discretion) through control over execution decisions. Assets under ‘Advisory Only’ relationships, where the manager has no such control over execution decisions are currently not permitted to be included in total firm assets.
The challenge here is to determine whether such exclusions need to be revised and what the state of change will look like.
The obstacles identified in the GIPS 2020 conference presentation and outlined in this post are not exhaustive and the GIPS Organizationthrough its contact desk welcomes feedback for consideration in the standards setting process. You can also share your thoughts and opinions using our Comments box below and by completing our ‘Post Survey’ below which will take a minute or less.
Credits & References
*Chart Image CFA Institute GIPS 20:20 Conference Presentation
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