Reading 3 & 4 LOS's

Question 1

LOS 3a: Explain why the GIPS standards were created, what parties the GIPS standards apply to, and who is served by the standards

Answer 1

Questions relating to the accuracy and credibility of the data used in investment performance presentations make comparisons difficult. Misleading practices that have been common in performance presentation are:

• Representative accounts - use only the best performing portfolios to represent the firm’s overal performace
• Survivorship Bias - excludes performance of accounts that performed poorly and were terminated
• Varying time periods - presenting performance from time periods where the fund did well

The GIPS standards aim to provide clients and prospects with comparable and representative investment performance data.

Who Can Claim Compliance?

Compliance with GIPS standards for any firm is voluntary and not required by any legal or regulatory authorities. However, only investment management firms that actually manage assets can claim compliance. There is no such thing as partial compliance, you must comply with all GIPS standards to comply at all

Who benefits from Compliance?

The GIPS standards benefit 2 main groups - investment management firms and prospective clients

1. Compliance with GIPS assures clients that historical records presented by a firm are both complete and fairly presented so it helps investment management firms in their marketing activities.
2. Investors are provided with credible data for different investment firms and can therefore, easily compare firms’ performance to make an informed decision regarding the selection of investment managers

Question 2

LOS 3b: Explain the construction and purpose of composites in performance reporting

Answer 2

The GIPS standards require the use of composites. A composite is formed by combining discretionary portfolios into one group that represents a particular investment objective or strategy. A composite representing a particular strategy must include all discretionary portfolios managed according to that strategy

To ensure that the firm does not include only its best performing funds when presenting investment performance, GIPS standards require that the criteria for classifying portfolios into composites are decided before performance is known, not after the fact

Question 3

LOS 3c: Explain the requirements for verification

Answer 3

Firms that claim compliance with GIPS standards are responsible for ensuring that they are really compliant and maintaining their compliant status going forward.

Verification assures that the investment manager is compliant with GIPS standards on firm-wide basis. Verifiation tests:

1. Whether the investment firm has complied with all the composite construction requirements on a firm-wide basis
2. Whether the firm’s processess and procedures calculate and present performance information according to GIPS standards

Verification is optional and it cannot be performed by the firm itself

The structure of the GIPS Standards

The provisions within the 2010 edition of the GIPS standards are divided into the following nine sections:

1. Fundamentals of Compliance
2. Input data
3. Calculation Methodology
4. Composite Construction
5. Disclosure
6. Presentation and Reporting
7. Real Estate
8. Private Equity
9. Wrap Fee/ Separately Managed Account (SMA) Portfolios

Question 4

LOS 4a: Describe the key features of the GIPS standards and the fundamentals of compliance

Answer 4

Objectives of GIPS

• To establish investment industry best practices for calculating and presenting investment performance that promote investor interests and instill investor confidence
• To obtain worldwide acceptance of a single standard for the calculation and presentation of investment performance based on the principles of fair representation and full disclosure
• To promote the use of accurate and consistent investment performance data
• To encourage fair, global competition among investment firms without creating barriers to entry
• To foster the notion of industry “self-regulation” on a global basis

Key Features of GIPS

• GIPS standards are ethical standards to ensure full disclosure and fair representation of investment performance
• Apart from adhering to the minimum requirements of the GIPS standards, firms should try to adhere to the recommendations of the GIPS to achieve best practice in the calculation and presentation of performance
• Firms should include all actual, discretionary, fee-paying portfolios in at least one composite defined by investment mandate, objective, or strategy in order to prevent firms from cherry-picking their best performance
• The accuracy of performance presentation is dependent on the accuracy of input data.
• Firms must comply with all requirements of the GIPS standards, including any updates, Guidance Statemetns, interpretations, Q&As, and clarifications published by the CFA Institute and the GIPS Executive Committe

Fundamentals of Compliance

Requirements

• Firms must comply with all requirements of the GIPS standards, including any updates, Guidance Statemetns, interpretations, Q&As, and clarifications published by the CFA Institute and the GIPS Executive Committe
• Firms must comply with all applicable laws and regulations regarding the calculations and presentations of performance
• Firms must not present performance or performance related information that is false or misleading
• The GIPS standards must be applied on a firm-wide basis
• Firms must document their policies and procedures used in establishing and maintaining compliance with the GIPS standards
• IF the firm does not meet all the requirements of the GIPS standards, it must not represent or state that it is in compliance with GIPS
• Statements referring to calculation methodolody as being in accordance with GIPS are prohibited
• Statements referring to the performance of a single, existing client portfolio as being “ calculated in accordance with the GIPS standards” are prohibited
• Firms must make every reasonable effort to provide a complian presentation to all prospective clients
• Firms must provide a complete list of composite descriptions to any prospective clients that make such a request
• Firms must provide a compliant presentation for any composite listed on their composite descriptions to any prospective clients that make such a request
• Firms must be defined as an investment firm, subsidiary, or division
• Total fism assets must include assets assinged to a sub-advisor
• Changes in a firm’s organization must not lead to alteration of historical composite performance

Recommendations

• Firms should comply with the recommendations of the GIPS standards, including any updates, Guidance Statemetns, interpretations, Q&As, and clarifications published by the CFA Institute and the GIPS Executive Committe
• Firms should be verified
• Firms should adopt the broadest, most meaningful definition of the firm, encompassing all geographical offices operating under the same brand name regardless of the actual name of the individual investment management company
• Firms should provide to each existing client, on an annual basis, a compliant presentation of the composite in which the client’s portfolio is held

Question 5

LOS 4b: Describe the scope of the GIPS standards with respect to an investment firm’s definition and historical performance record

Answer 5

Compliance with GIPS standards facilitates an investment firm participation in the global investment management industry. To claim compliance, investment management firms must define an entity that claims compliance (the firm)

Firms are required to present a minimum of five years of GIPS-compliant historical investment performance. If the firm is less than 5-years old, it should file reports from inception. Once accepted, the firm must add one year of compliant performance each year, until they have a performance record of 10 years

Firms that manage private equity, real estate, and/or wrap fee/separately managed account (SMA) portfolios must also comply.

Question 6

LOS 4c: Explain how the GIPS standards are implemented in countries with existing standards for performance reporting and describe the appropriate response when the GIPS standards and local regulations conflict

Answer 6

The GIPS Executive Committee strongly encourages countries without an investment perfromance standrad to promot GIPS standards as the local standard.

In countries where laws and regulations regarding performance presentation do exist, firms are encouraged to adhere to GIPS in addition to their local laws. In case of conflict, local laws are applicable and firms are required to disclose the conflict

Question 7

LOS 4d: Describe the nine major sections of the GIPS standards

Answer 7

1. Fundamentals of compliance- discusses issues pertaining to definition of a firm, documentation of policies and procedures, maintaining compliance with any updates and ensuring proper reference to claim of compliance with GIPS
2. Input Data - specifies standards for input data to be used to calculate investment performance
3. Calculation Methodology - definitions of specific methods for return calculations of portfolios and composites
4. Composite Methodology- Composites should be constructed to achieve consistency and fair presentation
5. Disclosures - Requirements for disclosure of information pertaining to a firm’s poilicies and performance presentation
6. Presentation and reporting - Performance presentation must be according to GIPS requirements
7. Real Estate- Standards must be applied to present performance relating to real estate investments
8. Private equity - GIPS private Equity Valuation Principles must be used to value private equity investments, except for open-end and everygreen funds
9. Wrap Fee/ Separately Managed Account (SMA) Portfolios : Firms must include the performance record of all wrap fee/SMA portfolios in appropriate composites in accordance with the firm’s established portfolio inclusion policies