Reading 4 - Introduction to Global Investing Performance Standards Flashcards
Reading 4 Learning Objectives
(1) explain why the GIPS standards were created, what parties the GIPS standards apply to, and who is served by the standards;
(2) explain the construction and purpose of composites in performance reporting;
(3) explain the requirements for verification.
The objective of this reading is to orient the Level I candidate approaching the assigned sections of the GIPS standards. It explains why the GIPS standards were created, who can claim compliance, and who benefits from compliance. It also introduces the key notion of composites, states the purpose of verification, and previews the structure of the Standards.
Why were the GIPS Standards Created?
In the past, the investment community had great difficulty making meaningful comparisons on the basis of accurate investment performance data. Several performance measurement practices hindered the comparability of performance returns from one firm to another, while others called into question the accuracy and credibility of performance reporting overall.
Misleading practices included:
Representative Accounts: Selecting a top-performing portfolio to represent the firm’s overall investment results for a specific mandate.
Survivorship Bias: Presenting an “average” performance history that excludes portfolios whose poor performance was weak enough to result in termination of the firm.
Varying Time Periods: Presenting performance for a selected time period during which the mandate produced excellent returns or out-performed its benchmark—making comparison with other firms’ results difficult or impossible.
Making a valid comparison of investment performance among even the most ethical investment management firms was problematic. Give an example.
For example, a pension fund seeking to hire an investment management firm might receive proposals from several firms, all using different methodologies for calculating their results.
What are the GIPS Standards
The GIPS standards are a practitioner-driven set of ethical principles that establish a standardized, industry-wide approach for investment firms to follow in calculating and presenting their historical investment results to prospective clients. The GIPS standards ensure fair representation and full disclosure of investment performance. In other words, the GIPS standards lead investment management firms to avoid misrepresentations of performance and to communicate all relevant information that prospective clients should know in order to evaluate past results.
Who can claim compliance? First.
First, any investment management firm may choose to comply with the GIPS standards. Complying with the GIPS standards is voluntary. Compliance with the GIPS standards is not typically required by legal or regulatory authorities.
Who can claim compliance? Second.
Second, only investment management firms that actually manage assets can claim compliance with the Standards. Plan sponsors and consultants cannot make a claim of compliance unless they actually manage assets for which they are making a claim of compliance. They can claim to endorse the Standards and/or require that their investment managers comply with the Standards.
Who can claim compliance? Third.
Third, compliance is a firm-wide process that cannot be achieved on a single product or composite. A firm has only two options with regard to compliance with the GIPS standards: fully comply with all requirements of the GIPS standards and claim compliance through the use of the GIPS Compliance Statement; or not comply with all requirements of the GIPS standards and not claim compliance with, or make any reference to, the GIPS standards.
Who benefits from compliance to GIPS?
The GIPS standards benefit two main groups: investment management firms and prospective clients.
How do Investment Management Firms benefit from GIPS?
By choosing to comply with the GIPS standards, investment management firms assure prospective clients that the historical “track record” they report is both complete and fairly presented. Compliance enables the GIPS-compliant firm to participate in competitive bids against other compliant firms throughout the world. Achieving and maintaining compliance may also strengthen the firm’s internal controls over performance-related processes and procedures.
How do Investors benefit from GIPS?
Investors have a greater level of confidence in the integrity of performance presentations of a GIPS-compliant firm and can more easily compare performance presentations from different investment management firms. While the GIPS standards certainly do not eliminate the need for in-depth due diligence on the part of the investor, compliance with the Standards enhances the credibility of investment management firms that have chosen to undertake this responsibility.
What is a composite?
One of the key concepts of the Standards is the required use of composites. A composite is an aggregation of one or more portfolios managed according to a similar investment mandate, objective, or strategy. A composite must include all actual, fee-paying, discretionary portfolios managed in accordance with the same investment mandate, objective, or strategy.
GIPS Verification
Firms that claim compliance with the GIPS standards are responsible for their claim of compliance and for maintaining that compliance. That is, firms self-regulate their claim of compliance. Once a firm claims compliance with the Standards, they may voluntarily hire an independent third party to perform a verification in order to increase confidence in the firm’s claim of compliance. Verification may also increase the knowledge of the firm’s performance measurement team and improve the consistency and quality of the firm’s compliant presentations.
Verification is performed with respect to an entire firm, not on specific composites. Verification does not ensure the accuracy of any specific composite presentation. Verification tests:
- whether the investment firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis, and
- whether the firm’s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards.
How can a firm perform verification?
Verification must be performed by an independent third party. A firm cannot perform its own verification.
