Since the release of the 2020 Global Investment Performance Standards (GIPS®), the investment community has been anxiously awaiting the arrival of what was formerly known as the GIPS Handbook. Recognizing the need for additional guidance for firms to comply with the 2020 GIPS standards, CFA Institute has committed to releasing the revised GIPS Handbook, now called Explanation of the Provisions, as they are completed. Earlier this year, CFA Institute updated the Explanation of the Provisions for Firms in Sections 1-4 and will continue to release guidance for additional sections as they become available.
Section 2 focuses on clarifying the input data and calculation methodology requirements to be compliant with the 2020 GIPS standards. The following is an overview of some of the most significant changes.
Total Firm Assets
Provision 2.A.1 notes that firms must not include advisory-only assets, uncalled committed capital, and overlay exposure in total firm assets. The explanation for this provision goes into detail regarding the definitions for each of these terms and specific circumstances in which they would apply.
Advisory-only assets are assets for which the firm provides investment recommendations and for which the firm:
- has no control over implementation of investment decisions, and
- does not have trading authority over the assets.
A firm can show advisory-only assets in the GIPS Report, either combined with total firm assets or separately, and does not need to label them as supplemental information. However, if the firm wishes to present a combination of total firm assets and firm-wide advisory-only assets, it must also present firm-wide advisory-only assets for the same periods for which the combination is presented.
If there is concern about whether certain UMA assets can be included in the GIPS firm assets or should be considered advisory-only assets, there is a useful table on page five of the provision. There are also factors to consider on pages seven and eight, including:
- the contract between the sponsor and the firm,
- trading authority, and
- authority at the portfolio level.
Because of the complexities that often exist when determining the level of discretion for a firm’s UMA assets, firms often opt to exclude them from total firm assets and treat as advisory-only.
Firms must not include overlay exposure in total firm assets. This applies if the overlay is managed as a separate strategy from the underlying portfolio and the firm offers the overlay strategy as a segregated account. It does not apply when an overlay is part of a broader strategy. Overlay exposure for strategies is the notional value of the overlay strategy being managed, the value of the underlying portfolios being overlaid, or a specified target exposure.
The topic of fees is bifurcated according to investment vehicle. There are different rules for different vehicle types.
Provision 2.A.32 addresses pooled fund net returns. It states that a firm may use either actual total pooled fund fees or a model pooled fund fee appropriate to prospective investors to calculate this return.
If the firm wishes to use actual total pooled fund fees and the fund has multiple share classes, the firm may either:
- deduct from the pooled fund gross-of-fees return the highest total pooled fund fee of any individual share class in the fund, or
- calculate pooled fund net-of-fees returns using a weighted average of actual pooled fund net-of-fees returns from all share classes.
If the firm wishes to use a model pooled fund fee, the firm may use the total expense ratio if the total expense ratio includes all fees and costs. If the total expense ratio does not include all fees and costs, such as performance-based fees, the firm must also deduct the additional fees and costs when calculating pooled fund net-of-fees returns. A firm may also use the model total pooled fund fee that is applicable to the specific pooled fund investor.
Using either actual total pooled fund fees or a model pooled fund fee, full disclosure of the calculation must be included. This is especially true if net-of-fees returns are not straightforward and/or have multiple assumptions. Also, pooled fund net-of-fees returns shown must be equal to or lower than those that would have been calculated if using actual (effectively charged) total pooled fund fees. If a firm wants to show a second net-of-fees return in a GIPS Report that is applicable to the specific pooled fund investor, but does not meet this requirement, the second net-of-fees return must be labeled as supplemental information and additional disclosure is needed to explain how the firm arrived at the return.
Provision 2.A.47 addresses carve-out net-of-fees returns. When calculating net-of-fees returns for carve-outs, the fee used to calculate these returns must be representative of the investment management fees charged or that would be charged to the prospective client.
The investment management fees used to calculate the net-of-fees returns depend on the prospective client the GIPS Report is designed for. If the prospective client is a prospect for a standalone portfolio, the investment management fee must be representative of the investment management fees for a standalone portfolio managed according to that strategy. For example, assume Firm B manages a balanced strategy. The firm charges 0.50% for the balanced strategy but plans to charge 0.75% for the equity strategy. When calculating and presenting net-of-fees returns to the prospect for the equity strategy, the firm must use the 0.75% fee.
Provision 2.A.48 addresses wrap composite net-of-fees returns. When calculating returns to be presented to a wrap fee prospective client, returns must be calculated net of the entire wrap fee. This is applicable to all wrap fee portfolios in the composite as well as any non-wrap fee portfolios that are included in the composite.
“Pure” gross-of-fees returns, which represent the return on investments that is not reduced by any transaction costs incurred during the period, are permitted only as supplemental information in a GIPS Composite Report and must be clearly labelled as such.
If a firm chooses to use a non-wrap fee composite to show a track record of a wrap fee strategy before actual wrap fee portfolios are managed, the firm must calculate the historical net-of-fees return by reducing the gross return of the non-wrap fee composite by the highest total wrap fee charged to the client by the wrap sponsor. If a firm can identify the portion of the highest total wrap fee attributable to transaction costs or estimate this amount, the firm may then increase the net-of-fees return by this identifiable portion.
There is a useful table on page 68 of the explanations that lays out the different fees and types of returns depending on what part of the fee can or cannot be unbundled.
Provision 2.A.13 addresses estimated transaction costs. All returns must be reduced by transaction costs and when a portfolio’s transaction costs are not known, the 2020 GIPS standards allow firms to use an estimate. For wrap-fee portfolios, the explanations suggest using the highest estimated transaction costs. Other approaches require knowledge of actual transaction costs for portfolios that the firm manages in the same or similar strategy, or similar securities that trade in a similar market. That percentage can then be applied to the portfolio where transaction costs are unknown.
This section acknowledges the fact that there are certain market brokers offering zero commission trades. However, it is not permissible to use $0 commissions as an estimated transaction cost. If a portfolio is actually paying zero commissions, then it is appropriate to calculate gross-of-fees and net-of-fees returns that reflect zero transaction costs, but the explanations state that firms should disclose this fact. They also note that not disclosing this fact could be misleading.
Private Market Investments
"Private market investments" is a new term that includes real assets (e.g., real estate and infrastructure), private equity, and similar investments that are illiquid, not publicly traded, and not traded on an exchange.
Private market investment portfolios are portfolios that have an investment objective to invest primarily in private market investments. There are different valuation and calculation requirements for portfolios considered to be private market investment portfolios. These are outlined in Provisions 2.A.40 and 2.A.41.
For time-weighted returns, these portfolios must be valued at least quarterly and are not required to be valued at the time of large cash flows. The portfolio and composite calculation frequency are aligned with the minimum valuation frequency, which is quarterly.
Real estate is included in private market investments and thus must be valued quarterly as well. The quarterly valuations can either be internal or external. Real estate must have an external valuation at least once every 12 months. External valuations must be performed by an independent third party which is a professionally designated or certified commercial property valuer/appraiser.
The explanations acknowledge that it is common for private market investments to be valued using preliminary, estimated values. If the firm uses the last available historical price or preliminary value, the firm must consider the estimated value to be the best approximation to the current fair value. When using estimated values, the firm should obtain an understanding of the process used to establish estimated values and must reassess the difference between the approximation and final value on assets and performance. Adjustments must be made to these statistics when the final value is received.
ACA assists many firms in their efforts to claim compliance with the GIPS standards and ultimately become verified. If your firm is looking for more information into this effort, please contact Jamie Stewart.
About the Author
Elena McKee-Dabbs is a Senior Principal Consultant at ACA Compliance Group. As a specialist in the GIPS standards, Elena works in ACA’s performance division with more than 40 advisers. Her engagements include verifications, performance exams, performance certifications, and focused performance reviews, among others. Prior to joining ACA, Elena served as a manager at Ashland Partners and as a statistical analyst at a hedge fund.