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. In February, CFA Institute updated the Explanation of the Provisions for Firms in Sections 1, 2, and 3 and will continue to release guidance for additional sections as they become available.
The 2010 edition of the GIPS standards were based on composite reporting. A composite is an aggregation of one or more portfolios managed according to a similar investment mandate, strategy, or objective and all fee-paying, discretionary portfolios were required to be included in at least one composite. Firms managing broadly distributed pooled funds often offered strategies that were not available as a standalone portfolio and ended up creating composites to accommodate these pooled funds, just to meet this requirement. The new structure of the 2020 GIPS standards addresses this. Effective January 1, 2020, firms are only required to create composites for strategies that are managed for or offered as a segregated account. A segregated account is defined in the glossary as a portfolio owned by a single client. Firms may choose to terminate any composite that was created solely to include pooled funds, based on past requirements, if the strategy is not offered or managed as a segregated account, but they are not required to do so.
Two important nuances should also be mentioned here:
- If a firm is a sub-advisor for a pooled fund, the firm must treat the sub-advised pooled fund as a segregated account and not a pooled fund.
- All pooled funds, both Broad Distribution Pooled Funds (BDPF) and Limited Distribution Pooled Funds (LDPF), must be included in a composite if they meet the composite definition. Keeping in mind composites are only required when managing or offering strategies as segregated accounts.
The Glossary for the 2020 GIPS standards defines composite definition as:
“Detailed criteria that determine the assignment of portfolios to composites. Criteria may include, but are not limited to, investment mandate, style or strategy, asset class, the use of derivatives, leverage and/or hedging, targeted risk metrics, investment constraints or restrictions, and/or portfolio type (e.g., segregated account or pooled fund; taxable versus tax exempt).“
Prior to January 1, 2020, firms could differentiate between segregated accounts and pooled funds when defining composites. However, as of January 1, this approach is no longer allowed. Firm’s may no longer exclude portfolios from composites based solely on legal structure differences. Firms need to take other factors into consideration when deciding whether a pooled fund should be included in a composite with segregated accounts. For example, if the fund is managed differently than the segregated accounts due to high liquidity requirements and turnover, then the composite will need to be defined to support the separation of funds and separate accounts. If the separation of segregated accounts and pooled funds can’t be supported, then the firm must redefine one of the composites to include the other vehicle or create a new composite to include the segregated accounts and pooled funds historically.
Providing GIPS Reports to prospective clients and investors
The 2010 edition of the GIPS standards required firms to provide a compliant presentation (now called a GIPS Report) to all prospective clients at least once every 12 months. In principle, this requirement remains in effect, though it has been refined to consider whether the ‘prospect’ in question is a prospective client for a segregated account or a prospective investor in a pooled fund. When a strategy is offered as a segregated account, and the portfolio would be eligible for inclusion in a composite, this requirement still applies. The following outlines which type of GIPS Report each prospective client/investor must receive on an annual basis.
- Prospective clients for a segregated portfolio must receive a GIPS Composite Report.
- Prospective investors in a LDPF must receive a GIPS Report. The GIPS Report may either be:
- A GIPS Pooled Fund Report, or
- A GIPS Composite Report, only if the LDPF is included in a respective composite.
- Prospective investors in a BDPF may be provided with a pooled fund report for the BDPF if the BDPF is not included in a composite, but there is no obligation for firms to do this.
- Prospective investors in a BDPF may be provided with a composite report if the BDPF is included in a composite, but it is not required.
Classifying pooled funds as limited or broadly distributed
There are certain provisions of the 2020 GIPS standards that are dependent on whether a pooled fund is classified as BDPF or LDPF. The primary difference relates to the firm’s obligation to provide prospective investors a GIPS Report. Given it is required for LDPF investors and only recommended for BDPF investors, it is important for firms to properly classify any pooled funds under management. The terms BDPF and LDPF are defined in the Glossary of the GIPS standards in the following way:
A broad distribution pooled fund (BDPF) is a pooled fund that is:
- regulated under a framework that would permit the general public to purchase or hold the pooled fund’s shares, and
- is not exclusively offered in one-on-one presentations.
A limited distribution pooled fund (LDPF) is any pooled fund that is not a broad distribution pooled fund.
Given the broad scope of these definitions, there is additional guidance in the Explanation of Provisions in Section 1 covering an array of scenarios to help firms properly classify pooled funds as either LDPF or BDPF.
Presenting and linking non-GIPS compliant information
A firm must only present GIPS compliant performance in a GIPS report after the minimum effective compliance date. Real estate and private equity composites and pooled funds and wrap fee composites have a minimum effective compliance date of 1 January 2006. All other composites and pooled funds have a minimum effective compliance date of 1 January 2000.
For firms reporting time-weighted returns in GIPS Reports, there is no change from the 2010 GIPS standards – no non-compliant performance presented or linked to compliant performance beginning on or after the minimum effective compliance date in a GIPS report. For firms presenting money-weighted returns in GIPS Reports, non-GIPS-compliant performance must not be presented for periods ending on or after the minimum effective compliance date. The distinction of performance ending or beginning on or after the minimum effective compliance date is important, because it allows for the presentation of a since-inception money-weighted return that may include performance inputs that pre-date the firm’s claim of GIPS compliance and/or the minimum effective compliance date. Any performance inputs prior to the firm’s claim of compliance, after the minimum effective compliance date, must of course meet any/all applicable requirements of the GIPS standards.
The prohibition against presentation and linking of non-GIPS compliant information to GIPS-compliant information is specific to GIPS reports. Outside of a GIPS report, the firm may present linked GIPS compliant and non-compliant performance if requested by a prospective client or prospective investor.
Creating carve-outs with allocated cash
Prior to January 1, 2010, firms could include carve-outs with allocated cash in composites. Effective January 1, 2010, firms were no longer allowed to do so, though firms could still include carved-out portions of broader portfolios in composites, if they were managed with their own cash balances.
With the arrival of the 2020 GIPS standards comes the re-introduction of carve-outs with allocated cash, with the goal being to make GIPS compliance more attainable for a greater number of private wealth managers and managers of private market investments. The guiding principles behind carve-outs remain the same – carve-outs must be representative of a standalone portfolio managed, or intended to be managed to that strategy, and all similar segments must be carved out. There is no required methodology to synthetically allocate cash, however there are four acceptable methodologies list in the Explanation of Provisions in Section 3 based on beginning-of-period allocation or strategic asset allocation.
An important requirement firms should keep in mind when creating carve-outs with allocated cash is when the firm obtains standalone portfolios managed to the same strategy as a carve out with allocated cash, then the firm is required to create a separate composite for the standalone portfolios. A standalone portfolio being a portfolio that is not a subset of a larger portfolio. The returns and composite assets for composite of stand-alone portfolios must be presented in the GIPS Composite Report for the carve-out composite in order to give a prospective client the ability to compare the returns between the two composites.
Additional requirements and recommendations for creating and presenting carve-out performance can be found in the Explanation of the Provisions in Section 3.
ACA Compliance Group’s Crista Desrochers and Sonja Asllani discuss the key takeaways from the Explanation of Provisions from Sections 1 and 3 in this complimentary webcast. Don’t miss this opportunity to discover hidden requirements and hear explanations of how to effectively comply with the 2020 GIPS standards.
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 Authors
Douglas Finlay, CIPM, is a Director with ACA’s performance division. Douglas joined ACA in 2007 and has worked with over 50 clients including several asset owner clients. Douglas earned his B.A. in History from the University of the South (Sewanee). He also holds an MBA with a concentration in Finance from the University of Tennessee at Chattanooga, where he was awarded the John C. Stophel Distinguished Student Award. He is a member of CFA Institute and the CFA Society of East Tennessee.
Sonja Asllani is a Principal Consultant with ACA’s performance division. She joined ACA’s Chattanooga, TN office in July 2015. Her primary responsibilities include managing client relationships and conducting GIPS compliance verifications, performance certifications, and focused review engagements. Sonja received her MBA from the University of Tennessee at Chattanooga in May 2015, where she was awarded the Master of Business Administration’s Outstanding Student Award.