The release of the Exposure Draft of the 2020 Global Investment Performance Standards (GIPS®) in August has forced many firms to assess how the new requirements will impact their business, both from marketing and operational perspectives. Not only will this impact firms currently claiming compliance with the GIPS standards, but also those considering doing so. Though not finalized (the period for public comment runs through December 31, 2018), the exposure draft document promotes GIPS compliance in sectors of the market that have either not needed/wanted to claim compliance, or have experienced difficulty in doing so in the past. One such example is the Outsourced Chief Investment Officer (OCIO) division of those firms.
AON Hewitt Investment Consulting and Marquette Associates issued separate press releases in August announcing their OCIO division’s claim of compliance with the GIPS standards (and subsequent third-party verification). Although AON Hewitt Investment Consulting and Marquette Associates are the latest OCIO firms to claim compliance with the GIPS standards, there are others that have been claiming compliance for years.
It shouldn’t be any surprise that there is developing interest in this space. After all, most OCIOs are registered investment advisors with the SEC, which puts them in the same population of independent RIA’s, banks, and other advisors marketing their services to consultants, asset owners, and other third-party intermediaries. Thus, it makes sense that OCIOs would face the same market pressure to adhere to industry-recognized standards for those asset-owning entities that require a certain level of due diligence and comfort with the performance they are evaluating.
So Why Now?
There is no market survey we are aware of that gives a definitive reason(s) for this new trend. It is easy to conjecture that there are three primary reasons that could be driving the trend.
- The OCIO market has experienced significant growth over the last five years. However, how much of that growth has been driven by the firm’s current clients switching from advisory to OCIO services? Presumably, once that initial influx slows down, OCIOs will likely become subject to the same due diligence requirements as any other money manager seeking to expand its business.
- The inherent nature of using third-party advisors in the OCIO space has made performance measurement a challenge, both historically and ongoing. In fact, ACA Performance Services has worked with firms that calculate performance using their own in-house systems, for both their OCIO and advisory clients, so they are able to support their GIPS compliance for any stakeholder that utilizes that service. As these systems and processes have improved, many OCIOs find themselves with a clearer path to compliance.
- The current GIPS standards were designed without OCIOs in mind. However, with newly released guidance, Q&As that address some of the main issues that OCIOs face, and the release of the 2020 GIPS Standards Exposure Draft, the needs of this sector are being addressed and make the path to GIPS compliance clearer.
To Claim GIPS Compliance, What Do OCIOs Need to Consider?
To be sure, not all OCIOs are alike. Some OCIOs use all third-party management, some use all internal management, and some use a mix of internal and external management. Some OCIOs utilize only separate accounts while others have created their own fund-of-funds to implement their strategies. In addition, OCIOs may be formed for high net worth clients and be product focused while others stick to an institutional focus where each client has their own allocations. Regardless, there are several basic issues that the industry faces when pursuing GIPS compliance. Some will be mitigated by the OCIO’s structure and focus, while others will be exacerbated. Although the following areas are common issues for all firms that claim compliance with the GIPS standards, OCIOs can have additional firm-specific issues.
The Common Issues
Books and Records – Section 1.A.1 of the GIPS standards requires, “all data and information necessary to support all items included in a compliant presentation must be captured and maintained.” This can be a particular challenge for OCIOs that use third-party managers, especially real estate and private equity. For an OCIO, the lack of full transparency into underlying portfolios and mismatched reporting frequencies are obstacles that need to be addressed early in the process of claiming GIPS compliance. In addition, OCIOs need to assess the processing of this information in their internal systems so that all information is captured and maintained.
Performance Calculations – The GIPS standards require in Section 1.A.3 that, “firms must value portfolios in accordance with the composite-specific valuation policy. Portfolios must be valued:
- For periods beginning on or after 1 January 1 2001, at least monthly.
- For periods beginning on or after 1 January 2010, on the date of all large cash flows……”
For OCIOs, the second requirement can create issues when there is an intra-month cash flow between one external manager and another. Reliance on manager-reported data often leads to a lack of transparency into underlying cash flows and intra-month valuations that can be significant hurdles when calculating performance at the OCIO.
- Composite Construction – Section 3.A.1 requires that, “all actual, fee-paying, discretionary portfolios must be included in at least one composite….” This has historically been one of the key roadblocks for a variety of firms’, including OCIOs, pursuit of GIPS compliance. Although some OCIOs have very defined “product-like” solutions, many have to address the wide variance of clients’ investment objectives, benchmarks, and asset classes. There are multiple methods, that are best discussed at the outset of the project, that can be utilized to address the “apparent” mismatch between the requirements of the GIPS standards and the business and investment models of the OCIO.
- Marketing – OCIOs commonly ask how their past marketing efforts are going to be affected by a claim of compliance with the GIPS standards. In general, marketing is not affected, except for any required information that needs to be delivered to prospective clients. However, the OCIO needs to contemplate how best to balance the requirement to create composites that are representative of its strategies in an operationally efficient way, while also maintaining the marketability of the OCIO. The use of supplemental and additional information can add value to the prospective client while offsetting dispersion dictated by the OCIO’s investment process.
- Valuation Policies – Every GIPS-compliant firm needs to maintain valuation policies for the determination of fair value. Combined with the need to produce time-weighted returns on a monthly basis, the OCIO needs to create a valuation policy that addresses the mismatch between the reporting frequencies and methodologies of underlying managers, specifically real estate and private equity, and the needs of the OCIO.
- Firm Definition – Section 0.A.12 requires that, “firms must be defined as an investment firm, subsidiary, or division held out to clients or prospective clients as a distinct business entity.” For many entities, the OCIO is separated from the advisory business through its own legal entity or regulatory registration. However, for those that are not, the OCIO will need to determine the definition of the firm which can lead to the separation of the portfolios and assets that will be part of the distinct business entity. These decisions will ultimately determine the size of the OCIO, how it is marketed, and composite construction. The firm’s definition is often a main factor in many of the other issues a firm coming into compliance will face.
Join us on Thursday, November 15 at 11 a.m. ET for our complimentary webcast discussing the main challenges for OCIOs to claim compliance with the GIPS standards and the industry best practices on how to navigate through these. Register today.
ACA Performance Services assists many different OCIOs 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 Jason Millard or Christie Dillard Horsman for more information.
About the Author
Jason Millard, CFA, CIPM, is Managing Director with ACA Performance Services, a division of ACA Compliance Group.Jason primarily conducts sales and marketing activities for GIPS consulting and verification services, performance certifications, and performance reviews. Prior to joining ACA, Jason served as Partner of Business Development with Ashland Partners & Company LLP, where he had similar responsibilities. He has also worked as Vice President of sales and marketing for a boutique investment management firm. Jason earned his Bachelor of Chemical Engineering and Master of Business Administration (MBA) from the Georgia Institute of Technology. He is a Chartered Financial Analyst (CFA) and holds the CIPM certificate.