Executive Summary
In the world of investment advisors, competition has long been driven at least in part by investment performance results. Yet the challenge is that performance reporting can also be prone to abuse, due to the lack of consistent standards - amongst individual financial advisors in particular - about how those results are measured and reported in the first place. In fact, in recent years a number of advisory firms are trying to improve their performance reporting process to meet the Global Investment Performance Standards (GIPS) requirements specifically as a means to differentiate themselves.
Accordingly, in this guest post, GIPS compliance consultant Amy Jones and marketing expert Thusith Mahanama share some of the details that advisors should be aware of in considering whether to pursue the path of GIPS-compliant performance reporting for their own advisory firm. And notably - as the authors point out - the decision about whether to pursue GIPS-compliant reporting is a firm-wide decision, as one of the first key requirements of GIPS reporting is that it must be done on a firm-wide basis, to eliminate the potential that advisors try to cherry-pick the best performing accounts to include in their composite results.
So if you're an advisory firm that manages portfolios on a model basis, and have already been considering whether to adopt GIPS as a means to differentiate yourself, hopefully this primer on the requirements for GIPS compliance will be helpful for you. Alternatively, if you're an advisory firm that's had strong results for clients but is currently struggling to differentiate yourself from the marketing of other advisory firms, you may find the idea of GIPS-compliant reporting appealing as a means to differentiate why your performance reporting results really should be viewed as more 'credible' than the competition!
Authors:
When Siharum Advisors LLC, a Boston-based wealth advisory firm, was evaluating whether or not to seek Global Investment Performance Standards (GIPS®) compliance for its performance reporting, they knew they were going where many financial advisors feared to tread. But for CEO Bala Cumaresan, the decision was a no-brainer. “We decided to pursue GIPS because it is a ‘best practice’ for all investment advisors, even those who employ an open architecture, outsourced CIO approach. We believe that an objective measure of our investment performance is the first step in holding ourselves accountable for the quality of advice we provide to our clients,” he recalls.
In fact, claiming GIPS compliance has led to some unexpected benefits. Cumaresan notes that “internally, [it] was a good test of our internal control policies and procedures. Externally, the reports provide prospective clients with an objective measure of our investment capabilities, and it also helps us filter our prospect list. Prospects who are able to understand the importance of tangible, long-term GIPS-compliant results tend to be good long-term clients.”
Why Consider GIPS Compliance?
GIPS is a set of standardized, industrywide ethical principles established by the CFA Institute to provide investment management firms with guidance on how to calculate and report their investment results to prospective clients. Investment managers voluntarily choose to abide by the GIPS standards — compliance is not mandated by any law or regulation. For many years, GIPS compliance has been seen as an essential ingredient that can make or break an institutional investment firm’s marketing efforts in terms of winning new mandates and maintaining clients. A decade ago, institutional firms saw claiming GIPS compliance as a differentiator, but now there are so many firms claiming compliance that it has become a disadvantage to not adhere to the GIPS standards.
Today, many financial advisors and wealth managers—especially those interested in moving up-market—are starting to take an interest in GIPS as well. Even some smaller RIAs are becoming GIPS compliant in order to gain a competitive advantage and have the peace of mind that comes from complying with industry best practices. Although GIPS compliance may not make sense for every financial advisory firm, it does confer tangible marketing advantages, including:
- The early-adopter edge. Since GIPS compliance is not yet a “must-have” in the financial planning and wealth advisory industry, early adopters of the standards, like Siharum LLC, find that compliance offers a way to differentiate themselves from the competition.
- The institutional-quality advantage. While it’s become something of a buzzword in the financial advisory and wealth management industry, claiming “institutional quality” services and procedures does confer a certain gravitas in the minds of many investors. Compliance with the GIPS standards is a legitimate reason to make the claim. Institutional investors know they benefit when their managers comply with the GIPS standards, and private clients are beginning to understand the benefits as well. The main advantage is knowing that their advisor’s performance results are calculated and presented conforming to rigorous standards. If the firm is verified, there is additional peace of mind that an independent third-party has vetted the policies and procedures the firm follows to calculate performance.
Adherence to the GIPS standards is not only a marketing tool, it also provides other benefits to advisors. By making the operational changes necessary for compliance, the average advisory firm will need to streamline operations and keep all their portfolio accounting data clean. While this might seem like a headache at the start, it pays huge dividends in the long run.
In fact, at Assette, we have seen a clear difference between GIPS-compliant and noncompliant firms. The compliant firms’ return streams are consistently updated, and details such as security types and sectors are always coded. In other words, the data is always clean, which enables these firms to easily produce compliant presentations (CPs) and leverage the same data for overall sales and client communications. The noncompliant firms often have holes in their data, requiring them to do multiple rounds of updates before they can use the data to produce sales and client materials.
What Are The Requirements To Be GIPS Compliant?
In order to claim GIPS compliance, a financial advisor must adopt and document policies and procedures that address all of the requirements of the standards. Since GIPS compliance affects many areas of the firm, several departments are often involved with maintaining and supporting the initiative. Operations, client service, performance, compliance and marketing frequently play a role, depending on the firm’s size and complexity. While the ultimate responsibility varies across firms, the ownership of the composite calculations and GIPS policies and procedures tends to fall to the group that has the time and/or the required expertise.
The GIPS standards are quite extensive and, while a complete outline of the details associated with achieving compliance is beyond the scope of this article, there are some specific aspects of the GIPS standards that financial advisors should consider:
- Compliance with the GIPS standards can only be achieved on a firmwide basis by an investment firm, subsidiary or division that is held out to the public as a distinct business entity. The manner in which “firm” is defined is the foundation for GIPS compliance. Individual portfolios, funds or composites — or the performance results thereof — do not themselves comply with the GIPS standards and, as a result, cannot be reported as “in compliance.” Only if the firm as a whole has adhered to all of the requirements of the GIPS standards — and has a process in place to ensure continued adherence— can the firm publicly claim compliance.
- A key component of the GIPS standards is the concept of a “composite.” A composite is an aggregate of one or more portfolios managed according to a similar investment mandate, objective or strategy. The composite is then used to represent — in a transparent and comprehensive manner — how the investment strategy performed historically. The GIPS standards require all fee-paying discretionary portfolios managed by the firm to be included in at least one composite. This is often a showstopper for financial advisors who manage highly individualized, client-specific portfolios. But for those firms using a model portfolio approach, creating one or more composites for GIPS reporting purposes is not typically an issue.
- There is a common misperception that the GIPS standards are strictly “performance standards” and, therefore, if the prescribed calculation methodologies are properly followed, then the firm can represent that it is “GIPS compliant.” In reality, there are many more aspects to the GIPS standards than the performance calculations. Ultimately, the accuracy of a claim of GIPS compliance depends not just on how performance results are calculated, but on how those results are communicated to the investing public. In particular, the GIPS standards have detailed requirements that address disclosure and statistical information that must be provided to prospective clients. In addition, all firms that claim GIPS compliance must document policies and procedures for establishing and maintaining compliance with the GIPS standards.
- The GIPS standards are very specific that, in order to claim compliance, firms must comply with all requirements of the GIPS standards. In other words, firms cannot pick and choose which parts of the GIPS standards they want to follow. Either they comply completely, or they do not comply at all. In fact, a firm that is not in compliance with the GIPS standards should not make any references to the GIPS standards in the context of reporting performance or performance presentations. “GIPS®” is a trademark owned by CFA Institute, and it is only authorized for use by firms that claim compliance.
GIPS Compliance Is An Ongoing Effort
GIPS compliance is not a one-time event that, once achieved, no longer requires much attention. In fact, maintaining compliance requires significant effort. There are tasks that must be completed on a monthly and annual basis in order for a firm to maintain compliance. For example, each month, portfolio returns have to be calculated, composites have to be updated, and a review of the results and necessary audit checks should be performed. The day-to-day maintenance procedures should either be documented in the GIPS policies and procedures or be separately documented as desktop procedures. At least annually, firms should review and update their GIPS policies and procedures, the firm’s list of composite descriptions and the firm’s GIPS-compliant presentations.
Having the right technology is critical, but the firm must also have knowledgeable personnel involved to review the output and oversee the process. If the firm does not have internal resources who are knowledgeable about the standards, enlisting the aid of performance experts or outsourcing key aspects of the process could be a good solution. Taking this approach can inject a higher level of expertise into the process, free up internal resources to focus on other tasks and instill confidence that the firm is adhering to industry best practices.
Firms may also choose to undergo third-party verification. Verification is encouraged, but not required, in order to claim compliance with GIPS standards. Verification is defined in the GIPS standards as the “process by which an independent verifier assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firmwide basis, and (2) the firm’s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards.” Verification does not ensure the accuracy of any specific composite presentation, nor is it considered equivalent to an audit — it merely validates that the firm has a control structure in place in order to facilitate compliance. The verifier must remain independent and is not allowed to perform calculations or prepare presentation materials.
Updating Compliant Presentations And Disclosures, And Correcting Errors
Under the Global Investment Performance Standards, a “compliant presentation” (CP) is a presentation for a composite that contains all the information required by the GIPS standards and may also include additional or supplemental information. The term “compliant presentation” can be confusing, since it refers to a single page within a marketing presentation — not the marketing presentation itself. Just think of it as the page that presents the required GIPS compliance information within your sales pitch book.
The CP is typically found toward the end of a presentation to prospective clients. This single page packs in a lot of information about the composite being presented. The CP has two categories of information: statistical data and disclosures. Statistical data includes annual performance, annual firm AUM, standard deviation and other data points helpful for prospective investors. The disclosures tell the investors how “the firm” is defined, what the composite represents and, if applicable, whether the firm’s GIPS-compliance procedures have been verified by an independent third-party.
While the GIPS standards only require firms to update CPs annually, most firms update the numbers quarterly. Advisors are often asked to provide current performance data to prospective clients. For example, a prospective investor who meets with an advisor in October may be reluctant to invest based only on the prior year’s numbers. And while performance results should never be the primary reason for choosing a financial advisor, just the knowledge that the firm is GIPS-compliant can be a powerful validator in a prospect’s decision-making process — or an existing client’s willingness to provide referrals.
When updating statistical data in presentations, advisors must be careful to ensure accuracy. Generally, composite and benchmark returns are taken from a portfolio accounting system, so there is not much risk in getting these numbers wrong. However, if an advisor manually calculates firm AUM, standard deviation and things like dispersion — and especially percentages of non-fee-paying or bundled-fee assets — using spreadsheet technology such as Excel, they need to be very careful indeed.
Even if there are no changes to the firm or composite definitions, an advisor must update disclosures with the latest examination and verification dates, if applicable. They must also be sure that all required disclosures are included, keeping in mind that the requirements change regularly.
In addition, any supplemental information — such as pages in the front of the presentation showing detailed performance, attribution statistics and portfolio characteristics – must include required disclosures pointing readers to the CP. This includes little details like getting the page number of the CP right in the presentation — something that can easily slip through the cracks as slides are added or removed from sales presentations throughout the year. Finally, compliance staff needs to verify that all sales material comply with the GIPS standards as well as regulatory requirements.
No firm wants to have to restate their CP due to errors. The GIPS error correction requirements are labor- and time-intensive, and restatement can raise a red flag with clients as well as prospects. Fortunately, there are software solutions that take underlying data directly from an advisor’s accounting or composite maintenance system to automatically calculate statistics, update disclosures and produce a complete CP. Some systems also provide overall compliance benefits by generating required disclosures on supplementary sales slides and putting safeguards in place to make sure the CP is included in every marketing presentation.
GIPS Compliance - Differentiator Today, Must-Have Of The Future?
Complying with the GIPS standards is good for both investors and their financial advisors. While the standards may seem overwhelming at first, with proper guidance and thoughtful execution it is easy to make GIPS compliance part of a firm’s operational DNA — especially with new technologies that automate and streamline the entire CP production and compliance process.
Taking the steps to comply allows you to differentiate yourself from your competition and start a conversation with clients about the importance of transparency. The GIPS presentation requirements also create the framework for you to compile your performance and present it in a straightforward way that is easy for investors to understand, while giving you the peace of mind that comes from knowing you are adhering to industry best practices for calculating and presenting performance returns.
While GIPS compliance may not seem like a “must have” today, you will be better off being ahead of the curve by giving some thought to how you calculate performance and how you document and maintain relevant processes. Once firms realize they need to be GIPS-compliant in order to win certain mandates, it is often too late to begin the process. If you start laying the foundation today — adopting controls, maintaining records, tracking strategy changes and implementing technology — then you will be well-positioned when prospective clients inevitably start asking to see performance results.
So what do you think? Does your advisory firm report GIPS-compliant results? How has it impacted your business? Or are you a firm considering whether to pursue GIPS compliance in the future?
