Executive Summary
Historically, financial advisors that help clients with their investment decisions have attempted to differentiate themselves by everything from the merits of the products they offer and the companies they represent, to their expertise and experience, to the personal financial advice they can deliver outside of the portfolio. Yet despite how standard it is in the institutional world, surprisingly few RIAs that work with consumers actually aim to differentiate with their actual performance results and track record... due in no small part to the difficulties in standardizing the process of reporting results on a wide range of clients with different needs, different goals, and different timing of when they became a client.
To create some consistency in performance reporting, the CFA Institute has helped to establish Global Investment Performance Standards (GIPS). While the process has primarily been adopted by institutional advisors so far, it appears some RIAs are deciding that in an era of increasing competition, actually being willing to stand by a performance track record and be accountable for it can be an effective differentiator - especially in a world where standardization of investment process and technology to implement model portfolios consistently for clients really does make it feasible to do so.
Ultimately, it remains to be seen how widespread the trend of RIAs adopting GIPS compliant reporting will become, especially since the costs are not trivial - in terms of both staff time, necessary technology infrastructure, along with consulting and even third-party verification. But arguably it doesn't take a lot of advisors choosing to do so before the pressure is on everyone else to go through with it as well; few advisors will want to be in a competitive position for a client as "the only one" who isn't willing to share their performance track record, where a lack of transparency and unwillingness to be accountable for results can easily be interpreted as hiding poor performance. On the other hand, the reality is that some advisors may find that once a consistent performance reporting standard is applied by following the GIPS compliance rules, their results really aren't competitive... which itself may be an interesting force that impacts the industry in the coming years as well!
Performance Reporting For RIAs
For most of their history, financial advisors have not reporting on their investment management results for one simple reason: recommendations to clients were just that – recommendations – and it was up to the client to implement. Given that clients would vary about whether they even take the advice and when they implement it, there was no feasible way to measure results when every client’s outcome would be different due to their own actions.
At best, an advisor might be judged based on just what they suggested to implement, but that is generally the domain of investment newsletters that give a specific recommendation once, to everyone, at a specific time, not for advisors who deliver recommendations face-to-face, one-at-a-time, over the span days, weeks, and months. In other words, while a newsletter recommending an investment has a clear uniform measuring point, when an advisor recommends that clients take some risk off the table and makes that recommendation to 4 different clients over the span of 4 weeks, the measuring point is less clear. Do you measure results by the first client who received the recommendation, or the last, or some combination thereof (and if so, how do you weight the results)?
Yet over the past decade, the advisor landscape is changing, as more and more advisors adopt a discretionary investment management approach – where they really do control the investment implementation – by becoming an RIA, and are implementing their investment process by using model portfolios managed with the assistance of trading and rebalancing software. The end result is a consistent, systematized process for clients – and one that really can be reasonably measured on a reliable basis.
Of course, advisors must still be careful to report investment results in an appropriate manner, as regulators (and investors!) do not look kindly on performance reporting that is deemed to be “misleading” in nature. Fortunately, though, there actually are standards that can be followed to ensure appropriate performance reporting, in a manner that meets regulator approval as well.
Introducing GIPS – Global Investment Performance Standards
Global Investment Performance Standards (or “GIPS” for short) were created by the CFA Institute, as a part of its recognition that in an increasingly global investment management world – where different investment managers and different countries had different standards for reporting – it was crucial to establish a more uniform standard for reporting (both for client reporting, and consistent determination of performance-based or fulcrum fees). The current version of GIPS reporting was adopted by the CFA Institute in 2005 after a first version that was introduced in 1999, but the effort by the organization for more consistent performance reporting dates back to when it was still known as the Association for Investment Management and Research (AIMR) and had created the first Performance Presentation Standards (AIMR-PPS) nearly 25 years ago.
Firms that report their results in a manner consistent with GIPS – which has specifications for everything from how to fairly value assets for reporting input, to the methodology for calculating and weighting investment results (especially given investor cash flows in/out of the portfolio) and netting out investment fees, to what should and should not be included in strategy composite results, to how the results should be presented and reported and what additional information must be disclosed. Firms that report results following GIPS can be said to provide “GIPS compliant” performance reporting, and some firms may wish to obtain a third-party review and verification to substantiate the credibility of their proper performance reporting results and ensure GIPS compliance.
Notably, GIPS reporting is not necessarily “perfect” – as it’s very difficult to make “universal” standards to handle all possible situations, and there are concerns that some investment advisors are already figuring out how to “game” the GIPS system to make a track record appear longer and more favorable than it actually is. Nonetheless, relative to a world where every investment manager reports their own results using their own methodology – which would make it impossible to confidently compare the results of manager A to manager B – there is a clear benefit for consumers to have consistent performance reporting standards.
Implementing GIPS Reporting For Advisors
Executing the process to comply with GIPS standards is not trivial. The requirements to meet, in terms of the preparation and management of data, and the supporting calculations, are significant. As the CFA Institute itself notes, for some firms the first steps are just figuring out if the firm can comply, and building the infrastructure necessary to be able to do so!
For instance, Orion Advisor Services actually uses their ability to support GIPS-compliant reporting as a differentiator, and John Norwood (original founder of Performance Technologies that was the parent company of Centerpiece-now-PortfolioCenter) designed a software add-on called CompositeBuilder for firms to do GIPS-compliant reporting from within PortfolioCenter.
Beyond the software/technology hurdles for doing GIPS-compliant reporting, there is also the challenge of just knowing how to do it. For firms that want to train a member of their investment team to support this part of the process, the CFA Institute actually offers a supporting professional designation called the CIPM – Certificate in Investment Performance Measurement – specifically on how to analyze investment performance, including measurement, attribution analyses, and more, and also how to ensure compliance with GIPS (a role that is becoming a niche specialization unto itself!). There are also consulting firms that work with advisors specifically to help implement GIPS compliance.
And notably, for firms that report they are GIPS compliant, it’s important to actually be GIPS compliant; in fact, the SEC recently barred an advisor from the industry for misrepresenting his firm’s investment performance and GIPS compliance! In addition, the reality is that reporting requirements for GIPS and for the SEC do not precisely overlap; though they don't really outright conflict, being compliant with the requirements for one does not automatically mean the firm is compliant with the other and additional steps are necessary to reconcile the two and ensure compliance with both.
Practical Implications Of Trying To Be GIPS Compliant
Historically, GIPS reporting was primarily about asset managers trying to validate their investment results to institutions; it has not been the domain of financial advisors reporting on their performance with individual clients to solicit new ones.
Nonetheless, as advisors increasingly take on the role of discretionary investment management and standardize their investment process, many of the ‘traditional’ reasons that advisors don’t report on their results are falling away. In turn, this is leading to some calls in the media that perhaps it is time for financial advisors to start showing their numbers as well.
Of course, there are still some significant practical implications that advisors must consider. First and foremost, the cost – in terms of building infrastructure, establishing process and procedure, training staff, getting consulting support, and possibly paying for third-party verification – may cost $5,000 - $10,000 or more, which will not break the profitability of a successful advisory firm but is certainly a non-trivial cost.
Perhaps more significant, though, is the simple fact that advisors who report on investment results in a consistent GIPS-compliant manner may be held accountable for those results in a manner that they ever have before. For some advisors, the black-and-white results of their own investment management decisions – stripped of selective memory and confirmation bias – may actually be quite unfavorable, and emphasize that it’s time for them to reassess their own capabilities as an investment manager and consider whether they need to change their process, reinvest into resources to support it, outsource to a third party, or just become a more passive investor and focus their value proposition elsewhere. On the other hand, from a consumer perspective that’s arguably a good thing – the whole point of transparent performance reporting is to help prospective (and current) clients hold their investment managers accountable for their results!
I suspect that many (or even most?) advisors, who either are concerned that reporting performance results in this manner will make clients “performance-centric”, or perhaps are fearful that the results of their active investment management decisions simply may not be favorable at all, will not be interested in going through the process of building GIPS-compliant composites to report on the track record of their strategies and recommendations.
Nonetheless, in an environment where some firms are beginning to share their (GIPS-compliant and verified) track records with prospective clients, and many advisors are suffering from a crisis of (insufficient) differentiation, it may soon become a competitive disadvantage to not provide that information, and a positive differentiator for the firms that are willing to be publicly accountable for and stand by their investment track records (above and beyond whatever other value they also provide for clients). It will be interesting to see how this unfolds in the coming years!
So what do you think? Is standardized investment performance reporting on the rise amongst financial advisors working with consumers (and not just those working with institutions)? Has your firm ever considered trying to provide GIPS compliant reporting? Have you actually been through the process? Do you find it to be a differentiator when competing for prospective clients?
If a prospect comes to me and asks for performance data- I would ask “what for”? Past performance is not only irrelevant but even if I had a the greatest performance history; there is a probability I would revert to the mean sometime in the future. That prospect may do worse because he/she picked the past winning investment manager. There is 60 years of data that support passive investing but everyone wants to go with a winner. That prospect would be told that I am an “average investment manager” that uses index funds and we could look up the GIPS compliant investment managers in the area and he/she could pick the one with the best score. As Charles Ellis (Winning the losers game) has written: an investment manager can follow what the client wants and underperform “the market” for years in some cases and out perform the market in others as it depends on the time period judged, the date the new client tracked performance, and the investment style of the investment manager (value tilt, small tilt, foreign tilt…etc.) and how favorable the market is to their style. An investment manager should be judged if he/she followed the agreed upon plan regardless of short term performance. If RIA’s begin to play the same games that mutual funds play; I think they will lose in the long run.
Ok, GIPS is an extension of transparency. If you run model portfolios then it makes sense get certified. If you plan to distribute, it makes sense. If you want to differentiate, it makes sense.
Michael,
Isn’t GIPS compliance mostly important when a firm is “advertising” performance rather than simply “reporting” performance one-on-one to clients? Also, doesn’t GIPS compliance for discretionary performance reporting/advertising require an advisor to refuse instructions from any client who wants to make changes to her portfolio?
You don’t need to refuse just take those accounts out of composite.
When the Client’s financial goals, not raw performance, is the focus of investmetnt advice delivered to the client I can’t see how competing on performance is possible. For example, I don’t have client’s invest any more aggressively than they need to to achieve what they are trying to achieve. How could a performance reporting standard possibly appropriately incorporate client goals in to itself? Very puzzled.
I think the answer to your question is Sharpe ratio. If your
client only needs 4% then produce 4% with the highest Sharpe ratio.
That’s how you would compete on “performance”.
3+ years have now passed. What do you see in terms of the extent to which GIPS compliance (track record) has been adopted by the marketplace?
Anecdotally, I’m seeing firms with GIPS compliant track records more often in competitive situations with other advisory firms, but it’s still not common. Unfortunately, I’m not aware of any industry studies/surveys that proactively track this, so we don’t have good data on overall adoption trends. :/
– Michael