fbpixel
IFT Notes for Level I CFA® Program

R05 The GIPS Standard

Part 2


 

Nine Major Sections of the GIPS Standards

The provisions within the 2010 edition of the GIPS standards are divided into nine sections:

  1. Fundamentals of Compliance
  2. Input Data
  3. Calculation Methodology
  4. Composite Construction
  5. Disclosure
  6. Presentation and Reporting
  7. Real Estate
  8. Private Equity
  9. Wrap Fee/Separately Managed Account (SMA) portfolios

The provisions are categorized into requirements and recommendations. All the requirements must be implemented to claim compliance.

  1. Fundamentals of ComplianceSeveral core principles create the foundation for the GIPS standards, including properly defining the firm, providing compliant presentations to all prospective clients, adhering to applicable laws and regulations, and ensuring that information presented is not false or misleading. Two important issues that a firm must consider when becoming compliant with the GIPS standards are the definition of the firm and the firm’s definition of discretion. The definition of the firm is the foundation for firm-wide compliance and creates defined boundaries whereby total firm assets can be determined. The firm’s definition of discretion establishes criteria to judge which portfolios must be included in a composite and is based on the firm’s ability to implement its investment strategy.Sample firm definition: XYX Investment Firm is a balanced portfolio investment manager that invests solely in US-based securities. XYZ Investment Firm is defined as an independent investment management firm that is not affiliated with any parent organization.The requirements of Provision 0 are presented below (reproduced from the curriculum).

    0.A.1: Firms must comply with all the requirements of the GIPS standards, including any updates, Guidance Statements, interpretations, Questions & Answers (Q&As), and clarifications published by CFA Institute and the GIPS Executive Committee, which are available on the GIPS standards website (www.gipsstandards.org) as well as in the GIPS Handbook.

    0.A.2: Firms must comply with all applicable laws and regulations regarding the calculation and presentation of performance.

    If there are no applicable laws and rules, then GIPS compliant firms must follow the GIPS standards. But, if a country has applicable laws and regulations regarding the calculation and presentation of performance, then the country laws must be followed and any differences with GIPS must be documented.

    0.A.3: Firms must not present performance or performance-related information that is false or misleading.

    0.A.4: The GIPS standards must be applied on a firm-wide basis.

    0.A.5: Firms must document their policies and procedures used in establishing and maintaining compliance with the GIPS standards, including ensuring the existence and ownership of client assets, and must apply them consistently.

    0.A.6: If the firm does not meet all the requirements of the GIPS standards, the firm must not represent or state that it is “in compliance with the Global Investment Performance Standards except for . . .” or make any other statements that may indicate partial compliance with the GIPS standards.

    Firms are not allowed to claim partial compliance with the GIPS standards.

    0.A.7: Statements referring to the calculation methodology as being “in accordance,” “in compliance,” or “consistent” with the Global Investment Performance Standards, or similar statements, are prohibited.

    0.A.8: Statements referring to the performance of a single, existing client portfolio as being “calculated in accordance with the Global Investment Performance Standards” are prohibited, except when a GIPS-compliant firm reports the performance of an individual client’s portfolio to that client.

    0.A.9: Firms must make every reasonable effort to provide a compliant presentation to all prospective clients. Firms must not choose to whom they present a compliant presentation. As long as a prospective client has received a compliant presentation within the previous 12 months, the firm has met this requirement.

    0.A.10: Firms must provide a complete list of composite descriptions to any prospective client that makes such a request. Firms must include terminated composites on the firm’s list of composite descriptions for at least five years after the composite termination date.

    A composite must be clearly described as to what mandate or strategy it is following: For example, small-cap equity value, Japan-equity, fixed-income etc. If a composite was terminated, then its performance must be presented for at least five years after termination to overcome survivorship bias.

    0.A.11: Firms must provide a compliant presentation for any composite listed on the firm’s list of composite descriptions to any prospective client that makes such a request.

    A compliant presentation is one that complies with all the GIPS provisions.

    0.A.12: Firms must be defined as an investment firm, subsidiary, or division held out to clients or prospective clients as a distinct business entity.

    Scenario: Assume there is a firm called UBL and it has a subsidiary called UBL-Asset Management (UBL-AM). If investors approach UBL-AM to trade and invest in securities/funds, then UBM-AM is the firm here, and must comply with the GIPS standards.

    0.A.13: For periods beginning on or after 1 January 2011, total firm assets must be the aggregate fair value of all discretionary and non-discretionary assets managed by the firm. This includes both fee-paying and non-fee-paying portfolios.

    Do not confuse this with a composite. A composite must include only actual, fee-paying discretionary portfolios. But, when a firm reports its total assets, it must include the fair value of all discretionary and non-discretionary assets and all fee-paying and non-fee paying portfolios.

    0.A.14: Total firm assets must include assets assigned to a sub-advisor provided the firm has discretion over the selection of the sub-advisor.

    0.A.15: Changes in a firm’s organization must not lead to alteration of historical composite performance.

    0.A.16: When the firm jointly markets with other firms, the firm claiming compliance with the GIPS standards must be sure that it is clearly defined and separate relative to other firms being marketed, and that it is clear which firm is claiming compliance.

    Outlined above are requirements. The GIPS standards also include requirements. For example, assume an investment management company, HS, has different geographical offices, which operate under the same brand name but as individual investment management companies such as HS Malta plc, HS Spain, HS India Limited, HS Malaysia Limited. The firm definition should be broad enough to include all geographical offices under one umbrella. This is just a recommendation, not a requirement.

    Instructor’s Note:

    At Level I you are required to know the details of Provision 0 (Fundamentals of Compliance).  For provisions 1 – 8 you just need to know the basic descriptions which are given below:

  1. Input data Consistency of input data used to calculate performance is critical to effective compliance with the GIPS standards and establishes the foundation for full, fair, and comparable investment performance presentations. For periods beginning on or after 1 January 2011, all portfolios must be valued in accordance with the definition of fair value and the GIPS valuation principles.
  1. Calculation MethodologyAchieving comparability among investment management firms’ performance presentations requires uniformity in the methods used to calculate returns. The GIPS standards mandate the use of certain calculation methodologies to facilitate comparability.
  1. Composite ConstructionA composite is an aggregation of one or more portfolios managed according to a similar investment mandate, objective, or strategy. The composite return is the asset-weighted average of the performance of all portfolios in the composite. Creating meaningful composites is essential to the fair presentation, consistency, and comparability of performance over time and among firms. Assume there are two portfolios in a composite: portfolio 1 with a value of $10 million and portfolio 2 with a value of $90 million. The returns of the two portfolios are 10% and 12% respectively. The overall return of the composite must be closer to 12% as the 12% return has a 90% weightage.
  1. DisclosureDisclosure allows firms to elaborate on the data provided in the presentation and give the reader the proper context in which to understand the performance. To comply with the GIPS standards, firms must disclose certain information in all compliant presentations regarding their performance and the policies adopted by the firm. One of the essential disclosures for every firm is the claim of compliance. Once a firm meets all the requirements of the GIPS standards, it must appropriately use the claim of compliance to indicate compliance with the GIPS standards. The allowed format for firms that claim compliance is: <<Name of firm>> claims compliance with the Global Investment Performance Standards (GIPS) and has prepared and presented this report in compliance with the GIPS Standards.
  1. Presentation and Reporting
    After constructing the composites, gathering the input data, calculating returns, and determining the necessary disclosures, the firm must incorporate this information in presentations based on the requirements in the GIPS standards for presenting investment performance. No finite set of requirements can cover all potential situations or anticipate future developments in investment industry structure, technology, products, or practices. When appropriate, firms have the responsibility to include in GIPS-compliant presentations information not addressed by the GIPS standards.
  1. Real Estate
    Unless otherwise noted, this section supplements all of the required and recommended provisions in Sections 0-5. Real estate provisions were first included in the 2005 edition of the GIPS standards and became effective 1 January, 2006. The 2010 edition of the GIPS standards includes new provisions for closed-end real estate funds. Firms should note that certain provisions of sections 0-5 do not apply to real estate investments or are superseded by the provisions within section 6. The provisions that do not apply have been noted within section 6.
  1. Private Equity
    Unless otherwise noted, this section supplements all of the required and recommended provisions in sections 0-5. Private equity provisions were first included in the 2005 edition of the GIPS standards and became effective 1 January 2006. Firms should note that certain provisions in sections 0-5 do not apply to private equity investments or are superseded by the provisions within section 7. The provisions that do not apply have been noted within section 7.
  1. Wrap Fee/Separately Managed Account (SMA) Portfolios <
    Unless otherwise noted, this section supplements all of the required and recommended provisions in sections 0-5. Firms should note that certain provisions in sections 0-5 of the GIPS standards do not apply to wrap fee/SMA portfolios or are superseded by the provisions within section 8. The provisions that do not apply here have been noted within section 8.

 

Sample Presentation

A sample GIPS-compliant presentation report is presented below. Some of the important aspects that you can take note of are:

  • Name of firm: Sample 1 Investment Firm; Composite: Balanced Growth
  • Gross return, net return, and no. of portfolios are required data which are presented.

Sample 1 Investment Firm Balanced Growth Composite (from the curriculum)

                   1 January 2002 through 31 December 2011

Year Composite Gross Return (%) Composite Net Return (%) Custom Benchmark Return (%) Composite 3-Yr St Dev (%) Benchmark 3-Yr St Dev (%) Number of Portfolios Internal Dispersion (%) Composite Assets ($ M) Firm Assets ($ M)
2002 -10.5 -11.4 -11.8 31 4.5 165 236
2003 16.3 15.1 13.2 34 2.0 235 346
2004 7.5 6.4 8.9 38 5.7 344 529
2005 1.8 0.8 0.3 45 2.8 445 695
2006 11.2 10.1 12.2 48 3.1 520 839
2007 6.1 5.0 7.1 49 2.8 505 1,014
2008 -21.3 -22.1 -24.9 44 2.9 475 964
2009 16.5 15.3 14.7 47 3.1 493 983
2010 10.6 9.5 13.0 51 3.5 549 1,114
2011 2.7 1.7 0.4 7.1 7.4 54 2.5 575 1,236

Sample 1 Investment Firm claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Sample 1 Investment Firm has been independently verified for the periods 1 January 2000 through 31 December 2010. The verification report is available upon request. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide 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.

Notes:

  1. Sample 1 Investment Firm is a balanced portfolio investment manager that invests solely in US-based securities. Sample 1 Investment Firm is defined as an independent investment management firm that is not affiliated with any parent organization. Policies for valuing portfolios, calculating performance, and preparing compliant presentations are available upon request.
  2. The Balanced Growth Composite includes all institutional balanced portfolios that invest in large-cap US equities and investment-grade bonds with the goal of providing long-term capital growth and steady income from a well-diversified strategy. Although the strategy allows for equity exposure ranging between 50–70%, the typical allocation is between 55–65%. The account minimum for the composite is $5 million.
  3. The custom benchmark is 60% YYY US Equity Index and 40% ZZZ US Aggregate Bond Index. The benchmark is rebalanced monthly.
  4. Valuations are computed and performance is reported in US dollars.
  5. Gross-of-fees returns are presented before management and custodial fees but after all trading expenses. Composite and benchmark returns are presented net of non-reclaimable withholding taxes. Net-of-fees returns are calculated by deducting the highest fee of 0.83% from the monthly gross composite return. The management fee schedule is as follows: 1.00% on the first $25 million; 0.60% thereafter.
  6. This composite was created in February 2000. A complete list of composite descriptions is available upon request.
  7. Internal dispersion is calculated using the equal-weighted standard deviation of annual gross returns of those portfolios that were included in the composite for the entire year.
  8. The three-year annualized standard deviation measures the variability of the composite and the benchmark returns over the preceding 36-month period.