​MAJOR CHANGES FOR FIRMS (ASSET MANAGERS)

​We’ve identified five of the changes to the Standards as being worthy of being classified as “major.” The many remaining changes may not be “major,” but are still important, and are delineated below.

1.    The ability to allocate cash for carve-outs*

A “carve-out” is the segregation of components of a portfolio into one or more composites. For example, taking the fixed income securities from a balanced portfolio and putting them into a fixed income composite.

Three important points:

The idea of carve-outs originated with the AIMR-PPS®, where the ability to “allocate” cash was permitted. Because the AIMR-PPS was chiefly a standard for North America, the ability to use carve-outs appealed greatly to American managers. As these standards served as the basis for the GIPS standards, carve-outs came along. However, they were not as well received by non-US or non-North American managers. The chief criticism seemed to be the legitimacy of these allocations. The argument was the questioning as to whether these carve-outs, with their allocated cash, were truly representative of the composite strategy they went into.  As a result, in 2010 the ability to allocate cash was stopped.7 Henceforth, the only permissible approach to handle cash was to manage that cash separately for each carve-out. Meaning, for example, that the fixed income asset class would have a separate and distinct book of records for cash from the equity asset class. While some accounting systems supported this, it was deemed quite challenging for many, and as a result, few firms that had previously used carve-outs continued to do so after 2010.

With the introduction of the 2020 version of the Standards, the ability to once again use an allocation approach has returned. This was apparently chiefly done to appeal to wealth managers. Frequently, wealth managers have balanced portfolios where the allocation is controlled or defined by the individual clients. Since the allocation decision is a major contributor to the resulting return,8 and because these allocations may vary quite a bit, the ability or justification to include the entire portfolios into composites might be questioned. An alternative and more desired approach would be to carve out the various asset classes into separate composites. Because of the accounting and cash reconciliation challenges with managing the cash separately, the rules of the 2010 version would make compliance difficult. By now resurrecting the allocation approach to cash, compliance becomes more feasible.  

An existing Q&A, which mandates that firms that use carve-outs still include the entire portfolio into a composite, even if the entire underlying components have been assigned to one or more composite, is being removed going forward. This means that firms that use carve-outs can avoid placing the entire portfolio into a composite, unless it is deemed appropriate to do so.

7   ¶ I.3.A.8, Global Investment Performance Standards, 2010.

8   As explained, for example, by Brinson, Gary P., L. Randolph Hood, and Gilbert L. Beebower, 1986, “Determinants of Portfolio Performance,” Financial Analysts Journal: August.

Historical / retroactive adoption 
Firms that wish to employ carve-outs will be permitted to do so on a retroactive basis. This will be quite appealing to many, who will want to take advantage of this option for their historical performance.

​Additional requirements
​If the firm has or obtains standalone portfolios [i.e., portfolios that were not derived from carve-outs] managed in the same strategy as the carve-outs, the firm must create a separate composite for the standalone portfolios.9

If a firm provides a prospective client with a composite that consists of carve-outs with allocated cash, the composite presentation must include, for the composite of standalone portfolios:
​ ∙ The composite returns for each annual period for which the composite of standalone portfolios exists
 ∙ The composite assets as of each annual period end for which the composite of standalone portfolios exists

This information must be included in the GIPS composite report of the composite that includes carve-outs of allocated cash.10

9    ¶ 3.A.18.
10    ¶ 4.A.13.

​Also, if the firm uses carve-outs with allocated cash, then they must:11

In addition, as is currently required, firms must disclose the percentage of the composite assets that come from carve-outs.

​Cash allocation methods

While no methods for allocating cash have yet to be defined, we anticipate that the old methods from the AIMR-PPS days will reappear. Fundamental rules, that these methods not be “arbitrary,” and that they be employed in a consistent manner, will likely be required.

 Three examples of previously permitted cash allocation methods:

​a. Beginning of Period Allocation Method 
In this approach, the ratio of the amount invested in the asset class12 (or other portion of) the portfolio relative to the total amount invested, excluding cash, is used to determine the amount of cash to allocate. Note that these values are starting values.

​Two additional ratios are then constructed:

∘    the amount invested in the asset class, divided by the sum of the amount invested in the asset class and the amount allocated to cash

​∘    the amount allocated to cash, divided by the sum of the amount invested in the asset class and the amount allocated to cash.

11    ¶ 4.C.28.
12    For simplicity, we will assume that the carve-out is done at the asset class level. This is not a requirement, but the assumption makes the writing a bit simpler.

Here’s the math:

This approach is reasonably easy to employ. Its shortcoming is that one might question why it’s appropriate. For example, if the target allocation is 60% stocks, 40% bonds, and if the actual allocation is 60% stocks, 30% bonds, and 10% cash, the stock portion will get two-thirds of the cash, even though one might argue that all the cash belongs to the bond portion. Nevertheless, the approach is simple and avoids the risk of “gaming.”

This approach is reasonably easy to employ. Its shortcoming is that one might question why it’s appropriate. For example, if the target allocation is 60% stocks, 40% bonds, and if the actual allocation is 60% stocks, 30% bonds, and 10% cash, the stock portion will get two-thirds of the cash, even though one might argue that all the cash belongs to the bond portion. Nevertheless, the approach is simple and avoids the risk of “gaming.”

b. Define a percentage of cash to allocate
This method is at risk of being considered “arbitrary,” unless the firm can justify the basis for their percent. We would generally expect this to be in line with the firm’s strategic or tactical cash allocation. E.g., if the portfolio is to be 60% equities, 40% fixed income, then the use of the 60% for stocks and 40% for bonds would be deemed appropriate. The method can be considered questionable when an extreme allocation, e.g., 95% to bonds and 5% to equities, when the strategic or tactical allocations are quite different. This, to us, smacks of “gaming,” and is therefore one that the verifier would be expected to be sensitive to and quick to question.

The firm would be expected to document the basis for the percentage(s) used, with some justification for it.

While this approach was permitted under the AIMR-PPS, and may very well be permitted with the 2020 version, we consider it to be the weakest approach.

 c. Actual breakdown vs. tactical allocation
This approach takes into consideration the actual allocation of the portfolio, relative to the target. As noted above, for example, if the equity allocation is to be 60% and actually is 60%, then there may be no justification to give it any cash.

We begin by determining the amount of cash needed for the asset class to meet its target:

We now use this value to derive the asset class + cash return:

This method seems to be the most appropriate way to allocate the cash, as it takes into consideration the target vs. actual investments, and avoids giving cash to an asset class that is fully invested.

In the event the asset class’s actual allocation exceeds the target, it would get zero cash, while the other asset class(es) would get the full amount of cash. A variation of this would be to charge the asset class some interest amount for “borrowing” the cash from the other asset class(es). While such a method was deemed acceptable, it can be a bit more challenging to carry out.

Note that the use of separate cash “buckets” is still deemed acceptable, and is arguably the best approach, although (as noted above) difficult to accomplish.

A disclosure requirement
If the carve-out presentations are being used to a prospect for a multi-asset strategy portfolio, then the fee schedule needs to reflect the fees for a multi-asset strategy portfolio managed according to that strategy.13

2.  Estimated Transaction Costs*
Gross-of-fee returns must be calculated net of transaction costs, while net-of-fee returns must be net of both advisory fees and transaction costs. The 2010 version of the Standards requires firms to use only actual transaction costs.

This is problematic when it’s not possible to ascertain what these costs actually are. For example, with “wrap fee” programs, the wrap fee sponsor typically charges a flat fee (e.g., 2.00%), and this fee includes all portfolio expenses (e.g., custodial charges, advisory fees, broker fees, and transaction costs). While the advisor will know what amount of this fee they are getting, they will not usually know what amount belongs to transaction costs.

Consequently, when deriving the net-of-fee return, it will be net of the entire wrap fee, while the gross-of-fee return cannot be properly derived. The Standards allow firms to provide the “pure gross-of-fee” return14 as supplemental information, but this would be higher than what the actual gross-of-fee return would be. As a result, the net-of-fee return understates the actual net (i.e., the return that would be net of only the advisory fee and transaction costs), while the pure gross-of-fee return is higher than what the gross-of-fee return would be. Not a particularly good situation. 

13    ¶ 4.C.11.b.
14    A return not net of anything.

In addition, if the composite contains both wrap and non-wrap fee accounts, the resulting “gross-of-fee” return is actually a hybrid of both true gross and pure gross, and is therefore also to be identified as “supplemental information.”

The 2020 version includes the major change of now allowing firms to use estimated transaction costs.15 And by allowing firms to use estimated transaction costs, these problems go away. The challenge: how to do this.

We detailed an approach in our February 2019 newsletter.16 We repeat a significant portion of that narrative here.

Estimating transaction costs comes in two parts
When planning to estimate transaction costs there are two things that must be addressed:
∙    What will the actual estimated transaction costs be?
∙    How do we implement it?

It would seem that the first issue might be difficult, but we don’t think so. Let’s take two different scenarios:

The manager has non-wrap fee accounts investing in same securities

In many cases, the manager who has wrap fee portfolios also has non-wrap, meaning portfolios that pay a single advisory fee and for whom transaction costs are part of each trade. In this case, the manager needs to review what these costs are and use them for the wrap fee.

The complexity comes in if the costs can vary widely across different types of securities (e.g., small cap vs. large cap, domestic vs. non-domestic vs. emerging markets). As a result, a table may be necessary to derive the appropriate costs for each security traded.

 The manager only has wrap fee accounts investing in certain securities

If the manager doesn’t have non-wrap fee portfolios investing in some or all the securities that the wrap fee accounts are invested in, then they don’t have an internal benchmark to draw upon. Therefore, they will need to reach out to the brokers they’re dealing with and ask them what the transaction costs would have been had these trades been done for non-wrap accounts. 

15    Estimated transaction costs may only be used for portfolios for which actual transaction costs are unknown.
¶ I.2.A.13.
16    See https://tsgperformance.com/wp-content/uploads/2019/02/NLFEB19.pdf

Again, these costs may vary by market, capitalization, etc., so a table may be needed.

Now that we have the transaction costs, how do we incorporate them into performance?

As noted above, we had promised to address this topic. In Dave Spaulding’s comment letter17 he fully supported this change. However, when he began to ponder it he wondered how it would be accomplished.

Transaction costs come into play with trades; and the Standards don’t explicitly deal with trades; rather, as you know we deal with starting and ending values and cash flows.

Let’s take a really simple example where we are not able to isolate the transaction costs:

    ∙    January 1: Account holds $100,000 in cash only
    ∙    January 15: Account spends $50,000 to purchase a security.
    ∙    January 31: The cash earns approximately 0.10% interest for the month              while the security’s value has increased by approximately 0.18 percent.

​Table 1 summarizes the data.

We calculate the return as:

We now want to incorporate estimated transaction costs; in this case, the commission on the trade. We will assume that it’s 0.10% of the principal amount. The principal amount won’t change. However, we will need to reduce the cash amount by the commission. The result is shown in Table 2.

17    See
https://www.gipsstandards.org/standards/Documents/Guidance/gips_2020_exposure_draft_spaulding.pdf

​The security’s value increased the same as in Table 1, and the interest income percent for cash is the same, except that there was less cash in the account for the second part of the month. As a result, the ending portfolio value is lower and we see a corresponding drop of 0.05% in the monthly return.

The challenges
On the surface, estimating transaction costs may sound like a pretty simple undertaking, once you know the amount. However, in reality it seems to be far from that.

We think there’s a temptation to come up with a fee, similar to the firm’s management fee. Some percent that would be used to adjust the return each month. However, while the advisory fees are typically based on amount of assets, transaction costs are based on the individual transactions that occur; and these can vary from number and size from one month to the next.

We are essentially wanting to adjust the cash amount to reflect the additional transaction costs. Any interest that is realized in the month is based on the amount of cash, and the party who is paying this interest doesn’t know or care whether there were commissions paid on the trades that were done. But we will want to adjust the cash somehow, so that the overall portfolio value will change.

A “simple” solution for monthly return methods

No large cash flows

We suggest that the process be a 4-step one. For each account, if a monthly return method is used:

Step 1: Inventory all trades done during the month and determine the estimated transaction costs for each one.

Step 2: Sum these costs to know the total estimated transaction costs for the month.

​Step 3: Reduce the end-of-month cash amount by the estimated transaction costs.

Step 4: Use the adjusted cash value in the total value for the portfolio to derive the monthly return.

Table 3 provides an example.

​We start the month with $350,000 and found that the total estimated transaction costs are $70. The “Original Values” reflect the case where no transaction costs were taken out; the “Adjusted Values” sees that we’ve reduced the cash amount, which results in a lower overall total portfolio value. The result is a 2 basis point drop in performance.

This approach is “simple,” because we are not worrying about the anticipated reduced interest on the now lower cash balance; this would likely be de minimis, and not worth worrying about.

It’s also “simple” because we are not taking into consideration the presence of “large cash flows,” which might make their way into the portfolio. It would arguably be incorrect to only adjust the end of the month values, if the presence of large flows resulted in intra-month returns to have occurred.

A large external cash flow occurs

Consequently, if there are intra-month large flows resulting in more than one return for the month, then we need to adjust the ending cash value for each sub-period. This adjustment would result in an adjusted end-of-period cash amount. Consider the example in Table 4.

Here we see there was a single $50,000 (i.e., large) external cash flow on January 10. And so, we break the month into two parts.

We have to determine the transaction costs for each part of the month (from the 1st to the 10th, and then for the balance of the month). The “Original Values” section reflects the case where there are no transaction costs reflected; the “Adjusted Values” has the ending period cash and total positions reduced by the transaction costs. We see that as a result there’s a 0.2% drop in performance.

You’ll see that we did not adjust the starting period value for the second period. One might consider whether we should begin the second period with the adjusted ending values from the first period. Something perhaps to reflect upon.

A solution for daily return methods
If the firm is using daily performance, then each day they should derive the estimated transaction costs and adjust that day’s ending cash and total values by these amounts.

In summary
Incorporating estimated transaction costs into performance is not a trivial undertaking, but is probably worth the effort. In what I propose there are two main aspects that need to be dealt with:

    ∙    Arriving at the actual transaction cost estimates
    ∙    Applying the estimates.

Transaction cost estimates can be based on the actual costs that occurred for non-wrap fee portfolios. In the absence of such trades, they should be able to be obtained from the brokers who do the trades. It is likely that there will be multiple sets of estimates, depending on the markets the firm is investing in.

As for applying the estimates, the firm needs to determine these estimates through the month. In the simplest case, where a monthly method is used and there are no large external cash flows, these estimates can be reduced from the ending cash and total portfolio amounts. When a monthly return method is used and large flows occur, then the period has to be broken up, where the estimates are applied to the end of each of these periods. Finally, when a daily method is used, then these estimates are applied on a daily basis.

The benefits of incorporating such an approach are that firms can avoid reporting “pure gross” returns and their net-of-fee returns can be adjusted for their fee and these costs.

3. Extension of Money-Weighted Returns*
The requirement for time-weighting is quite dominant within the current version of the Standards, as the use of money-weighting is quite restricted. Granted, anyone can report the IRR in addition to the TWRR as supplemental information, but what is questioned is the value of the TWRR.

After years of lobbying by our firm and others, the decision was made to broaden the use of MWRR. If the manager controls the cash flows, and meets one or more of the following characteristics:

    ∙    Closed-end,
    ∙    Fixed life,
    ∙    Fixed commitment, or
    ∙    Illiquid investments as a significant part of the investment strategy18

they can opt to use MWRR instead of TWRR.

Note that this broadening also included the actual method. Historically, it’s been limited to the internal rate of return. However, now any “money-weighted” method (including Modified Dietz) can be employed. We recommend firms use the IRR, as it’s more accurate and can be considered the “true” MWRR.

4. Pooled Funds*
Since its inception, the Standards have required “all actual, fee-paying, discretionary” portfolios to be included in at least one composite. For many firms this meant creating composites for their mutual funds, even though they had no intention of marketing that strategy to separate accounts. In addition, since they had regulatory-mandated marketing materials for these funds, these composites served no purpose.

A few years ago there was a push, by some, to require mutual fund managers to report their claim of compliance to their fund prospects, and to include the appropriate fund composite presentation(s) within their marketing materials. Fortunately, this did not occur.

The change here is definitely big, as it allows firms that have pooled funds that are not being used to market to separate accounts to avoid creating composite presentations. Instead, they must have “GIPS Pooled Fund Reports” that include the performance of the pooled fund. In addition, they must maintain lists of limited distributed pooled funds (LDPFs) and broadly distributed pooled funds (BDPFs).

As a result of these changes, we anticipate many fund managers who have previously avoided compliance because of the anticipated need to create tens of, if not hundreds of, presentations for funds not marketed to separate accounts, to move to compliance.

5. Portability Rule Changes*
As a result of mergers, acquisitions, lift outs, and the movement of managers and their teams from one firm to another, the Standards have “portability rules.” And these rules have both been ambiguous and controversial for decades.

18    ¶ 1.A.35.

The 2020 version simplifies them.

Where a situation arises where historical performance qualifies to be “ported” to a new firm, the firm has the option to bring any, all, or none of the history across: compliance can begin with the start of the ported entity to the new firm. The firm will continue to have one-year to bring the newly added entity into compliance.

As to the portability rules, a new one has been added: “There must be no break in the track record between the past firm or affiliation and the new or acquiring firm.”19

NOT-SO MAJOR CHANGES
In addition to the aforementioned five “major” changes, there are a host of other important changes that need to be reviewed.

1. Composites for both “marketed” and “non-marketed” composites
Many years ago, Dave Spaulding publically debated the head of another verification firm on this topic. He argued that composites were only necessary for “marketed” composites, while Dave took the view that they were required for all composites. And despite Dave being supported on this by a key player at the Association for Investment Management & Research (i.e., the CFA Institute under its prior name), he failed to concede, continuing to demur on this matter. As a result, many compliant firms have, over the years, only created composites and presentations for their “marketed” composites.

Well, in the “it’s about time” category, the Standards now quite explicitly address this: “The firm must create composites for the firm’s strategies that are managed for or offered as a segregated account.”20

As verifiers, we expect our clients to either maintain the appropriate presentations or be able to produce them in a timely manner. We believe this is consistent with the Standards.

2. Creation & Inception Date
The exposure draft proposed eliminating the need to report a composite’s creation date, substituting inception date. We can understand this, as many, many firms found this to be confusing, often thinking the Standards meant inception date.

19    ¶ 1.A.32.d.
20    ¶ 3.A.1.

Well, the resulting version modifies what was proposed, and requires both the composite’s creation21 and inception22 dates to be reported.

3. Some flexibility on the movement of portfolios across composites*
Historically, firms could only move composites from one to another composite if there were documented client-directed changes or the composite was redefined. Because many wealth (and perhaps other) managers have the freedom to make changes in mandate, strategy, objective, etc., the rules have changed. As long as this “freedom” to change is documented within the client’s agreement, then the movement can be a result of the manager’s changes.

4. Terminology changes
We no longer have “composite presentations,” but instead “GIPS reports.”

The term “linking” used to mean “mathematical linking” (i.e., geometric linking of returns) and “presentation linking” (that is, visually connecting information on a page). As to the latter, it was inappropriate to provide both hypothetical, back-tested results alongside of actual results.

The Standards are changing such that only the “mathematical linking” remains.

5. Trademark disclosure
Over the past several months, we have attempted to educate many in the industry about the CFA Institute’s increased desire to protect the GIPS registered trademark (i.e., the ®). We have done this primarily through a series of presentations on the 2020 version.

Something we didn’t know: such “marks” must be used as adjectives. And so, to state “we comply with GIPS” would be deemed inappropriate.

In addition to working on our writing and grammar, we are now obligated to make certain disclosures regarding the use of the mark. Several of our firm’s website’s pages, for example, now include the following disclosure: CFA Institute does not endorse, promote or warrant the accuracy or quality of TSG, Inc. GIPS® is a registered trademark owned by CFA Institute.

Well, such a disclosure is now required within GIPS reports:  “GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.”23 

21    ¶ 4.C.14
22    ¶ 4.C.13

23    ¶ 4.C.2.

6. Deadline for updating
We have, at times, stumbled upon the verification reports of firms that were quite dated. For example, they would report information only through the year-end, two years prior (e.g., in August 2019 finding a firm’s report through December 2016).

The exposure draft proposed that firms be required to update within six months. We, as well as many others, agreed that a deadline was needed, but felt that six months was too tight. The GIPS Executive Committee agreed, and so firms must have their materials updated within 12 months of the most recent annual period. E.g., in August 2019, firms’ presentations must be through at least December 2017.

7.  Side pockets*
The 2010 version requires hedge fund managers who comply to report returns both with and without side pockets; the decision has been made to only require them with side pockets. Firms can, if they want, still report without; it’s just not required. In addition, there’s a slight change to the wording: “discretionary side pockets.”

8. Returns with and without subscription lines of credit*
Many private equity managers obtain lines of credit, based on the committed capital, for initial investing and expenses. As a result, the internal rate of return tends to be a bit higher than perhaps it otherwise would be.

In meetings with asset owners and others, this practice has not been favorably looked upon.

As a result, we were pleased to see the 2020 version looking to address this. Firms will be required to report money-weighted returns both with and without subscription lines of credit. Note that firms will not be required to present returns without the subscription line of credit when the subscription line of credit has all of the following characteristics:

    ∙    The principal was repaid within 120 days using committed capital drawn down through a capital call.
    ∙    No principal was used to fund distributions

9.  Advisory assets*24

One item that was proposed, and which made it through, was to allow firms to report the amount of advisory assets, as well as the amount of “firm and advisory assets.” We have for some time suggested that clients do this, if they wish, as we felt there were benefits to it. And so, we’re glad that it’s formally defined as an option.25

10. Material Errors
Compliant firms who discover material errors will be required to provide the corrected materials to their verifier. In addition, if the correction covers a period(s) that was(were) handled by a different verifier, then that verifier must be sent the corrected material.  

11. Distribution of reports
Firms must now “be able to demonstrate how it made every reasonable effort to provide” the appropriate GIPS composite reports and/or GIPS pooled fund reports.26 This will be something verifiers will be checking on, so it’s critical that this be done. The exposure draft had suggested verifiers would have to do some fairly strong due diligence here, which would have been quite challenging and cumbersome; fortunately, this didn’t make it through. But, we are still expected to do some testing.

So far, there isn’t much in terms of how a firm is to do this. Might a list of recipients suffice? Probably. We’d expect the firm’s policies and procedures to detail how they do this, and this would most likely be what the verifier will key off of.

12. Lists of pooled funds
Firms must maintain lists of broad distribution pooled funds (BDPFs) and limited distribution pooled funds (LDPFs). The firm has always been required to maintain a list of composite descriptions. One big difference: while firms must include terminated composites on their list of composite descriptions for a minimum of five years, they are not required to retain the names of terminated pooled funds on the corresponding list.

The exposure draft had proposed that firms provide prospective investors with lists of only those broad distribution pooled funds they would be eligible to invest in. This was something that we, and apparently many others, objected to. And so, the language has changed to “this list may include only the broad distribution pooled funds for which the prospective investor is eligible.”

24    Note: if a firm wishes to adopt this in advance of adopting the entire block of changes, they may do so, provided they identify it as “supplemental information.”

25    ¶ 4.A.10, ¶ 4.A.11.
26    ¶ 1.A.17, Global Investment Performance Standards, 2020.

Note that firms must disclose, if appropriate, that these lists are available upon request.27

13. Where’s the report?
It’s typical for firms to include their GIPS materials within their “pitch book” or marketing materials. Firms must now indicate that the materials are included.28 There is no indication as to how one would do this. A simple way might be to include a table of contents, which would include this reference and the corresponding page number(s). Another would be to include tabs, where the tab for the GIPS report section is so noted.

14. Verifier independence
The exposure draft proposed that compliant firms have a policy to ensure verifier independence; this was dropped. That said, firms must still “gain an understanding of the verifier’s policies for maintaining independence and must consider the verifier’s assessment of independence.”29

15. Secondary benchmarks
It is not uncommon for firms to show a “primary” and “secondary” benchmark. With the 2020 version, the firm must report “all required information for all benchmarks”30 (e.g., the 36-month ex post annualized standard deviation for both; previously, it was not unusual to see it only shown for the primary).

16. Benchmarks*
If the firm changes benchmarks, under the 2010 version they must disclose the date, description, and reason for the change.31 However, the 2020 edition has dropped the need to provide the reason.32

If the firm uses a custom or blended benchmark, the firm must now disclose the calculation methodology and clearly label the benchmark to indicate it’s a custom benchmark.33

27    ¶ 4.C.15.
28    ¶ I.A.37.
29    ¶ 1.A.39.
30.    ¶ 4.A.4
31    ¶ I.4.A.30 GIPS Standards 2010.
32    ¶ 4.C.32.

33    ¶ 4.C.33.

The Standards also speak to “portfolio-weighted custom benchmarks,” requiring firms to disclose:34

    ∙ That the benchmark is rebalanced using the weighted average returns of the benchmarks of all the portfolios included in the composite
    ∙  The frequency of rebalancing
    ∙  The components and their weights, as of the most recent annual period end
    ∙  That the components and weights of each component are available for prior periods upon request.

17. Some clarity on large external cash flows
Compliant firms are required to revalue portfolios for “large” external flows. This only applies to firms who use a monthly, day-weighted method. If you calculate returns daily, then you’re revaluing for all flows, so you might say that your definition of large is any cash flow greater than or less than (or, actually, equal to) zero.

A question occasionally arises as to whether firms can revalue in the case where the external flow is not “large.” The answer has always been “no.” And why is this? Well, because it becomes a risk that the firm will elect to also revalue when that revaluation results in a higher return. This would be a problem.

Well, the 2020 Standards make this point quite clear: “For external cash flows that are not large cash flows, calculate portfolio returns that adjust for daily-weighted external cash flows, if daily returns are not calculated.”35

18.  A word on model fees
Some of the changes were either not in the exposure draft or not obvious, perhaps due to them not being highlighted. One such change is that model fees used in net-of-fee returns can’t be lower than the actual; the wording is that  “the returns calculated must be equal to or lower than those that would have been calculated using actual investment management fees.”

19.  Speaking of fees, fees and carve-outs
As noted above, the ability to allocate cash for carve-outs has returned. The 2020 Standards also speak about the investment management fees regarding carve-outs. The fees charged for carve-outs “must be representative of the investment management fees charged or that would be charged to the prospective client.”36 This may require firms to use model fees for the carve-outs. 

34    ¶ 4.C.34.
35    ¶ 2.A.24.d.

36   ¶ 2.A.47.

20. Goodbye to composite assets as a % of firm assets
The 2010 edition requires firms to report “either total firm assets or composite assets as a percentage of total firm assets, as of each annual period end.”37 Thus, they had an option to pick one or the other.

The 2020 version has removed the option to report “percentage of total firm assets,” meaning that they must report total firm assets.

If you’ve been using the “%” option, you can show that through November 2020, but once you start reporting the calendar year-end (i.e., December) 2020 figures, you must convert. You can convert your history, which we think would make the most sense, or simply change going forward.

21. Change in claim of compliance wording*
Firms that have been verified must alter their wording:

“[Insert 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. [Insert name of firm] has been independently verified for the periods [insert dates]. The verification report(s) is/are available upon request.”

“A firm that claims compliance with the GIPS standards must establish policies and procedures for complying with all the applicable requirements of the GIPS standards. Verification provides assurance on whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis. Verification does not provide assurance on the accuracy of any specific performance report.”38

Likewise, firms that are both verified and have had composite examinations have new wording, as well:

37    ¶ I.5.A.1.h. GIPS 2010.
38    ¶ 4.C.1.a.

​“[Insert 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. [Insert name of firm] has been independently verified for the periods [insert dates].”

“A firm that claims compliance with the GIPS standards must establish policies and procedures for complying with all the applicable requirements of the GIPS standards. Verification provides assurance on whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis. The [insert name of composite] has had a performance examination for the periods [insert dates]. The verification and performance examination reports are available upon request.”39

22. Fee disclosure changes
Firms have been required to disclose whether their net-of-fee performance is net of performance-based fees. They must now also indicate if it’s net of carried interest.40

In addition, if model fees are used and the firm isn’t disclosing a gross-of-fee return, then the model fee that was used to calculate the net-of-fee returns must be disclosed.41

Plus, if model fees are used, the methodology used to calculate the net-of-fee return must be disclosed.42

Also, the firm has to disclose which fees and expenses other than investment management fees (e.g., research costs) are separately charged by the firm to clients, if material.43

23. A slight change regarding currency*

“The firm must disclose or otherwise indicate the reporting currency.”44 ​

39    ¶ 4.C.1.b.
40    ¶ 4.C.7.b.
41    ¶ 4.C.7.d.
42    ¶ 4.C.7.e.
43    ¶ 4.C.8.
44    ¶ 4.C.9.

​This presumably will allow a firm to show “USD” or £ or € or US$ or similar notation, rather than specifying the currency. This is a bit of simplification.

24. Estimated transaction cost disclosures*
If a firm uses estimated transaction costs, they must disclose:45
    ∙    That they were used
    ∙    The estimated transaction costs used46 and how they were determined.47

25. Sunset provisions*
The Standards have modified certain disclosures to allow firms to discontinue their reporting if it is no longer deemed relevant to interpret the track record.48

26. 36-month standard deviation disclosure change*
With the 2010 version, firms are required to disclose if the standard deviation isn’t shown because there weren’t 36 monthly returns.49

The Standards have been altered to simplify this. Henceforth, the firms need only disclose this if there are “at least three annual periods of performance.”50

As for risk measures (e.g., 36-month standard deviation), we generally recommend firms use gross-of-fee returns. The 2010 version did not require firms to disclose which return they used; the 2020 does.51

27.    New disclosure

Firms are only required to report the number of portfolios and a measure of internal dispersion if there are five or fewer portfolios in the composite. Some firms simply leave these fields blank, while others will insert an “n/a,” <6, ≤5, or a similar notation.

The 2020 version of the Standards will not permit the field to be blank. It requires firms who have to disclose that “the measure is not applicable or use similar language.”52

45    ¶ 4.C.18
46    We do not yet know what this means.
47    Hopefully you’ll reference “the Spaulding method.”
48    E.g., ¶ 4.C.19, ¶ 4.C.23
49    ¶ 4.A.33. GIPS Standards 2010.
50    ¶ 4.C.36.
51    ¶ 4.C.44.

52    ¶ 4.C.39, ¶ 4.C.40