(Note: I wrote this post as a guest blogger for the STP Investment Services blog, but it appears that blog is offline and we received a request for the information, so I decided to post the information directly here.)
The What, Why and Who of the GIPS Standards
In this blog post, I give you some quick and simple answers to the “what,” “why” and “who” questions that many people ask with respect to the GIPS Standards.
What are the GIPS Standards?
What items must a firm show in a composite presentation?
- Generally, time-weighted returns (TWR) that separate client contribution from manager results. For closed end real estate and private equity funds, since inception internal rate of return is shown.
- Annual composite returns (a composite is the aggregation of accounts managed to the strategy).
- A measure of the internal dispersion (i.e., range) of returns of portfolios within the composite.
- As a measure of risk, the variability (standard deviation)of the composite’s historical returns.
- The amount of assets in the composite each year and the number of portfolios in the composite
- The amount of firm assets each year.
- Disclosures about the firm and the given composite designed to help the reader of the presentation understand the firm, the composite, and the performance history being shown.
The GIPS Standards promote the comparability of manager performance across firms and across borders. By requiring firms to show the same information, the prospect is better equipped to compare managers and make an informed decision as to which manager it should hire.
Why are there standards for performance presentation to prospective clients?
- Presentations that only showed the firm’s best performing accounts
- Returns calculated based on unsubstantiated pricing
- Annualization of partial annual periods
- Reporting/presentation of best performing periods, omitting poor performing periods
- Comparisons of performance with either low-return, or inappropriate benchmarks
- Calculations that did not segregate manager returns from the client contribution
- Presentations created by marketing departments that underplayed unfavorable data and highlighted persuasive elements
Key events in the history of performance standards development:
- 1966: Peter Dietz’s seminal work, “Pension Funds: Measuring Investment Performance,” was published, introducing what came to be known as the time-weighted return.
- Late 1960s: the Bank Administration Institute published return calculation guidelines based on Dietz’s work.
- 1987: Financial Analysts Federation created the Committee for Performance Presentation Standards (CPPS). Key recommendations from their report:
- The use of time-weighted return was recommended.
- Presentation of performance gross-of-fees was recommended.
- The report recommended the inclusion of cash in portfolio returns.
- Construction and presentation of asset-weighted composites was recommended.
- 1990: The Association for Investment Management and Research (AIMR) board of governors endorse the AIMR-PPS.
- 1993: The AIMR-PPS is published.
- 1997: 2nd edition of AIMR-PPS published
- 1999: The first edition of the GIPS Standards was published.
- 2005: The second edition of the GIPS Standards was published.
- 2010: The third and current edition of the GIPS Standards was published, going into effect on January 1, 2011.
- 2012: Guidance Statement on Alternative Investment Strategies and Structures issued
- 2013: Exposure draft for the Guidance Statement on the Application of the GIPS Standards to Pension Funds, Endowments, Foundations and Other Similar Entities reeased
To whom do the GIPS Standards apply?
How does compliance with GIPS benefit managers, beyond being hired?
- providing track record transparency and the ability to have a full/fair review of performance results for internal purposes
- creating a framework within which the manager’s firm can document the decisions made and the justification behind them when a new scenario occurs in the performance processing and/or investment operations of the firm
- allowing a better process for ensuring the marketing literature reflects the underlying information
- promoting an improved reputation due to the recognition of GIPS compliance
How does the existence of GIPS benefit investors?
What is Verification and How Does It Add Value for Investment Firms?