Hedge Funds and GIPS Compliance
The Chartered Financial Analysts (CFA) Institute has spearheaded and implemented the Global Investment Performance Standards (GIPS) for investment managers as a means of establishing a higher standard for compliance with measurement and reporting of hedge fund performance. GIPS standards set forth a universal set of guidelines and standards for measuring, calculating, and presenting aggregate gain and loss percentages in discretionary, managed investment accounts. Compliance with GIPS standards is voluntary, but it helps investment managers to attract and retain institutional investors who may require a higher standard for disclosure and accurate reporting.
What is GIPS?
The reporting and measuring standards from which GIPS originated were developed by CFA Institute beginning in the late 1980’s and have been gradually modified and reevaluated over the years. While the CFA Institute initiated and funded the development of GIPS, the GIPS Executive Committee is responsible for maintaining the standards. The key provision of GIPS is the requirement to include all of a firm’s fee-paying, discretionary amounts in a ‘composite’, or an aggregate of portfolios that share common investment objectives or strategies. The goal of using composites is to ensure ease of comparability between firms due to enhanced consistency. To further aid the comparison of fund performance, the standards specifically disallow ‘nondiscretionary’ accounts from being included in the composites (where certain client restrictions render the fund’s performance more reflective of the clients’ decisions than the managers’ decisions). Understanding and adhering to strict composite construction requirements is critical to GIPS compliance.
When should a Manager use GIPS?
There are several advantages to complying with GIPS and getting third-party verification. First and foremost is the added credibility of your hedge fund brought on by the claim of compliance (to be used in presentations, marketing materials, advertising, service agreements, etc.). This credibility can help reinforce investor trust and create new relationships with new prospective clients. Secondly, the level of consistency brought on by adherence to GIPS creates a more cohesive set of procedures regarding the calculation and presentation of performance. Thirdly, compliance with GIPS can assist firms with keeping up with the requirements of the SEC and avoid encountering claims of fraudulent conduct. This is especially important for managers who may have had a prior track record with such claims or have had any actions brought against them by the SEC – incorporating GIPS compliance standards into the hedge fund practice will vindicate these managers of their past and help rebuild investor trust.
Twelve Steps to GIPS Compliance
The following procedure has been recommended by GIPS Execute Committee members in order to establish an effective compliance program for your firm.
- Management support. Management must make a commitment of time and resources to bring the firm into compliance.
- Know the Standards. Assign individuals or teams to review and familiarize themselves with the Standards and to complete each subsequent step.
- Define the firm. The definition should accurately reflect how the entity is held out to the public and will determine the scope of firm wide assets under management.
- Define investment discretion. The Standards use the term “discretion” more broadly than just whether or not a manager can place trades for a client. Defining investment discretion is an important step in determining whether or not accounts must be included in a composite.
- Identify all accounts under management within the defined firm over the past five years, or since firm inception if less than five years. This should include all discretionary and nondiscretionary accounts, including terminated relationships.
- Determine if your firm has the appropriate books and records to support historical discretionary account performance.
- Separate the list of accounts into groups based on discretionary status, investment mandate, and/or other criteria. These groups will be the foundation for your composites.
- List and define the composites that will be constructed.
- Document your firm’s policies and procedures for establishing and maintaining compliance with the Standards.
- Document reasons for composite membership changes throughout each account’s history and reasons for nondiscretionary status, if applicable.
- Calculate composite performance and required annual statistics.
- Develop fully compliant marketing materials.
How to Get Started
As of 2007, 28 countries have adopted the GIPS standards or have had their local performance reporting standards endorsed by the GIPS Executive Committee. Formally recognized in 29 major financial markets, GIPS compliances enables investment firms to fairly compete throughout the world and provides a standard framework to ensure that funds’ performance figures are directly comparable. Although it is in the best interest of any investment firm that wants to compete effectively and fairly to adhere to the GIPS standards, the issue for most firms is how to accomplish this successfully and cost-efficiently. For many firms, this may require adding GIPS experts to staff or turning to outside professionals, depending on the firm’s size, available resources, and overall business strategy. There are many GIPS service providers, including software vendors and verification/consulting firms, that can help investments firms become and remain GIPS compliant.
To help you select a service provider to help your firm get started with compliance efforts, you can refer to the list of GIPS Service Providers. You can also find the full text of the GIPS standards here.