Industry standards for the calculation and presentation of investment performance have been gaining acceptance in the mainstream investment management industry for over 25 years but alternative investment managers have been reluctant to adopt them. In this Viewpoint, we examine the Global Investment Performance Standards® (GIPS®) and discuss the outlook for their uptake by hedge funds and funds of hedge funds.
What are the GIPS standards?
The GIPS standards have their origins in the late 1980s, when the Association for Investment Management and Research (AIMR), an investment management industry association, first developed the Performance Presentation Standards (AIMR-PPS) for the North American markets. In the late 1990s, the GIPS Committee of AIMR recognized the need for a global solution, and began to develop a broader set of standards. The Committee first published the GIPS standards in 1999 after receiving extensive public commentary and formal endorsement from the AIMR Board of Governors. However, it wasn’t until January 1, 2006 that the GIPS standards became a truly global standard, eliminating all country-specific versions, when the standards were approved by AIMR’s successor, the CFA Institute.
The GIPS standards are voluntary, ethical standards for the calculation and presentation of an investment firm’s performance results. The GIPS standards were advanced to encourage investment managers to present their performance history in a fair and comparable way. They are designed to discourage the selective use of time periods and the temptation managers may have, when seeking new business opportunities, to “cherry pick” funds and accounts that have had the best performance. The GIPS standards help create both a level playing field on which managers can compete and an environment in which investors can reinforce the governance of their manager selection decisions.
The GIPS standards are voluntarily applied at a firm-wide level to define the boundaries for determining total firm assets, as GIPS compliance cannot be met on a composite or product-specific basis. More specifically, such boundaries are expected to capture all of the discretionary investments of a manager in all of the countries in which they operate. They require managers to group the performance histories of different client funds into so-called composites of similar portfolios. The concept of standardized performance composites is central to the GIPS standards; managers are asked to include all discretionary, fee-paying portfolios in at least one composite defined by investment mandate, objective, or strategy. The GIPS standards also require a firm to show the full history of each composite beginning either since inception, or with five years and including up to ten years, and it is considered best practice for any manager’s GIPS claim of compliance to be independently verified by a third-party, usually an audit firm or compliance consultant.
Implementing the GIPS Standards
There are two main parts of the implementation of the GIPS standards: compliance and verification. Compliance focuses on ensuring that a fund manager’s processes and procedures meet the six components of the GIPS standards, which are: Fundamentals of Compliance, Data Input, Calculation Methodology, Composite Construction, Disclosures, and Presentation and Reporting. When it comes to verification, this must be performed by a qualified independent third-party who assesses whether the firm has complied with not only all composite construction requirements, but also all GIPS requirements surrounding the calculation and presentation performance data. The GIPS Executive Committee strongly recommends verification.
GIPS: Slow Adoption in Alternatives
Despite wide take-up in the traditional investment management industry, the adoption of the GIPS standards by alternative investment managers has been slow. There are currently only a handful of fund of hedge fund managers that claim GIPS compliance and, similarly, only a select number of individual hedge funds that do so. This is perhaps surprising given the increasing institutionalization of alternative managers’ client base. In the long-only world, the GIPS standards are generally seen as a necessary condition to winning institutional mandates. A 2012 industry survey* of 339 investment and consulting firms found that more than two-thirds of those questioned reported that a claim of GIPS compliance was essential to compete in the institutional arena.
There is no technical reason why hedge funds or funds of hedge fund firms should not be GIPS compliant. The GIPS standards can be applied to managed portfolios of all asset classes, including alternative investment strategies. Indeed, the CFA Institute has recently issued guidelines on the application of the GIPS standards to alternatives in the form of a Guidance Statement.
It may be that the recent increase in regulation of the alternative investment industry has made managers reluctant to adopt the additional burden of voluntary standards. The more likely reason is that managers do not feel the need because GIPS compliance has not been demanded by investors for alternatives to the extent that it has for traditional investments.
The slow take-up is therefore a rather circular pattern: institutional investors are not insisting on the GIPS standards for non-traditional investments because to do so might limit the number of candidates; the investment managers, on the other hand, are not adopting GIPS standards as they are yet to be perceived as a necessary requirement to generating new institutional business. Investors can break this pattern and prompt managers to adopt GIPS standards for consideration of new business
Consultants too can also play a part in driving this change. Consultants were important in the development of the GIPS standards for traditional investment mandates by insisting that managers be compliant if they want to be considered in searches (81% of the consultants in the survey mentioned above said they exclude managers from searches if they do not claim GIPS compliance some or all of the time). With the development of portfolios of hedge funds advised by consultants, some of which amount to the status of discretionary portfolios, a number of consultants have, in effect, become investment managers. It is not unreasonable to expect, in conformity with their historic advocacy of the GIPS standards, that consultants will want to use the GIPS standards for the presentation of their own performance track records. Such a development could be decisive in the development of a wider use of the GIPS standards by fund of hedge fund firms and other alternative asset managers.
* The Value of GIPS Compliance: 2012 Manager and Consultant Survey by eVestment Alliance and ACA Beacon Verification Services
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Stephen Oxley, IMC is a Managing Director who heads the firm’s Client Service Group with overall responsibility for the firm’s global client relationships. He is based in London. He is involved in all stages of the investment process and is a member of PAAMCO’s Account Management Committee. Prior to joining PAAMCO, Stephen was a partner and Senior Investment Consultant at Watson Wyatt, LLP in London, where he provided investment advice to a number of large pension fund clients. In addition, he was head of the hedge fund research team and took part in the management of that firm’s investment practice. Stephen is a frequent guest speaker at investment conferences and writes regularly in various industry publications. In 2012 he was awarded the Lifetime Achievement Award by Hedge Funds Review in recognition of his long standing service to and championship of the global Fund of Hedge Funds industry. He has completed the three investment management programs at London Business School and in addition holds the Investment Management Certificate. Stephen has twenty-seven years of investment management experience with institutional investors.
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