GIPS® compliance 20/20: The way forward

Expected outcomes for high-income proposals

Six high-impact GIPS proposals warrant a closer look. These proposals would significantly change the current standards and widen their application.

1. Three-pillars concept

The three-pillars concept recommends that performance presentations be based on the relationship between the parties presenting and receiving information. The standards would be organized into three pillars:

• One-to-one: Where a one-to-one relationship exists between the investment manager and the client (for example, an institutional separate account)
• One-to-many: Where an investment manager sells participation in pooled funds (for example, a mutual fund)
• One-to-none: Where asset owners don’t have any prospective clients (for example, sovereign wealth funds)

The three-pillars concept would adjust the reporting standards to match the type of investment relationship. Accordingly, composite performance should be presented for one-to-one relationships, whereas fund performance should be presented for one-to-many relationships.

The feedback on this proposal is moderately positive, with 71 percent of IM firms and industry associations agreeing with the proposal. However, many respondents are seeking additional clarifications, especially for the real estate and advisory asset classes. These clarifications aim to make the pillars structure well-defined, exhaustive, and free from overlaps so that each reporting relationship is unambiguously covered by the standards. Further, the Investment Company Institute (ICI) is recommending the exclusion of regulated funds from the purview of these additional reporting requirements.

2. Pooled funds treatment

The Consultation Paper proposes the following treatment for pooled funds:

• A "pooled fund report" should be provided to prospective clients instead of a composite presentation
• Performance should be presented net of all fees and expenses; gross returns may be presented to satisfy regulatory requirements
  
• Single-fund composites need not be created for funds with a unique strategy
  
• A list of all composites and pooled fund descriptions must be maintained
  

IM firms' perspective is leaning toward disagreement (55 percent). Further, the proposal has received divergent responses from IM firms of varying size. IM firms with fewer than $100 billion in assets under management (AUM) agree with the proposal but have asked for clarifications regarding the content of the pooled fund presentation and treatment of different asset and share classes.

On the other hand, IM firms with more than $100 billion in AUM have raised concerns over additional compliance burdens. The combination of the three-pillars concept and proposed pooled funds treatment may result in discontinuity in the historical track record of composites. The pillars concept proposes that presenting composite performance for one-to-one relationships and fund performance for one-to-many relationships is appropriate. For example, if a new pooled fund is created following the same strategy as that of a poorly performing existing separate account, the poor track record of the separate account would not be presented to the prospective client.

3. Choice of IRR or TWRR for firms controlling the timing of cash flows

This proposal provides a choice to IM firms that control cash flows for closed-ended, fixed-life, fixed-commitment funds to present either internal rate of return (IRR) or time-weighted rate of return (TWRR). The majority (70 percent) of IM firms and industry associations have agreed with the proposal. However, there's a difference of opinion among them.

Investment managers (87 percent) are in favor of being allowed to choose the appropriate method, whereas most (60 percent) industry associations have recommended that IRR be the primary method for closed-ended funds. Requiring all closed-ended funds to use IRR would make performance comparison easier.

Moreover, IM firms suggest that control over timing of cash flows should determine the calculation method for performance presentation. ICI recommends the exclusion of regulated funds, as the performance reporting requirements are specific and detailed in many jurisdictions.

4. Creating a new advisory assets category

In light of the fact that advisory assets represent a considerable portion of the IM industry, the Consultation Paper proposes to create a new category of assets. It would include managed, overlaid, and advised assets, such as unified managed accounts, advisory-only portfolios, and model portfolios.

IM firms' perspective is in favor (61 percent) of the proposed new advisory assets category. However, most of the IM firms and industry associations (72 percent) suggest that this should only be a recommendation or presented as supplemental information in compliant presentations. Some firms have also asked for clarifications and clear definitions so that the provision can be implemented without any ambiguity.

5. Including non-fee-paying portfolios in composites

This proposal requires firms to include non-fee-paying portfolios in composites in contrast to the discretion offered to firms earlier. Based on the responses from IM firms, there's no clear consensus on this proposal, with just under 53 percent agreeing. Those in favor have stated that fee-paying status doesn't restrict a portfolio manager from applying a strategy to the portfolio and hence should be included.

However, those against the proposal have advocated that firms should continue to have the discretion to include these portfolios in composites. Some firms have communicated that they're in the best position to gauge the meaningfulness of a portfolio to investors. Further, the value added by such calculations may not be worth the additional effort required.

6. Provide pooled fund report to investors annually; provide compliance presentation to investors annually; make an offer to provide pooled fund reports or compliant presentations to investors annually

This proposal asks IM firms to provide pooled fund reports or compliant presentations to existing investors annually. Both of the suggestions have received overwhelmingly negative responses, with 95 percent of IM firms and 90 percent of industry association respondents expressing their disagreement.

Alternatively, it proposes IM firms should make an offer to present these documents to investors on an annual basis. More than two thirds (68 percent) of the IM firms and industry associations have opposed this provision as well. Investors receive regular performance reports based on local regulation or in accordance with their governing agreement with IM firms.

Some respondents note that additional reporting requirements imposed by GIPS 20/20 may be duplicative. Some local jurisdictions may also prohibit this additional reporting. Moreover, the additional reports may also confuse the investors who may not understand the objective of these reports.

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Next steps in the GIPS 20/20 journey

Although the GIPS standards are voluntary, this comment period creates the opportunity for sensing and influencing. Consisting of three stages, the framework follows a life-cycle approach to respond effectively to changes in regulatory and compliance standards. The approach begins with the sensing and influencing stage, followed by planning and prioritization for the firm response, and implementing the compliance change management program. For investment managers, the sensing and influencing stage provides an opportunity to voice their opinion and help shape the upcoming standards.

The first stage of sensing and influencing for the GIPS 20/20 standards is closer to the finish line. Investment managers that missed out on the previous window can utilize the August 2018 exposure draft to help shape the performance standards. Some proposals are likely to be adopted with minimal change, while others are more uncertain. Much of the uncertainty will likely be reduced in the fall of 2018 when the revised guidelines are published.

After sensing and influencing comes planning and prioritizing, followed by implementing. The planning phase is important because IM firms face differing levels of changes to maintain or achieve GIPS compliance depending on their operating models. Coordinating the GIPS-driven process and technology changes with the overall technology modernization plan can represent a challenge for some IM firms.

Figuring out how these initiatives can dovetail or complement one another may present difficulty but can also provide value. Even though GIPS compliance is a voluntary standard, it's considered important by many. Since planning and marshaling resources may take significant time prior to implementation, IM firms should consider starting now to prevent having to play catch-up.

To learn more about the other proposals in GIPS 20/20, download the full report.

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