9 Important Highlights from the 2020 GIPS Standards Conference

1. Portfolios

There are two types of portfolios: segregated accounts and pooled funds. A segregated account is a portfolio owned by a single client. Whereas a pooled fund is a portfolio where ownership interests may be held by more than one investor. If your firm is acting as a sub-advisor to a pooled fund, then the portfolio is considered a segregated account because the firm is not offering participation in the pooled fund.

There are two types of pooled funds: broad distribution pooled funds and limited distribution pooled funds. Broad distribution pooled funds are regulated under a framework that would permit the general public to purchase or hold positions in the pooled fund. These funds are not offered exclusively in a one-on-one setting.

A limited distribution pooled fund is anything that is not a broad distribution pooled fund. Classifying pooled funds may be a complex process and must be done at the fund level, not the class level. There is an excellent table within the Explanation of the Provisions in Section 1 of the GIPS standards (pages 17-19) that includes eleven different pooled fund classification scenarios. We encourage you to work through those examples when classifying pooled funds.

2. Composites

Prior to Jan. 1, 2020, firms could differentiate between segregated accounts and pooled funds when defining composites. As of Jan. 1, 2020, firms may no longer take this approach.

If a pooled fund has a mandate that is also offered as a segregated account strategy, the pooled fund and segregated accounts must be included in the same composite. However, if a pooled fund’s mandate is different because it is a pooled fund (which has different liquidity needs or diversification requirements), then the pooled fund should not be included in the composite with segregated accounts.

Moreover, if the strategy of the fund is not offered as a composite strategy to segregated accounts, firms are not required to create composites that include only one or more pooled funds. Firms may terminate composites that were created to include only one or more pooled funds when the firm does not offer the pooled fund strategy as a composite strategy to segregated accounts. Firms may continue to maintain composites with single pooled funds included in case it is determined at a future date that the pooled fund’s strategy will be offered as a segregated account.

So, what options do firms have effective Jan. 1, 2020 when taking a fresh look at composites and pooled funds?

• Redefine the composite that previously included only segregated accounts to include segregated accounts and pooled funds on a prospective basis
• Redefine the composite that previously included only pooled funds to include pooled funds and segregated accounts on a prospective basis
• Create a new composite that includes both segregated accounts and pooled funds for all time periods

Remember, combining segregated accounts and pooled funds is only appropriate if it has been determined that these different types of portfolios are managed the same way.

Client type should not be a determining factor for how composites are created if the type of the account does not impact the way the strategy is implemented. However, if the client type does affect the way the strategy is implemented, then different composites should be created.

Assigning portfolios to composites may not be as easy when dealing with multi-strategy portfolios.

Firms now have the option to include the total multi-strategy portfolios in a multi-strategy composite or to include each segment in a composite consistent with their strategy. Another approach is for firms to include the total multi-strategy portfolios in a multi-strategy composite and some of the segments in composites consistent with their strategy. This ensures the firm has met the requirement to include all fee-paying, discretionary accounts in a composite, but does not require all segments to be included in single strategy composites. Firms must remember to include either actual or synthetically allocated cash in each segment. Importantly, this change applies to all periods in which a firm claims compliance.

3. Composite Performance Measurement Period

Composites must include only those portfolios that are managed for the full period. There is now an exception for the first portfolio that starts a composite track record. If the first account is invested in the mandate mid-month, the composite can have a start date mid-month. The same is true for the last portfolio that terminates in a composite.

Firms may terminate the composite mid-month and not through the last full measurement period under management. This optional provision may be useful when the first portfolio in a composite is a pooled fund and the firm wants to match the track record of the composite with the pooled fund. When presenting returns, firms should make sure to also present the benchmark for the time period consistent with the composite’s time period presented.

4. Composite and Pooled Fund Lists

Prior to the 2020 GIPS standards, it was required to maintain a list of composite descriptions, which is available upon request. Now, firms must maintain a list of composite descriptions, limited distribution pooled fund descriptions, and broad distribution pooled fund names without descriptions. Firms may combine these lists into one document.

Descriptions for composites and pooled funds must include key characteristics of the strategy. These lists should be reviewed and potentially expanded to ensure they include the following new requirements:

• Material risks of the strategy
• How leverage, derivatives, and short positions may be used (if material)
• Illiquid investments (if material)

Terminated pooled funds are not required to be on these lists.

5. GIPS Reports (Formerly known as Compliant Presentations)

Firms must make every reasonable effort to provide GIPS reports to all qualified prospective clients and prospective investors when they become a prospect and every twelve months thereafter if they remain a prospect. Some important highlights are:

• Investment consultants, consultant databases, and other third parties are considered prospective clients or investors if they represent individuals or entities that qualify as prospective clients or investors.
• If a GIPS report is included with other marketing materials, like a pitchbook, the location of the GIPS report must be indicated in a prominent way. It is suggested to include the report in the Table of Contents, although the firm may determine whether to note it elsewhere in the document.
• If a firm chooses to provide a prospect with an electronic link to the GIPS report, it must be a direct link to the report and not a general link to the firm’s website.
• Firms may provide a GIPS report to a broad distribution pooled fund prospective investor but are not required to do so.

Providing GIPS reports to prospective investors in limited distribution pooled funds requires firms to set policies. Firms may provide a GIPS pooled fund report or a GIPS composite report if the pooled fund is included in the composite. Firms may provide both the GIPS pooled fund report and GIPS composite report to a prospective investor.

There is no requirement to provide a GIPS report to broad distribution pooled fund prospective investors. Firms may choose to provide a GIPS report for one, some, or none of their broad distribution pooled funds.

Firms are also required to demonstrate how they ensure every reasonable effort is made to deliver GIPS reports. Some suggested ways to demonstrate this effort include:

• Establishing formal policies and procedures around the distribution
• Ensuring formal internal communication channels are in place between client relationship managers and sales personnel
• Tracking of GIPS reports distributed
• Including the appropriate GIPS report in all sales materials

6. Net returns

Composite net of fees returns may be calculated using either actual or model investment management fees. In some markets, it is standard practice to use model fees. The model fee used should reflect current fees. However, when a firm is coming into compliance, they may apply the current fee to the historical track record. Firms can also use as a model the fees that were in effect for the historical period. Returns calculated using model fees must be more conservative than if the returns had been calculated using actual fees.

The model fees used must be appropriate to prospective clients. However, if the appropriate model fee produces composite returns that are higher than the composite net of fees returns calculated using actual fees, then the firm must use a model fee that is higher than the appropriate fee.

There are new disclosure requirements when using model fees to calculate net of fees returns:

• The methodology used; and
• The model fee used if the GIPS report only includes net returns.

Pooled fund net of fees returns included in a GIPS pooled fund report must reflect the deduction of transaction costs and total pooled fund fees including management fees and administrative fees. These fees must be disclosed. Like composites, pooled fund net of fees returns may use either actual or model fees. There is some complexity when a pooled fund has multiple share classes.

Options for firms with multiple share classes and calculating actual net of fees returns are to:

• Use the highest total pooled fund fee of any individual share class in the fund as the actual fee; or
• Use a weighted average of the actual net return from all share classes.

When calculating model net of fees returns for pooled funds, returns must be the same or lower than if actual fees had been used. This conservative test must be done at the pooled fund level, not the share class level. The model fee used must be appropriate to prospective investors.

If the appropriate model fee does not pass the conservative test, then the firm must use a model fee that is higher than the appropriate fee. If there are multiple appropriate fee schedules, then the firm may use the highest fee schedule as the model fee. Firms may find it easier to use the fund’s total expense ratio as the model total pooled fund fee if the total expense ratio includes all fees and costs.

Firms have the option to present model net of fees returns for composites or pooled funds using a model that does not produce a more conservative fee in a GIPS report if it is presented alongside proper net returns. This second series of net returns must be labeled as supplemental information and include a disclosure for how these supplemental returns were calculated.

7. Benchmarks

Benchmark net of fees returns must be considered a custom benchmark and must be presented only when net of fees composite returns or net of fees pooled fund returns are presented. In addition, these returns must be clearly labeled as a custom net benchmark and the methodology used to calculate them must be disclosed. These returns may only be presented when composite net of fees returns are presented.

Firms may use an ETF as a benchmark in a GIPS report. When using ETF benchmarks, it is recommended to include net of fees returns in the presentation. When using ETFs as benchmarks, several items must be included:

• Whether ETF returns are gross or net of fees and other costs, including transaction costs
• The ETF expense ratio (if ETF net returns are presented)
• Whether ETF returns are based on market prices or NAVs
• The timing of the market close used to determine valuation
• Whether ETF returns are gross or net of withholding taxes, if known

8. Fee Schedules

Firms must include the current fee schedule appropriate to the prospect in the GIPS report. If a GIPS composite report is being provided to a prospective client, then the firm must include the current fee schedule for a segregated account. If a GIPS composite report is being provided to a prospective investor who has expressed interest in a pooled fund, then the firm must include the fee schedule for that pooled fund in the GIPS composite report.  If there are multiple fees schedules, firms have options:

• Use the highest fee schedule as the appropriate fee for all prospective investors
• Include the various fee schedules that are offered (disclosing a range of fees is prohibited)
• Attach an exhibit with appropriate fees to the GIPS report which could be a separate fee schedule or the fund offering document

Firms must also disclose the current expense ratio that is applicable to the pooled fund. If the pooled fund has multiple expense ratios, the firm may use the highest expense ratio for all prospective investors. Firms have the option to present either:

• Expense ratio as of the last annual period end
• Last known expense ratio

If there has been a material change in assets or costs, firms should disclose the most current expense ratio so prospective investors have the most recent information for what they are likely to pay as investors. In addition, expense ratios for periods of less than one year must be annualized.

Similar to pooled fund management fees, firms with pooled funds that have multiple expense ratios have the following options:

• Include the various expense ratios that are offered (disclosing a range of expense ratios is prohibited)
• Attach an exhibit with appropriate fees to the GIPS report (which could be a separate list of expense ratios or the fund offering document)

Firms could also create different versions of the GIPS composite reports and/or GIPS pooled fund reports for each fee schedule or fee schedule and expense ratio and then provide the appropriate report to the proper audience.

9. Errors

An error, which can be qualitative or quantitative, is any component of a GIPS report that is missing or inaccurate. The 2020 GIPS standards update guidance from the 2010 edition to clarify that a firm’s error correction policy and the materiality thresholds only pertain to the GIPS reports, not to performance information outside of the GIPS reports, including GIPS advertisements. Firms should review their policies and procedures to determine if updating is necessary.

Performance and disclosures included in marketing materials outside of a GIPS report must be supported and not be false or misleading. While the GIPS Error Correction Policy only pertains to GIPS reports, best practice is to also have policies and procedures to address error identification, evaluation, and corrections to performance and disclosures outside of a GIPS report.

Source: https://www.cfainstitute.org/en/ethics-standards/codes/gips-standards/firms