Market Integrity Insights 12 Feb 2019
2020 Global Investment Performance Standards (GIPS®): Industry Feedback
Which topics in the 2020 Global Investment Performance Standards (GIPS) Exposure Draft generated significant comments?
The Exposure Draft of the 2020 Global Investment Performance Standards (GIPS®) was available for public comment through 31 December 2018. We received over 100 comment letters, which include almost 5,000 separate comments. We are extremely grateful that so many firms and other organizations took the time to provide helpful, thoughtful comments. To those of you who provided comment letters, please accept our sincere thanks. We would like to share with you some of the topics that generated significant comments. All information below is based on the 2020 GIPS Standards Exposure Draft and final requirements are subject to change.
Requirement to use GIPS Pooled Fund Reports:
Currently the GIPS standards are based on the use of composites. Our goal was to better accommodate firms that wish to present performance of a specific pooled fund versus a composite. In the 2020 Exposure Draft, we require firms to consider what they are offering to a prospect. If the firm is offering a composite strategy to a prospect for a segregated account (a segregated account is a portfolio owned by an individual client), it must provide composite performance in a GIPS Composite Report. If the firm is offering participation in a specific limited distribution pooled fund (e.g., a hedge fund or limited partnership), the firm must provide performance of that specific fund in a GIPS Pooled Fund Report. Firms that offer a strategy in both a segregated account format and via participation in one or more limited distribution pooled funds will be required to create a GIPS Composite Report and one or more GIPS Pooled Fund Reports. We heard from multiple firms that requiring a GIPS Pooled Fund Report for each limited distribution pooled fund would be an unmanageable burden. Many firms that currently use composites to market to pooled fund prospects wish to continue to use the GIPS Composite Report for all prospects, whether the prospect is interested in a segregated account or a specific pooled fund, and not be required to provide a GIPS Pooled Fund Report.
We also heard from firms that there is much confusion over the distinction between limited distribution and broad distribution pooled funds and how to treat funds that have both institutional and retail share classes. We received comments that our current definitions for limited distribution and broad distribution pooled funds have too many factors and should be simplified.
Requirement to use net returns in GIPS Pooled Fund Reports:
We proposed that returns in a GIPS Pooled Fund Report must be net of total pooled fund fees, because this is the return that a fund investor would receive. We heard from numerous firms in non-U.S. jurisdictions that funds are marketed using gross returns, and there is no requirement to present net returns. Also, some funds have many share classes with different fee structures, and it would be challenging to determine which net return stream to use for a given prospect. For example, consider a firm with 20 funds with 3 share classes in each fund. Requiring net returns could greatly increase the GIPS standards reporting obligation. Many firms suggested instead allowing gross or net returns in GIPS Pooled Fund Reports. Doing so would make fund reports comparable to composite reports. Some firms also suggested requiring disclosure of the total expense ratio, versus only the investment management fee schedule.
Carve-outs with allocated cash:
As of 1 January 2010, firms are not allowed to synthetically allocate cash to carve-outs. (A carve-out is a segment of a larger portfolio, such as the equity sleeve of a balanced portfolio.) To be included in a composite, a carve-out must be managed separately, as if it were a separate portfolio rather than a segment of a larger portfolio. It must be representative of a stand-alone portfolio managed to the same strategy, and it must have its own cash. We have heard from high-net-worth and alternative managers that the requirement to create separate cash accounts for many carve-outs is not practical, so we proposed allowing firms to once again allocate cash to carve-outs. Firms either love this or are very opposed to it. Many of the comments that opposed this focused on the fact that a carve-out with allocated cash may not be representative of the strategy of a stand-alone portfolio. We again heard the concern that the 2 French stocks carved-out of a 500-stock portfolio would be misleading. We agree, but the carve-out guidance has always had the requirement that any carve-out must be representative of a stand-alone portfolio managed to that strategy, and this would continue. We also propose additional requirements around carve-outs, e.g., if a firm chooses to allocate cash to a carve-out, the firm would be required to do so for all similar carve-outs within the entire firm.
Expanded ability to use money-weighted returns:
Currently, firms are required to use time-weighted returns for all composites except private equity composites. Closed-end real estate funds have the unique requirement to present both time-weighted returns and money-weighted returns. Many firms have asked us to expand, beyond private equity, the types of funds and composites that may use money-weighted returns. In the 2020 Exposure Draft, we allow firms to use money-weighted returns instead of time-weighted returns when the firm controls the cash flows, and the portfolios in the composite have or the pooled fund has at least one of the following four characteristics:
- Fixed life
- Fixed commitment
- Illiquid investments are a significant part of the strategy.
While firms were very pleased with the expanded ability to use money-weighted returns, many firms suggested deleting the additional tests because they are duplicative and instead having only a single test: if the firm controls the cash flows.
Requirement to present money-weighted returns both with and without the subscription line of credit:
When a firm uses a subscription line of credit (LOC) and presents a money-weighted return, we propose requiring firms to present returns both with and without the LOC. Some firms said that calculating returns without the LOC is a hypothetical return. Some also questioned why we are focused on this one type of leverage, because they view a LOC as just another type of borrowing. These firms felt that we should not require returns both with and without the LOC. While it is true that a LOC is a type of borrowing, a LOC is often used to delay calling capital from limited partners, which shortens the time period for the money-weighted return calculation, and generally results in a higher return. Lines of credit have been used more extensively over the past few years due to the very low cost of borrowing. However, lines of credit are also used by many firms to facilitate administration of capital calls and are used for very short time periods. For these firms the difference in the two required returns would be de minimis. Finally, almost every firm that commented on this topic requested guidance for how the calculation without the LOC should be done.
Over the next few months we will be meeting with many of our volunteers, discussing the comments received, and making agreed-upon revisions. This process is well underway. We plan to issue the final version of the 2020 edition of the GIPS standards on 30 June 2019.