A Practical Guide to Implementing the Global Investment Performance Standards (GIPS) for Asset Managers

Adhering to GIPS is in the best interest of any investment firm that wants to compete effectively and fairly. It helps build a framework for implementing industry best practices while helping engender the trust of prospective and current clients.

The Global Investment Performance Standards (GIPS) are a worldwide set of ethical standards for calculating and presenting strategy gains and losses in discretionary, managed investment accounts. The CFA Institute, which is the global membership association that confers the Chartered Financial Analyst (CFA) designation, released GIPS in 1999 to ensure prospective investors receive "full disclosure and fair representation."

Subject to continual reevaluation and modification, the current GIPS went into effect in January 2006. As of 2007, 28 countries have adopted GIPS or have had their local performance reporting standards endorsed by the GIPS Executive Committee. Compliance with GIPS has become a virtual requirement in North America -- the Standards are recognized as an industry best practice and go a long way in yielding credibility and improved client confidence for investment managers.

GIPS in a Nutshell: Creating Composites

The key provision of GIPS is the requirement to include all of a firm's fee-paying discretionary accounts in a meaningful composite to ensure "apples to apples" performance comparability from one firm to another and to prevent cherrypicking of only a manager's best-performing accounts. While non-fee-paying discretionary accounts also may be included in composites, the Standards specifically exclude nondiscretionary portfolios, broadly defined as accounts that contain investment guidelines significantly restricting the ability to manage the assets according to an appropriate composite strategy. The returns on such portfolios are more reflective of a client's decisions than an investment manager's decisions. Even certain accounts that meet the legal definition of discretionary may be deemed nondiscretionary for GIPS purposes and exempted from composite inclusion if client restrictions limit the manager's discretion.

Constructing representative composites is perhaps the greatest challenge -- and the one that consumes the most time and resources -- in GIPS compliance. Managers need to define composites, understand their nuances, select portfolios correctly and address portfolios that do not fit neatly into composites -- avoiding too many overly narrow composites or overly broad, meaningless composites.

Don't Just Comply -- Verify

The GIPS strongly recommend that firms claiming compliance hire an independent firm to verify that their policies, procedures and composite construction methodology adhere to the Standards. In practice, most firms prefer bringing in the verification firm early on for objective guidance on the process. Verification services are offered by accounting firms and firms focused on GIPS consulting and verification, and such firms typically also offer performance examinations. Effective verification and performance examinations generally follow three phases:

1. Preverification: The verifier reviews performance policies and procedures and firm brochures and/or performance presentations. This establishes the framework for a gap analysis wherever existing policies do not meet GIPS requirements.
2. Verification. The verifier reviews the same documentation as in a preverification with the expectation that any areas of noncompliance have been corrected. The verification process also tests supporting documentation on a sample basis. This engagement results in either a management letter outlining areas of noncompliance or the issuance of an opinion letter stating that the firm has complied with all the composite construction requirements of GIPS and that the firm's processes and procedures are designed to calculate and present performance results in compliance with the Standards.
3. Performance Examination. The verifier drills down into specific composite performance track records to affirm whether the underlying valuations, calculation methodologies and transaction records are accurate and adhere to GIPS requirements.

Role of Technology

Given that data integrity is one of the key requirements of GIPS, technology has an important role to play in GIPS compliance. Today's most advanced portfolio management, accounting and reporting systems offer a high level of flexibility in the ways data can be organized and managed. They allow quick access to portfolio information for verification and performance examination purposes, and they enable firms to automate much of the performance calculation process. Customized reporting capabilities enable firms to create and generate performance reports in accordance with GIPS and quickly respond to an SEC inquiry. Generally, the right technology can help ease the administrative burden of compliance while bringing greater speed, efficiency and accuracy to the process -- ultimately giving managers greater confidence that their performance reporting is GIPS-compliant.

Adhering to GIPS is in the best interest of any investment firm that wants to compete effectively and fairly. It helps build a framework for implementing industry best practices while helping engender the trust of prospective and current clients. All these advantages are further reinforced by expert third-party verification. The issue for most firms is not whether to comply with GIPS, but how to accomplish it successfully.

Anthony Sperling is SVP of services for investment management technology provider Advent Software. He is responsible for developing and enhancing Advent customers' overall experience. Sperling joined Advent in 1993.

Kimberly Cash is the partner in charge of compliance verification services for CPA firm Ashland Partners & Co. She is responsible for responding to the Investment Performance Council (IPC) on proposed guidance statements.