First-Steps for Segregated Account Managers
Firms managing segregated accounts who claim compliance with the GIPS standards – and firms who currently include pooled funds in composites, present TWRs, and expect to continue doing that: this article is for you.
Since the major rewrite of the GIPS standards was first announced, the focus has been on updates to make the GIPS standards more relevant to different types of discretionary asset managers. For firms already claiming compliance, especially managers of segregated accounts, changes were expected to be minor… and they are.
The completely new format, however, and new optionality, makes tracking exactly what did change more challenging.
- Much of what is “new” in the GIPS standards was already required in guidance statements, such as error correction, portability and verifier independence.
- Actual requirements that must be updated to remain in compliance are detailed below.
THE GAME PLAN
Step 1 – Review your current policy and procedure document.
Absorb the details the firm currently has documented. If your current Policy and Procedure document is a question and answer format, take the time to read the current question as well as the answer, because the question may have old terminology or might not be applicable anymore.
Step 2 – Review the 2020 GIPS standards with the firm policy and procedure document open on a separate screen.
If your documentation quotes and references sections of prior GIPS standards, a whole new template may be in order, as the reorganization of requirements and recommendations in the 2020 standards is substantive. With your P&P open alongside the GIPS standards, highlight or create draft edits as you go – whether for your own review, your internal GIPS committee, or for a conversation with your verifier or consultant.
Want an experienced verifier to review your policies with you? Cascade Compliance is offering complementary P&P reviews and 30-minute consultations on our findings. Sign up at cascadecompliance.com/P&P review.
We suggest firms with sufficiently detailed current requirements and recommendations consider the following four areas that might be in need of minor updating: 1) firmwide reporting policies, 2) input data and calculation methodology, 3) composite presentation and disclosures, and 4) verifier independence, if your firm receives a verification.
- Reporting: Compliant firms already document policies for how they distribute GIPS Composite Reports to prospective clients. We recommend firms review and consider enhancing the documentation of detailed procedures, however, as the GIPS standards for verifiers has been updated to require verifiers to perform sufficient procedures to determine that the firm has made every reasonable effort to provide GIPS Composite Reports to prospective clients. More new details to add to your reporting documentation:
- If your policies explicitly refer to “Compliant Presentations,” the new terminology for composite presentations is “GIPS Composite Reports.”
- How you will indicate that your marketing materials include your GIPS Composite Report (new requirement). If you provide GIPS Reports within your marketing materials, you need to detail whether you are going to include the GIPS Report in the Table of Contents, for example, or have a tab indicating “GIPS Reports,” or reference the GIPS Reports on pages that show performance. Simply including the reports in the back of a pitchbook or in a generic “Disclosure” or “Legal and Compliance” section is not sufficient.
- Procedures for updating your firm’s GIPS Reports within 12 months of the annual period end. Most firms update reports far sooner, but the 12-month timeframe is now a requirement, so we recommend adding a timeline to your documented procedures that is within 12 months—or within three months, or six months, whatever time period reflects your current procedures.
- If your policies and procedures address portability, there is new guidance that permits rather than requires linking performance from a prior firm if all requirements are met. Clarification was added that there must be no break in the track record between the past firm and the new firm in order to link prior firm performance, and clarification that if there is a break during the transition, but all other portability requirements are met, unlinked performance from the prior firm may be presented.
- Input data and calculation methodology: The 2020 GIPS standards don’t include changes to input or calculation requirements for firms investing in publicly traded securities, ETFs and mutual funds. You may not have any updates to this section at all. Since the GIPS standards added the recommendation that gross-of-fees returns should be used for calculating risk measures, firms may want to specify the use of gross or net returns for risk measures in your policy document. You may also need to update/add details to your policies if the firm:
- uses discretionary leverage: assets must be reported net of discretionary leverage and returns must be calculated net of discretionary leverage.
- has performance-based fee clawbacks: any repayment of fees must be reflected in performance during the period in which it is repaid.
- manages private market investments: portfolios are required to be valued at each quarter end, and composite and portfolio returns are required to be calculated at least quarterly and adjusted for daily-weighted external cash flows (real estate external valuations continue to be required annually, which we will discuss in more detail when providing guidance to managers of pooled funds).
- manages overlay exposures: detail how the firm calculates the overlay exposure and use the same method for calculating overlay returns for all portfolios within a composite. The three valuation methods permitted are either: 1) the notional exposure of the overlay strategy portfolios, 2) the value of the underlying portfolios being overlaid, or 3) a specified target exposure.
- Presentation and disclosures: If your policy and procedure document details the disclosures included in your GIPS Composite Report, changes to the GIPS Composite Report applicable across all firms are minimal. We counted five:
- Updated compliance statement language more accurately describes the firm’s claim of compliance and the scope of verification to align with new verification procedures.
- Disclosure must be added that “GIPS is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.”
- The availability of policies for valuing investments, calculating performance and preparing “compliant presentations” is now “…and preparing GIPS Reports…”
- Whether gross or net returns are used to calculate presented risk measures.
- The inception date of composite performance, in addition to the composite creation date.
All other disclosure updates only apply to some firms/situations:
- The availability of the firm’s list of composite descriptions must be expanded to include, if applicable, limited distribution fund descriptions or a list of broadly distributed pooled funds.
- Additional benchmark details that might need to be updated in your policies and GIPS Reports:
- More clarity is provided for retroactive vs proactive benchmark changes.
- Custom benchmarks must be labeled as such.
- Additional details for portfolio-weighted custom benchmarks, including that component weights for prior periods are available upon request.
- Reasons for a firm’s redefinition of the firm or a composite, or for benchmark changes, are no longer explicitly required.
- Fee details:
- More details about model fees, if used, including the amount of the model fee if net-only performance is shown, and the methodology for calculating the fee.
- Details about expenses other than management fees, such as research costs, if material.
- The percentage of non-fee-paying portfolios in the composite as of each year-end doesn’t need to be presented if the firm uses model fees for the calculation of net-of-fee performance.
- Advisory assets for the firm or the composite may be presented as a stand-alone amount without being labeled supplemental. Such assets can also be presented combined with firm assets/composite assets, but if they are shown combined, firms must also present them as a stand-alone amount and assets must be clearly labeled.
- If your firm uses subjective unobservable inputs, you must present the percentage of composite assets valued with subjective unobservable inputs as of the most recent year-end.
- Firms must disclose if preliminary, estimated values are used to determine fair value.
- If the firm presents additional risk measures in the GIPS Composite Report, the firm must describe the measure and disclose the name of the risk-free rate used, if applicable.
- If the firm manages overlay strategies, add disclosure regarding the methodology used to calculate the overlay exposure and if collateral and collateral income are reflected in composite returns.
- If the firm manages real estate, disclosure of the frequency of external valuations or that the firm relies on financial statement audits.
- If theoretical performance is included in the GIPS Composite Report, several additional disclosures are required from the supplemental guidance statement, in additional to labeling such performance supplemental.
- Verifier independence: document how your firm has gained an understanding of its verifier’s policies for maintaining independence. Verifier independence is critical to the verification process. If you receive a verification from a firm that bundles verification with other services, such as firm or fund financial statement audits, SOC 1 reports, or Mock SEC exams or pre-verification consulting, independence could be compromised. That doesn’t mean verification firms can’t perform other services and still maintain independence; it just means that it’s important to assess independence to ensure the integrity of the GIPS verification.
Recommendations in the 2020 GIPS standards are important for firms to review and consider adopting. Most of the recommendations didn’t change, but you will want to document any nuanced changes to recommendations that the firm adheres to.
Step 3 – Determine and document the adoption timeline that makes the most sense for your firm.
The GIPS standards go into effect January 1, 2020, but firms have until after presenting December 2020 performance to update GIPS Composite Reports with the new disclosures. Early adoption may or may not make sense for your firm. Know that a firm’s early adoption of a claim of compliance in accordance with the 2020 GIPS standards requires the firm’s verifier to also apply the new 2020 verification requirements.