From Team Performance to Investment Returns: Ted Lasso and GIPS Standards

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What do the GIPS Standards and Ted Lasso have in common?

The third season of Ted Lasso began in March 2023. For those that have not seen the show, it is about a small-time college football coach from Kansas named Ted Lasso, who is unexpectedly hired to coach a struggling English Premier League soccer team, AFC Richmond, despite knowing very little about soccer. While it may seem that Ted Lasso and the Global Investment Performance Standards (GIPS®) have nothing in common, we invite anyone working with GIPS compliance to explore the important similarities below and feel as good about what they bring to work as what Ted brings to his coaching.

At its core, Ted Lasso is about ethics, transparency, teamwork, and continuous improvement, and we are using the GIPS Standards framework to help clients tackle similar challenges every day.

Ethics: Ted and the GIPS Standards focus on ethics. Ted Lasso is known for his strong moral compass and commitment to doing what is right. Similarly, the GIPS Standards require investment managers to adhere to a strict code of ethics when reporting performance data, ensuring that they are not misrepresenting their results or misleading their clients. Choosing to be ethical is more than just following the rules; it’s the foundation for all of the decisions that come after.

Transparency: In the show, Ted is known for his open and honest communication style, an understated superpower that helps to build trust and rapport with his team. The GIPS Standards provide a powerful framework for investment managers to provide transparent and accurate performance data to their clients to build trust and confidence in their investment strategies.

Teamwork: Of course, a soccer show is about teamwork, but so is GIPS compliance. It applies to the whole firm, not just the back office or the front office, and the best GIPS compliance teams have representatives from executive leadership, compliance, operations, technology, marketing, and portfolio management.

Continuous Improvement: Ted is constantly looking for ways to improve himself and his team, even when things are going well, just as the GIPS Standards require investment managers to regularly review their performance reporting processes and make changes as needed to ensure they are meeting the highest standards of accuracy and transparency.

And the list goes on….

Attention to Detail: Both Ted Lasso and the GIPS Standards place a high value on attention to detail. Ted is known for his meticulous planning and attention to small details that can have a big impact on the success of his team. Anyone that’s worked with the GIPS standards knows compliance requires fiduciaries to pay close attention to the details, quarter after quarter, to ensure accuracy and consistency.

Standards of Excellence: Finally, both Ted Lasso and the GIPS Standards are focused on achieving high standards of excellence. In the show, Ted Lasso sets high expectations for himself and his team and is always striving to improve and achieve their goals. When the GIPS Standards were created, they were designed to provide the investment management industry a pathway to achieve the highest standards of accuracy, transparency, and ethical behavior for investment performance reporting, for firms (and now asset owners) to build credibility and trust with their clients and constituents.

While the connections between Ted Lasso and the GIPS Standards may seem tenuous at first, both share a commitment to excellence, ethics, transparency, teamwork, and continuous improvement. They also emphasize the importance of thinking long-term, paying attention to detail, and building trust through open and honest communication. Additionally, both have a strong focus on teamwork and collaboration, whether that’s between the characters in the show or between investment managers and their clients. Ultimately, these shared values and principles can help individuals and organizations achieve success in their respective domains, whether it’s on the soccer field or in the investment management industry.

Cascade Compliance has over 34 years of combined experience working with SEC Regulations, the GIPS standards, and performance. Our employees have worked with hundreds of firms in the U.S. and abroad. One of the best parts of working with clients is getting to share expertise and knowledge of best practices across the industry. Whether you are a client of ours or not, we are here to help you get better at what you do and answer any questions you may have. Contact us at connect@cascadecompliance.com.

ESG Disclosure Standards

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In February 2023, CFA Institute released third-party assurance standards for firms claiming compliance with its Global ESG Disclosure Standards for Investment Products (the “Standards”).  As controversy over the proposed SEC ESG Rule grows, it’s important to understand the CFA Institute’s voluntary framework and assess the benefits of voluntary compliance and assurance on a firm’s investment products, as well as the similarities and differences in proposed regulations.

An Overview of the CFA Institute’s Global ESG Disclosure Standards

The CFA Institute’s Standards are designed to provide investors consistent, reliable ESG information that is complete and clear, to increase investor trust in the industry and avoid misleading greenwashing. The Standards allow firms to have specific ESG investment products claim compliance with these Standards and, as of February 2023, firms can have an independent third-party provide assurance for this claim. Unlike the proposed SEC ESG Rule, the Standards do not include any corporate or firm-level disclosures (other than stewardship activities discussed below).  The Standards include consideration of the intersection of a firm’s ESG policies, on a product-by-product basis, and that investment product’s objectives, investment strategy, and stewardship activities.  Firms that claim compliance with the Standards must document internal ESG policies and procedures that support the firm’s ESG-related marketing statements. Third-party assurance then adds an extra layer of accountability to further increase investor’s confidence that these products are actively and intentionally carrying out their ESG initiatives.

Sources and Types of ESG Information and Associated Disclosures

The ESG Disclosure Standards have different required disclosures for the various sources and types of ESG information. Below is a list of the sources and types of ESG information and a summary of the ESG Disclosure Statement requirements associated with each source/type.

  1. Financially Material ESG Information: Disclosures will need to describe how financially material ESG information is identified and incorporated into investment decisions, and any exceptions in which financially material ESG information is not considered in investment decisions.
  2. ESG Investment Universe (ESG index): if an ESG index is used as part of a product’s investment selection process, the disclosures will need to include either a description of how investors can obtain information about the index’s construction methodology, or, if the index is readily recognized, just the name of the index.
  3. Screening: If the investment product excludes certain investments or has criteria that must be met before an investment is considered, required disclosures include the characteristics and thresholds/conditions used to evaluate the investment, where the criteria are applied in the investment process, and whether there are any laws, regulations, or third-party frameworks used in the evaluation criteria.
  4. Portfolio-Level ESG Characteristics: products with portfolio-level targets for ESG characteristics will need to disclose:
    • the portfolio-level ESG characteristics, how they are measured, the target value or range, how the target is expected to be attained, any risks that could hinder an attainment of the target, and whether there are any laws, regulations, or third-party frameworks used to measure the characteristics or targets.
    • If the product’s targets are compared to an ESG index, additional disclosures include the characteristic that is compared to the index, information about the index (depending on recognizability, similar to ESG Investment Universe requirements), and how investors can obtain information about the index calculation methodologies.
    • How progress toward, or attainment of, the targets are reported to investors.
  1. Portfolio-Level Allocation Targets: products with portfolio-level allocation targets must disclose the specific ESG characteristics that are targeted, the value or range of the target, and how progress toward, or attainment of, those targets is reported to investors.
  2. Stewardship Activities: disclosures must include the types of Stewardship Activities undertaken by the product, how the Stewardship Activities are relevant to the product’s objectives, and the processes/systems that support the Stewardship Activities. Additionally, disclosures must be made on how investors can obtain all policies which govern the products’ Stewardship Activities and how the Stewardship Activities are reported to investors.
  3. Environmental and Social Impact Objectives: disclosures must include the impact objectives (in measurable or observable terms), stakeholders who will benefit from these objectives, the time horizon over which the objectives are expected to be attained, how these objectives relate to other objectives of the product, and how the pursuit of impact objectives could result in a trade-off with other objectives. Other required disclosures include:
    • The proportion of the portfolio focused on these impact objectives
    • How they’re expected to be attained
    • Any risks that may hinder attainment of these objectives
    • How progress toward, or attainment of, the impact objectives is measured/monitored/evaluated
    • How progress is reported to investors
    • The process for assessing/addressing/monitoring/managing potential negative social and environmental impacts that may occur while attaining these objectives
    • How the attainment of impact objectives will contribute to third-party sustainable development goals.

The Standards vs. the Proposed SEC ESG Rule

Key Differences

  • The Standards are voluntary guidelines for asset managers and asset owners, while the proposed SEC ESG Rules would be mandatory for public companies that are subject to SEC reporting requirements.
  • The Standards include a new investment product-specific disclosure document—the ESG Disclosure Statement, while the proposed SEC ESG Rule disclosures would be added to already-existing documents such as fund prospectuses, annual reports, and regulatory reporting (Form ADV Parts 1 and 2), and the disclosure requirements vary based on the document in question.
  • The proposed SEC ESG Rule includes a significant emphasis on corporate Greenhouse Gas Emission (GHG) disclosures and a prescribed methodology for the calculation and presentation of GHG computations, while the Standards provide a framework that would include such considerations, if included in an investment product’s ESG approach, without addressing them specifically.
  • In contrast to the type of ESG investment-specific disclosures required by the Standards, the proposed SEC ESG Rule’s general requirements are broken down into two types of funds:
  1. Integration Funds: ESG factors are incorporated alongside non-ESG factors in the investment process, but the ESG factors are no more significant than the other factors.
  2. ESG-Focused Funds: Funds which focus on one or more ESG factors as a significant or main consideration in investment decisions (includes Impact Funds).

The required disclosures for Integration Funds are not as comprehensive as the required disclosures for Focused Funds (detailed in the graph below), and include ESG factors considered, a few sentence summary of how the Fund incorporates such ESG factors in the investment selection process, and a description of GHG selection process and calculation methodology, if any.

  • The Standards provide a set of recommended metrics and data points for reporting on ESG issues, while the SEC’s Proposed Rules do not prescribe specific metrics beyond GHG calculations, but instead require companies to disclose material climate-related risks and opportunities.
  • The Standards are a finalized, flexible global framework, while the proposed SEC ESG Rule is still a moving work-in-progress limited to U.S. companies.

Similarities

The Standards and the proposed SEC ESG Rule both prioritize the disclosure of material ESG information that is relevant to a company’s business and financial performance.  They also are designed to be compatible with existing reporting frameworks, such as the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB)

Below is the tabular format in which the SEC has proposed ESG-Focused Funds present the required information in their Fund Prospectuses. We’ve added an additional column to show the comparison between the proposed SEC ESG Focused Fund disclosures and the Standards.


In summary, the Standards and the proposed SEC ESG Rule have different scopes, focus areas, and approaches to ESG reporting. However, both initiatives are aimed at improving transparency and accountability in ESG reporting, which can help investors make better-informed decisions and promote more sustainable business practices.

As firms consider if they will comply with the CFA Institute’s voluntary Standards, we are here to help.  If your firm is interested, please contact us to discuss Cascade Compliance’s ESG consulting  and assurance solutions.

Cascade Compliance has over 34 years of combined experience working with SEC Regulations, the GIPS standards, and performance.  Our employees have worked with hundreds of firms in the U.S. and abroad.  One of the best parts of working with clients is getting to share expertise and knowledge of best practices across the industry.  Whether you are a client of ours or not, we are here to help you get better at what you do and answer any questions you may have.  Contact us at connect@cascadecompliance.com.

Year-End Marketing Material Updates

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And a new FAQ from the SEC

RIAs across the country are preparing year-end 2022 performance presentations, and for most GIPS compliant firms, it’s time to update annual performance on your GIPS Reports.  Or is it?  Below are four timely Q&As as we kick-off annual verifications and performance examinations.

1) Is it better to send updated GIPS Reports to your verifier at the beginning or end of the verification?

Most verifiers provide an initial request list asking for policies, performance data, and GIPS Reports right from the start. However, many firms prefer waiting right until the end of the verification to update their GIPS Reports, in case there are updates made to a composite that could change year-end statistics.  At Cascade, we’ll work with your preferences, while also making suggestions to make the process more efficient.  We encourage firms to draft GIPS Reports using their best data, generally the performance data being provided as part of the initial request at the beginning of the verification, and send the GIPS Reports along with the performance.  That way, your verifier can triangulate the most up-to-date policies, performance, and GIPS Reports from the beginning.  Firms may have to make an update to their GIPS Reports at the end of the verification, however more general updates can be communicated from the onset of the initial data review, rather than after multiple rounds of open items at the end of the verification.

2) With the new SEC Marketing Rule in effect, can we distribute GIPS Reports as stand-alone performance presentations with just the performance updated by January 31 (and the rest of the statistics provided through 2021)?

Yes.  Only the required time period performance (1-, 5-, and 10 year returns) is required to be updated within 30 days.  However, as stand-alone presentations, GIPS Reports must include 5- and 10-year returns (or since inception returns, if 5 or 10 year returns aren’t available) through December 2022, in addition to annual 2022 performance.  GIPS Reports must also include benchmark performance for the same time periods composite performance is presented.

January 2023 is the first time firms are required to make annual updates to GIPS Reports while also taking the new Marketing Rule into consideration. For firms that distribute GIPS Reports annually to databases, it’s a great time to consider adding a separate table for SEC required performance time periods, if you haven’t already.

3) With the new SEC Marketing Rule in effect, can we leave 2021 performance in GIPS Reports unchanged until our firm’s AUM is finalized and the GIPS Reports are verified, which is usually during February or March, as long as the GIPS Reports are part of a fair and balanced presentation that includes 2022 performance?

Maybe.  Firms may satisfy SEC general prohibitions by documenting procedures for fair and balanced presentations that prominently present SEC required performance time periods, updated through December 2022 by the end of January. It depends on each firm’s appetite for risk, because what a fair and balanced presentation is under the Marketing Rule is still untested.  At a minimum, we would recommend including references from GIPS Reports to performance pages that have been updated through 2022 and to include required performance time periods.

Because of the significant differences between strong 2021 performance and bearish 2022 performance, we also recommend firms not updating their GIPS Reports to be prepared with an answer if an SEC examiner asks why they weren’t updated, since the performance numbers were available.  Even firms that elect not to include the SEC’s required time period performance on their GIPS Reports this year, may want to update just the annual performance (net and benchmark, and optional gross) through 2022 by the end of January.

The fourth and final Q&A below isn’t our own – it’s an FAQ published by the SEC in January, specifically for firms that manage private funds and want to show investment level returns.  Presenting deal level returns to prospective clients net of fees requires firms to make assumptions that aren’t necessarily helpful/meaningful when applied to unrealized gains and losses of individual investments. The SEC knows this and included a statement to that effect in the proposed PF guidance for reporting to existing clients.  The new marketing rule FAQ below emphasizes subjective selection of best performers as a concern when reporting to prospective clients, and it addresses case studies and groups of investments, rather than addressing a complete side-by-side presentation of all gross deal level returns.  A law firm might argue that such a breakdown of every investment return could still be shown gross of fees in support of fund level returns presented both net and gross of fees.  With only three published FAQs, however, we believe the SEC’s decision to not explicitly permit such a presentation speaks volumes.

What do you think?  We’re not lawyers, but we’d be happy to help you with straightforward assumptions and methodologies for allocating management fees to deal level returns and documenting calculations in performance disclosures.

From: SEC.gov | Marketing Compliance Frequently Asked Questions

 Q. When an adviser displays the gross performance of one investment (e.g., a case study) or a group of investments from a private fund, must the adviser show the net performance of the single investment and the group of investments?

A. Yes. The staff believes that displaying the performance of one investment or a group of investments in a private fund is an example of extracted performance under the new marketing rule.[1]Because the extracted performance provision was intended, in part, to address the risk that advisers would present misleadingly selective profitable performance with the benefit of hindsight, the staff believes the provision should be read to apply to a subset of investments (i.e., one or more). Accordingly, an adviser may not show gross performance of one investment or a group of investments without also showing the net performance of that single investment or group of investments, respectively.[2]In addition, the adviser must satisfy the other tailored disclosure requirements as well as the general prohibitions, including the general prohibition against specific investment advice not presented in a fair and balanced manner, when showing extracted performance.[3]

At Cascade Compliance, we believe that every firm deserves personalized, timely service provided by experienced professionals.  Cascade Compliance has over 34 years of combined experience working with SEC Regulations, the GIPS standards, and performance.  Our employees have worked with hundreds of firms in the U.S. and abroad.  One of the best parts of working with clients is getting to share expertise and knowledge of best practices across the industry.  Whether you are a client of ours or not, we are here to help you get better at what you do and answer any questions you may have.  Contact us at connect@cascadecompliance.com.

[1] Extracted performance means “the performance results of a subset of investments extracted from a portfolio.” Rule 206(4)-1(e)(6). See section II.E.5 of the adopting release.

[2] The rule prohibits any presentation of gross performance in an advertisement unless the advertisement also presents net performance. See section II.E.1 of the adopting release. The gross and net performance requirement applies to not only an entire portfolio but also to any portion of a portfolio that is included in extracted performance. See sections II.E.1(a) and (b) and the definitions of gross and net performance in rule 206(4)-1(e)(7) and (10) (“Net performance means the performance results of a portfolio (or portions of a portfolio that are included in extracted performance…”)). The adopting release also states that the rule requires that advisers that show extracted performance must show net and gross performance for the applicable subset of investments extracted from a portfolio. See section II.E.1.a. of the adopting release (discussing gross performance).

[3] The adopting release states that “advisers should evaluate the particular facts and circumstances that may be relevant to investors, including the assumptions, factors, and conditions that contributed to the performance, and include appropriate disclosures or other information such that the advertisement does not violate the general prohibitions…or other applicable law.” See section II.E.1 of the adopting release (discussing the net performance requirement). In addition, it would be considered “misleading under the final rule to present extracted performance in an advertisement without disclosing whether it reflects an allocation of the cash held by the entire portfolio and the effect of such cash allocation, or of the absence of such an allocation, on the results portrayed.” See section II.E.5 of the adopting release (discussing extracted performance).

Exploring and Documenting Consistent Calculation Methodologies

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Exploring and Documenting Consistent Investment Performance Calculation Methodologies

When trying to understand the limits of the SEC Marketing Rules requirements for consistent related account performance calculation methodologies, advice circulating that firms cannot link daily and monthly performance valuations is misguided. Established in 1993, a key objective of the GIPS® Standards 30-year framework, referenced throughout the SEC Adopting Release, is to “ensure uniformity in reporting so that results are directly comparable among investment managers.”¹ In 2022, compliance with the GIPS standards establishes that consistent calculation methodologies and changes over time are not mutually exclusive, and the GIPS standards also set a best practice precedent for documenting prospective methodology changes and keeping the history intact.

In this article, we explore different methodologies over time, among related account performance calculations, and what different methodologies aren’t permitted in the SEC Marketing Rule.

Individual firms are encouraged to raise the bar on a prospective basis as technology permits. The GIPS standards themselves have prospectively changed both valuation and calculation methodology requirements, keeping historical requirements intact. The documentation of historical changes are contained throughout the GIPS Standards, with illustrative provisions 2.A.24 and 2.A.25 included below.

Examples include the transition from quarterly to monthly valuations in 2001, requiring trade date accounting in 2005, and using fair values instead of market values in 2011. A firm’s historical performance is not only still permitted to be shown for GIPS compliant firms using historical methodologies after there is a prospective change in the GIPS Standards, a ten-year record is required to be maintained, and restating historical performance is to be avoided.

Although the SEC Marketing Rule Adopting Release doesn’t prescribe specific valuation periods or calculation methodologies the way the GIPS standards do, the Adopting Release allows for related accounts to contain immaterial differences in performance calculations.  When discussing the ability to include or exclude accounts from the related account prescribed time-period performance, the SEC gives “advisers additional flexibility to present related performance when there may be immaterial differences in performance results depending on the methods of calculation of returns or as between the different prescribed time periods.”²

This guidance indicates that it is permissible to group related accounts that utilizing more than one calculation methodology for performance.  Further, the Adopting Release states that a firm may “use the same criteria to construct any composites to meet the GIPS standards in order to satisfy the ‘substantially similar’ requirement of the Marketing Rule’s definition of ‘related portfolio.’”³ The GIPS Standards require accounts to be included in composites if they are managed to the same strategy, and specifically permit different calculation methodologies between pooled funds and segregated accounts within the same composite. From a discussion in the 2020 GIPS Standards 2.A.164:

“Although a firm must establish a composite-specific or pooled fund–specific calculation policy, that policy may differentiate calculations used for different types of portfolios in the composite. For example, suppose that a firm has a composite that includes pooled funds, which use a daily TWR calculation methodology, and segregated accounts, which use a Modified Dietz return (with revaluations for large cash flows) calculation methodology. The firm may have a different policy for the return calculation methodologies used for pooled funds versus segregated accounts that are included in the same composite. The firm must apply the composite-specific calculation policy consistently, however, based on the return calculation methodology for each type of portfolio in the composite.”

“Policies and procedures should be reviewed regularly to determine if they should be changed or improved, but it is not expected that they will change frequently. A firm must not change a policy retroactively solely to increase performance or to present the firm in a better light. Retroactive changes to policies and procedures should be avoided.”5

Any advice that firms will not be able to link monthly Modified Dietz performance with daily performance may have been taken out of context, perhaps from the following passage from the rule: “… net performance must be calculated over the same time period, and using the same type of return and methodology as, the gross performance.”

This passage requires that gross returns and net returns are presented using the same calculation methodology as one another.  This does not require the methodology used to calculate both net and gross returns to remain the same over a period of time, as discussed above.  For example, the rule prohibits gross performance from being calculated using the Modified Dietz method, if net performance is calculated by linking daily performance, but the rule does not prohibit a portion of the track record for both gross and net returns from being calculated with Modified Dietz, while another portion of both gross and net are calculated by linking daily performance. Another example of a prohibited calculation methodology would be if gross returns were presented as time-weighted returns and net performance was presented as money-weighted returns.

In conclusion, Modified Dietz, Modified Dietz plus subperiod revaluations for large cash flows, and daily valuations are all acceptable methods for calculating time-weighted returns. Linking any of those three methodologies over time as the GIPS standards have evolved (and portfolio accounting system functionality has evolved) is a common practice in almost every GIPS compliant performance record presented over the past 30 years.  There are many unanswered questions when implementing the SEC Marketing Rule, but the permissibility of calculation methodology changes isn’t one of them.  Documentation and disclosure of changes is all part of a consistent calculation methodology for firms to be able to show meaningful performance that spans decades while also being able to adapt as technology continues to advance and performance calculations become more sophisticated.

Cascade Compliance has over 34 years of combined experience working with SEC Regulations, the GIPS standards, and performance.  Our employees have worked with hundreds of firms in the U.S. and abroad.  One of the best parts of working with clients is getting to share expertise and knowledge of best practices across the industry.  Whether you are a client of ours or not, we are here to help you get better at what you do and answer any questions you may have.  Contact us at connect@cascadecompliance.com.

¹Performance Presentation Standards, AIMR, 1993, (p. ix)

²Investment Advisor Marketing, 17 CFR Part 275 and 279, SEC Final Rule, 2021 Adopting Release, (p. 189)

³Investment Advisor Marketing, 17 CFR Part 275 and 279, SEC Final Rule, 2021 Adopting Release, (p. 194)

4GIPS Standards Handbook, CFA Institute, 2020, (p. 90)

5Investment Advisor Marketing, 17 CFR Part 275 and 279, SEC Final Rule, 2021 Adopting Release, (p. 319)

SEC Marketing Rule – Hypothetical & Extracted Performance

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Hypothetical performance and extracted performance are a key point in the SEC Marketing Rule set to take effect on November 4, 2022.  Firms that have previously used model, targeted, projected, and back tested performance need to take special care when presenting such performance to prospective clients.  The new rule is a significant change from what a lot of firms have been previously allowed to do.

Hypothetical performance will only be allowed after November 4, 2022, if the advisor takes specific steps to address its potentially misleading nature. The SEC’s goal with this portion of the rule is to ensure that advertisements containing hypothetical performance are only distributed to investors who have the financial expertise and resources to interpret the data and understand the risks and limitations of these types of presentations.

There is no distinction between retail and non-retail investors in the new rule when considering the sophistication of the audience receiving the hypothetical performance). The only exception to the hypothetical performance rule is one-on-one communications provided in response to unsolicited investor requests or provided to a private fund investor.

What is considered hypothetical performance?

Hypothetical performance is defined as performance results that were not achieved by any portfolio of the investment advisor. Hypothetical performance includes, but is not limited to: model performance, backtested performance, and targeted or projected performance returns.

Model performance includes performance where the advisor applies an investment strategy that is similar to an actual investor account but makes slight changes to the model to accommodate different investor objectives. Computer generated models are included in the definition of model performance. This type of performance was originally described in the Clover Capital No Action Letter.

Backtested performance is performance that has had a strategy applied historically to market data from prior periods when the strategy was not actually used. This includes scenarios where an advisor could backtest performance based on current strategy data and apply it historically either because the manager doesn’t have actual portfolios during the period, or because the manager doesn’t have access to portfolio books and records for the past period.

Targeted and Projected performance reflects an advisor’s aspirational performance goals. These returns reflect an advisor’s performance estimates, often based on historical data and assumptions. Projections of general market performance or economic conditions are not subject to the provision on presentation of hypothetical performance.

What’s New

  1. The advisor must create and implement policies and procedures designed to ensure the performance information provided is relevant to the financial situation and investment objectives of the intended audience of the advertisement. These policies do not need to address each specific recipient’s circumstances but rather the likely investment objectives and financial situation of the advertisement’s intended audience. Being thoughtful in your establishment of policies and procedures that connect your firm’s hypothetical performance as a useful tool for your typical clients is a key step in being ready for November 2022.

What’s Familiar

  1. The performance being presented must be net performance—just like all actual performance beginning November 2022.
  2. An advisor must provide sufficient information to the intended audience to enable them to understand the criteria and assumptions used in calculating the performance. Sufficient information includes details about how the hypothetical performance is calculated and describes any assumptions used.
  3. An advisor must provide (or offer to provide if the audience is a private fund investor) sufficient information that enables the intended audience to understand the risk and limitations of using hypothetical performance in making investment decisions. Risk information should include reasons why the hypothetical performance might differ from actual performance of a portfolio. An example of this would be external cash flow timing. Simply disclosing the possibility of loss is not enough to satisfy this requirement.

Hypothetical Performance Example

Below is sample disclosure language pertaining to risk information for prospective clients and investors to understand the hypothetical performance shown.  Much of the sample language is straight from rescinded SEC no-action guidance, and we expect such guidance to live on in the implementation of the new Marketing Rule.  While there are familiar disclosures below, we encourage firms to be thoughtful in considering the variety of reasons that their hypothetical performance may differ from actual performance.

The presented performance represents hypothetical model results during the measurement time period. As such, these results have limitations, including, but not limited to, the following:

  • model performance may not reflect the impact that material economic conditions and market factors would have had on the adviser’s decision making or on individual clients, or the impact of the timing of actual client cash flows into or out of an actual portfolio;
  • results do not reflect actual trading by specific clients, but were achieved by [describe calculation methodology and material objectives or strategies used to obtain results];
  • model performance does not reflect brokerage commissions, custodian fees, taxes, or any other expenses a client would have paid, and as such, actual investment returns would be lower;
  • how (if) model performance reflects investments that differ from advisory services currently offered; and
  • hypothetical past performance [just like actual past performance] is no guarantee of future results.

One final note on hypothetical that bridges both policies and disclosures pertaining to hypothetical performance: with the new requirement to show related account performance for actual accounts, now more than ever, it is important to have policies and procedures for reviewing actual portfolio performance to results portrayed in a model.  Results that are materially similar will lend credibility to the usefulness and relevance of the hypothetical/model performance.  Alternatively, we recommend firms reconsider using model performance where model results materially differ from the actual results of related accounts, nor can firms use model results as a replacement for doing the difficult work of aggregating related account performance histories.

Extracted Performance

Extracted performance is defined as performance results of a subset of investments extracted from a single portfolio. This type of performance is commonly known as a “carve-out” to firms that comply with the Global Investment Performance Standards (GIPS®). Additional requirements will apply to advisors who present this type of performance.

The advisor must provide, or offer to provide promptly, the results of the total portfolio from which the extracted performance was derived. This is intended to prevent advisors from cherry-picking certain performance results.

Performance that is extracted from a composite of multiple portfolios is not considered extracted performance because it is not a subset of investments extracted from a single portfolio. This type of performance (including carve-out composite performance that complies with the GIPS Standards) is considered hypothetical and will be subject to the hypothetical requirements discussed above.

The final rule does not require a specific treatment for cash allocation in extracted performance. However, it would be considered misleading to not disclose the allocation of cash and the effects of the cash allocation, or the absence of a cash allocation. When crafting disclosures to meet the SEC rule, it’s important to consider the intended audience. For firms claiming compliance with the GIPS Standards,  cash allocations and additional disclosures are required.

With the SEC Marketing Rule, please remember that when performance is shown, firms must show performance as net of fees.  Firms can also show gross of fee performance however, net must be shown in equal prominence.

Read our blog on SEC portability and predecessor performance here.

If you have any other questions regarding the marketing rule, contact us here.

Cascade Compliance has over 34 years of combined experience working with SEC Regulations, the GIPS standards, and performance.  Our employees have worked with hundreds of firms in the U.S. and abroad.  One of the best parts of working with clients is getting to share expertise and knowledge of best practices across the industry.  Whether you are a client of ours or not, we are here to help you get better at what you do and answer any questions you may have.  Contact us at connect@cascadecompliance.com.

 

SEC Marketing Rule – Prescribed Time Periods

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The modernization of the SEC Marketing Rule has firms hard at work to comply with new requirements related to the presentation of performance. One of these requirements is referred to as Prescribed Time Periods, where a firm must present a 1-, 5-, and 10-year net returns in any of its marketing materials that show performance. This level of prescription is a significant departure from the SEC’s past performance disclosure requirements.  Similar to the GIPS Standards®, this requirement is particularly valuable in that it prevents firms from presenting only the best time periods and also provides prospective clients comparable short-term and long-term performance figures across RIAs. Below, Cascade outlines the requirements for presenting the prescribed time periods, and what this will mean for GIPS Compliant firms.

Presentation Requirements

Beginning November 4, 2022, all performance presented in an SEC-registrant’s marketing materials must include the additional time period requirements. Private funds are currently exempt from the prescribed time periods; however, there is a proposed rule that would require the same time periods for liquid private funds for their current investors.

One-, five- and ten-year net performance must be included in marketing materials when presenting performance. For strategies without ten (or five) years of performance, a since inception return is required. The SEC Marketing Rule does not specify whether cumulative or annualized returns are to be used when calculating these returns. Cascade recommends annualized returns for easier comparison to annual performance and for consistency with industry best practices.

All returns must be updated through an end date no less recent than calendar year-end. The one caveat is if there has been an event which has had a significant negative effect on performance. In that case, performance through the most recent quarter-end is required (if available). If the most recent quarter-end performance is not available, the adviser should include appropriate disclosure on the performance that is presented.

As of now, it’s expected of firms to have updated performance numbers on marketing materials within one month of year-end (or quarter-end when there’s been significant negative performance as mentioned above). While this is not explicitly stated in the SEC’s marketing rule document, it was addressed in an April Q&A which can be found here. If your firm has illiquid products, stay tuned. Future SEC guidance for illiquid investment performance is expected, and we will update this article when/if additional guidance is released for updating performance.

Implications for GIPS Compliant Firms

If your firm claims compliance with the GIPS standards and is SEC registered, additional requirements will apply. Showing a GIPS Report with 10 years of performance is not a substitute for the prescribed time period requirements. Each firm will need to consider how they present their GIPS Report to prospective clients to better understand their options for presenting the SEC required prescribed time periods.

  • If the GIPS Report is used as a standalone advertisement, 1-, 5- and 10-year net returns must be added to meet the SEC requirement.
  • If the GIPS Report is included as part of a pitchbook, the 1-, 5- and 10-year returns can be presented on a separate page.

Another important consideration is that the GIPS Standards require the presentation of benchmark returns for the same periods that composite returns are presented. If your firm claims compliance with the GIPS standards and adds 5- and 10-year composite gross and net returns to the GIPS Report, benchmark returns must also be shown for those same periods. Further, if your firm follows the GIPS Advertising Guidelines, a 3-year annualized return for the composite and benchmark is required in addition to the 1- 5- 10-year SEC prescribed time periods. Remember that everything on the GIPS Report is subject to your firm’s GIPS error correction policies, including the 5-, and 10-year returns, if added. We recommend firms add error correction policies and procedures for the prescribed time periods, should a firm include them in the GIPS Report.

Example 1-, 5-, and 10-year returns:

If you would like to receive a copy of our template for calculating annualized and cumulative performance, or have any other questions regarding the marketing rule, contact us here.

Cascade Compliance has over 34 years of combined experience working with SEC Regulations, the GIPS standards, and performance.  Our employees have worked with hundreds of firms in the U.S. and abroad.  One of the best parts of working with clients is getting to share expertise and knowledge of best practices across the industry.  Whether you are a client of ours or not, we are here to help you get better at what you do and answer any questions you may have.  Contact us at connect@cascadecompliance.com.