Level III

Overview of the Global Investments

Performance Standards

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Graphs, charts, tables, examples, and figures are copyright 2014, CFA Institute.
Reproduced and republished with permission from CFA Institute. All rights reserved.
Contents
1. Introduction
2. Background of the GIPS Standards
3. Provisions of the GIPS Standards
4. GIPS Valuation Principles
5. GIPS Advertising Guidelines
6. Verification
7. Other Issues

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1. Introduction
• The GIPS standards fulfill the need for a consistent, globally
accepted standard for investment management firms in
calculating and presenting results

• The GIPS standards are based on the ideals of fair representation

and full disclosure of an investment management firm’s
performance history

• Only investment management firms can claim compliance with

the GIPS standards

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2. Background of the GIPS standards

2.1 The Need for Global Investment Performance Standards

2.2 The Development of Performance Presentation Standards

2.3 Governance of the GIPS Standards

2.4 Overview of the GIPS Standards

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The Need for Global Investment Performance Standards
Unscrupulous employees at investment managers firms can misrepresent
performance data in several ways:

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Client/Prospective Client Benefit
• Well established, well formulated and
consistent standard makes it easier to
compare and evaluate investment
firms
• Greater confidence that performance
data is fairly presented
GIPS compliance does not exempt
prospective client from thorough due
diligence
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Investments Firm Benefits
• GIPS benefits investment management
industry as a whole
• Widespread adherence to GIPS
standard helps build the industry’s
credibility
• In some markets clients/fund sponsors
look for GIPS-compliant investment
management firms
• GIPS implementation might enable
improvement of internal processes
and strengthen managerial controls
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The Development of Performance Standards
• Direct lineage of the current GIPS standards starts with the voluntary
guidelines for the North American marketplace defined by a committee of
the Financial Analysts Federation
• The Association for Investment Management and Research’s Performance
Presentation Standards (AIMR-PPSR®) was another milestone
• AIMR Board of Governors endorsed the GIPS standard in 1999
• The GIPS standards have evolved
• Country Version of GIPS (CVG): GIPS standards as the core, supplemented by
country specific requirements
• Current reading is based on the 2010 edition which became effective on 1
January, 2011

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Governance of the GIPS Standards
• The GIPS Executive Committee (EC), a standing committee of the
CFA Institute Center for Financial Market Integrity, is the
decision-making body responsible for developing and
implementing the provisions of the Global Investment
Performance Standards

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 Overview of the GIPS Standard

Read from the

Handbook

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The goals of the GIPS Executive Committee are:
• To establish investment industry best practices for calculating and
presenting investment performance that promote investor interests and
instill investor confidence;
• To obtain worldwide acceptance of a single standard for the calculation and
presentation of investment performance based on the principles of fair
representation and full disclosure;
• To promote the use of accurate and consistent investment performance
data;
• To encourage fair, global competition among investment firms without
creating barriers to entry; and
• To foster the notion of industry “self-regulation” on a global basis.

Source: GIPS Handbook, 2010

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GIPS Key Characteristics
• The GIPS standards are ethical standards for investment performance
presentation to ensure fair representation and full disclosure of investment
performance. In order to claim compliance, firms must adhere to the
requirements included in the GIPS standards.
• Meeting the objectives of fair representation and full disclosure is likely to
require more than simply adhering to the minimum requirements of the
GIPS standards. Firms should also adhere to the recommendations to
achieve best practice in the calculation and presentation of performance.
• The GIPS standards require firms to include all actual, discretionary, fee-
paying portfolios in at least one composite defined by investment mandate,
objective, or strategy in order to prevent firms from cherry-picking their
best performance.

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GIPS Key Characteristics (Cont…)
• The GIPS standards rely on the integrity of input data. The accuracy of input
data is critical to the accuracy of the performance presentation. The
underlying valuations of portfolio holdings drive the portfolio’s
performance. It is essential for these and other inputs to be accurate. The
GIPS standards require firms to adhere to certain calculation methodologies
and to make specific disclosures along with the firm’s performance.
• Firms must comply with all requirements of the GIPS standards, including
any updates, Guidance Statements, interpretations, Questions & Answers
(Q&As), and clarifications published by CFA Institute and the GIPS Executive
Committee, which are available on the GIPS website
(www.gipsstandards.org) as well as in the GIPS Handbook.

Source: GIPS Handbook, 2010

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Historical Performance Record
• A firm is required to initially present, at a minimum, five years of annual
investment performance that is compliant with the GIPS standards. If the firm
or the composite has been in existence less than five years, the firm must
present performance since the firm’s inception or the composite inception
date.
• After a firm presents a minimum of five years of GIPS-compliant performance
(or for the period since the firm’s inception or the composite inception date if
the firm or the composite has been in existence less than five years), the firm
must present an additional year of performance each year, building up to a
minimum of 10 years of GIPS-compliant performance.
• Firms may link non-GIPS-compliant performance to their GIPS-compliant
performance provided that only GIPS-compliant performance is presented for
periods after 1 January 2000 and the firm discloses the periods of non-
compliance.
Source: GIPS Handbook, 2010
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 3. Provisions of the GIPS Standards
0. Fundamentals of Compliance 6. Real Estate
1. Input Data 7. Private Equity
2. Calculation Methodology 8. Wrap Fee/SMA Portfolios
3. Composite Construction
4. Disclosure
5. Presentation and Reporting

A composite is an aggregation of one or more portfolios managed according

to similar investment mandate, objective or strategy

Read Exhibit 2 a few times; this gives a good summary of all 9 provisions

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Excerpt from GIPS
Handbook, 2010

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 3.1 Fundamentals of Compliance
• Properly define the ‘firm’
Requirements  Investment firm, subsidiary or division held out to clients or potential
clients as a distinct business entity
Firms must: • Document policies and procedures used in establishing and
maintaining compliance with the GIPS standards
• Define criteria for including portfolios in specific composites
• “Make every reasonable effort” to provide all prospective clients
with compliant presentation
• Meet all requirements

Recommendations • Be verified
• Adopt broadest, most meaningful definition of the firm
Firms should: • Annually provide each existing client a GIPS-compliant
presentation for any composite in which client’s portfolio is
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 3.2 Input Data
Requirements • Maintain all data and information necessary to support all items
presented in a compliant presentation
Firms must: • Value portfolios in accordance with definition of fair value
• Use trade-day accounting
• Use accrual accounting for fixed-income securities

• Value portfolio not merely when large cash flows occur, but on
Recommendations the date of all external cash flows
• Obtain valuation from qualified independent third party
Firms should:
• Accrue management fee when presenting net-of-fee returns

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 3.3 Calculation Methodology
Requirements • Use total return (realized and unrealized return)
Firms must: • Use time-weighted rates of return
• Formulate and document composite-specific policies for the
treatment of external cash flows; adhere consistently
• Describe methodology for computing time-weighted returns
and assumptions about timing of capital flows
• Define “large” external cash flow

There are many more requirements but the curriculum has broken this provision
into several sections

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 Calculation Methodology Examples
For periods beginning on or after 1 January 2010, the GIPS standards require firms to
calculate returns by geometrically linking period returns before and after large cash flows
1. Compute portfolio value when external cash flows occur
2. Compute sub-period returns
3. Geometrically link sub-period returns

BV = 100,000 on 31 May
V = 109,000 on 5 June including inflow of 10,000
EV = 110,550 on 30 June
Compute TWR

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For periods prior to 1 January 2005, cash flows can be assumed to occur at
the midpoint of the measurement period

BV = 100,000 on 31 May
Inflow of 10,000 during the period
EV = 110,550 on 30 June
Compute TWR

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For periods beginning on or after 1 January 2005, the GIPS standards require
time-weighted total return calculations that adjust for daily weighted cash
flow; acceptable approaches are Modified Dietz method and Modified IRR

BV = 100,000 on 31 May
Inflow of 10,000 on 5 June
EV = 110,550 on 30 June
Compute TWR

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 3.4 Return Calculations: External Cash Flows

Summary of previous example

Inputs

Solutions

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External cash flows can potentially distort estimated rates of return

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In volatile markets large external cash flows may have a material impact on
the accuracy of the estimated return

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 3.5 Additional Portfolio Return Calculation Provisions
Requirements • Include returns from cash and cash equivalents held in portfolios
in total return calculations (See Exhibits 7 and 8)
Firms must: • Calculate returns after deducting actual trading expenses
• If the actual trading expenses cannot be identified and segregated
from a bundled fee then reduce return by entire amount of
bundled fee or by portion of bundled fee that includes direct
trading expenses

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 3.6 Composite Return Calculation Provisions
Requirements • Asset-weight individual portfolios in a composite using beginning
Firms must: of period values or a method that reflects both beginning of
period values and external cash flows
• For periods beginning on or after 1 January 2006, asset-weight
the individual portfolio returns at least quarterly
• For periods beginning on or after 1 January 2010, asset-weight
the individual portfolio returns at least monthly

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Sum of beginning assets and weighted external cash flows

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Composite return under
“beginning assets”
weighting method

Composite return under

“beginning assets weighted
cash flows” method

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 3.7 Constructing Composites I – Qualifying Portfolios
Requirements All actual, fee-paying, discretionary PORTFOLIOS MUST be included
Firms must: in at least one COMPOSITE. Although non-fee-paying discretionary
PORTFOLIOS may be included in a COMPOSITE (with appropriate
disclosure), non-discretionary PORTFOLIOS MUST NOT be included
in a FIRM’S COMPOSITES.

COMPOSITES MUST include only actual assets managed by the

FIRM.

FIRMS MUST NOT LINK performance of simulated or model

PORTFOLIOS with actual performance.

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 3.8 Constructing Composites II – Defining Investment Strategies

Requirements COMPOSITES MUST be defined according to investment mandate,

Firms must: objective, or strategy. COMPOSITES MUST include all PORTFOLIOS
that meet the COMPOSITE DEFINITION. Any change to a COMPOSITE
DEFINITION MUST NOT be applied retroactively. The COMPOSITE
DEFINITION MUST be made available upon request.

Suggested
Hierarchy:

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 3.9 Constructing Composites III – Including/Excluding Portfolios

Requirements COMPOSITES MUST include new PORTFOLIOS on a timely and

Firms must: consistent basis after each PORTFOLIO comes under management.

Terminated PORTFOLIOS MUST be included in the historical

performance of the COMPOSITE up to the last full measurement
period that each PORTFOLIO was under management.

PORTFOLIOS MUST NOT be switched from one COMPOSITE to

another unless documented changes to a PORTFOLIO’S investment
mandate, objective, or strategy or the redefinition of the
COMPOSITE makes it appropriate. The historical performance of the
PORTFOLIO MUST remain with the original COMPOSITE.

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 3.9 Constructing Composites III – Including/Excluding Portfolios
Recommendation To remove the effect of a SIGNIFICANT CASH FLOW, the FIRM
Firms should: SHOULD use a TEMPORARY NEW ACCOUNT.

Requirements FIRMS that wish to remove PORTFOLIOS from COMPOSITES in cases

Firms must: of SIGNIFICANT CASH FLOWS MUST define “significant” on an EX-
ANTE, COMPOSITE-specific basis and MUST consistently follow the
COMPOSITE-specific policy.

If the FIRM sets a minimum asset level for PORTFOLIOS to be

included in a COMPOSITE, the FIRM MUST NOT include PORTFOLIOS
below the minimum asset level in that COMPOSITE. Any changes to
a COMPOSITE-specific minimum asset level MUST NOT be applied
retroactively.

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 3.10 Constructing Composites IV – Carve-Out Segments
CARVE-OUT: A portion of a portfolio that is by itself representative of a distinct investment strategy.
It is used to create a track record for a narrower mandate from a multiple-strategy portfolio
managed to a broader mandate.

Large-Cap Large-Cap
Equity (60%) Equity (40%)

Corporate Government
Bonds(40%) Bonds(60%)

Requirements For periods beginning on or after 1 January 2010, a CARVE-OUT

Firms must: MUST NOT be included in a COMPOSITE unless the CARVE-OUT is
managed separately with its own cash balance.

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Three multi-class composites.

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3.11 Disclosure
• 35 requirements and 8 recommendation
• The ideal of fair presentation and full disclosure is quite apparent
• Disclosures with regards to:
 Specific wording on how to claim GIPS compliance
 Definition of firm
 Composites (general and specific)
 Valuation, Currency
 Benchmark
 Fees
 Internal dispersion (of returns of portfolios in a composite)

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Requirements

Firm

Recommendation

Requirements

Significant
Events

Recommendation

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Requirements for
All Composites

Requirement for
Specific Composites

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 Valuation
Requirements

Valuation
Recommendations

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 Currency

Tax

Benchmarks

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Key point: monthly rebalancing and quarterly rebalancing produce different return numbers

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Under presentation and reporting requirements firms must present ex
post standard deviation of returns for last 36 months

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3.12 Presentation and Reporting Requirements

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Indication of how consistently firm implemented strategy across portfolios

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 Measures of Internal Dispersion – Pros and Cons of Different Measures

Measure Pros Cons

High-Low Range Easy to understand Outliers can make the measure
misleading

Interquartile Range: Spread Eliminates outliers Prospective clients might be

between return of portfolio at unfamiliar with this measure
the 25th percentile and return of
the portfolio on the 75th
percentile

Standard Deviation: If returns Valid measure of dispersion;

are normally distributed, about available in most statistical
68% percent of returns fall software (including Excel)
within one std dev of mean
Asset-weighted standard
deviation
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 Note that here we are talking
about the overall composite
and benchmark; not the
individual portfolios in a
composite

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Exam Tip

• It is possible you that you’ll be given a performance presentation

that claims to be GIPS compliant, and you’ll be asked to identify
omissions and errors

• Pay close attention to Question 26 in the curriculum

• It is nearly impossible to remember every performance provision

but at least learn the omissions and errors given here

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3.13 Presentation and Reporting Recommendations

Gross-of-fees returns are more easily

comparable with benchmark and allow clients to
evaluate manager’s skill without regard to fees

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3.14 Introduction to Real Estate and Private Equity Provisions

• In general GIPS standards apply to real estate and private equity

• Real estate and private equity provisions identify the exceptions
• Additional requirements and recommendations are also set forth
• The following investment types are not considered under the real estate
provisions
 Publicly traded real estate securities
 Commercial mortgage backed securities
 Private debt investments which are not influenced by economic performance of
underlying real estate
• Private equity provisions pertain to private equity investments made by
fixed life, fixed commitment vehicles
 Private equity open-end (evergreen) funds remain subject to main GIPS standards
• Focus on main concepts
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3.15 Real Estate Provisions

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3.16 Private Equity Provisions

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3.17 Wrap Fee/Separately Managed Account (SMA) Provisions

• Single bundled fee which combines fees for investment management,

trading, custody and administrative functions
• Wrap fee/SMA provisions supplement regular standards

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4. GIPS Valuation Principles

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5. GIPS Advertising Guidelines
Guidelines only apply to firms that already satisfy all requirements

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6. Verification
• Verification is a process whereby an independent expert assesses
a firm’s policies and procedures for constructing composites
and calculating and presenting performance
• Provides users of performance presentation greater confidence
in the claim of compliance
• Verification is not required by strongly recommended

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• Pre-qualification procedures
 Knowledge of GIPS standards, regulations, firm, valuation procedures
• Verification procedures

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7. Other Issues (After-Tax Return Calculation Challenges)

• Even if a composite is made up for portfolios managed on a tax-

aware basis, GIPS standards do NOT require presentation of
after-tax returns; there are several challenges in presenting
after-tax information
• Tax-related guidance moved to country specific provisions
• Timeframe of when estimated tax liability will be realized
impacts returns
 We might assume that taxes on unrealized gains take place every at the
end of every period but this will overstate tax effect
• Selecting or devising appropriate benchmark is difficult

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Concluding Remarks
• GIPS typically shows up as an item-set (MCQ) in the afternoon
paper
• Summary
• Learning Objectives
• Practice Problems
 Nearly impossible to learn all the details; know the material covered in
practice problems very well

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