Investment management firms will be required for the first time to provide risk disclosure and report returns based on fair-value measures under Global Investment Performance Standards revisions that become effective Jan. 1.
The revisions to GIPS — a voluntary set of performance presentation standards developed by the CFA Institute for the investment management industry worldwide — include requiring money management firms to disclose whether their compliance with GIPS has been verified by an independent firm. However, revised standards do not make verification mandatory.
Risk disclosure will require the three-year standard deviation of monthly composite portfolio performance and a discussion of risk in the investment management strategy.
“Some argue standard deviation is not a risk measure,” said Jonathan Boersma, executive director of the Global Investment Performance Standards of the CFA Institute, and a member of the nine-person GIPS executive committee, which independently adopts revisions to GIPS. “But it’s the basis of a lot of risk measures. It’s a measure of volatility or variability of returns. It’s relatively well understood and provides a basis for comparison data.”
Currently, GIPS recommend firms disclose risk measures, but there was no requirement and no consistent measure, he said. “As a result, there is no comparability in risk measurement,” Mr. Boersma said.
The GIPS fair-value measurement requirement follows a general trend by the Financial Accounting Standards Board and International Accounting Standards Board to move to fair-value accounting, Mr. Boersma said.
Currently, GIPS require market valuation.
The revision won’t mean any change in valuation for assets in liquid markets where prices are readily available. But current standards didn’t have any guidance for illiquid assets, except for a little on private equity, which “is not helpful when trying to price CDOs,” or collateralized debt obligations, for example, Mr. Boersma said.
For new fair-value measures, GIPS require a hierarchy of valuation, from observable market pricing for identical assets to internal pricing models.
On verification disclosure, “We thought it wasn’t necessary to impose that cost on everyone” by making verification of GIPS compliance mandatory.
“We though it is a good initial step (to require whether firms verified GIPS compliance) and market pressure will take it on from here,” with pension funds and other clients and potential clients compelling investment advisory firms to have their GIPS compliance verified, Mr. Boersma said.
The GIPS executive committee didn’t require mandatory verification because firms that provide verification services aren’t in every market worldwide, Mr. Boersma said.
“So are we better off having firms they are in compliance, or prohibiting firms from doing that because they have no verification in that jurisdiction?” Mr. Boersma said. It’s better to have firms comply with GIPS, even without verification and then let the market push for verification, Mr. Boersma said. “I’d rather have clients demand it,” he added.
Among other revisions, the new GIPS include what Mr. Boersma jokingly called a “Bernie Madoff memorial provision to make sure there are actual assets underlying the performance.” It requires investment management firms to have policies to ensure the existence and ownership of client assets, such as through a reconciliation process with custodians.
GIPS allow money management firms anywhere to claim voluntary GIPS compliance, although in 32 countries, Charlottesville, Va.-based CFA Institute partners with organizations in those countries, such as pension funds or investment management associations, to monitor GIPS and provide GIPS education services.
The standards provide pension funds and other investors with consistent performance data by which they can compare investment managers and strategies.
GIPS doesn’t require going back to update previous performance presentations for the revisions.
The most recent previously adopted GIPS revisions became effective in 2006, Mr. Boersma said.
The CFA Institute doesn’t have data on the extent to which investment management firms comply with GIPS and how important compliance is viewed by pension funds and other clients, said Mr. Boersma, who cited a joint study by eVestment Alliance LLC, Marietta, Ga., and ACA Beacon Verification Services, a unit of ACA Compliance Group, Washington.
ACA Beacon and eVestment examined the extent to which 1,561 investment management firms that submitted information to eVestment as of Oct. 31, 2009, claim compliance with GIPS. Of those firms, 68% claim compliance, according to the study, “The Value of GIPS Compliance: An Industry Survey,” released Dec. 16, 2009.
Of the compliant firms, 75% had their compliance verified, the study said.
Of the 333 firms responding to a survey for the study, the study found firms claiming compliance report a different perspective on the important of GIPS compliance than firms that do not claim compliance.
The survey found 83% of responding firms claiming GIPS compliance stated that more than half of all RFPs they receive request a claim of compliance, while only 44% of non-compliant firms responding say they see GIPS compliance as a requirement in the majority of RFPs.
The survey reported in the study found 72% of responding firms say GIPS compliance is essential to compete in the institutional arena, 65% say it reinforces a firm’s commitment to a higher ethical standard, 57% say it enhances the firm’s internal controls, 40% say it provides competitive advantage and 10% say it is not worth the time and expense from a marketing perspective.
On their most important reason for verifying GIPS compliance, 85% cited marketing to institutional sponsors, 77% cited industry best practices, 49% cited consultant demand, 30% cited transparency, 19% cited operational efficiency and 19% cited need to satisfy regulatory bodies.