More than five years ago, compliance with the Global Investment Performance Standards became available for asset owners. I have spoken on this topic before several groups, and the general response has always been "why would we want to do that?" As a result, the adoption of the standards by asset owners has been underwhelming. That, however, is beginning to change.
Roughly three years ago, the $372.8 billion California Public Employees' Retirement System, Sacramento, began the process to adopt the standards and, to date, has undergone two annual verifications. Since then, the $69.3 billion Massachusetts Pension Reserves Investment Management Board, Boston; the $31.1 billion South Carolina Retirement Systems, Columbia, and the Saudi Arabian Monetary Authority have adopted the standards.
Clearly, these organizations decided to make the investment to not only comply but to also undergo independent verification. But why?
Public funds, especially, are subject to scrutiny by a variety of parties. Would not achieving compliance with a globally recognized standard seem to be a worthwhile undertaking? Would it not add some degree of credibility to what's being reported, perhaps a kind of imprimatur?
The GIPS have, since their creation 20 years ago, been seen as best practice in terms of reporting past performance to interested parties and stakeholders. Who is comfortable passing on best practice for something less? Who says "second best is good enough for me?" And, in the absence of any other reporting "standard," where is an institution to turn to for guidance?
The GIPS standards are a set of voluntary guidelines created by the CFA Institute in 1999, initially for asset managers, about how to present past performance. This is critically important, because without rules, problems such as "cherry picking" might arise. By having a set of standards, we ensure that all compliant firms are following the same rules. The appeal for asset owners is somewhat similar to that of asset managers, in that these standards are considered to be "best practice." They are ethical principles that foster full disclosure and fair representation of investment performance. They speak to how to assemble composites, create policies and procedures, calculate returns and other statistics, and to put the information together into a meaningful report.
Compliance, followed by a verification of the calculations, will provide the parties who create the materials, as well as those who receive them, with greater confidence in what is being done.
Many asset owners have chosen to also have composite examinations done, which result in the verifier testifying to the accuracy of the underlying data, as well as the calculations, that are used in the actual returns. This is sometimes seen as even more beneficial than the verification, though a verification must be done in advance of or concurrent with a composite examination.
One common concern is the time and cost to achieve and maintain compliance. The reality is that for asset owners, compliance should be relatively straightforward. First, unlike asset managers, which must have a minimum of five years (or since inception, if the firm isn't 5 years old) of annual returns, building to 10 years, asset owners need only bring a single year into compliance (also building to 10). Second, much of the required information should be available from the institution's custodian.
We are seeing increased pressure on custodians to be able to support compliance with the standards, and have witnessed some that have taken a leading role in not only ensuring what they produce conforms to the standards, but championing compliance with their asset owner clients.
"Composites" must be created to represent the performance of all accounts being managed to a particular strategy. Presentations, which include both statistical details as well as disclosures, are needed for each composite. Even where an asset owner has multiple accounts, they are typically managed differently enough that they warrant having their own composites. And for many pension funds, a single composite will be all that is required.
One challenge with compliance asset owners have is the need to report performance net of all fees and expenses, including internal costs. Coming up with these internal costs might be a challenge, but definitely not an insurmountable one. The organization's verifier can help with this.
Verification firms include accounting firms and non-accounting firms, such as ours. The key requirement for verifiers is that they have extensive knowledge about the GIPS standards, the verification process, investments and the investment process. Verifiers are also expected to be familiar with the regulatory requirements that apply to reporting and calculating performance, the characteristics of the different asset classes, and performance and risk measurement.
The verifier should also educate the organization on the GIPS standards' requirements and help assess the tasks that need to be done so that compliance is realized.
Many institutions find creating written policies and procedures to be a daunting task, and it admittedly is. That said, some asset owners who have achieved compliance have agreed to provide theirs to others for review. This, no doubt, will be quite helpful. These documents can serve as great examples from which an institution can craft their own.
The GIPS standards recently underwent a major revision, with the changes announced June 28 and due to take effect in 2020.
Asset owners who choose to comply today will be recognized as being one of the early adopters, serving as a great example for others. We believe the decision to comply by the institutions mentioned adds increased pressure on asset owners to do the same. We also believe that over time, compliance with the standards by asset owners will become de rigueur. And so, why not be a trailblazer and begin the process now?
David D. Spaulding is founder and CEO of The Spaulding Group Inc., Somerset, N.J. This content represents the views of the author. It was submitted and edited under P&I guidelines but is not a product of P&I's editorial team.