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Highlights of Changes to the GIPS® Standards

Karyn D. Vincent, CFA, CIPMChair, GIPS Interpretations Subcommittee

Member, GIPS Executive Committee

Vincent Performance Services LLC

Portland, OR

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The GIPS standards revision process

In 2005, all country versions of the GIPS standards, including the AIMR-PPS standards, converged with the GIPS standards

At that time it was agreed that the GIPS standards would be reviewed and updated every 5 years

That process was completed when the GIPS Executive Committee adopted the 2010 edition of the GIPS standards in January 2010

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2010 edition of the GIPS standards

Great attention was paid to conforming language between provisions and using consistent language throughout

Some provisions were moved between sections Some provisions were split if there was more than

one concept within a single provision Provisions were re-ordered within sections RE, PE and wrap fee sections state which provisions

in sections 0-5 do not apply

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1 January 2011 effective date

Any calculation or data changes must be reflected for periods that begin on or after 1 January 2011

Any presentation or disclosure changes must be reflected in compliant presentations that include performance results for periods beginning on or after 1 January 2011

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Fundamentals of Compliance

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Laws and regulationsNew provision 0.A.2.

Firms must comply with all applicable laws and regulations regarding the calculation and presentation of performance Explicitly stating what has been implicit, as a firm has

always been required to disclose if the presentation conformed with local laws or regulations that differ from the GIPS requirements

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False or misleading informationNew provision 0.A.3.

Firms must not present performance or performance-related information that is false or misleading Consistent with the long-standing goals of full disclosure

and fair representation

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Policies and proceduresRevised provision 0.A.5.

Firms must document their policies and procedures used in establishing and maintaining compliance with the GIPS standards, including ensuring the existence and ownership of client assets, and must apply them consistently For most firms that are properly and consistently

reconciling to custodian positions, should not result in any changes

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Providing a compliant presentationRevised provision 0.A.9.

Firms must make every reasonable effort to provide a compliant presentation to all prospective clients. Firms must not choose to whom they present a compliant presentation. As long as a prospective client has received a compliant presentation within the previous 12 months, the firm has met this requirement. Revised to reflect that “compliant presentation” and

“prospective client” are now defined terms

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What is a compliant presentation? New definition

A presentation for a composite that contains all of the information required by the GIPS standards and may also include additional information or supplemental information. Example on next slide

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What is a prospective client?New definition

Any person or entity that has expressed interest in one of the firm’s composite strategies and qualifies to invest in the composite. Existing clients may also qualify as prospective clients for any strategy that is different from their current investment strategy. Investment consultants and other third parties are included as prospective clients if they represent investors that qualify as prospective clients. Allows for a firm to have a screening process

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Complete list of composite descriptionsRevised provision 0.A.10.

Current requirement: Firms must provide a composite list and composite description to any prospective client that makes such a request.

Some read this as a list of composite names had to be provided first, and then a separate composite description thereafter, if requested

Updated to clarify requirement that firms must provide a complete list of composite descriptions to any prospective client that makes such a request.

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Total firm assetsRevised provision 0.A.13.

Currently, firm assets must be the aggregate of the market value of all discretionary and non-discretionary assets under management within the defined firm

If a firm manages assets for which a market value cannot be determined, these assets are excluded from firm assets

For periods beginning on or after 1 January 2011, total firm assets must be the aggregate fair value of all discretionary and non-discretionary assets managed by the firm Assets that do not have a market value but do have a fair value will be

required to be included in firm assets prospectively Will primarily impact managers of GICs/stable value assets and other

assets for which a market value is not available

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Input Data

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RecordkeepingRevised provision 1.A.1.

Currently, all data and information necessary to support a firm’s performance presentation and to perform the required calculations must be captured and maintained

Guidance supporting this provision is included in the Recordkeeping Guidance Statement

All data and information necessary to support all items included in a compliant presentation must be captured and maintained This expands recordkeeping requirements to cover any additional or

supplemental information that is included in a compliant presentation

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Portfolio valuationRevised provision 1.A.2.

Currently, portfolio valuations must be based on market values (not cost or book values)

For periods beginning on or after 1 January 2011, portfolios must be valued in accordance with the definition of fair value and the GIPS valuation principles in Chapter II

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Fair value definition

The amount at which an investment could be exchanged in a current arm’s length transaction between willing parties in which the parties each act knowledgeably and prudently. The valuation must be determined using the objective, observable, unadjusted quoted market price for an identical investment in an active market on the measurement date, if available. In the absence of an objective, observable, unadjusted quoted market price for an identical investment in an active market on the measurement date, the valuation must represent the firm’s best estimate of the market value. Fair value must include accrued income.

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Fair value disclosure requirements

Firms must disclose that policies for valuing portfolios, calculating performance, and preparing compliant presentations are available upon request (Provision 4.A.12.)

For periods beginning on or after 1 January 2011, must disclose the use of subjective unobservable inputs for valuing portfolio investments, if these investments are material to the composite (Provision 4.A.27.)

For periods beginning on or after 1 January 2011, firms must disclose if the composite’s valuation hierarchy materially differs from the recommended hierarchy in the GIPS Valuation Principles (Provision 4.A.28.)

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Portfolio valuationRevised provision 1.A.3.

As of 1 January 2010, must value portfolios on the date of all large cash flows Large cash flow must be defined for each composite

Portfolios must not be valued more frequently than required by the composite-specific valuation policy May not “opportunistically” value a portfolio based on a

cash flow that does not meet the level of “large” for that composite

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Large cash flow policy

The composite-specific policy for valuing portfolios may have a different valuation frequency for different types of portfolios Daily valued pooled funds Monthly valued segregated portfolios

Sample policy: Pooled funds are valued daily. All other portfolios are valued monthly and on the date of any cash flow greater than 5% of the portfolio’s market value

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Composite Construction

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Composite constructionRevised provision 3.A.4.

Composites must be defined according to investment mandate, objective, or strategy. Composites must include all portfolios that meet the composite definition. Any changes to a composite definition must not be applied retroactively. The composite definition must be made available upon request. To clarify that composites must be “fully inclusive”

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Carve-outsProvision 3.A.8.

For periods beginning on or after 1 January 2010, a carve-out must not be included in a composite unless the carve-out is managed separately with its own cash balance

New carve-out definition: 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. For periods beginning on or after 1 January 2010, a carve-out must be managed separately with its own cash balance

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Carve-out disclosureRevised provision 5.A.5.

For periods beginning on or after 1 January 2006 and ending prior to 1 January 2011, if a composite includes carve-outs, firms must present the % of composite assets represented by carve-outs as of each annual period end

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Significant cash flows New provision 3.A.10.

Firms that wish to remove portfolios from composites in cases of significant cash flows must define “significant” on an ex-ante, composite-specific basis and must consistently follow the composite-specific policy Portfolios that experience a significant cash flow are

temporarily considered non-discretionary Currently, guidance is included in the Significant Cash

Flow Guidance Statement

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Presentation and Reporting

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Periods that must be shown

What if the first year of a composite is a partial year? New requirement to present the initial first partial year for

composites with an inception date of 1 January 2011 or later (Provision 5.A.1.c.) Can’t exclude the initial partial year of performance from the

compliant presentation because it is not a complete annual return

New requirement to present the final partial year for composites with a termination date of 1 January 2011 or later (Provision 5.A.1.d.) Can’t exclude the final partial year of performance from the compliant

presentation because it is not a complete annual return

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Gross or net of fees

Gross or net returns (or both) may be presented in the compliant presentation

Currently provision 4.A.6. requires firms to clearly label returns as gross or net of fees

Revised provision 5.A.1.b. requires a firm to clearly identify returns as gross or net of fees

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Internal dispersion

Firms are required to present a measure of dispersion of the annual portfolio-level returns using only those portfolios that are included in the composite for the full year Not required if the composite contains less than 6

portfolios for the year Language was clarified to refer to this as a measure of

internal dispersion (Provision 5.A.1.i.)

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Standard deviationNew provision 5.A.2.a.

For periods ending on or after 1 January 2011, firms must present, as of each annual period end, the three-year annualized ex-post standard deviation (using monthly returns) of the composite and the benchmark Inputs to the calculation are the 36 monthly returns of the composite

and benchmark (also referred to as external standard deviation)

If the firm determines that standard deviation is not relevant or appropriate, must present an additional 3-year ex-post risk measure for the composite and the benchmark (in addition to the standard deviation)

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PortabilityRevised provision 5.A.8.

Clarification that portability tests must be met on a composite-specific basis Only a composite is portable from a prior firm

Elimination of the test requiring substantially all of the assets from the prior firm to transfer to the new firm

The one-year allowance for firms to bring acquired assets into compliance is no longer limited to an acquisition where one of the firms is not compliant (Provision 5.A.8.b.)

Updated provision 5.A.8.ii.: Test is for the (deleted: “staff and”) decision making process to remain substantially intact and independent within the new firm

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PortabilityRevised provision 5.A.8.

If the three portability tests are met, the new or acquiring firm must link the performance from the old firm

Also must not have a break in performance Just like any other composite, performance must not be linked across a

break in a composite’s history

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Disclosures

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New claim of complianceRevised provision 4.A.1.

Firms are required to disclose if the firm has been verified or not

Previously the expectation was to require (at some point in the future) a firm to be verified if they wanted to claim compliance with the GIPS standards The EC decided to not mandate verification Instead, a firm is required to disclose if the firm has been

verified or not

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What is verification?

It’s a process by which an independent third party assesses whether: The firm has complied with all the composite construction

requirements of the GIPS standards on a firm-wide basis, and The firm’s policies and procedures are designed to calculate and

present performance results in compliance with the GIPS standards

Verification does not verify a firm’s claim of compliance with the GIPS standards

Verification applies to entire firm, not specific composites Verification does not provide assurance about the results of

any specific composite

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Claim of compliance for a verified firm

“[Insert name of firm] claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. [Insert name of firm] has been independently verified for the periods [insert dates]. The verification report(s) is/are available upon request.

Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm’s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. Verification does not ensure the accuracy of any specific composite presentation.”

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Claim of compliance for a verified firm for an examined composite

“[Insert name of firm] claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. [Insert name of firm] has been independently verified for the periods [insert dates].

Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm’s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. The [insert name of composite] composite has been examined for the periods [insert dates]. The verification and examination report(s) are available upon request.”

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Claim of compliance for a firm that has not been verified

“[Insert name of firm] claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. [Insert name of firm] has not been independently verified.”

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Benchmark descriptionNew provision 4.A.4.

Firms must disclose the benchmark description New definition for benchmark description: General

information regarding the investments, structure, and/or characteristics of the benchmark. The description must include the key features of the benchmark, or the name of the benchmark for a readily recognized index or other point of reference.

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Net returnsRevised provision 4.A.6.

Currently, if net returns are presented, the firm must disclose if anything other than transaction costs and management fees are deducted

Revised: When presenting net-of-fees returns, must disclose: If any other fees are deducted in addition to the investment

management fees and trading expenses If model or actual investment management fees are used If returns are net of any performance-based fees

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List of composite descriptions Revised provision 4.A.11.

Firms must disclose that the list of composite descriptions is available upon request

Edited provision to clarify that this is one document, with all composites, and each composite’s description Must include composites that terminated within the past 5

years It is not a list with composite names only Sample list is included as Appendix C

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Policies and procedures availableRevised provision 4.A.12.

Current required disclosure: Additional information regarding policies for calculating and reporting returns is available upon request

Revised: Policies for valuing portfolios, calculating performance and preparing compliant presentations are available upon request

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Leverage and derivatives Revised provision 4.A.13.

Currently, firms must disclose the presence, use, and extent of leverage and derivatives (if material), including a sufficient description of the use, frequency, and characteristics of the instruments to identify risks

Revised: Firms must disclose the presence, use, and extent of leverage, derivatives, and short positions, (if material), including a description of the use, frequency of use, and characteristics of the instruments sufficient to identify risks

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Periods of non-complianceRevised provision 4.A.15.

Currently, firms must disclose any periods of non-compliance prior to 1 January 2000, and the reason for why the presentation is not in compliance

Revised: Disclosure of the reason for non-compliance is eliminated

But still must disclose if any non-compliant periods are presented

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Withholding taxesRevised provision 4.A.20.

Currently, firms must disclose relevant details of the treatment of withholding taxes on dividends, interest income, and capital gains. If using an index that is net of taxes, must disclose the tax treatment of the benchmark versus that of the composite

Revised to require disclosure of treatment of withholding taxes only if material

Revised to require disclosure of benchmark tax status only if net and if this information is available

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Differences in exchange rates Revised provision 4.A.21.

Currently must disclose and describe any known inconsistencies in exchange rates used among the portfolios within a composite, and between the composite and the benchmark

Revised to require disclosure only if differences in exchange rates or valuation sources are material (for periods beginning on or after 1 January 2011)

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Custom benchmarkRevised provision 4.A.31.

Currently, if using a custom benchmark, must disclose the benchmark creation and re-balancing process

Revised to require disclosure of the benchmark components, weights, and rebalancing process

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Significant cash flowsNew provision 4.A.32.

Currently, if a firm has adopted a significant cash flow (SCF) policy for a specific composite, the SCF Guidance Statement requires the following disclosures: How the firm defines SCF for the composite The grace period for the composite If the definitions, policies, or grace periods have been redefined, the date

and nature of the change, and That additional information regarding the treatment of SCFs is available

upon request

New provision: Must disclose how the firm defines a significant cash flow for that composite and for which periods A firm would still be required to track all activity for SCFs, and be ready

to provide that information upon request

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Standard deviationNew provision 4.A.33.

Must disclose if the three-year annualized ex-post standard deviation of the composite and/or the benchmark is not presented because 36 monthly returns are not available Composites may be calculated quarterly through 1 January

2010 Benchmark returns may not be available monthly

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Standard deviationNew provision 4.A.34.

If the firm determines that the three-year annualized ex-post standard deviation is not relevant or appropriate, must: Describe why the ex-post standard deviation is not relevant

or appropriate; and Describe the additional risk measure presented and why it

was selected

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Other Asset Classes

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Wrap Fee/SMA Portfolios

No significant changes to provisions Simply tightening up the language

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Private Equity

Must use daily cash flows in the SI-IRR calculation beginning 1 January 2011

Open end funds of funds can follow the PE provisions versus the general GIPS standards

New requirements for PE funds of funds composites Composites can be based on vintage year and/or strategy

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Real Estate

Component returns (income and capital) must be calculated separately beginning 1 January 2011

External valuations must be conducted every 12 months as of 1 January 2012 Exception: If the client agreement stipulates otherwise,

must externally value in accordance with client agreement or at least every 36 months if client agreements have a longer frequency

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Real Estate

Closed-end real estate funds must be included in composites defined by vintage year

Must calculate and present both time weighted and SI-IRRs composite returns

New SI-IRR requirements are generally consistent with the Private Equity requirements

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GIPS Advertising Guidelines

No change to the claim of compliance: “[Insert name of firm] claims compliance with the Global Investment Performance Standards (GIPS®).”

No required disclosure of verification status Additional option added for periods of returns that must be shown (if

choosing to include returns in an advertisement) May present 1-, 3-, and 5-year annualized returns through the most recent

period Current options are tied to the period presented in the related compliant

presentation Updates to required disclosures that match those changes in the disclosures

included in the compliant presentation as previously discussed

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Next steps

Changes in the GIPS standards required changes in Guidance Statements and Q&As A compliant firm must consider all guidance, and not just

the GIPS standards themselves Most guidance statements have been updated; the rest

will follow shortly GIPS Handbook should be issued by the end of the

year Website: www.gipsstandards.org Subscribe to the GIPS newsletter and RSS feed:

http://gipsstandards.org/news/index.html

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Contact information

Karyn D. Vincent, CFA, CIPM

Vincent Performance Services LLC

Portland, Oregon

503-288-2704, ext. 102

kvincent@vincentperformance.com

www.vincentperformance.com