GIPS and Performance Evaluation

Overview

• Global Investment Performance Standards (GIPS) provide ethical guidelines for investment firms to calculate and report their performance.
• Developed by CFA Institute to ensure fair representation and full disclosure.
• 2020 edition includes standards for firms, asset owners, and verifiers.

Problems Addressed by GIPS

• Representative Accounts: Avoids selecting top-performing accounts to represent overall results.
• Survivorship Bias: Prevents excluding poorly performing portfolios.
• Varying Time Periods: Ensures consistency by not cherry-picking time periods of high performance.

Objectives of GIPS

• Promote investor interests and confidence.
• Ensure accurate and consistent data.
• Foster global acceptance of a single performance standard.
• Encourage fair competition among investment firms.
• Support industry self-regulation.

Compliance

• Firms managing assets can choose to comply with GIPS.
• Consultants and software cannot claim compliance.
• Asset owners may comply similarly to firms if competing for business.
• Compliance is voluntary and firm-wide.

Compliance Questions

• Correct Statement: Asset owners managing assets can claim compliance.
• Incorrect Statements: Software cannot be compliant; firms cannot claim partial compliance.

GIPS - Composites

• Composites: Aggregated portfolios sharing similar investment mandates, objectives, or strategies.
• Prevents cherry-picking of top-performing accounts.
• Must include all fee-paying, discretionary accounts.
• Non-discretionary portfolios are excluded.

Practice Question on Composites

• Correct: Composites must consist of portfolios managed according to a similar strategy.
• Incorrect: Does not require multiple portfolios or ex post selection.

Fundamentals of Compliance

• Firm Definition: Adopt a broad definition including all geographical offices.
• Discretion: Determines portfolio inclusion in composites based on the ability to implement investment strategies.

Verification

• Firms self-regulate compliance claims.
• Third-party verification is voluntary but can increase confidence.
• Verification covers the entire firm, not specific composites.

Performance Evaluation Components

1. Performance Measurement: Calculates portfolio return.
2. Performance Attribution: Analyzes performance sources.
3. Performance Appraisal: Assesses skill versus luck.

Performance Calculation

• Time-Weighted Return (TWR): Preferred for its independence from cash flow timing.
• Money-Weighted Return (MWR): Used when managers control cash flows.
• Annualized Return: Compounds shorter period returns for comparison.
• GIPS mandates TWR, but allows MWR under specific conditions.

Key Points on Performance Calculation

• Accurate calculation requires portfolio valuation upon each external cash flow.
• TWR eliminates external cash flow impacts.
• Firms must report at least 5 years of annual performance in GIPS Composite Reports.

Conclusion

• Method of performance calculation is critical to accurate investment reporting.

References

• Various CFA Institute publications and Investopedia as reference materials.