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# GIPS & Performance
# Evaluation
Global Investment Performance Standards (GIPS) and Performance
Evaluation
> Fernando Forcada, CFA
> Selected Topics, February 2025
# 1GIPS
>
Global Investment Performance Standards (GIPS) are a set of
ethical principles, developed and promoted by the CFA Institute, that
provide investment firms with guidance on how to calculate and report
their investment results to prospective clients
>
The GIPS standards are based on the ideals of fair representation and
full disclosure of an investment management firms performance
history
>
The 2020 edition of the GIPS standards has three chapters :
GIPS Standards for Firms
GIPS Standards for Asset Owners
GIPS Standards for Verifiers
# 2GIPS
>
In the past, the investment community had great difficulty making
meaningful comparisons on the basis of accurate investment
performance data . Misleading practices included :
Representative Accounts : Selecting a top -performing portfolio to represent
the firms overall investment results for a specific mandate
Survivorship Bias : Presenting an average performance history that
excludes portfolios whose poor performance was weak enough to result in
termination of the firm/portfolio
Varying Time Periods : Presenting performance for a selected time period
during which the mandate produced excellent returns or out -performed its
benchmark
# 3GIPS
The objectives of the GIPS standards are as follows :
Promote investor interests and instill investor confidence
Ensure accurate and consistent data
Obtain worldwide acceptance of a single standard for calculating and presenting
performance
Promote fair, global competition among investment firms
Promote industry self -regulation on a global basis
Who Can Claim Compliance?
Any firm that actually manages assets may choose to comply with the GIPS
standards
Consultants cannot make a claim of compliance unless they manage assets for which
they are making a claim of compliance
Software (and the vendors who supply software) cannot be compliant
Asset owners may comply with the GIPS standards in the same way as
firms if they compete for business
If they dont compete for business but report their performance to an oversight body,
asset owners may choose to comply with the GIPS standards for asset owners
Compliance is a firm -wide process that cannot be achieved on a single
product or composite
Complying with the GIPS standards is voluntary . It is not typically required
by legal or regulatory authorities 4Practice Question
Which of the following statements regarding GIPS compliance is
correct?
> A.
Asset owners that manage assets can claim compliance with the GIPS
Standards
> B.
Software that calculates performance in a manner consistent with the
GIPS standards can claim compliance with GIPS standards
> C.
Firms can comply with the GIPS standards by limiting their
compliance claims to the provisions they have chosen to follow
# 5Answer
A is correct . Asset owners can make a claim of compliance if they actually
manage assets for which they are making a claim of compliance
B is incorrect because software (and the vendors that supply software)
cannot be GIPS compliant . Software can assist firms in achieving
compliance with the GIPS standards, but only an asset manager can claim
compliance
C is incorrect because a firm has only two options regarding compliance
with the GIPS standards : fully comply with all requirements of the GIPS
standards and claim compliance through the use of the GIPS Compliance
Statement ; or not comply with all requirements of the GIPS standards and
not claim compliance with, or make any reference to, the GIPS standards
# 6GIPS - Composites
One of the key concepts of the GIPS is the required use of composites .
A composite is an aggregation of one or more portfolios managed
according to a similar investment mandate, objective, or strategy
The requirement to create, use and maintain composites is designed to
prevent firms from cherry -picking using the best -performing
accounts to represent the performance of an investment strategy
A composite must include all actual, fee -paying, discretionary
portfolios managed in accordance with the same investment mandate,
objective, or strategy
All fee -paying discretionary accounts managed by the firm must be
included in at least one composite
Non -discretionary portfolios must not be included in a firms composites
Non -fee -paying discretionary accounts may be included in a composite (with
appropriate disclosure)
# 7Practice Question
Each composite of a GIPS -compliant firm must consist of :
A. Multiple portfolios
B. Portfolios selected on an ex post basis
C. Portfolios managed according to a similar investment strategy
# 8Answer
C is correct . A composite is an aggregation of one or more portfolios
managed according to a similar investment mandate, objective, or strategy .
For example, if a GIPS -compliant firm presents performance for a global
equity composite (the composite), the composite must include portfolios
that are managed, or have historically been managed, according to the
firms global equity strategy
A is incorrect because a composite is an aggregation of one or more
portfolios managed according to a similar investment mandate, objective,
or strategy . A composite may consist of a single portfolio when it is the only
portfolio managed according to a particular mandate
B is incorrect because the determination of which portfolio(s) to include
in a composite should be done according to pre -established criteria (ex ante
basis), not after the fact (ex post basis)
# 9GIPS Fundamentals of Compliance
Two important issues that a firm must consider when becoming
compliant with the GIPS standards are :
Definition of the firm : The firm should adopt the broadest, most meaningful
definition of the firm . The scope of this definition should include all
geographical (country, regional, etc .) offices operating under the same
brand name, regardless of the actual name of the individual investment
management company .
For small investment management boutiques, defining the firm may be a relatively
easy task, but it can prove challenging for large firms
Firms definition of discretion establishes criteria to judge which portfolios
must be included in a composite and is based on the firms ability to implement
its investment strategies
Non -discretionary portfolios must not be included in a firms composites
Generally speaking, a portfolio is discretionary if the manager is able to implement the
intended investment strategy
# 10 GIPS - Verification
Firms that claim compliance with the GIPS standards are responsible for
their claim of compliance and for maintaining that compliance . That is,
firms self -regulate their claim of compliance
Firms may voluntarily hire an independent third party to perform a
verification in order to increase confidence in the firms claim of
compliance
Verification is performed with respect to an entire firm , not on specific
composites
Verification does not ensure the accuracy of any specific composite
presentation
Verification must be performed by an independent third party . A firm
cannot perform its own verification
# 11 Practice Question
Which of the following is not a commonly perceived benefit of the
GIPS standards?
A. Comparability of results across managers that claim compliance
B. Adherence to regulatory requirements
C. Increased confidence by investors and beneficiaries
# 12 Answer
B is correct . Compliance with the GIPS standards is not typically
required by regulators, nor are the GIPS standards intended to cover all
regulatory requirements .
# 13 Intro - Performance Evaluation
The three components of Performance Evaluation are :
Performance Measurement : what was the portfolios performance? It
consists of calculating rates of return based on investment -related changes in a
portfolios value over specified time periods . The total rate of return is the
primary measure of investment performance
Performance Attribution : why did the portfolio produce the observed
performance? It investigates both the sources of the portfolios performance
relative to a specific investment benchmark and the importance of those sources
Performance Appraisal : is the portfolios performance due to luck or skill? It
tries to draw conclusions concerning the quality (that is, the magnitude and
consistency) of the portfolios relative performance . Risk -adjusted relative
performance measures (Sharpe ratio, Treynor Measure, Information ratio )
are typically used for this
By using appropriate financial market indices as benchmarks, the
portfolio performance can be decomposed to reveal the sources of
returns . Depending on the nature of the portfolio, the performance
might come from the following sources :
Asset allocation
Sector selection
Stock selection
Currency exposure 14 Intro - Performance Calculation
There are several methods to calculate the performance (esp . to deal with
external cash flows ):
Time -weighted rate of return reflects the compound rate of growth over a
stated evaluation period of one unit of money initially invested in the
portfolio . It requires that the portfolio be valued every time an external cash
flow occurs , that is, requires computing a set of subperiod returns (with the
number of subperiods equaling one plus the number of dates on which external
cash flows occur)
Money -weighted rate of return (or IRR) measures the compound growth
rate in the value of all funds invested in the portfolio over the evaluation period,
that is, it represents the average growth rate of all money invested in a
portfolio, linking the ending value to its beginning value plus all intermediate
cash flows . It gives greater weight to time periods where the portfolio has
greater value than to periods where the portfolio has less value
Other methods (developed by Peter O. Dietz) :
Original Dietz (approximation that assumes all the cash flows occur at the midpoint
of the evaluation period, that is, cash flows are weighted equally regardless of when
they occurred)
Modified Dietz (approximation based on a time -weighted factor for each cash flow,
that is, the cash flows are weighted based on the time they occurred in the period)
# 15 Intro - Performance Calculation
Money -Weighted vs . Time -Weighted Rate of Return :
The time -weighted rate of return is preferred because it is not affected by the
timing and amount of cash inflows and outflows
Note : Decisions regarding contributions and withdrawals from a portfolio are
usually made by clients . Since these decisions are not typically in investment
managers hands, it would be inappropriate to evaluate their performance based
on money -weighted returns
However, if a manager does have discretion over withdrawals and contributions
of funds in a portfolio, money -weighted return might be a more appropriate
measure of portfolio performance
If funds are deposited into the investment portfolio prior to a period of superior
performance, money -weighted return will be higher than time -weighted return
If funds are deposited into the investment portfolio just before a period of
relatively poor performance, money -weighted return will be lower than time -
weighted return
If a portfolio is valued daily over the course of a year, the time -weighted rate of
return can be calculated as :
(1 + r1) (1 + r2) (1 + r365 ) 1
where r = daily holding period returns
# 16 Intro - Performance Calculation
Annualized return : for comparison purposes, rates of return are
typically reported on an annualized basis . The calculation is also
known as the compound growth rate or geometric mean return
To annualize any return for a period shorter than one year, the return for the
period must be compounded by the number of periods in a year
where c is the number of periods in a year (365 d, 52 w, 12 m, 4q)
# 17 Intro - Performance Calculation
# 18 The GIPS standards mandate the use of a Time -weighted return
(TWR)
However, Money -weighted returns (MWRs) may be used for
portfolios meeting certain conditions :
If the firm has control over the external cash flows and : (1) the portfolios
are closed -end, fixed life, or fixed commitment or (2) illiquid investments are a
significant part of the investment strategy
Under TWR :
If returns are not calculated daily and the portfolio receives a large cash
flow , the portfolio must be valued , and a sub -period return must be
calculated at the time of the large cash flow
What constitutes a large cash flow is defined by the firm . It may be defined either
relative to an absolute monetary threshold or as a % of the portfolio
If returns are not calculated daily and the portfolio experiences cash flows
that are not large , portfolio returns must be calculated using a method
that adjusts for daily weighted cash flows (approximation of a true TWR)
Examples of acceptable approaches are the Modified Dietz and the Modified IRR
# 19
# GIPS - Performance Calculation The most accurate way to calculate a total return , while
eliminating the impact of external cash flows, is to value the portfolio
whenever an external cash flow occurs, compute a sub -period
return , and geometrically link sub -period returns expressed in
relative form according to Equation :
>
Therefore, GIPS require the use of time -weighted rates of return,
or approximations to time -weighted rates of return , to eliminate
the impact of external cash flows on the return calculation
>
For each GIPS Composite Report that includes time -weighted returns,
the GIPS standards require that firms show at least 5 years of
annual performance (unless the composite has been in existence for
less than 5 years)
>
Conclusion : The investment performance calculation method matters!! 20
# GIPS - Performance Calculation References
>
Ethics and Investment Professionalism . Gerhard Hambusch ,
CFA . Investment Foundations, CFA Institute, 2016
>
Introduction to the Global Investment Performance
Standards (GIPS) . CFA Institute, 2024
>
Code of Ethics and Standards of Professional Conduct . CFA
Institute, 2014
>
Standards of Practice Handbook . 2014 11 th Edition, CFA
Institute
>
https ://www .investopedia .com
# 21