What are GIPS 2020?
The Global Investment Performance Standards were created in the 1990s to ensure performance transparency and facilitate comparability. Asset managers in asset classes other than alternatives have adopted them widely, in large part at the demand of their institutional investors, while private equity firms simply haven’t. The updated standards, GIPS 2020, which represents the first big update in nearly a decade, are broadening that goal to all asset classes including alternative asset managers, which have gained relevance since the last recession.
What changes will make the standards more relevant to GPs?
“Currently over 1,700 firms and asset owners from more than 46 markets claim compliance with the GIPS standards,” says Karyn Vincent, head of global industry standards at the CFA Institute. “However, we have had less success with alternative and pooled fund managers, who have indicated that the structure of the GIPS standards is not a good fit for them. We believe it is important for these firms to choose to comply with the GIPS standards. To make GIPS compliance a realistic option for them, we needed to make some changes to the structure of the GIPS standards.”
There are several. One of the most important relates to the use of composites, which under GIPS is considered the true number reflecting the skills of the portfolio manager.
The GIPS standards were originally designed for investment firms selling participation in a strategy through a separate account that is managed solely for that client. Composites are used to aggregate the performance of all client accounts and any pooled funds managed in a specific strategy. The rule didn’t make much sense for a private equity firm once it had finished with its capital raise and was no longer marketing that product. It was expensive and unnecessary, particularly for the GPs that had raised several funds since inception. The 2020 edition of the GIPS standards still accommodates the marketing of composites, but the CFA Institute also added additional reporting designed for firms selling participation in a specific pooled fund. It has also included guidance tailored for asset owners.
The other change has to do with the way asset managers report returns. Under the current standards, if a private equity manager was going to use a money-weighted return calculation, it had to give a performance number every year, which is meaningless in the private equity world. The CFA Institute decided to change that. Now firms have to show money-weighted return from fund inception and it doesn’t have to break it down year by year.
Are there some downsides to complying?
GIPS compliance is expensive and creates regulatory risk if a firm gets it wrong. The Securities and Exchange Commission has shown through enforcement actions that asset managers can get in some trouble.
If compliance with GIPS 2020 is voluntary, why should GPs adopt the new standards?
The CFA Institute wants to convince LPs that compliance with GIPS 2020 has to become a marketing necessity for private equity funds and other alternative asset managers. If it is successful, GPs will start embracing the standards, but it’s still several years away before wider adoption, if it ever happens.
“The CFA Institute is on a very active marketing program, where they are really trying to strongly encourage institutional clients, endowments, foundations, sovereign wealth funds, to require anybody who is trying to market to them a fund that it is GIPS compliant, because it creates an apple-to-apple comparison,” says Michael Caccese, head of the financial services practice at K&L Gates. “There’s no more cherry picking, they’re all complying with the same rules.”
But he adds that most PE firms, unless the market tells them they have to do it, are not going to comply with GIPS 2020. “There will be a couple out there who are trying to distinguish themselves by adopting the standards and being GIPS compliant, but I think that would definitely be a minority,” he says. On the other hand, not adopting could end up being detrimental to a GP if the CFA Institute is successful in building a strong group of institutional investors to require compliance.
Are there signs LPs are pushing for adoption?
There are some early ones. According to an August survey conducted by eVestment and ACA Compliance Group, 67 percent of alternative asset managers believe investors and consultants will ultimately require alternative managers to comply with GIPS, which would be a fundamental change for the industry.
“Some LPs and their consultants ask GPs if they are GIPS-compliant,” Vincent says. “With more asset owners themselves claiming compliance with the GIPS standards, we expect to see even more asset owners/LPs push for GPs to comply with the GIPS standards.”
Could there be a surprise when GIPS 2020 comes out June 30?
We don’t know fully what will be in the final standards, Caccese says, adding that he thinks at least 70-80 percent of what was initially proposed will stay.
A part in the initial proposal on subscription lines of credit and how they should be included in performance reporting was controversial with private equity firms and it remains to be seen whether it makes it into the final standards. The proposals require managers to show performance both with and without a line of credit, which GPs find too cumbersome.
What is the timeline for adoption?
GIPS reports that include performance for periods that end on or after December 31, 2020, must be prepared in compliance with the 2020 edition of the GIPS standards. Because most firms include calendar year returns in GIPS reports, this would be at some point in 2021. Firms may also choose to comply with the 2020 GIPS standards earlier.