In October, the CFA Institute issued a new requirement for investment managers who claim compliance with the Global Investment Performance Standards (GIPS). Starting in January, those managers will have to file a notification with the CFA as part of the organization’s attempt to catalogue the firms that use its global reporting system.
Put differently, it just got a whole lot easier for investors (and regulators) to fact-check fund managers who claim top-quartile status using an objective performance benchmark.
The purpose of GIPS is to give LPs an apples-to-apples comparison of potential GPs, based on the fair representation and full disclosure of at least five years of performance results.
As of today, the GIPS standard hasn’t caught fire in the private funds industry. According to an independent survey conducted by ACA Compliance Group, only about one in five private equity or hedge fund managers currently provide presentation decks compliant with GIPS, and industry sources agree that the private firms prioritizing GIPS compliance are few and far between. The reason why is partly a chicken and egg issue. Most GPs say they’ll only invest the time and expense required to comply with GIPS when LPs demand it. But LPs are reluctant to start demanding it when so few GPs are using it.
Another problem is that some managers believe that GIPS is too rigid as a standard. For example, one frequent bone of contention is around vintage years, which different GPs define in different ways. Proponents of GIPS say this is a mistake, noting that GIPS doesn’t actually prescribe (nor proscribe) any particular definition; it just requires that the method used is disclosed. The same is true for GPs using “public market equivalent” (PME) methods, something investors are increasingly keen on: GPs can use whatever version of PME they like, as long as the method and public market index is disclosed.
A call for transparency
With measures like the notification requirement, its new initiatives to engage with LPs, and the formation of a Private Equity Working Group, the CFA is trying to change GIPS’ image in the private sector. The organization hopes that these efforts, combined with increased regulatory scrutiny, will bring GIPS into the mainstream.
As chairman of the GIPS PE subcommittee, Jesse Reyes has witnessed the difficulty in bringing private equity players on board firsthand. The main challenge, notes Reyes, is the lack of an external catalyst to push GPs into complying with a voluntary set of standards.
“Real GIPs compliance will come with one of two things: pressure from regulators or pressure from LPs,” he says.
Although the US Securities and Exchange Commission (SEC) does not require that investment advisers use GIPS, the standards are on the regulator’s radar. Any firm that claims GIPS compliance must provide proof of that designation during a presence exam. The SEC issued its first formal GIPS-related sanction this past June against ZPR Investment Management.
“That headline changed people’s perceptions about how important this might be from a regulatory perspective,” says Reyes. “If there are more cases like that, I think it will start creating more demand for GIPS compliance on the part of LPs and raise more awareness from GPs.”
Cynics also say the absence of a common performance standard is advantageous to some GPs (since it makes it easier to manipulate track record data). But in light of greater regulatory oversight – not least that related to SEC registration in the US and the implementation of Alternative Investment Fund Managers Directive in Europe – the absence of such a standard has become a growing compliance risk. Inspectors want the performance figures adorning marketing materials and websites to have been generated via an independent set of guidelines – thus eliminating the chance of a GP cherry-picking data to achieve top-quartile status. Looser rules on mass-marketing (or general solicitation) in the US could also push regulators to demand tighter performance reporting requirements, in the name of investor protection.
Since the institution of Dodd-Frank, the industry has found itself under a regulatory microscope, and complying with a set of third-party requirements might work in a GP’s favor, notes chief GIPS examiner at the CFA Jonathan Boersma.
“GIPS is one way to answer that call for transparency from regulators,” says Boersma. “Showing GIPS compliance is raising the bar as to how transparent a firm is willing to be.”
LP apathy
For investors in traditional asset classes, GIPS has become a fundamental tool. However, that reliance on GIPS does not transfer to the private funds sphere (see graphs). For example, the Orange County Employees Retirement System (OCERS) requires potential hedge fund managers to provide annual calendar year returns for 10 years in accordance with GIPS standards. Yet OCERS told pfm that it does not look for GIPS compliance when investing in private strategies, nor would it look more favorably on a private firm that was GIPS compliant.
“I don’t know of any LPs that won’t invest in a fund or review a fund because the firm isn’t GIPS compliant,” adds Reyes. “If there were a case like that with a large enough investor, it would change the game.”
Boersma notes that even putting a question about GIPS compliance in a request for proposal for a private equity fund might increase GPs’ awareness and willingness to comply.
“No one wants to check the ‘no’ box, so just asking the question goes a long way,” he notes. He adds that GIPS addresses many of the top issues that keep investors up at night – such as fees and internal controls and processes – so asking about compliance with GIPS would be a simple way to add an extra layer of comfort and security.
Time and money
Despite the enthusiasm from the CFA, for most managers, GIPs, and other third-party efforts for industry standardization like the Institutional Limited Partners Association (ILPA) reporting requirements, are too time consuming and costly to opt into without the LP demand.
“Frankly, we private equity CFOs have plenty of things that we are required to pay attention to (SEC registration, Form PF, FACTA, the custody rule) so something like GIPS or the ILPA templates are distractions that we don’t have time for,” said one private equity CFO in an email to pfm. “I have not had a single LP ask about GIPS.”
In order to comply with GIPS, managers must hire an independent verifier such as EY or Deloitte to audit their performance. While Reyes suggests that managers who have undergone an SEC presence exam likely fit the bill for GIPS compliance already and would only need to be verified, managers suggest that the added work is not worth the hassle.
“I don’t think that the LP community would ever coalesce around a single set of standards that are not in the US generally accepted accounting principles, so I am not concerned about GIPS becoming an issue during my career,” added the CFO.
Indeed, the ACA survey verified these sentiments when it asked managers who do not comply with GIPS why they have not yet done so. In the top responses, 43 percent of non-compliant managers said the process was “cost prohibitive,” while 39 percent said the process was “too time consuming.”
“I’ve heard some people say, ‘We’re compliant with the spirit of GIPs, why go through the headache of getting certified?’” says Reyes. “It’s not like a driver’s license where you need to have it to drive the car.”
Moving the needle
While the industry remains resistant now, wider acceptance of the standards in the private funds community eventually might be on the horizon. With the new notification requirement, the list of firms claiming compliance will be posted on the GIPS website. Making this information public for the first time “may motivate firms not currently claiming compliance to do so, resulting in broader adoption,” according to a release from the CFA.
“For example, if a firm sees that four of its top five competitors are all compliant with these standards, they might consider it more seriously,” says Boersma.
The list will also serve as a resource for potential investors during the due diligence process, as they can verify a firm’s compliance with GIPS. The CFA realizes the importance bringing investors on board, and also issued a guidance statement effective in January to help “asset owners” (or LPs) interpret and apply GIPS.
“If I’m an investor and a firm I’m investing with is not on this list, I might go back to the manager and ask ‘Why aren’t you on this list?’” adds Reyes. “From a promotion and awareness perspective, it’s a step in the right direction.”
A few firms like Adams Street, LGT Capital Partners and Pinebridge make note of their GIPS compliance on their websites, but come the publication of the list next year, it will be far easier to judge what actual impact GIPS has had on the industry.
Until then, the CFA will continue working to find ways to incorporate the private investment community into the GIPS world. “We’re always looking at the standards to see if something’s making it difficult for firms to comply,” says Boersma. “We’re not going to lower the bar, but if there’s an aspect that’s causing firms not to claim compliance, we’ll make adjustments.”
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