In private equity, there still isn’t much agreement on how to measure performance. From a risk perspective, this has always posed a significant problem for LPs. But these days, it's increasingly an issue for GPs too.
For investors, the risk is obvious: an inability to assess GPs’ performance on an apples-to-apples basis makes it hard to know who’s truly top-quartile (and thus worthy of their attention).
As such, the lack of a common standard has arguably been an advantage 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 AIFMD 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.
In other words: there's clearly a growing case for industry-wide adoption of an agreed performance standard. So why not use one that already exists?
The Global Investment Performance Standard (GIPS) – which is intended for fund managers in private equity, real estate and any other area that uses vintage year and IRR in its calculations – was originally launched in 1997 by the CFA Institute, a global nonprofit organization of investment professionals, and has been gradually developed and tweaked ever since. So it's an alternatives-specific standard, built by the industry for the industry. The only trouble is: only about one in five private equity or hedge fund managers actually provide presentation decks compliant with GIPS, according to a 2014 ACA Compliance Group survey.
Why the low take-up? It's 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.
A bigger problem is that some managers still believe that GIPS is too rigid as a standard. This is a mistake. For example, one frequent bone of contention is around vintage years, which different GPs define in different ways. But GIPS doesn't actually prescribe (nor proscribe) any particular definition; it just requires that the method used is disclosed. Ditto 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.
Jesse Reyes, chairman of the private equity GIPS sub-committee, suggests there's also some confusion about when GIPS should be used. “The only prescribed use for a GIPS-compliant presentation is when presenting performance track records to prospective investors; no other use is required, recommended nor prescribed.” In other words, quarterly statements and other material sent to existing LPs doesn’t necessarily have to follow GIPS. Nor does GIPS apply to LPs' own reporting procedures (although GIPS does provide a framework for best practice here too).
It's probably also true that GIPS can be a difficult read for fund managers, given some of the terminology it uses (terms like 'clients', 'products' and 'composites' might seem a bit odd to GPs who are used to thinking more in terms of 'investors', 'strategy' and 'funds'). But Reyes says that once these terms are understood, GIPS becomes a much easier read. In fact, he says, other than some additional disclosures, much of GIPS (at least as far as private equity goes) “is not significantly different than what GPs already do on a day-to-day basis”.
The salient point, though, is that more and more LPs are beginning to request GIPS-compliant presentation materials. Throw in the extra regulatory scrutiny, and a growing understanding of its idiosyncracies, and it's easy to see GIPS starting to get a lot more traction across the industry. Let's hope so.
For a special report on risk management, including an investigation into how GPs are meeting the AIFMD's difficult risk provisions, see the upcoming August edition of pfm.