1.4 INTRODUCTION TO THE GLOBAL
INVESTMENT PERFORMANCE
STANDARDS (GIPS)
1.4.a(i). WHY GIPS WERE CREATED
Before a uniform set of performance presentation standards were available, it was quite difficult
to compare the performance between investment managers. Discrepancies arose for many
reasons. For instance, a manager may have only chosen her best accounts when presenting
historic performance, or the performance might have been subject to survivorship bias, whereby
only the performance of existing accounts were included in the presentation. This latter practice
would ignore accounts that were previously managed but which were eventually transferred out
by clients perhaps due to poor performance. Furthermore, managers had an incentive to report
only their best performing periods.
Therefore, the CFA Institute created GIPS, a ‘voluntary’ set of best practices in performance
presentation that should facilitate a more fair and complete presentation of the performance
figures of managers domiciled anywhere in the world. The primary objectives of GIPS are as
follows:
i) Establish best practices for the computation and reporting of investment performance.
ii) Obtain world-wide acceptance of the notion of a single set of performance presentation
standards.
iii) Promote the use of accurate performance data.
iv) Encourage fair, global competition among investment firms without creating barriers to entry
(i.e. GIPS is not intended to make performance presentation more costly).
v) Foster the notion of industry self-regulation on a global basis.
Thus, by adhering to a global set of standards, firms in countries with a minimal set of
performance standards will be able to compete on an equal footing with firms operating in
jurisdictions with a more established set of standards. Clients will benefit as the performance
presentation among the firms will become more comparable, thus fostering a greater degree of
confidence among investors.
1.4.a(ii). PARTIES AFFECTED BY GIPS
GIPS may be used by any entity that routinely reports its investment performance (examples
include mutual funds, private wealth management firms, pension fund managers, etc.). Other
parties, such as pension sponsors or consultants, may endorse GIPS, but since they are not
directly involved in the investment management process, cannot claim compliance with GIPS.
While the choice to comply with GIPS is voluntary, a firm may only claim compliance if it meets
the conditions of GIPS on a firm-wide basis, and not just for a few portfolios or composites (a
compilation of similar portfolios). If compliance is not on a firm-wide basis, then a claim of
“partial” compliance cannot be made.
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GIPS is meant to serve two groups. First of all, investment management firms should benefit
since GIPS compliant performance figures will be deemed as being of high quality, thus enabling
them to compete globally. And second, prospective investment clients will benefit as GIPS
compliant performance figures may be more comparable between the various competing
investment managers. However, GIPS does not eliminate the need to perform the due diligence
required in selecting investment managers.
1.4.b. COMPOSITES
Composites are a compilation of portfolios which have a similar investment objective or are
managed the same way. For example, a domestic equity composite is a compilation of all the
portfolios (or parts of larger portfolios) managed at the firm that have a mandate to invest in
domestic stocks. Consequently, it is the performance of this composite which is used to report
how the firm did on its domestic equity strategy. In other words, the firm’s reported performance
of its domestic equity strategy should take into account the performance of ALL its domestic
equity portfolios.
For a portfolio to be included in a composite, the following conditions must be met:
i) The portfolio must be discretionary (i.e. the manager has the power to select the investments
for the portfolio). Since these composites are meant to measure the performance of the manager,
client-directed accounts (client makes the investment decisions) are excluded.
ii) The portfolio must be real. Since GIPS only captures actual returns, simulated portfolios may
not be included in the composites.
iii) The portfolio must be fee paying. Therefore, non-fee paying portfolios are excluded from the
composites.
In other words then, composites reveal the return on all actual, fee-paying, discretionary
portfolios that were managed by the firm.
A composite’s historical performance is a matter of fact and thus should not be changed. For
instance, suppose that a composite generated a return of 5.2% in 2003. If in 2005, one of the
poorer performing portfolios from that composite was withdrawn from the firm, the firm then
would not be able to retroactively re-compute the composite’s return for 2003 (this time
excluding the withdrawn portfolio). This prohibition of retroactive restatement of composite
returns will ensure that the reported performance figures are free from survivorship bias.
Survivorship bias occurs when the weaker variables are dropped from a group, thus causing the
average for the group to look much better than had the weaker variables been included.
It is largely up to the investment manager to determine how to allocate all the qualifying
portfolios to the various composites. Best practice would be for the firm to establish a
predetermined set of allocation criteria. The existence of these allocation rules would ensure that
portfolios are not allocated in such a way that would result in the manipulation of composite
returns. For example, if the portfolio manager was soliciting a large equity based account, he
may have an incentive to allocate all the best performing equity portfolios in the equity
composite, and place the inferior performing equity portfolios in some other composite.
Consequently, the equity composite returns would be made to look artificially high in the hopes
of attracting that prospective equity client.
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1.4.c. VERIFICATION
A firm is allowed to self-proclaim compliance with GIPS. However, prospective clients would
be more assured of this assertion if the firm were to hire an outside 3 rd party to independently
verify the firm’s claim of compliance (much like how a publicly traded company hires an
independent auditor to verify that its financial statements are accurate and fair). A firm cannot
verify (i.e. audit) its own compliance with GIPS. Verification may only be performed by an
independent party.
GIPS compliance may only be verified if the following 2 conditions exist:
i) The firm has complied on a firm wide basis in constructing its composites (i.e. all qualifying
portfolios at the firm have been included in at least one composite).
ii) The calculations and the performance presentations are in compliance with GIPS.
Therefore, verification can only be for the firm as a whole (i.e. verification is not possible on a
composite by composite basis). While verification is not mandated, it is strongly recommended.
Investment firms must realize that verification by an independent third party adds credibility to
their stated performance figures.
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