Complying with the Global Investment Performance Standards (GIPS ® ) The Frank J. Fabozzi Series Fixed Income Securities, Second Edition by Frank J. Fabozzi Focus on Value: A Corporate and Investor Guide to Wealth Creation by James L. Grant and James A. Abate Handbook of Global Fixed Income Calculations by Dragomir Krgin Managing a Corporate Bond Portfolio by Leland E. Crabbe and Frank J. Fabozzi Real Options and Option-Embedded Securities by William T. Moore Capital Budgeting: Theory and Practice by Pamela P. Peterson and Frank J. Fabozzi The Exchange-Traded Funds Manual by Gary L. Gastineau Professional Perspectives on Fixed Income Portfolio Management, Volume 3 edited by Frank J. Fabozzi Investing in Emerging Fixed Income Markets edited by Frank J. Fabozzi and Efstathia Pilarinu The Handbook of Traditional and Alternative Assets by Mark J. P. Anson The Global Money Markets by Frank J. Fabozzi, Steven V. Mann, and Moorad Choudhry The Handbook of Financial Instruments edited by Frank J. Fabozzi Interest Rate, Term Structure, and Valuation Modeling edited by Frank J. Fabozzi Investment Performance Measurement by Bruce J. Feibel The Handbook of Equity Style Management edited by T. Daniel Coggin and Frank J. Fabozzi The Theory and Practice of Investment Management, Second Edition edited by Frank J. Fabozzi and Harry M. Markowitz Foundations of Economic Value Added, Second Edition by James L. Grant Financial Management and Analysis, Second Edition by Frank J. Fabozzi and Pamela P. Peterson Measuring and Controlling Interest Rate and Credit Risk, Second Edition by Frank J. Fabozzi, Steven V. Mann, and Moorad Choudhry Professional Perspectives on Fixed Income Portfolio Management, Volume 4 edited by Frank J. Fabozzi The Handbook of European Fixed Income Securities edited by Frank J. Fabozzi and Moorad Choudhry The Handbook of European Structured Financial Products edited by Frank J. Fabozzi and Moorad Choudhry The Mathematics of Financial Modeling and Investment Management by Sergio M. Focardi and Frank J. Fabozzi Short Selling: Strategies, Risks, and Rewards edited by Frank J. Fabozzi The Real Estate Investment Handbook by G. Timothy Haight and Daniel Singer Market Neutral Strategies edited by Bruce I. Jacobs and Kenneth N. Levy Securities Finance: Securities Lending and Repurchase Agreements edited by Frank J. Fabozzi and Steven V. Mann Fat-Tailed and Skewed Asset Return Distributions by Svetlozar T. Rachev, Christian Menn, and Frank J. Fabozzi Financial Modeling of the Equity Market: From CAPM to Cointegration by Frank J. Fabozzi, Sergio M. Focardi, and Petter N. Kolm Advanced Bond Portfolio Management: Best Practices in Modeling and Strategies edited by Frank J. Fabozzi, Lionel Martellini, and Philippe Priaulet Analysis of Financial Statements, Second Edition by Pamela P. Peterson and Frank J. Fabozzi Collateralized Debt Obligations: Structures and Analysis, Second Edition by Douglas J. Lucas, Laurie S. Goodman, and Frank J. Fabozzi Handbook of Alternative Assets, Second Edition by Mark J. P. Anson Introduction to Structured Finance by Frank J. Fabozzi, Henry A. Davis, and Moorad Choudhry Financial Econometrics by Svetlozar T. Rachev, Stefan Mittnik, Frank J. Fabozzi, Sergio M. Focardi, and Teo Jasic Developments in Collateralized Debt Obligations: New Products and Insights by Douglas J. Lucas, Laurie S. Goodman, Frank J. Fabozzi, and Rebecca J. Manning Robust Portfolio Optimization and Management by Frank J. Fabozzi, Peter N. Kolm, Dessislava A. Pachamanova, and Sergio M. Focardi Advanced Stochastic Models, Risk Assessment, and Portfolio Optimizations by Svetlozar T. Rachev, Stogan V. Stoyanov, and Frank J. Fabozzi How to Select Investment Managers and Evaluate Performance by G. Timothy Haight, Stephen O. Morrell, and Glenn E. Ross Bayesian Methods in Finance by Svetlozar T. Rachev, John S. J. Hsu, Biliana S. Bagasheva, and Frank J. Fabozzi The Handbook of Municipal Bonds edited by Sylvan G. Feldstein and Frank J. Fabozzi Subprime Mortgage Credit Derivatives by Laurie S. Goodman, Shumin Li, Douglas J. Lucas, Thomas A Zimmerman, and Frank J. Fabozzi Introduction to Securitization by Frank J. Fabozzi and Vinod Kothari Structured Products and Related Credit Derivatives edited by Brian P. Lancaster, Glenn M. Schultz, and Frank J. Fabozzi Handbook of Finance: Volume I: Financial Markets and Instruments edited by Frank J. Fabozzi Handbook of Finance: Volume II: Financial Management and Asset Management edited by Frank J. Fabozzi Handbook of Finance: Volume III: Valuation, Financial Modeling, and Quantitative Tools edited by Frank J. Fabozzi Finance: Capital Markets, Financial Management, and Investment Management by Frank J. Fabozzi and Pamela Peterson-Drake Active Private Equity Real Estate Strategy edited by David J. Lynn Foundations and Applications of the Time Value of Money by Pamela Peterson-Drake and Frank J. Fabozzi Leveraged Finance: Concepts, Methods, and Trading of High-Yield Bonds, Loans, and Derivatives by Stephen Antczak, Douglas Lucas, and Frank J. Fabozzi Modern Financial Systems: Theory and Applications by Edwin Neave Institutional Investment Management: Equity and Bond Portfolio Strategies and Applications by Frank J. Fabozzi Introduction to Fixed Income Analytics, Second Edition by Frank J. Fabozzi and Steven V. Mann The Basics of Finance + Website by Pamela Peterson Drake and Frank J. Fabozzi Emerging Market Real Estate Investment: Investing in China, India, and Brazil by David J. Lynn, Ph.D with Tim Wang, Ph.D Simulation and Optimization in Finance + Website by Dessislava A. Pachamanova and Frank J. Fabozzi Probabilty and Statistics for Finance by Svetlozar T. Rachev, Markus H ¨ ochst ¨ otter, Frank J. Fabozzi, and Sergio M. Focardi Financial Models with Levy Processes and Volatility Clustering by Svetlozar T. Rachev, Young Shin Kim, Michele Leonardo Bianchi, and Frank J. Fabozzi Complying with the Global Investment Performance Standards (GIPS ® ) BRUCE J. FEIBEL KARYN D. VINCENT John Wiley & Sons, Inc. Copyright c  2011 by John Wiley & Sons, Inc. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at www.wiley.com/go/permissions. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. GIPS ® is a registered trademark of CFA Institute. For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com. ISBN 978-0-470-40092-0 (hardback); 978-1-11-09300-9 (ebk); 978-1-118-09301-6 (ebk); 978-1-118-09302-3 (ebk) Printed in the United States of America. 10987654321 To Eli and Sam —BJF To Erin —KDV Contents About the Authors xi Preface xiii Acknowledgments xv Introduction xvii PART ONE Explanation of the GIPS Standards CHAPTER 1 Fundamentals of Compliance 3 Scope of the GIPS Standards 3 History of the GIPS Standards 4 Governance of the GIPS Standards 5 Organization of the GIPS Standards 7 Fundamentals of Compliance 8 Summary 12 CHAPTER 2 Defining the Firm and Composites 13 Defining the Firm 13 Defining Composites 23 Summary 50 PART TWO The Methodology for Calculating Returns CHAPTER 3 Portfolio Return Measurement 53 Single Period Rate of Return 54 Time Value of Money 63 Performance of the Investor: Money Weighted Returns 67 vii viii CONTENTS Internal Rate of Return 71 Performance of the Investment Manager: Time Weighted Returns 77 Portfolio Return Calculations for the GIPS Standards 82 Summary 90 CHAPTER 4 Composite Return Measurement 91 Composite Constituents 91 Composite Returns 93 Single Period Composite Return Considerations 97 Multi-period Composite Returns 100 Summary 107 CHAPTER 5 Dispersion and Risk Measurement 109 Internal Dispersion 109 Equal Weighted Dispersion 111 Asset Weighted Dispersion 114 Risk 119 Summary 137 PART THREE Reporting and Maintaining Compliance with the GIPS Standards CHAPTER 6 Disclosing and Advertising Composite Performance 141 Required Numerical Information 141 Required Disclosures 149 Length of Time for Disclosures 168 Presentation and Disclosure Recommendations 168 Supplemental Information 170 GIPS Advertising Guidelines 171 Summary 177 CHAPTER 7 Wrap-Fee/SMA, Private Equity, and Real Estate 179 Wrap-Fee/Separately Managed Accounts 180 Private Equity 188 Real Estate 198 Summary 203 Contents ix CHAPTER 8 Maintaining Compliance with the GIPS Standards 205 Organization and Oversight 205 Return Calculation 211 Error Correction 215 Managing Composites and Presentations 220 Summary 226 CHAPTER 9 Verification 227 Verification 228 Performance Examinations 229 Verification Considerations 230 Required Verification Procedures 234 The Verifier’s Report 241 Preparing for Verification 241 Summary 245 Index 247 About the Authors Bruce J. Feibel, CFA is Managing Director of Products for Investment Manager Services at BNY Mellon. Formerly, Mr. Feibel was Chief Strategy Officer for Eagle Investment Systems, a BNY Mellon company. He also has been Director of Global Products for BNY Mellon Analytical Solutions and Product Manager of Performance Measurement Technology at Eagle Invest- ment Systems. Prior to joining Eagle, Feibel was a principal at State Street Global Advisors. He is a past member of the CFA Institute Investment Per- formance Council and the GIPS Risk Standards Working Group. He is also the author of the book Investment Performance Measurement published by John Wiley & Sons. He earned his B.S. in Accounting from the University of Florida. Karyn D. Vincent, CFA, CIPM is the founder of Vincent Performance Ser- vices LLC, which provides GIPS consulting and verification services. Previ- ously, she served as the global practice leader for investment performance services at PricewaterhouseCoopers. Ms. Vincent is an active volunteer with CFA Institute and serves on the GIPS Executive Committee, which is re- sponsible for overseeing the GIPS standards globally. She chairs the GIPS Interpretations Subcommittee and previously was a member of the CIPM Advisory Council. From 2002–2006 she chaired the AIMR-PPS ® Implemen- tation Committee and the GIPS Verification Subcommittee. She earned a B.S in Accounting from the University of Massachusetts Dartmouth. xi Preface P erformance measurement is an important concept for anyone managing or investing institutional assets. Complying with the Global Investment Performance Standards (GIPS ® ) provides individuals and firms with two things: (1) guidance for the investment firm in achieving compliance with the Global Investment Performance Standards—the GIPS standards—and (2) detailed explanations of the rationale and methodology behind the numbers. Expanding upon the information on the GIPS standards published by CFA Institute, this book is intended to be a comprehensive overview, but also detailed enough to provide the practical hands-on guidance required by investment professionals. Our intent is to explain not just what the GIPS standards are, but also how to comply with them. Our opinions on achiev- ing and maintaining compliance with the GIPS standards are represented in the following chapters and when writing this book, we referred to the 2010 edition of the GIPS standards, which is officially titled, Global Investment Performance Standards (GIPS ® ): As Adopted by the GIPS Executive Com- mittee on 29 January 2010 (Charlottesville, VA: CFA Institute 2010). We also refer to other applicable interpretive guidance issued by CFA Institute and available on the GIPS standards web site as of March 19, 2011. As this book is not official guidance, individuals and firms should check the resources provided by CFA Institute if questions arise and consult with their GIPS advisors. Official CFA Institute resources for the GIPS standards, in- cluding any updates to the GIPS standards and any interpretive guidance, are located at www.gipsstandards.org. This book covers the requirements and recommendations of the 2010 edition of the GIPS standards, which went into effect on January 1, 2011. xiii [...]... representing the needs of institutional investors and the investment managers that serve them The GIPS standards are voluntary If a firm chooses to claim compliance with the GIPS standards, the firm must comply with all of the required guidance Failure to do so may subject the firm to regulatory scrutiny The following chapters provide detailed guidance for complying with the GIPS standards Complying with the Global. .. Introduction he investment management industry has global standards for the calculation and presentation of investment performance to prospective investors These are the Global Investment Performance Standards (GIPS® ), which were created and are administered by CFA Institute The topic of this book is how to calculate returns and present investment performance results in accordance with the GIPS standards The. .. that are not compliant with the GIPS standards will not be able to participate in the search, requests such as these often drive investment firms to attain compliance with the GIPS standards From the point of view of a money manager who wishes to attain compliance with the GIPS standards, the first key step is to formally define the firm that produced the historical performance The next key step is to... in the GIPS standards In 2000, the AIMR-PPS standards became a CVG The process to become a CVG was quite simple for the AIMR-PPS standards, since the GIPS standards were primarily based on the concepts in the AIMR-PPS standards When the GIPS standards were originally created, it was agreed that they would be reviewed and updated every five years This first five-year review resulted in the issuance of the. .. that the firm complied with the GIPS standards for all periods and make no reference to prior compliance with the AIMR-PPS standards Reciprocity allowed firms throughout the world to remove references to local standards from their presentations and to speak only about the GIPS standards The next five-year update was completed in January 2010 when the 2010 edition of the GIPS standards was issued The 2010... comply with the GIPS standards Defining Fundamentals of Compliance 9 the firm is the first step in the GIPS compliance process Chapter 2 of this book provides guidance on defining the firm Complete Compliance An organization that does not claim compliance with the GIPS standards can make no reference to the GIPS standards Investment managers cannot state that they are in “partial compliance” with the GIPS standards. .. govern performance presented as part of internal reporting within the investment management firm or for client reporting to existing clients The GIPS standards are primarily concerned with marketing performance history to prospective clients There is no global law that requires a firm to comply with the GIPS standards (But if an investment manager claims compliance, the local 3 4 EXPLANATION OF THE GIPS STANDARDS. .. the process of creating a set of performance standards that could be used by all firms globally The end result of this effort was the issuance of the first edition of the GIPS standards in February 1999 Several countries adopted the GIPS standards as their local standard as issued, making no changes However, other countries that already had their own standards were hesitant to replace their current standards. .. of the GIPS standards This may have been true when the GIPS standards and their predecessor standards were new However, given the maturity of the GIPS standards, this is no longer the case and we should view the recommendations as simply best practices FUNDAMENTALS OF COMPLIANCE The Fundamentals of Compliance section (Section 0) was first included in the 2005 edition of the GIPS standards Several of the. .. presented their performance in compliance with the GIPS standards The GIPS standards provide investors with assurance that performance records are comparable and that they are prepared based on the ethical principles of fair representation and full disclosure The GIPS standards do not attempt to address every performance measurement issue that a money manager may face For example, the GIPS standards . assets. Complying with the Global Investment Performance Standards (GIPS ® ) provides individuals and firms with two things: (1) guidance for the investment firm in achieving compliance with the Global. clients. There is no global law that requires a firm to comply with the GIPS standards. (But if an investment manager claims compliance, the local 3 Complying with the Global Investment Performance Standards. prospective investors. The Global Investment Performance Standards (GIPS ® ), administered by CFA Institute, fill that void. SCOPE OF THE GIPS STANDARDS The Global Investment Performance Standards are