Marlena Fitts is Director, Product Marketing at Solovis
Understanding GIPS 2020 Standards and what asset owners need to do from a compliance perspective has become crucial for those in the market. A recent StatPro article on bobsguide provides a high-level overview of the GIPS 2020 changes that would be required at the end of the reporting period that begins on or after January 1, 2020. In other words, asset owners would be impacted for period-end reports produced in 2021.
This article, along with multiple GIPS sources, also illustrates efforts the CFA Institute has made toward organising these new standards into three coordinated chapters, which are as follows:
- GIPS Standards for Firms (Asset Managers)
- GIPS Standards for Asset Owners
- GIPS Standards for Verifiers
These are the three main market participants that have a compliance role. This article focuses on asset owners, which are defined by the GIPS for asset owners 2020 chapter as “an entity that manages investments, directly and/or through the use of external managers, on behalf of participants, beneficiaries, or the organisation itself. These entities include, but are not limited to, public and private pension funds, endowments, foundations, family offices, provident funds, insurers and reinsurers, sovereign wealth funds, and fiduciaries.” The aim is to get more granular for asset owners looking to have a summarised understanding of what’s needed and by whom in order to achieve compliance and why compliance is important.
Of course, there will be hybrid situations where some aspects of the business act as asset owner, but other areas act as a “firm” that competes for business (ie conducting themselves as an asset manager in the sense that they compete to win external client business). For these situations, there are three options:
- Split compliance into two entities – one reports as a firm, the other as asset owner
- Let everything fall under the definition of “firm” for reporting
- Have an overarching reporting entity but have each business area (“asset owner” vs “firm”) follow the relevant guidance
Why comply as an asset owner?
The CFA sites asset owners should comply with the GIPS Standards for the following reasons:
- Demonstrate commitment to transparent, comparable investment performance reporting
- Adhere to global best practices for reporting investment performance
- Identify investment managers committed to ethical principles for performance reporting
- Provide comparable, reliable data for manager selection across all asset classes and strategies
One of the more obvious reasons, beyond the above, is if asset owners are expecting their managers to comply with the new standards, they should be placing priority and setting the right example themselves. That said, the new standards do attempt to make it more reasonable for asset owners to get into compliance than in the past. The hope is that more asset owners will make the commitment and effort to participate in meeting requirements and achieving the desired level of industry standards.
Tips on GIPS: what’s needed to comply in 2020
Composite construction: This is still only required to be done at the fund level for the asset owner’s oversight body. Like the compliance history requirements, because they’re reporting to an oversight body and not competing with one another, if an asset owner has different funds that have the same investment mandate, they can choose whether they want to construct separate composites or just one composite for the oversight body. Of course, this will largely depend on the oversight body’s needs and what they have asked for from the asset owner.
Returns: Net of fee returns is still what’s required to be put on the GIPS total fund composite net of fee returns reporting. The costs that have always been required to derive the net are transaction costs and internal investment costs. In addition, there are two types of fees that used to be optional in the netting calculation which are now recommended. These are:
- Fees and expenses for externally managed pooled funds, and
- Investment management fees for externally managed segregated accounts
The main takeaway here is that if an asset owner was not previously requiring that this information be tracked and reported, they will now need to do so. In addition, if this information was not previously passed into the system currently used to calculate this net of fee return, then it now needs to be incorporated in the net of fee calculation and the system just needs to be able to accommodate this change.
Key changes for 2020
While it is ultimately the asset owner’s responsibility to declare compliance, there are a couple changes to the standards that merit consideration of the level of flexibility that currently exists with custodians, the software products, spreadsheets or other methods currently enlisted to support production of the end-state reported returns.
In the new 2020 standards, if transaction costs are known, actual rather than estimates must be used, but if transaction costs are not known, they need to be estimated. When using an estimation, returns must be reported at the equivalent or less, not higher, than when using actual costs. As we know, transaction costs are based on individual transactions, which are variable from one period to the next. In its February 2019 newsletter, Spaulding Group provided the following example, along with additional details, of estimating transaction costs intra-month. The same concept is shown and can be followed for other periods (ie daily, monthly, etc) if the cash flow is recorded on the appropriate intra date, so the concept of knowledge date will be important here. The CFA will also be providing guidance on this in its handbook.
In the 2020 requirements, a new term was coined called “private market investments,” which was defined as assets that are Illiquid, not publicly traded, or not traded on an exchange. It was recommended as best practice that all private market investments that are non-RE investments have an annual external independent evaluation, and that all private market investments in general, including RE investments, will have a valuation review, or financial statement audit at least every 12 months. Final guidance on RE specific investments was that they need to be externally valued at least once every 36 months unless the oversight body requires it more frequently.
Asset owners must correct all material errors, and the revision must be given to the current verifier and any former verifiers that received the report, as well as any oversight bodies that received the report, with the material error.
Asset owners are still required to present time-weighted returns for total funds in accordance with the GIPS requirements. In the 2020 standards, while not required, they now also have the option to include money-weighted returns in the GIPS Asset Owner Reports for total funds. Depending on the asset owner’s asset classes, they may consider money weighted returns to be the more relevant of the two and would therefore choose to include this additional reporting. Asset owners that decide to create and report additional composites in compliance with the GIPS standards can pick whether to present either time-weighted returns or money-weighted returns for those.
There were also minor reporting clarifications made in GIPs 2020. The provisions clarified that only GIPS-compliant performance can be presented on the GIPS asset owner report. Other return calcs can be presented outside of the report but not on it. Another clarification was regarding how an asset owner would provide proof to the verifier that they indeed provided reports to the oversight body when they needed to be distributed or redistributed (ie updates for error correction purposes).
Some new requirements were also added in GIPS 2020. One was the time limit placed on reporting. Now, asset owners need to update the asset owner report within 12 months of annual period end. Another was a new best practice recommendation that, using a monthly return calculation, a three-year annualised return be reported for every period the three-year annualised ex-post standard deviation was presented. Finally, there are multiple reporting disclosure requirements added that will require language updates in current reporting software or document templates in order to claim compliance. These changes for asset owners are as follows:
- Disclosures surrounding what a verification covers
- Standalone trademark disclosures on all asset owner reports
- Total fund’s inception date and composite inception date disclosures
- Estimated transaction costs calculation disclosure
- Preliminary estimated values for fair value disclosures
- Timing of disclosures for retroactive benchmark changes, a significant event, etc
- A retro benchmark change disclosure must be reported if relevant or at least one year, whichever is longer
- Most recent period end percentage of material subjective unobservable inputs disclosure
There was one reporting provision that relaxed requirements in the GIPS 2020 reporting standards, stating that Real Estate component returns are no longer required and have instead been made a recommendation in the 2020 requirements.
Lastly, advertising guidelines for asset owners have been provided. These guidelines would need to be followed if there are reporting materials asset owners want to widely distribute (ie An annual report post on the website, reporting that is being sent out to all beneficiaries, etc). In these instances, the full GIPS asset owner report would not be required. There are separate guidelines given for when performance is presented on such reporting and when the asset owner is just stating the claim of compliance.
Summarised considerations for asset owners
To wrap up the main differences between the 2010 and 2020 standards for asset owners, there are truly only a few provisions that will require changes to the existing process. Some asset owners may be under the impression that fee schedules would also be required. However, while the draft provisions did initially require a fee schedule if an asset owner is compensated in a manner similar to a “firm”, there is no requirement at all to expose a fee schedule in the final 2020 standards. So, updates from the 2010 standards can be summarised in a few bullets as follows:
- Whether to define as asset owner or firm and how to report accordingly
- How to estimate transaction costs, where to handle
- Ensuring all the cost bucket information is flowing through all systems, spreadsheets, etc currently utilised in the net return calculation
- Update reporting (add disclosures, decide whether to additionally report money weighted returns, etc)
Given 2020 will be the first year of compliance with the new standards, once the asset owner’s performance personnel or GIPS committee has internally thought through how they want to handle the above and all relevant policies and procedures have been updated, it would be prudent to have an auditor review them prior to moving forward with verification.
In the end, the changes aren’t as daunting for asset owners as some may have originally thought. In fact, there were changes and concessions made that may make it more relevant and, in some cases, easier for new asset owners to get into compliance. Overall, the new standards demonstrate the CFA is more tuned in to the needs of asset owners with respect to the creation of industry-wide performance standards.
Finally, for these and any changes to industry directives, it is critical that asset owners scrutinise key reporting and technology platforms in use to ensure they are flexible enough to accommodate market and regulatory changes of any kind in an agile, low impact way. If a solution is not flexible enough to handle the required updates from a template, calculation, configuration or data transmission perspective, inadequacies of this nature will continue until the route cause is addressed. If an asset owner or allocator is considering transitioning to a more flexible and efficient technology platform that readily accommodates changes such as calculating both a time-weighted and money-weighted return or receiving in and replacing estimated expenses for performance calculation purposes, that transition should start now. This would ensure the right level of software, processes and people are in place to meet the GIPS 2020 reporting deadline and minimise future disruption from any other upcoming industry shifts – which we know will inevitably come.