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The Actuary The magazine of the Institute & Faculty of Actuaries

Global investment performance standards

GLOBAL INVESTMENT performance standards
(GIPS) have become a fact of life in the
investment industry since being officially
launched on 1 January 2000. There is no
doubt that GIPS will greatly benefit the investment
community, and especially major owners of capital
such as pension funds, which have a major duty of
care in connection with safeguarding their beneficiaries’
standard of living. GIPS constitute an unprecedented
revolution in how fund performance achieved
by asset managers is published and verified. In a nutshell,
GIPS amount to a fundamental and objective
global standard which asset managers can use to proclaim
their own expertise in fund performance.
Standard incompatibility
I became involved with the GIPS committee at its creation
in 1995. There was a lack of compatibility
between the two standards published at that time: the
US Association for Investment Management and Research
(AIMR) standards, and the National Association
of Pensions Funds (NAPF) code in the UK. This lack of
compatibility meant that it was not possible to make an
assessment of a firm’s performance that was simultaneously
AIMR and NAPF compliant because the standards
produced different returns. With individual European
countries shaping up to produce their own standards,
the situation was rapidly becoming untenable.
The lack of an objective standard meant that ‘beauty
parades’ at which different asset managers competed
were in fact events of only modest usefulness when it
came to helping pension funds decide which asset
manager to choose. It was as if judges were assessing
physical beauty while wearing opaque spectacles. The
situation has been rectified by the introduction of
GIPS standards.
Radical improvements
The introduction of GIPS marks a significant upgrade
in procedures and controls for asset managers and
applies to the entire firm. The objective is ultimately to
provide a comprehensive and representative overview
of the performance standards achieved by that entire
firm. They constitute a radical improvement in the
entire conceptual and practical basis for assessing and
promoting fund performance.
Naturally enough, a new initiative as radical as GIPS
puts great pressure on asset managers to revamp their
systems and procedures in order to accommodate it.
Most asset managers are now grappling with these
issues for the first time and are being obliged to spend
time and money to improve their procedures and
controls to the appropriate level.
In the UK, the GIPS-compliant performance standard
is known as the UK Investment Performance
Standard (UKIPS). Its origins can be traced to 1992
when the NAPF Performance Monitoring Group
(PMG) published a standard for the presentation
within the UK of the performance track records of balanced
UK pension funds, known as the Pension Fund
Investment Performance Codes (PFIPC), which was
updated in 1996 to incorporate segregated accounts.
The GIPS standards were published in 1999. In the
light of this, the NAPF PMG reviewed the PFIPC, and
decided to adopt an edition of GIPS to be entitled ‘the
UK Investment Performance Standard’ (UKIPS). UKIPS
was published in March 2000. It will replace PFIPC,
and will help ensure that UK investors benefit from
the significant advances incorporated in GIPS, especially
the standardisation of performance reporting. A
crucial difference between UKIPS and GIPS is that
UKIPS requires mandatory independent verification,
whereas GIPS permits voluntary verification.
Positive attitudes
What exactly is the general climate of morale among
asset managers as far as GIPS compliance is concerned?
My view is that the attitude to GIPS among
asset managers is generally a positive one. They can
see how GIPS benefits their industry as a whole, creating
much more of a level playing field and a fairer
framework for enabling investors to assess different
performance levels by different asset managers. In
practice, most asset managers are treating GIPS as a
difficult requirement (and, with five years’ fund performance
stipulated as the basis for compliance for
the whole firm, it is a difficult requirement) but also
as a necessary one.
A consequence of the introduction of GIPS is that it
trains a brighter spotlight on the performance measurement
function. This means that people working
in this area will need to do considerable extra work
and to a higher standard, but that they will benefit in
terms of a definite sense of their greater importance
within the organisation. Probably somewhere along
the line they are likely to receive financial rewards for
their greater effort. What is certain is that people
working in performance measurement are already
keen to ensure that GIPS is mentioned in their CVs.
Before long, such a mention is going to be essential
for anybody who wants to develop a serious career in
an area of asset management which has in the past
sometimes been seen as rather less glamorous than
the actual choosing of investment instruments, but
which is now literally essential to the competitive success
of any organisation.
One question which many people ask is how anyone
can expect GIPS to be effective when compliance
is still only optional. The point I am making is not
that I think GIPS compliance should be optional, but
rather that there is in any case a basic momentum
that will encourage firms to comply even if GIPS compliance
does remain optional. Firms that do not comply
with GIPS will be at a considerable competitive
disadvantage in the future, and likely to be looked at
in a negative light by prospective clients who may
wonder why the firm is not going to be GIPS compliant.
I believe that this factor is a major driver and will
in due course lead the vast majority of asset management
firms to comply with GIPS.
It is important to note that the breadth and depth of
information which a firm must gather in order to
comply can benefit it in other ways. By gathering this
information together, the firm can gain unprecedented
insights into its performance, including the
source of its most successful areas of performance and
even early warnings of problems. This information
can have a real impact on the firm’s bottom line and
constitutes a bonus for GIPS compliance.
Teething problems
Complying with GIPS places a new technological burden
on asset management firms. Gathering and marshalling
the information needed to comply is not
something that can be done manually. Firms need a
technological solution to comply a solution that will
raise their standards and improve their efficiency.
As with any new initiative, there are some teething
problems. One is that there is some evidence that
asset managers claiming compliance without verification
are actually not in compliance. Another challenge
concerns education. In order to maintain
compliance, all aspects of the firm’s presentations of
itself and promotions of its performance measurement
must be in harmony and standardised. It is not
sufficient for only the performance measurement
team to understand the standards; salesmen and marketing
people must also understand them and adhere
to them.
A major question is whether the Association for
Investment Management and Research (AIMR) standard
is better than GIPS itself. This question now
seems to be heading towards a resolution. On 2 October
2000 AIMR published its version of GIPS. This
marks a significant move and in effect a recognition
by AIMR that GIPS will become the global standard.
As in so many areas of investment, the US leads the
way in compliance with GIPS. The very fact that the
US has accepted that its own standard will be GIPS is
confirmation of the importance of this new protocol.
The GIPS standards are owned by the Investment
Performance Council (IPC), which is responsible for
the development and maintenance of these standards.
Other temporary subcommittees covering such
issues as derivatives, fees, real estate, venture capital,
and so on, will introduce standards for areas that are
currently absent from GIPS.
The notion of verification, like the principle of
requiring firms to be assessed according to a composite
of their entire performance not just their best performance
lies at the heart of GIPS. As the GIPS
standards emphasise:
A single verification report is issued in respect of
the whole firm: GIPS verification cannot be
carried out for a single composite Third-party
verification brings credibility to the claim of
compliance and supports the overall guiding
principles of full disclosure and fair
representation of investment performance.
Verification is strongly encouraged and is
expected to become mandatory (but no earlier
than 2005). Countries may require verification
sooner through the establishment of local
Readers should note that verification is already
mandatory in the UK, in line with the UK tradition of
third-party measurement.