2020 global investment performance standards

2020 Global Investment Performance Standards

Considerations for alternative managers

Part 1

| 2020 Global Investment Performance Standards: considerations for alternative managers | part 12

The new GIPS landscape

Alternative investments have experienced robust growth in the last 15 years. Global alternative assets under management have increased from US $2.9 trillion to over US $10 trillion by 2019.¹ While the alternative asset management industry has faced several challenges throughout its existence, such as the great financial crisis, scandals, illiquidity issues and, most recently, a global pandemic, it has always been able to meet those challenges by continually evolving and finding ways to generate alpha and attract investors.

As institutional investors are increasingly looking for new approaches to generate better performance and increase allocations to alternatives, more and more fund managers have met a familiar question in their request-for-proposal (RFP) questionnaire about compliance with the Global Investment Performance Standards (GIPS®). GIPS were initially designed to cater to traditional money managers and investment banks that managed large groups of similar, separately managed accounts. Many alternative managers gave up on the idea to adopt the standards, while others tried to fit their products into the then-existing framework. Managers that had more complex, multi-asset strategies — with more active use of derivatives and higher-risk side pockets, often with more intricate fee structures — struggled to apply many of the concepts.

While there were prior attempts to provide guidance to the alternative asset management industry, the 2020 edition of GIPS has brought more favorable changes to the world of alternative managers, making their journey to compliance easier. Several alternative asset managers are rekindling the idea of adopting GIPS to increase their ability to attract new capital. Nevertheless, the growth of the alternative asset management industry — as well as increased allocation from institutional investors that got used to investing with compliant firms — has created a new demand for alternative managers that are seeking to become compliant and better understand the impact of compliance.

¹ “Alternatives in 2020,” Preqin, 5 February 2020, https://www.preqin.com/insights/research/reports/alternatives-in-2020.

The EY FSO Investment Performance team

is issuing a new series of articles to provide

guidance to alternative asset managers’ most

burning questions about the 2020 Global

Investment Performance Standards. This

inaugural article of the series will cover the

road to compliance and address issues that

many alternative asset managers are facing in

claiming compliance with GIPS for the first

time. Later articles will cover more specific

questions about GIPS that EY professionals

have been receiving from industry members.


The first question most alternative investment managers are asking us is, “GIPS has changed to make it easier for us to be compliant, but why should I be compliant?” Being compliant with a globally recognized ethical standard of providing performance information and full and fair disclosures for prospective investors gives firms a marketing advantage, as it increases the confidence in their performance data. Institutional investors are often specifically requesting managers to be compliant; thus compliance increases managers’ chances to be considered for RFPs from asset owners. Building protocols around performance calculation and related data inputs, as well as maintaining compliance with the standards, will also improve internal policies and procedures — resulting in more effective controls and supporting an organization’s overall risk assessment and compliance function. Even regulators are referring to GIPS compliance, which is entirely voluntary, recognizing that it is a way to promote consistency and quality in performance calculations. Specifically, the Financial Industry Regulatory Authority (FINRA) released Regulatory Notice 20-21 in mid-2020, which requires firms in retail communications to utilize the calculation methodologies of GIPS for investment programs or funds that include both realized and unrealized holdings. While being GIPS compliant overall is significantly broader than simply using GIPS calculation methodologies, compliance with the latter could provide peace of mind to compliance and marketing teams at firms when presenting performance metrics to retail clients.

Before we move on to highlighting more technical questions that alternative investment managers are navigating as they explore their road to compliance, it is crucial to discuss and identify who should be involved in the process. As alternatives often have less infrastructure and headcount than traditional asset managers, we frequently receive calls from representatives from one or two functional units within a firm, usually finance and accounting, since they are the “numbers” people. Our experience is that the lack of involvement of all relevant stakeholders in planning, designing and maintaining the performance measurement and reporting policies and procedures often results in suboptimal solutions. Any alternative asset manager that is planning to consider adoption of GIPS would benefit by setting up a GIPS steering committee made up of all relevant stakeholders, including but not limited to those involved in performance measurement and analytics, compliance and legal, investor relations and marketing, back-office and accounting, and portfolio management. The involvement of various stakeholders in the development and maintenance of the performance-reporting process allows management to consider various points of view. It also secures internal buy-in for the support of GIPS compliance.

The road to GIPS compliance

For alternative managers that are looking to become GIPS compliant, there are some key questions and considerations fundamental to adoption.

What is the proper definition of “firm”? As with any challenging journey, the first step is always the hardest, and this applies to GIPS compliance as well. GIPS is claimed at the firm level; it is inappropriate to claim for individual asset classes, pooled funds or even at the strategy level. The decision about a firm’s definition is critical as it sets the boundaries for what assets will be included in the total firm assets and, more fundamentally, what accounts should be included in the firm definition and therefore eventually covered by GIPS compliance. The question, “How do I approach the firm definition?” often arises with alternative asset management firms that have a number of separate investment-advisor legal entities managing different investment products, which are often overlapping and multilayered. The basic question alternative asset managers need to answer here is whether a prospective investor can distinguish between the legal entities or business units they want to include in the firm definition. If the legal entities market under one “brand” name, using the same letterhead in their official communications and the same business cards for their representatives, they are one and the same regardless of the underlying legal structure. A broader definition could allow a firm to reap the benefit of GIPS compliance for more of its products and go through its “growing pains” only once. This approach, however, could take more time to achieve GIPS compliance and result in increased external and internal costs.

A correct but narrow definition of a firm could shorten the time to achieve GIPS compliance, making it easier for ongoing maintenance. On the other hand, this definition


limits a firm’s ability to leverage the marketing advantage of being compliant; eventually, firms that decide to expand the definition will need to go through the time- and resource-consuming process of bringing noncompliant elements into compliance. In addition, firms need to closely monitor how they keep the compliant and noncompliant entities and products they manage separate to avoid misleading prospective clients.

Determining discretionAccording to the GIPS 2020, firms must create and maintain composites of all strategies for which the firm uses to manage or market to segregated accounts. Firms must include all actual, fee-paying, discretionary segregated accounts in at least one composite defined by the investment mandate, objective or strategy.² Determining discretion is a key step in assessing whether an account should be included within a composite. However, we have found that it may be difficult to determine discretion for certain accounts due to their nature. For example, a firm may manage multiple insurance portfolios that have a significant amount of trading restrictions. These trading restrictions are due to insurance companies having limitations on realized profit and loss, which may inhibit the firm from executing the trading strategy. Depending on the strategy the insurance portfolio is invested in, the restrictions could result in the account not being considered discretionary (i.e., if the insurance portfolio is included in an S&P 500 composite and the portfolio has restrictions on trading S&P 500 companies).

Determining when discretion ends can also be a tricky process. For example, a firm could be managing a collateralized debt obligation (CDO). The firm may consider discretion to have ended when the reinvestment period is over because the only trading that can be done at that point is to buy loans to replace loans that are paying down. Other firms may define discretion as ending when the redemption notice is received, because that is when the issuer will start selling investments in preparation for paying down the notes in full.

when the redemption notice is received, because that is when the issuer will start selling investments in preparation for paying down the notes in full.

Return determination

Prior to the GIPS 2020, most accounts reported a time-weighted return (TMR), given that there were limited instances when the money-weighted return (MWR) or internal rate of return (IRR) could be used. The new standards provide additional flexibility around the ability to use the IRR. According to the 2020 GIPS, a firm may present IRR only if the firm has control over the external cash flows into the portfolios in the composite or pooled fund, and if the portfolios in the composite have, or the pooled fund has, at least one of the following characteristics: (1) closed-end, (2) fixed life, (3) fixed commitment or (d) illiquid investments as a significant part of the investment strategy.³ As a result, alternative managers can now report an MWR for accounts that are funds, including (but not limited to) private equity funds, private-equity-style hedge funds and collateralized loan obligations (CLOs).

Investor tracking

One of the fundamental requirements of GIPS is that firms claiming compliance must make every reasonable effort to provide all prospective clients with a compliance presentation. We found that identifying prospective clients, monitoring their status as prospective clients for the relevant strategies, and tracking the distribution of compliance presentations often caused confusion and inefficiencies. Business development and investor relations teams need to differentiate between parties that expressed interest in a particular product or strategy and parties that are prospective clients — those that are interested and qualified to invest in the composite strategy

² “Global Investment Performance Standards (GIPS) for Firms 2020,” CFA Institute, 2019, https://www.cfainstitute.org/-/media/documents/code/gips/2020-gips-standards-firms.ashx.

³ Ibid.

What account-related considerations should firms be thinking about?


or pooled-fund vehicle. Firms need to keep in mind, especially for investments in a pooled-fund vehicle, that it requires sophisticated investors in addition to certain net worth and other requirements. It is important to identify and track which composite strategy or pooled vehicle was the subject of interest, as it is possible to be an investor for one composite strategy or pooled-fund vehicle and a prospective client for others. When identified prospective clients are left on a prospective-client distribution list even when they have not expressed further interest in the firm and have stopped communicating, it creates undue burden on business development and investor relations. Firms should adopt a policy of removing these prospective clients from the distribution list after a certain amount of time and stop monitoring them as prospective clients.

We found that processes to track the distribution of GIPS-compliant presentations to clients are often informal and manual at many alternative investment management organizations. In recent years, the GIPS reports are commonly distributed via email; however, there are various other means through which GIPS presentations are distributed, such as pitch books, RFP responses and submissions to consultant databases. There are multiple groups in addition to business development and marketing teams that can access GIPS-compliant presentations (such as portfolio managers) and distribute them to prospective or deemed prospective clients, without formal tracking. These actions create regulatory risks, such as challenges from regulators, and operational inefficiencies. Firms that have implemented protocols requiring levels of review and approval before dissemination have experienced improved reporting accuracy and reduced regulatory risk. For example, these protocols may include enacting compliance department reviews for disclosure and performance analytics for quantitative disclosures, as well as deploying centralized systems or platforms that both distribute and track materials to the recipient — rather than relying on much less secure means of distribution.

How can EY teams help?Alternative asset managers have more complexities and unique scenarios than traditional asset managers, which

have been compliant for decades now. EY GIPS professionals have extensive experience delivering verification or

consulting projects related to GIPS compliance. In addition to verification engagements, these professionals service

investment managers in the areas of regulated and unregulated investment company audits, SOC 1 reporting

and other advisory-related engagements. With these services, EY professionals bring a breadth of knowledge and

experience that enable EY teams to be proactive in helping clients manage their GIPS compliance — providing added

value along the way.

Our EY FSO Investment Performance team has worked with clients in their initial phases of compliance with GIPS by

performing gap analyses as well as verification upon their completion. EY approach to GIPS compliance is client-

focused and will vary depending on the situation because we know every alternative asset manager is different.

To be effective, EY approach is “codeveloped” with each client. Our initial verifications always start with a gap

analysis and scoping exercise as well as an evaluation of the current state of performance measurement, policies,

procedures, the surrounding control environment and the client’s goals.

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This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, legal or other professional advice. Please refer to your advisors for specific advice.

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Ernst & Young LLP contacts

Todd JohnsonPartner and Leader Registered Funds

[email protected]

Gabor KomjathyManaging Director

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Jennifer A. EstrellaSenior Manager

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2020 global investment performance standards

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