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Many investment management firms tout that they are GIPS compliant. GIPS are ethical standards that apply to the way investment performance is presented to potential and existing clients. The investment management industry is becoming more global. Many asset managers not only compete for business in their home markets but in foreign markets as well.
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The North American and Western European markets are very well developed, but other markets are catching up and becoming more sophisticated as well. For investment firms outside the U. Being GIPS compliant can actually make things easier for firms that are trying to compete in multiple markets because they only have to abide by one set of standards and they can avoid having to make major changes in their presentation or calculation methods when working in other countries.
In other words, GIPS fills a need for standardization across a far-flung industry. GIPS are standards, not laws. Firms do not have to be GIPS compliant. Furthermore, these standards are not codified into U. However, although they are voluntary, they provide discipline to the calculation and confidence in the performance represented. Before performance is calculated and presented, there is some groundwork for the firm to do.
The first thing a firm must do is actually define the firm. This may sound very obvious, but there might be legitimate reasons that a subsidiary would be excluded from a firm definition.
The next step involves a firm's composites. One of the most important things a firm can do is to define its composites in a logical and meaningful way. GIPS requires that all of a firm's discretionary, fee-paying portfolios be included in at least one composite. The GIPS Handbook defines a composite as, "an aggregation of one or more portfolios into a single group that represents a particular investment objective or strategy"—think "emerging market equity" or "global fixed-income.
The provisions of the standards cover several other items including calculation, as well as presentations and disclosures. For example, time-weighted as opposed to money-weighted rates of return are required.
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Some firms probably feel as though the largest part of their performance presentations are the GIPS required disclosures , as firms are required to disclose many items including a definition of the firm, whether performance is net of fees or gross of fees, and what additional information must be disclosed upon request. One of the stated objectives of GIPS deals with ensuring accurate and consistent investment performance.
The standards require firms to initially show a minimum of five years of GIPS compliant history. After this minimum, the firm must build up to a track record of 10 years. If the composite has been in existence for fewer than five years, the firm must show its entire history since inception. Because investors should always be wary of firms that show only the best years of their performance, this requirement should be able to stop the practice of " cherry picking.
For example, an investment may look great if a firm only shows the last two years of performance, in which the investment experienced positive returns. However, suppose that the three years prior to this, the investment experienced negative returns. If the firm did not reveal the investment's earlier performance, investors would get a completely different impression of the firm's asset-management abilities.
Global Investment Performance Standards (GIPS): Definition & Uses
Having a consistent standard helps investors make more informed choices and may increase their confidence in the investment management industry. It may also encourage firms from developed markets to be more comfortable dealing with firms from emerging markets that are GIPS compliant. When all firms follow the same standards, regardless of the region of investments, cross-investments and partnerships can be made easier.
It may seem that with all of the extra work involved, it would be a hassle for a firm to be GIPS compliant. However, because the GIPS standards have become so widely accepted, an institutional asset manager who is non-compliant may be at a competitive disadvantage.