Are ETFs A Better Benchmark?

Jocelyn Gilligan, CFA, CIPM

Partner

June 28, 2024

15 min

Using Exchange-Traded Funds (ETFs) as benchmarks instead of traditional indices has become a common practice among investors and fund managers. ETFs offer practical advantages, such as reflecting real-world trading costs, and incorporating management fees and tax considerations. These aspects make ETFs a more accurate and accessible benchmark as they are an actual investible alternative to the strategy being assessed.

However, this approach is not without its drawbacks. Understanding both the advantages and disadvantages of using ETFs as benchmarks is crucial for making informed investment decisions and ensuring accurate performance comparisons.

This article discusses the pros and cons of using an ETF as a benchmark and considerations for making an informed decision on how to go about selecting one that is meaningful.

The Advantages:

Using an ETF as a benchmark rather than the underlying index has several advantages. These include:

Cost:

The decision to use an ETF rather than an actual index as a benchmark often stems from the costs associated with using index performance data. While index providers typically charge licensing fees for access to their indices, these fees can be cost-prohibitive for some firms, especially smaller ones, or those with limited resources.

ETFs offer a more accessible and cost-effective alternative, as they provide readily available, real-time performance data and can be traded easily on stock exchanges and accessed by anyone. By using an ETF as a benchmark, firms can circumvent the barriers to entry associated with marketing index performance directly, allowing them to still compare performance against a relevant benchmark.

Practical Investment Comparison:

ETFs represent actual investment vehicles that investors can buy and sell, thus providing a more practical and realistic performance comparison. Indices, on the other hand, are theoretical constructs that do not account for real-world trading costs, whereas ETFs do. Additionally, ETFs are traded on stock exchanges and can be bought and sold throughout the trading day at market prices, unlike indices which cannot be directly traded.

Incorporation of Costs:

ETFs include trading and management expenses and other costs associated with managing the pool of securities. When using an ETF as a benchmark, you get a more accurate reflection of the net returns an investor would actually receive after these costs. In addition, ETF performance considers the costs of buying and selling the underlying assets, including bid-ask spreads and any market impact, which indices do not.

Dividend Reinvestment:

ETFs may account for the reinvestment of dividends, providing a more accurate measure of total return. Indices often do not factor in the practical aspects of dividend reinvestment, such as timing delays, transaction costs, and tax implications, leading to a potentially less realistic depiction of investment returns.

Tax Considerations:

ETFs may have different tax treatments and efficiencies compared to the theoretical index performance. Using an ETF as a benchmark will reflect these considerations, providing a potentially more relevant comparison for taxable investors.

Replication and Tracking Error:

ETFs can exhibit tracking error, which is the deviation of the ETF's performance from the index it seeks to replicate. While tracking error may be perceived as a limitation, it also reflects the real-world challenges and frictions involved in managing an investment portfolio. Thus, using an ETF as a benchmark encompasses this aspect of real-world performance—which acknowledges the practical complexities of investing and serves to enhance transparency and accountability in investment decision making.

Transparency and Real-time Data:

ETFs provide real-time pricing information throughout trading hours, allowing investors to monitor and compare performance continuously as market conditions fluctuate. This real-time data enables more informed and timely decision-making, as investors can react instantly to market events, manage risks more effectively, and capitalize on opportunities as they arise.

Advantages Summary

In summary, using an ETF as a benchmark provides a less-costly, more realistic, practical, and accurate measure of investment performance that includes real-world considerations like costs, liquidity, tax implications, and dividend reinvestment, which are not fully captured by indices. ETFs are a true investable alternative, while indexes are not directly investible.

The Disadvantages:

While using an ETF as a benchmark has several advantages, there are also some potential drawbacks to consider:

Downside of Tracking Error:

ETFs may not perfectly track their underlying indices due to various factors such as imperfect replication methods, sampling techniques, and management decisions. This tracking error can result from differences in timing, costs, and portfolio composition between the ETF and its benchmark index.

This deviation can lead to discrepancies when comparing the ETF's performance to the actual index and can affect investors' expectations, portfolio management decisions, and performance evaluations. Thus, it is prudent to evaluate and monitor tracking error of ETFs when they are used as a benchmark.

Tracking Method: Full Replication vs. Sampling

ETFs employ different replication strategies to track their underlying indices, with some opting for full replication, while others utilize sampling techniques. These differences can lead to varying levels of tracking error and performance differences from the underlying index.

Full replication involves holding all of the securities in the index in the same proportions as they are weighted in the index, aiming to closely mirror its performance. In contrast, sampling techniques involve holding a representative subset of securities that capture the overall characteristics of the index.

While full replication theoretically offers the closest tracking to the index, it can be more costly and logistically challenging, especially for indices with a large number of securities. Sampling, while potentially more cost-effective and manageable, introduces the risk of tracking error, as the subset of securities may not perfectly reflect the index's performance.

Non-Comparable Expense Ratios:

ETFs incur management fees, which reduce returns over time. While these fees are part of the real-world costs, they can make the ETF's performance look worse compared to the theoretical performance of the index, especially when compounded over time. This may be problematic when using an ETF as a comparison tool (think expense ratios dragging down ETF benchmark performance thus making the strategy appear to have performed better than it would have against the actual index). This has the potential to influence investment decisions and performance evaluations. To address this concern, the GIPS Standards now require firms that use an ETF as a benchmark to disclose the ETF’s expense ratio.

Many active managers might argue that it’s “unfair” that the SEC requires them to compare net returns against an index that has no fees or expenses. However, if the strategy’s goal is to beat the index with active management, the manager should be doing this even after fees, otherwise passive investing (with lower fees) is a better option.

Liquidity Constraints:

Some ETFs may suffer from lower liquidity, leading to wider bid-ask spreads and higher trading costs, especially for large transactions. This can affect the ETF's performance and make it less ideal as a benchmark.

Selection Dilemma

Multiple ETFs may track the same index, each with different structures, expense ratios, and tracking accuracy (e.g., check out the differences between SPY, IVV, VOO, SPLG). As a result, choosing the most appropriate ETF as a benchmark should involve consideration of factors such as cost-effectiveness, liquidity, tracking error, and the strategy’s specific investment objectives. As a result, some due diligence should be done to ensure that the selected ETF aligns closely with the desired index and makes sense for the investment strategy.

Some firms have made it a habit to mix the use of different ETFs in factsheets, often because their data sources lack all the data needed for one ETF. While it may seem like it’s all the same, for many of the reasons discussed in this post, not all ETFs are created equal. We do not recommend mixing benchmarks, even when using actual indices (e.g., comparing performance returns to the Russell 1000 Growth, but then showing other statistics like sectors compared to the S&P 500). Similarly, we wouldn’t recommend doing that with ETFs either (e.g., comparing performance returns to IVV but using sector information from SPY). Mixing benchmark information in factsheets is messy and likely to be questioned by regulators, especially when doing so makes strategy performance look better.

Regulatory and Structural Issues:

ETFs are subject to evolving regulatory oversight that might affect their operations, costs and performance as benchmarks. This is not the case for indices.

In addition, the structural differences between ETFs, particularly regarding whether they are physically backed or use synthetic replication through derivatives, can significantly impact their risk profile and performance relative to their underlying indices.

Physically backed ETFs typically hold the actual securities that comprise the index they track, aiming to replicate its performance as closely as possible. In contrast, synthetic ETFs use derivatives, such as swaps, to replicate the index's returns without owning the underlying assets directly. While synthetic replication can offer cost and operational advantages, it also introduces counterparty risk, as the ETF relies on the financial stability of the swap provider.

As a result, it’s best to consider the structure of the ETF before using it as a benchmark.

Market Influences:

ETFs can trade at prices above (premium) or below (discount) their net asset value (NAV), which can introduce short-term performance differences that are not reflective of the underlying index performance.

These premiums and discounts arise due to supply and demand dynamics in the market, as well as factors such as investor sentiment, liquidity, and trading volume. These fluctuations can affect the ETF's reported returns and introduce discrepancies when comparing its performance to the benchmark index. Therefore, investors must consider the impact of these premiums and discounts on the ETF's short-term performance and recognize that these variances may not accurately represent the true performance of the underlying index.

When material differences in price vs. NAV exist, some firms believe that the NAV is a better representation of the fair value rather than the price and have used NAV for performance calculations. Please note that when this is done, it is important to document how fair value is determined and if the performance is based on the change in NAV or change in trading price.

Currency Risk:

Investors utilizing ETFs tracking international indices face the added complexity of currency fluctuations, which can significantly influence the ETF's performance. When investing in foreign ETFs, investors are exposed to currency risk, as fluctuations in exchange rates between the ETF's base currency and the currencies of the underlying index's constituents can impact returns. Currency movements can either enhance or detract from the ETF's performance, depending on whether the base currency strengthens or weakens relative to the underlying currencies.

Consequently, currency risk should be considered when using international ETFs as benchmarks.

Dividend Handling:

The handling of dividends by ETFs, whether they are paid out to investors or reinvested back into the fund, can have a notable impact on their total return compared to the index they track. Indices typically assume continuous reinvestment of dividends without considering real-world frictions such as transaction costs or timing delays associated with reinvestment. In contrast, ETFs may adopt different dividend distribution policies based on investor preferences and fund objectives.

ETFs that reinvest dividends back into the fund can potentially enhance their total return over time by capitalizing on the power of compounding. However, this approach may result in tracking errors if the reinvestment process incurs costs or timing discrepancies that deviate from the index's assumed reinvestment.

ETFs that distribute dividends to investors as cash payments may offer more immediate income but could lag behind the index's total return if investors do not reinvest these dividends efficiently. Therefore, the dividend handling policy adopted by an ETF can significantly influence its performance relative to the index and should be carefully considered.

Lack of Historical Data:

Some ETFs, especially newer ones, may not have a long track record. This can make historical performance comparisons less reliable or comprehensive. Without an extensive performance history, sufficient data may be lacking to assess an ETF's performance across various market conditions and economic cycles, making it challenging to gauge its potential risks and returns accurately.

Strategies that existed long before an ETF was created to track the comparable index, may end up with timing differences. Many firms often need to use multiple benchmarks to cover the entire period. But, for some strategies that go way back, an ETF may not exist back to inception. Be sure to include rationale in your documentation for benchmark selection so that it is clear when and why a benchmark was selected for the given time periods.

Conclusion:

In conclusion, using ETFs as benchmarks offers practical benefits, potentially making them a more accurate and accessible measure of investment performance compared to traditional indices since they are an actual investable alternative to hiring an active manager. However, these benefits do not come without shortcomings. By carefully evaluating these factors and considering the specifics of the ETFs selected for each strategy, managers can effectively use ETFs as benchmarks to assess and monitor investment strategies. In understanding these factors, an ETF may actually be a better comparison tool for your strategy than the underlying index.

Calculation Methodology, Books & Records, Composite Definitions & Rules, and Error Correction Policies

As discussed in Part 1 of this two part series, GIPS compliant firms are required to document how they comply with the GIPS requirements as well as any recommendations that the firm chooses to follow. This document acts as the firm’s internal representation of their GIPS compliance, and is intended to state the firm’s policies and describe the procedures the firm follows to maintain its compliance.

In Part 1 of this two part series we covered Firm Definition and Definition of Discretion. Now, in Part 2 we will cover calculation methodology, books and records, composite definitions and rules, as well as error correction policies.

https://www.youtube.com/watch?v=UhaTy-4c-EM&feature=emb_logo

Calculation Methodology

While GIPS provides a framework for how to calculate performance, firms may have different methods for handling external cash flows, asset-weighting portfolios, calculating dispersion, etc. The specifics of the methods used must be documented in the firm’s GIPS P&P. This section is typically broken down to separately discuss portfolio-level calculation methodology and composite-level calculation methodology.

The main consideration when establishing your firm’s portfolio-level methodology is the treatment of external cash flows. Since the start of 2010, GIPS requires firms to revalue for all “large” cash flows. It is up to your firm to define the term “large,” but it should be defined based on when your firm feels that estimation methods, such as Modified Dietz, lose their accuracy. Most portfolio accounting systems either value portfolios daily (essentially defining “large” as 0%) or value portfolios for all cash flows 10% or greater. Firms without a portfolio accounting system that are calculating their portfolio-level performance more manually (e.g., in Excel) frequently use 20%, but higher than that is less common.

With regard to composite-level performance, the most important information to document is the method used to asset-weight the portfolio returns to get the composite-level performance results. This is typically achieved through one of the following three methods:

Asset-weight each individual portfolio’s return for the month based on each portfolio’s beginning market value and then sum the portfolios’ weighted returns to get the composite return for the month.
Asset-weight each individual portfolio’s return for the month based on each portfolio’s beginning market value plus weighted cash flows and then sum the portfolios’ weighted returns to get the composite return for the month.
Aggregate the underlying data of all portfolios in the composite and then calculate the performance for each month as if all of the aggregated data is for one large portfolio.

This section should also include information regarding how the other required GIPS statistics are calculated, such as dispersion and 3-year annualized ex post standard deviation. Here, it is important to note whether these statistics are calculated based on gross or net-of-fee returns, whether calculated by your portfolio accounting system or outside the system, (e.g., in Excel) and the specific standard deviation formula used to do the calculation (e.g., a population or sample based formula).

Policies Regarding Books and Records

Firms must be able to support all information included in GIPS compliant presentations as well as support that their client assets are real. This section of your GIPS P&P can outline the types of records that are maintained and in what format/location they are stored. Specifically, firms typically outline the types of documents they have (e.g., custodial statements, records maintained within a portfolio accounting system, printed records from a former portfolio accounting system such as holdings reports, transaction summaries, etc.). In this section, it is also important to mention whether files are hardcopy or electronic, whether they are maintained onsite or offsite, and if there is a limit to the amount of time they are saved.

Composite Definitions and Rules

irms must create policies to ensure that portfolios are placed in the appropriate composite for the correct time period. The timing of portfolio movement in or out of composites must be based on objective criteria that is outlined in this section of the firm’s GIPS P&P. For example, firms typically either set a policy based on the amount of time passed since discretion was granted or based on when the portfolio becomes “fully invested” – which must be clearly defined.

For example, if based on time, the policy may be written as, “portfolios are included in the composite at the start of the first full month under management.” If based on when the portfolio becomes fully invested, the policy may be written to state, “portfolios are included in the composite at the start of the first full month after the portfolio is at least 90% invested in line with the strategy.” The percentage set can be whatever your firm feels is appropriate, but you want to establish a clear threshold that can be followed. Simply stating “fully invested” is subjective and difficult to follow consistently.

Other rules can also be documented in this section such as minimum asset levels and significant cash flow thresholds, to keep portfolios out of composites during periods where the intended strategy cannot be fully implemented. Minimum asset levels set for GIPS composite purposes are different than minimums your firm may set for marketing purposes. While your firm can state any marketing minimum you wish based on the size portfolios you hope to attract, the minimum set for composite inclusion must be based on the minimum amount needed to fully implement that strategy. For example, even if your firm states that your strategy has a $1M minimum, portfolios accepted below this threshold must still be included in the composite if they can be managed the same as the portfolios over $1M. In this example, if you determine that below $500k you can no longer diversify the same way as you do for your larger portfolios, then $500k would be an appropriate minimum to set for composite inclusion purposes.

A significant cash flow policy can be established if your firm is concerned with very large cash flows moving in or out of a portfolio. Often these cash flows affect the portfolio’s performance and could distort the composite’s statistics. Firms wishing to implement a significant cash flow policy establish a threshold for the size of a cash flow (typically based on the percentage of the portfolio’s beginning of month market value) that would trigger the temporary removal of the portfolio from the composite while trading takes place to accommodate the cash flow.

This “significant” cash flow threshold is different than the “large” cash flow threshold discussed in the calculation methodology section. While the “large” cash flow threshold is set to improve the mathematical accuracy of the performance calculation, the “significant” cash flow threshold is based on the size of a cash flow that disrupts the actual management of the portfolio. Significant cash flows often lead to distorted performance figures that were out of the portfolio manager’s control in terms of timing or amount.

Error Correction Policies

Firms must create materiality thresholds that pre-determine the action required if errors occur in a compliant presentation. This section should include thresholds for all statistics as well as criteria for determining when errors in disclosures are material. Defining materiality thresholds can be difficult, but CFA Institute, in conjunction with the United States Investment Performance Committee (USIPC), conducted a GIPS error correction survey seeking information regarding the typical materiality thresholds used by GIPS compliant firms. We recommend reviewing the Executive Summary of this survey’s results to get an idea of the thresholds that have been set by your peers.

Typically, thresholds are set that define the level when an error becomes a material error. Anything above the threshold would require the firm to redistribute an amended GIPS compliant presentation to any prospective client or clients that relied on the erroneous presentation. This amended GIPS compliant presentation would also need to include a disclosure that explains the correction. Anything below the materiality threshold will only trigger a correction for future distributions, but no disclosure or redistribution of previously circulated presentations.

Updates for GIPS 2020

The GIPS standards were updated in 2020. Check out our post How to Update Your GIPS P&P for GIPS 2020 to make sure your P&Ps are consistent with these changes.

Want to Learn More?

If you have any questions about the GIPS Standards, we would love to help. Longs Peak’s professionals have extensive experience helping firms become GIPS compliant as well as helping them maintain compliance with the GIPS Standards on an ongoing basis.

GIPS Compliance Actions for the New Year 2020

January 9, 2022

15 min

Your firm works hard to comply with the Global Investment Performance Standards (GIPS®) and likely expects the benefits of GIPS to far outweigh any burden associated with maintaining compliance. Most of the policies and procedures your firm set when first becoming compliant will never need to change; however, as both the standards and your firm evolves, it is beneficial to conduct a high-level review of your GIPS compliance each year. This high-level review will help ensure that you continually refine your processes and policies to maximize the benefits of claiming compliance with GIPS year after year.

This year, conducting a review of your firm’s GIPS compliance is especially important because of the 2020 Edition of the GIPS Standards that was published in mid-2019. For information specific to the 2020 changes, please check out 2020 GIPS Standards: Prepare for the Changes.

Even without the release of a new edition of the standards, each year you should conduct a review. In the review, you should first make sure you have the right people involved. One person or department may be responsible for managing the day-to-day tasks that maintain your GIPS compliance; however, high-level oversight from a larger group should take place to help ensure that any decisions made or policies set will integrate well with your firm’s other strategic initiatives. This larger group, often called a GIPS Committee, typically consists of representatives from compliance, marketing, portfolio management, operations/performance, and senior management.

Not everyone on the committee needs to be an expert in the GIPS standards. In fact, many will not be. What they will need is to be available to share their opinions and represent their department’s interests when establishing or changing key policies for your firm. Your GIPS compliance expert/manager can set the agenda for your meeting and can provide any background on the requirements that will be part of the discussion. If you do not have a GIPS expert internally, or need independent advice about your policies and procedures, a GIPS consultant can be hired to help.

High-Level GIPS Topics to Consider Annually

Once you select the right group to represent each major area of your firm, the following high-level questions can help determine if any action is necessary to improve your GIPS compliance this year:

Have there been any changes to the GIPS standards?
Have there been any material changes to your firm or strategies?
Do your composites meaningfully represent your strategies or should their structure and descriptions be reconsidered?
Are the materiality thresholds stated in your error correction policy appropriate for the type of strategies you manage and are they consistent with the thresholds set by similar firms?
Are you satisfied with the service received from your GIPS verifier for the fee that is paid?
Is there any due diligence you need to conduct on your verification firm?

Changes to the GIPS Standards

It is important to consider whether there have been any changes to the GIPS standards since last year that would require your firm to take action. For example, if a new requirement is adopted, you should consider if any changes to your firm’s policies and procedures or GIPS Reports are needed.

Keep in mind that GIPS compliant firms must comply with all requirements of the GIPS standards including any updates that may be published in the form of Guidance Statements, Questions & Answers (Q&As), or other written interpretations.

If your firm is verified or works with a GIPS consultant, these GIPS experts are likely keeping you informed of any changes to the standards. The best way to check for changes yourself is to visit the “Standards & Guidance” section of www.gipsstandards.org. Specifically, you should check the “GIPS Q&A Database” where you can enter the effective date range of the previous year to see every Q&A published during this period. You should also check the “Guidance Statements” section. The guidance statements are organized by year published, so it is easy to see when new statements are added.

With the new 2020 Edition of the GIPS Standards, a review of the changes to determine how they affect your firm is especially important this year. These changes must be fully adopted before presenting returns in your GIPS reports for periods ending on 31 December 2020 or later.

Changes to Your Firm or Strategies

Similar to changes in the standards, it is important to also consider whether any changes to your firm or its strategies would require you to take action. Examples include, material changes in the way a strategy is managed, a new strategy that was launched, an existing strategy that closed, mergers or acquisitions, or anything else that would be considered a material event for your firm.

Even if no changes were made this year, you should still read your entire policies and procedures document at least annually to make sure it adequately and accurately describes the actual practices followed by your firm. Regulators, such as the Securities and Exchange Commission (SEC), commonly review firms’ policies and procedures to ensure 1) that the document includes actual procedures and is not simply a list of policies and 2) that the stated procedures truly represent the procedures followed by the firm. Many firms have created their policies and procedures document based on template language, so tweaks may be necessary to customize the document for your firm.

Meaningful Composite Structure

The section of your GIPS policies and procedures requiring the most frequent adjustment is your firm’s list of composite descriptions, as you must make changes each time a new composite is added or if a composite closes. However, even without adding new strategies or closing older strategies, the list of composite descriptions should be reviewed at least annually to ensure they are defined in a manner that best represents the strategies as you manage them today.

Since your firm’s prospects will compare your composite results to those of similar firms, it is important that your composites provide a meaningful representation of your strategies and are easily comparable to similar composites managed by your competitors. If a review of your current list of composite descriptions leads you to realize that your strategies are defined too broadly, too narrowly, or in a way that no longer accurately describes the strategy, changes can be made (with disclosure).

Keep in mind that changes should not be made frequently and cannot be made for the purpose of making your performance appear better. Changing your composite structure for the purpose of improving your performance results, as opposed to improving the composite’s representation of your strategy, would be considered “cherry picking.”

Two examples of cases that may require a change in your composites include:

A strategy has evolved and certain aspects of the way the strategy was managed and defined in the past are different from today. This can be addressed by redefining the composite. Redefining the composite requires you to disclose the date and description of the change. This disclosure will help prospects understand how the strategy was managed for each time period presented and when the shift in strategy took place. Changes like this should be made to your composite descriptions at the time of the change, but an annual review can help you address any items that may have been overlooked when the change occurred.
A composite is defined broadly to include all large capitalization accounts. Within this large capitalization composite, there are accounts with a growth focus and others with a value focus. If your closest competitors are separately presenting large capitalization growth and large capitalization value composites, your broadly defined large capitalization composite may be difficult for prospects to meaningfully compare to your competitors. To address this, you can create new, more narrowly defined composites to separate the accounts with the growth and value mandates. In this case, the full history will be separated and the composite creation date disclosed for these new composites will be the date you make the change. Note that this will demonstrate to prospective clients that you had the benefit of hindsight when determining the definition.

Materiality Thresholds Stated in Your Error Correction Policy

Another section of your firm’s GIPS policies and procedures that should be reviewed in detail is your error correction policy. Your error correction policy includes thresholds that pre-determine which errors (of those that may occur in your GIPS Reports) are considered material versus those deemed immaterial. These thresholds cannot be changed upon finding an error; however, they can be updated prospectively if you feel a change would improve your policy.

Many firms had a difficult time setting these thresholds when this requirement first went into effect back at the start of 2011. Now that much more information is available to help you determine these thresholds, such as the GIPS Error Correction Survey, you may want to revisit your policy to ensure it is adequate.

Setting and approving materiality thresholds that determine material versus immaterial errors is a task best suited for your firm’s GIPS committee rather than your GIPS department or manager. The reason for this is that opinions of what constitutes a material error will vary from one department to another. Your committee can help find a balance between those with a more conservative approach and those with a more aggressive approach to ensure the thresholds selected are appropriate.

GIPS Verifier Selection and Due Diligence

If your firm is verified, it is important to periodically evaluate whether you are satisfied with the quality of the service received for the fees paid. You may also want to consider whether you need to conduct any periodic due diligence on your verification firm with respect to data security or other concerns important to your firm.

With several mergers, acquisitions, and start-ups in the verification community over the last few years, you may need to do some research to ensure you are familiar with what your options are when selecting a verification firm.

All verifiers have the same general objective: to test and opine on 1) whether your firm has complied with all of the composite construction requirements of the GIPS standards and 2) whether your firm’s GIPS processes and procedures are designed to calculate and present performance in compliance with GIPS. Where they differ is in the fees charged and process followed to complete the verification.

With regard to fees, much of the difference between verifiers is based on their level of brand recognition rather than differences in the quality of their service. For example, smaller firms specialized in GIPS verification may have more experience with the intricacies of GIPS compliance than a global accounting firm; yet, a global accounting firm will likely charge a higher fee. When selecting a higher fee firm, it is important to consider whether the higher fee is offset by the benefit your firm receives when listing their brand name as your verifier in RFPs you complete.

With regard to process, the primary difference between verification firms is whether the verification testing is done onsite or remotely. There are pros and cons to both methods and it is important for your firm to consider which works best for the team that is fielding the verification document requests. The onsite approach may result in finishing the verification in a shorter period, but may be disruptive to your other responsibilities while the verification team is in your office. The remote approach may be less disruptive to your other responsibilities, but likely will take longer to complete and may be less efficient as documents are exchanged back and forth over an extended period of time. Another difference is how the engagement team is structured, whether you can expect to work with the same team each year, and how much experience your main contact has.

Regardless of whether the verification is conducted onsite or remotely, be sure to ask any verifier how your proprietary information and confidential client data is protected. If the work is done remotely, how are sensitive documents transferred between your firm and the verifier (e.g., is it through email or a secure portal) and once received by the verifier, do they have strong controls in place to ensure your data is not breached.

If the work is done onsite, it is important to ask what documents (or copies of documents), if any, the verifier will be taking with them when they leave, and whether these documents are saved in a secure manner. Documents saved locally on a laptop are at higher risk of being compromised.

Questions?

For more information on how to maximize the benefits your firm receives from being GIPS compliant or for other investment performance and GIPS compliance information, contact Sean Gilligan at sean@longspeakadvisory.com.

How to Become GIPS Compliant

May 24, 2017

15 min

Many firms are interested in becoming GIPS compliant, but are intimidated by the initial process of bringing their firm into compliance. As long as you know the steps to become GIPS compliant and understand the options you have to complete each step, this process is very manageable. The information provided here is intended to provide you with a high-level overview of the steps you must complete to become GIPS compliant.

https://www.youtube.com/watch?v=E6zBnbW_OMU&feature=emb_logo

Before holding your firm out to the public as a GIPS compliant firm, there are three main steps that must first be completed. Firms must:

Document GIPS policies and procedures
Construct composites that consistently follow these policies and procedures
Create compliant presentations to show the results of each composite

Document GIPS Policies and Procedures

Firms are required to document how they comply with the GIPS requirements as well as any recommendations that the firm chooses to follow in a document known as the firm’s GIPS Policies and Procedures (“GIPS P&P”). This document acts as the firm’s internal representation of their GIPS compliance, and is intended to state the firm’s GIPS policies as well as describe the procedures the firm follows to maintain their compliance. Examples of items typically found in this document include:

Firm Definition – GIPS is applied to your firm as a whole, not to a single product or strategy you manage. How your firm is defined for GIPS purposes is primarily based on how the firm is held out to the public, which may differ from the legal structure of your firm.
Definition of Discretion –Discretion is defined differently for GIPS than it typically is for legal or regulatory purposes. You may have a discretionary contract for an account that you deem to be non-discretionary for GIPS purposes because of restrictions the client places on the implementation of the strategy. The “Definition of Discretion” section of your firm’s GIPS P&P should outline objective criteria for determining the discretionary status of accounts.
Policies Regarding Books and Records – Firms must be able to support all information included in compliant presentations as well as support that their client assets are real. This section of your P&P can outline the types of records that are maintained and in what format/location they are stored.
Calculation Methodology – While GIPS provides a framework for how to calculate performance, firms may have different methods for handling external cash flows, asset-weighting accounts, calculating dispersion, etc. The specifics of the methods used must be documented in the firm’s GIPS P&P.
Composite Definitions and Rules – Firms must create policies to ensure that accounts are placed in the appropriate composite for the correct time period. The timing of the movement of accounts in or out of composites must be based on objective criteria that is outlined in this section of the firm’s GIPS P&P. Other optional rules, such as minimum account sizes and significant cash flow thresholds can also be documented here to keep accounts out of composites during periods where the intended strategy cannot be fully implemented.
Error Correction Policies – Firms must create materiality thresholds that pre-determine the action required if errors occur in a compliant presentation. This section should include thresholds for all statistics as well as criteria for determining when errors in disclosures are material.

Construct Composites

After the GIPS P&P is created, firms can use these policies to construct the composites defined in the policy document. To do this, firms must:

Identify all of the accounts that meet the definition of a composite. In other words, group all accounts by strategy, but then remove accounts that do not meet the firm’s definition of discretion or that do not meet a composite-specific rule, such as a minimum account size.
Determine the correct time to include each account as well as remove any account that closed, changed strategies, or otherwise caused you to lose discretion. Portfolios must only be included in composites for periods in which they were considered discretionary for GIPS purposes. This helps ensure that the composite results accurately represent the firm’s management of the composite’s strategy and does not include outside noise created from client-requested restrictions.
Asset-weight the monthly account-level results for each account included in the composite to calculate the composite-level performance results.
Calculate all required composite-level statistics (see the list below) that must be included in the composite’s compliant presentation.

Create Compliant Presentations

Compliant presentations act as the firm’s external representation of their GIPS compliance and must be provided to all prospective clients. Each composite has a separate presentation that includes all of the required statistics as well as the required disclosures. Statistics included in compliant presentations include:

Annual composite performance (gross and/or net)
Annual benchmark performance
Number of accounts in the composite as of each year-end
Total assets in the composite as of each year-end
Total assets of the GIPS firm as of each year-end
A measure of internal dispersion for each annual period
Three year annualized ex-post standard deviation of both the composite and the benchmark based on monthly returns

Other statistics may also be required such as the percentage of non-fee paying accounts or the percentage of bundled fee paying accounts as of each year-end, where applicable.

Want to Learn More?

If you have any questions about how to become GIPS Compliant, we would love to help. Longs Peak’s professionals have extensive experience helping firms become GIPS compliant as well as helping them maintain compliance with the GIPS Standards on an ongoing basis.

How to Comply with the 2020 GIPS Standards

April 23, 2020

15 min

A new decade is upon us and with the new decade comes a series of new requirements in terms of investment performance reporting for firms and asset owners that elect to claim compliance with the GIPS standards.

Many organizations have elected to adopt the 2020 edition of the GIPS standards early and have already put a solid foundation in place for the updated requirements; however, many organizations have not. The adoption deadline for all compliant organizations is rapidly approaching, so if your organization has not begun this conversion, now is the time to get started.

What is Changing and Why

It has been over a decade since the last edition of the GIPS standards was released, and quite frankly, the industry has changed since 2010. As the industry has evolved, CFA Institute has released a number of Q&A’s, guidance statements, and interpretations on how the changes in the industry impact the standards.

Ten years of updates have resulted in a vast repository of information needed to obtain the guidance required to comply. Having so many different resources for guidance (the 2010 GIPS Handbook, separate guidance statements, the Q&A database, and the GIPS Help Desk) has made managing the requirements of GIPS a pretty daunting task; thus, one of the goals of the 2020 standards is to centralize all of the updates that have come out over the past ten years. The 2020 GIPS standards consolidates many of the concepts previously addressed in guidance statements and Q&A’s, allowing the new provisions and explanation of the provisions to serve as the primary source that firms, asset owners, verifiers, and consultants can look to for guidance.

Additionally, the 2010 standards were heavily focused on composites and the traditional definition of prospective clients. Using this as the main framework is not always applicable to organizations that primarily manage pooled funds or asset owners that do not compete for business or report performance to prospective clients. To address this, CFA Institute set out to make this new edition of the standards more applicable to pooled fund managers and asset owners. These updates were designed to make claiming compliance easier and more relevant for these types of managers, while not creating additional burdens on organizations that are already compliant with GIPS. This goal is evident in the new format of the provisions, which separately focuses on requirements for investment firms, asset owners, and verifiers.

In addition to the separation of pooled funds and composites, the guidance is broader on when organizations may present money-weighted returns instead of time-weighted returns. This change now allows the decision to be based on the investment vehicle structure and who controls the timing and amount of external cash flows, rather than limiting money-weighted returns to certain asset classes. This is a welcomed update in the industry as many organizations were frustrated by requirements to calculate and present time-weighted returns when this type of return was not the most meaningful representation of how they managed their investment strategies.

How the 2020 GIPS Standards are Organized

For ease of use and navigation, the 2020 GIPS standards is broken out into three different groups of tailored provisions – firms, asset owners, and verifiers. Each containing specific requirements and recommendations applicable for that type of organization.

As an organization claiming compliance or working to become compliant for the first time, you will need to determine whether the set of requirements for firms or assets owners is applicable to your claim of compliance. The primary distinguishing factor is whether your organization competes for business and manages external money, or reports to an oversight board and manages internal money. The answer to this determines which set of tailored provisions should be followed and sets the framework for how the standards will apply.

Where to Start – GIPS Compliance Updates

Regardless of whether you are excited for the updates to the standards, they are coming and will be required for all firms and asset owners claiming compliance with GIPS. The new requirements take effect once your GIPS Reports (formerly called Compliant Presentations) present performance information that is inclusive of the period 31 December 2020.

There is a lot of information available and dissecting everything that has been released can be overwhelming. For organizations that have never claimed compliance, the good news is that the new standards are more applicable and easier to adopt than they were previously.

For most organizations currently claiming compliance, what’s great is that the new standards do not require a lot of changes, rather they mostly provide optional procedures that you may choose to adopt if you find it beneficial to do so. However, some firms will require more work.

At Longs Peak, we have created the following questionnaire designed to help you determine if converting to the 2020 GIPS standards will require more than a few minor tweaks. This list does not include all changes, but includes the top ten material changes that may require a project plan to implement the required changes by the effective date of the 2020 GIPS standards.

Answering “Yes” to any of the following questions means your organization may require more than a few quick tweaks to implement the 2020 changes:

GIPS 2020 Checklist

Does your firm have limited distribution pooled funds (i.e., private funds that are not regulated under a framework that would permit the general public to purchase shares in the fund without a one-on-one presentation)?
Has your firm created single account composites for pooled funds solely for the purpose of meeting the GIPS requirement of having every discretionary, fee-paying portfolio in at least one composite?
Does your firm have multi-strategy portfolios (e.g., balanced portfolios where the equity and fixed income segments each could be represented as standalone strategies) where you would like to carve-out the individual strategies into their own composites?
Does your firm have portfolios where actual transaction costs are unavailable (e.g., wrap accounts or other bundled fee arrangements) and you would like to estimate transaction costs to show gross-of-fee returns without labeling the returns as supplemental information?
Does your firm have portfolios where your firm controls the amount and timing of external cash flows (other than for private equity or real estate) and you would like to present money-weighted returns rather than time-weighted returns?
Does your firm have real estate or private equity composites?
Does your firm include theoretical performance (e.g., model performance) as part of a GIPS report?
Does your firm follow the Advertising Guidelines to claim compliance with the GIPS standards outside of your GIPS Reports?
Does your firm currently update your GIPS compliant presentations more than 12 months after the year ends?
Does your firm have advisory-only assets or uncalled committed capital you wish to present in your GIPS Report?

Although the intent is for the adoption of the standards to be more relevant, many organizations find themselves asking “where do I even begin?” The great news is that you don’t have to figure this all out on your own.

At Longs Peak, we have spent countless hours familiarizing ourselves with the new standards and have helped all of our clients begin to adopt the changes. We know what issues come up and how to navigate the changes required.

As a consultant, we do not have independence requirements like your verifier, so we can actually help you implement many of the 2020 changes required for your organization. If you do not already work with a GIPS consultant, now may be a good time to consider hiring one, especially if you lack the resources needed to get this done by the deadline to convert to the 2020 GIPS standards.

Contact us if you do not wish to read through all of the requirements and recommendations to identify what actions are required for your organization.

Finally, if you would like to read more about what changed and why, we have summarized the main changes to the GIPS standards in GIPS 2020 What’s Changing and What you Should Do.

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A Practical Framework for Implementing the GIPS® Standards

15 min

Most firms that decide to pursue compliance with the Performance Standards (GIPS®) already understand why it matters. They know institutional investors and consultants often expect it. They understand the credibility that comes from standardized, transparent performance reporting. And they recognize that a strong performance reporting process can improve internal consistency well beyond marketing.

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What many firms struggle with is not the “why,” but the“how.”

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The GIPS standards can be especially intimidating at first glance. There are detailed requirements, technical terminology, and a long list of considerations that touch everything from performance, to operations, compliance, and marketing. For firms approaching GIPS compliance for the first time, it is easy to feel like they need to solve everything at once.

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Whether working independently or with external GIPS support,becoming GIPS compliant is significantly more manageable when approachedthrough a structured process.

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At a high level, implementing the GIPS standards comes down to four major phases:

Define the firm and scope the universe of portfolios
Build policies and procedures
Construct composites and calculate performance
Create GIPS Reports and establish ongoing monitoring controls

The order matters more than many firms realize. When the foundation is built correctly at the beginning, the downstream work becomes significantly easier. For a broader overview of what the GIPS standards are and why firms choose to comply, see our earlier post, What Are the GIPS Standards?

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_{Phase 1: Define the Firm and Scope Your Universe}

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Before constructing composites or calculating returns, firms first need to define the “firm” for the purpose of claiming compliance with the GIPS standards. This sounds simple, but it is often one of the most important decisions in the entire implementation process.

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The GIPS standards require compliance on a firm-wide basis. Firms cannot selectively apply compliance to only their best-performing strategies or business lines. The firm definition determines which portfolios fall within the scope of compliance and ultimately impacts composite construction, total firm assets, disclosures, and marketing claims.

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For smaller organizations, this step is often straightforward. The legal entity, branding, regulatory registration, and operational structure are usually aligned. In those situations, the firm definition may be relatively easy to document.

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For larger organizations with complex legal structures or ones that operate under multiple brands, the analysis can become significantly more complex.

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The following questions should be considered:

How is the firm held out to the public?
Do affiliates or subsidiaries share investment personnel or investment decision-making?
How are the various entities registered and branded relative to one another?
How are investment strategies actually managed across entities?

The answer to these questions matters because the firm definition affects everything that follows. For complex organizations, it is worth investing real time here and involving compliance and legal teams before any other work begins.

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Once the firm is defined, the next step is performing a full inventory of assets (or portfolios) that fall within the defined firm. That includes discretionary accounts, non-discretionary accounts, pooled funds, terminated portfolios, and any other assets managed by the firm over the entire period for which the firm will claim compliance.

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One of the most common implementation mistakes is discovering late in the process that certain portfolios were overlooked or incorrectly categorized. Taking the time upfront to fully scope the universe of portfolios prevents significant cleanup work later on.

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Phase 2: Build Your GIPS Standards Policies & Procedures Manual

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The next step is building the firm’s GIPS standards policies and procedures manual, often referred to as the GIPS standards “P&P.”

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The GIPS standards require firms to document the policies and procedures used to comply with all applicable requirements. But beyond satisfying the standards themselves, strong documentation creates consistency across operations, compliance, marketing, and portfolio management teams. Your GIPS standards P&P becomes the operational blueprint for how your firm calculates performance and maintains GIPS compliance. When drafted thoughtfully, ongoing maintenance becomes manageable. Firms that rush this phase often find themselves cleaning up problems indefinitely.

A well-designed P&P typically addresses the following:

Firm definition
Definition of discretion
Composite construction rules
Treatment of significant cash flows and composite minimums
Calculation methodologies
Fair valuation hierarchy
Error correction procedures
Books and records retention
GIPS Report distribution policies
Benchmark selection and changes
Fee schedules and policies for the use of actual or model fees

The definition of discretion deserves particular attention. Under the GIPS standards, discretion is not the same thing as having legal discretion documented in the investment management agreement. A client may impose restrictions that prevent full implementation of the strategy, and if those restrictions are significant enough, the portfolio should be classified as non-discretionary under the GIPS standards. Firms should establish objective criteria that can be applied consistently across portfolios and clearly document those criteria within their P&P. This determination has a direct impact on composite construction, as only portfolios deemed discretionary maybe included in composites, while non-discretionary portfolios must be excluded.

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Calculation methodology should also be clearly addressed within the P&P. Firms should define how external cash flows are handled, the methodology used to asset-weight portfolios within composites, and whether any composites are subject to minimum asset levels or significant cash flow policies. For a more detailed discussion of large cash flow policies versus significant cash flow policies—and why both matter—see our post Large vs. Significant Cash Flows: What’s the Difference? These methodologies should be clearly documented.

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Finally, firms often do not devote enough attention to developing their error correction policy during implementation. The GIPS standards require firms to establish materiality thresholds in advance that determine what actions must be taken when an error is identified. The time to think through that process is before an error occurs, not in the middle of responding to one.

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We often find that this is the phase where firms realize that implementing GIPS compliance is not just a performance reporting exercise. It frequently exposes inconsistencies in operational workflows, account coding, historical records, or portfolio classifications. That is not necessarily a bad thing. It allows you to intentionally strengthen processes and reporting before those issues surface in higher-stakes situations such as verification, a regulatory examination, or investor due diligence.

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One of the biggest hidden benefits of the GIPS compliance implementation process is that it forces firms to formalize processes that may have evolved informally over time. Many firms come out of the GIPS compliance implementation process with cleaner data, stronger internal controls, and more consistency across teams.

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The key is to make the policies practical. The best GIPS standards P&Ps are not written purely for regulators or verifiers. They are designed to reflect what the firm actually does in practice and to provide internal teams with a framework they can follow consistently.

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Phase 3: Construct Composites and Calculate Performance

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Once your policies and procedures are in place, firms can begin the process of constructing composites and calculating performance. This is the phase most firms typically associate with GIPS compliance because it is where the visible performance reporting work happens. At this point, much of the difficult decision-making should already be complete. Composite construction is next and while that may sound straightforward conceptually, this is the phase where most firms get stuck in the implementation process.

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Under the GIPS standards, discretionary portfolios must be grouped into composites based on similar investment mandates. The goal is to ensure firms present strategy-level performance fairly and consistently instead of selectively highlighting individual account results. The construction process typically has four steps:

Identify every portfolio that meets the composite definition
Determine the correct dates each portfolio should be in and out of the composite
Asset-weight the portfolio-level monthly returns to produce composite-level performance
Calculate all required composite-level statistics, including internal dispersion and the three-year annualized ex-post standard deviation of both the composite and the benchmark

It sounds simple, but it’s not always easy. The data work alone is substantial. Before anything meaningful can be built, the underlying portfolio-level data must be reviewed to ensure it is reconciled and accurate. That foundation matters because everything downstream depends on it.

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The historical composite membership analysis adds another layer of complexity. Strategies evolve. Clients add or remove restrictions. Portfolios change mandates. When building a composite with a ten-year history, the question is not simply which portfolios belong in the composite today. Itis which portfolios belonged in the composite during each period in the historical record, and why. Working through that analysis portfolio by portfolio and period by period requires both strong documentation and sound judgment.

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The good news is that there are tools available to help firms identify historical performance outliers to help test if composite inclusion was accurate. When a portfolio within a composite posts a return that deviates meaningfully from its peers during a given period, that deviation can be identified for further research. Was there a client-imposed restriction during that period that prevented full implementation of the strategy (i.e., making it non-discretionary)? Or was the deviation driven by a large cash flow, different starting position, security-specific activity, or simply the normal variation expected across portfolios managed within the same strategy? The answer determines whether the portfolio appropriately belongs in the composite for that period, and the wrong conclusion in either direction can undermine the integrity of the track record.

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It is also important to be direct about the limits of technology in this process. Software can identify anomalies, efficiently perform calculations, and output results once the inputs are correct, but no system makes judgment calls. Determining how composites should be defined, how discretion should be applied, what constitutes a significant restriction, and how to evaluate edge cases in historical membership all require experienced professionals who understand both the investment strategies and the GIPS standards. The policies documented in Phase 2 provide the framework but applying that framework consistently across real portfolios and real historical circumstances requires thoughtful human judgment at every step.

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Perhaps most importantly, composite construction should not be treated purely as an operations exercise. If composites are built solely around how data happens to be structured within the portfolio accounting system, without input from the investment team and without alignment with sales and marketing, the result may be operationally convenient but commercially ineffective. Bringing together operations, performance, investment professionals, and sales and marketing teams early in the process is essential. That collaboration is what ultimately produces results that are not only GIPS compliant, but also meaningful, defensible, and aligned with how the firm communicates its investment approach.

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Phase 4: Create GIPS Reports and Go Live

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The final phase of becoming compliant is creating the GIPS Composite Report(s). The GIPS Report is the firm’s external-facing proof of compliance and is a presentation that must be provided to every prospective client. Getting to this stage is what most people think of as going live, but in practice it is a milestone, not the finish line.

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GIPS Reports require more than simply presenting returns in a table. Firms must include required statistics, disclosures, benchmark information, and firm-level details necessary for prospective clients to properly interpret the results. The disclosures are especially important because they provide context investors need to understand how the performance was calculated and what the results represent. They are very specific and must be in sync with what is documented in the P&P and what was performed to construct the composites. For more specifics on what is required, see our previous post, How to Update Your GIPS Reports for the 2020 GIPS Standards.

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Once the GIPS Reports are complete and all requirements have been met, the final administrative step to claiming compliance is submitting the GIPS Compliance Notification Form to CFA Institute. This must be filed before compliance can be claimed, and it must be renewed annually.

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Ongoing Maintenance: Where Most Firms Struggle

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Getting to compliance is an achievement. Staying there requires consistent operational discipline.

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The most common breakdowns in ongoing maintenance are rarely dramatic failures. More often, they are small process gaps that compound over time. Portfolios that should have been added to composites were omitted or added late. Significant cash flows were not handled in accordance with the composite’s policy. A new strategy was launched without formally determining whether it warranted the creation of a new composite.

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To avoid these breakdowns, firms should incorporate GIPS compliance procedures into their regular monthly or quarterly performance processes rather than treating compliance as an annual reporting exercise. Clear ownership should be assigned internally and firms should establish a recurring compliance calendar that includes monthly composite reviews and annual GIPS Report updates. The GIPS standards policy manual should also be reviewed at least annually to confirm it continues to reflect how the firm actually operates. For a deeper look at what effective ongoing governance looks like in practice, see our post What Good GIPS Compliance Governance Looks Like in Practice.

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Should You Get Verified

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Verification is not required. Firms that are early in the process sometimes view this as a bigger decision than it needs to be. If a firm chooses to pursue verification, it must be performed by an independent third party, but the decision itself is entirely voluntary.

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That said, verification is generally worthwhile, particularly for firms competing for institutional mandates where GIPS compliance is often considered table stakes. According to eVestment, two out of three searches conducted in their database by investors or consultants exclude firms that are not GIPS compliant, so the marketing benefit can be meaningful. Verification also provides an added level of assurance that the firm’s policies and procedures have been designed in accordance with the GIPS standards and implemented consistently across the organization. Operationally, it can create valuable discipline as well, since the expectation of independent review encourages firms to maintain strong processes throughout the year.

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For firms that are newer to compliance or navigating budget constraints, the best path is often to first establish a solid compliance foundation and then pursue verification when the timing makes sense. We have also worked alongside nearly every major verifier in the industry and can provide practical insight into how different firms approach the process, what working styles may align best with your organization, and how to evaluate which verifier may be the best fit for your needs. For a more detailed walkthrough of the process, see our series on How to Survive a GIPS Verification.

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Final Thoughts

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Becoming GIPS compliant can feel overwhelming at the start, especially when going through it for the first time. But it does not have to be. For firms that approach implementation as a structured operational framework — rather than a collection of isolated technical requirements —typically find the process much more manageable.

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The goal is not simply to produce a compliant presentation. The real value comes from building a repeatable, transparent, and defensible framework for calculating and presenting investment performance.

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When implemented thoughtfully, the GIPS standards do more than support marketing efforts. They help firms improve consistency, strengthen controls, and communicate performance results with greater credibility and transparency. And in an environment where investors continue to demand greater transparency and comparability, those operational improvements can provide a meaningful competitive advantage, strengthening both credibility and investor confidence.

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How Mission-Based Endowments & Foundations Should Think About Investment Performance Reporting

April 27, 2026

15 min

Mission-driven institutions are entrusted with something larger than capital. They are entrusted with purpose.

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Endowments, foundations, and long-term investment pools exist to support education, healthcare, research, environmental initiatives, religious or cultural programs, community development, and countless other causes—often for generations.

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That long-term horizon changes how investment performance should be reported. Because when an institution thinks in decades instead of quarters, investment performance is not just about what happened recently, itis about whether the portfolio is structured to sustain spending, preserve purchasing power, and remain aligned with its mission through full market cycles.

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Many institutions rely entirely on their investment managers to calculate and present investment performance. That’s common, but it’s not always sufficient.

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Performance Oversight Is Not the Same as Performance Results

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Investment managers are responsible for generating returns. Boards and oversight committees are responsible for evaluating those results.

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Those responsibilities are distinct.

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Oversight is a fiduciary duty. It is not passive, and it cannot rely solely on the information created by the party being evaluated. Effective oversight requires independence, consistency, and clarity.

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When the same party both manages assets and determines how performance is calculated and presented, the lines between management and oversight can blur—even when intentions are sound and calculations are technically accurate.

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In some situations, reporting may not be:

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Consistent across managers
Based on uniform calculation methodologies
Presented in a format designed for governance review
Structured to facilitate long-term policy evaluation

Consider a board reviewing results from three different managers. Each reports strong performance, but one calculates returns net-of-fees, another presents gross results, and a third uses slightly different valuation timing.

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At first glance, the numbers appear comparable. In reality, they may not be measuring the same thing.

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Some larger institutions maintain internal performance teams or engage independent performance professionals to standardize reporting, organize data across managers, and present results in accordance with established best practices—often aligning reporting with their Investment Policy Statement and/or recognized frameworks such as the Global Investment Performance Standards (GIPS® standards).

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But many of these organizations operate lean. They may not have dedicated performance measurement expertise or the infrastructure required to consolidate, normalize, and present results in a governance-ready format.

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In those cases, boards are often reviewing manager-produced materials that were designed primarily for client communication—not institutional oversight. Performance reporting for these institutions should be designed to serve the governing body—not simply to showcase results.

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Why This Matters for Mission-Based Institutions

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Boards of endowments and foundations are often composed of dedicated volunteers, philanthropists, community leaders, and subject-matter experts. They bring vision, experience, and commitment to the institution’s mission—but not always a deep understanding of investment management and reporting.

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That makes investment performance clarity essential. When reporting is unclear, oversight weakens—not because trustees lack commitment, but because the information is not presented in a way that supports meaningful evaluation.

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When reporting is structured and tied directly to policy benchmarks, risk parameters, and spending objectives, trustees know what questions to ask. Conversations remain focused on long-term sustainability and mission impact.

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A Practical Framework for Strong Performance Reporting

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Boards of mission-driven institutions are often operating at the governance-level and should evaluate their reporting structure against four questions:

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1. Is performance calculated independently?

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Independent calculation or oversight reduces potential conflicts and strengthens fiduciary governance. In institutional investing, separating portfolio management from performance oversight is widely viewed as a best practice.

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2. Is the methodology consistent across managers?

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Multi-manager portfolios require uniform return calculation, fee treatment, and valuation policies to ensure comparability. Without consistency, “relative performance” becomes difficult to interpret.

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One practical way institutions address this challenge is by complying with and requiring their managers to comply with the GIPS® standards.

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The GIPS standards are a globally recognized framework administered by CFA Institute designed to promote fair representation and full disclosure in the calculation and presentation of investment performance.

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Endowments and foundations that adopt the GIPS standards for their own performance calculations—and require the same of the managers they hire—send a powerful message to their boards and stakeholders that the institution is committed to transparency in how results are calculated and presented.

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3. Is reporting aligned with policy benchmarks?

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Boards should see performance relative to long-term policy objectives, not just absolute returns. And this information should be shown at the level at which it is managed. Simply reporting that “the portfolio returned 8%” does not answer the real governance question.

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A portfolio can have a positive year and still fail to meet its strategic role within the overall allocation.

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For example:

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Did the equity allocation meet its return objective relative to its benchmark?
Did the diversifying strategies provide the downside protection they were intended to deliver?
Did fixed income serve its role as a stabilizer?
Did alternative investments justify their complexity and liquidity constraints?

Even if the overall portfolio met its expected return, boards should understand how it got there. Reviewing performance by allocation allows boards to evaluate whether each segment is fulfilling its mandate, not just whether the total return looks acceptable.

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When reported this way, it becomes easier to see where the portfolio is meeting expectations and where it may be falling short.

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4. Is communication designed for governance?

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Once performance is aligned to policy benchmarks, reporting should help trustees interpret what the results mean without requiring them to operate at the manager or security-selection level.

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Reports should help answer key questions:

· Are we meeting long-term objectives?

· How are managers performing relative to their mandates?

· Is risk aligned with the investment policy?

· Are we preserving capital appropriately given our spending needs?

· Did managers follow investment guidelines that align with our institution’s mission?

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If any of these areas underperform, governance-level reporting should prompt clear, high-level discussion: Why did this occur? Was the result consistent with expectations? What steps, if any, are being considered to address issues going forward? If shortfalls persist, boards may need to evaluate whether the strategy or manager remains appropriate.

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This kind of oversight strengthens outcomes by reinforcing accountability. Performance reporting should be communicated in plain language and simplify complex data into clear actionable insight. When this occurs, it enables boards to move from procedural review toward informed, effective governance.

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From Calculation to Communication

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Accurate returns are the starting point. Clear communicationis the outcome.

When performance calculation, oversight, and presentation are thoughtfully structured, board discussions become more strategic and less reactive. Boards gain confidence in their oversight, managers operate within clearer expectations, and the institution stays focused on its purpose.

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A Closing Thought

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Mission-driven institutions think in decades, not quarters. Their performance reporting should reflect that same discipline. Investment oversight is not just about generating returns, it is about ensuring those returns are measured, understood, and aligned with the institution’s long-term purpose.

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Clear reporting strengthens governance.
Strong governance protects sustainability.
And sustainability protects the mission.

What Good GIPS Compliance Governance Looks Like in Practice

March 19, 2026

15 min

If you’ve been around the Global Investment Performance Standards (GIPS®) long enough, you know that governance is one of those topics everyone agrees is important, but far fewer firms can clearly explain what good governance with the GIPS standards actually looks like day to day.

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Most firms don’t fail at GIPS compliance because they misunderstand a technical requirement. They struggle because ownership is unclear, decisions are informal, or key knowledge lives in one person’s head. When that person leaves (or when the firm grows) things start to break.

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So, let’s simplify this.

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Below is a practical, real-world view of what good governance looks like when complying with the GIPS standards—not in theory, not in a policy document that no one reads, but in how well-run firms actually operate.

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Start with the Right Mindset: Governance Is About Sustainability

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At its core, GIPS compliance exists to answer one question:

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Can this firm consistently calculate, maintain, and present performance fairly and accurately—regardless of growth, staff changes, or market stress?

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The GIPS standards are built on the principles of fair representation and full disclosure, but governance is what turns those principles into repeatable behavior. Good governance doesn’t mean more paperwork or compliance headaches. It means clear accountability, documented decisions, and controls that actually get used.

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1. Clear Ownership (It’s Rarely Just One Person)

One of the most common governance risks we see is a “GIPS compliance department of one” where critical knowledge, decisions, and processes are concentrated with a single individual. While this can work in the short term, it creates challenges around continuity, oversight, and scalability as the firm grows or changes.

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Good governance starts by clearly defining:

Who owns GIPS compliance overall
Who performs monthly/quarterly/annual tasks
Who reviews and approves key inputs/outputs
Who resolves judgment calls
Who ensures it also complies with other relevant regulations

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In practice, this often looks like:

A GIPS compliance committee or designated governance group
Representation from performance, compliance, operations, and senior management
Defined escalation paths for gray areas (e.g., discretion, composite changes, error corrections)

When a firm isn’t large enough to support a formal committee, outsourcing to a GIPS compliance consultant or a provider of managed services can be an effective alternative. These individuals can help you design policies, create procedures, and essentially manage governance for you.

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But even if you are big enough, having an independent third party on your GIPS compliance committee can provide an objective, well-informed perspective formed by experience across many firms and a deep understanding of what works well in practice.

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2. Policies and Procedures That Reflect Reality

Every GIPS compliant firm has GIPS standards policies and procedures (GIPS standards P&P). Well-governed firms actually use them.

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Strong GIPS compliance governance means your GIPS standards P&P:

Include procedures your firm actually follows instead of only stating policies
Reflect how performance is really calculated
Clearly document firm-specific elections and judgments
Are updated when the business changes (for new products, systems, asset classes)

Think of your GIPS standards P&P as the firm’s operating manual for performance, not a static compliance artifact. If someone new joined your performance team tomorrow, they should be able to follow your policies and procedures to calculate performance and arrive at the same results. If not, governance needs work.

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3. Formalized Review and Oversight

Good governance includes independent review, even if it’s internal.

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In practice, this often means:

Secondary review of composite membership decisions
Review of significant cash flow thresholds and discretion determinations
Approval of new composites and composite definition changes
Oversight of error identification and correction

This is where governance protects firms from subtle but costly mistakes, especially those that show up during verification and increase complexity and scope of these engagements. In an ideal situation, these internal reviews should catch issues before they become problems.

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As a provider of managed services, Longs Peak helps firms identify performance outliers, accounts that are breaking composite rules, and other data anomalies. This review significantly reduces the risk of erroneous data ending up in your performance and later caught in verification. If you are not able to do this internally, we strongly recommend outsourcing this effort.

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4. Governance Extends to Marketing and Distribution

One area that has been increasingly important is the intersection of GIPS compliance, the SEC marketing rule, and how you manage the distribution of marketing materials.

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Well-governed firms:

Control who can distribute GIPS Reports and how they are distributed
Ensure Marketing understands what is and is not an advertisement that meets the requirements of the GIPS standards
Coordinate GIPS compliance requirements with broader regulatory rules, including the SEC marketing rule
Have a clear process for tracking distribution

This alignment helps firms avoid inconsistencies between factsheets, pitchbooks, and GIPS Reports—one of the fastest ways to lose credibility with prospects and regulators.

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Some clients prefer not to mention GIPS compliance at all in their marketing (i.e., on their factsheets and pitchbooks) until a client is clearly interested in one of their strategies. Once they meet the definition of a prospect (as outlined in your GIPS standards P&P), it triggers the requirement to send a GIPS Report and they find this smaller list of prospects easier to maintain. For others, having everything in one document including required GIPS compliance information and disclosures is easier to manage than separate documents.

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There is no “right” way to manage this, but in either case, having a clear process for tracking and reporting performance errors is key.

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5. Documentation of Decisions (Not Just Results)

Here’s a subtle but critical point: Good governance for your GIPS compliance program documents decisions, not just outcomes.

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Why was that composite redefined?
Why was this benchmark changed?

Why was this model fee selected?

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Strong governance creates an audit trail that:

Supports sound reasoning (which aides in the verification process or even regulatory exams later on)
Reduces key person risk
Makes future reviews faster and less stressful

This is especially valuable when firms grow, merge, or experience turnover. Clear documentation allows others to step in seamlessly and continue critical functions without disruption. More importantly, it enables independent parties, such as a regulator or your verifier, to understand, assess, and validate how you are calculating and presenting performance that may not be immediately intuitive.

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6. Governance Is Ongoing, Not a One-Time Project

The best-governed firms don’t “set and forget” their GIPS compliance program. They revisit governance when:

New strategies launch
Systems or custodians change
Regulations evolve
The firm’s structure changes

In other words, governance evolves with the business—because performance reporting doesn’t exist in a vacuum.

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Even for firms that are not regularly launching new strategies, changing systems or structure, an annual review of your GIPS compliance program and governance framework is critical. This review helps confirm that practices have remained consistent, while also providing an opportunity to reflect on whether you are satisfied with your verifier, assess whether new regulations require updates, and reconsider how composites are managed or described.

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The best time to do this is at year-end so that if you decide something should be changed, you can do that proactively for the upcoming year, rather than having to fix it retroactively.

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What Good GIPS Compliance Governance Really Buys You

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When GIPS compliance governance is working well, firms experience:

A structured, intentional process for validation of your performance results
A framework that supports consistency and transparency over time
Fewer surprises or last-minute scrambles during verification or regulatory review
Greater confidence from regulators and verifiers that you are following established policies and procedures
Lower operational and reputational risk

Most importantly, it creates trust internally and externally. Good GIPS compliance governance isn’t about being perfect. It’s about being intentional.

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Clear ownership. Thoughtful documentation. Real oversight. Those are the firms that don’t just claim compliance, they live it.

Are ETFs A Better Benchmark?

The Advantages:

Cost:

Practical Investment Comparison:

Incorporation of Costs:

Dividend Reinvestment:

Tax Considerations:

Replication and Tracking Error:

Transparency and Real-time Data:

Advantages Summary

The Disadvantages:

Downside of Tracking Error:

Tracking Method: Full Replication vs. Sampling

Non-Comparable Expense Ratios:

Liquidity Constraints:

Selection Dilemma

Regulatory and Structural Issues:

Market Influences:

Currency Risk:

Dividend Handling:

Lack of Historical Data:

Conclusion:

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A Practical Framework for Implementing the GIPS® Standards

Phase 1: Define the Firm and Scope Your Universe

Phase 2: Build Your GIPS Standards Policies & Procedures Manual

Phase 3: Construct Composites and Calculate Performance

Phase 4: Create GIPS Reports and Go Live

Ongoing Maintenance: Where Most Firms Struggle

Should You Get Verified

Final Thoughts

How Mission-Based Endowments & Foundations Should Think About Investment Performance Reporting

Performance Oversight Is Not the Same as Performance Results

Why This Matters for Mission-Based Institutions

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A Practical Framework for Strong Performance Reporting

From Calculation to Communication

A Closing Thought

What Good GIPS Compliance Governance Looks Like in Practice

Start with the Right Mindset: Governance Is About Sustainability

1. Clear Ownership (It’s Rarely Just One Person)

2. Policies and Procedures That Reflect Reality

3. Formalized Review and Oversight

4. Governance Extends to Marketing and Distribution

5. Documentation of Decisions (Not Just Results)

6. Governance Is Ongoing, Not a One-Time Project

What Good GIPS Compliance Governance Really Buys You

Simplify Performance. Amplify Impact.

_{Phase 1: Define the Firm and Scope Your Universe}