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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.

We at Longs Peak Advisory Services were thrilled to sponsor and participate in the 22nd Annual Performance Measurement, Attribution & Risk Conference (PMAR™) held on May 22-23, 2024. The event was a fantastic opportunity for us to engage with industry experts and share our insights. We always appreciate how TSG encourages participants to engage with sponsors and if you were there, hope we had a chance to meet you!

If you couldn’t make it this year, here are some of the key takeaways from the event that we found most impactful:

Artificial Intelligence in Performance and Reporting

This year’s event included two powerful sessions on the use of AI in the performance industry. Harald Collet from Alkymi presented a compelling session on the transformative impact of artificial intelligence (AI) in performance measurement and reporting. AI's capability to process vast amounts of data and generate actionable insights is indeed revolutionizing our field. Collet's discussion highlighted both the opportunities AI presents, such as enhanced efficiency and accuracy in reporting, and the challenges it brings, including concerns about data integrity and ethics. This session resonated with us as we continually seek to integrate advanced technologies to better serve our clients while carefully managing associated risks.

The application of AI, even on a small scale, can have a profound impact, helping optimize processes, and enhancing customer/employee experience and overall satisfaction. It has the power to enhance productivity and decision-making, making even modest use of this technology extremely valuable. One example provided was how to integrate AI with Excel. It is now possible to augment Excel’s capabilities to automate data entry, cleaning, and formatting, which saves time and reduces human error.

The “human in the loop” (HITL) concept was also discussed which emphasizes the role of human oversight and intervention in AI systems, where AI technologies are guided and corrected by human judgment, particularly in complex or critical tasks where machine errors could have significant consequences. While experts in many fields are often concerned that AI technologies will replace individuals in the workforce, Collet encouraged the crowd with a simple reminder that “You’re not going to lose your job to AI. You’re going to lose your job to someone who is using AI.”

Implementing SEC Guidelines

Our very own partner, Matt Deatherage, CFA, CIPM, had the privilege of moderating a session on the practical implementation of the new SEC guidelines alongside Lance Dial and Thayne Gould. They aimed to provide attendees with a comprehensive overview of these guidelines and share strategies for effective compliance. Now that the guidelines have been in place for over a year, the discussion underscored the importance of understanding regulatory expectations and adapting internal processes accordingly. Some of the key reminders from this session were:

• Most of the time the SEC will likely view Yield as a performance statistic and should therefore be shown net of fees. If the investment firm believes yield is not performance and wants to show it gross, they must be comfortable in defending that stance.
• Attribution analysis is often seen as performance-related information and therefore needs to be net of fees.
• Do not put hypothetical performance on your website! In most scenarios, it is generally not appropriate to present hypothetical performance. This is also a relevant topic in current events, where organizations have been fined for adding hypothetical performance to their website.
• Any sort of statement made in marketing needs to be supported. For example, if a firm claims to be “the best” they need to be able to support that claim – according to what/whom are you the best?
• A MWR (“also known as “IRR”) stream must also be presented with the prescribed time periods, net of fees. As of this publish date, the SEC has not put out any prescribed calculation methodology on how the MWR is to be calculated.

This panel offered actionable insights to help firms navigate the regulatory landscape efficiently and ensure adherence to the latest SEC standards. Reach out if you would like us to connect you with an SEC compliance consultant.

GIPS® Standards OCIO Guidance Statement

One of the standout sessions was the panel discussion on the Global Investment Performance Standards (GIPS®) OCIO Guidance Statement, featuring Joshua O’Brien, Todd Juillerat, Amy Harlacher, and G.R. Findlay. This session was invaluable as it delved into the implications of the guidance for firms managing outsourced chief investment officer (OCIO) services. While there is still some gray area around the OCIO guidelines, the panel emphasized the necessity of aligning with global best practices and provided insight into the important considerations to keep in mind for compliance. It reinforced the importance of transparency and consistency in performance measurement, which are core values we uphold at Longs Peak.

GIPS® Compliance Q&A

In another interactive session, Matt Deatherage joined John D. Simpson, John Norwood, and Susan Agbenoto for a Q&A on GIPS® compliance. They addressed a variety of common questions and concerns, providing practical advice for firms striving to adhere to the GIPS® standards. Some of the questions they answered were:

Q: What are some best practices to prepare for a verification?

A: Outlier reviews are extremely important to make sure composite construction is accurate and in line with expectations and your policies and procedures. Performing this type of review can help catch composite construction mistakes that may otherwise delay a verification if found in the testing process. This review is important no matter the approach you take as outliers can be reviewed in a variety of ways.

Never done an outlier review? Fill out this form and put PMAR2024 in the message box -- we will test a sample of your composite data and provide you a list of outliers for review.

Q: What should be reviewed annually by a GIPS compliant firm?

A: GIPS standards policies and procedures. Your policies and procedures are the backbone to your claim of compliance and should be reviewed periodically to ensure they are still up to date. Reviewing this at least annually and documenting any changes will go a long way.

Q: What tips do you have for firms looking to become GIPS compliant or adjust their current compliance program?

A: We have lots of suggestions, but here are two big ones:

• Leverage software as much as possible, whether that be for composite construction or GIPS report creation. Software can help build efficiencies and remove risk of human error.
• Don’t over-complicate your compliance program or policies and procedures. Make sure your policies and procedures are meaningful, but not so complex that they become difficult to consistently follow and implement.

What resources are available for organizations going through verification (whether it’s their first or 10^th)?

A: While it can be helpful to appoint someone internally as the head of your GIPS compliance program to oversee all relevant requirements are being met, depending on the size of your organization, you might need to seek out additional help if you have no one in-house with this knowledge. We have helped over 150 firms become GIPS compliant by serving as their outsourced GIPS standards experts and would love to support your firm too.

There are also third parties, such as your verifier, that can help answer questions about GIPS standards verification. The CFA Institute also has a lot of great resources available such as the GIPS standards help desk (email them at: gips@cfainsitute.org), GIPS handbook and/or the GIPS standards Q&A Database.

We hope this session was rewarding for participants and left them with clear takeaways for enhancing their GIPS compliance practices.

WiPM Event

For the second year in a row, the Women in Performance Measurement (WiPM) group hosted a meaningful and enlightening day-long event in conjunction with PMAR. With sessions addressing communication in the workplace, ethical considerations in performance, and work-life balance, the conversations and knowledge-sharing did not disappoint.

It was inspiring and encouraging to hear from so many female thought leaders engaged in discussion about how we can further equip the next generation of female leaders in performance measurement. Two key highlights from the women-focused content shared included:

• The importance of creating a “brag book.” Oftentimes as women, it can feel arrogant or uncomfortable to share successes, but it’s important to remember that we can be our biggest advocates when we keep a record of our own accolades and triumphs. While the title of “brag book” could be off-putting, it is intended to simply be a “fact book” of all the accomplishments you’ve had in the workplace.
• Especially for women, work-life balance can feel impossible to achieve, so we explored the idea of “work-life harmony” instead. We discussed how the idea of “work-life balance” always feels like a give and take where one area has to give for the other area to grow – causing women to feel more guilt around the area that is now lacking. When we reframe this topic to be “work-life harmony,” it allows us to think about work and life in tandem – ebbing and flowing with a level of musicality that doesn’t require one to be “less” for the other to be “more”, but rather gives women the ability to recognize how they can be successful in both areas of life as the demands of each shift in different seasons.

While WiPM is still a relatively new organization, the group is excited to continue to offer group and individual programs to aid in the advancement of women in the performance measurement industry. During the event, the group highlighted the existing Mentoring program that matches mentors/mentees together to support one another in their performance-related careers.

Conclusion

PMAR™ 2024 was a resounding success, offering a wealth of knowledge and practical insights on the latest advancements and regulatory updates in performance measurement and risk management. Our sponsorship and active participation underscored our commitment to supporting the industry's growth and evolution. We at Longs Peak are dedicated to advancing best practices and helping our clients navigate the complexities of performance measurement and GIPS compliance. If you have any questions about the 2024 PMAR Conference topics or GIPS and performance in general, please contact us.

We hope to see you at PMAR & WiPM in 2025!

The SEC's Marketing Rule, Rule 206-4(1), outlines specific criteria for the disclosure of "performance." However, determining whether metrics like yield constitute "performance" under this rule seems ambiguous. Based on our experience, yield information falls into one of three categories:

1. Performance - prompting the Marketing Rule's requirements;
2. A portfolio characteristic – exempt from the performance presentation rules; or
3. Both

While SEC staff have discussed this ambiguity publicly and privately, a definitive stance on the treatment of yield in advertisements remains elusive. In practice, presenting the actual yield of an account or composite often qualifies as performance, as it aims to demonstrate the income generated and expected.

Conversely, the yield of an individual investment, such as a specific bond, could be considered a characteristic, especially when presented alongside other metrics like duration and maturity.

Determining if yield should be considered performance or characteristic may also depend on its intended use and the overall context. For instance, displaying the average yield of investments as part of a risk assessment suggests it may be a characteristic, while presenting the portfolio's yield likely implies performance under the Marketing Rule. Similarly, the yield of an individual investment may be deemed a characteristic or "extracted performance" based on context.

You may also want to consider the significance of yield to the performance presented as this could also determine how the SEC may interpret the information. During the 2023 GIPS Standards Conference, extensive discussion was had about the significance of yield to strategy performance. For example, the yield of a bond portfolio may be more likely considered performance while dividend yield, presented for a large cap equity portfolio, could be regarded as a characteristic.

What to do

To navigate this ambiguity, we recommend that firms pre-determine whether a metric is intended as performance or a characteristic and document this decision and reasoning internally. If yield is deemed a characteristic, marketing materials should reflect this classification and include appropriate disclosures. All presentations should include comprehensive performance disclosures, including gross and net figures over relevant time frames.

Although SEC staff interpretation may differ, internal documentation and disclosure can mitigate regulatory risks unless expressly contradicted by SEC guidance.

As the year draws to a close, we can’t help but marvel at the whirlwind of activities and achievements that have marked 2023 for Longs Peak. Not only have we continued to provide outstanding professional services to our clients, but our team has also celebrated significant personal milestones and accomplished impressive feats. Join us in recapping the memorable moments that shaped our year in this edition of “Around the Peak”.

Celebrations and New Beginnings

Love was in the air at Longs Peak this year with not one, but three major life events. James Blazer and his fiancé Melanie became engaged, Cameron Payseno and Kelsey celebrated their union in a beautiful wedding here in Denver, and anticipation fills the air as Matt Deatherage prepares to welcome his first child likely before the end of the year.  These joyous occasions have not only strengthened our bonds, but have also added an extra layer of happiness to our close-knit Longs Peak family as we #LiveOurBestLife.

In addition, our founder, Sean Gilligan celebrated the 10^th and 20th anniversaries of his two open heart surgeries, inspiring us to remember that the human spirit, much like the heart, is resilient, enduring, and capable of soaring to new heights even in the face of adversity.

Educational Triumphs

Longs Peak takes pride in the continuous growth and development of its team members. In 2023, Mila Gao and Sara Celapino achieved a significant milestone by passing their CFA Level 1 exam. These accomplishments reflect our commitment to excellence and the continuous pursuit of knowledge within our organization.

Internally, our team – under Matt Deatherage’s tutelage –  developed a robust training program for all employees. One of our favorite training sessions this year was spearheaded by our in-house Excel wizard, Henry Jones, who writes formulas while he sleeps and makes everything he touches more efficient.

Global Engagements and Industry Recognition

Our team members Matt, Sean and Cameron showcased their expertise on the international stage, presenting and #SimplfyingTheComplex to five CFA societies across the globe, including Greece, Brazil, and the UK. Domestically, our presence was felt at four conferences, including PMAR North America, the inaugural Women in Performance Measurement (WiPM) Conference, the 27^th Annual GIPS Standards Conference, and the ComplyConnect Conference and Expo. Jocelyn also moderated a virtual WiPM panel discussion on performance measurement outside the US while Matt shared his insights at the PMAR Conference, participating in a panel on Performance Reporting; Beyond the GIPS standards #UsePrudentJudgement.

Jocelyn was honored with the Outstanding Women in Performance & Risk Measurement award by the Journal of Performance Measurement. Additionally, Jocelyn’s inclusion in ColoradoBiz magazine’s list of Top 25 Young Professionals in Colorado underscored our team’s dedication, impact, and ability to #ActWithIntegrity.

In addition, Jocelyn is using her financial expertise to serve on the Board of Directors of a Longmont community bank and giving back to our community by serving on the Board of Education and Treasurer for the St. Vrain Valley School District.

Team Growth

Longs Peak expanded its team this year, welcoming Dhwani Desai as an Associate and McKinley Rich as the Director of Operations. These new additions have brought fresh perspectives and expertise to our dynamic team.

For the first time, we have a fully functional internal operations team with Cally Chenault and McKinley Rich at the helm – supercharging the infrastructure and planning for growth in the years to come.

Kelley Cooney earned a well-deserved promotion to the role of Senior Associate, a testament to her outstanding work. We feel fortunate to have her on our team.

Sara Celapino was made a Manager at the end of 2023, in recognition of her remarkable achievements and contributions to Longs Peak. We consider ourselves lucky to have found Sara and remain confident that she will continue to drive our success in the years to come.

As we celebrate the accomplishments of the past year, we also take a moment to acknowledge Cameron Payseno, who marked an impressive five years of #OperatingWithExcellence at Longs Peak. His dedication and contributions have been integral to our success, and we look forward to many more years of collaboration.

Unity in the Mountains

A top highlight of the year was our office retreat in Granby, CO, where the team came together for three days of team-building activities, including a challenging ropes course, bowling, and baking in the breathtaking scenery of the mountains. This retreat reinforced our sense of #BeOneTeam, laying the foundation for continued success in the years to come.

Industry Accolades and Milestones

Longs Peak’s commitment to excellence was acknowledged by ColoradoBiz Magazine, which names us one of the Top 200 Privately Owned Companies in Colorado.

As we bid farewell to 2023, we carry with us a sense of pride for the accomplishments, growth, and moments of joy that have defined this year. Looking ahead, we remain committed to delivering exceptional service, fostering professional development, and building on the strong foundation that has made Longs Peak a leader in the industry.

Cheers to a 2024 that is filled with even more excitement and triumphs!

CFA Institute hosted the 27th annual GIPS Standards Conference on October 17^th - 18^th 2023 in Chicago, Illinois. As expected, it was filled with a lot of familiar faces, but also had quite a few first timers, which was nice to see.

Being almost a year into the SEC Marketing Rule and with implementation of the Private Fund Adviser Quarterly Statement Rule on the horizon, the hottest topics of this year’s conference were the sessions relating to regulatory compliance. These sessions included discussions with representatives from the U.S. Securities and Exchange Commission (“SEC”) answering practical questions related to adherence to these rules as well as sessions with senior performance professionals discussing the detailed performance methodology required to comply.

Other topics included a review of the proposed guidance statement for applying the GIPS standards to OCIOs, helpful advice for updating consultant databases, a proposed method to risk-adjust performance attribution, and some lessons on soft skills for leaders managing relationships.

SEC Marketing Rule

Michael McGrath, CFA, Partner with Dechert LLP and Robert Shapiro, Assistant Director, Division of Investment Management with the SEC together with Karyn Vincent, CFA, CIPM and Krista Harvey, CFA, CIPM of CFA Institute did an excellent job emphasizing the key lessons learned as we near the 1-year mark of the adoption of the Marketing Rule. Below are some key takeaways worth noting:

Defining “Performance”

Since the Marketing Rule requires investment managers to present performance net-of-fees, it is important for firms to define what they consider “performance.” The SEC takes a straightforward approach, generally considering any statistic that demonstrates how much an investor earned from an investment to be performance. But, even with this simple and easy to understand approach, there can be some grey areas.

Based on the discussions in this session, it seems to now be widely accepted that in addition to basic returns being considered performance that contribution is also considered performance, while attribution and most performance appraisal measures are not considered performance. Performance appraisal measures should be individually considered to confirm if they are demonstrating the amount earned (which would be performance) or if it is used as a measure of the manager’s skill(which would not be considered performance).

Some portfolio characteristics could also be a grey area that firms should be careful to consider before presenting solely as gross-of-fees. For example, yield was discussed at length. It was said that total portfolio yield for something like an enhanced cash portfolio likely would be performance because the yield in that case is essentially the return the investor earned. On the other hand, dividend yield for a growth strategy where this does not directly indicate the amount the investor earned *might* be performance. This really would come down to how it is presented and how material the yield is to the strategy. If material to the strategy’s return, this may be considered performance and, in this case, would need to be reduced by a model fee.

After determining that a statistic is not performance and will be presented based on gross-of-fee input data, it is important to clearly label these figures as gross. A disclosure under the table or chart that simply states something like, “Risk statistics are presented gross-of-fees,” should suffice.

There was also a lot of discussion relating to applying fees to extracted performance such as sector and holdings-level performance. It was made very clear that each segment must be reduced and presented net-of-fees so fees cannot just hit the cash segment or something like that. To achieve this, most firms are using a model fee. For example, if the highest fee for the strategy is 1% per year and quarterly sector returns are presented, each sector’s quarterly return is reduced by 0.25%.

Hypothetical Performance

Hypothetical performance has been a focus of the initial SEC enforcement actions taken against firms under the Marketing Rule. The main issue has been firms broadly distributing hypothetical performance without any policies and procedures in place to ensure the distribution of this type of performance is limited only to those that can be reasonably expected to understand it.

The key is that firms must document policies that clearly define the intended audience for a particular presentation of hypothetical performance and then ensure that the presentation only goes to this audience. In addition, documentation should include the tools necessary to understand the information provided. For example, the type of hypothetical performance should be clearly described as well as any assumptions made to create this performance.

Hypothetical performance is very broadly defined. It could be anything from a back-tested model to a paper portfolio or even just an aggregation of extracted returns (e.g., a composite of carveouts). It should be clear what the performance represents and consideration should be given to the complexity of the information, especially when determining it’s appropriate audience.

Private Fund Adviser Quarterly Statement Rule

Anne Anquillare, CFA, Head of US Fund Services with CSC Global Financial Markets and Pamela Grossetti, Partner with K&L Gates together with Krista Harvey, CFA, CIPM of CFA Institute walked us through the key elements to prepare for with the new Private Fund Adviser Quarterly Statement Rule. Below are some key takeaways worth noting:

The Compliance Date for the Quarterly Statement Rule is March 14, 2025. This may sound like a long time away, but it is important to keep in mind that the requirement to include cross-references to the underlying governing documents in the Quarterly Statement may require amendments to such documents before the first Quarterly Statement is issued, and this could be time consuming.

Under this new rule, private fund managers must distribute a quarterly statement to the investors in the fund within 45 days after each quarter ends and 90 days after year-end. This is required for any private fund that has at least two full quarters of operating results.

There are many items that must be included in the quarterly statements relating to general fund details like fees and expenses as well as disclosures that are cross-referenced to the private fund’s offering documents; however, being the GIPS conference, this presentation was primarily focused on the performance requirements.

The performance requirements for liquid funds are very different for illiquid funds. An illiquid fund is one that is not required to redeem interests when requested by an investor and has limited opportunities for an investor to withdraw funds prior to the fund’s termination. If a fund manager determines that their fund is liquid, the performance requirement for the quarterly statement is limited to showing the following three items, each in equal prominence:

1. Annual net-of-fee returns for each of the past 10 fiscal years (or back to inception if shorter)
2. Annualized net-of-fee returns for the past 1, 5, and 10 years through the end of the latest fiscal year (or since inception if shorter)
3. Year-to-date net-of-fee return for the current fiscal year

Illiquid funds have a much more significant requirement with 12 figures they are required to present:

Portfolio-Level

Investment-Level

Unlike the GIPS standards, under this rule, there is no exemption for funds that only use a subscription line of credit for a short period of time. Funds that utilize a subscription line of credit for any period are required to show the metrics listed above both with and without the subscription line.

Another notable difference from the GIPS standards is that this rule requires interest expense charged from the subscription line of credit to be added back when calculating the “without subscription line of credit” version of the required metrics. The GIPS standards do not require this adjustment.

It was also discussed that if these quarterly statements were provided to prospective investors instead of only current investors then they would also need to be reviewed to confirm that they meet the Marketing Rule on top pf the Quarterly Statement Rule.

Current State of SEC Exams

Mark Dowdell, Assistant Regional Director with the SEC together with Ken Robinson, CFA, CIPM from CFA Institute discussed current trends in SEC examinations. Below are some key takeaways worth noting:

There was a strong emphasis on the need for clear policies and procedures that have been customized for the firm. Specifically, it was emphasized that policies and procedures relating to hypothetical performance are not the only thing firms should make sure they add for the Marketing Rule. For example, if firms are presenting predecessor performance or extracted performance there should be documented policies for this as well.

It was mentioned that in addition to standard examinations, the SEC is also conducting some risk-based exams that may be limited in scope, but go very deep on a narrow area. This may even include the recalculation of performance in their own systems to get comfortable with the accuracy of presented figures.

Outside of the recent enforcement actions relating to hypothetical performance, the SEC continues to see firms make exaggerated or untrue statements relating to the number of staff they employ, the qualifications of staff, awards received, the use of AI in the investment process, and their adherence to ESG standards in the investment process. While it is okay to state opinions in marketing materials, statements of fact absolutely must be substantiated.

Developing a Database Strategy

Jill Banaszak, Global Head of Omni Success at eVestment lead a great session on getting the most out of 3^rd party and consultant databases.

The most important takeaway was the importance of using databases to tell the story of your firm in a complete and accurate way. Often firms leave a number of fields blank or neglect to revisit (or update) the narrative sections to remain accurate and in sync with their other messaging online or in marketing materials. Asset owners and their representatives use the databases to make short lists of firms meeting their criteria and many firms end up excluded as a result of blank fields or inconsistencies in messaging. At a minimum, firms should target completing at least 80% of the requested information.

It is also important to ensure information is completed timely and accurately. Firms should have monthly figures updated by the 12^th business day of the month at the latest to avoid missing out on searches. To avoid errors or incomplete information, firms should consider who is tasked with updating the information and also ensure this person or team is qualified and has access to all relevant information so it can be fully completed. Implementing a quality control process to double check the information is also important to avoid typos or other mistakes in the information presented.

Applying the GIPS Standards to OCIOs

There is currently an exposure draft of the Guidance Statement for OCIO Strategies out for public comment with comments due by 20 November 2023. This session was led by a group of panelists who were part of the OCIO working group that created this new guidance statement. The purpose of this guidance statement is to improve comparability between OCIO strategies. The primary change in this proposed guidance that deviates from the current requirements of the GIPS standards for firms is the required composite structure that all OCIO managers would need to follow.

The required composite structure would separate liability-focused composites from total return objective composites and would then further break the composites down by their allocation between risk mitigating assets and growth assets ranging from conservative to aggressive allocations. There are specific weightings defined for each that are intended to line up with commonly used OCIO benchmarks.

These new composites are only required to build out five years of history, but like other composites firms manage, must then build up to showing a ten year track record before any performance periods can be removed.

This guidance statement also proposes requiring both gross-of-fee returns and net-of-fee returns instead of only one because of the complexity of OCIO fees.

This guidance statement has not yet been officially adopted, but once approved, it is expected to allow for a 12-month implementation period for firms to update their policies and procedures, construct composites that align with the prescribed composite structure, and create GIPS reports for these new composites.

Conclusion

This year’s speakers did a great job providing clarification on the SEC Marketing Rule and other relevant topics that impact GIPS compliance and investment performance.

We were happy to see many old friends in person this year in Chicago and look forward to seeing everyone again next year in San Diego. It was announced that next year’s conference will be held on the 17^th – 18^th of September in San Diego, California!

If you have any questions about the 2023 GIPS Standards Conference topics or GIPS compliance and performance measurement in general, please contact us.

*A previous version of this article included a mistake for investment-level figures for illiquid funds. This has been corrected.

We all know that investing involves a delicate balance of seizing opportunity and managing risk. Even if you do it well, your factsheet may not adequately explain how your strategy manages that balance. Your factsheets tell the story of your performance history and play a crucial role in your sales process by helping prospective investors make informed investment decisions. But how do you know if you’ve included the right information?

Types of Measurements

While every strategy differs in terms of its investment objective, it’s important to identify which types of statistics will be the best at helping you tell the story behind your investment strategy.

Before you choose the exact statistics to include, take a moment to think through what makes your strategy unique and then consider the audience you’re speaking to (sometimes this may mean making more than one factsheet for the same strategy – think retail vs. institutional).

Here are the main categories that should be included…

• A measure of volatility – to demonstrate stability (or variability) of your strategy
• Correlation – to express sensitivity to the benchmark or market
• Risk-adjusted returns – to standardize performance evaluation when considering risk
• Downside risk – to explain how your strategy performs in down markets
• Market Capture – to display how the strategy performs during market movements (up or down)

Only you know what makes your strategy unique and appealing to prospective investors, so take the time to determine the key pillars of your strategy and then select statistics that help demonstrate or reinforce that story.

Once that’s clear, it’s time to crunch some numbers.

Top 5 Risk Statistics

Here’s a list of the top 5 risk statistics our experts see included on our clients’ factsheets.

1.  A Measure of Volatility: Standard Deviation

Investment managers have different ways of measuring volatility – often dependent on the strategy employed. Most commonly, we see standard deviation used, which is a measure of total risk (i.e., both systematic and unsystematic risk). Standard deviation quantifies the variability of a strategy’s returns from its average over a specific period. A higher standard deviation indicates greater volatility, implying that the strategy’s returns have experienced significant fluctuations or high variability.

Standard deviation is generally presented for both the strategy and a comparable benchmark. Risk-averse investors are generally looking to invest in strategies that achieve higher returns than the comparable benchmark while having a lower standard deviation than the benchmark over the same period.

Be sure to use this measure to demonstrate the stability of your strategy when it is historically low or to attract those with higher tolerance for fluctuation when it has been historically high. An explanation about how that higher fluctuation translates into outperformance will help paint a more complete picture.

2. Strategy Correlation: Beta

When assessing a new strategy, investors often want to consider how the strategy will fit into their broader portfolio. One way to evaluate this is by considering how sensitive the strategy is to the market (or the total portfolio’s benchmark) using beta. When armed with this information, investors can determine if adding your strategy would increase or decrease their exposure to the pulse of the market. If your strategy intends to offer diversification benefits, beta should be less than one (or negative). If you are adding market exposure, it should be greater than one.

In factsheets, we commonly include beta, calculated against the strategy’s benchmark, to show how the strategy moves relative to its benchmark. This is useful for investors to see if the calculated beta aligns with how an investment manager has described its investment process.

For example, for a strategy described as a “bottom-up approach that holds a concentrated portfolio of the best-performing stocks from a larger universe” (and therefore not directly tied to an index), we would expect beta to be very low (or even negative) or very high, but not close to 1. If it is close to 1, they may be a “closet indexer” that claims to have an in-depth research process, uncorrelated with the market, but in reality, is still basically replicating the benchmark. Investors would want to know this because they can invest in ETFs or funds designed to replicate a benchmark for much lower fees.

Conversely, for a strategy that is described as "enhanced indexing," beta should be close to 1 with returns that outperform the index. In this case, the goal is to track the risk level of the index while beating it performance-wise.

In either case, investors want to see strategy metrics support how your strategy and process is described. If any of these risk measures don’t align, we recommend taking the time to understand and explain why.

3. Risk-Adjusted Returns: Sharpe Ratio

While arguably the most common risk statistic to include, the Sharpe ratio is helpful as a comparison tool because it standardizes performance and risk into one measure.

The Sharpe ratio demonstrates a strategy’s risk-adjusted return by considering its excess return (return above the risk-free rate) per unit of risk taken (standard deviation). A higher Sharpe ratio is preferred. If your strategy claims to offer superior returns with lower risk, the Sharpe ratio is an appropriate measure to demonstrate that.

However, keep in mind that this measure may not be useful for strategies that are not normally distributed (e.g., hedge funds or other strategies with returns that are materially positively skewed when the strategy is successful). For most traditional investment managers, especially those targeting institutional investors, this measure is often expected on a factsheet, so don’t overlook it.

4. Assessing Downside Risk: Maximum Drawdown

Maximum drawdown measures the largest peak-to-trough decline in a strategy’s performance over a specific period. This metric is crucial because it quantifies the potential loss an investor could have experienced during the strategy’s worst-performing period. A larger maximum drawdown implies higher downside risk.

This measure is often good to show along with the max drawdown of the market or benchmark for comparison. While higher potential returns often correlate with greater downside risk, investors, equipped with this information, can determine their tolerance for this kind of loss. In addition, they can use it to compare to other similar strategies they are considering.

If your strategy claims to manage downside risk, maximum drawdown is arguably the best measure to demonstrate tactful management during down markets.

5. Market Capture: Upside/Downside Capture

These measures assess how well a strategy or portfolio performs during market movements, specifically in comparison to a benchmark. Upside capture measures the degree to which a strategy captures the positive returns of a benchmark during periods of market growth. Downside capture measures the degree to which a strategy is exposed to losses when the benchmark declines.

These capture ratios can be used to explain how a strategy aims to achieve specific goals related to market conditions. For example, “beats the market on the upside and protects on the downside” (you’d hope to see over 100% upside capture with less than 100% downside capture) or “capital preservation with risk targets below the overall market” (you’d expect to see lower than 100% upside capture with hopefully a very low downside capture).

Please note that it is most common to show these measures together (or to show total capture ratio that combines the two). Considering the “fair and balanced” requirements in the SEC marketing rule, it’s likely prudent to include both to explain the full picture.

For an aggressive strategy that is over 100% capture both on the upside and the downside or a capital preservation strategy that is under 100% both on the upside and downside, you ideally can still show that the total capture ratio is greater than 1. This demonstrates that the strategy is winning on the upside by a greater amount than it is losing on the downside or that protection on the downside more than offsets the lagging performance on the upside.

Conclusion

When it comes to investing, knowledge is power. Factsheets provide investors with valuable information to help them make informed decisions about your firm and strategies. When you provide them with a full picture of your performance that includes risk, they are more fully equipped to consider you for further due diligence.

Investment firms that understand these statistics and use them to help explain the story of their investment performance provide context and transparency in a saturated landscape of investment options.

Make sure to take the time to understand what these measures say about your performance each period and include that in some form of market commentary when you share your factsheets with prospects. This demonstrates how informed you are about the strategies you manage, how decisions made impact results, and what your plans are to address them.

Want to discuss how you can improve your factsheets with risk statistics? Schedule a free 30-minute brainstorm with one of our partners on which statistics you should include to help explain your investment performance.

Today, September 3, 2023, marks Longs Peak's 8th anniversary, and I couldn't be more grateful for the incredible journey we've had over the last 8 years. As we celebrate this milestone, I'd like to reflect on what this date means to me each year, both personally and professionally, and how I've embraced it to live my best life (one of our core values at Longs Peak).

In 8 years, I am proud to say that we have served over 250 investment firms, providing them with consulting services related to calculating and presenting their investment performance. Many of these firms achieved GIPS compliance for the first time with our assistance, allowing us to live out our mission of making investment performance more transparent and reliable – empowering investors to make better, more informed investment decisions.

Our growing team is a testament to the power of teamwork as we focus on this shared vision. The growth we have experienced is not just in numbers but also in our commitment to make a difference in the investment community. As we continue to grow, we remain steadfast in our belief that, together, we can overcome challenges, reach new heights, and inspire others to join us on this journey.

But beyond the business achievements, this date holds a profound personal significance for me. On September 3, 2003, exactly 20 years ago, I underwent my first open heart surgery to repair an aortic aneurysm and receive an aortic valve from a pig. A decade later, on September 3, 2013, I underwent my second open heart surgery to replace the pig valve with one from a cow, as the pig valve had torn.

Facing these challenging surgeries and the recovery periods was undoubtedly difficult, but I made a conscious decision to embrace a positive outlook on life. I chose to see myself as a survivor, part farm animal or not, and this mindset inspired me to live life to its fullest. For me, that meant taking bold chances and not letting fear hold me back from pursuing my dreams.

One of the most significant risks I took was starting Longs Peak with my wife, Jocelyn. At that time, we had two babies and no other income. That giant leap led to so much more and although there have been times of fear (like trying to scale a business through a pandemic!), it has been an immensely rewarding adventure, all thanks to our incredible clients and team.

This approach to life has also pushed me to make decisions that go beyond work. Each year, on or around September 3rd, I celebrate my life and health by doing something that I wouldn't have been able to do without the success of those surgeries. In the past, I've run marathons, completed long hikes, and climbed 14ers (mountains with peaks higher than 14,000 feet) in Colorado and even summitted Mount Kilimanjaro in Tanzania. This year, I am grateful to spend this anniversary hiking La Plata Peak (Colorado’s 5^th highest mountain) with Jocelyn followed by a trip with my brother to Slovakia to hike the High Tatras.

On this special day, I am reminded of how precious life is. By seizing opportunities and pushing myself to new heights, I've discovered the true meaning of living my best life. This year, as we mark both the 10th and 20th anniversaries of my surgeries (and 8^th anniversary of Longs Peak), I wanted to take a moment to thank some key players in my life that have inspired me along the way.

To my parents, thanks for raising me with an entrepreneurial spirit. Growing up with a paper route, mowing lawns, and shoveling driveways taught me more about starting and running a business than anything I learned in school. I also appreciate your encouragement and support along the way!

To my brother, the time we both spent living in New York in our 20’s was transformational for me. Coming from a small town, I never would have moved to New York if you weren’t already there clearing the way. I learned so much in those years both from you and from the invaluable work experience I gained there early in my career. That experience and time we spent together really changed the course of my life and career and I owe a lot of that to you.

To my wife, thanks for always being up for an adventure! In 2009, shortly after we got married, I suggested we leave New York and move to Shanghai for an amazing work opportunity and you said, “let’s do it!” In 2015 I suggested that I quit my job and we start Longs Peak together and you said, “let’s do it!” In 2019 I suggested we have a 4^th baby and you said, “let’s do it!” You make life fun. I appreciate your optimism and the faith you have in us. Most of all, I appreciate the way you always show up 100% for our family, team, clients, and anyone else who needs you. We love you!

To my kids, thanks for putting up with me and mom talking about work all the time and for patiently riding the entrepreneurial rollercoaster with us! One of the reasons we started our business was so we could work from home and be close to you all before working at home was as common as it is now. I may not always love it in the moment when you walk in on an important video call to ask an urgent question, like if you can have a snack, but I know I will love looking back on memories like that someday.  You all are my inspiration for everything I do. Whether it is the things I do to improve my health or career, I am motivated to do it imagining the long healthy future I want to enjoy together with all of you.

To our team, who we affectionately refer to as our “big kids,” we appreciate everything you do to make Longs Peak the best it can be. All of you embody our core values and that shines through in how each of you approach the exceptional service we strive to provide to our clients. At the same time, you make Longs Peak an enjoyable place for me to work every day.  I truly appreciate that and am grateful to each and every one of you.

To our clients, thank you for entrusting us with the opportunity to assist in projects that we hope have led you to further growth and success. Your confidence in our expertise fuels our commitment to delivering exceptional service and innovation. Your GIPS and performance objectives are the driving force behind our growth. We are genuinely honored to be a part of your journey to grow your firm.

To everyone, I would not be where I am today without your influence and support in my life. You have inspired me to do everything I can to live my best life. I hope everyone reading this takes the opportunities presented to them to take calculated risks (pun intended) and live life to its fullest. Thank you all - I look forward to the many more adventures yet to come!

In today's highly competitive financial landscape, your company must stand out and demonstrate its commitment to transparency and accuracy. One powerful tool at your disposal is the Global Investment Performance Standards (GIPS®).

We know how complicated it can be to become GIPS compliant and that’s exactly why we built Longs Peak – to do the heavy lifting for firms and simplify the verification process. By allowing us to tackle the behind-the-scenes work, we’ve helped hundreds of firms become compliant at a much faster rate than if they’d handled it internally – giving them the opportunity to quickly leverage their GIPS compliant status in their marketing and messaging.

By becoming GIPS compliant and incorporating GIPS compliance into your marketing materials, such as factsheets and pitchbooks, you can strengthen your credibility and trustworthiness among clients and prospects.

Let’s explore how to effectively utilize the GIPS standards in your marketing to help highlight your competitive advantage.

Understanding GIPS Compliance & Its Benefits

Before delving into marketing, let's review the fundamentals of GIPS compliance. The GIPS standards are a globally recognized set of ethical principles that provide a standardized framework for calculating and presenting investment performance to prospective investors.

By complying with the GIPS standards, you demonstrate that your performance results are genuine, comparable, and fairly presented. Moreover, GIPS compliance promotes transparency and instills confidence in potential investors, enhancing your marketability.

Highlighting Your Firm’s GIPS Compliance

After going through all the hard work to become GIPS compliant, it is important to share that status with the world so you can reap the benefits of your efforts! By including information about your firm’s GIPS compliance in your marketing, you instantly communicate your dedication to adhering to global best practices.

Trust is so important in the investment industry. By explaining how your firm is going above and beyond regulatory requirements to ensure your investment performance is presented in a fair and transparent manner helps demonstrate your firm’s trustworthiness and can help you stand out in an oversaturated landscape of options.

Tailoring the Message to Different Audiences

With any marketing effort, it’s important to consider your target audience. Understanding the needs, preferences, and concerns of that audience allows you to speak directly to their interests, fostering stronger connection and engagement.

When mentioning GIPS compliance, keep in mind that retail investors may be less familiar with the Standards and therefore may need more information to understand the benefits. Institutional investors tend to know about the Standards and likely need less explanation. By employing language that resonates with the target audience, you not only capture their attention but further build credibility and trust.

Advertising Your Firm’s GIPS Compliance

Now that we have emphasized the importance of highlighting your firm's GIPS compliance in your marketing materials, it is important to consider how this should be done. When mentioning GIPS compliance, there are some very specific disclosures that must be included. It is important that your firm does not state or imply that your firm is GIPS compliant without these disclosures.

Firms mentioning GIPS compliance in their marketing have the option either to follow the GIPS Advertising Guidelines or to attach a GIPS Report for the relevant composite or fund being marketed. You can download our checklists of what disclosures to include when following the GIPS Advertising Guidelines or when creating GIPS Reports.

For any marketing piece that includes a GIPS Report, we encourage firms to create a standalone page for the GIPS Report. The GIPS standards have specific requirements for reporting errors on the GIPS Report, so you want to limit information on that page to only what’s required and avoid the potential of having to report errors that could have been avoided if the information was kept separate.

Using Visuals to Enhance Understanding

GIPS Reports and their required disclosures tend to leave marketing teams feeling creatively stifled. But the goal of a good marketing presentation is to be engaging and digestible. Graphs, charts, and infographics can help convey complex performance data with clarity and impact.

Visual representations can be especially effective in illustrating return data and depicting how your strategies have outperformed benchmarks (i.e., growth of dollar line chart) over time. However, always ensure that the visual representations are aligned and never conflict with the information presented within the GIPS Report.

Incorporating Risk Statistics

Of course, no investment performance presentation is complete without discussing risk. There are a variety of risk statistics that can (and should) be used to demonstrate how each strategy you manage performs relative to risk. If you want to learn more about what risk statistics to include, you can read about the most common ones we see here.

Showcasing the Competitive Advantage

Beyond GIPS compliance, highlight the distinct features that set your investment strategies apart from the competition. Emphasize your expertise, team capabilities, and successful track record. While GIPS compliance is a powerful differentiator, showcasing your unique approach to investment management will further position your firm as a top choice for potential investors.

Wrap Up

By incorporating GIPS compliance into your marketing materials, you signal a commitment to transparency, accuracy, and investor protection. Emphasize the benefits of GIPS compliance, use visuals to enhance understanding, incorporate a discussion about risk and spotlight your competitive advantage. With these strategies in place, your marketing materials will become powerful tools for attracting and retaining investors, ultimately propelling your company to new heights of success.

Are you ready to leverage the power of GIPS compliance in your marketing materials?  Schedule a call with one of our partners to elevate your credibility with investors and gain a competitive edge. Let us help you get started!

TSG hosted the 21^st annual Performance Measurement, Attribution & Risk (PMAR) North America Conference on May 24^th - 25^th 2023 in New Brunswick, New Jersey. Longs Peak had the pleasure of sponsoring the event and being represented on the Performance Reporting: Beyond the GIPS standards panel on day 2 of the conference by our very own Matt Deatherage, CFA, CIPM.

With many unanswered questions still circulating on the implementation of the SEC Marketing Rule that took effect last November, there were multiple sessions that touched on this topic. Other topics included ESG and its impact on performance, maximizing the potential of AI, performance evaluation and risk when returns aren’t normally distributed, evaluating benchmark misfit risk, and other hot topics such as talent retention and outsourcing.

With many women in the industry already attending PMAR, the conference also facilitated the first in-person Women in Performance Measurement (WiPM) meeting May 23^rd. Longs Peak co-sponsored this event with TSG and sent four members of our team to the event. Interacting with so many brilliant women in different stages of their careers was a great experience, and the women of Longs Peak are looking forward to being part of the continued growth and development of the group.

ESG

ESG reporting requirements are ramping up, coming from pressure from shareholders and employees as well as in response to looming federal climate-disclosure regulations. The trend is no different for prospective investors as interest in ESG information is increasingly being requested by prospects. According to this WSJ article, “Nearly 80% of roughly 400 global institutional investors surveyed last year said companies should make investments that address ESG issues, even if doing so reduces profits in the short term.” The speaker reiterated this sentiment and said although the regulations in the US are behind Europe and Australia, he said that the SEC is getting there.

AI and Machine Learning in Investment Management

It is no secret that large language models (LLMs) like ChatGPT or BloombergGPT are increasingly being incorporated in investment management. LLMs offer powerful technologies that can be utilized for a variety of advancements from data analysis and research to providing valuable insights from financial reports and supporting decision-making. In addition, they can contribute to risk assessment, compliance, and portfolio management by analyzing data and optimizing strategies. It is our opinion that this technology will revolutionize the financial services industry and will do so rapidly.

Of course, the integration of AI and Machine Learning technology comes with advantages and disadvantages. While the technologies offer improved efficiency and accuracy, relying too heavily on this technology can introduce algorithmic biases that can impact investment decisions. As performance experts, we wonder if it will create an overreliance on historical data and as we know, past performance may not always be indicative of future results. Key takeaways from this session were to consider how your firm might utilize LLMs and Machine Learning in your own processes and that while this technology is still somewhat new, it is increasingly accessible to anyone at reasonable cost.

Performance Reporting: Beyond the GIPS Standards

The panel discussed the types and frequency of performance they’re seeing internally and externally. Depending on the asset class, monthly or quarterly external reporting is most common, while some portfolio managers have found value in utilizing daily reporting internally to see how their strategies are performing in real-time. Firms seem to be steering away from manual updates and relying more heavily on automation and external resources for reporting. Beyond the statistics required by the SEC, including visuals in their reports was touched on by the panel as well as focusing on the story the firm is looking to tell based on the goals of the specific strategy.

Firms distributing performance also need to consider the internal controls needed to ensure that they are presenting accurate performance relevant to the specific audience. The importance of audit logs and extensive internal review was stressed, and firms are constantly looking for ways to improve these processes and save time. These challenges extend to updating databases in a timely and efficient manner, with some firms opting to upload preliminary performance to meet database deadlines and then making retrospective changes as needed.

While Excel is still king in the performance world, utilizing performance systems for calculation and reporting can create efficiencies and reduce opportunity for manual error. Flexibility is key, as end users want to be able to customize reporting for their specific needs. The ultimate reporting goal for many firms seems to be aggregating performance and risk statistics from different sources, and firms have found success using dashboards and other technology to simplify these processes.

SEC Insights

With many of our clients being SEC-registered investment firms, we’ve been just as eager as the rest of the industry for additional guidance on the SEC Marketing Rule. Unfortunately, it sounds like it may be a while until additional FAQs are released. One requirement that has raised many questions is the requirement to present performance net-of-fees. “Performance” isn’t defined by the SEC, so the PMAR panel, focused on extracted performance and attribution, attempted to shed some light on what could be considered performance under the new SEC guidelines.

It's been made clear that the net performance requirement applies not only to performance of an entire composite or portfolio, but also to that of a subset of investments or a single investment. If the gross performance of a single investment is shown, net performance also needs to be presented. When presenting extracted performance, firms should apply a model fee to calculate the net return, include appropriate disclosures, and be able to support why they’re presenting this information.

This gets a little trickier when considering attribution, and many firms are still figuring out how to navigate this grey area. The SEC will likely want to see attribution net-of-fees in some cases but not others. For now, it seems providing clear documentation for what’s shown and why is key. According to the panel, things like average weight and Sharpe ratio seem less likely to be considered performance, while contribution to return seems more likely to be considered performance. Yield in particular was discussed in detail, with the takeaway being that if yield is presented in a way that it is synonymous with a return and what investors can expect to take home, this may be subject to the net performance requirement.

Some other takeaways from this panel discussion on attribution are that metrics derived from performance and those that are relative to a benchmark are less likely to be considered performance in the eyes of the SEC. Firms should be able to support their decision of what they consider performance and be aware of the context in which attribution is being presented.

This panel also touched on key deficiencies from recent SEC exams, as well as what to expect for the next round of exams. While Phase I focused on more evaluating whether firms were addressing the new rule, Phase II is expected to include a deep dive across 175-200 firms. This will also include 20-25 exams involving recalculation of performance, as well as a focus on predecessor performance and testimonials/endorsements.

Some of the deficiencies the panel touched on from Phase I were material misstatements in advertisements, manipulation of performance, omitting poor performance, and failure to present net-of-fee performance. Another deficiency noted was the lack of policies and procedures around presenting hypothetical performance. The key to presenting hypothetical performance is that recipients must be able to fully understand what is being shown, and that this performance is not being distributed to a retail audience. You also need to have the ability to recreate any hypothetical performance presented, as this has the potential to be tested by the SEC.

To get ready for the next phase of SEC exams, firms should make sure their policies and procedures are designed to prevent violations of the marketing rule and that their marketing materials comply. We recommend extending this review to your website to ensure historical information published prior to adoption of the new rule is also in compliance. One suggestion from the panel was to leverage other firms in the industry to see what types of disclosures are being used. Many large firms are putting a lot of time and resources into navigating the marketing rule, so leveraging these firms as best practice is encouraged.

WiPM Group

Officially launched in late 2022, the Women in Performance Measurement (WiPM) Group was developed as a resource for women in the investment performance industry to connect with, learn from, and uplift one another. With initial members of the group spread across multiple regions and countries, the first in-person meeting had an impressive turnout of over 50 attendees.

The meeting featured Lisa Kaplowitz as its keynote speaker. Kaplowitz is a professor at Rutgers Business School and is the Executive Director at Rutgers Center for Women in Business. Her background includes everything from taking part in the landmark Title IX case to multiple CFO positions. Throughout her career, Kaplowitz has remained a champion of women and challenging the status quo.

Kaplowitz shared statistics supporting that the majority of women in C-suite positions competed in athletics, with nearly half of those executives being previous college-level athletes. This connection may not be all that surprising when you consider the life lessons around discipline, resiliency, and teamwork that are taught through athletics and the valuable leadership skills that are developed through those experiences. She also offered some insightful information on maladaptations women have to endure to survive in the workforce today and offered suggestions for addressing them. This topic really seemed to resonate with the group.

Another topic discussed was how to make the workplace “work” for women, which led to some insightful conversations during the WiPM panel discussion that touched on work life balance and the unique challenges women face in the workforce, particularly the performance measurement industry.

The group is working out details of a mentorship program that will help facilitate relationships between women across the industry and allow them to share the knowledge and experience gained throughout their careers. This program is expected to launch in the fall of 2023 and is open to all women within the WiPM group.

Anyone interested in the WiPM Group is encouraged to contact us to get connected.

Conclusion

This year’s PMAR speakers offered a lot of great insights on topics related to investment performance measurement and challenges facing the industry.

We enjoyed connecting with other performance measurement professionals in-person and are looking forward to attending future PMAR and WiPM events.

If you have any questions about the 2023 PMAR Conference topics or GIPS compliance and performance measurement in general, please contact us.