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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.

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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:

1. Document GIPS policies and procedures
2. Construct composites that consistently follow these policies and procedures
3. 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:

1. 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.
2. 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.
3. Asset-weight the monthly account-level results for each account included in the composite to calculate the composite-level performance results.
4. 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. 

An Exposure Draft of the Global Investment Performance Standards’ (GIPS®) new Guidance Statement on Broadly Distributed Pooled Funds was recently published. The intention of this exposure draft is to seek comments from the public regarding this proposed new guidance before it is officially adopted in January of 2017.

Anyone with opinions regarding the guidance, especially with regard to questions the GIPS Technical Committee has included within the exposure draft, is encouraged to provide written feedback by 29 April 2016. Witten feedback can be submitted by emailing your comments to: standards@cfainstitute.org.

Who does the pooled fund guidance apply to?

Any GIPS compliant firm that manages and markets a “broadly distributed pooled vehicle” (which includes mutual funds or other similar vehicles) fits within the scope of this guidance.

If a firm is only responsible for managing the fund (e.g., as a sub-advisor), but has no responsibility for filing the fund’s official documents (e.g., the prospectus or KIID) or for creating fund-specific marketing materials, then this proposed guidance statement is not applicable.

The requirements set forth in the proposed guidance statement are specific to marketing pooled funds. Marketing pooled funds should not be confused with marketing a strategy or composite that contains a pooled fund. The guidance is specific to situations where the fund itself is being marketed to attract new investors within that fund.

What is the purpose of the proposed guidance?

GIPS requires firms to make every reasonable effort to provide compliant presentations to all prospective clients; however, most firms have historically interpreted this to only include new separate account prospective investors, not pooled fund investors that simply invest in a fund that is already included in a composite.

The purpose of this guidance statement is to ensure GIPS compliant firms are consistent in the way they present their pooled fund information to prospective investors. This consistency is intended to help prospective pooled fund investors make meaningful comparisons between funds. To achieve this, the exposure draft proposes requiring official fund documents, as well as all fund-specific marketing materials (i.e., materials that are specifically marketing the fund itself, not the strategy or composite), to include specific statistics and disclosures.

What does the proposed guidance require?

If adopted in its current form, the new guidance would require GIPS compliant firms to include the following in each of their funds’ official documents as well as any fund-specific marketing materials:

1. A description of the fund’s objective or strategy.
2. An indication of the risk involved in investing in the fund, which can be either qualitative or quantitative.
3. Pooled fund returns calculated according to the methodology and time periods required by local laws or regulations. If local laws or regulations do not specify a methodology or time period then firms must present the fund’s returns net of all fees and expenses for periods that are acceptable based on the current GIPS Advertising Guidelines.
4. Benchmark returns for the same periods that the fund’s performance is presented, as well as a description of the benchmark. If no appropriate benchmark exists, this can be disclosed in lieu of including benchmark performance.
5. The currency used to express performance.

There is no requirement to mention GIPS or provide (or even offer) a compliant presentation. The guidance statement does recommend, however, that firms include the following claim of compliance in their fund’s official documents and fund-specific marketing materials: “XYZ Firm, the firm managing this pooled fund, claims compliance with the Global Investment Performance Standards (GIPS®). For more information about the GIPS standards, please visit www.gipsstandards.org.”

It is important to note that this claim of compliance is new and differs from the wording used in compliant presentations or materials adhering to the GIPS Advertising Guidelines. When claiming compliance, firms must ensure that the correct claim is used and is stated verbatim from the standards.

What can firms do now to prepare for this new guidance?

Firms managing pooled funds should first determine whether they fit within the scope of the proposed guidance. If so, then your firm should review its current official fund documents and fund-specific marketing materials to determine if changes are needed in order to meet the new requirements, if adopted.

If there are material changes that are not reasonably feasible for your firm, use this opportunity to provide comments to the GIPS Technical and Executive Committees before the guidance is formally adopted.

In addition to sharing your general feedback on the guidance, responding to the specific questions the GIPS Technical Committee has included within the exposure draft will greatly help shape the final version of the guidance statement before it is officially adopted. The entire exposure draft, which includes these questions, can be reviewed here.

To learn more about the Exposure Draft of the Guidance Statement on Broadly Distributed Pooled Funds or other GIPS and performance measurement topics, please contact us.

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.

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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.

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Before getting into the specific aspects to 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.

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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.

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Your GIPS 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.

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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?

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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 compliant presentations 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.

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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.

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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.

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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.

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Meaningful Composite Structure

The section of your GIPS policies and procedures requiring the most frequent adjustment is your firm’s list of composites, as you must make changes each time a new composite is added or a composite closes. However, even without adding new strategies or closing older strategies, the list of composites and their 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.

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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 composites 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).

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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.”

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

1. 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, reason, and nature of 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.
2. 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.

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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 compliant presentations) 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.

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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.

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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.

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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.

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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.

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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 the highest 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.

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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.

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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.

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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.

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

Calculating gross and net investment performance should be simple, right? Yes, however, firms often face fee-related portfolio accounting or administrative issues that cause complications, resulting in inaccurate performance. It is essential that all types of fees are accounted for correctly to ensure reported performance can be relied upon for evaluation by clients and prospective investors.

Which Fees and Expenses Reduce Investment Performance?

Gross-of-fee performance represents a portfolio’s return net of transaction costs only. Net-of-fee performance is net of transaction costs and investment management fees, so the only difference between gross and net performance is the investment management fee. According to the Global Investment Performance Standards (GIPS®), investment management fees are defined to include both asset-based and performance-based fees that are earned for managing a portfolio.

If your firm is GIPS compliant, it is important to reduce performance by both types of fees when calculating net-of-fee performance. For non-GIPS compliant firms, this is still considered best practice; however, it is common for firms with both types of fees to report performance reduced only by the asset-based fee as “Net” and performance reduced by both the asset-based fee and performance-based fee as “Net Net.”

Administrative fees, such as custody fees, do not reduce performance. This is the typical practice because clients have some control over selecting a custodian and, therefore, the administrative fees charged to their portfolio. For this reason, administrative fees are excluded from performance calculations and instead are treated like external cash flows that do not reduce their return.

The most common exception to this is net performance reported for mutual funds, which is typically calculated based on the change in the fund’s net asset value (NAV), resulting in performance that is net of all fees and expenses. Mutual fund investors do not have control over the custodian used or administrative fees charged (i.e., the manager selects the custodian), so these fees do reduce performance when calculating net returns for mutual funds.

What Are the Most Common Fee-Related Administrative Issues and How Can They Be Addressed?

The most common administrative issues that affect performance results usually are derived from:

1. Clients paying their management fee by check or from another outside source
2. Accounts with bundled fee structures (e.g., wrap accounts)
3. Accounts paying asset-based fees for transactions in lieu of per-trade commissions

We will examine each of these issues below.

1.  Clients Paying Their Management Fee by Check or from Another Outside Source

In an ideal world all clients would have their management fees directly debited from the account that earned the fee; however, this is not always the case. Some clients prefer to pay their management fees by check or out of one of their multiple accounts managed by your firm. Since many firms record their accounts receivable in an accounting system separate from their portfolio accounting system (which calculates performance), a matching entry must be added to the portfolio accounting system when fees are paid. If this fee is not recorded in the portfolio accounting system, the client’s gross and net returns will be equal (neither being reduced by the management fee), which is inaccurate.

How to Add Adjusting Accounting Entries to Ensure Net-of-Fee Performance Is Accurate

When a client pays their fee by check, to correctly record this, two entries are needed in the portfolio accounting system:

1. An external cash inflow matching the management fees paid by check.
2. A management fee expense for the same amount.

After these two transactions are made, the portfolio’s market value will be the same as it was before entering these transactions since the two transactions offset each other. While these entries do not change the value of the portfolio, an expense is recorded that will allow the system to report the correct net-of-fee performance for the period.

Similarly, when the management fee is directly debited from another account, adjustments need to be made to both the account that paid the fee and the account that earned the fee. The account that paid the management fee will need two accounting entries:

1. A negative management fee expense for fees paid on behalf of a different account.
2. An external cash outflow for the same amount.

The account that earned the management fee will also need two accounting entries (note that these are the same as the entries when paid by check):

1. An external cash inflow matching the fees paid by the other account.
2. A management fee expense for the same amount.

Again, these transactions will not change the market value of any account as these entries simultaneously adjust cash and management fee expense by the same amount. While this has no effect on the total portfolio’s market value, it will allow net-of fee performance to be accurately reported, regardless of the source or method of the actual payment.

Forgetting to make these adjustments is very common and often leads to erroneously overstating net-of-fee performance for clients paying their fees from an outside source. It will also result in an overstatement of net-of-fee performance for any composite that includes these accounts. To avoid regulatory deficiencies or non-compliance with GIPS requirements, it is best to look into whether your firm has accounts paying management fees from outside sources and ensure proper adjustments are made.

2.  Accounts with Bundled Fee Structures, Such as Wrap Accounts

As previously discussed, gross-of-fee performance is reduced by transaction costs and net-of-fee performance is reduced by transaction costs and management fees. This can become complicated when fees and expenses are bundled together and accounted for as one bundled fee.

What to Do If Fees and Expenses Are Bundled Together and Cannot Be Separated

If fees and expenses cannot be separated, gross-of-fee performance is calculated by reducing performance by transaction costs and any fees or expenses that cannot be separated from those transaction costs. Net-of-fee performance is then calculated by reducing performance by transaction costs and management fees, as well as any fees or expenses that cannot be separated from the transaction costs or management fees. This often results in identical gross-of fee and net-of-fee performance, as both performance measures are reduced by the entire bundled fee.

This most commonly occurs with wrap accounts, where the client pays one bundled fee and the individual fees for transaction costs, management fees, etc. cannot be separately determined. When this occurs, disclosures should be included with the performance to clarify if any fees other than transaction costs and management fees have been used to reduce performance.

Alternative Presentation Options for Gross-of-Fee and Net-of-Fee Performance With Bundled Fees

Instead of presenting gross-of-fee performance that is equal to net-of-fee performance, firms often only include net returns as their official performance, but then also present “pure gross” returns as supplemental information. Pure gross returns are gross of all fees and expenses and must be disclosed as such.

3.  Accounts That Pay Asset-Based Fees for Transactions in Lieu of Per-Trade Commissions

As discussed earlier, gross-of-fee performance is reduced by transaction costs. Typically these transaction costs are the commissions tied to each executed trade; however, there has been a trend towards using asset-based fee structures for transaction costs, instead of per-trade commissions.

If an account is actively managed and trades frequently enough that an asset-based fee structure results in lower expenses than paying commissions on each trade, an asset-based fee structure may be a good option for your client. However, properly accounting for this kind of fee structure in your portfolio accounting system may be challenging, as many portfolio accounting systems have not caught up with this trend, leading to errors in the client’s reported performance.

With a commission-based structure, portfolio accounting systems typically account for each trade net of commissions, which ensures that gross-of-fee performance is net of transaction costs. All other fees and expenses are recorded as separate line items that are coded as either “performance affecting” (e.g., management fees, which reduce performance to arrive at net-of fee-returns), or “non-performance affecting” (e.g., administrative fees, which are treated as external cash flows that do not have an effect on performance).

When asset-based fee structures replace per-trade commissions, the asset-based fee is commonly accounted for as a line item, similar to management fees or other administrative expenses. The problem with this is that neither of the two options available (“performance-affecting” or “non-performance-affecting”) reduce gross-of-fee performance to account for trading costs. Instead, these options were only designed to reduce net-of-fee performance or reduce neither performance measure (i.e., there is often no transaction code that only reduces gross-of-fee performance).

How to Make Adjustments to Properly Account for Asset-Based Transaction Costs

Many systems have not created a solution for asset-based transaction costs, leaving firms to develop their own workarounds to reduce gross-of-fee returns. One example of a workaround that firms use is to record these fees as negative dividends, which results in the desired effect of reducing gross-of-fee performance. While this approach works, it is not ideal since the dividend transaction code is not intended to be used for this purpose, and should only be used as a short-term solution until your portfolio accounting system provider can offer an appropriate transaction code that will properly account for this type of fee.

Firms that have accounts with this type of fee structure for transaction costs should check with their portfolio accounting system provider to confirm if there is a way to ensure these fees are accounted for properly. Ideally, this should be addressed with a system developer or senior representative from your system provider, as this question is likely beyond the knowledge of a typical helpdesk associate, and may not be addressed in the reference materials they have available to them.

While this post is focused on fee-related administrative issues that affect performance, there are many other fee-related issues that firms face in reporting investment performance. We intend to cover additional fee-related topics in future posts, including: determining whether to use cash basis or accrual accounting for management fees, and considerations for determining when it is appropriate to use hypothetical or model management fees instead of actual management fees to calculate net-of-fee performance. If you would like to receive periodic information on these kinds of topics, please subscribe to our blog by submitting your email at the bottom of the webpage or check back frequently for new posts.

For more information on fee-related administrative issues or to discuss other investment performance or GIPS® topics, please contact Sean Gilligan at sean@longspeakadvisory.com.

The Global Investment Performance Standards (GIPS®) are an ethical framework that standardize how investment managers calculate and report their investment performance to prospective investors. Standardized presentations help ensure the information presented is meaningful, complete, and comparable to performance presentations of other GIPS compliant firms, regardless of location or regulatory jurisdiction.

This comparability helps simplify the due diligence process for prospective investors as it allows them to make an “apples-to-apples” comparison of similar strategies managed by different investment managers regardless of their location. Currently, there are 37 countries that have officially adopted GIPS, making it a true global standard.

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Why are the GIPS Standards Necessary?

GIPS is designed to address potentially misleading practices employed by some investment managers when presenting investment performance to prospective clients. Examples of misleading practices include:

• “Cherry-picking” accounts – Showing a strategy’s best performer as a representation of how the strategy performed as a whole
• Using selective time periods – Presenting the performance of a strategy only for the period it performed the best
• Utilizing model or back-tested results when results of actual managed accounts could have been used
• Survivorship bias – Excluding accounts that have closed (often the worst performing accounts) from performance calculations

Under GIPS, discretionary accounts are grouped into composites based on the strategy they follow. Performance is then reported at the composite level, based on the aggregation of the accounts within the composite. Composites only include actual discretionary accounts, not models, and it is required to present each composite’s performance statistics for each annual period.

These requirements, implemented in conjunction with the rest of the GIPS requirements, help prevent compliant firms from manipulating their results and improve comparability between firms that are GIPS compliant and manage similar strategies.

Why Become GIPS Compliant?

GIPS compliance offers investment managers both marketing and compliance benefits.

According to eVestment, two out of three searches made in their database by investors or consultants are set to exclude firms that are not GIPS compliant. Being able to “check the box” in RFPs and consultant databases indicating that your firm is GIPS compliant can be a valuable marketing benefit.

Being GIPS compliant requires firms to document policies and procedures, addressing how their firm complies with all of the GIPS requirements as well as the recommendations they choose to adopt. The practice of documenting and implementing these policies is an excellent way to ensure your firm is consistent in its practices across the firm, which can be immensely valuable to your compliance department.

Misconceptions About GIPS that Discourage Managers from Complying

Misconception 1: GIPS Compliance is Burdensome and Expensive

The initial process of becoming compliant can be time consuming; however, if sufficient time is put in at the start of the process to create detailed GIPS policies and procedures and construct composites that consistently follow these policies, the ongoing maintenance is very manageable.

For firms that do not have the resources available internally to bring their firm into compliance, GIPS consulting firms such as ours, Longs Peak Advisory Services (“Longs Peak”), are available to assist with the creation of policy documents, construction of composites, the creation of compliant presentations, etc.

Verification is often the largest direct expense associated with GIPS compliance; however, having your firm verified is not required. If you choose to be verified, the marketing benefit received will likely outweigh the cost. If the cost of a verification is more than your firm can currently afford, you can always become complaint now and add verification at a later date when it fits more comfortably in your budget.

If a firm can comply with all of the GIPS requirements without the help of a GIPS consultant and elects not to have their compliance verified, there is no direct cost for a firm to be GIPS compliant.

Misconception 2: GIPS is Not Relevant for My Firm

As mentioned earlier, GIPS offers both marketing and compliance benefits. Even if you are not marketing your strategies to institutional investors that require their managers to be GIPS compliant, your firm can still benefit from GIPS. More specifically, if your firm:

Only manages funds:

It may seem pointless to create a composite of one account; however, when marketing a composite rather than the fund itself, adjustments can be made to the fund’s fees to make the performance results more representative of what a separate account would have experienced following your strategy. This composite performance could be used to market your strategy to prospective separate account investors or to help prospective clients compare your performance to a competitor whose performance is based on a composite of separate accounts.

Manages customized portfolios:

Even if you are not managing a strategy strictly to a model, composites can be built based on the risk level of the client. For example, many wealth management firms have Conservative, Moderate, Growth, and Aggressive composites. There may be some dispersion between accounts within each composite, but these composites at least give you the opportunity to present an aggregation of your actual accounts with similar risk and objective profiles.

Questions?

If you have questions about the GIPS standards, we would be love to talk to you. Longs Peak’s professionals have extensive experience helping firms become GIPS compliant as well as helping firms maintain their compliance with GIPS on an ongoing basis. Please feel free to email Sean Gilligan directly at sean@longspeakadvisory.com.

Every Spring, the performance measurement community gathers for PMAR: The Performance Measurement, Attribution & Risk Conference, hosted by TSG. This year marked the twenty-fourth annual, and I left thinking about it differently than I have in years past.

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Most years, the themes evolve gradually. This year, I felt like the ground was moving.

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The theme nobody put on the agenda but ran underneath nearly every session was the pace of change. Specifically, what artificial intelligence is about to do to our work. And while I came away energized, I also came away with a healthy dose of " we (as in everyone) are not ready for how fast this is coming."

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Here's what stayed with me.

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AI Was the Undercurrent of the Whole Event

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The session titled "AI, Anxiety, and Opportunity: What Performance Professionals Need to Know" was, predictably, one of the most sought-after sessions of the conference. The panel, which included practitioners from across the industry, did a nice job naming both sides of the coin: the anxiety of not knowing what your job looks like in five years, and the opportunity sitting right in front of us if we lean in.

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Here's my honest read of the room, though. The mood was optimistic. Maybe a little too optimistic. There was a comfortable assumption that AI will mostly handle the tedious parts and leave the interesting work to us. Or that AI won’t take your job, someone that knows AI will. I'm not sure it'll be that tidy.

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From what we're already seeing in our own work and across the firms we serve, the capabilities are advancing faster than most people can comprehend. The days where “our industry is just slower to adapt” are gone. Just last week, anthropic released Fable 5 and before it was shut down (temporarily?), we played around with it a little and its capabilities are dumbfounding. I don't think it will be long before these conferences look drastically different. Different sessions, different vendors, maybe a different sense of what the job even is. That's not a doom prediction. It's just a reason to pay closer attention than feels comfortable.

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Separating Skill From Luck Just Got Harder and More Important

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One of my favorite sessions was Michael Ervolini's "You Can't Find Skill in Returns: Distinguishing Performance From the Decisions That Generate Them." It's a deceptively simple premise: returns tell you what happened, not whether the manager was actually good. A great number can come from a great decision, or from luck. A bad number can hide genuine skill.

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What I appreciate about PMAR is that the community keeps bringing fresh perspectives to this old, hard problem: how do we actually evaluate skill versus luck? It's a question that never fully resolves, and every year someone pushes the thinking forward.

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It struck me that this question gets more important in an AI world, not less. As machines take over more of the calculation and even some of the decision-making, our value shifts toward judgment – knowing which decisions deserved credit, which results were noise, and what a number actually means in context. That's the kind of discernment a model can assist with but can't own. For more from Mr. Ervolini, here's a link to his latest book Skill vs. Luck.

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The GIPS Challenges That Keep Coming Back

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I'm biased here, but the "Common GIPS Challenges and How to Avoid Them" session was a highlight for us, in part because our own Matthew Deatherage, CFA, CIPM, was on the panel alongside peers from TSG, MassPRIM, and Strategic Investment Group.

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What I always find striking about this topic is how consistent the challenges are. Firms pursuing compliance with the Global Investment Performance Standards (GIPS®)* tend to stumble on the same handful of issues year after year, and almost all of them are avoidable with the right foundation in place. That's a big part of why we do what we do at Longs Peak: helping firms get ahead of those pitfalls instead of discovering them during verification or, worse, during a regulatory exam.

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Matt is a familiar face on these panels, and it's great to have our perspective in the mix. But the takeaway that stuck with me tied right back to the AI thread running through the whole conference.

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Across several different panels, presenters talked about feeding the GIPS standards into their own AI models to churn out GIPS reports. And here's the thing, anyone can do that. You can drop the standards into a model in minutes. What a model can't do is provide critical judgment about how a principles-based framework should be applied to your specific facts and circumstances and whether those GIPS reports and statistics were calculated correctly. The GIPS standards aren't a checklist; they're a set of principles that require interpretation, and interpretation is exactly where experience earns its keep.

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I'm not saying don't use AI to help build a framework. Use it. But like any model, if you don't really know what you're asking it to do, the output won't save you. Simply asking a model to "make my firm GIPS compliant" isn't going to make it so. At least not yet!

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And there's one problem every performance professional already knows AI hasn't solved: data. As they say, garbage in, garbage out. Meaningful performance lives and dies on clean, well-organized data, and no software tool or AI model fixes messy inputs alone. At Longs Peak, we have spent the last 10 years working with clients to improve data quality through data integrity testing. For us, these AI models have only expanded what’s possible. We know one thing for sure: setting these tools up with the proper context (i.e., knowing what to look for) and then evaluating that context on an ongoing basis may turn out to be the most crucial piece of it all.

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CFA Institute Is Listening on the CIPM

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A session I didn't expect to find as interesting as I did was "CIPM Through the Practitioner Lens," facilitated by Rob Langrick of CFA Institute. Rather than simply presenting at the room, CFA Institute came to listen and gather candid feedback on the CIPM designation: where it's delivering value, where it's falling short, and how it should evolve to stay relevant to the work we actually do day to day.

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The audience didn't hold back, and there were some genuinely thoughtful suggestions including how the code of ethics will evolve in this new AI era, some recommendations on reformatting the exam to break it into smaller chunks (going into greater detail on each) as well as adding a CIPM group within the CFA societies to encourage further connection. It was refreshing to see CFA Institute putting real energy behind a credential that so many of us have invested in and want to see grow in value. Given the pace of change in our field, willingness to adapt feels necessary. For anyone interested in contributing ideas to the CIPM, you can use this link to provide feedback.

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A Quick Word on the Trivia

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I'd be remiss not to mention that Performance Trivia got a much-needed upgrade this year. In past years, only a handful of contestants got to play while the rest of us watched (though in fairness, not all of us were clamoring for the spotlight). The new format this time allowed everyone to participate (without taking center stage), and it was a lot more fun for it. A small change, but it captured something I value about this community: it's competitive, but it's also genuinely collegial and prides itself on memorizing quirky names and vintage formulas.

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Before PMAR Even Started: Women in Performance Measurement

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For me, the week actually started the day before the conference, at the Women in Performance Measurement (WiPM) gathering. An event created just for the women in our industry. It's one of my favorite parts of this trip every year, and not only because the conversation is good. There's something energizing about being in a room full of women who do this work, comparing notes and reconnecting.

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Fittingly, AI came up here too, though in a much more hands-on way than it would on the main stage. Practitioners shared real use cases, both personal and professional: the small ways AI is already saving them time day to day, and the bigger experiments they're running at their firms. It was practical, curious, and refreshingly free of hype.

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We were also lucky to have a guest speaker, Lidia Arshavsky, who spoke on executive presence. She broke down how executive presence actually gets evaluated inside organizations (the signals people pick up on, often without realizing it) and offered practical recommendations for strengthening your own. It was the kind of talk that's useful no matter where you are in your career.

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It was a great way to kick off PMAR, and an even better way to reconnect with women I only get to see a few times a year. Sometimes the most valuable part of a conference happens in these opportunities to network and reconnect within our niche performance community. A big thank you to TSG who donated the space for this event to take place and have done so for many years.

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What AI Can't Take From Us

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The conference's forward-looking sessions, including "Innovative Ways to Present Performance: Dashboards & Analytics," got me thinking. The tools are evolving so quickly and so much of the analysis, presentation, and reporting can now be automated. I am left wondering how long the traditional use of software in our space will last in its current form.

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When the capabilities advancing fastest don’t always come from the established vendors, who benefits? My hope is that everyone does. That these tools level a playing field that used to tilt heavily toward the largest institutions, give smaller firms the ability to deliver high-caliber analytics previously out of reach, and push the whole field toward better solutions. That makes for a more competitive space and ultimately a clearer picture for investors to evaluate their options.

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That's the optimistic case, and I believe it. But it only holds if we stay clear-eyed about where our own value comes from and that's the note I want to leave you on. The pace of change is a reason to focus, not to panic. The things that make us valuable are the things AI can't take: consciousness, judgment, and the human-in-the-loop accountability that clients ultimately trust. Machines will calculate faster and present prettier. They won't sit across the table from a client and take responsibility for what a number actually means.

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So, by all means, get curious about the tools (Claude seemed to be most people’s favorite – mine as well). Experiment. Don't be the individual or firm that gets left behind. But anchor yourself in the part of this work that's irreplaceably human, because that's the part that was always the point.

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See you at PMAR 2027. I suspect it'll look a little different.

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________________________________________

GIPS® is a registered trademark owned by CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.

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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:

1. Define the firm and scope the universe of portfolios
2. Build policies and procedures
3. Construct composites and calculate performance
4. Create GIPS Reports and establish ongoing monitoring controls
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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?
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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
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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:

1. Identify every portfolio that meets the composite definition
2. Determine the correct dates each portfolio should be in and out of the composite
3. Asset-weight the portfolio-level monthly returns to produce composite-level performance
4. 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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‍Why “Net” Is Not a One-Size-Fits-All Answer

If you’ve worked in the investment industry, you’ve probably heard some version of this question:

“Should we show net or gross performance—or both?”

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On the surface, the answer seems straight forward. The rules tell us what’s required. Compliance boxes get checked. End of story.

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But in practice, presenting net and gross performance is rarely that simple.

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How you calculate it, how you present it, and how you disclose it can materially change how investors interpret your results. This article goes beyond the rulebook to explore thepractical considerations firms face when deciding how to present net and gross returns in a manner that is clear, helpful, and in compliance with requirements.

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Let’s Start with the Basics (Briefly)

At a high level, for separate account strategies:

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• Gross performance reflects returns before investment management fees

• Net performance reflects returns after investment management fees have been deducted

Both gross and net performance are typically net of transaction costs, but gross of administrative fees and expenses. When dealing with pooled funds, net performance is also reduced by administrative fees and expenses, but here we are focused on separate account strategies, typically marketed as composite performance.

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Simple enough. But that definition alone doesn’t tell the full story—and it’s where many misunderstandings begin.

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Why Net Performance Is the Investor’s Reality

From an investor’s perspective, net performance is what actually matters. It represents the return they keep after paying the manager for active management.

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That’s why modern regulations and best practices increasingly emphasize net returns. Investors don’t experience gross returns. They experience net outcomes.

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And let’s be honest: if an investor chooses an active manager instead of a low-cost index fund or ETF tracking the same benchmark, the expectation is that the active approach should deliver something extra—after fees. Otherwise, it becomes difficult to justify paying for that active management.

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Why Gross Performance Still Has a Role

If net returns are what investors actually receive, why do firms still talk about gross performance at all?

Because gross performance tells a different, but complementary, story: what the strategy is capable of before fees, and what investors are paying for that capability.

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The gap between gross and net returns represents the cost of active management. Put differently, it answers a question investors are implicitly asking:

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How much return am I giving up in exchange for this manager’s expertise?

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Viewed this way, gross returns help investors assess:

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• Whether the strategy is adding value before fees
• How much of the performance is driven by skill: security selection, asset allocation or portfolio construction
• Whether fees are the primary drag—or whether the strategy itself is struggling

When gross and net returns are shown together, they create transparency around both skill and cost. When shown without context, they can easily obscure the economic tradeoff.

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Gross-of-fee returns are also most important when marketing to institutional investors that have the power to negotiate the fee they will pay and know that they will likely pay a fee lower than most of your clients have paid in the past. Their detailed analysis can more accurately be done starting with your gross-of-fee returns and adjusting for the fee they expect to negotiate rather than using net-of-fee returns that have been charged historically.

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The Real-World Gray Areas Firms Struggle With

How to Present Gross Returns

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Gross returns are pretty straightforward. They are typically calculated before investment management or advisory fees and usually include transaction costs such as commissions and spreads.

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For firms that comply with the GIPS® Standards, things can get more nuanced—particularly for bundled fee arrangements. In those cases, firms must make reasonable allocations to separate transaction costs from the bundled fee. But, if that separation cannot be done reliably, gross returns must be shown after removing the entire bundled fee. [1]

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Once you move from gross to net returns, however, the conversation becomes less straightforward. We’ve had managers question, “why show net performance at all?” This is especially the case when fees vary across clients or historical fees no longer reflect what an investor would pay today. Others complain that the “benchmark isn’t net-of-fees,” making net-of-fee comparisons inherently imperfect. These concerns highlight why presenting net returns isn’t just a mechanical exercise. In the sections that follow, we’ll unpack these challenges and walk through how to present net-of-fee performance in a way that remains meaningful, transparent, and fit for its intended audience.

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How to Present Net Returns

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This is where judgment and documentation matters most.

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Not all “net” returns are created equal. Even under the SEC Marketing Rule, there is no single mandated definition of net performance—only a requirement that net performance be presented. Under the GIPS Standards, net-of-fee returns must be reduced by investment management fees.

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In practice, firms may deduct:

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• Advisory fees (asset-based investment management fees)
• Performance-based fees
• Custody fees
• Transaction costs

Two net-return series can look comparable on the surface while reflecting very different assumptions underneath. This lack of transparency is one of the main reasons institutional investors often require managers to be GIPS compliant—it simplifies comparison by requiring consistency in the assumptions used and how they are presented or additional disclosure when more fees are included in the calculation than what is required.

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And context matters. A higher fee may be perfectly reasonable if it reflects broader services such as tax or financial planning, holistic portfolio construction, or access to specialized strategies. The problem isn’t the fee itself, it’s failing to use a fee scenario that is relevant to the user of the report.

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Deciding Between Actual vs Model Fees

The next hurdle is deciding whether to use actual fees or a model fee when calculating net returns. Historically, firms most often relied on actual fees, viewing them as the best representation of what clients actually experienced. But that approach raises an important question: are those historical fees still relevant to what an investor would pay today? If the answer is no, a model fee may provide a more representative picture of current expected outcomes. Under the SEC marketing rule, there are cases where firms are required to use a model fee when the anticipated fee is higher than actual fees charged.

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This consideration becomes even more important for strategies or composites that include accounts paying little or no fee at all. While the GIPS Standards and the SEC Marketing Rule are not perfectly aligned on this topic, they agree in principle—net performance should be meaningful, not misleading, and should reflect what an actual fee-paying investor should reasonably expect to pay. Thus, many firms opt to present model fee performance to avoid violating the marketing rule’s general prohibitions. [2]

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Additional SEC guidance published on Jan 15, 2026 on the Use of Model Fees reinforced that the decision to use model vs actual fees is context-dependent. While the marketing rule allows net performance to be calculated using either actual or model fees, there are cases where the use of actual fees may be misleading. The SEC emphasized flexibility and that while both fee types are allowed, what’s appropriate depends on the facts and circumstances of the situation, including the clarity of disclosures and how fee assumptions are explained.

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Which Model Fee Should Be Used?

Most firms offer multiple fee structures, typically based on account size, but sometimes also on investor type (institutional versus retail clients). That variability makes fee selection a key decision when presenting net performance.

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If you plan to use a single performance document for broad or mass marketing, best practice—and what the SEC Marketing Rule effectively requires—is to calculate net returns using the highest anticipated fee that could reasonably apply to the intended audience. This helps ensure the presentation is not misleading by overstating what an investor might take home.

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A common pushback is: “But the highest fee isn’t relevant to this type of investor.” And that may be true. In those cases, firms have a few defensible options:

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• Create separate versions of the presentation tailored to different investor types, or
• Present multiple fee tiers within the same document, clearly explaining what each tier represents

Either approach can work—but only if disclosures are explicit and easy to understand. When multiple fee structures are shown, clarity isn’t optional; it’s essential.

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In practice, many firms maintain separate retail and institutional versions of factsheets or pitchbooks. That approach is perfectly reasonable, but it comes with operational risk. If this becomes standard practice, firms need strong internal controls to ensure the right presentation reaches the right audience. That means:

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• Clear internal policies
• Consistent naming and version control
• Training marketing and sales teams on when each version may be used

This often involves an overlap of both marketing and compliance to get it right because getting the fee right is only part of the equation. Making sure the presentation is used appropriately is just as important to ensuring net performance remains meaningful, compliant, and credible.

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Which Statistics Can Be Shown Gross-of-Fees?

Since the introduction of the SEC Marketing Rule, there has been significant debate about whether all statistics must be presented net-of-fees—or whether certain metrics can still be shown gross-of-fees. Helpful clarity arrived in an SEC FAQ released on March 19, 2025, which confirmed that not all portfolio characteristics need to be presented net-of-fees. The examples cited included risk statistics such as the Sharpe and Sortino ratios, attribution results, and similar metrics that are often calculated gross-of-fees to avoid the “noise” introduced by fee deductions.

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The staff acknowledged that presenting some of these characteristics net-of-fees may be impractical or even misleading. As long as firms prominently present the portfolio’s total gross and net performance incompliance with the rule (i.e., prescribed time periods 1, 5, 10 years),clearly label these characteristics as gross, and explain how they are calculated, the SEC indicated it would generally not recommend enforcement action.

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Bringing it all Together

On paper, presenting net and gross performance should be a straight forward exercise.

In reality, layers of regulation, evolving expectations, and heightened scrutiny have made it feel far more complicated than it needs to be. But complexity doesn’t have to lead to confusion.

When firms are clear about:

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• Who they are communicating with,
• What that audience expects,
• What the performance is intended to represent, and
• Why certain assumptions were chosen

…the decisions around what gets presented become far more manageable.

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Net returns aren’t about finding a single “correct” number. They’re about telling an honest, well-documented story. And when that story is clear, investors don’t just understand the performance—they trust it.

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[1] 2020 GIPS® Standards for Firms, Section 2: Input Data and Calculation Methodology(gross-of-fees returns and treatment of transaction costs, including bundled fees).

[2] See SEC Marketing Rule 2 026(4)-1(a) footnote 590 as well as the SEC updated FAQ from January 15, 2026. Available at: https://www.sec.gov/rules-regulations/staff-guidance/division-investment-management-frequently-asked-questions/marketing-compliance-frequently-asked-questions

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Understanding Tracking Error & R-Squared

When evaluating the performance of an investment portfolio, it's essential to consider metrics that help measure the portfolio's consistency and alignment with its benchmark. Two critical metrics in this context are Tracking Error and R-Squared. These metrics provide insights into the portfolio's performance and risk characteristics. Let's explore what these metrics mean, how they are calculated, and their significance.

What is Tracking Error?

Tracking Error measures the deviation of a portfolio's returns from its benchmark returns. It indicates how closely a portfolio follows the benchmark to which it is compared. A lower tracking error suggests that the portfolio's returns are closely aligned with the benchmark, while a higher tracking error indicates greater deviation.

Tracking Error Formula

Tracking Error= standard deviation of (P-B)

where:

• P = Portfolio return
• B​ = Benchmark return

Annualized Tracking Error

When using monthly data, tracking error is annualized by multiplying the result by the square root of 12.

What is a Good Tracking Error?

A "good" tracking error depends on the investment strategy. For passive funds that aim to replicate a benchmark, a lower tracking error is desirable. For active funds that seek to outperform the benchmark, a higher tracking error might be acceptable, reflecting the manager's active bets.

What is R-Squared?

R-Squared (R²) measures the proportion of the portfolio's movements that can be explained by movements in its benchmark. It ranges from 0 to 100%, where a higher R-Squared indicates a greater correlation between the portfolio and its benchmark.

R-Squared Formula

R² = (Correlation of portfolio and benchmark returns)²

What is a Good R-Squared?

A higher R-Squared (closer to 100%) indicates that the portfolio's returns are highly correlated with the benchmark. For passive funds, a high R-Squared is preferred. For active funds, a lower R-Squared might indicate that the manager is taking independent positions relative to the benchmark.

How to Interpret Tracking Error and R-Squared

• Tracking Error: Indicates the consistency of the portfolio's returns relative to the benchmark. A lower tracking error is desirable for passive strategies, while active strategies might tolerate higher tracking errors.
• R-Squared: Shows the degree of correlation between the portfolio and benchmark returns. A high R-Squared suggests strong alignment, suitable for passive strategies, while a lower R-Squared might indicate active management.

While both Tracking Error and R-Squared are good measures to understand how closely a track record is managed to a benchmark, they should be analyzed with other available performance metrics. A high or low Tracking Error and R-Squared does not indicate if the performance was good or not. Therefore, using Tracking Error in combination with other metrics like Alpha or the Sharpe Ratio can help provide additional information on whether the strategy performed well while analyzing how closely it was managed to a benchmark. Any selected performance metric should also cover the same time periods as the calculated Tracking Error and R-Squared for the most relevant comparison.

Why are Tracking Error and R-Squared Important?

Both metrics are crucial for assessing portfolio performance and understanding the risk-return profile. They help investors gauge how well a portfolio is managed relative to its benchmark and assess the effectiveness of active versus passive management strategies.

Conclusion

Tracking Error and R-Squared are essential tools for evaluating portfolio performance. Understanding these metrics can help investors make informed decisions about their investment strategies and better manage their portfolios.

For more information on performance metrics and investment strategies, feel free to contact us or explore our other resources on investment performance.