The 2020 edition of the Global Investment Performance Standards (GIPS 2020) was released on June 30, 2019 and is effective beginning January 1, 2020. GIPS 2020 introduced a significant number of additions and changes, the most notable of which can be found in our “Top 5 Things You Need to Know about GIPS 2020” article.
Number two on our “Top 5” list, and perhaps the one with the most extensive changes from prior GIPS versions, is the treatment of pooled investment funds.
Below are four areas with key changes impacting firms that manage pooled vehicles.
GIPS 2020 introduces two categories of pooled funds:
- Broad Distribution Pooled Funds (BDPFs)
- Limited Distribution Pooled Funds (LDPFs)
BDPFs are defined as pooled funds that are regulated under a framework that would permit the general public to purchase or hold the pooled fund’s ownership interests and that are not exclusively offered in one-on-one presentations. In other words, BDPFs are publicly-traded or retail funds, such as a 1940 Act fund or a UCITS fund. As a point of emphasis, the definition of BDPFs has been revised from the GIPS 2020 exposure draft and earlier guidance statement drafts based on feedback received from comment letters.
LDPFs are those pooled funds that cannot be classified as a BDPF. To put it another way, LDPFs are generally private funds, such as a hedge fund, a private equity fund, a limited partnership, or a collective investment trust.
For firms that market pooled funds, the first step under GIPS 2020 is to classify the pooled vehicle offerings as either BDPFs or LDPFs. This is important since certain provisions and reporting requirements within GIPS 2020, some of which are described below, are applicable to one category versus the other.
Categorization of a firm’s pooled vehicle offerings does not come without its challenges, however. Questions arise in situations such as a multi-share class fund. A comment letter response to the GIPS 2020 exposure draft was presented describing a publicly-traded pooled fund with both a retail and an institutional share class and with the institutional share class marketed only in one-on-one presentations. The adopting release that accompanied the issuance of GIPS 2020 laid out that the rules were not intended to have share classes themselves be classified. In this specific situation, the pooled fund would be a BDPF, because the fund is not exclusively offered in one-one-one presentations.
One item to consider related to classifying pooled funds, which may help in these other situations, is to evaluate the firm’s typical marketing practices. A firm should consider whether or not those marketing practices involve contact between the firm and the prospective investor (thus an LDPF) or do not involve contact (thus a BDPF). Further guidance and examples are expected to be provided in the GIPS 2020 Handbook when it is released.
What will likely go down as the most welcome change, at least amongst fund managers, is that the guidance surrounding composite inclusion for pooled funds has been relaxed in GIPS 2020. Prior GIPS versions did not distinguish between separately managed portfolios or pooled portfolios when it came to composite creation and inclusion. To that end, investment firms that only managed pooled funds (e.g. an ETF only shop), were required to create a large number of single account composites to hold each of the pooled fund offerings. For those types of firms, compliance with the new iteration of the standards should be more easily attainable.
Under GIPS 2020, although pooled funds must still be included in a composite if they meet a composite definition, firms are only required to create composites for strategies that are managed for or offered as a segregated account. In other words, a firm is not required to create a composite that only includes pooled funds unless the firm also offers that strategy as a segregated account. Additionally, firms that created composites to house just pooled funds under past rules may terminate those composites under the new set of standards.
Similar to the definitions described above, this change to composite inclusion does not come without its challenges. Firms that manage both separate portfolios and pooled portfolios may actually see some additional complexities. A change to one provision related to how composites must be defined could create some interpretative challenges for these types of firms. A new sentence was added to that provision in the new rules that indicates a firm must not exclude portfolios from composites based solely on legal structure differences.
Under prior GIPS versions, specifically the Guidance Statement on Composite Definition, firms could use the portfolio type (i.e., separate portfolios versus pooled proposals) as a constraint when defining composites. Expressed in a different way, pooled funds could previously be treated as separate composites or combined with other portfolios of the same strategy.
The new sentence appears to contradict the previous guidance statement and, as such, firms that have both types of portfolios and that previously separated them may now need to combine them. As noted above, further guidance and a decision on whether past guidance statements still apply are expected to be provided in the GIPS 2020 Handbook.
Reporting under GIPS 2020 has been changed significantly. Compliant presentations, which were previously utilized for all prospective clients regardless of type, are replaced by GIPS composite reports. Additionally, a second type of GIPS report – the GIPS pooled fund report – has been added. This report will be utilized in connection with a newly added and defined type of prospect, the prospective investor. Before comparing and contrasting the new report types, let us first discuss which report is utilized when.
Determining Which Report to Utilize
Reporting to prospective clients (i.e., those that qualify to invest in a composite) is largely unchanged under GIPS 2020. A firm must still make every reasonable effort to provide a GIPS composite report – similar in nature to the past compliant presentations – to prospective clients when they initially become a prospect and at least every 12 months, assuming they remain a prospective client.
From there, GIPS 2020 eliminated the confusion surrounding past versions as to what, if anything, should be provided to prospective investors. This is where the categorization of BDPFs and LDPFs comes into play, as noted above. For BDPF prospective investors, firms are not required to provide a GIPS composite report, which must include the BDPF if provided, or a GIPS pooled fund report. However, firms may elect to do so.
For LDPF prospective investors, firms must make every reasonable effort to provide a GIPS pooled fund report, or a GIPS composite report that contains the LDPF, when the investor initially becomes an LDPF prospect and at least every 12 months, assuming they remain an LDPF prospective investor.
One key point to reiterate is that regardless of whether it is a BDPF or LDPF investor, the GIPS composite report can only be utilized if that composite report contains the respective pooled fund in the composite.
Comparing and Contrasting GIPS Composite Reports and GIPS Pooled Fund Reports
The purpose of creating a GIPS pooled fund report was to afford a more appropriate method for providing GIPS-compliant information to prospective pooled fund investors. In that regard, there a few less requirements in a GIPS pooled fund report as compared to a GIPS composite report, such as the number of portfolios and a measure of internal dispersion.
One specific requirement of a GIPS pooled fund report that is not required of the GIPS composite report is the inclusion of the pooled fund expense ratio. The pooled fund expense ratio is similar to the expense ratio that a mutual fund would report in its annual financial statements. Overall, the two reports are similar, with the GIPS pooled fund report information being limited to that of the particular pooled investment vehicle. Fund managers may be able to leverage existing fund materials by integrating the GIPS reporting requirements into those materials. While this may create a few additional compliance checks internally, the overall result should be an easier path for fund managers to claim GIPS compliance.
Although this article discussed the two high-level GIPS reports (GIPS Composite Report versus GIPS Pooled Fund Report), one key point to mention is that there are actually four types of reports as a result of the expanded ability to use money-weighted returns (MWRs). Those four reports are:
- GIPS Composite Report – Time-Weighted
- GIPS Composite Report – Money-Weighted
- GIPS Pooled Fund Report – Time-Weighted
- GIPS Pooled Fund Report – Money-Weighted
In GIPS 2020, firms may present MWR if they have control over the external cash flows of the composite portfolios or pooled fund, and the composite portfolios or pooled fund has at least one of the following characteristics:
- Fixed life
- Fixed commitment
- Illiquid investments are a significant part of the investment strategy
Other Reporting Matters
The following other reporting matters related to pooled investment vehicles were also addressed in GIPS 2020:
- Firms have a choice of presenting gross or net returns in a GIPS pooled fund report. The GIPS 2020 provisions allow for this so that firms can meet the various regulatory requirements in different countries. In the U.S., net is generally required.
- Firms must maintain a complete list of BDPFs (note that descriptions are not required) and a complete list of LDPFs with descriptions.
- Firms are not required to include terminated pooled funds on the above mentioned lists.
- Firms must provide the LDPF list with descriptions if requested, and that list may be tailored if the firm wishes to do so.
- Firms must provide the BDPF list if requested, and that list may be tailored if the firm wishes to do so. Alternatively, firms can direct a prospective investor to their website if a complete list is maintained there. Descriptions must also be provided upon request.
- It is recommended (not required) that firms selling participation in a new LDPF provide the prospective LDPF investor with a GIPS report containing the most appropriate (same or similar strategy) track record.
Similar to composite inclusion, another welcome change for fund managers should be the broader application of the GIPS Advertising Guidelines, which remain voluntary.
First and foremost, consistent with the changes in the general GIPS 2020 provisions, the GIPS Advertising Standards also no longer have a composite-centric approach and will be broken down in sections related to composites, BDPFs, and LDPFs. In that regard, fund managers that wish to reference their GIPS claim of compliance in fund materials must adhere to the relevant sections of the GIPS Advertising Standards. Those managers that elect not to follow the advertising guidelines must make no reference to GIPS in advertisements.
The second key change in this area is that the definition of an advertisement has been expanded to include pooled fund fact sheets and pooled fund offering documents. This should allow firms to acknowledge their claim of compliance in documents such as a prospectus or in other fund-specific marketing materials.
GIPS 2020 introduced significant changes for firms that manage pooled investment vehicles. Some additional internal procedures may have to be incorporated by fund managers, but overall, these changes should reduce the compliance burden and provide a more relevant and attainable path to GIPS compliance.
If you are a fund manager that claims compliance or are thinking about becoming compliant once the new standards are effective, you will be impacted by GIPS 2020. While this article offered an overview of the most significant changes in GIPS 2020 for pooled fund managers, it is important to understand how the new guidance will specifically impact your firm. For more guidance about GIPS 2020, please contact us.
And, if you already claim compliance with GIPS, consider taking advantage of Kreischer Miller’s free GIPS initial assessment which will:
- Identify potential issues and areas for improvement, and
- Provide meaningful feedback about your current process.