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Special Report

ESG: The metrics jigsaw


The rocky road to compliance

The Global Investment Performance Standards (GIPS), developed from the AIMR-Performance Presentation Standards first issued in 1987, provide a framework for asset managers calculating and presenting investment performance results to prospective clients and consultants. They are increasingly being adopted by managers seeking to gain a marketing advantage from achieving compliance. Achieving compliance is a difficult process, however. It requires committing the necessary resources not only to the initial compliance effort, but also to maintaining it in future. The path to compliance is not for the faint-hearted. It demands a culture change towards a highly professional and disciplined performance measurement environment.
Our recent global survey of investment firms has highlighted some the difficulties faced by firms that have followed this route. These findings indicate that there are many aspects in achieving compliance that need to be overcome:
q Compliance is a firm-wide decision. It will have required the involvement of a number of groups within a firm. The decision to comply often starts with the marketing department, as requests for proposals (RFPs) increasingly inquire about compliance. The process will also involve performance, legal, operations and portfolio management departments.
q Achieving compliance takes time. Rushing to meet an external deadline typically leads to poor decision-making and, often, errors. Achieving compliance takes longer than you think.
q Without documentation, you have nothing. A firm must have the underlying documentation to support all its performance in accordance with the standards or risk accusations of ‘cherry-picking’ or fraud. It must also have documented its policies and procedures governing compliance. This helps not only the verifiers and regulators who may examine a firm’s claim of compliance, but also helps the firm itself follow its own policies consistently and remain in compliance with the standards.
q Compliance is not a one-off event. Firms often make the mistake of thinking that, once in compliance, their work is done. However, time, resources and coordination are constantly needed to monitor and maintain compliance.
Given these overriding issues, a typical firm that has come into compliance with the standards might have included the following project steps:
q Establish a steering committee. The compliance process itself needs clear direction and support throughout the firm. A steering committee comprising individuals from various functional groups within the firm allows expression of the issues and concerns of each group. It is extremely important that these groups are involved throughout the process.
q Create a project plan. As with any project, goals, responsibilities and timeframe for the completion of major steps must be set out. Gathering data often takes longer than expected. The survey found that nearly 20% of respondents had data issues such as locating historical records or capturing the information needed to establish the required track record. Without this the compliance project might have stopped in its tracks.
q Define the firm. Depending on the size and complexity of a firm, there are different approaches to defining it under the standards. A firm must examine its options in this area and consider what it hopes to accomplish by becoming compliant (usually marketing objectives), while also considering long-term goals. Considerations may include legal, regulatory or marketing issues as well as functional or currency management lines.
q Identify all accounts. Under GIPS, all accounts managed by the firm must be identified for at least the past five years, the minimum period for a compliant presentation. Firm mergers, acquisitions and changing systems often make the account identification process difficult.
q Create the composites. Composites are groupings of accounts managed in a similar style. The firm articulates a policy on the definition of discretion during the process of constructing composites. Under the standards, discretion refers to ‘investment discretion’ – the ability to implement the firm’s normal investment process and style. Composite construction also involves careful judgment about definitions of composite criteria – too broad and they will not be meaningful, too narrow and they will not represent management styles.
The survey indicates that nearly 25% of respondents reported composite construction issues such as the definition of discretion and identifying strategies. It is essential that the considerations given to composite construction are adequately documented and applied consistently.
q Performance systems. The capabilities of the systems used can have a significant impact on the ease or difficulty of getting into and maintaining compliance.
The survey results show a wide variety of performance systems in use. Approximately half the respondents use performance systems developed in-house, with most of the remaining respondents external systems or service providers. While a performance system itself cannot be compliant with the standards, careful selection of a system that calculates account and composite performance using an acceptable method and also provides monitoring features can go a long way in helping the compliance process.
Calculation methodology was described as an area of difficulty by 10% of the survey respondents. The standards provide guidelines for the calculation of account performance. The firm considers the following issues: how and when are accounts valued; is accrued income included in market values, and if so, for which periods; how have external cash flows been treated in the performance calculations?
Once account performance has been calculated, a firm must calculate composite performance. Again, the standards provide for various calculation methodologies, as long as the individual account returns are weighted based on their beginning-of-period market values.
q Prepared disclosures. Unless the firm has demonstrated that it can prepare fully compliant presentations for each of its composites, the firm will not be able to claim compliance.
q Maintaining compliance. Coming into compliance is a waste of time without adequate attention and resources devoted to maintaining it, and 15% of the survey respondents say maintenance and monitoring of composites is an area of difficulty. Typically compliance is monitored on a monthly or quarterly basis through a review of accounts to ensure the composite populations are correct.
q Verification. At present under the standards, verification is only ‘strongly encouraged’ and not mandatory. Verification provides comfort to management that an independent party has reviewed the firm’s performance measurement procedures. Independent verification has become more widely accepted in the industry and can aid a firm’s sales and marketing efforts.
It is required that the verification be performed by an independent third party (for example, accounting, consulting or law firms). The survey results indicate that ‘Big 5’ accounting firms account for nearly 80% of verifications, other accounting firms represent almost 15%, and other types of firms make up the balance.
Nearly 75% of survey respondents have been verified, and 67% of those not currently verified plan to go through the process within the next two years. Clearly verification is moving toward acceptance as the industry norm.
Achieving compliance is therefore an arduous, costly and time-consuming process, requiring much co-ordination and commitment. However, when the firm finally finds itself GIPS compliant, it will have demonstrated a high level of professionalism and adhered to a process encouraging uniformity and comparability in investment performance standards.
Damian Regan and Joseph DiMaria are at PricewaterhouseCoopers in London. Copies of PwC’s 2001 Global Trends in Performance Management can be obtained from Damian Regan +44 20 7804 9984

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