Now, these same asset owners are being encouraged to comply themselves.
Earlier this year, the GIPS Executive Committee (the nine-member board that oversees the Standards) published a guidance statement (GS) titled “The Application of the GIPS Standards to Pension Funds, Endowments, Foundations, and Other Similar Entities.” The public comment period ended August 1, and the final version is expected to be finalized in the next few months.
Since most plan sponsors do not offer their investment services to other parties, one might ask “why comply?” There are at least three reasons plan sponsors should consider compliance:
- To adhere to best practice. Most institutions wish to abide by best practices, wherever they’re established. And for performance measurement and reporting, GIPS is recognized as best practice. While parts of the Standard don’t apply to plan sponsors, those parts that do should be followed.
- To enhance confidence and credibility. All asset owners answer to stakeholders who want confidence in what is being presented, as do those who prepare the numbers. By adhering to a globally accepted standard, the institution’s reports will provide increased credibility with what’s presented.
- For consistency. Plan sponsors often want to compare how they’re doing with others. With no consistent method to calculate and present returns, this can be difficult; however, as more institutions adopt the Standards, comparisons will be much easier to accomplish.
The idea of pension fund compliance has been addressed in the past, initially with the Association for Investment Management and Research’s Performance Presentation Standards (AIMR-PPS), the standard that arguably led to the development of GIPS. Some argued that it would be inappropriate for a plan to adopt the AIMR-PPS. I see no harm for pension funds to do so, and perhaps there are benefits by complying. Over the past few years this idea has been addressed at length, leading to the new GIPS guidance statement.
The GS provides clarification about those provisions that apply, as well as highlights ones that do not. In addition, it offers a few changes that are unique to asset owners. For example, GIPS requires compliant firms to make every reasonable effort to provide compliant materials to prospective clients. But, as already noted, most plans don’t market their services. However, there is still a requirement for the materials: instead of giving their compliant presentations to prospective clients, plan sponsors must make every reasonable effort to provide them to those who have oversight responsibility for total fund assets. This might include a board of trustees that establishes investment policies or mandates for the fund, and monitors the fund’s performance relative to its objectives.
For the most part, GIPS requires time-weighted rates of return (which eliminate or reduce the impact of cash flows). While this holds true for asset owners as well, GIPS recommends these institutions also consider reporting money-weighted returns (which take cash flows into consideration). Even though neither the plan sponsor nor the pension fund typically controls the timing or size of cash flows, money-weighted returns will demonstrate how cash flows impacted the fund’s performance. I have long been a supporter of broader adoption of money-weighting, and applaud this specific recommendation.
Those provisions that don’t apply to plan sponsors are addressed within the new GS. For example, while asset managers are encouraged to use temporary accounts when significant cash flows occur, this option isn’t available to plan sponsors since all cash flows must be included in the total fund.
One question that plan sponsors might ask is “should we be verified?” As with asking asset managers if they comply with the Standards, a typical second question is “are you verified?” Since these same institutions recognize the importance and value of requiring verification for their external managers, it would only seem logical that they apply the same requirement to themselves, as it will further enhance the credibility of their claim and provide heightened confidence to those responsible for the management of the plan, as well as those who receive the presentations.
How the market will respond to this new guidance and expansion of the Standards is yet to be determined. However, early empirical evidence suggests many institutions are at least giving compliance some consideration. Our firm’s largest verification client has been complying for several years, and we expect more to do so, given the benefits compliance provides.
David Spaulding is founder and CEO of The Spaulding Group. He is a globally recognized authority on investment performance measurement, and has written several books on this subject. The firm has offices in both the NYC and LA metropolitan areas, as well as London. David has more than 30 years of experience in the investment industry.
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.