GIPS compliance levels playing field

In a perfect world, smaller investment firms would be judged on their performance within de-fined investment objectives without…

In a perfect world, smaller investment firms would be judged on their performance within de-fined investment objectives without being pe-nalized for being “too small” or -having less established market awareness.

But many advisers have experienced the frustration of investors’ passing over their firms’ innovative strategies for bigger names delivering less impressive returns. Merit, it is sad to say, will get them only so far.

Many advisers accept this imperfect reality, but a few intrepid, small firms have decided to implement the CFA Institute’s Global Investment Performance Standards, designed to let them compete on a more level playing field with the big boys.

Clarity Asset Management Inc., an Ames, Iowa, registered investment adviser serving primarily wealthy investors, decided to implement GIPS to establish credibility around its performance and to ensure the highest possible level of accuracy.

“We wanted to put ourselves on a level playing field with much larger money managers,” said Bradley Peyton, president and chief investment officer of the firm.

GIPS permits the firm to compete for business from bank trust departments, because the banks know the methodology by which performance is calculated and composites are assembled, whether the asset manager is in Europe, Asia or the United States, he said.

When working with separately managed account platforms, compliance with GIPS is becoming industry standard.

“From an institution’s standpoint, who knows how an adviser is aggregating accounts or calculating performance? Is the adviser using time-weighted returns? Are they "cherry picking’ the best-performing accounts? When reviewing a GIPS-compliant firm, these questions have been answered,” said Mr. Peyton.

GIPS is essential for third-party advisers approaching institutions, but less so for the consumer, said Edward Foy, president of Foy Financial Services Inc. in Lincoln, Neb. “In the retail world, you end up doing a lot of educating. Because the awareness isn’t there yet, you find yourself explaining the intricacies of the internal-combustion engine to someone who simply asked how fast the car goes.”

Although the standards are not familiar to some clients, Mr. Foy believes that clients have become more sophisticated than ever and are eager to pick up new concepts.

“When introducing GIPS to clients, I keep the message simple,” he said. “This is a standard that’s designed for fairness. It isn’t for the short-term; it isn’t representing just the best sides of the market.”

Potomac Fund Management Inc. of Easton, Md., has seen a clear shift toward GIPS as a prerequisite when working with broker-dealers. “This wasn’t as important a year ago, but it’s turning into an absolute must,” said Manish Khatta, vice president.

GIPS gives guidelines for grouping clients into meaningful classifications and deciding which accounts should be excluded from them. The standards’ subjective nature leaves the process open to interpretation.

“Translating GIPS guidance into compliant composites was challenging, especially when applying it to historical data,” Mr. Peyton said.

The toughest part for his firm was establishing policies and procedures that adhered to the standards and fit the business. However, once the policies and procedures were set, it was then only a matter of reviewing accounts to ensure that rules were applied in a consistent fashion.

“This has, without question, boosted our firm’s credibility,” Mr. Peyton said.

Clarity relied on GIPS reports and composite generation tools from its back-office firm to produce investment returns.

“Technically, the composites could be calculated by hand, but that would be like churning your own butter,” said Mr. Peyton. “It’s possible but not worth doing given the low-cost technology that’s available.”

But technology alone is not sufficient.

Mr. Foy, for instance, emphasized the importance of correctly interpreting the standards. “When we began implementing GIPS,” he said, “we looked at a number of other firms’ procedures and discovered that many aren’t fully adhering.

“It’s easy to claim that you’re compliant, but we encourage due diligence, saying: "We invite your scrutiny.’”

While putting the standards into practice has required some effort, Mr. Foy said, the payoff has been worth it. Recently, after eight months of due diligence, his firm signed a solicitor’s agreement with a major broker-dealer network.

Mr. Khatta said that Potomac is currently establishing selling agreements with multiple broker-dealers — deals, he said, that wouldn’t be happening without the standards.

Eric Clarke is president of Omaha, Neb.-based Orion Advisor Services, a back-office service provider for registered investment advisers.