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Lesson 1 of 4 · 11 min
Why the GIPS standards exist and who benefits
The GIPS standards give every investment firm one common, ethical way to calculate and present past performance, so that track records are fair, complete and comparable.
In short
- Before GIPS, firms could flatter their record with representative accounts, survivorship bias and varying time periods.
- GIPS is a voluntary, practitioner-driven set of ethical principles built on fair representation and full disclosure.
- Objectives: protect investors and their confidence, accurate and consistent data, one worldwide standard, fair global competition, and global self-regulation.
- Beneficiaries: firms (credibility, access to competitive bids, stronger internal controls), prospective clients and investors (trust and comparability) and asset owners and their oversight bodies.
- Compliance raises credibility but does not replace the client's own due diligence.
The problem: track records that could not be trusted
Clients choose managers largely by looking at past returns. That only works if every manager measures and presents returns the same way, and honestly.
Before a common standard existed, firms used different methods, so a pension fund comparing proposals from managers in several countries was comparing apples with oranges. Worse, some common habits made a record look better than the firm's true results.
Three misleading practices are named by the curriculum and appear often in exam questions. Each one quietly removes bad results from what the client sees.
| Practice | What the firm does | Why it misleads |
|---|---|---|
| Representative accounts | Shows its single best portfolio as 'the' result for a strategy | The client sees the winner, not the typical outcome |
| Survivorship bias | Builds an 'average' record that leaves out portfolios lost because they did badly | The failures that drove clients away vanish from the history |
| Varying time periods | Shows only the window in which the strategy did well or beat its benchmark | Picking flattering dates makes comparison with other firms impossible |
The fix for each is the mirror image of the abuse: include all portfolios (not one), include terminated portfolios (not just survivors), and use consistent, standard periods (not hand-picked ones). An answer option that describes the mirror image is a GIPS-consistent practice, not an abuse.
What GIPS is and what it aims to do
The GIPS standards are a set of ethical principles written by practitioners. They set out one industry-wide approach for calculating and presenting historical investment results to prospective clients.
The two guiding ideas are fair representation (no misleading picture of performance) and full disclosure (tell prospects everything they need to judge the record). The stated mission is to promote ethics and integrity and build trust, by getting asset owners to demand compliance, asset managers to adopt it and regulators to support it.
The 2020 edition has three chapters: Standards for Firms, for Asset Owners and for Verifiers. Organisations that compete for business follow the Standards for Firms.
- Promote investors' interests and investor confidence.
- Ensure data are accurate and consistent.
- Win worldwide acceptance of one standard for calculating and presenting performance.
- Promote fair competition among investment firms globally.
- Promote self-regulation by the industry worldwide.
Who gains from compliance
Firms gain credibility: a compliant firm signals that its reported record is complete and fairly presented. It can compete in searches against other compliant firms anywhere in the world, and the work of complying often tightens its internal controls over performance policies and procedures.
Prospective clients and investors can place more trust in a compliant firm's presentation and can compare compliant firms more easily. Compliance does not remove the need for their own in-depth due diligence; it simply makes the starting information more credible.
Asset owners report performance to oversight bodies (for example, a pension fund's board), which use it to make decisions and to judge the funds they supervise. When an asset owner requires its external managers to comply and reports to its own board on the same principles, it becomes easier to see where risk and excess return come from.
Meeting regulatory requirements is not a listed benefit. GIPS compliance is voluntary and is not usually required by regulators, and the standards are not meant to cover every regulatory rule.
Worked examples
Example 1 Spotting the misleading practice
Halvorsen Kapital runs nine Nordic equity mandates. Its pitch book shows the five-year return of the one mandate that beat its benchmark by the widest margin, labelled 'Nordic Equity track record'. Which practice is this, and what would GIPS require instead?
Example 2 Survivorship or time period?
A manager's emerging-market bond record starts in the year after a severe loss, and excludes three accounts whose clients left after that loss. Which misleading practices are present?
On the exam
Expect a question asking which practice GIPS was designed to prevent (often with a GIPS-consistent practice, like including terminated portfolios, as a distractor), or which item is not a benefit of compliance.
- Including terminated portfolios is what GIPS wants; excluding them is the abuse.
- Presenting all periods since inception is fine; it is hand-picking a good window that misleads.
- Regulatory compliance is not a benefit of GIPS: the standards are voluntary and not generally required by regulators.
- Compliance makes presentations more credible but does not remove the client's need for due diligence.
Check yourself
Q1Which practice is a firm least likely to be criticised for under the GIPS standards?
Q2A firm's 'average' strategy record omits accounts that were lost after poor results. This is best described as:
Q3Which of the following is least likely an objective of the GIPS standards?
Q4For prospective clients, GIPS compliance by a manager most likely:
Q5Which party is an intended beneficiary of the GIPS standards alongside firms and their prospective clients?
Answer the 5 questions: +10 XP for each one you get right first time.
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