November 2017 Performance Update: Increasing Demand for Performance Reporting Transparency

For roughly 25 years, institutional investors have increasingly required asset managers with whom they invest to claim compliance with the Global Investment Performance Standards (GIPS^®). This requirement is largely required of traditional fixed income and equity strategies and applied to asset managers that work predominantly with institutional investors. Early on, most private wealth managers were exempt from the requirement, and thus their rates of compliance paled in comparison to those of traditional institutional managers (more than 80% of U.S.-based institutional managers comply with the GIPS standards).

However, in recent months, ACA has observed a substantial number of manager advisory platforms that aggregate third-party performance data (e.g., wrap/SMA, TAMPS) start to shift towards requiring some sort of performance attestation. This requirement will drive hundreds, if not thousands, of asset managers to demonstrate greater levels of performance reporting transparency.

Manager advisory platform requirements

Through conversations with clients, ACA has learned that a number of manager advisory platforms require third-party managers to have their performance returns independently validated as a minimum qualification for participating in these platforms. The requirements vary among platforms, but typically include:

• The manager must comply with the GIPS standards and have an independent third-party verification;
• The manager must either comply with the GIPS standards and have an independent third-party verification or must have independent validation for active strategies available on the platform; and
• In the case of presenting model performance, the manager must have an independent track record validation for models available on the platform.

While the majority of managers meet these requirements, others are scrambling to do so. Clearly these requirements have a broad impact on managers that cater to retail investors through such platforms, and we believe this is a good thing for investors.

Why has regulatory scrutiny of investment performance increased?

Regulators continue to focus on investment advisers that market third-party performance data without having sufficient due diligence and documentation in place. This new requirement is a direct result of a recent SEC sweep that has roots dating back to December 2014 when F-Squared was penalized $35 million for allegedly producing false performance and defrauding investors. Since this announcement in 2014, 15 other firms have been fined by the SEC for allegedly perpetuating the false performance claims of the same third-party investment management firm. These managers marketed the investment to their clients without obtaining sufficient documentation to support the accuracy of the performance data, which led clients to receive false and misleading information.

The outcome of these cases led multi-asset class platforms to rethink the standards of care they have associated with the usage of third-party performance results and how they rely on, and take responsibility for, the reporting of such performance. The following is an excerpt from one manager platform’s website:

“In order for a SMA Portfolio Manager or Model Advisor to be selected for the Platforms, XYZ platform generally requires a third-party verification letter related to compliance of the firm’s performance information with Global Investment Performance Standards (GIPS) or a similar letter indicating that the performance information has been audited by an independent auditor.”

What is the impact of these new requirements?

These new manager platform requirements result in increased transparency and reliance on performance, which we believe is a valuable development. Areas of impact include:

1. Momentum towards GIPS compliance for private wealth managers will increase as firms seek to remain competitive and a part of these multi-asset class platforms.
2. As multi-asset class platforms continue to evaluate the control environments related to performance reporting, we expect to see more platforms require independent performance validation in order to be selected for and participate in the platforms.
3. Model performance will be further scrutinized, resulting in more transparency and disclosure about what model performance represents, as well as limitations related to relying on model performance.

About the Author

Justin S. Guthrie, CFA, is a partner at ACA Performance Services, a division of ACA Compliance Group. His primary responsibilities include serving as a partner on traditional and alternative GIPS compliance verification engagements and the day-to-day operations of the GIPS compliance verification and consulting division of ACA. Previously, Justin served as an auditor at Ernst & Young. He is a past president of the CFA Society of East Tennessee and is current Chair of the United States Investment Performance Committee. Mr. Guthrie is a co-author of the survey “The Value of GIPS Compliance – 2014 Manager and Consultant Survey.” He is a Certified Public Accountant. Justin earned his Bachelor of Science degree in Accounting and his Master’s Degree in Accounting from the University of Tennessee, Knoxville.