Alternative Investment Management Association Representing the global hedge fund industry
Ernst & Young LLP
Having first written in a 2005 edition of the AIMA Journal on the benefits of Global Investment Performance Standards (GIPS) for hedge funds, I am perhaps not ideally placed to laud the newly released “Guidance Statement on Alternative Investment Strategies and Structures” as finally giving hedge fund managers a reason to embrace GIPS. But it is certainly a significant step in the evolution of GIPS from its traditional roots, chiming as it does with the key strategic aim of the CFA Institute’s GIPS Executive Committee: to broaden the reach of GIPS to all corners of the asset management industry.
At a time when the concept of self-regulation is anathema to many, GIPS reminds us of what success in this area looks like — a simple set of principles that are both globally endorsed (in over 35 countries from Australia to the United States, including important emerging markets such as China, Russia and Mexico) and credibly enforced through independent annual verification of a “Firm’s” claim of compliance on an annual basis.
The GIPS establish the core principles of performance measurement and reporting (input data, calculation methodology, composite construction, disclosure and presentation), and the Guidance Statements provide detailed application notes. They can be about a single topic, such as calculation methodology, or, in this case, how to apply GIPS standards to a specialist segment of the industry. Guidance Statements on applying GIPS standards to private equity and to real estate have already been issued. The new guidance, focused primarily on hedge funds, has inevitably come later because, as we have seen, GIPS tout court was perfectly workable for hedge funds albeit with a considerable degree of interpretation required.
The “Guidance Statement on Alternative Investment Strategies and Structures” is a good one. The technical content is of a high calibre and the layout is logical and easy to follow. The consultation process also reached the right people, such as the Hedge Fund Standards Board and other organisations that could effectively represent the views of large groups of managers. The crucial question now is whether awareness will follow, in the form of increased levels of adoption — an area where the private equity and real estate equivalents have arguably come up short.
I believe this Guidance Statement will succeed where these predecessors have struggled. For one thing, there have been early movers to comply with GIPS, such as GAM and GLG Partners, whose peers will want to follow them. At the time, they had to make judgement calls in many of the areas where there is now (thanks to the new release) clear guidance, such as the treatment of incentive fees in performance calculations, illiquid investments (including side pockets), creating composites out of master feeder structures, and disclosing the use of leverage, derivatives and the risk metrics used to control them. The major achievement of this Guidance Statement is therefore reducing the cost and time involved in achieving compliance, thereby favourably influencing the cost-benefit ratio since I first discussed it back in 2005.
Since that time, the benefits of GIPS standards have become clearer, but largely as a function of the direction the industry is taking. We have seen a markedly increased appetite for hedge funds among pension funds, driving the institutionalisation of this segment of the industry like an irresistible force. GIPS compliance is well known to the pensions sector and is a cost-effective means by which hedge fund managers can signal that they are on a level playing field with their traditional counterparts, particularly when it comes to a strong control environment over their published records. My concern is that the prolonged financial crisis may form an immovable object in the path of this simple and logical step forward for hedge fund managers focusing on institutional flows, many of whom are unfortunately being forced to reach once more for the “survival mode” section of the cost management manual.
On balance, I remain optimistic that the post-crisis spirit we have seen among hedge fund managers will prevail through an extended period of market stress, treating it as an opportunity to establish alternative investments, delivered through a robust control framework, as an essential component of institutional portfolios. GIPS has always had an important role to play in enabling this process, and this Guidance Statement makes taking that step even easier.
The views reflected in this article are the views of the author and do not necessarily reflect the views of the global Ernst & Young organization or its member firms.
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