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Institutional Investors Should Agree To Mandate GIPS Standards Compliance

Rebecca Hampson’s recent article, “How Quickly Will Hedge Funds Adopt The 2020 GIPS Standards?” raises two key points.

The first is to answer the title’s question, and it’s the same answer that applies to all asset classes and sectors: when the demand is present; hedge funds will not comply until the market demands it.  This demand cannot be from just a few institutional investors, but must come from a large enough number that hedge funds will recognize that to attract business and continue to grow, they must make the investment and comply with the Global Investment Performance Standards. If only a few prospects require compliance, hedge funds can simply pass them by, because there are enough who don’t to provide them with the funds they seek.

David Spaulding
David Spaulding

It would also help if some of the largest hedge funds make the investment in compliance: to take the lead and adopt these valuable rules. And why should they? While the Standards can provide compliant firms with a marketing advantage, they are also considered “best practice”. They provide a consistent way for firms to represent their performance to the market, something that is lacking in this space. The Standards are ethical principles that promote full disclosure and transparency. And while there is an investment to comply, most hedge funds will find compliance to be a relatively simple exercise.

The second point was raised by Don Steinbrugge, CEO and founder of Agecroft Partners, and it deals with the lack of transparency surrounding net-of-fee returns. The issues he raised are not unique to hedge funds. The Association for Investment Management and Research’s Performance Presentation Standards (AIMR-PPS®), which were the foundation for the GIPS® standards, required firms that reported net-of-fee returns to include the weighted-average fee, which helped investors understand what the return represented. These standards recognized that “performance results after deduction of an average management fee will not be representative of results for a portfolio that is much larger or much smaller than the size of the portfolio represented by the average fee”. Without some insight into what that net-of-fee return really represents, it has little value.

And so, we need institutional investors to agree to mandate compliance with the GIPS standards: perhaps with an effective date of 1 January 2021. While the 2020 version goes into effect on 1 January 2020, firms do not actually have to comply with the changes until they begin to report their 31 December 2020 results. Secondly, we need to see greater transparency into the makeup of the net-of-fee returns. This will benefit hedge fund managers, their clients, as well as their prospective investors.

David Spaulding is Founder and CEO of The Spaulding Group

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