Wednesday, January 27, 2010

Being discrete when we can...

One of the most difficult and confusing aspects of the Global Investment Performance Standards (GIPS(R)) is "discretion." As we know, "discretion" has multiple meanings. First, we have "legal" discretion and then "GIPS" discretion.

I've always viewed "legal discretion" as the starting point to decide if an account is discretionary for GIPS purposes. If the account isn't legally discretionary, no need to move forward. But, that was until fairly recently. We have a new client that has a slightly different twist on this. They will allow accounts that are not legally discretionary to be discretionary for GIPS purposes if the client always takes their advice.

In our classes, we look at scenarios where an account is legally discretionary, but where the client requires the manager to ask them (or alert them) before trading, as a point to consider as to whether or not the account is discretionary for GIPS purposes. If, for example, this legally discretionary account always says "yes, sure, do what you want," then to include it as discretionary for GIPS purposes is deemed fine. However, if there are times when the client may say "no, I'd prefer if you didn't do this trade," then they should consider having this account be non-discretionary for GIPS purposes.

The standards do not specifically address (to my recollection) the issue of "legal" discretion. And therefore, I'm of the opinion that this client's decision to allow accounts that are not legally discretionary to be treated as discretionary for GIPS purposes under the scenario outlined above should be permitted; this view was supported by the GIPS Help Desk, so I am confident in its interpretation.  Discretion is, as I think we agree, in the eyes of the manager, and therefore should be their call. 

And in conclusion a legally discretionary account can be discretionary for GIPS purposes but also may not be, based on the firm's rules. In addition, an account that is NOT legally discretionary CAN be discretionary for GIPS purposes, again, depending on the firm's rules. 

1 comment:

  1. Bravo. Your assessment of discretion is both sound in its logic and crystal clear in its presentation. Once again, we see that the key to finding the right answer is understanding the question at hand. In terms of discretion, the question is really whether the account is representative of the manager's skill in executing the investment process. It's not an issue of legality at all. In fact, if we put legality aside and simply ask: "Does this account fairly represent the results that were achieved as a result of your investment decisions and your investment process?" then we have our answer - that the account should be included in the manager's composite. This is rather similar to the concept that the firm is defined by function and not be legality - it's what we hold out to the public, not what's been chartered by the government as a legal entity.


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