Let's consider mutual funds. Are the shareholders clients? I believe the consensus opinion is that "no, they aren't." At least for GIPS purposes. That is, a mutual fund manager isn't obligated to provide prospective shareholders GIPS compliant presentations. The fund itself is the client.
What about private equity partnerships? At first glance it appears that they're analogous to mutual funds and therefore the prospective partners wouldn't constitute clients for GIPS purposes, but rather the partnership itself would be the client. However, this seems to be a bit of a gray area. A private equity manager is the general partner of the plan and is seeking limited partners to participate. There is a whole host of rules regarding private equity and so wouldn't we expect that potential partners to receive materials that align with the GIPS standards? Further clarity here may be in order.
In the case of wrap fees the asset manager actually has some flexibility when handling the accounts for GIPS purposes, but I'd say it's generally agreed that the sponsor of the wrap fee program is the client. The participants themselves, even though they have their own accounts, wouldn't be clients for GIPS purposes.
We're working with a verification client who is the manager of some 401-K programs, and this question arose during the course of the review. At first, because each account is sitting on the manager's system, I believed that THEY should be the clients. However, as with wrap fee programs, the 401-K sponsor selected the manager, and therefore for GIPS purposes the sponsor is the client; the individual participants in the plan are not.
Guidance on client definition would, I believe, be a helpful addition to the GIPS materials ... perhaps after GIPS 2010 is done?
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I am not so sure your interpretation is correct. Take a step back and remember that GIPS is for prospective investors. A mutual fund, partnership, or wrap sponsor does not have any capital at risk because they are not investors. If I was look to index my portfolio I could hire a manager (and I would receive a GIPS report) or I could simply buy an index fund (and, according to you, would not receive a GIPS report). How am I a prospective client for one and not the other? Does it say somewhere that you can do what you suggest? A fund prospectus is required in most places, but that doesn't satisfy the GIPS requirement, does it?
ReplyDeleteThanks for your note and glad that we might have some discussion on this. But first, please point me to where in the standards it refers to "prospective investors." Thanks!
ReplyDeleteSeriously? Ok, 6.B.7.c; Appendix D - Other Considerations #3 (page 40 of the 2005 GIPS). You are missing the forest for the trees. You tell me where is says that shareholders, LP's, or wrap clients are not "prospective clients"?
ReplyDeleteThe StatPro website has the following statement: "The Global Investment Performance Standards (GIPS) are a set of ethical principles used by investment management firms in order to establish a globally standardised, industry-wide approach to creating performance presentations that communicate investment results to prospective clients." Aren't "prospective clients" the same as "prospective investors?" And isn't this what GIPS is all about? (From Another Anonymous)
ReplyDeleteThanks for pointing out your source, which refers to private equity; your statement was broader, dealing with GIPS in general for which I'm unaware of any such reference. Note that I pointed out that private equity is no doubt a bit different than, for example, mutual funds.
ReplyDeleteWe have a precedent for my opinions: wrap fee, where the sponsor can be viewed as the client. There is no requirement in the wrap fee guidance for a GIPS compliant firm to provide the investor with a presentation. The firm can rely upon the sponsor to provide performance information that does not have to be GIPS-compliant.
As for mutual fund shareholders, you are correct that there is nothing that says they don't have to be provided presentations nor is there anything that says they do. This has been an area of some discussion / controversy. While I'm aware of one or two mutual fund managers that include their GIPS presentation in their mutual fund prospectuses, this, I believe, is probably a rare event.
We had expected something definitive to come out of the GIPS EC on this topic but I'm unaware that this has occurred.
Thanks, "another anonymous!" I'm being bombarded!
ReplyDeleteI guess this is the point ... who IS the client?
If I'm trying to market my services to Merrill Lynch, for example, to be part of the wrap fee program, isn't Merrill my client? That's what the wrap fee guidance proposes.
If I am a manager trying to market my services to a mutual fund, to be (for example) the subadvisor, then the fund board is my client, yes? I don't market to the shareholders using my GIPS returns. And technically, even if I am the advisor to a fund, the fund's board chooses me, yes?
If a firm is looking for someone to provide the investing options to their employees for their 401K program, isn't the firm's management my client?
Regarding mutual funds, isn't the fund's performance what really matters to a prospective investor?
ReplyDeleteDave:
ReplyDeleteYour wrap fee program example is representative of a pervasive problem in the world of investments: fiduciary responsibility (or the lack thereof.) Here's the ethical guidance from the CFA Institute (from whom we get the GIPS standards and the CIPM designation:) "Know your fiduciary responsibilities and to whom they are owed." This is simple, clear and unequivocal. The key is this: "Whose money is at risk?" It is NOT: "Who pays your fee?"
The classic example of knowing to whom your fiduciary responsibility is owed (AKA "Who is the client?") is the case of the investment manager who is hired by a company to manage their pension fund.
Q: Who is the client? To whom does this investment manager owe a fiduciary duty?
A: To the BENEFICIARIES of the pension plan, and NOT to the company who hired them, who can fire them, and who writes their check for services rendered. This example is typically used in CFA ethics classes, and this ethical guidance is the same for those who prepare performance analysis.
This issue is not that complicated, but it does illustrate the conflict of interest in the investment community who seem to fail to understand where their loyalties should lie. We need to serve the investors whose money is put at risk in these strategies that are evaluated using GIPS compliant presentations. They are "The Client." Everyone else is an intermediary.
It would be truly unfortunate to be expert in the GIPS standards but fail to know who the client is. Let's first get that part right...
"Another Anonymous"
Thanks, AA! Excellent points. But in the world of wrap fee products, the manager must win over the sponsor who provides the link to the ultimate investor. Should GIPS require that sponsors provide GIPS-compliant presentations? Can they? This has been debated I believe. I'm simply dealing with the reality of the current situation.
ReplyDeleteI believe the private equity terminology is an illustration of different words being used to say the same thing. I agree that the fund history is the most appropriate to show to a prospective fund investor, but there is nothing in GIPS that prevents that as a firm could simply create a composite that only contained the fund.
ReplyDeleteFollowing your reasoning does make it easier on the investment managers, but don't forget that the point of GIPS is to provide comparable, standardised information so that people can make informed decisions. And by the way, the term "investor" is used quite a number times throughout the introduction, so this is not a new concept. One page 1 of the standards it says "Requiring investment management firms to adhere to performance presentation
standards will help assure investors that the performance information is both complete
and fairly presented."
It may not be entirely clear one way or the other, but if you follow your reasoning there is a certain probability that you are not in compliance and therefore assume some regulatory risk. I wonder how you have advised your clients?
Interestingly, the new definition of "prospective client" in GIPS 2010 defines a prospective client as "Any person or entity that has expressed interest in one of the firm's composite strategies and qualifies to invest in the composite." If we focus on the word "invest," this would, in theory, eliminate wrap fee sponsors. However, the definition also includes "Investment consultants and other third parties are included as prospective clients if they represent investors that qualify as prospective clients." So, what if any impact does this have on wrap fee sponsors?
ReplyDeleteYes, a firm can have a mutual fund in a composite by itself. But here in the U.S., if a firm does this they can't make this fact known to the prospect (see SEC no-action letter to AIMR dated 1997). And, in the States the SEC provides the rules for marketing to prospects.
Again, this is a bit murky. Appreciate your input and insights.
Isn't the no-action letter in relation to when a fund is included in a composite with other accounts? Provided that their rules and regulations are also being met, why would any regulator object to a one fund composite?
ReplyDeleteThe SEC no-action letter addresses a few things, but one has to do with the inclusion of mutual funds (with or without other accounts), with the idea being that the presentation wouldn't be used to market the fund.
ReplyDeleteDave: To your question: "Should GIPS require that sponsors provide GIPS-compliant presentations?" how can the answer be anything other than "YES" since the entire purpose of GIPS is to provide the relevant information needed by investors to make informed decisions in their own best interest. Clearly, a wrap program sponsor is not an investor: the sponsor is not the one investing capital, but is merely making products available to the true investors. From the perspective of the fund managers, the plan sponsor may look like the client, since those sponsors are the "gatekeepers" or intermediaries to the ultimate clients. So, where is the confusion around who the clients are and whether they are entitled to a GIP-compliant performance presentation? If you think of this in terms of fiduciary responsibility to the ultimate investors, then it is obvious that the ethical standards require that the relevant information must be presented. So, the fact is that a GIPS-compliant presentation is required for BOTH the plan sponsor (for due diligence in selecting the fund managers) and for the investors (so that they can have a reasonable basis for deciding to invest their money with the fund manager.) This is not an "either/or" decision; there is a responsibility to BOTH parties to provide a GIPS-compliant presentation.
ReplyDeleteAA
You'll have to point out the issue from a fiduciary perspective. As long as the manager has comfort with the information that is shared with the wrap fee client, where is there an issue? The sponsors typically provide their prospects with returns from the wrap fee program itself, thus actual returns obtained by the manager.
ReplyDeleteWhen the AIMR-PPS Implementation Committee worked on the wrap fee guidance (which is now part of GIPS), I believe there was a desire for sponsors to provide compliant presentations; however, sponsors aren't claiming GIPS compliance (although they technically could, since they are picking sub-advisors, so to speak). Sponsors do pretty much what they want to do. Managers should be cognizant of what they give to their clients but can't expect it will be a GIPS presentation.
Perhaps you should lobby the EC about enhancing the guidance the next time the standards are revised.
I learned today from a UK-based client that for regulatory purposes a client is who the manager has the contract with (e.g., it can be a management company). In the case of a mutual fund, the contract is with the sponsor of the fund. Interesting.
ReplyDeleteSo it seems that a) it's OK for the CFA Institute, fund managers, leading performance professionals and CIPM certificants collectively to be comfortable with the idea of NOT providing GIPS compliant performance information to the people whose money is put at risk in these marketed products (AKA "the real clients") and further that b) there seems to be no connection between the ethical standards of the CFA Institute that state clearly that managers owe a fiduciary responsibility to those whom the investments are to benefit (using the example of pension beneficiaries as the client and not the company officials who hire the fund managers) then we clearly need someone to lobby the EC. Why hasn't this happened already? What's the good of all of these GIPS standards if the true client is not being served?
ReplyDeleteA.A.
Thanks for your note.
ReplyDeleteThe point of this blog post was to raise the issue about this question. Clearly there is room for clarity. Little guidance has been offered regarding this matter.
As for mutual fund clients, the manager, in theory, is marketing their services to the fund trustees, yes? The fund itself then markets its product(s) to potential investors, adhering to whatever standards or rules may exist (in the U.S., of course, we have the SEC's rules). A GIPS-compliant firm would be expected, at least in theory, to provide the fund board with their GIPS-compliant presentation(s). Granted, if the fund is administered by the same firm for which the manager belongs, even though it's set up as a separate legal entity, would probably not see a presentation put forward. But again, the shareholders will see the information that is required by regulators. This particular issue has been raised in the past, with some coming down on the side that says that potential shareholders would be expected to see GIPS-compliant presentations while others arguing against this, especially since the shareholders are not treated as "clients" or "accounts" within GIPS; rather, the "fund" is the account or client.
In the case of a 401-K plan, the plan administrators presumably are the ones who decide what managers will be chosen to provide management to the employees, yes? They have responsibility, on behalf of their employees, to select a manager they feel will serve their needs. A GIPS-compliant firm would be expected to provide the trustees with the appropriate composite presentation(s) in order to win that business. The trustees have, arguably, acted on behalf of their employees.
Your point about the "true client" is interesting. Are they being "served"? Presumably they are, when, for example, the 401-K plan administrators have the responsibility to act on behalf of the employees in selecting a manager. The same for a fund, when the fund, acting on behalf of the investors, selects a manager. For wrap fee, the wrap fee sponsor does this on behalf of their investors.
Interesting topic, I think.