GIPS allows for composites and pooled funds to be marketed on this basis, requiring firms to present performance both including and excluding side pockets, if the fund with the side pocket is the only portfolio in the composite or pooled fund, and the side pocket assets are managed on a discretionary basis. This applies to both gross and net-of-fees returns and allows prospective investors to interpret the performance of the fund without the impact of the side pocket. In this way, alternative investment managers are able to present the track record and performance of the fund for the liquid portion, thus giving more freedom to market these pooled funds with illiquid assets.
Utilizing carve outs
As previously mentioned, many alternative managers are now operating complex and intricate multi-asset portfolios which, under GIPS 2010, were historically difficult to market when following the guiding principles. This was particularly the case where prospective investors would request to see the performance for a distinct or bespoke sub-strategy of the portfolio, for instance the emerging market real estate portion of a multi-asset composite. Historically, from 1 January 2010, investment managers were not permitted to carve out this portion of the strategy and present it to prospects within a separate composite unless it had its own cash balance.
However, a welcome change under the 2020 refresh of the standards is the ability to once again utilize carve outs with allocated cash, to present a portion of a portfolio that is by itself representative of a distinct investment strategy. In this way, investment managers have the ability to create a track record for a narrower mandate from a multi-strategy portfolio managed under a broader mandate. This change makes it possible for a greater number of private market investments to come into compliance.
There are some prerequisites for utilizing carve outs. Firstly, firms must create carve outs with allocated cash from all portfolios within the firm that are managed to the same strategy. This prevents firms from cherry-picking which portfolios of a similar strategy will be carved out for inclusion in the composite. Further, the carve outs must be representative of a standalone portfolio managed or intended to be managed according to that strategy. This applies to both carve outs with allocated cash as well as those with their own cash (sub-portfolios). This is to prevent firms from creating carve outs that are misrepresentative of their management capabilities. In addition, firms must create and maintain composites that include only standalone portfolios managed in the same strategy as the carve outs with allocated cash. The returns and composite assets from the GIPS Composite Report for the standalone portfolios must be included in the GIPS Composite Report for the composite that includes carve outs with allocated cash. This is to present the performance of the carve out in comparison to the performance of a standalone portfolio.
There is no prescribed methodology for the allocation of cash, and the only requirement stipulated by the standards is that the allocation must be treated consistently and on a timely basis. There are however two acceptable allocation methods outlined in the Guidance Statement, being:
- Beginning of period allocation: Cash is allocated on a monthly basis based on the opening market value of the carved out section as a proportion of total opening market value for the portfolio (excluding cash).
- Strategic asset allocation: Cash is allocated based on target strategic asset allocation.
Firms are also required to disclose the allocation policy within the related GIPS report.
In this way, it is now easier than ever for alternative investment managers to present the performance for distinct portions of their portfolios, allowing for more tailored marketing and an ability to respond to bespoke client requests while still complying with GIPS.