The adoption of the SEC’s new Marketing Rule will have broad ramifications on investment advisers’ marketing activities. Following are some of the key areas that may directly impact firms that claim compliance with the GIPS standards and the manner in which they present performance in the future. We have summarized in the following matrix the implications for GIPS compliant firms, click here.
- Definition of Advertisement
The definition of an “advertisement” has been expanded to include “any direct or indirect communication an investment adviser makes to more than one person.” As a result, GIPS Reports will generally be considered to be advertisements, as they are often reused in multiple presentations without extensive customization, and they will be subject to the requirements of the Marketing Rule.
- Use of Model Fees to Calculate Net Returns
The Marketing Rule allows net performance to be calculated using model fees if:
- Doing so would result in performance figures that are no higher than if the actual fee had been deducted; or
- The model fee is equal to the highest fee charged to the intended audience to whom the advertisement is disseminated.
Though the Marketing Rule allows for net returns that satisfy either of these options, only net returns that meet the first option (equal to or lower than those that would have been calculated using actual investment management fees) can be presented as GIPS-compliant returns.
The Marketing Rule also requires a model fee to be applied when calculating net performance for non-fee-paying portfolios, while the GIPS standards allow for the inclusion of non-fee-paying portfolios to be addressed simply through disclosure while still presenting actual net returns.
- Prescribed Time Periods
The Marketing Rule prohibits the use of performance information in an advertisement unless results are presented for one-, five-, and ten-year periods (or since inception, if the track record is shorter than ten years). GIPS Reports are required to include at least five years of annual returns, building up to a minimum of ten years of GIPS-compliant performance. In order to meet both requirements going forward, firms will need to update their GIPS Reports to include five- and ten-year annualized returns, in addition to the one-year return that is already presented as one of the required annual periods.
- Related Performance and Composites
The Marketing Rule prohibits the presentation of any related performance, unless it includes all related portfolios. The rules states that performance for related portfolios may be presented “either on a portfolio-by-portfolio basis or as a composite aggregation of all portfolios falling within stated criteria.” As the GIPS standards require the presentation of composites consisting of all similarly managed discretionary portfolios, firms that claim compliance should already be well positioned to meet this element of the Marketing Rule.
- Hypothetical and Carve-Out Performance
Under the Marketing Rule, investment advisers will be prohibited from advertising hypothetical performance unless the firm:
- Adopts and implements policies and procedures reasonably designed to ensure that the hypothetical performance is relevant to the likely financial situation and investment objectives of the intended audience of the advertisement,
- Provides sufficient information to enable the intended audience to understand the criteria used and assumptions made in calculating such hypothetical performance, and
- Provides sufficient information to enable the intended audience to understand the risks and limitations of using such hypothetical performance in making investment decisions.
The rule also limits the use of advertisements including hypothetical performance information to investors who “have access to the resources to independently analyze this information and who have the financial expertise to understand the risks and limitations of these types of presentations.” Given this, it is unlikely that advisers will be allowed to use hypothetical performance as part of standard marketing communications.
The Marketing Rule specifies that composite results consisting of carve-outs should be treated in the same manner as hypothetical performance and are subject to the same limitations. Note that the Marketing Rule does not distinguish between extracted performance that include cash or do not. Regardless of whether cash has been allocated to the extracted returns, the same requirements of the Marketing Rule will apply.
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