GIPS Need to Know List

REQUIRED Disclosures

1. Definition of the Firm
2. Total assets under management (all types)
3. Composite description and creation date
4. Benchmark description
5. Currency used
6. if gross of fees returns are presented must disclose any deductions other than direct trading expenses. 
7. for net of fees returns must: a) disclose any deductions other than trading expenses and investment management fees b) if actual or model investment management fees are used and c) if returns are net of performance based fees 
8. State that composite descriptions are available upon request
9. Disclose valuation & performance measurement policies upon request
10. Disclose presence of leverage, short positions and use of derivatives. 
11. Significant events that would help interpret performance e.g. departure of key investment managers
12. For any non-compliant performance betfore 2000, must disclose period of non-compliance
13. If the firm or composite is redefined, must disclose date, description and reason
14. Must disclose minimum asset level 
15. Must disclose if the name of the composite was changed. 
16. Must disclose relevant treatment of taxes if material and provide benchmark returns net of withholding taxes if available
17. From 1st of Jan 2011, Must disclose any material differences in valuation sources and exchange rates used. (e.g. i used reuters for valuation in one portfolio and Bloomberg in another)
18. Must disclose any conflicts between GIPS and local laws/regulations
19. Must disclose carve out cash policies prior to 1 Jan 2010 (after carve outs were no longer allowed)
20. Must disclose fees included in the bundled fee
21. Disclose any sub advisors and periods they were used from jan 1 2006
22. For periods prior to 2010, must disclose if portfolios were not valued at calendar month end or last business day
23. After 2011, must disclose any material subjective unobservable inputs employed for valuation purposes and any difference in the valuation hierarchy than the one recommended
24. If no benchmark exists, must disclose why
25. If benchmark is changed must disclose date & reason
26. For custom benchmark, must disclose details of the benchmark including components, weights and rebalancing process
27. If the firm has a significant cash flow policy, must disclose how the firm defines it
28. Must disclose if a 3-year annualized ex-post standard deviation for the composite or benchmark is not presented because returns are not available
29. If the firm decides that the 3-year standard deviation is to be excluded because it is not relevant, must disclose why it is not relevant and a description of the alternative risk measure used with reason for its use
30. Must disclose if performance from past firm or affiliation is linked to the performance of the firm

Note valuation hierarchy:

1. Objective unadjusted market prices for similar investments in active markets

2.  Quoted prices for similar investments in non active markets

3. Use market based inputs other than prices

4. Subjective unobservable inputs

RECOMMENDED Disclosures

1. Disclose any material changes to valuation or calculation policies

2. Disclose material differences between the benchmark and the composite's investment mandate, objective or strategy

3. Key assumptions used to value portfolio investments

4. List of other firms contained within the parent company (if relevant)

5. Disclose any subjective unobservable inputs used to value portfolios prior to 2011 (after 2011 mandatory to disclose)

6. Disclose sub advisor used for periods prior to 2006

Options Strategies List

1. Covered Call: Long Stock + Short Call (income strategy)

2. Protective Put: Long Stock + Long Put (insurance strategy, the exercise of the put is near the current stock price, also known as a married put)

3. Collar: Long Stock, Out of the Money Short Call and Out of the Money Long Put

4. Bull Spread:

a) Long Call at X and Short Call at X+Y (Bull Call Spread)
b) Short Put at X and Long Put at X-Y (Bull Put Spread)

5. Bear Spread:

a) Short Call at X-Y and Long Call at X (Bear Call Spread)
b) Long Put at X and Short Put at X-Y (Bear Put Spread)

6. Seagull Spread:

a) Bullish Seagull = Bull Call Spread + Sell Put
b) Bear Seagull = Bear Put Spread + Short Call

7. Butterfly Spread:
 Long Call at X1 + 2 Short Calls at X2 and Long Call at X3 (Bull Call Spread + Bear Call Spread)

Alternatively you can construct a butterfly spread with a Bear Put and a Bull Put

The Butterfly spread is a bet on low volatility that the share price will not go up or down a lot.

A short butterfly spread is a bet on higher volatility

8. Condor Spread: Bull Call Spread and Bear Call Spread. (Volatility Bet)

9. Straddle: Long Call and Long Put Both at the Same Strike Price

10. Strangle: Long Call and Long Put wtih Different Strike Prices

11. Short Risk Reversal: Long Call + Short Put

12. Box Spread: Bear Put Spread + Bull Call Spread

13. Put Spread: Buy Put and Short Call



It is worth while to recall the put call parity relation when considering these:

p+S=c+X/(1+rf)^T
(for European options)

Portfolio Performance Evaluation Risk/Return Measures

	Type of risk measure	Advantages	Comments	Comments 2
Sharpe Ratio	Total Risk		Assumes normally distributed returns, based on the CAPM, slope of the CML	Biased upwards for hedge funds Uses portfolio total risk instead of systematic risk
Sortino Ratio	Total Risk	Good for hedge funds Good for assets with skewed distribution of returns	Improves on the Sharpe Ratio that penalizes for good performance which is incorporated in the up side deviation
Information Ratio (Appraisal Ratio)	Total Risk	Used to measure active performance of mutual funds	Higher information ratio (0.4-0.6) is considered better. The index has zero IR	IR = active return/active risk IR = IC x BR ^ (0.5)
Jensen’s alpha	Systematic	Used frequently to evaluate mutual fund performance	Based on the CAPM
Treynor	Systematic	Overcomes the Sharpe ratio limitation that it uses total risk	Slope of the SML
M squared	Total Risk	The Sharpe ratio is awkward to interpret when it is a negative value. M squared is always positive.	A skillful manager will generate an M2 greater than the return on the market	Rf + SR of asset x Market STD. M^2 measure ranks in agreement with the Sharpe ratio

SML and CML

Asset Allocation Ideas

Asset allocation according to the recent CFA survey is one of the most critical aspects in asset management, but what exactly is asset allocation and what does modern finance theory recommend when allocating capital across the different asset classes available to investors today.

Asset allocation may be defined as an investment strategy that aims to balance risk and reward by apportioning assets in accordance with the investors risk profile, investment horizon, return requirements and other contraints as may be specified in the investors investment policy statement (IPS).

Asset allocation allows the investor to identify the right mix between the asset classes available and then select a passive or active investment strategy within each asset class. An institutional investor may have access to different asset classes than the individual investor because they may be able to gain access to transactions that the individual investor may not. An example of this is Berkshire Hathaway doing deals during the great financial crisis when they could strike deals with Goldman Sachs for example that was lucrative but only available to them and not the general public.

Another example could be hedge fund and LBO fund investments where the minimum entry target committment can be $5m and therefore many individual investors are not able to participate.

The two traditional asset classes are the equity and fixed income markets. The alternative asset classes are real estate, hedge funds (all types), commodities (e.g. gold futures), private equity and venture capital. Most of these are highly illiquid, have large minimum investment size requirements and require the investor to be knowledgeable with expertise in evaluating managers for example.

There is a variety of methods that have been developed over the years to generate asset allocations either taking into account liabilities or not. Here is a summary of the main ones:

1. Mean-Variance Optimization (MVO) - developed in the 1950's by Harry Markowitz, this is perhaps the most common approach to developing an asset allocation. It builds on the key concepts of his modern portfolio theory (MPT) whereby one needs to not only look at the best risk vs reward ratio but also the correlation of the assets in the portfolio as well and thereby look at the risk and reward characteristics of any asset in the context of the overall portfolio.

The MVO uses the objective function as follows:

$$U_m=E\left(R_m\right)-0.005\lambda {\sigma }_m^2$$

where

U_m = the investor’s utility for asset mix (allocation) m

R_m = the return for asset mix m

λ = the investor’s risk aversion coefficient

${\sigma }_m^2$ = the expected variance of return for asset mix m

For example if the investor risk aversion coefficient is 2, expected variance is 20% and the expected return on the asset mix is 10% then the Um = 10% - 0.005 x 2 x 20% = 10%-0.002=9.8%

The formula is used to generate a set of asset classes that will generate the highest utilities from asset allocations. These are typically generated in the form of an efficiency frontier that shows the appropriate allocation for each specific require return and acceptable level of risk. Low acceptable levels of risk typically generate a high cash and fixed income component while high required risk will often allocate greater portions of the portfolio to equities and alternative asset classes. (emerging market equities are considered riskier and therefore have a higher expected return as an asset class compared to developed market equities)

Key criticisms of the MVO model

a) small changes in inputs may lead to large changes in outputs
b) asset allocations tend to be highly concentrated
c) many investors are concerned with not only mean and variance of returns which is the focus of the MVO approach
d) sources of risk may not be diversified even though assets are
e) does not take into account liabilities
f) single period approach which also has no way of dealing with trading costs and taxes


2. Monte Carlo Simulation  - this is a method that is typically used to complement the MVO because the MVO is a single period framework which is a disadvantage in real life. The method typically uses simulation software to identify the most optimal asset allocations by applying assumptions about probabilities of vairious outcomes 

3. Reverse Optimization - this technique is effective in dealing with the MVO criticisms a) - c)
In the MVO the optimizer uses the returns, variances and correlations to generate an optimal asset allocation. The reverse optimization identifies an optimal asset allocation over some period of time and then uses that allocation to produce implied asset returns that may be used in forward looking optimizations.

4. Black-Litterman Model - developed in the early 1990s. The model effectively uses the reverse optimization model to generate returns and then adjusts them as per the specific investor's views while still working well as an optimizer.

In practice most of these approaches are used via specialized software but the individual investor can learn from the broad approaches. The above are just the asset only asset allocation approaches but the individual or insitutional investor may have liabilities that need to also be taken into account. We will cover that in a separate post.