Explain the valuation hierarchy that the GIPS standards recommend
The idea
Fair value is required, and GIPS recommends an order of preference for its inputs. Best is an unadjusted quoted price for the identical investment in an active market on the valuation date. Next come quoted prices for similar investments in active markets, then quoted prices for identical or similar investments in markets that are not active, then other observable market inputs such as yield curves or credit spreads. Last are subjective, unobservable inputs, used only when markets offer nothing better, as for many private investments. The further down the order a firm goes, the more judgement enters and the greater the need for documented, consistently applied policies, independent review and disclosure. Mispricing illiquid holdings can flatter returns and understate volatility.
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- Discuss what the GIPS standards aim to achieve, whom they cover, and how they help investment managers as well as prospective clients and investors
- Explain the basic requirements for claiming GIPS compliance, including how the firm is defined and how it defines discretion
- Discuss the GIPS rules for calculating returns, covering how fees and expenses, cash and cash equivalents, and external cash flows are treated
- Explain the GIPS rules for calculating composite returns, including the permitted ways of asset-weighting the returns of member portfolios
- Explain what makes a portfolio discretionary for composite construction and, from a set of facts, judge whether a given portfolio is likely to qualify
- Explain how composites are defined around a shared mandate, objective or strategy, and why this matters
- Explain the GIPS composite construction rules, covering when portfolios may move between composites, when new portfolios must be added and when terminated ones must be removed
- Explain what the GIPS standards require in presenting and reporting performance
- Explain when a new or acquiring firm may link to, or show as its own history, the performance record of a prior firm or affiliation
- Discuss why firms seek GIPS verification, what it covers and how it is carried out