The Hedge Fund Law Report
and others have reported on the post-crisis ascendance of non-performance factors in hedge fund due diligence and investment decision-making. In short, before 2008, hedge fund allocations were driven largely by a manager’s past performance. After 2008, factors such as transparency, liquidity and robust risk management surpassed performance in the hierarchy of concerns of institutional hedge fund investors. See “Survey by SEI and Greenwich Associates Identifies the Primary Decision Factors and Concerns of Institutional Investors When Investing in Hedge Funds
,” Hedge Fund Law Report, Vol. 4, No. 11 (Apr. 11, 2011). However, we do not wish to overstate the case or the duration of the trend. The long-term lesson of the crisis likely will be that robust risk management, appropriate liquidity and transparency and well-developed infrastructure are necessary to justify a hedge fund investment, but not sufficient. Hedge fund managers without institutional caliber businesses will often be passed over, but as between two managers with good businesses, the deciding factor will often be past performance. Thus the immediate and important question for hedge fund managers: how can managers present performance information in a manner that maximizes capital raising efforts while complying with relevant law and standards? An increasingly common answer to this question in the hedge fund community is: by complying with the Global Investment Performance Standards (GIPS), an evolving set of practice standards designed to ensure consistency and uniformity in the presentation of investment performance results. Compliance with GIPS is ostensibly voluntary, but in practice, more and more institutional hedge fund investors are asking to see GIPS-compliant performance information. Accordingly, GIPS compliance is becoming a de facto requirement for hedge fund managers, and hedge fund managers are actively seeking to become GIPS compliant. The main challenge for hedge fund managers is that GIPS were originally designed for a long-only world. They have been an imperfect fit for managers with complex investment structures, side pockets, illiquid or hard-to-value assets and other typical elements of the hedge fund business. Sensitive to this, the GIPS Executive Committee recently promulgated guidance specific to alternative investment managers, and service providers have adapted their businesses to help hedge fund managers comply with GIPS and certify such compliance. However, despite the guidance and available assistance, GIPS compliance remains a challenge for hedge fund managers. This article aims to assist hedge fund managers in rising to that challenge and surmounting it. To do so, this article starts by providing a comprehensive overview of GIPS. The article then identifies five discrete categories of benefits of GIPS compliance and two categories of burdens of compliance. Next, and most importantly, this article provides a step-by-step process by which hedge fund managers can become GIPS compliant. In the course of this discussion, this article details the material points from two recent webinars and one recent white paper promulgated by leading GIPS service providers. Reading this article will enable a hedge fund manager to, among other things: revise its marketing materials to comply with GIPS; organize its front, middle and back offices to collect the data necessary to support a GIPS-compliant presentation; manage service providers with a view to GIPS compliance; ask the right questions of outside counsel; determine whether to engage a specific GIPS compliance service provider; define the scope of any such engagement; and respond effectively to due diligence inquiries on GIPS.