Benchmarking Costs Climb as Regulators Demand More Disclosure

Important standards bodies are shedding light on new ways registrants can satisfy both stakeholders and regulators.  For instance, the voluntary Global Investment Performance Standards (GIPS standards), developed by practitioner-led CFA Institute, require firms to select appropriate benchmarks for each composite and pooled fund and to include those benchmarks in disclosed investment reports.

The goal of the GIPS standards is to help investors make informed decisions by accessing current and relevant data for measuring investment performance–and that includes best practice guidance for benchmark selection. Both the SEC and the Financial Industry Regulatory Authority (FINRA) reference the GIPS standards as a widely accepted investment performance resource in addition to publishing guidance of their own.

The SEC’s Office of the Investor Advocate says benchmarking “is crucial” to understanding performance quality and mandatory disclosures should be tested to ensure that communication objectives (e.g., awareness, comprehension) are achieved.

Some firms are turning to free and publicly published exchange-traded fund performance data in lieu of buying or building custom benchmarks. Firms using an ETF as a benchmark will want to look to the GIPS standards for best practices on how to do this. The GIPS standards outline disclosures and which returns are best to present this type of information.

On the other hand, some of the new benchmarking services bring additional value-added benefits such as better analytics, customized indexes and advanced reporting tools.

Investment professionals need to conduct cost-benefit analyses of the benchmarks they are using or considering. Better aligned benchmarks — at a reasonable price — provide a better tool for performance evaluation, as well as more fair and balanced advertisements.

Depending on the nature and composition of a given fund or portfolio, benchmark data may price smaller funds and advisors out of more esoteric markets. As well, for less liquid markets, benchmark quality may be difficult to verify.  For example, there can be significant timing lags when using benchmarks for private market assets whose weighted exposure cannot be accessed on a timely basis.

The rising costs of benchmarking has significant implications for investors, advisors and asset managers.  As a result, regulators are scrutinizing the competitiveness of benchmark costs, quality, and accessibility to ensure that smaller firms and advisors (and by extension investors) are not disadvantaged.

By understanding the shift from free to fee-based benchmarks, stakeholders can navigate the evolving landscape and make informed decisions about their investment strategies and performance data needs. Investment performance professionals are well-positioned to help new or smaller firms choose a right-sized solution that is suited to their budget as well as their investment benchmarking needs.

Kim Cash (CFA, CAIA, CIPM, CSCP) is the founder of Cascade Investment Compliance & Verification. Janice Kitzman, CIPM, is a partner at Cascade Compliance and chair of the GIPS standards Verification Subcommittee.