June 15 th, GIPS Executive Committee. Dear GIPS Executive Committee,

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1 June 15 th, 2010 GIPS Executive Committee Dear GIPS Executive Committee, We thank you for the opportunity to respond to the Exposure Draft of the Guidance Statement on Alternative Investment Strategies and Structures. In the post-madoff era, we have seen an increased interest in the GIPS from hedge fund and other alternative asset managers. It is due to both this environment of increased openness as well as the fact that institutional investors have steadily increased their allocations toward alternative investments that we believe investors will continue to increase the transparency and comparability demands on alternative asset managers. It is our strong belief that this guidance will further help such managers seeking to comply with the GIPS. We know this guidance has been a long work in progress and we very much appreciate all the work that has been put into this process. We are as excited as ever when it comes to increased acceptance of the GIPS and particularly within the alternative investment space. The current regulatory environment on a global basis as well as increasing sophistication in all areas of investment management bode very well for the GIPS in our view. Sincerely, ACA Beacon Verification Services

2 ACA Compliance Group - Beacon Verification Services Division Comments Regarding the Exposure Draft of the Guidance Statement on Alternative Investment Strategies 1.2. Scope Section 1: Introductions and Scope The bullet point list of investment types falling under the umbrella of this guidance includes, Structured products requiring ongoing management of the underlying investments where there are identifiable elements of asset management embedded in the overall product. Another type of investment mentioned is a liability driven investment. We agree that the GIPS should apply to managers who make use of these types of investments. However, this draft guidance does not cover many of the unique issues related to such investments as structured products or liability driven instruments. If these are to be included explicitly in the scope of this guidance, it is our hope that clear guidance would also be included regarding many of the questions surrounding these investments and products. Some such questions where guidance would be appreciated include: Clarification on the preferred performance measurement calculation methodologies for structured products (CLOs, CDOs, etc.) How firms should address discretion with respect to LDI portfolios Discussion regarding how Composite Construction may apply to these types of products In sum, it seems there currently may not be enough guidance specifically pertaining to these types of alternative products and investment techniques for them to be included explicitly under the scope of this guidance. We would hope that additional guidance may be developed so that the inclusion of these products and investment types is warranted. 1

3 Section 2: Areas of Concern with Applying the GIPS Standards to Alternative Investments Frequency of Valuation of Portfolios Do you agree with the proposed requirements related to the frequency of portfolio valuations? Why or why not? Yes, we agree with the proposed frequency of portfolio valuations. Our belief is grounded in the notion that the same valuation policies should apply to all types of portfolios within a GIPS compliant firm. Making use of a firm s valuation policy will allow firms to value portfolios monthly and at all large cash flows. We recommend that a Q&A be added that specifically addresses the valuation requirements of a fund or portfolio that includes primarily listed securities and a private equity holding and/or a direct real estate holding. We also suggest in this section to require, or at the minimum recommend, that material be defined on an ex-ante basis, with respect to a firm s need to disclose the use of subjective, unobservable inputs, when material Estimated Versus Final Values Do you agree with the proposed treatment of estimated versus final values? Do you support different guidance for pooled funds and managed portfolios? Do you agree with requiring the disclosure of the use of estimated values? Why or why not? We do agree with the proposed treatment of estimated versus final values. We support the usage of estimates in a pooled fund, as these estimates serve as official valuations in the sense that NAVs are struck based on these estimates, and subscriptions and redemptions are made based on these valuations. In the case of managed portfolios, we would recommend clarification in the event a portfolio contains a mix of illiquid and liquid investments, where the valuation of the portfolio could be a mix of the given scenarios a) and b). This would be the case when some of the underlying holdings may be based on received final values while other values may be based on estimates. For valuations based on estimates, we do agree that firms should disclose the use of estimated values as this is material information for a prospective investor to consider when assessing valuations that go into the performance of the overall strategy. 2

4 Again, we would encourage the practice of setting objective policies for firms to follow when comparing the final values to estimated values. We would recommend that the guidance require firms to define material on an ex-ante basis with respect to a firm s need to determine if the final values and resulting performance are materially different than the performance derived from the estimated values Return Calculations and Treatment of Fees Do you agree with the proposed treatment of gross-of-fees returns and netof-fees returns for master-feeder structures? Why or why not? Generally, we do agree with the proposed treatment of gross-of-fees returns and net-of-fees returns for master-feeder structures. However, we do feel this section could be strengthened by including additional discussion on several related concepts. Specifically, we feel that one of the most common questions in this area will be regarding the use of an individual share class (the highest fee-paying share class) as a representation of fund performance. This valuable discussion is found in Q&A 4.3.1; however, we would recommend at least a general discussion of this option in this section. In effect, this section covers two of the three possible netdown options: using actual fees paid and using model fees; so it would seem to be most comprehensive to include discussion of the third option (use of a highest-fee paying share class) as well. We also feel this section would benefit from discussion on how to choose which model fee to use (i.e. which fee is highest), if the firm has two fee structures. A 1% management fee and 20% incentive fee and 2% management fee and 10% incentive fee will result in alternately higher and lower returns depending on market conditions. Guidance here would be helpful Segregated Investments ( Side Pockets ) Do you agree with the proposed treatment of side pockets? Why or why not? Should a firm be required to disclose the creation of a side pocket in all instances? Or, only when a side pocket is created to hold non-discretionary assets that are no longer reflected in composite performance? What should be required to be disclosed? We do agree with the proposed treatment of side pockets In the event the side pocketed investment was made as a discretionary decision by the firm to complement the strategy, we do agree that its performance should be included in composite performance. 3

5 We agree that a non-discretionary side pocket should not be included in performance; however, we would suggest adding an example of what may be a reason to classify a side pocket as nondiscretionary. The existing discussion makes reference to a client mandating a side pocket, but in most cases the hedge fund manager is the general partner in a limited partnership and has discretionary authority over the investment selection process. We feel there is some uncertainty regarding the discussion of what actually would constitute a non-discretionary side pocket, and believe an example or two would help clarify. Because exposure to side pockets is typically not available to new investors, we would recommend that the use of side pockets always be disclosed in a compliant presentation. We feel it is imperative that prospective investors be made aware that the composite performance includes the performance of side pockets, particularly because these are investments to which the prospective investor likely will not be exposed. We not only would recommend the disclosure of the existence of the side pocket(s), but also recommend the disclosure of the percent of the composite comprised of a side pocket(s), as of each annual period end. Managers sometime argue that new investors coming into a fund will not have exposure to existing side pockets, and thus they should not be included in performance. We believe the guidance should recommend that performance without side pockets, where the manager deems it applicable, can be shown as Supplemental Information Illiquid Investments Do you agree with the proposed treatment of illiquid investments? Why or why not? Yes. We agree with the proposed treatment of illiquid investments. The simple characteristic of being illiquid should not be reason automatically to classify an asset as non-discretionary (though there may be circumstances that cause an asset to be illiquid which also result in the asset being non-discretionary). When Lehman Brothers declared bankruptcy, some assets custodied with Lehman not only were illiquid but also were not able to be accessed, thus creating a nondiscretionary situation per the GIPS Q&A released in June, Perhaps it may be worthwhile to elaborate on this distinction. It is our opinion that a composite that contains illiquid assets does not always need a disclosure regarding their existence, but only should have a disclosure if the illiquid assets make up a material component of the composite s definition, or if a firm deems that the use of illiquid assets constitutes a significant event. 4

6 Section 4: Questions and Answers Should portfolios managed with discretionary leverage be allowed to be deleveraged for inclusion in composite performance? Why or why not? No, we believe that deleveraging a portfolio constitutes model/simulated performance, and should only be shown as Supplemental Information. Should portfolios managed with nondiscretionary leverage be allowed to be deleveraged for inclusion in composite performance? Why or why not? No. Even if leverage is employed as required by the client, deleveraging a portfolio implies that the portfolio holdings would have been the same even if leverage were not utilized. We believe this assumption is circumstantial and would cause misleading performance results to be presented to prospective investors. When presenting net-of-fees returns, firms are allowed to reduce gross-offees returns by the actual investment management fee incurred by each portfolio or a model fee. The model fee must be the highest investment management fee incurred by portfolios in the composite. Should firms also be allowed to present net-of-fees returns that are reduced by a model fee which is the maximum investment management fee applicable to the prospective client, even if it is not the highest investment management fee that is incurred by portfolios in the composite? Why or why not? We would recommend that net-of-fees performance, when using a model fee, use a model fee that is the highest investment management fee incurred by portfolios in the composite. Our reason for this is to maintain consistency in the net-down method, with respect to the existing GIPS Standards. The existing Standards require that if a model fee is used, it must be the highest fee incurred by a portfolio in the composite. We see no reason to change this requirement when applying it to composites comprised of alternative strategies. In this section, we would recommend further clarification regarding the use of performance of a single share class within a fund. The question above only refers to using the highest fee-paying share class in an offshore fund. We have seen many scenarios where a fund has two feeders (on-shore and off-shore), both managed identically to the same strategy and included the same composite. We would like to see explicit guidance in this section affirming that a firm can use the highest fee-paying share class in either of the feeders to arrive at net performance for the fund (assuming that assets are managed at the master level). This scenario 5

7 was brought up as a question during the April 27 th webcast covering this guidance, and Beth Kaiser did provide affirmative confirmation of this practice. Note that Q&A implies that presenting net of fees returns of a certain share class should be shown as Additional Information. However, the last sentence of the response to Q&A allows for the presentation of a certain share class as the proxy for the fund. Clarification and explicit guidance is requested on this topic. 1. Composite Construction Additional Comments: In the Section 2.4.2, we would suggest including discussion regarding the possibility of feeder funds being included in separate composites, if they are managed separately where they are exposed to different investments and thus experience different returns. We appreciate the discussion regarding which level should be considered for composite entry, but we feel it would be beneficial to have some explicit guidance on the treatment of multiple feeders that follow materially different investment strategies Marketing New Alternative Investment Strategies. Guidance here states that simulated, model, or hypothetical performance can be presented as Supplemental Information to a fully compliant presentation. However, the assumption in this section is that the strategy has not yet been implemented using actual assets, and thus a compliant presentation cannot be created. It seems that the guidance is in essence requiring that the Supplemental Information be presented as supplemental to a composite presentation that does not yet exist. Is the intent of this guidance to be that the Supplemental Information should supplement another composite presentation? Clarification here would be greatly appreciated. We do understand the bulk of this guidance was transplanted from the extended discussion of O.A.11 in the 2005 Standards; however, the second paragraph in Section is what seems to contradict this standing guidance. 6