This month’s newsletter is admittedly a bit short. We could ramble on-and-on about the topic we address, but feel that getting right to the point is sufficient. It’s an important one, and we hope what we share has value to you and your organization.

Sleeves: do they constitute “extracted performance” under the new SEC Marketing Rule?

In the past month, we’ve gotten multiple inquiries into the status of sleeves and the new SEC Marketing Rule.

On page 195 of the rule we find “‘Extracted performance’ means ‘the performance results of a subset of investments extracted from a portfolio.’”

The Rule doesn’t explain what it means to “extract” performance.

What is a sleeve?

I asked the folks at Orion about sleeves, and Ryan Donovan provided the following:

“Sleeves within Orion allow firms to take multiple models (strategies) and assign them to accounts. Each model (strategy) then turns into a sleeve (sub-account) in Orion. For example, a firm may have an Aggressive and Conservative strategy. The firm can then create a sleeve (sub account) for the aggressive strategy and one for the conservative strategy. From a cash management perspective each of the sleeves can contain a targeted amount of cash allowing for cash to live in each sleeve based on the strategy.

“Sleeves can also allow a firm to hold a particular asset within each strategy. For example, Apple could be held in both the Aggressive and Conservative sleeves. We accomplish this accurately because the firm places trades within Orion’s trading and rebalancing tool. Therefore from a reporting and performance standpoint we can track when the asset was purchased and sold to track the appropriate sub-account.” <emphasis added>

I have considered sleeves to be sub-accounts or sub-portfolios, and Ryan confirms that this is their view, as well.

At the custodian, an institution’s or individual’s assets might be stored in a single, unique, “legal” account. At the asset advisor, their accounting system might manage it in multiple sub-portfolios, each being distinct from the others, so as to allow individual strategies to be separate and apart.

To me, sleeves fail the test of being “extracted performance.” There is no “extraction” being done. Rather, the accounting system is set up to manage the assets separately. In many cases, an account may have 5-10 or more sleeves, each being managed differently, and in some cases, by different individuals or even advisors [in a sub-advisory relationship, not unlike unified managed accounts, or UMAs].

Unsure?

In this same section of the Rule we find “The final rule prohibits an adviser from presenting extracted performance in an advertisement unless the advertisement provides, or offers to provide promptly, the performance results of the total portfolio from which the performance was extracted.”

And so, if you choose to include sleeves in a composite, and are concerned that the SEC examiner who visits might consider them to constitute extracted performance, then simply include a disclosure that “upon request, we will provide the performance results of the total portfolio from which performance was extracted,” though I’d avoid the use of the term “extracted,” as it would seem to suggest you believe it’s extracted. Instead, I’d have “… from the entire portfolio of which the sleeve is a member of.”

I should also mention that the SEC’s Marketing Rule says that carve-outs of composites are not extracted performance, but rather hypothetical performance, which brings with it a whole other area of requirements.

I still don’t feel that sleeves are the same as carve-outs. Are they “extracted”? I don’t think that, either. For official ruling, we’ll have to wait for the SEC.

TSG’S 2023
INVESTMENT PERFORMANCE MEASUREMENT
CALENDAR OF EVENTS

◼ Asset Owner Roundtable 

  April 26, 2023 • Phoenix, AZ

◼ Performance Measurement Forum

  April 27-28, 2023 • Phoenix, AZ

◼ GIPS Workshop

  May 23, 2023 • New Brunswick, NJ

◼ Launch of Women in Performance

May 23, 2023 • New Brunswick, NJ

◼ PMAR North America 

  May 23-24, 2023 • New Brunswick, NJ

◼ Performance Measurement Forum 

  June 22-23, 2023 • Edinburgh, Scotland

◼ Performance Measurement Forum 

  November 9-10, 2023 • Porto, Portugal

◼ Asset Owner Roundtable 

  November 29, 2023 • Orlando, FL

◼ Performance Measurement Forum 

  November 30 – December 1, 2023 • Orlando, FL

For additional information on any of our 2023 events, please contact Patrick Fowler

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10 Common Mistakes Firms Make with the GIPS Standards
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The seven most confusing things about the GIPS standards
From discretion to significant cash flows, composite construction to advertising – there is a lot that is confusing about the GIPS standards. In this post, we reveal seven of the most confusing things.

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