Estimated study time: 45 minutes
Content:
The Global Investment Performance Standards (GIPS) are a set of ethical principles created by CFA Institute to ensure consistency and fairness in the reporting of investment performance. GIPS compliance is voluntary, but once a firm claims compliance, it must comply with all requirements and apply the standards on a firm-wide basis. Firms cannot selectively comply with GIPS for only some products or composites.
A composite is the centerpiece of GIPS. It is an aggregation of one or more portfolios managed according to a similar investment mandate, objective, or strategy. Every fee-paying, discretionary portfolio must be included in at least one composite. Non-discretionary portfolios and model portfolios are excluded from composites. Composites must be defined before a new period begins — firms cannot retroactively move underperforming accounts into different composites. The composite definition must document the strategy's investment objective and constraints, and any changes to composite definitions must be disclosed.
Performance must be calculated using time-weighted returns (TWR), which eliminate the distorting effect of client cash flows. The modified Dietz method or daily valuation are the two primary TWR calculation approaches. Portfolios must be valued at least monthly (and for periods beginning January 1, 2010, daily) or at the time of large external cash flows. Money-weighted returns (MWRI / IRR) are permitted for private equity and real estate composites where the manager controls the timing of cash flows.
Required disclosures under GIPS are extensive. Firms must disclose: whether the composite contains carve-outs, the composite creation date, the minimum asset level for inclusion, the treatment of withholding taxes, the list of all composites, the number of portfolios in the composite, composite assets as a percentage of total firm assets, and whether performance is gross or net of fees. The composite presentation must include at least five years of annual performance history (building to ten years). Returns less than one year must not be annualized.
Recommended but not required elements include presenting gross-of-fees returns alongside net-of-fees returns, presenting cumulative returns, and providing information about the benchmark's leverage and derivatives usage. Candidates must distinguish required from recommended disclosures — a common exam trap involves identifying which item a firm "must" include versus "may" include.
Verification is a separate engagement from compliance — a third party can verify that a firm's processes are designed to calculate and present performance in compliance with GIPS. Verification applies to the entire firm, not to individual composites. Performance examination verifies specific composites. Both are voluntary. A verified firm cannot claim that performance is "guaranteed accurate" — verification confirms processes, not individual calculations.
Key Terms:
Quiz Questions:
Q1. A firm manages 200 discretionary fee-paying portfolios and 15 non-discretionary portfolios. Under GIPS, which portfolios must be included in composites?
A) All 215 portfolios B) Only the 200 discretionary fee-paying portfolios C) Only portfolios with assets above $1 million D) Only portfolios that have been managed for at least one full year
Answer: B — GIPS requires that every fee-paying discretionary portfolio be included in at least one composite. Non-discretionary portfolios, where clients direct investment decisions, are excluded.
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Q2. A firm has presented three years of composite performance history in its GIPS-compliant presentation. A prospective client requests the presentation and notices only three years are shown. What is the firm required to do?
A) Nothing — three years is sufficient for a recently established composite B) Add performance going back to the composite's inception date, even if that is less than five years C) Obtain written confirmation from the client before providing the full history D) Present ten full years of history before claiming GIPS compliance
Answer: B — GIPS requires a minimum of five years of annual performance history, building to ten. If the composite is newer than five years, the firm presents performance since inception. The firm cannot "cap" history at three years arbitrarily — it must present from inception.
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Q3. Which of the following is a required disclosure under GIPS?
A) A description of the firm's derivatives risk management framework B) The composite's benchmark's standard deviation C) The number of portfolios included in the composite D) Whether the composite's returns were audited by an external accountant
Answer: C — The number of portfolios in the composite is a required GIPS disclosure (when the composite has five or more portfolios). Benchmark standard deviation is recommended but not required. External audit of returns is not a GIPS requirement; that is the role of GIPS verification.
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Q4. A firm claims GIPS compliance. An analyst reviewing its presentation notices that returns below one year are annualized "for easier comparison with annual benchmarks." Under GIPS, this is:
A) Permissible if the annualized figure is clearly labeled B) Permissible only for equity composites C) A violation — returns for periods less than one year must not be annualized D) A violation only if the composite uses leverage
Answer: C — GIPS explicitly prohibits annualizing returns for periods less than one year. Annualizing short-period returns implies compounding that did not actually occur and is misleading.
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Q5. A firm claims GIPS compliance and has been verified by an independent third party. In marketing materials, the firm states: "Our performance figures are GIPS-verified and guaranteed to be accurate." Which aspect of this claim is incorrect?
A) Firms cannot claim GIPS compliance in marketing materials B) Only individual composites can be verified, not the firm C) Verification confirms processes, not the accuracy of specific calculations — the "guaranteed accurate" claim is prohibited D) The claim is correct; verification does guarantee calculation accuracy
Answer: C — GIPS verification is a firm-wide review of processes and procedures. It does not verify every individual calculation or guarantee accuracy. Claiming performance is "guaranteed accurate" because of GIPS verification is a misrepresentation.
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