Learning Outcomes
After reading this article, you will be able to explain the Global Investment Performance Standards (GIPS) requirements for firm-wide compliance and composite construction, including how firms define themselves for GIPS purposes, the rules for creating and maintaining composites, and the consequences for not meeting composite integrity standards.
CFA Level 1 Syllabus
For CFA Level 1, you are required to understand core GIPS concepts for performance reporting. This article focuses on the following syllabus points:
- Explain why the GIPS Standards require firm-wide compliance, not just compliance by a single strategy or department.
- Identify the steps in composite construction and explain the requirements for including new portfolios and removing terminated portfolios.
- Describe how and why firms must present all actual, fee-paying, discretionary portfolios in at least one composite.
- Recognize the importance of written policies and procedures for GIPS compliance.
- Explain the periodic review obligations and records retention.
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- What is the fundamental difference between a compliant firm and a compliant composite under the GIPS standards?
- Why must all actual, fee-paying, discretionary portfolios be included in at least one composite?
- When should a terminated portfolio be removed from its composite?
- Can a firm claim GIPS compliance for a single strategy rather than for the whole firm?
Introduction
Investment managers are under growing pressure to provide potential and existing clients with transparent, comparable, and fair performance data. The Global Investment Performance Standards (GIPS) provide a globally accepted framework for calculating and presenting investment results. However, GIPS compliance is not just about producing compliant reports for a single product; it is a firm-wide commitment demanding systematic processes and controls for constructing and maintaining composites.
Key Term: GIPS Standards
The Global Investment Performance Standards are a standardized, voluntary set of ethical principles and requirements for investment managers to ensure consistency and fairness in reporting investment performance.Key Term: Composite
A composite is an aggregation of individual portfolios managed to a similar strategy, mandate, or investment objective, grouped to present a representative performance record.
GIPS Firm Definition and Firm-Wide Compliance
GIPS compliance is not selective. A compliant claim can only be made at the firm level—not for individual funds, strategies, or offices. A firm is defined under GIPS as a distinct legal entity or group of affiliated entities held out to the public as a single business. All actual, fee-paying, discretionary portfolios managed by the firm must be included in at least one composite.
Key Term: Actual, Fee-Paying, Discretionary Portfolio
An investment portfolio for which the firm has authority to make investment decisions and that pays a fee for management, used as the universe for composite construction.
Composite Construction Requirements
A firm's responsibility is to group portfolios according to consistent strategies, mandates, or objectives—these form composites. Every compliant firm must construct composites according to written policies and procedures, and must:
- Include all actual, fee-paying, discretionary portfolios in at least one composite, with no selective exclusion.
- Create a composite for each distinct investment strategy marketed to clients.
- Establish pre-defined criteria for portfolio inclusion/exclusion—these cannot be changed retroactively to boost or suppress returns.
For attracting clients with claims of GIPS compliance, including all eligible portfolios prevents cherry-picking and ensures that reported results are genuinely representative.
Joining and Terminating Portfolios
Portfolios must be included in composites at the start of their first full performance measurement period after they become discretionary and fee-paying. When a portfolio terminates, it must be removed from the composite after the last complete month it was managed according to the composite strategy.
Worked Example 1.1
A firm launches a high-yield bond composite on 1 January 2022. Portfolio A becomes fee-paying and discretionary on 5 January 2022.
Answer:
Portfolio A must be included in the composite from 1 February 2022, the start of the next full measurement period after it became eligible.
Consistency and Integrity of Composites
The GIPS standards prohibit creating composites based on hindsight, performance, or outcome. Changing composite definitions retroactively is not allowed. Portfolios cannot be moved between composites simply to improve results.
Exam Warning
A common error is trying to restrict GIPS compliance to a subset of managed strategies. GIPS requires firm-wide compliance—claiming compliance for just one strategy or team is misleading and non-compliant.
Written Policies and Documentation
Compliant firms must maintain clear, written policies and procedures describing all actions taken to construct, maintain, and terminate composites. This documentation must cover:
- Firm definition and definition changes
- The process for classifying portfolios as fee-paying and discretionary
- Composite assignment and criteria for inclusion/exclusion
- The timing and treatment of portfolio additions and terminations
Firms must keep documented evidence to demonstrate compliance to clients and, upon request, to verifiers or regulators.
Worked Example 1.2
A CFA charterholder reviewing a manager's GIPS report observes that terminated portfolios remain in the composite for additional months after being closed.
Answer:
This is non-compliant. Terminated portfolios must be removed from the composite at the end of the last complete month under management. Keeping them longer would distort results.
Ongoing Monitoring, Review, and Record Retention
Firms are required to periodically review their portfolios, composite assignments, and GIPS policies for ongoing accuracy. They must keep documentation of these reviews and retain relevant records supporting composite membership and the calculation of composite performance for at least seven years (or longer if required by law).
Summary
GIPS standards demand that compliance be a firm-wide system, not selective or limited to specific offerings. Firms must systematically include all actual, fee-paying, discretionary portfolios in composites, define composite inclusion rules in writing, and maintain rigorous controls over composite construction and change. Accurate record-keeping and regular review underpin the integrity of a firm's performance presentations.
Key Point Checklist
This article has covered the following key knowledge points:
- GIPS compliance must be claimed for the entire firm, not selected products or strategies.
- All actual, fee-paying, discretionary portfolios must be included in at least one composite.
- Composite construction must follow pre-defined, documented criteria and avoid retrospective changes.
- Written policies and record retention are required for composite integrity and verification purposes.
- Terminated portfolios must be promptly and correctly removed from composites.
- Regular review and robust controls are essential to ongoing GIPS compliance.
Key Terms and Concepts
- GIPS Standards
- Composite
- Actual, Fee-Paying, Discretionary Portfolio