GIPS standards advanced - Composite creation maintenance and...

Learning Outcomes

After reading this article, you will be able to explain GIPS requirements for composite creation and maintenance, articulate effective input data controls, and evaluate how these elements ensure compliant and comparable performance reporting. You will also apply GIPS rules to practical scenarios, identify pitfalls in firm procedures, and interpret what constitutes a material error versus a required update.

CFA Level 2 Syllabus

For CFA Level 2, you are required to understand GIPS standards in greater depth, focusing on how composites are constructed and maintained while ensuring integrity in input data. For your revision, focus on:

• Explaining firm policies for the creation, definition, and maintenance of composites under GIPS
• Recognizing procedures for including and excluding portfolios in composites
• Assessing the importance of accurate, consistent, and complete input data within GIPS-compliant reporting
• Evaluating procedures for error correction, updates, and firm documentation
• Applying composite and data principles to examples and recognising exam pitfalls

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.

1. What is the difference between a significant error and a required update in GIPS composite reporting?
2. True or false? Firms may retroactively add portfolios to a composite if it improves past performance.
3. Explain why input data integrity is central to GIPS-compliant reporting.
4. What documentation should accompany each composite a firm presents?

Introduction

GIPS standards require firms to present performance results that are both accurate and comparable by standardizing how composites are created, maintained, and reported. Firms must have written policies covering composite and portfolio inclusion rules, as well as controls for input data quality. These policies ensure that reported results fairly represent the firm’s actual investment process and preclude performance cherry-picking.

Key Term: Composite
A group of portfolios with a similar investment mandate, objective, or strategy, whose total performance is presented collectively.

Key Term: Input Data Integrity
The principle that all performance figures and portfolio information used in GIPS calculations must be consistent, accurate, and complete.

Composite Creation and Definition

Firms must define composites around a particular strategy or mandate before any performance is known, and assign portfolios to these composites according to objective, written criteria.

• All fee-paying, discretionary portfolios must be included in appropriate composites.
• Composite definitions must be comprehensive, cover all strategies offered, and be documented in firm policies.

Key Term: Discretionary Portfolio
An account for which the firm has authority to make investment decisions and implement the portfolio strategy without client approval for each trade.

Ongoing Maintenance and Portfolio Inclusion

After creation, composites require robust maintenance to ensure that all eligible portfolios are included on a timely basis and excluded promptly if they cease to qualify.

• Portfolios must be added to a composite no later than the end of the first full calculation period after becoming eligible.
• Portfolios must exit the composite immediately upon failing eligibility (loss of discretion, substantive client-imposed restrictions, etc.).
• Changes to composite membership must be based on criteria defined in advance—not to alter past performance.

Key Term: Composite Membership Rules
Documented firm guidelines setting the criteria for when a portfolio should be added to or removed from a composite.

Policies, Procedures, and Documentation

Written policies covering composite construction, inclusion/exclusion, and rebalancing are a GIPS requirement.

• Policies must specify how portfolios are classified, what qualifies as discretion, and exactly how inclusion/exclusion is applied.
• Composites must be defined around a full investment mandate, not just subsets of client accounts.

All key decisions—composite definitions, inclusion/exclusion, rebalancing methodology, and calculation methodology—must be documented and retained.

Key Term: Significant Error (GIPS)
A mistake in a GIPS composite or report that impacts a material number or causes a misleading representation of performance, requiring disclosure and correction.

Input Data Quality and Control

GIPS-compliant performance relies fundamentally on accurate and consistent input data for returns (both gross and net), valuations, and cash flows.

• Input data must be based on actual trades, using fair market value at measurement dates.
• Firms must implement controls and checks to detect, correct, and document input data errors.
• Firms must establish clear responsibility for data ownership, with documented procedures for correction and notification.

Worked Example 1.1

A firm discovers that a portfolio was not added to a composite when it became eligible, resulting in understated composite returns. What must the firm do under GIPS?

Answer:
The firm must correct the error by including the portfolio’s performance retroactively from its eligibility date. If the error is significant (impacts a material composite result or client report), the firm must disclose the correction to all parties who received the original data and update all affected reports, with full disclosure of the change, the reason for it, and its quantitative impact.

Exam Warning

Failing to clearly document composite inclusion/exclusion criteria—or retroactively altering composites after seeing returns—will result in a clear GIPS violation and is a common exam pitfall.

Error Correction and Required Updates

• Significant errors, meaning mistakes that misstate or mislead, must be corrected and disclosed. The firm must notify all recipients of the erroneous report and redistribute the corrected version with an explanation of the nature and impact.
• Required updates, such as routine data corrections that do not meaningfully affect reported performance, only need to be incorporated in future distributions.

Revision Tip

When evaluating an error, ask: Would a reasonable client consider this information important in deciding to hire the firm, or in understanding composite risk and return? If so, treat as significant.

Summary

Composites are the building blocks of GIPS-compliant reporting, demanding objective, documented membership criteria and rigorous maintenance. All input data must be accurate, timely, and supported by strong internal controls. Material mistakes require full disclosure and client communication, ensuring that performance reporting remains credible and comparable.

Key Point Checklist

This article has covered the following key knowledge points:

• Composite formation must be based on documented, pre-defined strategies, not realized performance.
• All eligible discretionary, fee-paying portfolios must be included in composites as soon as eligible and excluded when no longer eligible, based on written rules.
• Firms must implement written policies covering composite construction, portfolio inclusion/exclusion, and rebalancing.
• Input data for returns, valuations, and cash flows must be accurate, timely, and controlled, with documented correction procedures.
• Errors that are significant (impact material figures or cause misleading representation) require prompt disclosure and reissuance of reports with explanation.

Key Terms and Concepts

• Composite
• Input Data Integrity
• Discretionary Portfolio
• Composite Membership Rules
• Significant Error (GIPS)