## **Learning Outcomes**

This article explains GIPS firm definition, composite construction, pooled fund treatment, and carve-out provisions, including:

- Defining a GIPS firm boundary, identifying which legal entities, business units, and portfolios must be aggregated for compliance.
- Distinguishing fee-paying discretionary portfolios from other assets and determining which must be included in the GIPS firm.
- Classifying strategies and objectives so portfolios, pooled funds, and carve-outs are correctly assigned to composites from inception through termination.
- Applying GIPS rules for pooled funds, including when they form single-fund composites and when they must be combined with segregated mandates.
- Evaluating the conditions under which carve-outs with allocated cash may be included in composites and when their presentation is prohibited.
- Detecting common compliance pitfalls such as cherry-picking, double counting, or omitting eligible portfolios from the firm or composites.
- Interpreting disclosure and documentation requirements that support fair representation and full transparency in performance presentations.
- Linking firm definition, composite construction, and carve-out policy choices to exam-style scenarios, so you can justify whether a performance claim is GIPS-compliant.

## **CFA Level 3 Syllabus**

For the CFA Level 3 exam, you are expected to understand the specific requirements regarding firm definition, composite creation, treatment of pooled funds, and rules for carve-outs under the Global Investment Performance Standards (GIPS) and to carefully revise these areas, as errors here could risk non-compliance in practice or result in lost marks, with a focus on the following syllabus points:

- Explain how a GIPS-compliant firm must be defined and what assets must be included
- Describe the rules for constructing and managing composites, including for pooled funds
- Identify when and how carve-outs may be used in performance presentations
- Assess the implications of improper firm definition or composite construction for GIPS compliance

## **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. If a manager runs both segregated accounts and pooled funds, must all be included in the GIPS firm and in composite construction?
2. Can a carve-out be presented with allocated cash returns if the firm manages stand-alone portfolios to that strategy?
3. What is the primary reason for a clear GIPS firm definition?
4. Must a pooled fund be assigned to a composite under GIPS, and when might a single-fund composite exist?

## **Introduction**

GIPS-compliant performance presentation starts with an exact definition of the firm and strict adherence to composite construction. Any pooled fund or segregated account that fits the strategy must be included in appropriate composites. Carve-outs—sub-portions of portfolios managed to specific strategies—have strict rules to avoid cherry-picking. The integrity of GIPS performance claims depends on the rigorous application of these standards.

## Defining the Firm

A **GIPS firm** is the aggregation of all portfolios managed under a distinct business unit, legal entity, or group of affiliated entities held out to clients as a single investment operation.

> **Key Term: GIPS firm**
> The entity whose performance is claimed to be GIPS-compliant, consisting of all fee-paying discretionary portfolios managed to a specific investment mandate.

A proper firm definition ensures the full universe of performance is reported. Excluding business lines, offices, or products undermines comparability and credibility.

A GIPS-compliant firm must:

- Include all fee-paying discretionary portfolios and all pooled funds under its control or held out to clients
- Apply consistent compliance boundaries; legal form is not enough—consider also branding, marketing, and operational coherence
- Establish and document the firm definition at the outset; material changes must be disclosed

## Composite Construction

A **composite** groups portfolios by common investment objectives or strategies. All portfolios—including pooled funds—managed to that strategy must be presented in the relevant composite.

> **Key Term: composite**
> An aggregation of individual portfolios, pooled funds, or carve-outs representing a specific investment mandate or strategy.

Rules for composite construction:

- Every fee-paying discretionary portfolio must be included in at least one composite from inception to termination
- Pooled funds must be assigned to composites if they are marketed like segregated accounts; if not marketed separately, they may be in a fund-only composite
- Composites must be defined according to distinct investment objectives, not account type or client type

> **Key Term: pooled fund**
> An investment vehicle where multiple clients invest collectively, with pro-rata ownership of the fund's assets.

## Pooled Funds and Single-Fund Composites

If a pooled fund is offered as a stand-alone product, it may form its own single-fund composite. If the pooled fund shares a strategy with segregated portfolios, both must be in the same composite—this helps prevent selective performance cherry-picking.

Pooled funds not marketed or managed separately, or subject to client-directed restrictions, may be excluded from composites that only represent segregated, bespoke portfolios. However, GIPS requires documentation and disclosure of pooled fund inclusion/exclusion logic.

## Carve-Outs

A **carve-out** is a sub-portfolio or asset segment carved from a multi-asset portfolio for performance measurement when managed according to an investment mandate.

> **Key Term: carve-out**
> A portion of a portfolio representing a particular asset class or strategy, tracked for stand-alone performance when managed in line with the composite’s strategy.

Carve-out presentation is allowed only if:

- The firm manages segregated portfolios to the same standalone strategy as the carve-out (i.e., actual, standalone portfolios exist in the composite with the carve-out)
- Allocated cash returns are included for each carve-out segment
- The carve-out is included in the composite on the same basis as the full portfolios (from inception to removal)

> **Key Term: allocated cash**
> The notional cash assigned to a carve-out, representing income, contributions, and withdrawals the segment would have had if managed separately.

Carve-outs must be treated identically to full portfolios in terms of inclusion, rebalancing, and composite assignment. If a composite consists only of carve-outs, presentation is prohibited.

### **Worked Example 1.1**

**A GIPS-compliant firm manages 10 balanced portfolios with equities and bonds, and also accepts pure bond mandates. Can it present a 'fixed income composite' including carve-outs from the balanced portfolios along with pure bond portfolios?**

> **Answer:**
> Yes, if the firm manages stand-alone fixed income portfolios to the same strategy as the carve-out and assigns cash to the carve-out segment, then the carve-outs and pure bond portfolios may be included in a single composite. Carve-out and standalone portfolios must be treated identically for inclusion, and the logic/documentation must be maintained for GIPS verification.

### **Exam Warning**

> GIPS-compliant firms must not present composites that omit required portfolios or double-count assets. Allocated cash for carve-outs must accurately reflect the strategy as if managed on a stand-alone basis. Failing strict inclusion can lead to misleading performance claims.

## **Summary**

GIPS requires firms to define the firm boundary, include all discretionary, fee-paying accounts and pooled funds in composites, and apply consistent rules for carve-outs. Proper cash assignment for carve-outs and accurate disclosure ensure fair, representative, and comparable performance reporting—the GIPS standard’s primary goal.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Define the GIPS firm, including all fee-paying discretionary portfolios and pooled funds
- Construct composites grouping portfolios by investment strategy, including any pooled funds
- Apply rules for carve-outs, using allocated cash and only when the firm manages both carve-outs and stand-alone portfolios for the same strategy
- Document and disclose firm definition, composite logic, and carve-out treatment for GIPS compliance
- Avoid cherry-picking by including all eligible portfolios and not omitting poor performance

## **Key Terms and Concepts**

- GIPS firm
- composite
- pooled fund
- carve-out
- allocated cash

GIPS standards for firms and pooled funds - Firm definition composites and carve-outs