What are the mandatory composite construction rules under GIPS, and why do composites matter?

Composites are the backbone of GIPS because they prevent exactly the kind of cherry-picking you described. GIPS mandates specific construction rules to ensure fair, comparable performance reporting.

What Is a Composite?

A composite is an aggregation of one or more portfolios managed according to a similar investment mandate, objective, or strategy. Every discretionary, fee-paying portfolio must be included in at least one composite.

Mandatory Construction Rules

1. All actual, discretionary, fee-paying portfolios must be included in at least one composite
2. Composites must be defined before the period of performance — no after-the-fact grouping
3. New portfolios must be included in the composite on a timely and consistent basis (the firm's policy must specify the inclusion timing, e.g., first full month)
4. Terminated portfolios must remain in the historical composite record through the last full measurement period
5. Non-discretionary portfolios are excluded (the firm cannot control these portfolios)
6. Portfolios must not be switched between composites unless documented changes in investment mandate justify it

Anti-Cherry-Picking Provisions

The key anti-cherry-picking features:

• Firms cannot exclude portfolios from composites based on performance
• Portfolio inclusion criteria must be established in advance
• If a client constrains the mandate (making it non-discretionary), the portfolio can be removed, but this must be documented
• Simulated or model portfolios are never included in composites

Minimum Number of Portfolios

If a composite has five or fewer portfolios, the firm is not required to present a measure of internal dispersion. However, the composite must still be maintained and presented.

Practical Example — Ridgecrest Asset Management

Ridgecrest runs a US Large Cap Value strategy. They have 47 client portfolios following this strategy. They cannot pick the top 20 performers and call that the composite — all 47 must be included. If Portfolio #23 lost 15% while the rest averaged +8%, that poor performer stays in the composite.

Exam tip: GIPS composite questions focus on what must be included, when portfolios enter/exit, and the prohibition on retroactive composite creation.

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