What are the key rules for GIPS composite construction, and what are the most common mistakes firms make?

GIPS composite construction is one of the most detail-oriented topics on the CFA Level III exam. A composite is an aggregation of portfolios managed according to a similar investment mandate, objective, or strategy. The purpose is to present a fair, representative track record.

Fundamental Requirements:

1. All actual, fee-paying, discretionary portfolios must be included in at least one composite
2. Composites must be defined before the performance period (no cherry-picking after the fact)
3. Only actual assets managed by the firm can be included — no model portfolios, backtests, or simulated results in composites

Inclusion/Exclusion Rules:

Worked Example — Ridgemont Capital Partners

Ridgemont Capital manages a US Large Cap Value strategy. Here's how they should handle various portfolios:

Portfolio A: $45M pension fund, fully discretionary, fee-paying, invested per the Value strategy since January.

→ Must include in the US Large Cap Value composite.

Portfolio B: $2M individual account, fully discretionary, fee-paying, same strategy. Ridgemont's minimum asset level is $5M.

→ Exclude — below the stated minimum. But Ridgemont must disclose the minimum and apply it consistently.

Portfolio C: $30M corporate treasury account. The client dictates that no tobacco stocks can be held, which significantly constrains the manager.

→ Exclude — the client restrictions remove meaningful discretion, making this non-discretionary for composite purposes.

Portfolio D: $20M account from the firm's founder invested in the same strategy, no fees charged.

→ May include as a non-fee-paying account but must not commingle with fee-paying presentation.

Portfolio E: Funded on March 15, managed per the Value strategy.

→ If Ridgemont's policy is "include at the start of the first full month," Portfolio E enters the composite on April 1.

Portfolio F: Client terminated on October 22.

→ Include through September 30 (last full measurement period). The partial October return is excluded from the composite.

Common Mistakes That Violate GIPS:

1. Survivorship bias — Removing terminated accounts from historical composites ("They left because they underperformed, so let's drop them"). GIPS requires historical inclusion.

1. Cherry-picking — Placing a new portfolio in whichever composite has the weakest recent returns to boost it, rather than based on the investment mandate.

1. Switching composites opportunistically — Moving a portfolio to a different composite because its recent performance would improve that composite's track record.

1. Inconsistent timing — Including some new accounts immediately and others after a lag, depending on their first-month performance.

1. Retroactive minimum changes — Raising the minimum asset level and retroactively removing small accounts from historical composites.

Exam Tip: GIPS questions often present a firm's composite construction policy and ask you to identify violations. Focus on the three pillars: (1) all discretionary fee-paying portfolios must be in a composite, (2) inclusion/exclusion rules must be applied consistently, and (3) no retroactive changes to composite membership to improve reported returns.

Practice more GIPS scenarios in our CFA Level III question bank.