How must composites be constructed under GIPS, and what common composite construction errors lead to non-compliance?
I'm studying GIPS composites for the CFA exam. I know all actual fee-paying discretionary portfolios must be included in at least one composite. But how do I define a composite properly? Can I exclude underperforming portfolios? And what happens when a client's investment mandate changes?
Under GIPS (Global Investment Performance Standards), composites are aggregations of portfolios managed according to a similar investment mandate, objective, or strategy. Every actual fee-paying discretionary portfolio must be assigned to at least one composite. The fundamental principle is that composites must reflect the firm's investment capabilities accurately and without cherry-picking.
Composite Construction Rules:
Loading diagram...
Worked Scenario:
Compliance officer Ingrid at Ravenswood Capital manages composites for the firm's equity strategies. She reviews the following situations:
Situation 1 -- Portfolio exclusion violation: Client Morrison's large cap growth portfolio returned -8.2% while the composite averaged +4.1%. The portfolio manager asks Ingrid to exclude Morrison from the composite because the client imposed unusual cash flow constraints.
Ingrid's analysis: Morrison's portfolio has full discretion over security selection and allocation. The cash flow was large but did not remove discretion. Excluding Morrison would violate GIPS. The portfolio must remain in the composite regardless of its poor performance.
Situation 2 -- Mandate change: Client Wakefield shifts from large cap growth to balanced 60/40 mid-quarter. GIPS requires moving Wakefield to the balanced composite effective the date the mandate change occurs (or the first full measurement period after, depending on firm policy).
Situation 3 -- New account inclusion timing: New client Thornton opens a large cap growth account on March 15. GIPS requires firms to define a policy for new account inclusion timing (e.g., first full month after opening). If the policy is first full month, Thornton enters the composite on April 1.
Common Composite Construction Errors:
| Error | Why It Violates GIPS |
|---|---|
| Excluding poor performers | Cherry-picking inflates composite returns |
| Including non-discretionary accounts | Distorts strategy representation |
| Switching portfolios between composites retroactively | Rewrites performance history |
| Creating composites with only one portfolio to show best results | Not representative of strategy |
| Including model/paper portfolios | Only actual portfolios allowed |
Minimum Requirements:
- Composites must have clear, written definitions
- All composites must be maintained for a minimum of 5 years (or since inception if shorter)
- Terminated portfolios must remain in historical composite records
- Firms must disclose the number of portfolios and total assets in each composite
Master GIPS composite rules in our CFA Ethics course.
Master Level I with our CFA Course
107 lessons · 200+ hours· Expert instruction
Related Questions
Why does an early retirement provision lower risk tolerance but high turnover does not — both reduce liabilities, right?
Why does it matter if the pension fund is invested in stocks similar to the sponsor's business?
What is the rule about active vs retired lives and pension plan duration?
Why does the textbook recommend 100% equities for a young employee? That sounds extremely aggressive.
I run my own startup. My income is volatile and tied to my industry. Should I hold ZERO equities in my financial accounts?
Join the Discussion
Ask questions and get expert answers.