Explain the GIPS rules for calculating composite returns, including the permitted ways of asset-weighting the returns of member portfolios
The idea
A composite's return must be asset-weighted, using each portfolio's beginning-of-period value, or beginning value plus weighted external cash flows, or the aggregate method, which treats all member portfolios as one and computes a single return from their combined assets and flows. For periods from 2010 onward, composite returns must be calculated at least monthly and linked geometrically. With two portfolios starting at 20 million and returning 5%, and 80 million returning 2%, the composite return is 0.2 × 5% + 0.8 × 2% = 2.6%. An equal-weighted average would show 3.5%, overstating what the typical dollar earned because the small account happened to do better. Equal-weighted results may appear only as supplemental information. Membership follows the firm's documented inclusion and exclusion policies.
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- Explain the basic requirements for claiming GIPS compliance, including how the firm is defined and how it defines discretion
- Discuss the GIPS rules for calculating returns, covering how fees and expenses, cash and cash equivalents, and external cash flows are treated
- Explain the valuation hierarchy that the GIPS standards recommend
- Explain what makes a portfolio discretionary for composite construction and, from a set of facts, judge whether a given portfolio is likely to qualify
- Explain how composites are defined around a shared mandate, objective or strategy, and why this matters
- Explain the GIPS composite construction rules, covering when portfolios may move between composites, when new portfolios must be added and when terminated ones must be removed
- Explain what the GIPS standards require in presenting and reporting performance
- Explain when a new or acquiring firm may link to, or show as its own history, the performance record of a prior firm or affiliation
- Discuss why firms seek GIPS verification, what it covers and how it is carried out