gips-compliance

What this skill does

# GIPS Compliance — Global Investment Performance Standards

## Purpose
Ensure investment firms claiming compliance with the CFA Institute Global Investment Performance Standards (GIPS) satisfy all requirements for composite construction, performance calculation, presentation, verification, error correction, and advertising. This skill covers the 2020 edition of the GIPS standards (effective January 1, 2020) and addresses the practical application of GIPS requirements to traditional composites, pooled funds, wrap fee/SMA programs, and advertising materials.

## Layer
9 — Compliance & Regulatory Guidance

## Direction
prospective

## When to Use
- Constructing or reviewing composites for GIPS compliance
- Calculating composite returns using time-weighted return methods
- Preparing GIPS-compliant presentations for prospective clients
- Evaluating whether a firm meets the prerequisites to claim GIPS compliance
- Designing error correction policies and materiality thresholds for GIPS-compliant firms
- Assessing whether verification is appropriate and selecting a verifier
- Presenting performance for wrap fee, SMA, or overlay programs under GIPS
- Preparing GIPS-compliant pooled fund reports for limited-distribution or broad-distribution pooled funds
- Drafting GIPS-compliant advertisements
- Advising small firms on the practicality and requirements of GIPS adoption
- Responding to GIPS verification findings or correcting composite construction errors

## Core Concepts

### GIPS Overview and Applicability
The Global Investment Performance Standards are voluntary ethical standards maintained by the CFA Institute for calculating and presenting investment performance. GIPS are not law — no regulator mandates compliance — but they are widely adopted by investment managers seeking institutional mandates, as many institutional investors, consultants, and plan sponsors require or strongly prefer GIPS-compliant track records.

GIPS applies to "firms," defined as an investment firm, subsidiary, or division held out to clients or prospective clients as a distinct business entity. The definition of the firm is foundational: a firm must define itself consistently and cannot change its definition to manipulate compliance. A firm claiming GIPS compliance must do so on a firm-wide basis. A firm cannot claim compliance for select composites or strategies while excluding others — compliance is all or nothing.

The 2020 edition of GIPS (effective January 1, 2020) is the current standard, replacing the 2010 edition. Key changes in the 2020 edition include provisions for pooled fund reports, enhanced requirements for overlay strategies, broader applicability to asset owners, and streamlined advertising guidelines. The 2020 edition maintains the core principles that have defined GIPS since inception: fair representation of performance, full disclosure of material information, and comparability across firms and time periods.

GIPS compliance is self-declared — there is no central authority that grants or certifies GIPS compliance. A firm claims compliance by including a specific compliance statement in its GIPS-compliant presentations. However, the claim carries weight precisely because it binds the firm to a comprehensive set of requirements that can be (and frequently are) tested through independent verification.

### Composite Construction
Composite construction is the foundation of GIPS compliance. A composite is an aggregation of one or more portfolios managed according to a similar investment mandate, objective, or strategy. The purpose of composites is to prevent cherry-picking — firms cannot show only their best-performing accounts while hiding underperformers.

**Inclusion requirements.** All actual, fee-paying, discretionary portfolios must be included in at least one composite. The key terms are:

- **Actual portfolios** — only real portfolios with real assets. Simulated, model, or backtested portfolios are never included in composites.
- **Fee-paying** — portfolios that pay advisory fees to the firm. Non-fee-paying portfolios (such as employee accounts or pro bono accounts) may be included in composites, but the firm must disclose their inclusion.
- **Discretionary** — portfolios over which the firm has full investment authority to implement its intended strategy. Portfolios with client-imposed restrictions that materially prevent the firm from implementing its strategy are non-discretionary and must be excluded.

**Timing of inclusion.** New portfolios must be included in their respective composites on a timely and consistent basis. The GIPS standards recommend inclusion at the beginning of the next full measurement period after the portfolio is funded and invested. For example, if a new portfolio is funded on March 15 and the firm uses monthly measurement periods, the portfolio would be included in the composite beginning April 1. The firm must apply the same timing policy consistently across all composites.

**Exclusion of portfolios.** Portfolios must be excluded from composites only for valid, documented reasons:

- Non-discretionary status (client-imposed restrictions that prevent strategy implementation)
- Portfolios below a stated minimum asset level (if the firm has set a minimum, it must apply it consistently and disclose it)
- Portfolios in the process of funding or liquidation (significant cash flows that temporarily prevent strategy implementation)

**Terminated portfolios.** When a client terminates a portfolio, the portfolio must remain in the composite through the last full measurement period that the portfolio was under management. The terminated portfolio's historical returns remain in the composite permanently — they cannot be removed after the fact.

**Prohibition on retroactive composite creation.** Firms cannot create composites retroactively to cherry-pick favorable performance histories. Composite creation dates must be documented and disclosed.

**Composite switches.** If a portfolio's mandate changes and it moves from one composite to another, the switch must be documented with the effective date. Historical returns remain in the original composite; the portfolio's returns are included in the new composite only from the switch date forward.

**Documentation.** All composite membership decisions — inclusions, exclusions, switches, and the rationale for each — must be documented and retained.

### Performance Calculation Requirements
GIPS requires time-weighted returns (TWR) to eliminate the distorting effects of external cash flows (which are controlled by the client, not the manager). The goal is to measure the manager's investment skill independent of client-directed deposits and withdrawals.

**Valuation requirements.** Firms must use actual (not estimated) valuations. Prior to January 1, 2010, quarterly valuation was the minimum; since then, firms must value portfolios on the date of all large external cash flows, or more frequently. Best practice (and required for many institutional composites) is daily valuation.

**Large cash flow policy.** Each firm must define what constitutes a "large" external cash flow and apply the definition consistently. Common thresholds are 10% of portfolio value, though firms may set lower thresholds. Portfolios must be valued on the date of any cash flow that meets the threshold.

**Return calculation methods:**

- **True daily valuation** — the gold standard. Portfolio is valued every day, and returns are calculated daily, then geometrically linked. Eliminates all cash flow timing distortion.
- **Modified Dietz** — an approximation method that weights cash flows by the fraction of the measurement period they were present. Acceptable when the firm does not have daily valuations, but accuracy decreases with large or frequent cash flows.

**Gross-of-fees and net-of-fees returns:**

- **Gross-of-fees return** — the total return of the portfolio reduced only by actual trading expenses (commissions, transac