A GIPS-compliant firm manages a composite of 10 discretionary, fee-paying institutional portfolios that returned an average of 12% for the year. Two additional portfolios in the same strategy were terminated by clients mid-year with returns of −5% each before termination, but were excluded from the year-end composite presentation. Assuming equal weighting for simplicity, what is the correct asset-weighted composite return that should have been reported, and what standard is violated?
- A12.0%; no violation, since terminated portfolios may be excluded once assets leave the firm
- B7.0%; violation of Standard I(C), Misrepresentation, because the firm misstated the number of accounts in the composite
- C8.6%; violation of GIPS requirements and Standard III(D) because terminated portfolios must remain in historical composite returns through their last full period
- D12.0%; no violation, because GIPS only requires inclusion of currently active portfolios in composite returns
Show answer & explanationAnswer & explanation
Correct answer: C. 8.6%; violation of GIPS requirements and Standard III(D) because terminated portfolios must remain in historical composite returns through their last full period
True composite return = (8×12% + 2×(−5%)) / 10 = (96 − 10) / 10 = 8.6%. GIPS requires that terminated portfolios remain in the historical composite performance through their last full performance period, so excluding them overstates performance and also violates Standard III(D), Performance Presentation, and I(C), Misrepresentation, by presenting misleading results.
Why the other options are wrong
- A. GIPS requires terminated portfolios to remain in historical composite returns through the last period managed.
- B. The core issue is exclusion of terminated portfolio performance, not the account count.
- D. This misstates the GIPS requirement; historical inclusion of terminated portfolios is mandatory.
Composite Construction & Performance Presentation
GIPS requires that terminated portfolios remain in a composite's historical performance through their last full period under management, preventing survivorship bias.
- Excluding terminated accounts overstates composite returns (survivorship bias)
- Weighted average calc: sum(weight × return)
- Violates both GIPS standards and CFA Standard III(D)
Memory trick: "Don't let losers leave quietly — keep them in the history."