A GIPS-compliant firm maintains a composite of 20 discretionary, fee-paying portfolios in its "Global Balanced" strategy. One portfolio with $5 million in assets and a −8% return for the year is reclassified by the firm as "non-discretionary" and removed from the composite, even though the client never requested any change in the manager's investment authority and the manager continues to make all trading decisions without client input. The remaining 19 portfolios have combined assets of $95 million and a 10% return. What is the correctly calculated composite return that should have been reported, and is the firm compliant with GIPS?
- A10.0%; compliant, because firms have discretion to define which portfolios are truly non-discretionary
- B9.1%; not compliant, because the portfolio remains discretionary in substance and must be included in the composite
- C9.1%; compliant, because the asset-weighted calculation correctly reflects the exclusion
- D8.6%; not compliant, because GIPS requires equal-weighted, not asset-weighted, composite returns
Show answer & explanationAnswer & explanation
Correct answer: B. 9.1%; not compliant, because the portfolio remains discretionary in substance and must be included in the composite
Correct asset-weighted composite return = (95×10% + 5×(−8%)) / 100 = (950 − 40) / 100 = 9.1%. Because the manager retained full trading authority and the client did not request the classification change, the portfolio remains discretionary in substance; GIPS requires that all fee-paying, discretionary portfolios meeting the composite definition be included, so excluding this portfolio to improve reported performance is a compliance violation.
Why the other options are wrong
- A. Discretion is determined by actual investment authority, not by the firm's self-serving label.
- C. The calculated return is correct, but the classification change makes the firm non-compliant, not compliant.
- D. GIPS composite returns are calculated on an asset-weighted basis, not equal-weighted.
GIPS Composite Inclusion — Discretion in Substance
GIPS requires all fee-paying, discretionary portfolios meeting a composite's definition to be included; discretion is judged by actual investment authority, not by administrative relabeling by the firm.
- Asset-weighted composite return: sum(weight × return) across portfolios
- Reclassifying a portfolio to avoid inclusion without genuine change in authority violates GIPS
- Substance-over-form governs discretionary status determinations
Memory trick: "Relabeling a loser doesn't make it non-discretionary."