GIPS Explained for CFA Candidates: Firms, Composites and Verification

GIPS for CFA candidates can feel like a separate subject hidden inside the ethics readings, full of terms such as composites, carve-outs and verification. In reality, the Global Investment Performance Standards answer one simple question: how should an investment firm show its track record so that prospective clients can compare it fairly with others? This guide explains the key ideas in plain language, based on the 2020 edition of the GIPS standards for firms.

What GIPS Is and Why It Exists

Before GIPS, firms could present performance however they liked. A manager might show only its best accounts, drop the funds that closed after poor results, or pick a flattering start date. Prospective clients had no reliable way to compare one firm with another.

GIPS fixes this with a voluntary, globally recognised set of ethical principles for calculating and presenting investment performance. The two core goals are fair representation and full disclosure. When a firm claims compliance, a prospect can expect that the numbers include all relevant accounts, are calculated in a consistent way and come with the disclosures needed to interpret them.

GIPS connects directly to Standard III(D), Performance Presentation, in the Code and Standards. Standard III(D) sets the general duty to present performance fairly; GIPS is a detailed, standardised way of meeting that duty. Our article on Standard III duties to clients explains the broader principle.

Who Can Claim GIPS Compliance?

This is one of the most frequently tested points. Only an investment firm can claim compliance with GIPS. An individual portfolio manager cannot claim it. A software vendor cannot sell "GIPS-compliant software", and a consultant cannot make a firm compliant on its behalf. A single product or strategy cannot be compliant on its own either.

Defining the firm

Compliance applies to the whole firm, so the firm must first be defined. Generally, the firm is the entity that is held out to the public as a distinct investment business. A large financial group might define one division as the firm if that division presents itself to clients as a separate business.

All or nothing

A firm must meet all applicable requirements on a firm-wide basis. There is no such thing as partial compliance. A statement such as "we comply with GIPS except for our real estate composite" is not permitted. The firm either complies fully or it does not claim compliance at all.

Example: Neelgiri Asset Management has three strategies. Its equity team has followed GIPS for years, but the fixed income team has not. Neelgiri cannot advertise that its equity strategy is GIPS compliant. It can claim compliance only once the entire firm meets the requirements.

Composites: The Heart of GIPS

A composite is a group of one or more portfolios managed according to a similar investment mandate, objective or strategy. Instead of showing a single hand-picked account, the firm shows the combined performance of every portfolio that follows that strategy.

Which portfolios must be included?

Under the 2020 standards, every actual, fee-paying, discretionary segregated account must be included in at least one composite. Firms define composites using their own documented criteria, and they must apply those criteria consistently. Non-fee-paying discretionary portfolios are not required, but the firm may choose to include them under its documented policies. Pooled funds that meet a composite's definition should also be included in it.

The rules also stop firms from gaming the record. A portfolio cannot be moved from one composite to another simply because it performs better there. Switching is allowed only when the client's mandate genuinely changes or when the composite's definition is redefined, and the history of the portfolio stays in the original composite.

What "discretionary" means

A portfolio is discretionary if the manager can actually implement the intended strategy. If a client imposes restrictions so tight that the manager cannot follow the strategy, for example a ban on most of the stocks in the benchmark or a demand for large regular withdrawals, the firm may classify that portfolio as non-discretionary. Non-discretionary portfolios are excluded from composites. Firms should document how they decide.

Example: Coral Ridge Investors runs an "Indian large-cap growth" composite. One client allows only stocks from a short ethical list and requires the manager to hold 30 percent in cash for liquidity. Coral Ridge reasonably concludes it cannot implement the strategy for this client and classifies the account as non-discretionary, documenting the reason.

Carve-Outs: Only With Their Own Cash

A carve-out is a portion of a larger portfolio, such as the equity segment of a balanced account, that the firm wants to include in a single-asset-class composite. Earlier versions of GIPS allowed firms to assign cash to carve-outs on paper, which made results easier to manipulate.

The current rule is stricter. A carve-out may be included in a composite only if it is managed separately with its own cash balance. In other words, the equity segment must be run as if it were a standalone portfolio, with real cash that belongs to that segment, rather than cash that is allocated afterwards by formula.

Example: Tamarind Partners manages balanced mandates. The equity portion of each mandate is run by a dedicated team that holds its own cash account. Tamarind can include those equity segments in its "Global Equity" composite. If the cash were simply allocated on paper at month end, it could not.

Verification: Independent and Firm-Wide

Verification is a review of the firm by an independent third party. Under the 2020 standards, verification is recommended but not required. A firm can claim compliance without being verified, although many firms choose to be verified because it adds credibility.

What verification covers

Verification is always performed on the entire firm, not on one composite. The verifier tests whether the firm has followed all composite and pooled fund construction requirements on a firm-wide basis, and whether the firm's policies and procedures for calculating and presenting performance are designed to comply with GIPS and have been implemented that way.

Verification does not certify that a particular composite's returns are correct. A separate, optional engagement called a performance examination can look at a specific composite or pooled fund in more detail, but it is done in addition to, not instead of, firm-wide verification.

Independence matters

The verifier must be independent of the firm. A firm's own internal audit team or a consultant that designed its performance systems would not meet this test.

Presentation Basics: What a GIPS Report Shows

In the 2020 standards, the document a firm gives to prospects is called a GIPS Report (for a composite, a GIPS Composite Report). Some of the most testable items are listed below.

Element	What to remember
Length of track record	At least five years of compliant performance at first (or since inception if shorter), adding a year each year until at least ten years are shown
Annual returns	Composite returns for each annual period, with a benchmark for comparison where one is appropriate
Number of portfolios	Shown when the composite contains six or more portfolios at period end
Internal dispersion	A measure of how spread out individual portfolio returns are, required when six or more portfolios were in the composite for the full year
Assets	Composite assets and total firm assets (or composite assets as a share of firm assets)
Risk	A three-year annualised ex-post standard deviation for the composite and benchmark once enough monthly data exists

Firms must also include the required compliance statement, describe the composite and benchmark, state whether returns are gross or net of fees, and disclose other relevant information. The exact wording rules are detailed, so focus on understanding the purpose of each item rather than memorising text.

How GIPS Is Tested at Level 1 and Level 3

At Level I, expect direct concept questions: who can claim compliance, whether partial compliance is allowed, whether verification is mandatory, and what a composite is. These are fast marks if you know the rules clearly.

At Level III, GIPS questions are framed from the firm's side. You might be asked whether a manager has classified a restricted account correctly, whether a carve-out qualifies for a composite, or what a firm must change before claiming compliance. Our guide on CFA Level 3 ethics for portfolio managers explains how these practical scenarios fit together with the Code and Standards.

For targeted practice, the CFA Level 1 Ethics practice course covers foundational GIPS questions, while the CFA Level 3 Ethics course includes a dedicated GIPS chapter with portfolio-manager cases.

Frequently Asked Questions

Can an individual portfolio manager claim GIPS compliance?

No. Only investment firms can claim compliance, and they must comply on a firm-wide basis. Individuals, software products, consultants and single strategies cannot claim compliance on their own.

Is verification required to claim GIPS compliance?

No. Verification is recommended, not required. When a firm does choose verification, it must be carried out by an independent third party and must cover the whole firm rather than a single composite.

When can a carve-out be included in a composite?

Only when the carve-out is managed separately with its own cash balance. Allocating cash to a segment on paper is not enough under the current standards.

How many years of performance must a GIPS report show?

A firm initially shows at least five years of compliant performance, or performance since inception if the composite is younger, and then adds each new year until at least ten years are presented.

Want to check how well you understand GIPS for CFA candidates? Start with the free demo mock test, first chapter test and chapter notes in our CFA Level 1 course or the CFA Level 3 course, and browse the complete CFA Exam Series for all levels.