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LOS g: Explain the meaning of “discretionary” in the context of composite construction and, given a description of the relevant facts, determine whether a portfolio is likely to be considered discretionary. fficeffice" />

Q1. McGregor Investment Management promotes itself as a fixed-income investment management firm. The vast majority of the portfolios it manages are fixed-income portfolios. McGregor does, however, manage a few portfolios, utilizing a growth equity investment strategy, but the firm has no intention of ever promoting this strategy. Under the Global Investment Performance Standards (GIPS), must these portfolios be included in a composite?

A)   Yes, because the portfolios are discretionary and fee paying.

B)   No, because the firm does not normally manage portfolios to a growth equity strategy and is not planning to promote it.

C)   Yes, because the portfolios are managed to a widely recognized investment strategy.

Correct answer is A)

The GIPS Standards require that all actual fee-paying discretionary portfolios are included in at least one composite. It does not matter if the firm ever plans to promote the particular strategy to which a portfolio is being managed, if the portfolio is fee-paying and discretionary, it must be included in at least one composite. Thus, McGregor must include the growth equity portfolios in at least one of its composites.

 

Q2. Jessica French is an individual investment advisor with 200 clients and claims she conforms to Global Investment Performance Standards (GIPS). French includes all of the clients on her books. One of those clients is her father, to whom she charges no fee. However, she manages that portfolio using the same processes as she uses for her paying clients. Another client included in the composite is John Randolph, a wealthy entrepreneur. ffice:smarttags" />Randolph is the only client who does not give her discretion over the assets and makes every decision himself, getting suggestions from French and using her to implement decisions. French:

A)   conforms to GIPS, if disclosures are made about the non-fee-paying account.

B)   has violated GIPS because it includes her father's account, but not because it includes Randolph's account.

C)   has violated GIPS because it includes Randolph's account, but not because it includes her father's account.

Correct answer is C)

Non-fee-paying clients can be included in the same composite as fee-paying clients as long as it is disclosed. Nondiscretionary clients should not be included in the composite as the clients would not adhere to the investment strategy used by the investment advisor.

 

Q3. A portfolio changes from being discretionary to being non-discretionary. What action should the manager take with respect to composite construction and calculation?

A)   The manager must leave the portfolio in the calculation of historic performance but must remove the portfolio from future calculations.

B)   The manager may leave the portfolio in the calculation of historic performance but may remove the portfolio from future calculations.

C)   The manager must remove the portfolio from the composite, including the historic performance.

Correct answer is A)

Historic performance cannot be adjusted by removing the portfolio. However, once a portfolio becomes non-discretionary, it may no longer be included prospectively.

 

Q4. Which of the following portfolios is least likely to be included in a composite described as “U.S. Equity composite”? A portfolio:

A)   of U.S. equities that must hold at least 20% in cash.

B)   of U.S. equities that may not diverge from the S& 500 index performance by more than 100 basis points per year.

C)   consisting mostly of U.S. equities that is already included in the same manager’s “Global Equity composite”.

Correct answer is B)

A very limited tracking error is likely to remove the discretion from a portfolio, preventing it from being included in a composite. A portfolio may be in two composites provided it falls under both composite descriptions.

 

Q5. Which of the following statements is the best description of whether a portfolio should be included in a composite?

A)   All actual, fee-paying portfolios should be included in a composite.

B)   Non-fee-paying portfolios may be included in a composite if they are discretionary.

C)   All discretionary portfolios must be included in a composite.

Correct answer is B)

All actual, fee-paying, discretionary portfolios must be included in at least one composite. Non-fee-paying discretionary portfolios may be included in a composite, but non-discretionary portfolios may not be included.

 

Q6. The minimum procedures that must be followed to verify that an investment entity is GIPS compliant include:

A)   the manager's definition of discretion has been consistently applied over time.

B)   All of these choices are correct.

C)   the firm's guidelines for creating and maintaining composites have been consistently applied.

Correct answer is B)

Verification of compliance includes assessment of the firm’s guidelines for creating and maintaining composites and their application, that all accounts are included in the appropriate composite, and that the manager’s definition of discretion has been consistently applied over time.

 

Q7. The investment management firm of Rakes, Finch, and Weeks (RFW) manages several fee-paying portfolios to a long-short strategy. RFW does not ever intend to market this strategy, so they do not include the performance of these portfolios in any of the firm’s composites. Which of the following statements indicates what RFW must do if it intends to claim compliance with the Global Investment Performance Standards (GIPS)? RFW must:

A)   disclose the fact that the long-short portfolios are not included in any of the firm's composites.

B)   include the long-short portfolios in at least one of the firm's composites.

C)   include the long-short portfolios in a composite of portfolios managed to a strategy that the firm does not intend to market.

Correct answer is B)

GIPS Standard 3.A.1 requires that all actual fee-paying discretionary portfolios are included in at least one composite. It is irrelevant whether or not the firm ever plans to market a particular strategy to which a portfolio is being managed. If the portfolio is fee-paying and discretionary, it must be included in a composite.