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Graham and Crickenburg Associates is a large money-management company. The firm has been in existence for four years, and Graham and Crickenburg Associates has two divisions which are separate legal entities. One division in the company handles all the individual client accounts and one division handles all the corporate accounts. The co-owners and chief executive officers, Charles Graham and Kevin Crickenburg, are considering the advantages of conforming to the Global Investment Standards, GIPS®. Graham thinks that it may be more cost effective to only make the individual client division GIPS compliant. Graham thinks this it is only acceptable to make one part of the firm GIPS compliant if they sign a letter of intent that they will make the entire company GIPS compliant within a year. Crickenburg says that it is not possible, because the entire company must become GIPS compliant or not at all. They resolve to investigate the issue later, and Graham and Crickenburg move on to examining the requirements for input data and calculations.
Graham and Crickenburg note that they have records concerning the returns of portfolios in both divisions going back since the firm began. The returns were calculated monthly, used accrual accounting for fixed-income assets, used accrual accounting for dividend-paying stocks, and used settlement-date prices. They have all the final returns for the portfolios in hard copy form. Most of the raw data pertaining to the returns of the assets in the portfolios and calculation methods have been lost. This was because Graham and Crickenburg threw away the hard copy of the raw data. A computer virus destroyed many of the raw data files. Graham and Crickenburg discuss the adequacy of the data for GIPS compliance. Graham says that only having the returns data is sufficient since the company had an external CPA go over the books each year. Crickenberg says that having records going back four years is sufficient.
Graham and Crickenburg Associates has a wide variety of individual clients. Some of the clients are very conservative, and some are very aggressive. Two separate clients are so conservative that, four years ago, they stipulated that their entire portfolio simply be invested equally across US Treasury strips with two, four, six and eight years to maturity. As each group matures, as the first set did two years ago, it would be rolled over into the eight years to maturity strips again. These clients put their money with Graham and Crickenburg Associates so that the company would take care of the rollover, the paperwork, and computing the tax liability. The clients pay a fee for this service.
The portfolios of the more aggressive clients were managed by Jill Laporte, CFA, for the first two years of the existence of Graham and Crickenburg Associates. The portfolios she managed had higher returns and lower standard deviations than their respective indexes for those first two years. After two years, Laporte left the firm and took a small number of the clients with her. After she left, the aggressive portfolios that had been under her management and remained with Graham and Crickenburg Associates underperformed their respective indexes.
Graham and Crickenburg Associates is an American based firm with most of its clients living or doing business in the United States. Some of the clients are foreign, however, and have the majority of their holdings in foreign assets. Graham and Crickenburg have been computing the returns of these portfolios in their respective domestic currencies. The portfolios denominated in foreign assets use foreign benchmarks, naturally, and some of the indexes used as benchmarks report returns net of taxes. Graham and Crickenburg discuss the extent of the details they must report with respect to these facts. Graham says that they must disclose the currency used to express the performance of each portfolio. Crickenburg says they do not have to disclose details concerning indexes reporting returns net of taxes. In Graham’s and Crickenburg’s discussion concerning whether to make only a portion of the company GIPS compliant, they each gave an opinion concerning the possibility of making only one division GIPS compliant and a reason supporting that opinion. With respect to both the opinion and reason:

A) only one is correct.

B) both are incorrect.

C) both are correct.

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Because the subdivisions are distinct business entities, the company can define each of its divisions as a separate firm for the sake of GIPS compliance. Thus, one division can be GIPS compliant while the other is not. There need not be an intent to make all divisions GIPS compliant in such an instance. (Study Session 18, LOS 43.c)

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With respect to the historical input data, which of the following are impediments to Graham and Crickenburg associates becoming GIPS compliant? The returns:

A) are calculated using settlement-day prices.

B) are calculated monthly and on the date of all large cash flows.

C) of the dividend-paying stocks are calculated using accrual accounting.

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As of January 2005, trade-date prices must be used (Standard 1.A.5). Monthly calculations and accrual accounting for fixed-income assets is required. Accrual accounting for dividend-paying stocks is recommended. (Study Session 18, LOS 43.d)

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With respect to the historical input data, the existence of only the portfolio returns data, and the fact that data only goes back four years: Graham and Crickenberg both state the data is sufficient. Graham says only having the portfolio returns is sufficient, and Crickenberg says only having four years is sufficient. With respect to these statements:

A) only Crickenberg is incorrect.

B) both are incorrect.

C) only Graham is incorrect.

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Graham was incorrect because the supporting data must be maintained (Standard 1.A.1). Crickenberg was correct in that the firm has only been existence for four years, so four years of data is adequate. (Study Session 18, LOS 43.d)

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As described, Graham and Crickenburg Associates has two clients that have all their money in US Treasury strips. With respect to including these portfolios in a composite they:

A) must be included in a composite of fixed income portfolios.

B) cannot be included because they are nondiscretionary.

C) cannot be included because fees are paid.

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These two portfolios are clearly nondiscretionary, and they cannot be included in a composite (Standard 3.A.1). (Study Session 18, LOS 43.j)

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With respect to Jill Laporte leaving the company two years ago, to be GIPS compliant, Graham and Crickenburg Associates:

A) must disclose this as a significant event given her record.

B) must disclose this because she took some of the clients with her.

C) need not disclose this under any circumstances.

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Laporte’s leaving must be reported because a star portfolio manager leaving the firm is a significant event (Standard 4.A.14). (Study Session 18, LOS 43.k)

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Some portfolios hold foreign assets and use benchmarks that are net of taxes. In order to be GIPS compliant, Graham said that they must disclose details concerning the currency, but Crickenburg says they do not have disclose that some of the index returns are computed net of taxes. With respect to these statements:

A) only one is correct.

B) both are incorrect.

C) both are correct.

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Firms must disclose the currency used to express performance (Standard 4.A.7). Firms must disclose relevant details of the treatment of withholding tax on dividends, interest income, and capital gains. If using indices that are net of taxes, the firm must disclose if benchmark returns are net of withholding taxes if this information is available (Standard 4.A.20). (Study Session 18, LOS 43.k)

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Which of the following is NOT a composite construction requirement of the Global Investment Performance Standards (GIPS)?

A) All actual fee-paying discretionary portfolios must be included in at least one composite.

B) Composites must include new portfolios on a timely and consistent basis after each portfolio comes under management.

C) Terminated portfolios must be removed from the historical record of the appropriate composites for all years for which they were included in the composites.

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Standard 3.A.46 states that terminated portfolios must be included in the historical record of the appropriate composites up to the last full measurement period that each portfolio was under management. The inclusion of terminated portfolios in historical performance prevents survivorship bias.

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Which of the following is NOT a composite construction requirement under the Global Investment Performance Standards (GIPS)?

A) Firms must disclose the use of simulated or model portfolio results.

B) Firm composites must be defined according to similar investment objectives and/or strategies.

C) Carve-out returns excluding cash cannot be used to create a stand-alone composite.

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Under GIPS standard 3.A.2, composites must include only assets under management and under Standard 3.A.3 firms may not link simulated or model portfolios with actual performance. Simulated, back-tested, or model portfolio results do not represent the returns of actual assets under management and, thus, may not be included in composites performance results.

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Teaton Investment Management (TIM) has recently developed a proprietary prediction model. To test the model, TIM created a returns history for an equity value portfolio using hypothetical assets and a back-tested asset allocation strategy. TIM intends to include the simulated portfolio results in its performance presentation. Which of the following most accurately describes TIM’s compliance with the Global Investment Performance Standards (GIPS)? (Assume that TIM is GIPS-compliant in all other areas). TIM is:

A) GIPS-compliant as long as it discloses the inclusion of simulated returns in its performance presentation.

B) GIPS-compliant if it includes the simulated portfolio in a composite that consists solely of simulated portfolios.

C) not GIPS-compliant because the standards do not permit the inclusion of simulated portfolio results in performance presentations.

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A firm may not include model performance results in its presentation and claim compliance with GIPS. Under GIPS Standard 3.A.2, composites must include only assets under management and under Standard 3.A.3 firms may not link simulated or model portfolios with actual performance. Simulated, back-tested, or model portfolio results do not represent the returns of actual assets under management and, thus, may not be included in composites performance results.

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Which of the following reasons is least likely to explain why a portfolio has been moved from one composite to another?

A) The firm has redefined the composite, and the portfolio no longer falls under the new definition.

B) The portfolio size has grown above £5 million and is more suitable to the “UK Equities above £5 million” composite than the “UK Equities below £5 million” composite.

C) The portfolio size has recently fallen below the minimum threshold specified for the “Japanese Value Equities above ¥500 million” composite.

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All of the suggestions could be valid reasons for moving a portfolio into or out from a composite. However, if a portfolio falls below a specified minimum and the drop is not likely to be permanent, then the portfolio may remain in that composite in the short-term.

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Which of the following descriptions are appropriate qualifiers for a composite?

"Small Cap"

"High Duration"

"Above €10 million"

A) Appropriate Appropriate Not appropriate

B) Appropriate Not appropriate Appropriate

C) Appropriate Appropriate Appropriate

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All three qualifiers are appropriate for a composite. Note that each composite should have sufficient qualifiers to make it meaningful, but not too many so as to avoid fragmentation of portfolios.

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Which of the following statements best describes possible investment strategies of a firm’s composites?

A) Strategies should be as fully defined as possible so that portfolios within the composites closely match each other.

B) Strategies should avoid having too many qualifiers to prevent the manager from having a large number of small composites.

C) The strategies should not overlap, so as to prevent portfolios falling under multiple composite descriptions.

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Strategies may overlap, and portfolios may fall under two descriptions. Strategies should have a suitable number of qualifiers (such as sector, style, benchmark or capitalization) – having too many qualifiers results in a large number of composites each containing too few portfolios; having too few qualifiers results in composites that are too broad.

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A composite is an aggregation of discretionary portfolios into a single group that represents a particular investment objective or strategy. Composites are the primary vehicle for presenting performance to a prospective client. Which of the following statements concerning composites is least accurate?

A) Portfolios may not be switched from one composite to another.

B) All actual fee-paying discretionary portfolios must be included in at least one composite.

C) Firm composites must be defined according to similar investment objectives and/or strategies.

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Portfolios may be switched from one composite to another if documented changes to a portfolio's investment mandate, objective, strategy, or redefinition of the composite make switching appropriate.

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

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

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

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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.

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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. 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.

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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.