GIPS – Carve outs

I’m not particularly strong with GIPS, but I’ll give it a go.

A carve-out is a portion of a portfolio that can be representative of a investment strategy or asset class. The rationale here is that say if a client wants to see the performance of a firm in say equities, they can carve out the equity portion of the portfolio to allow for equity-only performance evaluation.

Now since asset management involves buying and selling stocks together with other asset classes, you have two problems with cash.

1. Cash gets mixed between classes. Cash can be used to buy and sell different asset classes, so obviously it becomes more difficult to carve out – i.e. if you sold some stocks and bought bonds with the cash, then made a ton of money from the bonds, sold them and reinvested in equities, that makes you look good equities-wise, even though it’s not due to your equity performance. Prior to 1 Jan 2010, you were allowed rectify this problem by ‘allocating’ cash in your portfolio to a carve-out ‘in a timely and consistent manner’, as well as accounting cash separately. This allocation method is very subjective, so after 1 Jan 2010 this method was scrapped. You can now only have a carve out if you’ve accounted your cash balance separately, e.g. no selling stocks to buy bonds if you want to carve out equities.

2. Presence of cash is also indicative of performance. You must always include your cash balance for your carve-out’s total returns. Why? The presence of cash itself is obviously indicative of performance. For example if I keep selling my poor-performing stocks and sit on the cash, my equities start to look very good if evaluated on its own. If you see the large cash balance, then you start to see a much better picture of my stock-managing qualities – fair representation.

Hope that helps – let me know if that solved your issues @ajfinance!

#ERROR!

Yes. Pre 2010, you were allowed to (more or less arbitrarily) allocate cash balances to assets, even though in practice you’d mix the cash (i.e. sell stocks to buy bonds). Post 2010, you’d have to have separate cash balances (i.e. not allowed to buy bonds with stock cash, & vice versa).

No problem @ajfinance. Your questions keeps us sharpened on the syllabus too so keep them coming! 🙂

@AjFinance, funny you say that. When I was doing L3, and practice exams showed that I consistently flunked GIPS, I made quick notes of that whole section during the last 2 weeks prior to exams. And read it 2 nights before again. Unfortunately it wasn’t much help… X(

Yes, best is just to keep calm and carry on @AjFinance! Hows the studies coming along?

@AJfinance I remember leaving GIPS revision till last minute simply because it was pure memorization. I really liked behavioural finance though – I could relate to all the biases 🙂

My parents have hindsight bias to the extreme when it comes to stocks, especially if it’s MY investments. Pisses me off.

I’ve just dont GIPS – if you can call that ‘done’. I barely remember what I just read.

GIPS = generally impossible piece of s*** =))