Multi-Asset Composite Membership Changes

In the 2020 GIPS Exposure Draft, provision 3.A.10 is a revision of 3.A.7 that incorporates the term “client-directed” from the GIPS handbook. It prohibits composite membership changes unless there is a composite redefinition or a documented “client-directed” change to a portfolio’s investment mandate, objective, or strategy.

This provision ensures an asset manager’s decisions are reflected in the composite’s performance, providing accountability for tactical decisions or style drift over time.

For a single product composite, the assumption that a manager knows the composite definition is fair, as it should be defined based on the management strategy. For a group of multi-asset composites with artificial asset allocation band limits, that assumption doesn’t hold.

By artificial, we mean these bands are defined by performance analysts to serve a composite performance function, in order to create a meaningful multi-asset performance history. The data during the initial five-year period can be used to set meaningful bands that will work for the majority of accounts.
For the exceptions, though, client direction for the past five years doesn’t likely exist. Portfolio managers with a multi-asset Investment Policy Statement (IPS) that has broader discretion than is captured in any one of the firm’s composites have a fiduciary obligation to put the client’s interests first in making investment decisions, which may or may not consistently align with the composite definitions.

Because provision 3.A.10 doesn’t align with how many, if not most, private wealth management (PWM) firms do business, Cascade Compliance has recommended the term “client-directed” not be added to the composite maintenance provision, and that additional guidance be added to Handbook, so that firms can create and consistently follow policies and procedures that reflect their firm’s investment management of multi-asset composites.

For some PWM firms: If the barriers to claiming compliance with the GIPS standards can be addressed, creating and maintaining multi-asset composites with different allocation bands can greatly improve operational efficiencies over time.

PWM firms already claiming compliance with GIPS might have client IPS templates that include target asset allocation ranges that align with the firm’s composites. They would then check the appropriate composite when on-boarding new clients. For these firms, changes to composites are easier to document. However, composite maintenance is still a challenge and depending on a firm’s policy for composite membership changes, accounts may be out of the composite for several performance periods.
PWM firms not claiming compliance often do not have composites, and these firms document client objectives and preferences in a variety of ways.

As currently written, this provision is a significant barrier to universal adoption of GIPS 2020, especially for long-standing firms with hundreds of PWM accounts that have been managed over the past five years with varying balanced allocation bands.

In stark contrast to 3.A.10, 3.A.11 compels composite membership changes without client-directed changes or composite re-definitions. According to 3.A.11: if an account in a composite with a $100,000 minimum falls to $98,000, it must be removed in a timely and consistent basis.

Similarly, it could strengthen the Standards to also permit timely and consistent membership changes among multi-asset composites with different asset-allocation bands. Firms wanting to comply with the GIPS standards could have a consistent method for documenting decisions to move accounts between composites based on allocation data and portfolio manager documentation.