Composite Construction: A Restricted Portfolio, a Minimum Asset Level and a Mid-Quarter Removal

Client-imposed restrictions do not automatically make a portfolio non-discretionary. The test is whether the restriction prevents the firm from implementing the intended strategy to a meaningful degree. Relevant factors here:

• The prohibited sectors are 3% of the benchmark. Excluding them removes a small slice of the opportunity set and is unlikely to prevent the firm from running a core balanced strategy.
• The 5% cash requirement is a constraint on asset allocation, but it is a liquidity buffer, not a prohibition on the strategy; many balanced mandates carry one.
• The firm has managed the portfolio since at least 2022 and evidently can implement its process.

On these facts the portfolio is most likely discretionary and should be included in the composite - either by widening the composite definition to state that restricted portfolios are included, or by creating a separate composite for restricted balanced accounts if the restriction is material enough to change the strategy's risk/return profile. The CIO's 'doesn't really bind' comment is an admission that the restriction is not material, which cuts against non-discretionary treatment rather than supporting exclusion.

The exclusion is therefore a likely GIPS violation, and it is not cured by a fee-schedule footnote. The composite definition must state the discretion policy and how restrictions are treated, and that policy must be applied consistently across all portfolios. If the firm genuinely believes the restriction is material, it must document the analysis, apply the same test to every restricted account, and disclose the policy - not simply omit a $25m account that would change the composite's return.

Minimum asset level. A minimum is permitted, but it must be part of the composite definition, set in advance, applied consistently, and not changed retroactively to manage the composite's return. The firm should be able to show every portfolio that crossed the threshold and how it was treated.

New portfolio. Adding a portfolio funded on 20 March at the start of the next full month (1 April) is a common and acceptable policy, provided the composite definition says so and the same rule is applied to every new portfolio. The risk is inconsistency: if some accounts are added mid-month and others at month-end, the composite becomes a selection rather than a definition.

February removal. This is the more serious problem. If the policy is that a portfolio is removed at the start of the month after it falls below the minimum, removing it immediately in February is inconsistent. If the policy is immediate removal, then the re-addition in May must follow the same rule and the firm must be able to show the dates and values. Either way, the firm must document the policy, the dates and the reason, and apply it uniformly.

A mid-quarter removal/re-addition also raises the question of whether the firm is timing the composite. Removing a small, presumably cash-heavy account after a weak period and re-adding it after a contribution can flatter composite returns. The firm should test the composite's return with the account included throughout; if the difference is material, the policy is doing work it should not be doing.

The firm must explain the composite definition, not simply assert that the other 28 accounts are irrelevant. The legitimate reasons for the gap include: accounts in other strategies, accounts below the minimum, non-fee-paying accounts (which may be included or excluded only per policy), non-discretionary accounts, and accounts that joined or left during the period. Each of those categories should be quantified so the prospect can see that 12 is the product of a rule rather than a choice.

Required presentation and disclosure points include:

• The composite description, including the minimum asset level and the discretion/restriction policy.
• Composite and firm total assets, and the percentage of firm assets the composite represents - this directly addresses the 12-versus-40 question.
• The number of portfolios in the composite at each period end.
• A benchmark description and the benchmark's returns.
• Internal dispersion for each annual period and the three-year annualized ex-post standard deviation.
• The fee schedule and whether returns are gross or net.
• The composite creation date and the since-inception date.

Finally, the firm should quantify the effect of the excluded $25m portfolio, correct the composite if the exclusion was improper, disclose the correction and its impact, and review whether the fee-schedule footnote was adequate disclosure - it was not. If the corrected composite return is materially different, prospective clients and any consultant who received the old numbers should be told.