Marketing a New Composite: Linked Model Performance, a Representative Portfolio and an Error in 2022
A boutique wants to market a 'Global Opportunities' strategy to a pension consultant. The composite was formally created in January 2020. For 2017–2019 the firm has model results produced by applying today's selection rules to historical data. The pitchbook presents 2017–2023 as one continuous series, annualized at 12.3% gross, labels the whole series 'GIPS-compliant', and links the simulated years to the actual composite. It also presents a single €65 million 'representative portfolio' because the composite includes a €4 million account that the CIO says 'would drag the number down'. The composite's since-inception money-weighted return is quoted as 10.1% net, with no fee schedule disclosed. The firm has never been verified. In preparing the presentation, the performance analyst also discovers that the 2022 composite return was overstated by 60 basis points because two accounts were omitted.
1. What is wrong with presenting 2017–2019 model results as part of a continuous 'GIPS-compliant' track record, and what may the firm actually show?
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Model or backtested results are not actual performance. Three separate failures are stacked here:
- Linking. GIPS does not permit linking simulated or model performance to actual composite performance to create a continuous record. The composite has actual performance only from its creation date; that is the record that must be presented, with the since-inception date stated.
- Labelling. 'GIPS-compliant' is a firm-wide claim. It can be made only if the firm has satisfied all the requirements of the standards across its composites, not just this one. Attaching the label to a series that includes model results is a misrepresentation regardless of the firm's overall compliance status.
- Track-record inflation. The five-year presentation requirement is met with actual composite performance (or since inception if shorter), building to ten years. Simulated years cannot be used to manufacture the five-year history the firm does not have.
What the firm may show: the actual 2020–2023 composite returns with the benchmark, number of portfolios, composite and firm assets, dispersion, three-year ex-post standard deviation and the fee schedule. If the model results are shown at all, they must be in a separate, clearly labelled section marked hypothetical/supplemental, with the assumptions (universe, rebalancing, transaction costs, survivorship, look-ahead bias) and a statement that they are not actual results and may not be reproducible. They must not be labelled GIPS-compliant and must not be placed on the same chart as the actual composite.
2. Why is the 'representative portfolio' presentation unacceptable, and what must replace it?
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A composite presentation must present the composite, not a hand-picked account. Choosing the €65 million portfolio specifically because a €4 million account would lower the average is cherry-picking: it substitutes a favourable anecdote for the required asset-weighted result and conceals the small-account experience from the prospect. The fact that the CIO's stated reason is to avoid a drag on the number makes the intent explicit.
A GIPS composite presentation must include, at a minimum:
- Composite and benchmark returns for each annual period (and the required multi-year annualized figures).
- The number of portfolios and the composite's total assets at each period end, plus firm assets and the composite as a percentage of firm assets.
- Internal dispersion for each annual period with enough portfolios to be meaningful.
- The three-year annualized ex-post standard deviation of the composite and benchmark.
- The fee schedule and a clear statement of whether returns are gross or net of fees.
- The composite description, benchmark description, minimum asset level, and creation/inception dates.
A single portfolio may be shown as supplemental information, clearly labelled as a representative account and accompanied by the reason it was selected and the fact that it may not be representative of the composite. It cannot replace or precede the composite presentation, and it cannot be the only performance shown.
3. Address the money-weighted 'since-inception return', the missing fee disclosure, the unverified status and the 60 bp error in 2022.
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Money-weighted return. For a public equity strategy, composite returns must be asset-weighted, calculated using beginning-of-period values or beginning-of-period values plus weighted external cash flows. A since-inception IRR is a money-weighted measure that reflects the timing of client contributions and withdrawals, not the manager's investment result, and it is not the prescribed composite return here. (Since-inception IRRs are used where the standards specifically provide for them, such as private market investments.) If the firm wants to show an IRR, it must do so as supplemental information, clearly labelled.
Fees. Net-of-fees returns require a disclosed fee schedule and a stated method (actual fees or the highest fee in the composite). Quoting 10.1% net without showing the schedule leaves the consultant unable to verify the deduction and is a required disclosure failure. Gross returns must also be labelled as gross.
Verification. Verification is voluntary. The firm must not state or imply that it has been verified, and if it ever is, it must disclose the level and scope. Absence of verification does not make the firm non-compliant, but claiming verification it does not have would.
The 60 bp error. The firm must correct the 2022 composite return, recalculate any affected multi-year figures and the since-inception number, document the cause, disclose the correction and its impact to affected prospects and clients, and review why two accounts were omitted (typically a mapping or inclusion-date failure). Correcting an error does not by itself breach the standards; failing to correct it, or quietly restating the number without disclosure, does. The corrected figures should be the ones used in the pitchbook, with the reason for the restatement available to the consultant on request.