What calculation methods does GIPS require?

Question

AcadiFi · Accepted Answer

GIPS prescribes specific calculation methods to ensure comparability across firms. Main requirements:

1. Time-weighted return (TWR): required for composites composed of portfolios where the manager does not control external cash flows. This isolates the manager's performance from client contribution/withdrawal timing. Computed by geometrically linking sub-period returns:

TWR = [(1 + r₁)(1 + r₂)...(1 + rₙ)] - 1

2. Money-weighted return (MWR) / Internal Rate of Return (IRR): required for composites where the manager controls the timing of external cash flows, such as private equity, private real estate, or closed-end funds. It equates the present value of cash flows to the ending value.

3. Valuation frequency: portfolios must be valued at least monthly, and on the date of all large external cash flows (definition of 'large' is documented by the firm, typically 10% or more).

4. Accrual accounting: fixed income portfolios must use accrual accounting for interest. Equity portfolios must accrue dividends as of ex-dividend date.

5. Trade-date accounting: required for all transactions.

6. Actual returns: composite returns must be asset-weighted from constituent portfolio returns. Simple averaging (equal-weighting) is not allowed.

Example: Amberwood Growth Composite has three portfolios with beginning values $50M, $30M, $20M and monthly returns of 2.1%, 2.4%, 1.8%. Asset-weighted composite return = (50 × 2.1 + 30 × 2.4 + 20 × 1.8) / 100 = 2.13%. Simple average (2.1%) would not be GIPS-compliant.

For private capital composites, GIPS 2020 requires MWR since inception, plus PME (public market equivalent) and other supplemental measures. On the CFA exam, the key distinction is control of cash flows: manager controls them → MWR; client controls them → TWR. Getting this wrong invalidates the GIPS claim.

What calculation methods does GIPS require?

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