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GIPS - Carve outs

Hey guys,

Can someone please elaborate on the GIPS standards that discuss about "Carve outs". I understood that it relates to an asset class seperated from the portfolio, and included in the composite to show the performance of that particular asset class. However, I couldn't get my head around the cash allocation part. Can someone help me with this? Just need more clarity.
“Once you decide on your occupation you must immerse yourself in your work. You have to fall in love with your work. Never complain about your job, you must dedicate your life to mastering your skill. That’s the secret of success and the key to being regarded honorably. I’ve never once hated my job, I fell in love with my work and gave my life to it.”—Jiro Ono
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  • christinechristine On the movePosts: 630 Sr Portfolio Manager
    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!
    jimmygAjFinanceartyeasel
  • edited March 2013
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  • Thanks for the explanation @Christine =D> So in short, it means that the asset classes are seperated out and cash balance is the result of the buying and selling activity within that asset class. Therefore, the cash balance is more representative and shows a better picture of the asset class.
    “Once you decide on your occupation you must immerse yourself in your work. You have to fall in love with your work. Never complain about your job, you must dedicate your life to mastering your skill. That’s the secret of success and the key to being regarded honorably. I’ve never once hated my job, I fell in love with my work and gave my life to it.”—Jiro Ono
  • christinechristine On the movePosts: 630 Sr Portfolio Manager
    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).
  • @Christine thanks again :)
    “Once you decide on your occupation you must immerse yourself in your work. You have to fall in love with your work. Never complain about your job, you must dedicate your life to mastering your skill. That’s the secret of success and the key to being regarded honorably. I’ve never once hated my job, I fell in love with my work and gave my life to it.”—Jiro Ono
  • christinechristine On the movePosts: 630 Sr Portfolio Manager
    No problem @ajfinance. Your questions keeps us sharpened on the syllabus too so keep them coming! :)
  • @Christine I'm just worried about tackling the essay part. Also, how do you retain stuff from the GIPS reading? ~X(
    “Once you decide on your occupation you must immerse yourself in your work. You have to fall in love with your work. Never complain about your job, you must dedicate your life to mastering your skill. That’s the secret of success and the key to being regarded honorably. I’ve never once hated my job, I fell in love with my work and gave my life to it.”—Jiro Ono
  • SophieSophie Posts: 1,953 Jr Partner
    edited March 2013
    @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(
  • @Sophie Really?? That can be frustrating. The reading itself is very difficult to retain. And the dates make it all the more confusing. :-SS
    “Once you decide on your occupation you must immerse yourself in your work. You have to fall in love with your work. Never complain about your job, you must dedicate your life to mastering your skill. That’s the secret of success and the key to being regarded honorably. I’ve never once hated my job, I fell in love with my work and gave my life to it.”—Jiro Ono
  • Yes, best is just to keep calm and carry on @AjFinance! Hows the studies coming along?
  • @Sophie just finished GIPS. I plan to start revisions at least by April. I really don't remember much of Behavioral Finance and IPS that I studied in the beginning. Although I know this is how it felt for the last 2 levels till I revisited and revised the concepts, I'm just a bit nervous since its Level 3 and conceptual clarity is of utmost importance.
    “Once you decide on your occupation you must immerse yourself in your work. You have to fall in love with your work. Never complain about your job, you must dedicate your life to mastering your skill. That’s the secret of success and the key to being regarded honorably. I’ve never once hated my job, I fell in love with my work and gave my life to it.”—Jiro Ono
  • christinechristine On the movePosts: 630 Sr Portfolio Manager
    @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 :)
  • @Christine yep GIPS is indeed pure memorization %-(
    “Once you decide on your occupation you must immerse yourself in your work. You have to fall in love with your work. Never complain about your job, you must dedicate your life to mastering your skill. That’s the secret of success and the key to being regarded honorably. I’ve never once hated my job, I fell in love with my work and gave my life to it.”—Jiro Ono
  • @Christine I like Behavioral Finance as well, thats why it was the first topic I touched when I started ;) . Which biases do you relate to the most? I think there are a few inherent in me as well :P
    “Once you decide on your occupation you must immerse yourself in your work. You have to fall in love with your work. Never complain about your job, you must dedicate your life to mastering your skill. That’s the secret of success and the key to being regarded honorably. I’ve never once hated my job, I fell in love with my work and gave my life to it.”—Jiro Ono
  • 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.
  • @artyeasel don't worry, we're all in the same boat :)
    “Once you decide on your occupation you must immerse yourself in your work. You have to fall in love with your work. Never complain about your job, you must dedicate your life to mastering your skill. That’s the secret of success and the key to being regarded honorably. I’ve never once hated my job, I fell in love with my work and gave my life to it.”—Jiro Ono
  • GIPS = generally impossible piece of s*** =))
    AjFinanceartyeasel
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