Carve outs

Can anybody explain in simple terms what is the deal with carveouts in GIPS?also allocating cash? Thanks

Carve outs are not allowed (aka, can not be presented in a single aset class composite) as of January 1, 2010 unless allocate cash and seperately managed.

You have to detail how cash was allocated after 2006 You have the present the proportion of a single asset class composite that is from carve-outs As N.VanCandidate said, starting January 1, 2010 carve-outs are not allowed unless they are separately managed and have cash allocated. Before this (i.e. 2006-2010), they have to have cash allocated only.

what exactly does allocating cash mean. I know you are supposed to allocate cash according to your composite - but what does that mean exactly?

thats a good question I know what it DOESNT mean, and that is allocating based on market value of each asset class of the mult-asset class portfolio - GIPS says thats not allowed. I assume there is some designed strategy that they need to present.

Say you have a bunch of managed accounts in a composite, and they all have 4% cash in them…and then you have another account which is your grandmothers retirement account, and within her large account with GM that she’s owned since 1969 and all the other sh@%$ stocks is a chunk of money that you manage to the same strategy as all the others in the composite. In order to properly include Granny’s account in the composite as a carve out, you need to allocate the same amount of cash to it as if it was in a separate account–as opposed to giving the P/L of all the stocks without any cash that would skew the performance…does this make sense as an explanation. I have gone through this a few times with a third party verifier for GIPS compliance as I manage a strategy that has 2 accounts “carved out” of other holdings, but there is no cash allocation to the other accounts inthe composite…the verifier doesn’t get it, she keeps telling me to allocate cash and I keep telling her that I am, i am allocatiing zero, just like the others. Its crazy. But it makes sense as a GIPS requirement especially in the last 2-3 months where any cash allocation would reduce performance, and conversely, failing to include the cash allocation would overstate monthly performance of the carve out.

so then the rest of the cash you would leave out?

Well, remember that you are carving out an account…so you are trying to make it look like the other accounts in construction…so in the example, the separate accounts all had 4% cash…so if you want to carve your strategy of stocks or whatever out of the big account (which could have 50% in cash) you have to allocate 4% of the carve out to cash.

I remember and end of chapter question in the CFAI text with detailed calculations for the two acceptable methods to allocate the cash. I would suggest you review this problem, it could very well show up. Having this problem at the end of chapter indicates that they’re expecting you to know more than the simple definition to the actual calculations.

Thanks for the insight Mo…I’m hittin that next–I remember hearing someone say last year walking out of the morning level two exam she was surprised there was no GIPS essay on her level III…I think we will see one this year.

Carve Outs: See problem 18 on page 318 in volume 6. Takes 5-10 minutes to work through. Here are some off the cuff formulas I’m using for the two methods noted, beginning of period allocation and strategic asset allocation. Beginning of Period Allocation- Step 1 - Get proper cash allocated to equity by: cash x (assets to be carved out/ (assets carved out + other non-cash assets) Step 2 - Calculate Returns for carved out assets Overall returns on equity you carved X (assets carved out - your equity for example)/ (Assets Carved Out + New Cash Amount Calced in step 1) = weighted return for carved assets. Returns on cash X (Cash Amount calculated from step 1/Total Assets Carved Out + New Cash Amount Calced in step 1) = weighted return for cash assigned to carve out Per the book’s example, the results are arithmetically added together. Strategic Asset Allocation Method Allocation to cash = Total Assets in portfolio X (Strategic AA - Actual AA). Calc returns same as Step 2 for above but use the adjusted cash amount for “new cash” in my equation.

Re: strategic asset allocation, what happens if Actual AA > Strategic AA? Do we not add any cash then?