GIPS - Carve Out

Can someone explain to me what is “carve out” and the logic behind it?

Isn’t it basically a strategy within a strategy? So let’s just say you have a composite of pure equities - but then you have a sub strategy of small cap. the small cap can be managed on it’s own and is a carve out.

Let’s say that you have a global portfolio of equities,bonds, fx, ect. If you want to present the returns for only the equity portion of this portfolio within a separate composite, then that would be considered a carve out. You must allocate the appropriate portion of cash balance to this carve out as well. Starting in 2010, a carve cannot be used unless it is separately managed.

This all comes down to forming a make believe composite carving out chunks (for a given asset class) from portfolios with a broarder mandate. You could do this pre-10 but post-10 only with a note from your mum. So you have a strategy for a portfolio :say 60/40 eq/fi. You get left with some cash for some reason instead of having full allocation. Dividends/Interest I guess. Anyway, you need to split this between the eq and fi portions with some logic, because as any paypal user will know, you earn jack on the funds. The logic is NOT split the cash 60% and 40%. You have 2 choices (and remember this is all pre 2010 only) Choice 1: Allocate the cash in a proportion matching the current % eq and %fi in the account (%eq + %fi + %cash you got stuck with = 100%) Choice 2: Top up your %actual eq to % target eq using the cash, and top up your %fi to target fi using the cash. In either choice 1 or 2 you’re pretending that the return on cash is aither a return on eq or a return on fi and hence scaling down the eq and fi returns a touch. Then you include these new scaled down returns in your make believe composite. Post 2010: You can only use carve outs where the asset is separately managed and not part of a combined portfolio so far as I am aware…

So does that mean multi-asset class portfolios MUST be split into separate “make believe composites” with the appropriate cash allocation, with each asset class managed separately?

No I don’t think so. I think it’s saying, if you are going to have a single asset class composite, you can only include a cave out if it “is actively managed with it’s own cash balance”. I have to confess, I have no clue what that sentence in quotes means. The full one from schweser book 5 below. Quoting schweser (it’s gone midnight and I can’t face book 6) : “beginning 01/01/10, carve-out returns are not permitted to be included in a single-asset class composite unless the carve-out is actively managed with it’s own cash balance”

wow! you guys are the best! I’ve got it now. I guess Schweser can learn something from you :slight_smile:

I’ve just checked the worst written chapter in 3 levels of the CFA curriculum (GIPS, Book 6), and the quote is identical. So…go figure!

thanks allépourpêcher, the gips guru of AF