Free CFA Level I Ethical and Professional Standards Practice Questions

A carve-out under GIPS is a segment of a larger multi-asset portfolio that is separated and presented as a single-asset strategy composite. For example, the equity portion of a balanced fund could be carved out and presented as part of an equity composite. GIPS requires that carve-outs have their own cash allocation and be separately managed with dedicated cash to be included in composites. Removing a terminated portfolio retroactively due to poor performance is precisely the type of survivorship bias GIPS prohibits. Excluding non-discretionary portfolios is a general GIPS requirement, not a definition of carve-outs.

GIPS requires presenting total returns (capital appreciation plus income) calculated using time-weighted returns, which eliminate the distorting effect of external cash flows on performance measurement, allowing fair comparison of manager skill. GIPS does not prohibit gross-of-fees presentations, but requires clear disclosure of whether returns are gross or net of fees. Constructing composites by selecting only representative portfolios is prohibited — all discretionary fee-paying portfolios following the strategy must be included.

Okonkwo most likely violated Standard IV(B) Additional Compensation Arrangements. Participating in an outside investment club — which involves investment advisory activity outside of her employer — without disclosing and obtaining written consent from her employer is a violation of IV(B). Even if there is no direct monetary compensation, the investment activity may conflict with her employer's business interests and creates obligations of disclosure. Standard VI(B) could also be relevant if club trades trade ahead of client trades, but the primary issue here is the undisclosed outside investment activity covered by IV(B). Standard III(A) is too broad to be the primary Standard here.