Takers vs. givers and GIPS discretion

Jed Schneider and I are doing a GIPS(R) (Global Investment Performance Standards) verification for a client, and a question came up regarding the need to create a composite.

A U.S. Equity manager is asked by a client to purchase some Canadian stock; would this (a) cause the account to become "non-discretionary" and/or (b) must the firm create a separate composite? Before I answer, let's consider the opposite situation:

Let's say you're a North America Equity manager (e.g., you invest in U.S. and Canadian stocks) and you have a client who says "No!" to the Canadian stocks; what would the answers be here? Well, first, it's up to the firm to determine if the exclusion of these stocks would cause such an impact that the account would not be representative of the strategy; if they feel that it would, they can declare it "non-discretionary" (for GIPS purposes). And, there would be no need to create a separate composite for the "U.S. only securities. However, they could (if they wanted) create a separate composite.

Why would the earlier example be any different? If the addition of Canadian stocks would cause the account to no longer be representative, why not declare it "non-discretionary"? And again, they would be under no obligation to create a separate composite. However, they could, if they wanted.

And what if they created a separate sub-portfolio for the Canadian stocks, so that they could have the U.S. stocks included, is this permitted? Yes, as long as the cash is being managed separately. And the Canadian-only portfolio, again, need not be included in a separate composite, because this was an accommodation for the client (just as the removal of Canadian stocks would be). Make sense?

In an email confirming his agreement with our position on this, our colleague John Simpson wrote:

If a client asked a US equity manager to buy some Canadian stock, then as far as composites there would be three options:

1. If the strategy is not inhibited/prohibited by the request, the portfolio should remain in the composite
2. If the strategy is inhibited/prohibited, the portfolio should be marked as nondiscretionary and excluded from composites
3. Alternatively, the portfolio could be added to a separate composite.

I do think that such a request might be more likely to make a portfolio nondiscretionary than a restriction in general, but I guess it depends on the Canadian stock purchased (or the restriction).

Whether the client is taking something away from your strategy ("no technology stocks for me!") or giving ("please add some health care to the mix"), the same rules for GIPS discretion can apply.

And so, we have agreement at our firm; what do you think?