I was at the Advent Users’ Group Conference in Chicago today, delivering a talk on the upcoming changes to the Global Investment Performance Standards (GIPS(R)). While there were several questions posed, a few dealt with the subject of “large cash flows.” Coincidentally, while at the event I got a call from a verification client who was trying to figure out how to calculate returns when large flows occur. And, I got an e-mail from a software vendor client who asked about netting flows to decide on “large.” A few quick points:
- What is “large”? That’s up to the firm, though I would think 10% should be the max
- Can you have more than one definition? Yes, you can define “large” by asset class or composite.
- Do bond managers who value their portfolios infrequently have to abide by this rule? (funny: this question came up in November during the GIPS conference, too). Yes! Sorry 🙁
The question about calculating has to do with the presence of both large and small flows in the same month. Large flows should be viewed as a breaking point, where you will split the month into two (or more, if there are more than one large flow) periods. If each subperiod has a small cash flow, then using Modified Dietz for each and then linking them would be fine.
The final point has to do with netting flows: can this be done to determine “large.” I don’t see why it wouldn’t work, provided you net absolute values and do it consistently. For example:
- 12/31 BMV = $100,000
- 1/5 Cash flow = $25,000
- 1/25 Cash flow = -$25,000
- 1/31 EMV = $110,000
If you do a straight net, you’ll have zero; clearly, you’ve got large flows at work. And so, by netting the absolute value you know you need to revalue. You would then revalue for both points where flows occur.