Performance Perspectives Blog

Significant cash flows … so easy to get wrong

by | Dec 10, 2009

Perhaps it’s partly because “significant” and “large” can be viewed synonymously that we find confusion regarding how firms can handle these within GIPS(R). One of our clients was clearly thinking that “significant” means the same as “large” when it comes to the standards, but it doesn’t. Significant flows deal with the opportunity to temporarily remove portfolios from composites in the event of large (sorry, I mean significant) cash flows…the idea being that all of a sudden you get a lot of cash and it may take time to invest it, so remove the account while you get the cash invested. On the other hand, effective 1/1/10, GIPS compliant firms will be required to revalue portfolios for large flows.

I’m at an outsourcing client who has a client who NETS cash flows during the month to determine if the account should be removed. NETS cash flows? And why do they do this??? Hopefully we’ll find out, but let’s think about this.

Their level to remove the account is >25% of the beginning market value. And so, we start with $1 million. On August 3 a $300,000 contribution is made. Then, on August 24, the account withdraws $250,000. Net = 300,000-250,000=5,000; 50,000/1,000,000 < 25%; therefore, don’t remove the account. WHAT???

If the firm actually wishes to take advantage of the optional significant cash flow provision, they should have removed the account because of the August 3rd contribution (because presumably there’s a bunch of cash they need to get invested). The fact that a few weeks later the client decided to withdraw funds has nothing to do with the earlier flow. In my opinion, they are confused!

Also, in my opinion: this is (a) wrong and (b) shouldn’t be permitted by the firm’s verifier.