Large vs Significant Cash Flows

& the GIPS Standards

While the requirements relating to “large” cash flows are focused on the accuracy of performance calculations, the purpose of establishing policies relating to “significant” cash flows are designed to help identify when portfolios should be temporarily removed from composites.

Large Cash Flow

Denotes the level at which the firm determines that an external cash flow may distort performance if the portfolio is not valued.

During volatile market periods, the Modified Dietz calculation methodology that daily-weights external cash flows based on the amount of time they were in the portfolio, begins to lose its accuracy as the size of the cash flow increases.

Significant Cash Flow

Describes the level at which the firm determines that a client-directed external cash flow may temporarily prevent the firm from implementing the composite strategy.

Large, external flows of cash or investments can significantly impair a firm’s ability to implement a portfolio’s intended strategy, causing the portfolio’s performance to deviate from that of the composite.

GIPS Requirement 3.A.12

A firm that removes portfolios from composites because of significant cash flows must define “significant” on an ex ante, composite-specific basis and must consistently follow the composite-specific policy.

GIPS Requirement 3.A.12

A firm that uses temporary new accounts to remove the effect of a significant cash flow must establish policies on an ex ante, composite-specific basis. Temporary new accounts must not be included in composite performance.

Establishing levels for the large cash flow policy and the significant cash flow policy should be done separately. Some implementation guidelines are provided below:

• The GIPS policy must be defined as a specific dollar amount OR a percentage of the portfolio assets.

• The cash flow’s 'impact' on returns is not a justifiable reason as a significant cash flow tolerance.

• The number of portfolios is also NOT a reason to remove the account from a GIPS composite (meaning, the firm may not 'suspend' a significant cash flow policy if the number of accounts in the composite goes below a certain level). The number of portfolios in a composite has no bearing on whether or not the portfolio ceased to become discretionary.

• Documentation and support for each time a portfolio is temporarily removed from a GIPS composite due to a significant cash flow must be maintained.

• The policy must only be applied prospectively and consistently – all portfolios that experience a significant cash flow must be temporarily removed from the composite.

• Both Large and Significant policies can exist independently of one another. The rule of thumb is that the Significant cash flow threshold is higher than the Large cash flow threshold.

• To avoice revaluting portfolios, firms are not allowed to set a Significant cash flow threshold equal to or lower than the Large cash flow threshold.

GIPS Significant cash flow policies are hard to maintain, and they create more hassle than they are worth. Your system should already be handling cash flows on a time-weighted basis, AND should have a calculation methodology for such items. The level for when a portfolio should be revalued mid-month will most likely be lower than the level for when an external flow would render a portfolio non-discretionary. Therefore, a policy of 'no policy' is the easiest route to take.