Friday, December 11, 2009

What's the standard way to handle cash flows?

Here, I'm addressing cash flows from a return calculation perspective.

First, recall that in two weeks we'll have a requirement for GIPS(R) compliant firms to revalue portfolios for large cash flows, where the firm decides what "large" represents. But what happens when the flows aren't large?

I'd guess that most firms treat all flows as start-of-day events. There are, of course, some firms that treat them as end-of-day events. My recommendation: treat inflows as start-of-day and out-flows as end-of-day. I'd like to provide you with a clear explanation and rationale for this, but I'm unable to do this. Anecdotal evidence suggests that this is the best approach. Of late we've seen many firms and vendors begin to adopt this practice. That doesn't make it "right," but it at least adds support for my position.

Regardless of what approach you take, ensure that you're consistent in its application.

p.s., I just realized I didn't answer my own question! There is NO standard on how cash flows should be handled. GIPS doesn't address this, either. The only "standard" would be to be consistent...i.e., don't use cash flow timing to "game" the process to generate higher returns.

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