Living large

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:

1. What is "large"? That's up to the firm, though I would think 10% should be the max
2. Can you have more than one definition? Yes, you can define "large" by asset class or composite.
3. 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.