Monday, June 14, 2010
Dynamic valuation tests
As you are probably aware, effective 1 January 2010, GIPS(R) (Global Investment Performance Standards) compliant firms must now revalue for large cash flows. I believe this is a lot more challenging that one would think at first glance. Let's take the case of an asset manager that uses monthly Modified Dietz and revalues for flows greater than 10%.
Consider the following:
What if there's a portfolio that begins the month with $100,000 and the client adds $20,000: clearly this is a flow that is greater than 10%, and so you revalue (let’s say that the initial $100,000 has grown to $101,000, so the portfolio value (with the flow) is now $121,000). A week later (still in the same month) a client gives the manager an additional $15,000...is this a large flow? If we compare it with the initial $100,000 we would say it is: but if we compare it to the most recent valuation ($121,000) it’s small, yes? I would argue that you shouldn't revalue for this second flow
Or, let’s say we begin with $100,000 and the client withdraws $20,000 (a large flow), and let’s say that the portfolio after the flow is valued at $82,000. And now the client adds $9,500: is this a large flow? No, if we compare it to the initial $100,000, but yes if we compare it to the most recent valuation. And I would argue that they should revalue.
My article addresses this in greater detail, and as soon as it's available I'll point you to it.