Wednesday, August 11, 2010

Getting rid of the cash

Let's say you have a client who asks you to raise a sum of money, which requires you to sell securities. At what point is this cash no longer yours? That is, at what point should the cash no longer be reflected in the portfolio as being under your discretion? Well, as we used to say in the military,

immediately, if not sooner.

A problem many asset managers face is that the client asks you to raise the money, but then takes days, weeks, or perhaps even months to wire the funds out, all the time the cash is sitting in the portfolio, but you can't touch it! And, its mere presence is impacting your return. This cash, once raised, is arguably non discretionary, and should be isolated.

GIPS(R) (Global Investment Performance Standards) permits firms to temporarily remove an account from its composite in the event of a large flow, but this only solves part of the problem: the portfolio's return will continue to reflect this cash. And, what if the cash is still present after the allotted removal time has expired?

A better solution is to use a temporary account. The problem is that this can be a challenge for many, especially when you have to reconcile with the custodian.Perhaps a better solution is to identify this cash as "unsupervised." This is an analogous approach. Some systems support this, and you should consider employing this technique, where applicable.


  1. Stephen Campisi, CFAAugust 13, 2010 at 6:30 AM

    In theory, this is a very interesting situation, but I wonder whether this really poses any problem for the representativeness of the performance record. After all, managing liquidity is a part of managing a portfolio, so these transactions fall within the manager's scope of responsibility. The scenario you outline is really nothing more than a withdrawal from an investment account, and there is usually no significant and unspecified gap of time when cash is sitting in an account. This is best illustrated in the three types of accounts that exist: mutual funds, separate accounts and multi-asset client portfolios.

    With mutual funds, daily redemptions are part of the overall net cash flow into and out of the account, and dealing with this is a fact of life for every fund manager. Managing liquidity is part of managing a fund. Everyone agrees that client redemptions do not affect the time weighted return that best represents a manager's performance record.

    With separate accounts (single investment products) clients will make partial redemptions either for rebalancing or because they need money for something. The manager then sells securities and cuts a check to the client. This is usually done in an orderly manner at some stated frequency (usually monthly) so that the redemption process becomes close to that of mutual funds. (In fact, the process of managing new money inflows and redemption requests is often netted out via "in kind" transfers between client accounts rather than sales.) Again, the manager is in control and this is considered part of the regular investment process. Again, no impact on performance.

    The third situation is the one most likely to represent the problem identified - the client makes a liquidity request but doesn't draw the money right away. We find this situation frequently since the charitable organizations we invest for will make grants every quarter. As you indicate, we get a "heads up" notice that they need some money, and we exercise our discretion as to when and where to liquidate. That's OUR decision and it does not affect our investment discretion - after all, supporting the organization's financial goals in terms of their grant making is the reason the portfolio exists. Each fund manager's performance is unaffected, but I am now holding cash in the overall client portfolio. And, just as you indicate - they may leave the money in the account for a short while, and this cash could be a drag or a boost to performance, depending on the markets.

    So, how do we handle this? First we recognize that the impact is likely to be immaterial. Clients typically withdraw less than 5% in a year to meet their financial commitments. In a quarter, this represents a little over one percent of the portfolio's value - that's not likely to have a significant impact on performance. And, it's a fact of life. So, we look to our performance attribution and to our communication with our clients, noting that liquidity is a client goal, and that there is sometimes a cost involved. In essence, the availability of funds to meet client goals is important, and measuring our success is not fully explained simply by showing a return relative to a benchmark. Another mark of success is supplying the funds when they are needed.

    So it seems that for funds and separate accounts this is really not an issue, but for multi-asset portfolios some explanation to the client is required. But even here, the impact is probably immaterial.

  2. Steve, thanks for your insightful comments. I agree that the manager is responsible for managing the liquidity of the portfolio. In cases where the cash is immaterial, then nothing need be done, though arguably the option to isolate the cash could be done at any level. I guess the question is "at what point is the asset no longer under the control of the manager?" If it wasn't for the purpose of responding to a client request, the cash would be invested. However, because the manager has been asked to raise funds, he/she sells assets, resulting in the required cash, which may be removed quickly or sit around for days, weeks, or months. Once the cash is raised the manager can no longer do anything with that cash; it's no longer under his/her discretion; am I correct? If I am, then moving it to a "non-discretionary" status would, I believe, be an appropriate step to take. There are clearly times when the cash sitting there can be helpful to the manager, while (hopefully) at other times, it would be drag. Either way, it's no longer his/her cash; it's the client's.

    This is obviously especially problematic when we're talking large sums, which actually was the reason this discussion arose recently with a client (one of their clients had asked to liquidate roughly 40% of the portfolio, but the cash sat around for a couple months).

    If a firm were to adopt this policy, then they would have to document it and ensure that they carry it out on a consistent basis.

  3. Stephen Campisi, CFAAugust 14, 2010 at 10:15 AM

    So it seems we agree that when the amount of the redemption request is small (which it usually is) there is no real issue here regarding the integrity of the performance record. We also agree that the performance record can be skewed in those exceptional circumstances where a) the request is significant in size and b) the client does not actually withdraw the cash. As you say, the cash is not under the control of the manager, and therefore it's not a discretionary asset. So, what's a manager to do?

    It seems that the answer lies in having the investment managers clarify their policy regarding redemptions. They probably already have an established notice period in place. They also need to inform the client that the money from redemptions is paid the day after the liquidation is completed and the proceeds are delivered to the investment manager. This eliminates the timing issue involved here. Mutual funds pay the day after the redemption requests. Separate account managers should follow the same standard.

  4. Steve, yes, we agree, though I wouldn't stand in the way of a firm that wishes to treat ALL cash raised for clients as non-discretionary, regardless of the impact. And I agree that they need a policy and should communicate with their clients on how this is handled.

    If we have two accounts which are managed identically, with very little cash, and then one decides to request funds, the cash that is raised, even if the manager does a sale that maintains the weights of the holdings, will result in a different return if the cash sits around for any length of time. We use time-weighting to eliminate the impact of client decisions, which is great save for the cash that IS impacting the return. By isolating it quickly, the goal of not having these non-manager directed decisions impacting returns is solved.


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