Dealing with significant cash flows

I had a conversation recently with a GIPS(R) (Global Investment Performance Standards) verification client who is trying to deal with occasions when clients make very large withdrawals. In preparation for the transfers, their managers sell securities to raise the necessary cash, which can include income that won't be reinvested but rather earmarked for the withdrawal. Unfortunately, the cash places an understandable drag on the performance. How might they deal with this?

I'd say there are three options:

1. They can take advantage of the "significant cash flow" option: that is, to temporarily remove the portfolio from its composite, so that the distortions that arise from this client-directed activity doesn't impact the composite's performance. There is a guidance statement that discusses this in detail. This is a great option, however it doesn't work well if you only have a few accounts in the composite. You can apply this policy on a composite-specific basis (i.e., you don't have to do it "firm wide"). You should only use it in cases where there are enough accounts in the composite such that its implementation won't risk a "break" or "gap" in performance.
2. You can create a "temporary account" to hold the cash as it's being raised. This is an administrative / accounting process and is often a challenge, depending on the firm's accounting system and reconciliation process. However, it can be viewed as an ideal approach to solve the problem.
3. You can "flag" the cash that is raised as "non-discretionary" or "non-managed." To do this effectively, it would probably make sense to create another cash account (perhaps something like "transition cash" or "unmanaged cash") to move the cash into. It would still show up on the client's statements but would be excluded from your returns. This will only work, of course, if your portfolio accounting system allows assets to be flagged as "non-managed," and your performance system set to exclude them from their return process.

To employ any of these approaches requires that you do it consistently. Therefore, a policy and process is necessary to ensure that you do.