Performance Perspectives Blog

Non-discretionary cash: what to do with it

by | Apr 27, 2011

I was contacted earlier this week by a client who was dealing with a situation where one of their clients had requested them to raise a sizable amount of cash, for the ultimate purpose of investing it into a new strategy, while keeping the balance of their portfolio in its existing strategy. Unfortunately, once the cash was raised the client was nowhere to be found to finalize the agreement for the new strategy, so the cash sat in its original GIPS(R) (Global Investment Performance Standards) composite for an extended period of time, putting a drag on that portfolio and composite’s performance. What options did they have available to deal with this? Well, actually three:

  1. Adopt the significant cash flow option. This allows the firm to temporarily remove accounts from composites when there are “significant” flows. The challenge for this firm is that many of their composites only have a few accounts, and to adopt this option might result in breaks or gaps in performance.
  2. Use a “temporary portfolio” to move the securities into which are to be sold, or the cash that results from the sales. While I think this is a great tool, it does create some accounting challenges when it comes time to reconcile to the custodian, since the custodian only knows about one account.
  3. Flag the cash that was raised as “non-discretionary.” This would require a separate cash account to be established (e.g., “Non-discretionary Cash”), which is flagged on their accounting system as “unmanaged.” There could be an issue with reconciliation here, too, but it’s not nearly as daunting as with temporary portfolios.

To me, this scenario is a clear example of cash being non-discretionary: once it was raised, the manager could do nothing with it until they got instructions from their client. While the standards don’t speak directly to this, within the Composite Definition Guidance Statement we find a reference to “client-restricted securities,” so the Standards are clearly mindful of situations where the manager is unable to take action for securities. Cash is no exception when the manager cannot invest it.

In my view, all firms should be sensitive to situations like this. Think about it, once you raise cash for a client it immediately becomes non-discretionary and you could arguably move it out (into a temporary portfolio) or flag it (as non-discretionary). Perhaps you don’t want to do this in all cases, especially when the impact is de minimis, but when the cash is sizable relative to the portfolio and/or remains in the portfolio for an extended period, waiting for the client to withdraw it (or, in a case like our client’s, to instruct you as to what they want done with it), to take such action is quite reasonable and appropriate. You should have a policy on this matter, however, and you should employ your process in a consistent manner.

p.s., Recall that I will discuss the topic of policies & procedures in next month’s webinar. To learn more or to sign up, please contact Patrick Fowler. (It will be held on May 27)
p.p.s., The GIPS website provides access to PDF versions of the standards and guidance statements. I frequently access these to quickly find information. Just do a “find” on the topic you’re interested in, and you can quickly be sent to the section(s) of interest.

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