We have a GIPS(R) (Global Investment Performance Standards) verification client who uses Advent’s Axys portfolio accounting system. Most of their clients are at Schwab, and they have a direct feed from Schwab to Advent. However, they had a couple accounts elsewhere, and hadn’t included them in their composites, because they hadn’t added them to Advent. This was a problem that had to be addressed.

They reached out to Advent, and were apparently told that they would have to add everything for each account for each time period, meaning market values and transactions. This would be a monumental task for our client. But, life doesn’t have to be so challenging. Before you continue to read, reflect on how you would handle this. [pause]

For GIPS, we don’t care about subportfolio activity; just market values and external cash flows: that’s it! But how can we get this onto Advent?

SIMPLE!!!

For each account, assign a unique dummy (fictitious) security, with them owning just one share. The security’s starting value is …

[drum roll]

…the starting value of the portfolio! For example, if the portfolio begins with $513,078.22, then the security is worth $513,078.22, and they have one share, meaning their market value is $513,078.22.

What happens when a cash flow occurs? Enter the flow on the date it occurs.

Subsequent months, whatever the broker/custodian tells you is the market value becomes …

…the price for the security! And so, if the next month the portfolio is worth $538,135.78, then this is the price of the security. And since the portfolio owns only one share, that’s what they’re worth. The only caveat here! Since they may have brought cash in, then the price of the security has to be the market value, minus the cash amount. Likewise, if there is a cash outflow, they will have to adjust the security’s price, so that cash is handled properly.

[i.e., the market value from the statement must equal the price of the ficitious stock, minus the value of cash, meaning (algebraically derived) the share price equals the market value of the statement minus the cash value!]

Two issues remain!

(1) As of January 1, 2010, GIPS compliant firms must revalue their portfolios for large external cash flows, even those firms who use the aggregate method to derive composite returns (which Advent uses), even though this method doesn’t use the underlying portfolio returns. So what must they do? IF they discover that large flows occurred, then they would have to revalue the portfolio on those days, and consequently set the fictitious security to this value (plus or minus the cash flow amount).

(2) ALSO, the “large cash flow rule” applies to the composite, too, meaning that if the composite has a large flow, the entire composite is revalued. HOWEVER, given the size of their composite, the likelihood of it (the composite) experiencing a large flow is infinitesimal.

Make sense?
Can you think of a better way or a flaw in my method? Let me know!