What is the significant cash flow policy under GIPS?

Question

AcadiFi · Accepted Answer

The significant cash flow (SCF) policy allows firms to TEMPORARILY EXCLUDE a portfolio from its composite during a period when an external cash flow significantly disrupts strategy implementation.

RATIONALE: large deposits or withdrawals can force the manager to buy or sell securities at non-strategy-optimal times, resulting in return distortion that doesn't reflect strategy execution. Including such periods would unfairly hurt composite returns.

KEY RULES:

1) Firms must DEFINE 'significant' in writing — typically as a percentage of portfolio value (e.g., 10%, 20%) or an absolute dollar amount. The threshold must be strategy-specific (thresholds differ for fixed income vs. equity vs. alternatives).

2) Policy must be APPLIED CONSISTENTLY — firms can't selectively invoke SCF only when it improves composite performance.

3) Exclusion is TEMPORARY — for the period affected (often one day, one week, or one month), after which the portfolio returns to the composite.

4) Firms must DISCLOSE use of the SCF policy and the threshold.

5) Policy must be documented in the firm's GIPS manual BEFORE being applied.

6) Records of excluded periods must be kept.

CAVEATS:
- SCF is OPTIONAL — firms need not use it
- Some firms prefer not to use SCF to avoid administrative complexity
- When SCF is used aggressively, it can border on return manipulation, so auditors scrutinize

At Evergreen Trust Advisors, the SCF threshold was set at 15% for the Core Equity composite. When the Henderson Family Trust deposited 25% of portfolio value in March 2024, the portfolio was excluded from the composite for that month. The policy was disclosed in all composite presentations.

GIPS 2020 clarified that SCF provisions exist, but firms should PREFER proper interim valuation at cash flow dates rather than exclusion when feasible.

For CFA, remember SCF = temporary exclusion for disruptive flows, consistent application required.

What is the significant cash flow policy under GIPS?

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