# INVESTMENT PERFORMANCE COUNCIL (IPC)

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2 Are there other areas of calculatio methodology that should be addressed i this Guidace Statemet? Is it reasoable to expect that firms will be able to value portfolios at the time of ay exteral cash flow begiig 1 Jauary 2010 (excludig real estate, veture capital, ad private equity)? Do you agree with the proposed Effective Date? If ot, whe should the guidace become effective? If commetators suggest other proposals, AIM requests that they explai the ratioale behid their proposal. 2

7 T that uses actual valuatios at the time of exteral cash flows (Likely required begiig 1 Jauary 2010) The actual valuatio of the portfolio each time there is a exteral cash flow will result i the most accurate T calculatio. I practice, this requiremet ca oly be met by havig the ability to obtai daily valuatios o all portfolio holdigs o a cotiuous basis. Daily Valuatio Method. The Daily Valuatio Method calculates the true T rather tha a estimate. The Daily Valuatio Method breaks the total performace period ito sub-periods, based o the occurrece of cash flows, i order to remove the effects of the cash flows. The formula for calculatig the sub-period retur is: ( EMV BMV ) BMV where EMV is the market value of the portfolio at the ed of the sub-period, before ay cash flows i the period, but icludig accrued icome for the period. BMV is the market value at the ed of the previous sub-period (i.e., the begiig of the curret sub-period), icludig ay cash flows at the ed of the previous sub-period ad icludig accrued icome up to the ed of the previous period. The sub-period returs are the geometrically liked accordig to the followig formula: T (( 1 + ) ( 1 + )...( 1 + )) where T is the total retur ad 1, 2 are the sub-period returs for sub-period 1 through respectively. Sub-period 1 exteds from the first day of the period up to ad icludig the date of the first cash flow. Sub-period 2 begis the ext day ad exteds to the date of the secod cash flow, ad so forth. The fial sub-period exteds from the day after the fial cash flow through the last day of the period. This method assumes that the cash flow is ot available for ivestmet util the begiig of the ext day. Accordigly, whe the portfolio is revalued o the date of a cash flow, the cash flow is ot reflected i the Edig Market Value, but is added to the Edig Market Value to determie the Begiig Market Value for the ext day. The chief advatage of this method is that it calculates the true time-weighted rate of retur rather tha a estimate. The major disadvatage is that it requires precise valuatio of the portfolio o the date of each cash flow, somethig that may ot be practical for some firms at this time. I practice, this meas that firms must have the ability to value portfolios o a daily basis. If all securities are ot accurately priced for each sub-period valuatio, errors geerated i the retur calculatio usig the daily valuatio method may be greater tha the errors caused by usig the approximatio methods. I such cases, it is importat to be able to correct for errors, 7

8 such as missed security splits, mis-pricigs, ad improperly booked trasactios, because day-today compoudig will ot correct for them automatically if there are cash flows. Sice a time-weighted rate of retur usig actual valuatios at the time of exteral cash flows will likely be required for periods begiig 1 Jauary 2010, firms usig a approximatio method will have to chage their calculatio method by that time. Geometric Likig If mothly portfolio returs are calculated, the mothly returs are liked geometrically to compute a quarterly retur usig this formula: QT (( + ) ( 1 + ) ( 1 + )) 1 1 MO1 MO2 MO3 where QT is the portfolio quarterly retur ad MO1, MO2, ad MO3 are the portfolio returs for moths 1, 2, ad 3, respectively. Similarly, to compute the aual rate of retur for portfolio returs calculated quarterly, the formula to use is (( + ) ( 1 + ) ( 1 + ) ( 1 + )) 1 Y 1 QT1 QT 2 QT 3 QT 4 where QT1, QT2, QT3, ad QT4 are composite returs for Quarters 1, 2, 3, ad 4, respectively. Alteratively, firms could geometrically lik the twelve mothly returs to calculate the aual retur. Applicatio: Example 1: Give the followig iformatio, calculate the rate of retur for this portfolio for Jauary, February, March, ad the first quarter of 1998, usig the Modified Dietz Method: Date Market Value ( ) Cash ( ) Market Value Post Cash ( ) 12/31/97 200,000 1/31/98 208,000 2/16/98 217, , ,000 2/28/98 263,000 3/22/98 270,000-30, ,000 3/31/98 245,000 8

9 Solutio: Jauary Ja ( 208, ,000) 200, % February ( 28 16) Feb ( 263, ,000 40,000) ( 208,000 + ( 40, ) ) 6.66% March ( 31 22) Mar ( 245, ,000 ( 30,000) ) ( 263,000 + ( 30, ) ) 4.72% Quarter 1 QT (( ) ( ) ( ) ) % 1 Example 2: Give the followig iformatio, calculate the rate of retur for this portfolio for Jauary, February, March, ad the first quarter of 2000, usig the Daily Valuatio Method: Date Market Value ( ) Cash ( ) Market Value Post Cash ( ) 12/31/99 500,000 1/31/00 509,000 2/19/00 513, , ,000 2/28/00 575,000 3/12/00 585,000-20, ,000 3/31/00 570,000 Solutio: Jauary ( 509, ,000) 500, % 9

10 February 1/31/00 2/19/00 ( 513, ,000) 509, % 2/19/00 2/28/00 ( 575, ,000) 563, % 1/31/00-2/28/00 (( ) ( ) ) % March FEB 2/28/00 3/12/00 ( 585, ,000) 575, % 3/12/00 3/31/00 ( 570, ,000) 565, % 2/28/00-3/31/00 (( ) ( ) ) % Quarter 1 QT Mar (( ) ( ) ( ) ) % 1 10

11 Stadard 2.A.4: Composites must be asset weighted usig begiig-of-period weightigs or aother method that reflects both begiig market value ad cash flows. Discussio: A composite is a aggregatio of idividual portfolios or asset classes represetig similar ivestmet objectives or strategies. The objective i calculatig the composite returs is to use a method that will produce the same value as if the assets of all the idividual portfolios i the composite were aggregated ad a retur is calculated for oe master portfolio. The GIPS stadards are based o the priciple of asset-weighted returs. For example, if a composite cotais two portfolios, oe of which is te times the size of the other, the rate of retur for the larger portfolio should have more impact o the composite retur tha that of the smaller portfolio. The asset-weighted retur method accomplishes this by weightig each portfolio s cotributio to the composite rate of retur by its begiig market value (as a percetage of the composite s begiig market value). The Stadards require asset weightig of the portfolio returs withi a composite usig begiig-of-period weightigs, begiig-of-period market values plus weighted cash flows, or by aggregatig portfolio assets ad cash flows to calculate performace as a sigle master portfolio. The begiig market value-weighted composite retur, BMV, ca be calculated usig the formula ( BMV ) i i 1 BMV BMVTOTAL i where BMV i is the begiig market value (at the start of the period) for Portfolio i, i is the rate of retur for Portfolio i, ad BMV TOTAL is the total market value at the begiig of the period for all the portfolios i the composite. The begiig market value plus cash flow-weighted method represets a refiemet to the asset-weighted approach. Cosider the case i which oe of two portfolios i a composite doubles i market value as the result of a cotributio o the third day of a performace period. Uder the asset-weighted approach, this portfolio will be weighted i the composite based solely o its begiig market value (i.e., ot icludig the cotributio). The begiig market value plus cash flow-weighted method resolves this problem by icludig the effect of cash flows i the weightig calculatio as well as i the market values. The weightig factor is calculated usig a similar formula as the Modified Dietz Method: i, j ( CD D ) CD i, j where CD is the total umber of caledar days i the period ad D i,j is the umber of caledar days sice the begiig of the period i which cash flow j occurred i portfolio i. 11

12 The begiig market value plus cash flow-weighted composite retur, BMV+CF, ca be calculated as follows: BMV + CF i m ( BMVi + ( CF ) ) j i, j i j i m ( BMVi + ( CFi, j i j ) 1 1, i 1 j 1, where CF i,j is cash flow j withi the period for portfolio i (cotributios to the portfolio are positive flows, ad withdrawals or distributios are egative flows) ad i is the retur for portfolio i. The aggregate retur method combies all of the composite assets ad cash flows to calculate performace as if the composite were oe portfolio. The method is also acceptable as a assetweighted approach. Applicatio: Calculate the composite retur usig each of the three methods based o the followig data: Portfolio 1 Date Market Value (\$) Cash (\$) Market Value Post Cash (\$) Mothly etur 11.32% 12/31/99 100,000 1/10/00 103,000 20, ,000 1/22/00 130,000 1/31/00 133,000 12

13 Portfolio 2 Date Market Value (\$) Cash (\$) Market Value Post Cash (\$) Mothly etur 8.26% 12/31/99 500,000 1/10/00 512,000 1/22/00 530,000-70, ,000 1/31/00 470,000 Composite etur Begiig Market Value eightig Method: BMV ( 100, ) + ( 500, ) ( 100, ,000) 8.77% Begiig Market Value Plus Cash s Method: ( 31 10) POT1 POT BMV ( ) 2 + CF (( 100,000 + ( 20, ) ) ) + (( 500,000 + ( 70, ) ) ) (( 100,000 + ( 20, ) ) + ( 500,000 + ( 70, ) )) Aggregate Method: (Usig Modified Dietz Method) ( 31 10) Port1 Port 31 ( 31 22) % Jauary (( 133, ,000) ( 100, ,000) ( 20,000 70,000) ) ( 100, ,000 + ( 20, ) + ( 70, ) ) 8.93% 13

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