Expert Level Item Set #15 - Modified Dietz and Significant Cash Flows

An Expert Level candidate asked some questions related to sample exam Item Set #15; the vignette is described below:


White Oaks Investment Management, a firm that claims to comply with the GIPS standards, manages an equity portfolio for the City of Kent’s pension plan. Patrick Lor, head of performance reporting, is reviewing Kent’s fourth-quarter portfolio activity and returns.

White Oaks uses the modified Dietz methodology to calculate monthly returns. The firm revalues portfolios when large external cash flows occur, and transfers cash and/or securities to or from temporary new accounts when there are significant cash flows. For the composite that includes the City of Kent’s portfolio, both large and significant cash flows are defined as cash flows that exceed ten percent of the portfolio’s market value.

The City of Kent contributed £6.5 million to its portfolio on 15 October and withdrew £22 million on 16 December.

The portfolio manager reallocated £20 million from the energy and gold sectors to the financials and health care sectors. The trading activity began on 20 November and was completed on 24 November.
Lor reviews Exhibit 1, which was prepared by a member of his staff.

 

In particular, the candidate's question was with respect to the second question in this Item Set:

Item Set 15, Question 2 (2010)

Calculated in accordance with the GIPS standards, the fourth quarter return for the City of Kent Pension portfolio is closest to:

( )A. 4.73%.

( )B. 5.86%.

( )C. 8.07%.

The activity with the temporary account is internal cash flow activity, not external cash flow activity.  Thus, your return calculations don’t need to consider it.

Thus your answer should be 4.73%.  This is the geometric linking of 3.688% for October, -2.804% for November, 0.9615% for the first sub-period in December and 2.926% for the second sub-period in December.

In calculating the October return, the contribution on October 15th should be day-weighted within the 31 day month.

November does not have any external cash flows.  The return can be calculated by simply taking 

(EMV - BMV) / BMV, where EMV is ending market value and BMV is beginning market value.

In calculating the December return, the withdrawal on the 16th of December breaks the month into two sub-periods.  The return for the first sub-period is 210/208 -1.  The return for the second sub-period is 
(193.5 - 210 + 22) / (210 - 22), which assumes start of day timing for cash flows.