External Cash Flows

Can anybody shed some light on the following: GIPS spends lots of time addressing how to treat the returns impact of large external cash flows, but also allows portfolios to be temporarily removed from composites when such cash flows occur, presumably to be added back to the composite once the cash flows are invested (in the case of an inflow). I don’t get how these two make sense together. If a large cash flow happens, let’s say on June 10, the portfolio would be removed immediately after the May 31 valuation then added back at some point after the new money is invested? Why, then, would the firm even need to bother about valuation on the date of the large cash flow for purposes of computing composite returns??? Clearly I’m missing something here. Any help would be much appreciated.

I don’t believe that the portfolio is removed at all. What happens is you create a temporary account to hold the large cash flow, so it does not affect the composite return. The portfolio is included in the composite as cash is invested gradually until the entire CF has been invested.

That’s the recommended approach. But since this approach presents practical difficulties for most firms, it’s OK to temporarily remove the portfolio from the composite. Not going to get too worked up on this one…just seems odd…

If you are restructuring a fund to a different strategy you can also use a temporary composite until the new strategy is up and running and then form a new composite.