Calculate Significant Cash Flows

Owned by Tom Fahey (Unlicensed)
Last updated: Aug 03, 2023 by Jacob Mathews (Deactivated)
6 min read

The performance calculations that can be distorted by external cash flow distortions are Modified Dietz and Internal Rate of Return. To eliminate this distortion, SCF defines a threshold level that causes the return calculator to break the month into sub-periods bounded by the dates where a relatively large external cash flow is encountered.

Returns for each side of the cash flow are created and linked to determine a single return for the period. When a cash flow that does not meet the threshold is encountered, it is weighted with the normal calculation methodology, using the actual number of days in the period.Modified Dietz Return Calculation.

The calculation that follows shows a Modified Dietz Return without significant cash flow processing, using a beginning of day assumption.

EndingMarketValue-BeginningMarketValue-NetCashFlowsBeginningMarketValue+i-1nCashflowi×DaysInPeriod-CashFlowDayi+1DaysInPeriod

Instead, with significant cash flow processing you calculate sub-period returns and then link them together.

Sub-Period Calculations

The sub-period calculations are the same as the monthly calculation when you are not using significant cash flow processing.

EndingMarketValue-BeginningMarketValue-NetCashFlowsBeginningMarketValue+i-1nCashflowi×DaysInPeriod-CashFlowDayi+1DaysInPeriod

Finalized Sub-Periods

Significant cash flow processing (SCF) recognizes finalized sub-period returns. If one of the sub-period returns in the month has a final status, the existing sub-periods are not recalculated. You can check for this condition in the Diagnostics tab of the monthly report or the monthly record in the Commit Journal. If you want to recalculate the sub-period returns, disapprove all sub-period returns for that entity for that month using the Commit Journal.

Monthly Calculation

The monthly calculation geometrically links each of the sub-period returns.

1+SubPeriodReturn1×1+SubPeriodReturn2…1+SubPeriodReturnn-1

Threshold Calculation

When using the beginning or middle of day assumption, the threshold percent should be applied to the prior day's ending market value plus the sum of the first day's cash flows. This is because the first day's cash flows are weighted as 100 percent. So, the threshold dollar amount would be calculated as:

[Threshold] = ( [Prior Day's EMV] + [Sum of 1st Day's Cash Flows] ) x [Threshold Percent]

Example 1: Beginning of Day Assumption Calculation

The following table lists an example using a beginning of day assumption given this scenario.

Date

Ending MV

Cash Flow

Date

Ending MV

Cash Flow

01/31/1999

$1000



02/22/1999

$1200



02/23/1999



$150

02/28/1999

$1240



  • Identify significant cash flows. Significant cash flows include such amounts as the following:
    - 10 percent threshold would be $100 (1000x.10)
    - $150 cash flow on 02/23 exceeds threshold

  • Determine sub-periods. The following table lists the sub-periods for this example.

Sub-period

Start Date

Sub-period

Start Date

1

01/31/1999

2

02/22/1999

  • Calculate sub-period returns. Sub-period returns are calculated using the Modified Dietz or Internal Rate of Return calculation. Returns for this example are listed in the following table.

Sub-period

Return Calculation

Sub-period

Return Calculation

01/31/1999–02/22/1999

(1200-1000-0)/(1000+(0x(0/22)))

02/22/1999–02/28/1999

(1240-1200-150)/(1200+(150x(6/6)))

  • Link sub-period returns. Monthly returns are calculated using the geometric linking calculation, as shown in the example in the following table.

Period

Return Calculation

Return

Period

Return Calculation

Return

01/31/1999– 02/28/1999

((1+.2000)x(1+.0815))–1

.1022 or 10.22%


Example 2: Middle of Day Assumption Calculations
The following table lists an example scenario for a middle of day assumption.

Date

Ending MV

Cash Flow

Date

Ending MV

Cash Flow

01/31/1999

$1000



02/22/1999

$1200



02/23/1999



$150

02/28/1999

$1240



  • Identify significant cash flows. Significant cash flows include such amounts as the following:

- 10 percent threshold would be $100 (1000x.10)

- $150 cash flow on 02/23 exceeds threshold

  • Determine sub-periods. Sub-periods for this example are shown in the following table.

Sub-period

Start Date

End Date

Sub-period

Start Date

End Date

1

01/31/1999

02/22/1999

2

02/22/1999

02/28/1999

  • Calculate sub-period returns. Sub-period returns are calculated using the Modified Dietz or Internal Rate of Return calculation. Returns for this example are shown in the following table.

Sub-period

Return Calculation

Return

Sub-period

Return Calculation

Return

01/31/1999– 02/22/1999

(1200-1000-0)/(1000+(0x(0/22)))

.2000 or 20.00%

02/22/1999– 02/28/1999

(1240—1200—150)/(1200+(150x(6.0/6)))

-.0822 or 8.22%

  • Link sub-period returns. Monthly returns are calculated using the geometric linking calculation, as shown in the example in the following table.

Period

Return Calculation

Return

Period

Return Calculation

Return

01/31/1999– 02/28/1999

((1+.2000)x(1+.0822))–1

.1014 or 10.14%


Example 3: End of Day Assumption Calculations
The following table lists an example scenario using an end of day assumption.

Date

Ending MV

Cash Flow

Date

Ending MV

Cash Flow

01/31/1999

$1000



02/23/1999

$1200

$150

02/28/1999

$1240



  • Identify significant cash flows. Significant cash flows include such amounts as the following:

- 10 percent threshold would be $100 (1000x.10)
- $150 cash flow on 02/23 exceeds threshold

  • Determine sub-periods. Sub-periods for this example are shown in the following table.

Sub-period

Start Date

End Date

Sub-period

Start Date

End Date

1

01/31/1999

02/23/1999

2

02/23/1999

02/28/1999

  • Calculate sub-period returns. Sub-period returns are calculated using the Modified Dietz or Internal Rate of Return calculation. Returns for this example are shown in the following table.

Sub-period

Return Calculation

Return

Sub-period

Return Calculation

Return

01/31/1999– 02/23/1999

(1200—1000—150)/(1000+(150x(0/23)))

.0500 or 5.00%

02/23/1999– 02/28/1999

(1240-1200-0)/(1200+(0x(0/5)))

.0333 or 3.33%

  • Link sub-period returns. Monthly returns are calculated using the geometric linking calculation, as shown in the example in the following table.

Period

Return Calculation

Return

Period

Return Calculation

Return

01/31/1999– 02/28/1999

((1+.0500)x(1+.0333))–1

.0850 or 8.50%

 

Process SCF without Begin or End of Month Positions

Performance allows you to run SCF processing for entities that do not have begin or end of month positions. When linking the sub-period returns, the SCF ignores the sub-period if the begin of month position is missing and the first sub-period return is null. Or the end of month position is missing and the last sub-period return is null.

The supported scenarios based on day weighting assumptions are as follows:

  • End of day assumption

If the begin of month position is not found, SCF processing creates a break at the first cash flow date. If this is the only cash flow date during the month, then you have two sub-periods. The first sub-period is from the prior month-end to the cash flow date and the second sub-period is from the cash flow date to the current month end. The first sub-period has a zero/null return because the cash flow equals the ending market value on cash flow date.

If the end of month position is not found, SCF processing creates a break at the last cash flow date. If this is the only cash flow date during the month, then you have two sub-periods. The first sub-period is from the prior month-end to the cash flow date and the second sub-period is from the cash flow date to the current month-end. The second sub-period has a zero/null return because there is a zero ending market value on both the cash flow date and the current month-end.

  • Begin or middle of day assumption

If the begin of month position is not found, SCF processing creates a break at the day before the first cash flow date. If this is the only cash flow date during the month, then you have two sub-periods. The first sub-period is from the prior month-end to the day before the cash flow date and the second sub-period is from the day before the cash flow date to the current month-end. The first sub-period has a zero/null return because there is a zero ending market value on both the prior month-end and the day before the cash flow date.

If the end of month position is not found, SCF processing creates a break at the last cash flow date. If this is the only cash flow date during the month, then you have two sub-periods. The first sub-period is from the prior month-end to the day before the last cash flow date and the second sub-period is from the day before the last cash flow date to the current month-end. The second sub-period would has a zero/null return because the cash flow equals the market value on the day before cash flow date and the current month-end market value should be zero.

Reduce Return Distortion

The distortion that significant cash flow processing reduces becomes apparent when comparing SCF to non-SCF returns, as shown in the following table.

Assumption

SCF Return

Non-SCF Return

Assumption

SCF Return

Non-SCF Return

Beginning of Day

10.22%

8.72%

Middle of Day

10.14%

8.74%

End of Day

8.5%

8.77%

Compare SCF with Daily Returns

The following table lists an example, using the beginning of day assumption, of the difference in returns using the SCF and daily return calculation methods.

Date

Ending Market Value

Cash Flow

SCF Return

SCF Growth Rate

Daily Return

Daily Growth Rate

Date

Ending Market Value

Cash Flow

SCF Return

SCF Growth Rate

Daily Return

Daily Growth Rate

1/31/1999

$1,000











2/1/1999

$1,001







0.0010

1.0010

2/2/1999

$1,002







0.0010

1.0010

2/3/1999

$1,003







0.0010

1.0010

2/4/1999

$1,004







0.0010

1.0010

2/5/1999

$1,005







0.0010

1.0010

2/6/1999

$1,006







0.0010

1.0010

2/7/1999

$1,007







0.0010

1.0010

2/8/1999

$1,008







0.0010

1.0010

2/9/1999

$1,009







0.0010

1.0010

2/10/1999

$1,010







0.0010

1.0010

2/11/1999

$1,300







0.2871

1.2871

2/12/1999

$1,012







-0.2215

0.7785

2/13/1999

$1,013







0.0010

1.0010

2/14/1999

$1,014







0.0010

1.0010

2/15/1999

$1,015







0.0010

1.0010

2/16/1999

$1,016







0.0010

1.0010

2/17/1999

$1,017







0.0010

1.0010

2/18/1999

$1,018







0.0010

1.0010

2/19/1999

$1,019







0.0010

1.0010

2/20/1999

$1,020







0.0010

1.0010

2/21/1999

$1,021







0.0010

1.0010

2/22/1999

$1,200



0.2000

1.2000

0.1753

1.1753

2/23/1999

$1,022

$150





-0.2430

0.7570

2/24/1999

$1,023







0.0010

1.0010

2/25/1999

$1,024







0.0010

1.0010

2/26/1999

$1,025







0.0010

1.0010

2/27/1999

$1,026







0.0010

1.0010

2/28/1999

$1,240



-0.0815

0.9185

0.2086

1.2086

Monthly Linked Return





0.1022



0.1022



The Significant Cash Flow monthly linked return equals the daily linked return.

About Required Positions

The required valuation varies depending on the cash flow timing assumption you are using. If using a beginning of day or middle of day assumption, a valuation for the end of the day prior to the cash flow is needed.

However, if using an end of day assumption, a valuation for the end of the cash flow day is needed. These requirements are listed in the following table.

Assumption

Positions Needed

Assumption

Positions Needed

Beginning of Day

Cash Flow Day -1

Middle of Day

Cash Flow Day -1

End of Day

Cash Flow Day

About Weekend Exceptions

If you use beginning or middle of day assumptions and the significant cash flow occurs on a Monday, Friday's valuation is used, but the sub-period ends on Sunday. The exception is when a month end falls on the weekend. If the month end falls on the weekend, the month end valuation is used instead of the Friday valuation. If the month end is on Sunday, no sub-period is created, but if the month end is on Saturday, a sub-period from Saturday to Sunday is created.

If you select the Use Business Calendar option in the report profile's Significant Cash Flow Processing dialog box and the prior day is not a business day, the sub-period ends on that date but uses positions from the next business day back.

If you use beginning or middle of day assumptions, select the Use Business Calendar option, and the significant cash flows occurs on the day after a non business day, the SCF Processing uses the entity level business calendar to find the nearest previous business day. It uses that market value in the calculation. If no entity level business calendar is available or if the source specified has no business calendar, the system uses the Eagle PACE business calendar.

Day weighting is based on the sub-period dates, not the end position date.