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ArchivedEffective: 1 September, 2011 - 31 December, 2019Categories: Aggregate MethodSource: GIPS Executive Committee
We use the aggregate method to calculate monthly composite returns. We calculate portfolio returns monthly, and only value a portfolio during the month if it experiences a large cash flow that is greater than 5% of its beginning-of-month value. We use the same large cash flow level for the composite. If any cash flow is greater than 5% of the composite’s beginning-of-month value we value all of the portfolios in the composite. For one month we calculated a composite return that was lower than the return of any portfolio in the composite. Does this mean that the aggregate method is not accurate and should not be used?
The aggregate method is an accurate method for calculating composite returns. This method calculates the composite return using the sum of the portfolio-level information for those portfolios included in the composite for the full period. The situation described in the question, where the composite return is outside the range of portfolio-level returns for a given period, can occur if the policies used to calculate portfolio-level returns do not flow through to the aggregate composite-level return calculation policies. What is meant by “flowing through” to the composite is as follows: if any portfolio is valued during the month due to a large cash flow, the entire composite would also be valued and the sub-period return calculated for both the portfolio and the composite. However, in this situation, the large cash flow policies have been established such that only those portfolios in the composite that experience a large cash flow during the month are valued at the time of the large cash flow while the portfolios that did not experience a large cash flow are not valued during the month. To prevent this situation from occurring, the firm should consider establishing a policy where all portfolios in the composite are valued if any portfolio in the composite is valued during the month due to large cash flows. Once a firm has established large cash flow policies for a composite the firm must apply the large cash flow policies consistently.