What Is a Temporary New Account?
A temporary new account is a holding place set up within a fund to hold a balance as a result of a significant cash inflow or outflow to the fund. The account is set up to temporarily hold these funds until they can be distributed to unitholders, used to acquire additional assets for the fund, or for other large fund expenditures. Temporary new accounts simplify fund accounting because they separate the balances intended for inflows or outflows from other balances or assets.
- A temporary new account is a holding place set up within a fund to hold a balance as a result of a significant cash inflow or outflow.
- The temporary new account holds the funds until they are used or distributed.
- The accounts streamline and simplify accounting and cash flow processes, and their use is recommended by the Global Investment Performance Standards.
Understanding Temporary New Accounts
Large external cash flows in a portfolio can be a problem for most firms. These flows of cash can significantly impact the implementation of an investment mandate, objective, or strategy. They can also affect the performance of a portfolio or a composite.
To better manage large cash flows, temporary new accounts are set up by funds to streamline and simplify the accounting and cash flow process. This process is recommended by Global Investment Performance Standards (GIPS), a set of voluntary best practices developed by the CFA Institute that is designed to give investors additional transparency to evaluate investment managers.
By setting up separate accounts, a fund can easily determine the amount of money that is going to be distributed to unitholders or roughly the amount of money it will use to purchase additional holdings for the fund.
According to the GIPS standards, an external cash flow is defined as "capital (cash or investments) that enters or exits a portfolio. A significant cash flow is defined as the level at which the firm determines that a client-directed external cash flow may temporarily prevent the firm from implementing the composite strategy. Transfers of assets between asset classes within a portfolio or manager initiated flows must not be used to move portfolios out of composites on a temporary basis."
Temporary New Accounts and Composites
Large amounts of cash inflow or outflow at one time can be disruptive to the maintenance of a composite. A composite is defined by the GIPS as an aggregation of one or more portfolios managed according to a particular investment mandate, objective, or strategy.
Fee-paying, discretionary portfolios are included in composites while non-discretionary ones are not. An anticipated significant inflow or outflow would call for the establishment of a temporary new account, in accordance with GIPS guidance, to minimize the impact on the composite that an investment manager would like to keep stable.
Example of the Use of a Temporary New Account
Let's say a significant cash flow is withdrawn from a portfolio at the end of the month, the firm would move the necessary cash and/or investments into a temporary new account for liquidation or distribution to the client.
The thresholds for such cash flows that require the set up of temporary new accounts should be determined before a composite is constructed and communicated to clients.