CFA Level IEthical and Professional StandardsHard
A GIPS-compliant firm's portfolio begins the year with a market value of $1,000,000. On day 182 of a 365-day year, the portfolio receives an external cash inflow of $200,000. The portfolio ends the year with a market value of $1,300,000. Using the Modified Dietz method (an approved approximation for time-weighted return), what is the approximate annual return?
- A9.09%
- B10.00%
- C13.00%
- D20.00%
Show answer & explanationAnswer & explanation
Correct answer: A. 9.09%
Weight = (365−182)/365 = 183/365 ≈ 0.5014. Adjusted denominator = 1,000,000 + (200,000 × 0.5014) ≈ 1,100,274. Numerator = 1,300,000 − 1,000,000 − 200,000 = 100,000. Return = 100,000 / 1,100,274 ≈ 9.09%. GIPS requires time-weighted (or accurately approximated) returns to fairly reflect performance independent of the timing of external cash flows.
Why the other options are wrong
- B. This ignores the weighting adjustment for the timing of the cash flow.
- C. This incorrectly treats the cash flow as if it occurred at the very start of the period.
- D. This uses only the ending gain relative to beginning value, ignoring the cash flow entirely.
GIPS Return Calculation (Modified Dietz)
GIPS requires firms to calculate portfolio returns using time-weighted methodology (or acceptable approximations like Modified Dietz) to neutralize the effect of external cash flow timing on performance.
- Modified Dietz weights cash flows by the fraction of the period they were invested
- Formula: R = (EMV − BMV − CF) / (BMV + CF × weight)
- GIPS mandates such methods to ensure fair, comparable performance reporting across firms
Memory trick: Weight the cash by the days it stayed.