What Is “Cash” In Your Investment Portfolio?

When you hear the word “cash,” you would think, “OK, I know what that is.”  But when it comes to portfolio accounting you should know that there are a few types of cash:
1) Cash, like you would have in your wallet, in your domestic currency
2) Cash, not in your domestic currency
3) Cash Equivalents (money market funds, short term investment vehicles)

Does Cash Earn Profits and Losses?

The surprising answer is, yes!  And I am not talking about inflation here – in that sense, cash does lose value.  What I am talking about profits and losses in the portfolio accounting system.
The following two types of cash holdings will earn profits and losses:
1) Cash not in your domestic currency will earn both gains and losses through fx rate changes, and
2) Cash equivalents will earn gains through interest, and possibly price changes.

 

What Other Ways Can Cash Change Value in a Portfolio Accounting System?

You will see cash values change when there is a transaction such as the following:
* A purchase of a security –> similar to when you buy anything, you have to spend money to buy a security (thus a decrease in cash, increase in securities)
* A sale of a security –> similar to when you sell anything, you will get cash when you sell a security (thus a increase in cash, decrease in securities)
* A cash flow where a client deposits cash (increase in cash) or withdraws cash (decrease in cash)
* A cash dividend where the security distributes income to shareholders (increase in cash)
Example of security accounting for domestic cash:
Date (Close of Business)Units of CashPrice per UnitTotal Market ValueP&LReturn
Day 11,0001.001,000
Day 21,0001.001,00000.00%

What is Traded Cash vs Settled Cash?

Typically, accounting systems will have two cash balances!  What??
Yep, thats right: One will reflect cash changes as trades are made, almost real-time (this is called traded cash).  The other will reflect cash changes only when the transaction really settles (this is called settled cash).
Think about your bank account.  Once you deposit a check, the balance will go up, but part of it will be pending.  The balance reflecting the check you just deposited would be like traded cash, and the balance without the cash deposited would be the settled cash.
These two will differ when there is an unsettled transaction.
Example in an investment account) You have $100 in an account and you decide to buy $80 worth of stock. You buy it on Monday and the transaction will “settle” in your account on Wednesday. Even though the stock and cash don’t move until Wednesday, the economic ownership of the stock and decrease in cash is effective Monday.
Date (Assume Close of Business, except where Market Open is noted)Stock PriceValue Held in StockSettled CashPayableTraded Cash
Friday

Simply hold $100 in cash
1000100,000100,000
Monday

"Trade Date," this is the day you take economic ownership of the Stock and a payable is established to reflect that you owe someone cash
9898,000100,000(98,000)2,000
Tuesday

Trade Date + 1, You get performance from market fluctuation even though cash and stock is not settled.
9999,000100,000(98,000)2,000
Tuesday

Settlement Date (Trade Date + 2), You get performance from market fluctuation and cash moves out from settled cash
103103,0002,0002,000
Day After Pay Date

Performance impact from hypothetical market fluctuation.
104104,0002,0002,000
From a performance standpoint, the correct way to reflect changes in cash (and trades) in the portfolio return is based on the economic ownership changes which is on trade date (Monday in this example). That’s why performance systems typically use trade date cash. There is also relevant GIPS Guidance on this topic under the under the Q&A section if you look at the “Trade Date Accounting” category.

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