By Alex Brandolini CFA
Time Weighted vs. Money Weighted Return
The time-weighted rate of return is appropriate when calculating the performance of broad market indices and mutual funds because the effect of contributions and withdrawals are not taken into account in the calculation methodology. This is because contributions and withdrawals can impact performance but are not under the control of the portfolio manager. When comparing the general performance of your portfolio or of your portfolio manager against benchmarks, the time-weighted rate of return is the most appropriate method.
The money-weighted rate of return represents the average growth rate of all funds in the account over a given time period. Both the timing and amounts of contributions and withdrawals have an effect and are taken into account when calculating performance.
To illustrate with an example, if a client makes a contribution right before a significant increase or decrease in portfolio performance, the money-weighted gain, or loss, will be higher than that of the time-weighted rate of return. Conversely, if a client makes a withdrawal right before a significant increase or decrease in performance, the money-weighted gain, or loss, will be less than that of the time-weighted rate of return.
Since portfolio managers normally compare their own performance to benchmarks most, including Croft, have used time-weighted return reports exclusively to make comparisons exclusive of each client’s individual cash flows. However, given the industry’s move toward transparency (new, industry-wide CRM 2 reporting requirements) and the need for an investor to be able to judge where they are at with respect to their costs and personal financial plan, money-weighted rate of return is now required for all Canadian investment account reporting.
Beginning with current Q3 reports, Croft has chosen to present both time-weighted return and money-weighted return performance numbers for comparison at both the Relationship (combined portfolio) and individual Client Account levels.