## Thursday, September 17, 2009

### Total return vs. NAV return

Just got a question from a client that I think is worthy of posting.

First, is "total return" the "industry standard." Before answering this, what IS "total return?" Total return simply means that the return includes income. It used to be fairly common practice to show income return, principal return, and total return. This is less common today. The GIPS(R) standards used to state that "total return, with income, is required," which was essentially redundant, since total return automatically includes income...this wording has changed! (hurrah!)

Yes, I'd say that "total return" IS the "industry standard."

Second, what about the NAV return? Is this a valid alternative? Well, the NAV return IS, first of all time-weighted and secondly includes income, since the NAV includes income, and therefore the NAV return is an equivalent approach.

1. My definition of total return is capital appreciation / depreciation + income earned and "+corporate action from distribution (yearly taxable gain/loss) and reinvestment from income distribution". I believe youre equation is a P/L calculation.

NAV per share is a fund accountant term defining as the total asset - total liability (total equity) and divided by total shares outstanding. Typically, the fund accounant uses an accrual base accounting system where as individual manager portfolio uses a cash basis accounting method. The differencs of the 2 methods relates to the expense accruals and not on the security accruals.

Since NAV is unite base (with flows already included), you normally would not need to use daily TWA or TTWA to calculate the monthly total return (you could).

Interestingly, a friend of my asked me a similar question several days ago, "What is the differences between a NAV versus a Price (in a fund and index). It took me over 10 min to explain. Do you think your client would know the differences?

2. If income is accrued daily to a capital account and distributed monthly doesn't this mean NAV % change isn't equal to Total Returns?

This may pertain more directly to mutual funds rather than institutional accounts. To magnify the degree to which NAVs can be massaged and misleading look at how their calculated for a hedge fund... and worse yet a Fund of Funds partnership.

3. If you use Bloomberg and look up a fixed income fund that makes monthly distribution, the TRA screen will show you both NAV return (I believe Bloomberg calls it the price return) and total return. Besides fund versus index, if you think this is confusing, we have not write about open end versus close end fund performance.

Unfortunate, GIPS does not mentioned anything about calculate a NAV return either using daily or monthly NAV when there is a distribution and / or reinvesment (because distirbution is not consider as a non discretionary cash flow). Calculating the NAV total return using monthly versus daily could have some differences (I perfer to use market value as a measure of my wealth). Just find a fixed income fund that makes monthly distribution, use Bloomberg TRA screen (change the frequency to daily than monthly) and you'll see what I mean. You can also use COMP screen as well.

Every performance calculations have its own limitation. For institutional or separate manage portfolio, the distribution should be treated as a non discretionary cash flow. If cash flow is material, make sure to run daily performance or have the portfolio value on the day of the flow. Whatever methods you plan to use, the results would be close but never identical.

Since I'm not familiar with IRR, anyone care to comment about how NAV with distribution and reinvestment be treated/calculated using IRR?

4. If you only use the ending NAV vs. the beginning NAV, then the return won't be a total return; you need to take into consideration the income (typically you assume that the income is reinvested).

5. In text book, we assume income and reinvestment rates are identical. In mutual fund world, the prospectus will spell out how the reinvestement rate is calculated (the calculation isn't difficult, but you might be surprised).

6. We are currently experiencing a similar challenge. We have daily NAV data captured for years and we would like to develop an internal performance report for the funds that we manage. Obviously we do not tie to the official fund performance particularly over long time periods because the nightly NAV's are not capturing the income component. Would it be better for us to calculate the performance using the market value data that also comes through in the nightly email? We are wondering what folks due to deal with this dynamic when they don't have access to the fund administration area of the fund entity?

7. I believe most firms shadow their funds. As long as you have accurate market values and cash flows you can derive returns, regardless of their source.