It appears that you believe a plan sponsor has 100% control of their cash flows, but this is not true. At the total fund level, the drivers of cash flows are contributions and retirements, and these are impacted by pension legislation and other factors. Within the asset classes, things like the asset allocation study and board policy (acceptable ranges within each asset class) are key drivers affecting allocation changes.
I won't argue that the external cash flows may be controlled by other parties, but the allocations across sectors, as well as the selection of the managers are controlled by the plan sponsor, even if the board is involved in these decisions. Thus, money-weighting has value here, too. I guess one question to ask: "what does a time-weighted return tell us at the fund level?" Your thoughts are invited.
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The money-weighted return provides several useful insights, even if the plan sponsor does not control all of the cash flows. First, it answers the critical question: "How did the portfolio do?" as opposed to the time weighted return which answers the question: "How did the individual fund managers do?" Surely it is important to know the return on the capital employed in the plan, especially since the amount of capital is changing. In fact, the plan exists for the purpose of supplying the cash flows that the participants receive, so these cash flows are a relevant part of the process, regardless of who directs them.
ReplyDeleteIt is an error to assume that the investment process is the result of a single person, or that the analysis of performance is narrowly limited to examining the alpha generated by a single decision maker. In reality, the investment process is often a collaborative one, both in terms of investment decisions as well as the exogenous factors such as contributions and withdrawals. That said, the relevant question remains as to how the overall portfolio performed. Once that is answered, one can go further into the various sources of return and relative return. There are several important questions to ask and answer, and the money weighted return provides insight into how the overall portfolio performed. Clearly, this is one of the first questions to answer satisfactorily. After all, you cannot understand the sources of return and relative return unless you have the starting point of the portfolio return. First things first.
Thank you for your insightful and detailed comments. I have already passed them along to the plan sponsor. In my case, "you're singing to the choir." Unfortunately, there are lots of folks who aren't yet "getting it." But we will continue to try.
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