This weekend's
WSJ has once again provided us with a topic to address, specifically from Jason Zweig's column, titled "
Why We Can't Tell if the Market is Half Empty or Half Full." He points out that "For most investors, getting a clear picture of where your portfolio stands isn't easy." The key words here are "your portfolio."
He later quotes Tom Chubb, a retired marketing executive who said "What I want to be able to do is to look at those different locations where my nest egg is stored and try to determine whether my financial advisers are doing a good job." Here we want to evaluate the financial advisers.
Jason identifies a few sites that might help the investor, such as Moringstar's, which has a "performance tab" where an investor can compmare their stock or ETF (exchange-traded fund) against the S&P 500, with dividends included. But would we really want to look at single investments? This has some value, no doubt, but the portfolio view is probably what most want to see. And if these investments are purchased and sold at different times, or in pieces, such a review won't really do us much good.
Apparently Google Finance is considering a "total-return chart," but they don't have any plans to introduce one. Yahoo apparently has one "in the pipeline."
What is it the investors are interested in? We've been through this a few times, yes? It depends on the perspective from which the question is posed:
- How am I doing? We want a money-weighted result.
- How is my portfolio manager or financial advisor doing? We're talking time-weighting.
Modified Dietz isn't a difficult return to calculate, and I'll be happy to provide anyone who'd like it a basic spreadsheet that can be used to derive these returns. They can then be chain-linked to develop an approximation to the true, time-weighted return, which will no doubt suffice for most investors who want to gauge the performance of those they rely on for their investments. For their own performance (i.e., money-weighting), they can rely upon Excel's built-in IRR functionality. We can provide guidance on how to do this, too. It's not really that hard.
Oh, and for Mr. Chubb and others like him, we are finding more and more broker/dealers (several of whom are our
clients) providing their clients with rates of return. Granted, they're often only from one perspective, but this solves at least one of their needs. And many can consolidate the holdings from other managers, so that the investor sees a single report that covers all their investments.
It really shouldn't be that hard, should it? We don't think so.
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I appreciate the clarity of your statement that linking money weighted returns (such as the Modified Dietz) is an APPROXIMATION of the true time weighted return. This continues to be a point of confusion for many, as those performance commentators (who should know better) keep on repeating the misstatement that linking money weighted returns "produces a true time weighted return.) This is simply not true. If a significant cashflow produced a biased money weighted return, then the linking of this incorrect return would be buried in the linking calculation and none would be the wiser. This point was brought up years ago (as part of the discussion behind the original AIMR PPS) by none other than Dr. Bruno Salnik, a giant in the academic world. Unfortunately, the myopic view of those in the traditional orthodoxy of time weighted returns paid no attention, and so we now have an incorrect understanding among performance practitioners that linking money weighted returns produces a true time weighted return. It does not.
ReplyDeleteSteve, thanks for sharing your thoughts. Unfortunately, in most literature we see Modified Dietz only shown as being a "time-weighted" rate of return (including the AIMR-PPS(R), GIPS(R), and most articles. Thus, the source of confusion. I'll credit Carl Bacon for clarifying the point for me, as linking Modified Dietz is equivalent to linking the IRR (as in the case of the BAI standards). Even Peter Dietz, in the articles of his which I've read, fails to make this point clear.
ReplyDeleteNot sure why anyone would consider the Modified Dietz to be a time weighted return, since the cash flows occurring within the performance period are an integral part of the return calculation. This is the definition of a money weighted return. It is the opposite of a TWR.
ReplyDeleteYour comment misses my point: you can link a series of money weighted returns (like the Modified Dietz) and this does not create a time weighted return. The mere fact that you link returns does not in itself create a time weighted return. This is the point of confusion and error that has become part of the performance analyst's training.
It's no more complicated than this:
a) Time weighted returns ignore the amount of capital at work. A TWR is simply the geometric average return that is applied to a static investment amount. It is a "constant force of return" that equates a single beginning value to an ending value.
b) Money weighted returns measure the rate of return on a variable amount of capital, whereby the changes to the amount of capital from withdrawals and contributions are part of the return calculation. MWR (in forms like Modified Dietz) create an average amount of capital that earns the money weighted return.
References to Modified Dietz being time weighted are simply incorrect - regardless of the source.