Thursday, October 6, 2011

When aggregate makes sense

Before you think "oh, here he goes again" please give me a second to explain. Okay, yes, it's true: I've been beating this to death (and will continue to, but not right now).

I was sent the following question from a client:

"How do you calculate performance for a composite that contains two or more funds?  Do you combine multiple funds' cash flows and calculate an IRR [internal rate of return] using all the funds' contributions, distributions and residual values as if they were from a single fund?"

Some background: the writer is speaking about a client's account, where they are reporting to the client, and are using the concept of a "composite" to pool the client's accounts together.

In this case, unlike with time-weighting, we would aggregate the accounts (starting and ending market values, as well as cash flows). We then calculate an IRR across this aggregate account. I would not encourage asset weighting individual IRRs, though to confess I haven't played around with it; my "gut" is speaking here.

And so, there is a place for aggregation: for IRRs, when we are reporting to a client about their return!


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