One of my favorite websites is www.Dictionary.com. I reference it frequently, when I come upon a word I'm unfamiliar with, or want to verify the meaning of a word I plan to use. I also subscribe to their "Word of the Day," which is usually a word I've never seen. A few weeks back the word was filiopietistic (fil-ee-oh-pahy-i-TIS-tik). It's an adjective "pertaining to reverence of forebears or tradition, especially if carried to excess." You may already be seeing where I'm going here.Excessive reverence for tradition.
As in ...
- Our devotion to, and love affair with, time-weighting
- Our need to use the (flawed) aggregate method to derive asset-weighted composite returns
- Our fixation on asset-weighted returns, rather than the much more meaningful equal-weighted variety.
There's a saying you may be familiar with:
"you can't teach an old dog new tricks."
Well, I'm 61, and I'm open to change and new tricks. Guys close to half my age refuse to budge.
And, to quote another saying, go figure.
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Except for some very specific situations (private equity, advisory agreements beyond the actual investment policy), the actions of investment managers are reflected in TWR. MWR are client's returns, for which the investment managers typically bears no reasonability. Reporting MWR is an extra (costly) service that could be provided by investment managers. It is also useful internally for investment managers, for example, a consistent negative difference between MWR and TWR can be used as a business case to promote advisory services. Mixing TWR and MWR in reports creates potential discussions or even legal issues. Last week, I talked to a group of investment professionals about this topic: they all agreed that bringing back MWR would be a reversion to pre-GIPS days. So in the context of your first example, I would expect "filiopietistic" tendencies to have relatively low explanatory power. Anyway: I wonder what the antonym of "filiopietistic" is!?
ReplyDeleteAndreas, I am a bit surprised by your thinking. MWR has HUGE benefits. Is it not beneficial to tell the client HOW THEY did? In cases where the client controls all of the decisions (e.g., retail brokerag), what possible role would TWRR play? Who controls subportfolio cash flows? MWRR should be the dominant method. "pre-GIPS days"? Parish the thought. First, it has nothing to do with GIPS. Second, it is recognizing that these two methods do two distinct things, each having value. And, putting them side-by-side isn't a legal issue, provided the report includes appropriate disclosures.
ReplyDeleteDave:
ReplyDeleteI tend to agree with you on this. The performance industry has to "get its head up off the desk" and end their myopic fixation on individual product returns and GIPS. We need to start thinking about the client. And we need to start thinking about the client's total portfolio, rather than simply looking at the individual pieces. Finally, we need to start thinking about the client's true benchmark: their financial goals - which are MONEY goals and not really RETURN goals.
That's a lot to think about. It's also the stuff that is left unaddressed by the performance industry - to our shame. Let's remember that our first duty of loyalty is to our clients - the people who give us their money to invest with the hope of achieving their financial goals. They need a return that reflects their goals, and that return is money weighted, not time weighted. We need the return on their portfolio and not the average of the individual managers. Let's remember that the portfolio cashflows that we consider a nuisance ARE the goals of the client - such as funding a key purchase or liability. So, let's answer the relevant questions (like "What was the return on my portfolio?") before devoting ourselves to the performance analyst's favorite "hobby" of examining mathematical nuances.
Steve, "tend to" isn't as strong as I'd like, but I'll take it. I don't see this as being complicated, but am surprised that use of MWRR hasn't become a de facto standard. I've got articles from Europe and the States from the '60s and '70s which basically say what you and I are saying, but somehow they got lost in the universal focus on TWRR. But, there's hope1
ReplyDeleteI would prefer to use the term IRR insted of MWR. IRR is a concept that has been analyzed at length in the context of theoretical economics almost 100 years ago, and even more so by later authors. The verdict is rather clear: it is a rather inconvenient and many times flawed decision criteria. Very interesting modifications have been proposed recently, but they are rather complex and not much work has been done in applying the proposed measures in investments. I am serious about these comments, but a bit naughty when I summarize them as: Promoting IRR is filiopietistic, not promoting better alternatives... ;-)
ReplyDeleteI would prefer the investment industry first to sort out their TWR calculations. Too many are still reyling on rather crude approximations, and calculating TWR on subportfolio level (segments, positions) is still in its infancy.
Andreas, IRR is too limiting; one can link IRRs and achieve an approximation to TWRR (aka, a "crude approximation"). One can employ Modified Dietz as a moneyweighted return (it is, of course, anyway), though it's arguably an approximation to TWRR.
ReplyDeleteWe've had a couple decades to "sort out" TWRR calculations; it's high time we used the better method!MWRR (aka, IRR)
Nuances like "I prefer to use the term IRR instead of MWR" and "first sort out TWR calculations" are perfect examples of the problem(s) facing the investment industry because of the "filiopietistic" reverence of mathematics rather than the duty of loyalty to our clients and the common sense around answering the critical questions that concern clients. How can anyone ignore the importance of the simple question: "What was the return of my portfolio" in favor of debating the intricate mechanics around the efficiency of solving an IRR calculation?
ReplyDeleteAt some point (AKA: right now) we should ask ourselves: "What is the purpose of performance?" Let's also answer the question: "Whom do we serve?" And let's not forget: "What questions do we answer with our calculations?" Let's take the last question: a TWR answers the question"What was the average rate of growth of a single money amount invested over a specific time period?" That's a good question and a good calculation method for a fund manager trying to get a new client, or to report his competitive performance to an existing client. It's not at all realistic for an investor whose goal is to withdraw money from the portfolio to satisfy financial needs while preserving enough value for future withdrawals. (Remember, these "cash flows" are not the equivalent of germs and diseases, as the current performance "orthodoxy" suggests.)
Now ask yourself: "Is calculating a TWR the extent of my responsibilities as a performance analyst?" What about the client and the questions that your clients care about? Imagine the pension fund manager who needs to know if the investments are fulfilling the goal of paying current benefits while preserving or growing the principal value so that future benefits will be paid? The TWR does NOTHING to answer that critical question - all it does is help individual fund managers stay employed. Is that all we are good for? The same is true for the foundation that makes regular grants (there are those pesky "cash flows" again!) and needs to know if it is earning a high enough return to continue fulfilling its mission. Does it start to occur to anyone that our clients need the return on the entire portfolio, including the effects of the cash flow withdrawals that represent the goal of the foundation?
So ask yourself, are you simply a "marketing minion" or are you a significant participant in the investment process? Do you want to hold arcane conversations regarding mathematical procedures, or do you want to play a role in truly helping our clients understand and manage their investments so that they meet their true financial goals? And remember, those goals are not to earn a time weighted return relative to a benchmark, adjusted for a textbook version of "risk" such as standard deviation.
Perhaps the first lesson for every performance analyst should be to go out and meet a real client and listen to why they invest and what they consider to be appropriate measures of success. I guarantee that they will not speak about the superiority of TWR nor the "inconvenient and flawed decision criteria" around the return on their actual portfolio as reflected by the MWR (oh, sorry - I should have said "the IRR...")
Little wonder why the performance industry continues to be compared to the "five blind men and the elephant." It's hard to measure something you've never seen. Fortunately, that's an easy problem to fix. The real question is this: "Are you serious enough about performance to learn about the clients you serve?"
I'm tired of asking myself so many questions ... geez! But, as I was told as a young boy, "listen to your elders," and so, I listen to Mr. Campisi, the "voice of the client." Thanks for sharing!
ReplyDelete(oh, and as I recall, the only one who compares the industry to the 5 blind men is you!)