As Philip explained, the Canadian Securities Administrators have proposed amendments to the National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103 or the Rule) as well as Companion Policy 31-103CP Registration Requirements, Exemptions and Ongoing Registrant Obligations (the Companion Policy).
The introduction to the document states:
"The proposed amendments set out requirements for reporting to clients, relating to investment charges, investment performance and client statements. These requirements are relevant to all categories of registered dealer and registered adviser, with some application to investment fund managers.
"The proposed amendments would apply in all CSA jurisdictions, and we would expect the requirements for members of the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA) (together referred to as the self-regulatory organizations or SROs) to be materially harmonized."
The document includes the following:
"We are proposing to mandate that registrants use the dollar-weighted method in calculating the percentage return on a client’s account or portfolio, in order to promote consistency and comparability in investor reporting from one registrant to another.
"We had previously considered permitting registrants to choose between a time-weighted and dollar-weighted performance calculation method. We have decided to mandate the dollar-weighted method because it most accurately reflects the actual return of the client’s investments. This is in keeping with one of the main themes of the project – allowing investors to measure how their investments have performed.
"Time-weighted methods are generally used to evaluate the registrant’s performance in managing an account, as the returns are calculated without taking into consideration any external cash flows. These methods isolate the portion of an account’s return that is attributable solely to the registrant’s actions. The philosophy behind time-weighted methods is that a registrant’s performance should be measured."
This is exciting news to those of us who continue to champion the use of money-weighted returns.
I thank Philip for sharing this information; and look forward to reviewing the document in its entirety.
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Like most things, this pronouncement on the requirement of money-weighted returns will be a good thing if it is applied appropriately, and the opposite if it is not (mirroring the current situation where time-weighted returns are required.) As stated, TWR is the appropriate method for evaluating a product manager's results, since this implicitly assumes that the quantity invested does not change over the measurement horizon. This answers the questions regarding the manager's skill - it's a return on a "manager portfolio." It provides no information regarding whether the client met his investment goal, even if that goal is stated as a total return. So clearly, the money-weighted return (what some firms refer to as the "personal return") is the correct method for evaluating the return on a "client portfolio."
ReplyDeleteThis is especially true when evaluating the client's total portfolio of investments. Why? Because in this context the withdrawals are typically tied to the client's spending goals. While the client's true goals are "money, not returns" if one were to examine the return necessary to meet those goals, the MWR would be the appropriate measure. In this client-focused context, the issue regarding "comparability" makes sense. While clients do not share the same risk tolerance or return requirements, they ALL intend to withdraw money from their investment portfolios at some point to meet their financial obligations. If we intend to serve these clients by answering the only relevant question regarding their personal goals, then the "personal return" or money-weighted return is the correct one.
Let's just be careful not to apply MWR to evaluating fund managers. That would simply replace our current problem with its mirror image.
Steve,
ReplyDeleteI haven't yet reviewed the report in detail, but am hopeful that it will serve as a great example for others. Thanks for your comments!
Dave, do you anticipate most managers using the Modified Dietz method to meet this money-weighted "potential" requirement given that the use of IRR calculation can be cumbersome?
ReplyDeleteI would hope not, as Modified Dietz, though often quite a good proxy, isn't alwaysj; IRR is best. And it really isn't cumbersome, at all; to do it by hand, perhaps, but it's not difficult to program, and most vendors offer it.
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