Reporting on consolidated accounts

This topic has come up a few times recently, so I thought it worth touching briefly.

The situation: a client's account holds multiple portfolios, which are handled by different managers. Some have time-weighted returns, while others have money-weighted returns. How should a consolidated return be calculated?

First, we need to know what the perspective is. If we want to know how the client is doing overall, then we'd want to:

• aggregate the holdings
• calculate a money-weighted return (e.g., internal rate of return)

This return takes the cash flows into consideration, and tells the client "this is how your entire account is doing."

If, however, we want to come up with a return that tells the client how his/her managers are doing overall, we're faced with a bit of a dilemma. There are at least three options:

1. Aggregate the account and calculate a time-weighted return
2. Calculate time-weighted returns for all portfolios and asset-weight these results
3. Asset-weight the portfolios' returns, even when they're a mix of time- and money-weighted.

The problem with the first approach is that it treats the account as if it's being managed in its entirety, when, in reality, its made up of individual portfolios which are managed individually. Recall my general dislike for the aggregate method, especially when it comes to GIPS(R) (Global Investment Performance Standards).

The second approach makes some sense, except when we recall that for some portfolios, MWRR is the preferred (and in some cases, mandated) approach. To switch to TWRR would yield an incorrect value, and thus provide an overall return that is suspect (actually, invalid).

The third is my preferred approach. The challenge is that with some of the client's portfolios, valuations may occur infrequently; perhaps at most quarterly. The firm could asset-weight based on the shortest common period of valuation. Or, for periods when an asset isn't revalued, still calculate the return (which will probably be zero).

More needs to be said and done about this, and I'll pursue this further, starting with this month's newsletter.