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GASB, the U.S. Government Accounting Standards Board, now requires public pension funds to report the internal rate of return (IRR). I was asked to provide some guidance during the directive's development. One could fully understand why time-weighting was considered, but they wisely saw the wisdom of money-weighting.
Our neighbor to the north, Canada, has a new set of security industry standards that also mandate the IRR.
GIPS(R)'s new initiative to encourage asset owners to comply includes the recommendation for the IRR. Regretfully, I didn't recommend in my comment letter that this be a requirement: I should have. But, a recommendation, for now, is very good.
What next? Well, there's plenty of room for more. For example, the GIPS Executive Committee should see the wisdom of mandating the use of the IRR whenever the manager controls cash flows. This is something a few of us have been asking about for some time; actually, dating back to the mid-1990s under the AIMR-PPS(R).
Stay tuned; I'm sure more will follow!
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Great news! We have seen that leadership in the regulatory sector can have a tremendous positive influence in terms of standards of service to clients. With that in mind, it should become clear to ALL clients (but especially those receiving a performance report on their TOTAL portfolio containing all of their assets) that unless they have a money-weighted return, they don't really have a report on the performance of their portfolio. Rather, they simply have a report on the managers of the funds held in their portfolio. It's critical to keep focused on the fact that clients frequently withdraw money from their portfolios to meet their financial needs. This applies to individuals, pension portfolios, insurance portfolios, endowment and foundations and other institutional clients. Clearly, what they need is a return that reconciles their beginning capital to their withdrawals (and/or contributions) and their ending capital. Of course, this is... the money-weighted return!
ReplyDeleteInteresting to note that when a portfolio withdraws from the portfolio, the money-weighted return will be higher than the time weighted return. Why? Because it includes the benefits provided by those withdrawals. Consider the idea that you (obviously) need a higher return to reconcile a beginning and ending value when you withdraw money in the interim. It's like saying that the TWR "leaves some return on the table" in only reporting on the success of the managers relative to their benchmarks; it ignores the success demonstrated by being able to withdraw money and retain or grow the value of the remainder. So, how could anyone argue against showing clients ALL of the success that's been achieved?
Thanks, Steve; great points!
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