Measuring active investment decisions
- On a portfolio level the TWR (time weighted return) is taken as the relative (%) performance figure because neutral in- and outflows should not distort the performance, since they are not under the influence of the portfolio manager.
- If the portfolio manager funnels actively assets into an asset class (e.g. active over weighting of Equity US against the benchmark) and hence withdrawals from another asset class (active under weighting) this is well under the influence of the portfolio manager, therefore I would like to see the effects of these active investment decisions.
- To see these effects, the MWR (Money weighted return) should be taken on sub portfolio levels as the TWR will not reflect any of those decisions (this is because the asset class in- outflows are again performance neutral with a TWR calculation)
- If the average invested capital (instead of start or end of period weights) is taken as the weight of the asset classes you don’t need to manipulate the figures with algorithms like Carino, Menchero or the like. They will sum up nicely on all levels.
- If there are no neutral in- and outflows, TWR equals MWR on a portfolio level and therefore you will end up with the TWR return in sum.
How to handle neutral in- and outflows?
- If there are neutral in- and outflows I suggest to take the difference of TWR and MWR on a portfolio level and call this the “client timing effect” or alike.
What do you think?
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