Gauge Portfolio Performance By Measuring Returns

Post on: 21 Июнь, 2015 No Comment

Gauge Portfolio Performance By Measuring Returns

Performance measurement is an important task for both investors and investment managers. Whether it is for a mutual fund. leveraged fund. derivative or fund of funds. performance must be calculated. Returns are most commonly quoted in absolute terms, but in reality they should always be compared to the strategy, and ultimately to the benchmark, they are designed to beat. Goals for each investor, whether they are individual or institutional, come in all shapes and sizes:

These varied goals mean that performance must be calculated frequently and accurately. Although institutions use industry standards to report performance, individual investors typically use less-sophisticated methods. Let’s take a look at some time-tested ways to calculate investment returns and determine how you can use them to judge your portfolio’s profitability. (Read Measure Your Portfolio’s Performance for more information.)

Return Calculation

To calculate rates of return accurately, you must account for the various transactions that occur during the period being evaluated. Buys, sells, income, distributions and contributions can all be included in the calculation, but the beginning market value (BMV) and ending market value (EMV) are the most important figures. All else being constant, a rough estimation can be made of the return.

To obtain these data points, asset values must be accurate:

  • Stock prices tend to be quoted based on the last trade of the day from the exchange on which they are traded. This value is rarely disputed, because it represents the price of the stock at that point.
  • Bonds, on the other hand, carry some variances in pricing. Because most bonds do not trade on an exchange, their prices are usually fed off a tape in a matrix pricing model.
  • Total bond market values can also include accrued income, which might or might not be included in the market value (MV), depending on the style of reporting. (Read more in Bond Market Pricing Conventions .)

In addition to variation in prices, there is also the debate over using trade date or settlement date as the method for evaluating MV. The difference between the two is that securities traded within settlement date of the month-end can hang out because they have not been delivered. Because the trade date is a better representative of what actually happened, the transactions can be backed into the portfolio’s transaction for the month as if they had settled. This provides a clean accounting of the portfolio’s actual value.

Time-Weighted Rate Of Return (TWRR)

Prior to the 1960s, returns were presented in various formats without much consideration as to when the cash flows were accounted for. Time-weighted rate of return takes cash flows into account for each period and standardizes them so they can’t hinder or help comparative performance. The TWRRs for each period are linked together to create the geometric return, instead of the arithmetic return, which is just the average. (Learn more about why the method of calculating returns matters in All Returns Are Not Created Equal .)

The calculation for TWRR is as follows:


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