When you think about it, what does the asset owner’s overall Time-Weighted Return mean?

For quite some time I have preached that the return should answer a question. To
determine, for example, whether to use a time- or money-weighted return, I’ll
ask “what question are you asking?”

For example, if you want to know your own performance, as an investor, money-weighting is what you want. Vanguard and other mutual fund companies now provide investors with the ability to see their
”personal rate of return.“ This is a money-weighted return that takes cash flows into attention.

If you ask ”how did my manager perform?,” I’d want to know what that manager was
investing in.

If it was public equities or bonds, then the time-weighted return would apply, as we do not want cash flows to influence the results (since the manager does not control the flows, the investor does). On the
other hand, if it’s a private equity manager, we’d want to use the internal rate of return, the ”true“ money-weighted return, because we want to capture the impact of flows, since in this case the manager controls the flows.

If an asset owner only invests in public equities and bonds, then the time-weighted return would tell them how well their managers performed, overall, collectively, in aggregate. This would, I believe, have some value. They can also use the TWR for each manager individually, to see how they did.

However, many, if not most, public pension funds, as well as many other asset owners, now have an allocation to private equity. We would never evaluate an individual private equity manager using the time-weighted return, because it would remove the impact of their cash flow decisions, and the result would have
zero meaning: it answers no question at all: zilch, nada.

And so, if we combine the asset owners private equity funds with their publicly
traded assets, what does the time-weighted return tell us?

Well, that’s quite simple, it answers the question ”how did ??? perform.”
That is, it doesn’t answer any question whatsoever. It has zero meaning. It means
nothing.

What question are you asking?

– David D. Spaulding, DPS, CIPM

Additional Resources on Time- and Money-Weighted Returns