Money-Weighted Return or the Internal Rate of Return (IRR, or sometimes called the MWR) or the Time Weighted Rate of Return (TWR). This conversation has evolved over the years, and has more recently come to the forefront. The below represents some information that was prepared for one specific client. This information might help your firm in deciding which performance calculation would best represent the return information to your clients.

• MWR was originally developed and used as a forward-looking basis for evaluating investment opportunities. Additionally, inherent in the MWR calculation is a constant rate of return assumption, which ignores the volatility of returns.  Volatility is an important consideration when measuring performance history.

• MWR measures the compound growth rate in the value of all funds over the evaluation period. MWR is an ‘average’ amount of dollars invested over the evaluation period. This return calculation links the ending value of the account to the beginning value, plus all of the intermediate cash flows.

• MWR requires that the account be valued only at the beginning of the evaluation period, along with the dates and values of any cash flows.

• MWR is sensitive to and affected by the Size and Timing of cash flows, while the TWR calculation removes the effect of Size and Timing of cash flows. Because TWR removes the impact of cash flows, under relatively normal conditions, these 2 calculation methods will produce the same result.

• Most investment managers typically have little or no control over the cash flow activity, therefore, TWR is most widely used in reporting investment returns. TWR is used because this calculation removes the effect of client-directed cash flow activity. Therefore, the investment manager’s capability is not penalized with this calculation method.

• If a firm does have control over the timing of the cash flows, them MWR is appropriate to use. Because the investment manager has discretionary authority over the Size and Timing of cash flows, the MWR calculation then includes these decisions in portfolio manager’s performance calculation return.

• MWR calculations are typically called ‘client returns’ in that the calculation represents the returns achieved at the account level, for the client. TWR calculations are typically referred to as the ‘manager return’, because this calculation removes the effect of cash flows, thereby only focusing on the investment manager’s strategy return.

In order to understand MWR vs TWR, it is important to understand the evolution of performance theory.

1. In the beginning, since regular valuations were not easy to come by, the MWR method was used because all your firm needed was 2 valuation periods, along with the cash flows, in order to generate the return.

2. The theory then evolved in such a matter that the true TWR began to be utilized. This calculation involves revaluing the portfolio each time there is an external cash flow. These sub-periods are then linked together.

3. The Linked MWR (or BAI Method) then evolved to create the MWR for each sub period, thereby linking those sub-MWR period calculations together (creating a hybrid of MWR and TWR). The recommendation is that if a flow is greater than 10%, that would trigger a portfolio revaluation.

4. The theory then evolved into the Dietz Method, whereby the cash flows within a sub-period be split into 2 equal parts. Thus, half of the cash flow is added to the beginning value and half is subtracted from the ending value. This calculation assumes that all of the cash flows occur mid-point through the evaluation period.

   Ending Market Value - (Beginning Market Value + Cash Flows) / (Beginning Market Value + Cash Flows/2)

5. The end result is an evolution of the Modified Dietz Method we have today, where the cash flows are day-weighted.

   Ending Market Value - (Beginning Market Value + Cash Flow) / Beginning Market Value + Time-Weighted Cash Flows

• Use MWR when accurate valuations are not available on a consistent basis.

• A Firm can use MWR when the investment manager is responsible for the Size and Timing of the cash flows in the account (ie. Private Equity investments)

• Use MWR when the time value of money is important, therefore, the Size and Timing of the cash flows matter

• Use TWR when comparing one portfolio manager’s discretionary strategy return against another for evaluation purposes

• Use TWR when trying to remove effects of Size and Timing of client-directed cash flows

• Can measure fund manager performance and compare it to fund benchmark

• Offers a rate that can be compared to other funds

• Shows your personal investment experience and account performance

• Helps clarify the impact your investment activity decisions are having on your account

• If funds are added to an account prior to a period of strong performance, the MWR method will provide a higher rate of return than the TWR method.

• If a large withdrawal occurs prior to a period of strong performance, the MWR method will provide a lower rate of return than the TWR method.

  Since the MWR takes into account the Size and Timing of cash flows, the MWR will produce more extreme results. TWR provides a more consistent and accurate measure in these cases.

In the 2010 edition of the GIPS standards, firms are required to present time-weighted returns (TWRs) for all asset classes with the exception of private equity, for which firms were required to present a since-inception internal rate of return (SI-MWR). firms

For GIPS 2020 (see Section 8) Firms are now allowed to present MWRs for those composites and pooled funds for which firms have control over external cash flows into the portfolios in the composite or into the pooled fund and that have at least one of the following characteristics: (a) closed-end, (b) fixed life, (c) fixed commitment, or (d) illiquid investments as a significant part of the investment strategy (provision 1.A.31).

Firms must meet the requirement to meet one of the four characteristics in addition to firms having control over external cash flows (provision 1.A.35).

Firms may still present TWRs if they think TWRs are most appropriate, but now have the added option to present MWRs if they meet the criteria for doing so.