How do I calculate time-weighted return and why is it the standard for manager evaluation?

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AcadiFi · Accepted Answer

Time-weighted return (TWR) measures the compound growth rate of one unit invested at the start, independent of subsequent cash flows. It evaluates investment decisions by neutralizing the effect of client-driven contributions and withdrawals, making it the CFA Institute GIPS standard for reporting manager performance.

Calculation: divide the measurement period into sub-periods bounded by cash flow events. For each sub-period, calculate the holding period return: HPR_i = (MV_end − CF − MV_begin) / MV_begin. Then chain-link: TWR = (1+HPR_1)(1+HPR_2)…(1+HPR_n) − 1.

Worked example: Sanderling Wealth Management reports a client account.

- Jan 1: MV = $1,000,000
- Apr 1: MV = $1,080,000 before a $200,000 contribution
- Sep 1: MV = $1,320,000 before a $100,000 withdrawal
- Dec 31: MV = $1,285,000

Sub-period 1 (Jan-Apr): HPR = (1,080,000 − 1,000,000) / 1,000,000 = 8.00%

Sub-period 2 (Apr-Sep): starting MV after contribution = 1,080,000 + 200,000 = 1,280,000; HPR = (1,320,000 − 1,280,000) / 1,280,000 = 3.125%

Sub-period 3 (Sep-Dec): starting MV after withdrawal = 1,320,000 − 100,000 = 1,220,000; HPR = (1,285,000 − 1,220,000) / 1,220,000 = 5.328%

TWR = (1.08)(1.03125)(1.05328) − 1 = 17.29%

Note that the contribution and withdrawal don't affect the measured return — they only change sub-period boundaries. This isolates the manager's investment decisions.

Why standard for managers: managers don't control when clients add or withdraw capital. Holding them accountable for returns earned on capital they did/didn't have isn't fair. TWR levels the playing field across managers with different cash flow patterns.

Practical implementation: daily valuation eliminates approximation errors. Modified Dietz provides an approximation when daily data isn't available. GIPS compliance requires TWR for composite performance reporting.

How do I calculate time-weighted return and why is it the standard for manager evaluation?

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