Understanding Performance Report Returns

There are basically two methods to calculate investment returns; dollar-weighted returns and time-weighted returns. Time-weighted returns represent the return an investor would have received with a single deposit left to accumulate and compound from point A to point B. It does not take into account the timing of additional cash flows to or from the portfolio. Therefore, the amount of time or the value of a deposit to the portfolio is not included in the analysis.

The time-weighted rate of return is the standard reporting measurement for the investment industry and the method utilized in our portfolio performance reports. It allows an investor to compare the performance of any two investment, funds, managers, etc. over any period of time. The performance is measured regardless of any other investor's behavior in owning the investment. We will explain more about this in a moment.

Dollar-weighted returns are also known as the internal rate of return. Dollar-weighted returns differ from time-weighted returns because they account for the timing and amount of cash flows to and from the investment or portfolio. Whereas, the timing of cash flows to and from an investment is irrelevant to the time-weighted return (i.e. the investor's behavior in allocating capital), they are significant to dollar-weighted returns.

Morningstar conducted a study of returns for growth mutual funds from 1988 to 1994 that will help to explain the difference between the two performance calculations. From 1988 to 1994 the time-weighted return for the approximately 200 funds studied was 12.01%. A dollar invested on January 1, 1988 and kept in the funds through December 31, 1994 earned 12.01%.

However, when the studied accounted for the timing of the cash flows; i.e. as investors committed cash to the funds over the six-year period, the dollar-weighted return for the 200 funds was reduced to 2.02%.

Though the study did not look at each individual investors return in the funds, it can be deduced that the average investor's return in the fund was something less than the time-weighted return of 12.01%. Growth fund investors on the whole tend to follow popular investments. Or said another way, they tend to buy investments that are increasing in value. There are other studies that reflect over 75% of investors commit their capital when over 50% of the investment's return has been realized.

As in the previous example, when investments are increasing in value and an investor continues to commit capital his dollar-weighted return will suffer. However, the opposite can occur. For example, when a portfolio is decreasing in value and additional investments are made the dollar-weighted return can actually improve over the time-weighted return. This was the case from March of 2000 through September 2001.

We have a discipline for investing cash added to portfolios. This dollar-cost-averaging discipline will change depending on our valuations of the relevant asset classes in an investor's portfolio. In 1999 we believed the majority of the asset classes were over-valued. This was particularly true of the Large Growth and Mid Cap Growth classes. As a result, we committed as little as 25% initially and 75 % over 12-18 months to the Growth asset classes. We believed the Value asset classes and the International asset classes were more fairly valued and committed 50% initially and dollar-cost averaged the balance.

In mid 2001, we believed that due to a decline in the equity markets stocks were becoming better values. We changed the dollar-cost-averaging discipline by increasing the initial investments in growth to 50% and value and international to 75%. The goal was to commit more capital at lower prices, thus improving the portfolio performance. This was a valuable strategy change and has improved the dollar-weighted returns. These changes are not as fully reflected in the quarterly performance report's time-weighted returns. However, we believe this strategy will be seen in the long-term time-weighted returns as prescient asset allocation and manager choices are made and their benefits realized.

The short-term differences in dollar-weighted returns versus time-weighted returns can be significant. As a portfolio becomes fully invested and cash flows to or from the portfolio or investment are minimized, the differences in the two types of returns are negligible.


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Understanding Performance Report Returns There are basically two methods to calculate investment returns; dollar-weighted returns and time-weighted returns. Time-weighted returns represent the return an investor would have received with a single deposit left to accumulate and compound from point A to point B. It does not take into account the timing of additional cash flows to or from the portfolio. Therefore, the amount of time or the value of a deposit to the portfolio is not included in the analysis. The time-weighted rate of return is the standard reporting measurement for the investment industry and the method utilized in our portfolio performance reports. It allows an investor to compare the performance of any two investment, funds, managers, etc. over any period of time. The performance is measured regardless of any other investor's behavior in owning the investment. We will explain more about this in a moment. Dollar-weighted returns are also known as the internal rate of return. Dollar-weighted returns differ from time-weighted returns because they account for the timing and amount of cash flows to and from the investment or portfolio. Whereas, the timing of cash flows to and from an investment is irrelevant to the time-weighted return (i.e. the investor's behavior in allocating capital), they are significant to dollar-weighted returns. Morningstar conducted a study of returns for growth mutual funds from 1988 to 1994 that will help to explain the difference between the two performance calculations. From 1988 to 1994 the time-weighted return for the approximately 200 funds studied was 12.01%. A dollar invested on January 1, 1988 and kept in the funds through December 31, 1994 earned 12.01%. However, when the studied accounted for the timing of the cash flows; i.e. as investors committed cash to the funds over the six-year period, the dollar-weighted return for the 200 funds was reduced to 2.02%. Though the study did not look at each individual investors return in the funds, it can be deduced that the average investor's return in the fund was something less than the time-weighted return of 12.01%. Growth fund investors on the whole tend to follow popular investments. Or said another way, they tend to buy investments that are increasing in value. There are other studies that reflect over 75% of investors commit their capital when over 50% of the investment's return has been realized. As in the previous example, when investments are increasing in value and an investor continues to commit capital his dollar-weighted return will suffer. However, the opposite can occur. For example, when a portfolio is decreasing in value and additional investments are made the dollar-weighted return can actually improve over the time-weighted return. This was the case from March of 2000 through September 2001. We have a discipline for investing cash added to portfolios. This dollar-cost-averaging discipline will change depending on our valuations of the relevant asset classes in an investor's portfolio. In 1999 we believed the majority of the asset classes were over-valued. This was particularly true of the Large Growth and Mid Cap Growth classes. As a result, we committed as little as 25% initially and 75 % over 12-18 months to the Growth asset classes. We believed the Value asset classes and the International asset classes were more fairly valued and committed 50% initially and dollar-cost averaged the balance. In mid 2001, we believed that due to a decline in the equity markets stocks were becoming better values. We changed the dollar-cost-averaging discipline by increasing the initial investments in growth to 50% and value and international to 75%. The goal was to commit more capital at lower prices, thus improving the portfolio performance. This was a valuable strategy change and has improved the dollar-weighted returns. These changes are not as fully reflected in the quarterly performance report's time-weighted returns. However, we believe this strategy will be seen in the long-term time-weighted returns as prescient asset allocation and manager choices are made and their benefits realized. The short-term differences in dollar-weighted returns versus time-weighted returns can be significant. As a portfolio becomes fully invested and cash flows to or from the portfolio or investment are minimized, the differences in the two types of returns are negligible.

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