Date: April 25, 2009 11:32PM
Can I get some intuition on:
Why is it called time weighted? Why is it better for performance evaluation?
Date: April 25, 2009 11:51PM
It is better for performance evaluation when evaluating managers in situations where the portfolio manager does not control cash flow magnitude or timing. The TWRR eliminates the affect that a cash flow has on the performance calculation. It does this by breaking down the return into different segments, with a new segment starting at the date of each cash flow.
Each segment is implicitly weighted by its length of time relative to the entire performance period. For example, if a cash flow occurs after 10 days, the compounding of sub-period returns is as follows:
Monthly return = (1+R1)*(1+R2)
BUT, the return for period 1 is actually the product of (1+Mean Daily Return1)^10 and the return for period 1 is actually the product of (1+Mean Daily Return2)^21. So the mean daily return for period 1 is given a weight of 10/31 and the return for period 2 is given a weight of 21/31 days.
Date: April 26, 2009 12:00AM
What kind of Cash Flow? I do not understand the formula. what is R1?
Date: April 26, 2009 12:09AM
R1 is the return for the first period (End MV - Beg MV- CF) / Beg MV. You need to calculate a return for a sub-period every time there is a cash flow (contribution or withdrawal). For example:
You have $100 on day 1, $20 contribution on day 10 (for a total of 140) and on day 31 you have $150.
The return for the first 10 days is (140 - 100 - 20) / 100 = 20%
The return for the last 21 days is (150 - 140 - 0) / 140 = 7.14%
The TWRR for the month is (1.20)*(1.0714) -1 = 28.57%
Don't worry about the explanation about "why" it is called time-weighted, that doesn't matter as far as the exam goes. Just know what the return is and when to use it.