Presenting MWR instead of TWR for Composites
For most managers a time-weighted return (TWR), which essentially removes or smooths the impact of external cash flows, is the preferred method to demonstrate how their strategy performed in portfolios over time. But for those managers who have discretion over the timing of contributions and distributions, a TWR does not capture the impact of the manager’s decisions with regards to external flows. In those cases, presenting an internal rate of return (IRR) or money-weighted return (MWR), results in a more meaningful representation of performance over time.
For those firms that claim compliance with the Global Investment Performance Standards (GIPS®)[1], TWR is the required calculation methodology, unless certain provisions can be met[2]. First, firms must have control over the external cash flows into the portfolios in the composite or pooled fund AND the portfolios or pooled fund must also meet one of the following characteristics; have a fixed life, structured as closed-end, have a fixed commitment, or hold illiquid investments as a significant part of the strategy. Once a firm decides to show MWR instead of TWR, it must do so consistently.
For firms that opt to show WMR, there are other statistics unique to MWR composites that must be shown. Section 5 of the Global Investment Performance Standards for Firms outlines provisions firms must follow when presenting money-weighted returns in a GIPS Report. Unlike TWR GIPS reports that show annual year end statistics for each year for assets, number of accounts, etc., MWR reports require these statistics as of the most recent year end. Firms must also present an annualized, since-inception money-weighted return (SI MWR) through the most recent annual period end for both the composite and the benchmark instead of the annual returns required when showing TWR. If a subscription line of credit is used, firms must present the SI MWR both with and without the subscription line of credit, unless certain provisions are met. Additionally, if the portfolios in the composite have committed capital the firm must also present the following items as of the most recent annual period end:
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- composite since-inception (SI) paid-in capital
- composite SI distribution
- composite cumulative committed capital
- total value to SI paid-in capital
- SI distributions to SI paid-in capital
- SI paid-in capital to cumulative committed capital (PIC multiple)
- residual value to SI paid-in capital (unrealized multiple or RVPI)
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For many firms, these statistics are calculated outside of a portfolio accounting system. As with any figures calculated manually in a spreadsheet, it is important for firms to have quality checks in place to ensure the accuracy of data used and the numbers presented. Undergoing a verification and a composite specific performance examination adds another set of eyes to ensure these statistics are accurate and comply with the calculation requirements outlined in the GIPS standards.
[1] GIPS® is a registered trademark owned by CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.
[2] 1.A.35 of the Global Investment Performance Standards (GIPS®) for Firms.