Businessman Investor

Touching base with the rational business psyche of stock market investors

Friday, August 26, 2011

Time-Weighted Rate of Return: It's All About Relative, Simple Yields

This is Part 2 of a Series. Go to Part 1: Measuring Portfolio Performance: The Market-Conscious Side of the Rational Investor

The Time-Weighted Rate of Return. This rational measure tries to capture the fund performance in terms of simple, periodic returns, discrediting the distorting effects of infusions and withdrawals.
Late last year, I began a private investment partnership (in common parlance, a hedge fund) with some friends and family members. Although the original plan for the partnership was to carry it on indefinitely as a going-concern, my partners and I were forced to liquidate it just recently because of personal constraints (this is another story). What follows are two letters addressing my partners on the subject of measuring performance. The first letter tries to explain my personal fund’s time-weighted performance (although it didn't explicitly tell I was using TW; I still had then the faintest idea of using the MW approach and thought that TW is the only correct way of presenting and measuring returns). The second letter explains the MW approach; there, I tried to explain and reconcile the differences between both approaches.

Note: For privacy and other reasons, while my portfolio's starting capital is presented below to be Php100,000, this isn’t the exact, actual amount; accordingly, succeeding deposits (withdrawals) and gains (losses) are proportionately adjusted.

January 12, 2011


As the partnership fund is still in its infancy (began late November 2010) and has yet to post historical annual returns spanning years or decades, I decided to compile herewith what my personal equity fund has achieved in my tenure of managing it for three years—my personal broker account was opened sometime late in December 2007 and I began deploying capital early January 2008. Similar to our intention of being long-term investors, I don’t prospect to liquidate my positions and fully withdraw whatever cash amount remains anytime soon; instead, I plan to hold onto my investments indefinitely as long as their underlying business fundamentals remain intact. Should I sell, then the relentless pursuit for good bargains begins anew.

Please note that this performance, while separate from our actual partnership operations, would at least give an idea on the earnings potential of investing in the stock market and tame our often too optimistic expectations. There’s no guarantee I’d be able to duplicate these yields for the partners; nonetheless, I can only assure I won’t be straying from my usual conservative approach to investing and that I shall never attempt to assume an unfamiliar method at the expense of the partnership’s assets.

Performance estimates for January 2008 onwards have been based on the monthly ledger records provided by my broker,, Inc.

I have to admit I simplified the derivation of returns at a certain extent. The timing of cash deposits or withdrawals from the account, for example, is assumed to have always been done at the beginning of each month period. Equity value is composed of both cash and stock positions. Monthly rate of return is computed as net gain (loss) divided by the beginning equity value.

Since the beginning of 2008, I was able to achieve a compounded annual growth rate of 17.15% (see Summary tab) versus the 4.14% of the Philippine Stock Exchange Index—a difference of 13.01%.

Note Insert: The 17.15% time-weighted (TW) annual growth rate was computed as follows:
(1-30.86%) x (1+48.56%) x (1+56.52%) - 1 = 60.77%, this figure represents the simple yield for the straight 3 years and should still be annualized; see below computation:
(1+60.77%)^(1/3)-1 = 17.15%

If you’re more attuned to how that sounds in peso terms, that translates to Ph353,833.87 of overall gains from the aggregate deposit of Php499,716.50 I have infused into my equity fund in a span of three years. It does not necessarily mean I have fully bagged-in this gain in hard cash—most are unrealized gains; admittedly this optimistically estimates the fund’s realizable net worth a bit overlooking market factors like the liquidity of my holdings (i.e. ease of converting to cash) and the transaction and other incidental costs I’d be incurring should I decide to cash in. A 17.15% return doesn’t sound much if one’s capital is small (e.g. Php100 yielding only Php17.15 every year); then again, not underestimating the power of compounding and percentage gains, that still converts to Php171,500 of passive income each year had you invested a million pesos. The more you put into it, the more it proportionally puts out for you.

Relative against the market as measured by the PSEi, my best year was 2010, surpassing the market by 22.55% while my worst was 2009—despite an exciting 48.56% gain, the market average at 63% has beaten me by 14.44%. In absolute returns, on the other hand, poorest performance was during 2008 when the global financial crisis took its heavy toll.

Points of view vary in the market. An optimistic, bullish market environment, for example, seems enticing since that boosts net worth; buying opportunities, however, would shrink dramatically as businesses are being offered too expensively—a double-edged sword. As in shopping, the preferred occasion to buy is when everything’s down and on sale. Accordingly, we should not be troubled when the market is bearish and depressed; even unorthodox in manner, should the price of a stock recently purchased further drop drastically in value, rather than panic, we’d even boldly buy more of it (assuming it’s really underpriced after exercising due diligence).

I hope this has framed your expectations from a more realistic angle. Despite presenting my yields in terms of market gains, I’d like to remind everyone that in the course of my investing, I did not follow any market indicators such as price patterns, trends, volume traded, etc. Further, I did not closely follow the stock market on a daily-basis nor did countless trades based on tips or popular beliefs of boom/gloom, general macroeconomic views and analysis, economic data such as GDP, GNP, unemployment rate, interest rates, foreign exchange rates, etc. Rather, what I simply minded were the company-specific fundamentals of the businesses I was partaking in—I did my own research, formed an independent opinion on the enterprise and the long-term economic prospects of its products, made sure the company-specific figures and ratios add up, and based my acquisition on these. This mindset shall save us from the lemming-like madness of the crowd, and shall open our eyes to the abundant business opportunities the market offers. Continue to Part 3: Money-Weighted Rate of Return: It's All About Absolute, Actual Returns

No comments:

Post a Comment


The information presented here is for educational purposes only. Under no circumstances should it be construed as a recommendation to buy, sell, or hold any stocks. If you choose to use this information, you do so at your own risk.

Popular Posts