Reporting Hedge Fund Performance

Great investment operations endure the test of time, spanning decades of consistently compounding money. Along these lines, we strongly maintain and attempt to be the same and consistently reach double digits growth on an annual-basis. 

This is Part 5 of a Series. Go to Part 4: Accounting as the Language of Business

The following is a portion of a letter addressing my partners which states, clarifies, and addresses the operating principle behind that private investment partnership (i.e. hedge fund) I began. I would recommend that you start your reading at the beginning.

Noting performance, our aggregate partners’ equity increased 2.82% from its inception on November 22, 2010—the date of approval of our proposed Articles of Partnership and registration with the Securities and Exchange Commission (SEC)—up to 2010’s yearend. This translates to an effective annual rate of return of 26.42% (computed as 2.82% multiplied by 365/39 days).

Money-Weighted Rate of Return: It's All About Absolute, Actual Returns

This is Part 3 of a Series. Go to Part 2: Time-Weighted Rate of Return: It's All About Relative, Simple Yields

Note: The following is a letter addressing my partners which clarifies the money-weighted (MW) and time-weighted (TW) measures of performance. I would recommend that you read first the earlier letter before proceeding.

March 6, 2011

TO MY PARTNERS:

The Money-Weighted Rate of Return. This rational measure of performance tries to capture the internal rate of return (IRR) of the portfolio. It is therefore sensitive to the timing and size of cash inflows (outflows) and accurately depicts absolute returns per actual fund results.

My January 12, 2011 letter presented how my personal portfolio has yielded since its inception in 2008. My number-crunching, while honest and innocent, failed to mention two ways in which fund returns maybe measured: the money-weighted (MW) and time-weighted (TW) approaches. For everyone’s information, the 17.15% rate of return previously presented considered the time-weighted method. Through this letter, I intend to further delve into this issue of measuring performance. I cannot overemphasize the importance of this matter to the investing partner; although I have to apologize in advance should this presentation be too technical.

Essentially, TW captures this scenario: had I started the fund with a pioneer partner in 2008 and that partner did not make any deposits to and withdrawals from the fund, he should be earning a 17.15% compounded annually. In reality, however, this may often not be the case: he may be making additions or withdrawals (these can dramatically magnify his profits or losses depending on how the fund performed after the additions/withdrawals)—this is the essence of the MW approach; it captures and weighs the timing and money amounts committed for any given period and pinpoints the real absolute returns per actual fund results.

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.

Measuring Portfolio Performance: The Market-Conscious Side of the Rational Investor

Rational Measures of Portfolio Performance. The Time-Weighted and Money-Weighted rates of return are two standard rational measures of portfolio return.

This Part 1 of a Series.

It was sometime early this year when I finally decided to bring unto myself the task of measuring the rate of return achieved by my personal portfolio. The whole idea intrigued me—I knew it's making some money, but knowing how much money—well, that really captivated my imagination.

I know the exercise was somewhat hypocritical... I preach business perspective investing which always focus on the financial performance of the stock based on its merits as a true, performing business, and give little or no value to how its stock market price performed.

While I admit I measure my portfolio’s returns based on stock price performance, and that this is my yardstick as a market-conscious fund manager, I likewise admit and insist (and I don’t see any inconsistency in saying) that in my career as a rational investor, my focus, nonetheless has still been and always will be the virtues of the underlying business. Further, I see that using and practicing value investing principles in managing my portfolio is an experiment and a profitable endeavor altogether. It is an experiment which tests whether this premise is true: "that the market may take an inconveniently long time to adjust to a rational valuation; (we) don’t know what the mechanism is, but (we) can tell that in our experience, it usually does readjust eventually" – Benjamin Graham on the market being rational (taken from the book Warren Buffett: An Illustrated Biography of the World’s Most Successful Investor).