A measure of the compound rate of growth in a portfolio. Because this method eliminates the distorting effects created by inflows of new money, it is used to compare the returns of investment managers.
This is also called the "geometric mean return," as the reinvestment is captured by using the geometric total and mean, rather than the arithmetic total and mean. It is assumed that all cash distributions are reinvested in the portfolio and the exact same periods are used for comparisons. When calculating time-weighted rate of return, the effect of varying cash inflows is eliminated by assuming a single investment at the beginning of a period and measuring the growth or loss of market value to the end of that period.
Calculation
To calculate the time-weighted rate of return, we use the daily valuation method:
r(T) = {MV(T)-MV(T-1)- C(T)}/{MV(T-1)+ w*C(T)}
r(T)... Return on day T
MV(T)... Ending market value on day T
MV(T-1)... Beginning market value on day T (or ending market value on day T-1 in our case)
C(T)... Net contribution occurring on day T
w(T)... weight of the net contribution on day T...
The current Guidance Statement implies an end of day cash flow assumption in the calculations. In reality, many managers use a start of day, end of day, or middle of day cash flow assumption.
W(T) = 0 for End of day cash flow assumption,
w(T) = 1 for Beginning of day cash flow assumption
w(T) = 0.5 for middle of day cash flow assumption
In our calculation, we shall use end of day cash flow assumption as default.