Money-weighting only way to track fund performance
By Pensions & Investments | May 30, 2011
I wish to respond to Jonathan Boersma's letter of April 18, which in turn was in response to my earlier one (Letters to the Editor, Feb. 21). I guess the love of time-weighting return knows no bounds.
First, let's consider the issue of pension funds complying with the Global Investment Performance Standards. Jonathan, no doubt, recalls my earlier letter (Letters to the Editor, Feb. 20, 2006) to this publication in reply to a commentary (Other Views, Jan. 9, 2006) that strongly criticized such an idea. It was only me, no one from the CFA Institute or the GIPS governing body, which chose to respond. I indicated that while technically the standards were designed for asset managers, what harm would there be for a pension fund to comply? In fact, an argument could be made that it would be appropriate. Thus, I have been on the record for quite some time championing this idea.
But let's consider the more important issue of time-weighting return. Of course, the control of the external cash flows might not fall entirely to the fund itself; however, who controls the internal cash flows? Clearly it is the fund that decides (a) where to put the money (i.e., what sectors and which managers) and (b) how much to place in each area. To judge the performance of the manager, time-weighting return is appropriate; but to judge the performance of the pension fund, money-weighting return is the right approach.
This is no new idea. Peter Dietz, whose early work led to the Bank Administration Institute's 1968 standards, followed by the Investment Council Association of America's standards in 1971 and others, strongly encouraged the use of time-weighting for one purpose: to assess the performance of the manager. On multiple occasions Peter called for money-weighting to assess how the fund itself is doing. Other luminaries as well, such as the U.K.'s Dugald Eadie, called for money-weighting to be used in this manner.
GIPS recognizes that control of the cash flows is a key determinant to decide whether to use time- or money-weighting. And nowhere in the standards is there any discussion of what is referred to as “subportfolio” performance. In the case of a pension fund, any monies given to managers to invest fall into this category, and here is clearly a case where money-weighting is in order.
And even at the fund level, money-weighting is the appropriate metric to determine how the fund is doing, as time-weighting eliminates the impact of the flows. There have been many occasions when a portfolio loses money but has a positive return; this isn't the case with money-weighting. And so, if a plan wants to know how it is doing overall, there is only one way to know this: by using a money-weighting approach.
As for the fund possibly concluding that it's “been doing it right all along,” sadly, I suspect, only in the eyes of individuals who cannot be open to alternative approaches. All one needs to do is compare the results of money- vs. time-weighting return to fully appreciate the differences. I encourage everyone, including Jonathan, to take the blinders off and see the wisdom of an approach that was encouraged 50 years ago.
President, The Spaulding Group Inc.