Concepts associated with portfolio performance calculation

Concepts associated with portfolio performance calculation

by Anne Tardif, CFA, Business Product Manager

Have you ever stopped to understand (not necessarily analyze) your portfolio’s performance that your manager presents to you?

Several concepts are associated with portfolio performance calculation, including performance contribution, net and gross performance, calculation methods and investment vehicle currency, to name a few.

Let’s take a closer look at a few that can tell you a lot about what your investment portfolio really earns you and thereby help you plan your timeline to retirement accordingly.

Whether you are an amateur investor or a client who can afford to use the services of a manager, performance calculation works the same way. However, if you want to evaluate your portfolio manager’s performance, I suggest you consider the time-weighted return calculation method, which is not impacted by investor cash flows. Since managers do not control the timing of cash inflows and outflows for the portfolios they manage, manager performance is not actually increased or decreased by large contributions or withdrawals made before the markets go up. This is why the time-weighted return calculation is the preferred method for evaluating your manager’s performance.

In contrast, the money-weighted return calculation method considers investor contributions and withdrawals to evaluate return. A contribution that is made just before a significant market increase will have a positive effect on return. Did you know that since 2017, firms are required to provide performance data using a money-weighted rate of return?

Although the results of the two calculation methods may differ significantly, both are valid. Note that if there are no external cash flows, both methods will produce the same results.

Now that we’ve picked a calculation method, let’s get under the hood of your portfolio return. One recommended tool for doing so is performance attribution analysis. What does the return that your portfolio manager communicated correspond to? If you have a diversified portfolio, which is what’s generally recommended, your return can be explained by or attributed to several variables. First of all, before you can consider your return good or bad, you need to compare it to a benchmark. Benchmarks are key in analyzing return. If your manager’s performance exceeds the benchmark, performance attribution analysis will help you understand why. Is it because of a selected asset class or selected securities?

Currency is another key variable to examine. If you hold U.S.-dollar-denominated securities, for example, and those securities have risen sharply, don’t be surprised if you find that the U.S. equity asset class in your portfolio is underperforming. Therefore, when you make an investment, you should look at both security performance and local currency performance, since the performance of one could wipe out the other. In other words, strong growth in an asset class combined with a depreciating local currency will reduce the gain potential of that asset class, and vice versa.

Finally, don’t forget to check whether management fees are included in the return. Of course, if you are looking at gross return (i.e. before management fees), the return amount will be higher than if it is net of fees.

No need to start programming performance calculations or pull out your calculator, paper, and pencils. Many great software tools, like Croesus to name one, are available to help you answer these kinds of questions. Your manager will also be able to provide you with all the information you need to fully understand your financial situation.


Experience it yourself, see the difference