Time-weighted return (TWR)
What is Time-weighted return (TWR)?
Time-weighted return, or TWR, measures investment performance while neutralizing the effect of the timing and size of external cash flows.
Performance records should identify valuation frequency, external cash-flow treatment, subperiod method, fees, tax, currency, and annualization. Estimated valuations around large flows can materially alter TWR. A composite or model portfolio return should not be presented as the exact experience of every account.
Linked subperiod returns must compound geometrically; averaging them produces a different and generally incorrect result.
Returns around account inception, termination, and partial periods need a documented convention. Composite reporting should include portfolios consistently rather than remove poor accounts after closure or add successful accounts retrospectively, which would introduce selection and survivorship bias.
Calculation
Divide the period at each external contribution or withdrawal, calculate return for every subperiod, then geometrically link them by multiplying one plus each return and subtracting one. Daily valuation is a common practical implementation. Modified methods can estimate around flows when exact valuations are unavailable, introducing approximation.
What it measures
TWR measures how a unit of capital performed under the strategy, largely independent of client-controlled cash timing. It is therefore commonly used to compare managers and benchmarks. It is not necessarily the return the investor experienced in money terms because a large balance may have been present during weak or strong subperiods.
External versus internal flows
Subscriptions, withdrawals, and transfers into or out of the measured portfolio are external. Dividends, interest, fees, and trades within it are internal and affect return. Classification depends on measurement boundary. Moving cash between two sleeves can be external for a sleeve but internal for the consolidated portfolio.
Example
A portfolio rises 10%, receives a large contribution, then falls 5%. TWR links 1.10 by 0.95 for a 4.5% return regardless of contribution size. Money-weighted return can be lower because more money experienced the loss. Neither result is wrong; they answer strategy and investor-experience questions respectively.
Practical reporting
State gross or net fees, tax, currency, valuation timing, cash-flow boundary, linking frequency, annualization, and benchmark. Reconcile values and flows before calculation. Large flows without timely valuations can distort results. Do not average periodic returns, confuse TWR with account gain, or use it alone to evaluate decisions controlling cash-flow timing.
Also known as: TWR
Sources and further reading
- Portfolio Performance Evaluation, CFA Institute
- Understanding Investment Performance, FINRA