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FRM Part II · FRM Exam Part II · Portfolio Performance Evaluation

A portfolio manager has no control over the timing or size of client deposits and withdrawals. For comparing her skill against peers, which return measure is most appropriate?

Time-weighted return is most appropriate. It chain-links sub-period returns and eliminates the influence of external deposits and withdrawals, so differences in performance reflect the manager's decisions rather than client cash-flow timing. Money-weighted return embeds flow timing and is better for evaluating the investor's experience.

  1. AMoney-weighted return, because it reflects the timing of client cash flows
  2. BTime-weighted return, because it removes the effect of external cash flowsCorrect
  3. CArithmetic average of month-end balances, because it smooths flows
  4. DSimple holding-period return on the ending balance versus the initial balance

Explanation

Time-weighted return links sub-period returns and so neutralizes cash flows the manager does not control. Money-weighted return (IRR) is affected by flow timing, so it would mix client decisions into measured skill. The simple ending-versus-initial approach also distorts when flows occur.

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