Still in India, but I have access to a computer ever now and then so it thought I would keep writing! Unfortunately, Fiona has been a bit ill – I think we both got a bit of food-poisoning, but it’s hit her harder than me. The rest of the family are off to Ranthambore on a tiger safari, but Fiona and I are still in Jaipur – not to worry though, as I’m getting some quality time with my aunts! :)
Time Weighted Returns
When you see the return of mutual funds, it’s important to make a distinction between the time weighted return which is similar to what is reported on performance charts and the dollar-weighted returns, which represents what the average investor actually earned – the two can be dramatically different. If we have a fund that has an average annual return of 20% for three years, it can attract a lot of new investors (performance chasers). Let’s suppose that the fund had $100 million invested at the beginning of this spectacular three year run. Now let’s further suppose that $1 billion of new money gets added to the fund due to the great performance, but that the NEXT three year period results in a flat performance of 0% each year. The time-weighted average return over the 6 years is 10% – still sounds great.
Dollar Weighted Returns
The dollar weighted returns tells you what the average investor experienced since it links the performance to the amount invested in the fund at the time. From above we see that only $100 million earned a great rate of return, but the $1 billion that followed after the first three years earned nothing. On a dollar weighted basis the average investor earned less than 2% – a far cry from the 6 year average of 10%.