Decoding Investment Performance: Total Return vs. Time-Weighted Return

11 August 2023

Introduction

Investing in financial markets comes with its fair share of challenges and complexities. The story of an anonymous investor's journey highlights the pitfalls of market timing and provides an opportunity to delve into the nuances of Total Return and Time-Weighted Return. By analysing investment decisions, we can uncover how these metrics differ in reflecting the impact of an investor’s choices.

A Risky Investment Path

Assume for example, an investor began his investment journey in March 2020, a period marked by unprecedented market volatility due to the onset of the COVID-19 pandemic. Eager to capitalize on potential gains, he made a small top-up investment in February 2021 and a substantial one in July 2021, coinciding with the market's peak. These actions set the stage for an insightful analysis of how Total Return and Time-Weighted Return differ in capturing the consequences of his decisions.

Total Return vs. Time-Weighted Return

Total Return accounts for all changes in portfolio value, including contributions and withdrawals, during a specific period. It provides a comprehensive snapshot of how an investment has performed over time, factoring in market timing and external influences. In contrast, Time-Weighted Return eliminates the impact of an investor's deposits and withdrawals, focusing solely on the inherent performance of the investment.

Total Return vs. Time Weighted Return - A Comparative Summary

Analysing the Impact

Client Time Weighted Portfolio normalized NAV (USD) & Timing of Deposits (10 Mar 20 to 31 Jul 23)*

*Blue line represents client's time-weighted NAV, and orange circles indicate dates when client made portfolio top-ups.

Client Example Expanded Comparison of Total Return vs. Time-Weighted Return Methods

The investor's top-up in February 2021; when the market was still recovering and the substantial investment in July 2021, at its peak, had divergent effects on Total Return and Time-Weighted Return. Total Return captured the immediate and distorting impact of these decisions, reflecting a -3.6% return due to the unfavourable trend after his ill-timed and large investment top-ups near market peaks.
Time-Weighted Return, however, paints a different picture. By eliminating the timing and size of the investments, it focuses solely on the performance of the underlying assets. Despite the market volatility, the Time-Weighted Return stood at a remarkable 18.61%, highlighting the potential of his investment choices (i.e. assuming investor made no market timing decisions).

Lessons Learned

This investor's journey underscores the dangers of market timing and the impact of entry points on Total Return. It also showcases the resilience of his investment when viewed through the lens of Time-Weighted Return, which emphasizes the underlying performance of the assets, rather than the timing of investments.

Conclusion

The story of this investor's journey serves as a valuable case study for understanding the difference between Total Return and Time-Weighted Return. By making investment decisions during volatile market conditions, he experienced divergent results when comparing these metrics. As investors, it's crucial to recognize the potential pitfalls of market timing and consider metrics like Time-Weighted Return to gain a more accurate understanding of our investment choices.

Disclaimer

The contents herein are intended for informational purposes only and do not constitute an offer to sell or the solicitation of any offer to buy or sell any securities to any person in any jurisdiction. No reliance should be placed on the information or opinions herein or accuracy or completeness, for any purpose whatsoever. No representation, warranty or undertaking, express or implied, is given as to the information or opinions herein or accuracy or completeness, and no liability is accepted as to the foregoing. Past performance is not necessarily indicative of future results. All investments carry risk and all investment decisions of an individual remain the responsibility of that individual. All investors are advised to fully understand all risks associated with any kind of investing they choose to do. Hypothetical or simulated performance is not indicative of future results. Unless specifically noted otherwise, all return examples provided in our websites and publications are based on hypothetical or simulated investing. We make no representations or warranties that any investor will, or is likely to, achieve profits similar to those shown, because hypothetical or simulated performance is not necessarily indicative of future results.

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