Time-weighted returns are a method of measuring the performance of an investment portfolio by taking into account the timing and size of cash flows. This method is beneficial for comparing the performance of different investment managers or strategies, as it eliminates the impact of cash inflows and outflows on the overall return. Time-weighted returns are calculated by breaking down the investment period into sub-periods and calculating the return for each sub-period, then geometrically linking these returns to arrive at the overall time-weighted return.
What is the primary purpose of using time-weighted returns to measure investment performance?
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A) Time-weighted returns focus on the timing of cash flows, not their size. B) Time-weighted returns account for the timing of cash flows, making them helpful in comparing investment managers or strategies. C) Time-weighted returns can be more complex to calculate than other methods, such as simple returns. D) Time-weighted returns can be used to compare performance across different time periods, but their primary purpose is to account for the timing of cash flows.
Which method of calculating investment performance is most sensitive to the timing of cash flows?
A) Time-weighted returns are specifically designed to account for the timing of cash flows, making them the most sensitive to cash flow timing. B) Dollar-weighted returns focus on the size of cash flows rather than their timing. C) IRR considers the size and timing of cash flows but is less sensitive to cash flow timing than time-weighted returns. D) Simple returns do not consider the timing or size of cash flows.
What is the process of combining sub-period returns to calculate the overall time-weighted return called?
A) Geometric linking is the process of combining sub-period returns to calculate the overall time-weighted return. B) Arithmetic linking is not used in calculating time-weighted returns. C) Cash flow linking is not a term for calculating time-weighted returns. D) Sub-period linking is not a term used in calculating time-weighted returns.
An investor has a portfolio managed by two different investment managers. Manager A generates a time-weighted return of 8% over the year, while Manager B generates a time-weighted return of 6%. By comparing these time-weighted returns, the investor can determine that Manager A has performed better in managing the portfolio, regardless of the timing and size of cash flows.
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Example Series 65 Example Practice Question
* Time-weighted return: Time-weighted return is a measure of the compound rate of growth of an investment portfolio over a specified period, taking into account the timing and size of cash flows (such as contributions and withdrawals). It eliminates the impact of cash flows and focuses solely on the investment manager's performance.
* Time-weighted return example: An investor starts with a $10,000 portfolio and contributes $5,000 after six months. The portfolio grows to $18,000 by the end of the year. The time-weighted return would account for the growth of the initial $10,000 and the growth of the additional $5,000 separately, then combine them to determine the overall return.