Arithmetic Returns for Investment Performance Measurement
23 Pages Posted: 10 Jun 2012 Last revised: 23 Apr 2014
This paper introduces new money-weighted metrics for investment performance analysis, based on arithmetic means of holding period rates weighted by the investment’s market values. This approach generates rates of return which measure a fund’s or portfolio’s performance and a fund manager’s performance. It also enables to show that the Internal Rate of Return (IRR) is a weighted mean of holding period rates associated with interim values which differ from market values, so that value additivity is violated. The manager’s Arithmetic Internal Rate of Return (AIRR) is shown to be the true period equivalent of the cumulative Time Weighted Rate of Return (TWRR), whereas the period TWRR (a geometric return) provides a different ranking. The method is easily generalized for coping with varying benchmark rates. We also cope with the practical problem of estimating interim values whenever they are not available.
Keywords: performance measurement, AIRR, value added, internal rate of return, time-weighted rate of return
JEL Classification: G00, G10, G11, G12, G31
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