Alternative Facts: The New Investment Performance Regime

Topic: Investments

John C.A. Stevenson CFA

February 8, 2017

Image used with permission: iStock/TheaDesign


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Alternative Facts: The New Investment Performance Regime

The concept of an “alternative fact” was introduced to the world in January by Donald Trump’s advisor, Kellyanne Conway, in the course of arguing over how many people attended the President’s inauguration. Conway insisted that “alternative facts”, none of which were specified, proved that Trump’s inauguration was the most attended ever. More conventional facts disagreed.

This blog, however, is not about Trump, or even about politics. It’s actually about math. By now, all Nexus clients will have received their first-ever “CRM2” reports. This topic has been featured in our Nexus blog series CRM2: Cutting through the complexity, as well as many articles in the financial press. For the most part, CRM2 is a positive development as it gives the clients of every financial service provider information that is important in the evaluation of their financial affairs. Nexus has always provided clients with most of this information, but not every advisor has.

However, there is one element of the CRM2 report that seems likely to create confusion – the reporting of investment returns. Those who have read their reports carefully will know that investment returns are calculated using the “money-weighted” methodology that regulations require. Traditionally, Nexus, and most other investment management firms like ours, have reported “time-weighted” returns. What’s the difference? As we have explained in a previous blog post Measuring Your Returns, the Right Way, time-weighted returns reveal how Nexus has done for a client. They are unaffected by any funds that a client adds to or takes from their account. A time-weighted return allows the client to see how Nexus results compare to stock market indexes, to other managers, or to other times in the past. Money-weighted returns reveal to the client how they have done. They are influenced both by how the manager managed, but also by the amount and timing of funds a client adds to or takes from their account.

We’ve written several times over the last year to explain the conceptual differences between these two approaches to return calculations. Following the completion of our CRM2 report process, however, we now have examples that hopefully will allow clients to better understand what we’ve been talking about.

Consider, for example, Nexus clients who have their TFSA invested in our Equity Fund. One might expect this to be a pretty homogenous group in terms of their investment experience since their TFSAs are invested identically. Over the course of 2016, the Equity Fund generated a return of about 11.5% after deducting Nexus’s fee. This was each client’s time-weighted return on their TFSA. It also was the money-weighted return in cases where a client neither put money into nor took money out of their TFSA. However, most of the 300 clients with TFSAs in the Equity Fund took advantage of the opportunity to make an annual TFSA contribution during 2016. Some made additional contributions to use up contribution room from prior years. A few took money out. Accordingly, the returns on CRM2 reports revealed a range of money-weighted return outcomes. How wide was the range? It was pretty wide.

One fortunate Nexus client had a money-weighted return of +24.5%. One unfortunate client had a money-weighted return of -38.3%. Remember, these were clients with the identical investment. What explains such a difference? In 2016, stock markets plunged early in the year and recovered strongly in the second half. The fortunate client benefitted by adding significantly to their TFSA at a market low point. The unfortunate client took significant money out of their TFSA at a market low point. This range is surprising, and also illustrates the reason why money-weighted returns cannot be readily compared to anything.

Both the time-weighted return and the money-weighted return are facts – an example of true “alternative facts”, unlike some of President Trump’s assertions. Both provide useful information, but many in our industry worry that the differences between them will not be easily understood. As Norman Rothery wrote in the Globe and Mail on February 5, this “new performance measure, money-weighted returns, is likely to create more confusion than clarity.” We hope clients remember that time-weighted returns tell them how Nexus did for them. As the examples above demonstrate, money-weighted returns may be more a reflection of the actions of the client than their manager.

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