A friend of mine, Mary, received a report from an administration service informing her that she earned a net return of 11.6 per cent in the past year.
Yet if Mary had exactly the same investment experience, but used a different administration service, she may have received a performance report saying she had a net return of 15% over the same period.
Does that mean that one performance report is wrong? Not necessarily. It probably means that they have used different methods to calculate Mary’s returns, leading to very different results.
One administration service may be using a Money Weighted Return (MWR) calculation method, where another service may be using a Time Weighted Return (TWR) method.
A MWR method tells you an internal rate of return (IRR). This method is impacted by external cash flow movements, such as the amount and timing of contributions or pension payments.
It gives more weight to your investment returns in periods where your account balance was higher, and that just comes down to luck.
This is perfectly fine if you are only measuring your fund returns in isolation – but it cannot be used for any comparison against a benchmark or against any other fund, because the timing of things like contributions and pension payments are unique for each fund.
The TWR method significantly reduces the effect of the timing of these external cash flows, so it is the only method that allows for fair comparisons.
There are Global Investment Performance Standards (GIPS), which apply to larger funds. GIPS specifies that managed funds must report their returns using a TWR method, to allow fair comparisons.
Although GIPS does not apply to SMSFs, if an SMSF investor wanted to compare their fund performance to a benchmark or to other SMSFs, all fund returns must be calculated using a TWR method. Only then could we say that we are comparing “apples with apples”.