A new way of knowing how your investments are doing

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Do you know how your investments are doing? Most retail investors do not. Measuring investment performance is more difficult than it might seem.

Starting next summer, though, firms that sell securities will have to show clients their personal rate of return – also known as money-weighted rate of return – thanks to new rules introduced by the Canadian Securities Administrators. Firms will also have to disclose all their fees. The moves are part of changes to securities legislation known as CRM2, or the second phase of the Client Relationship Model, designed to better inform investors.

As it stands, investment firms provide clients with time-weighted rates of return, which compare a manager's performance to the relevant benchmark. Both approaches have advantages and drawbacks.

Until recently, most of the fuss surrounding CRM2 has been about fees. Much less attention has been paid to the way cash-flows – money in and money out – affect investors' returns. Some investment advisers worry about how to explain the new measure to clients already befuddled by industry jargon.

"The timing of cash flow has a huge impact on the actual rate of return," says Kurt Rosentreter, an investment adviser at Manulife Securities Inc. in Toronto. Giving clients personal returns allows them to judge whether they are getting good value for their money, Mr. Rosentreter says. Besides, how do you know how you are progressing toward your retirement savings goal if you don't know how much you are making, he asks.

Outflows from a portfolio include the initial cost of buying the investment, reinvested dividends or interest, and withdrawals. Inflows include the proceeds from the sale of an investment, dividends and interest received, and new contributions, according to the financial education platform Investopedia.

Some industry participants are getting ahead of the game, introducing clients to the new performance number now – even though there is no benchmark to compare it with. Vancouver-based Steadyhand Investment Funds Inc. began giving clients their money-weighted returns effective Sept. 30.

"We've put a lot of time and effort into thinking about how to communicate it to clients," says Neil Jensen, Steadyhand's chief operating officer. "The response has been underwhelming so far," perhaps because most clients don't see a big difference, Mr. Jensen says. This could change as the July, 2016, deadline nears and people become more aware of the new measure, he adds.

On their statements, Steadyhand clients get their personal rate of return only. If they want to know how the fund manager performed relative to the benchmark, they can go to the firm's website, where fund performance is compared to the relevant benchmark or benchmarks. Trying to compare a personal rate of return to a benchmark would be comparing apples to oranges, Mr. Jensen says.

Steadyhand offers the following example, in which the firm compares returns of two investors, Steve and Sheila, who both held the Steadyhand Equity Fund in 2014.

On Jan. 1, Steve and Sheila both held $100,000 in the fund. On June 30, Steve bought another $100,000 worth of units. Sheila did not buy or sell any units during the year. Steve and Sheila's time-weighted rate of return was identical, at 13.2 per cent. Because Sheila did not add or withdraw money, her money-weighted return was the same as her time-weighted one. Steve's money-weighted or personal return was 9.7 per cent.

Why?

Steve's return was lower because the Steadyhand Equity Fund had a strong first half, gaining 11.8 per cent. The fund's performance cooled off in the second half, rising only 1.2 per cent. Because Steve had a much larger sum of money that only earned 1.2 per cent in the second half, his personal return was lower "and was thus a more accurate reflection of his investing experience," the firm says.

Clearly, this would have been difficult for Steve to calculate without the benefit of a computer program.

While the personal rate of return is more useful to investors than the time-weighted return only, it's not clear that it is the best way to judge an adviser's or manager's performance. That's because advisers and fund managers have no control over when a client withdraws or contributes more money to a portfolio.

Investopedia draws on the Chartered Financial Analyst Institute for a discussion of the limitations of the personal rate of return when it comes to assessing a manager's performance. The money-weighted rate of return tends to place a greater weight on the performance in periods when the account is highest, the CFA course material says.

If a manager's best years occur when a client's account is small, and then, after the client deposits more funds, market conditions sour, the money-weighted measures wouldn't treat the manager fairly, it says.

"Say the account has annual withdrawals to provide a retiree with income, and the manager does relatively poorly in the early years (when the account is larger), but improves in later periods after distributions have reduced the account's size," the CFA material says. "Should the manager be penalized for something beyond his or her control?"

People wishing to get an idea of their personal returns can try online calculators offered by Warren MacKenzie at Weigh House Investor Services (Calculate Your Portfolio's Return) or by Justin Bender on the Canadian Portfolio Manager Blog, (Money-Weighted Rate of Return Calculator). You will need your portfolio value at the beginning and end of the period plus any contributions or withdrawals and the dates on which they were made.