IBKR MWR Vs TWR For Layman

Take a look at my IBKR Portfolio Analyst and see the huge 100% difference between the MWR (508.66%) and TWR (383.07%).

The weirder thing was there is no difference in TWR and MWR for my benchmark SPY.

This led me to search the differences between MWR and TWR and which to use as a personal investor.

The details of TWR and MWR explained by IBKR can be found in their official Portfolio Analyst White paper.

So, IBKR MWR vs TWR? For a personal investor, use Money Weighted Returns (MWR) since it provides a more accurate return since you have the choice to inject or withdraw your cash. Time-Weighted Returns (TWR) is better suited for comparing fund managers who cannot control when their customers withdraw or inject cash into their funds. 

Why Is TWR Higher Than MWR

I still don't know why my TWR is higher than MWR.

However, I know the timing of my cashflow (injection or withdrawal) was not good. However, it is not possible to pinpoint which external cashflow since IBKR doesn't breakdown the calculation.

Therefore, I looked up examples online to learn the impact of external cashflow on when they differ.

The sequence of Event in Market Higher TWR than MWR Higher MWR than TWR
The initial investment was made on January 1. 
The markets declined by 4% between January 1 and June 30.
A person who anticipated a weakness and withdrew some investment on June 30 A person who saw a decline as an opportunity and invested more on June 30
From July 1 and December 31, investment rose 7% The person would have a higher TWR than MWR from withdrawing some investment out that end up higher The person would have a higher MWR than TWR from investing more during a downturn that ends up higher thereafter.

TWR is definitely useful for your traditional performance measurement of an asset manager like at a mutual fund, where they don't control the cash flows. It is also useful as a benchmark.

That's said, given IBKR MWR and TWR are the same throughout my screenshot, it probably meant that benchmark returns in IBKR don't account for an individual cashflow. Not really good as an actual returns benchmark.

2 Ways To Calculate Money-Weighted Returns

There are 2 ways to measure MWR, using modified Dietz Formula or trial and error Internal Rate of Return (IRR).

Based on IBKR whitepaper, they used the modified Dietz formula, named after Peter Owen Dietz, who wrote a 1966 classic book "Pension Funds: Measuring Investment Performance". His original Dietz formula was used to find a quicker way of calculating an Internal Rate of Return (IRR) than the methods that were available then. If the flows and rates of return are large enough, the results of the Modified Dietz method will significantly diverge from the internal rate of return, causing an inaccurate return.

The other method is using trial and error. Currently, IRR is as simple as using an Excel formula (XIRR to be exact given the expected cashflow). Excel uses trial and errors to arrive at a result, starting with the guess (if provided) or with .1 (10%) if not. If an accurate rate can't be calculated after a fixed number of iterations, the #NUM error is returned. Therefore, the underlying of IRR is computationally complicated and required trial and error, unlike the modified Dietz formula.  

Growing Uses of MWR over TWR

TWR is definitely used by many and fund managers since it provides them a fairer assessment without any control of cashflow. However, MWR is definitely gaining usage and popularity.

GIPS Standards for CFA Institute

In the 2010 version of the GIPS standards, a series of since-inception MWRs was required for private equity funds, but no other investment structure or strategy had the option to present MWRs without also showing a series of annual TWR. But now in GIPS for firm 2020,  both methods are recommended by the Investment Performance Council (IPC) as part of their Global Investment Performance Standards (GIPS). The GIPS for firm 2020 document is over 146 pages long if you wish to read them. GIPS® is a registered trademark of the CFA Institute. (cascadecompliance.com)

Canada's requirement for MWR

Also in Canada, in 2017 by the Investment Industry Regulatory Organization of Canada (IIROC), the Client Relationship Model - Phase Two (CRM2) regulation requires statement returns to represent money-weighted return (MWR), as it is believed that they are more relevant to individual investors than time-weighted returns are. Before 2017, investors saw time-weighted returns only on their statements. (atb.com)

Therefore, MWR is definitely gaining popularity as it is supposed to be more accurate. TWR removes the effect of cash flows to give you the return on a single unit of currency invested that seems useful only for firms or fund managers with no control in cashflow.

Conclusion

If there are no external flows, then all these methods (time-weighted return, internal rate of return, Modified Dietz Method) give identical results, so it is only the various ways they handle flows that make them different from each other.

Author
Sky Hoon. Read Full Bio
Website Owner, Twitter-er
He has been trading since 2008. He started this blog to share the journey about option trading. He dabbled in stocks, bitcoin, ethereum (in Celsius Network), ETF (lazy Dollar Cost Averaging) and also built websites for fun. He used this as a platform to share my experiences and mistakes in trading, especially options which I just picked up.

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