Dollar-weighted Returns Research Articles

Dollar-weighted return on aggregate corporate sector: How is it distributed across countries?

This paper computes the dollar-weighted returns (DWRs) on the aggregate corporate sector in each of 43 sample countries. The paper shows that the DWRs in U.S. dollars are similar across countries but the local-currency DWRs are not. Further analysis shows that the DWRs in local currency are higher in financially closed countries but their currencies lose value, thereby resulting in the parity of DWRs in U.S. dollars across countries. More generally, a country's DWR converges faster to the global benchmark, the more financially open the country is. Taken together, our results are consistent with the notion that capital flows in such a way that the return to investors is equalized across countries and any barriers to cross-border capital flows are overcome by currency value changes.

Does Trading by ETF and Mutual Fund Investors Hurt Performance? Evidence from Time- and Dollar-Weighted Returns

This paper analyzes the “return gap” between dollar-weighted returns that account for intermediate investor flows (internal rate of return) and buy-and-hold returns that funds typically report. Our sample constitutes all US-domiciled open-end mutual funds and exchange-traded funds (ETFs), and covers both fixed income and equity funds, as well as active and index styles of management. We find that return chasing behavior explains the cross-sectional pattern of the return gap. The high turnover of liquid ETFs does not lead to sub-par returns for investors in these funds.

Further Biases in Using Dollar-Weighted Returns to Infer Investment Timing Effects

The IRR (dollar-weighted return) reflects the periodic addition or withdrawal of funds by investors, and the difference between IRR and geometric mean is widely used to indicate the impact that the timing of these flows has had on investor returns. This is a biased measure, since it is also affected by investment flows which “chase” previous strong returns. A method has previously been derived for separating this bias from genuine timing effects. This paper demonstrates that using in-sample mean returns for this decomposition causes an additional bias which again misleadingly suggests bad investor timing. This paper quantifies this bias, allowing unbiased investor timing effects to be estimated. A proper understanding of these biases is of significant practical importance, since investors are often presented with biased timing indicators based on IRRs.

Dollar-Weighted Return on Aggregate Corporate Sector: How Is It Distributed Across Countries?

This paper computes the dollar-weighted returns (DWRs) on the aggregate corporate sector in each of the 43 sample countries, and shows that the DWRs in U.S. dollars are similar across countries. In contrast, the local-currency DWRs are found to be different across countries, suggesting a role played by currency in the parity of DWRs. It turns out that countries that are financially closed have a higher DWR in local currency but a lower return on their currencies and, consequently, DWRs in U.S. dollars converge across countries. The speed of convergence in DWR (in U.S. dollars) is also related to financial openness. That is, the convergence of a country’s DWR to the global benchmark is faster, the more financially open is the country. Taken together, our results are consistent with a version of efficient international capital markets where capital flows in such a way that the marginal product of capital is equalized across countries.

Dollar-Weighted Return on Aggregate Corporate Sector: How is it Distributed Across Countries?

This paper computes the dollar-weighted returns (DWRs) on the aggregate corporate sector in each of the 43 sample countries, and shows that the DWRs in U.S. dollars are similar across countries. In contrast, the local-currency DWRs are found to be different across countries, suggesting a role played by currency in the parity of DWRs. It turns out that countries that are financially closed have a higher DWR in local currency but a lower return on their currencies and, consequently, DWRs in U.S. dollars converge across countries. The speed of convergence in DWR (in U.S. dollars) is also related to financial openness. That is, the convergence of a country’s DWR to the global benchmark is faster, the more financially open is the country. Taken together, our results are consistent with a version of efficient international capital markets where capital flows in such a way that the marginal product of capital is equalized across countries.

Timing Poorly: A Guide to Generating Poor Returns While Investing in Successful Strategies

The value premium’s persistence and magnitude run counter to the behavioral explanation of the value anomaly. How can investors continue to make the same widely recognized mistake? By examining the difference between mutual funds’ reported buy-and-hold or time-weighted returns, and the average dollar-weighted returns or IRRs end investors earn, the authors quantify the consistently negative effect of value investors’ market-timing decisions: from 1991 to 2013, value mutual fund investors underperformed the funds they invested in by 131 basis points. Their analysis also reveals that investors in growth, large-cap, and small-cap funds are similarly prone to unproductive allocation timing. They also find that less sophisticated investors tend to make poorer timing decisions. Investors who hold funds with high expense ratios had larger return gaps than those who chose less costly funds, and investors in retail funds underperformed by a greater margin than those who qualified for institutional share-class funds. The authors suggest that, by giving away the excess return, value investors themselves finance the value premium and ensure its continuance. Financial education may help individual investors refrain from trading their funds in a counterproductive fashion.

Timing Poorly: A Guide to Generating Poor Returns While Investing in Successful Strategies

The persistence and magnitude of the value premium run counter to the behavioral explanation of the value anomaly. How can investors continue to make the same widely recognized mistake? By examining the difference between mutual funds’ reported buy-and-hold or time-weighted returns and the average dollar-weighted returns or IRRs earned by end investors, we quantify the consistently negative impact of value investors’ market timing decisions: over the 1991-2013 period, value mutual fund investors underperformed the funds they invest in by 131 basis points. Our analysis also reveals that investors in growth, large cap, and small cap funds are similarly prone to unproductive allocation timing. We additionally find that less sophisticated investors tend to make poorer timing decisions: investors who hold funds with high expense ratios had larger return gaps than those who chose less costly funds, and investors in retail funds underperformed by a greater margin than those who qualified for institutional share class funds. We suggest that, by giving away the excess return, value investors themselves finance the value premium and ensure its continuance. Financial education may help individual investors refrain from trading their funds in a counterproductive fashion.

Are target date funds the easy bake option?

Target date funds provide a simple, automated approach to retirement savings in defined contribution plans. The passing of the Pension Protection Act of 2006 has seen an increase in the popularity of these funds in the United States, becoming the default option for many plans. However, recent research findings have challenged the easy bake or ‘set-and-forget’ nature of target date funds. This study explores some of the critical design features of target date funds (which shifts an individual’s asset allocation from growth to defensive assets following a pre-set glidepath) against a simple balanced (or target risk) fund design. Using both time-weighted and dollar-weighted returns, our results suggest that there is more to achieving successful retirement outcomes than the investor simply selecting a proposed year of retirement. Our findings can perhaps be summarized by Einstein’s famous epithet, that in the murky world of retirement product design, everything should be made as simple as possible, but not simpler.

How to Evaluate the Share Price Performance During CEO Tenure: The Case of Josef Ackermann’s Stewardship at Deutsche Bank

This clinical paper gives guidance on how to correctly compute and evaluate the share price performance of a corporation during a specific CEO tenure. Although the emphasis is on Deutsche Bank’s share price performance between 2002 and 2012, a lot of general questions relevant for this kind of assessment are tackled as well. For instance it is shown that currency adjustments are essential when comparing global companies if their shares are listed in different currency areas. In addition, the differences of dollar-weighted versus time-weighted returns for peer groups during consecutive observation periods are discussed.At Deutsche Bank’s AGM at the end of May 2012, the CEO tenure of Josef Ackermann officially ended after ten years in office. During his stewardship, Deutsche Bank established itself in the bulge bracket of investment banking and was one of the few global banks which survived the financial crisis without any direct government support. Whether his regime was successful for shareholders is controversial. It is shown that in spite of the fact that Deutsche Bank’s original share price performance during Ackermann’s stewardship has been negative by −50 %; it significantly outperformed other German financial institutions, international sector indices or hand-selected investment banking peer groups. However, it is not clear if this relative outperformance is solely attributable to Ackermann’s and his board members’ management capabilities or perhaps a result of implicit guarantees by the German government.Moreover, share price performance figures published by Deutsche Bank are reviewed. It turns out that some figures overstate the real performance. The same is true for e.g. Morgan Stanley’s performance graph in its latest 10-K report. This finally raises the question, how reliable share price performance figures presented by companies are. This is important for the ongoing pay-for-performance discussion because already the underlying data of share price performance could be biased.

Timing of Retirement Plan Contributions and Investment Returns: The Case of Defined Benefit versus Defined Contribution

Abstract This paper examines the impact of the timing of contributions to defined benefit (DB) and defined contribution (DC) plans on investment returns. I show that net contributions to DB plans are counter-cyclical, while net contributions to DC plans are uncorrelated with the business cycle. Given the past mean reversion in equity prices, the counter-cyclicality of net contributions to DB plans means that dollar-weighted returns on DB plans are higher than the geometric average of annual returns. Therefore, using dollar-weighted returns as a measure of investment performance, the advantage of DB plans over DC plans is greater than using geometric average returns. Overall, I find that dollar-weighted returns on DB plans are more than one percentage point higher than that on DC plans.

Building a Better Mousetrap: Enhanced Dollar-Cost Averaging

This article presents a simple, intuitive investment strategy that improves upon the popular dollar-cost-averaging (DCA) approach. The investment strategy, called enhanced dollarcost-averaging (EDCA), is a simple, rule-based strategy that retains most of the attributes of traditional DCA that are appealing to most investors yet adjusts to new information, which traditional DCA does not. Simulation results show that the EDCA strategy reliably outperforms the DCA strategy in terms of higher dollar-weighted returns about 90% of the time and nearly always delivers greater terminal wealth for reasonable values of the risk premium. EDCA is most effective when applied to high-volatility assets, when cash flows are highly sensitive to past returns, and during secular bear markets. Historical back-testing on equity indexes and mutual funds indicates that investor dollar-weighted returns can be enhanced by between 30 and 70 basis points a year simply by switching from DCA to EDCA. <b>TOPICS:</b>Portfolio construction, mutual funds/passive investing/indexing, performance measurement

The Impact of Timing of Retirement Plan Contributions on Investment Returns

This paper examines the impact of the timing of contributions to defined benefit (DB) and defined contribution (DC) plans on investment returns. I show that net contributions to DB plans are counter-cyclical, while net contributions to DC plans are uncorrelated with the business cycle. The counter-cyclicality of net contributions to DB plans means that dollar-weighted returns on DB plans are higher than the geometric average of annual returns. Therefore, using dollar-weighted returns as a measure of investment performance, the advantage of DB plans over DC plans is greater than using geometric average returns. Overall, I find that dollar-weighted returns on DB plans are more than one percentage point higher than that on DC plans.

Higher risk, lower returns: What hedge fund investors really earn

The returns of hedge fund investors depend not only on the returns of the funds they hold but also on the timing and magnitude of their capital flows in and out of these funds. We use dollar-weighted returns (a form of Internal Rate of Return (IRR)) to assess the properties of actual investor returns on hedge funds and compare them to buy-and-hold fund returns. Our main finding is that annualized dollar-weighted returns are on the magnitude of 3% to 7% lower than corresponding buy-and-hold fund returns. Using factor models of risk and the estimated dollar-weighted performance gap, we find that the real alpha of hedge fund investors is close to zero. In absolute terms, dollar-weighted returns are reliably lower than the return on the Standard & Poor's (S&P) 500 index, and are only marginally higher than the risk-free rate as of the end of 2008. The combined impression from these results is that the return experience of hedge fund investors is much worse than previously thought.

Building a Better Mousetrap: Enhanced Dollar Cost Averaging

This paper presents a simple, intuitive investment strategy that improves upon the popular dollar-cost-averaging (DCA) approach. The investment strategy, which we call enhanced dollar-cost-averaging (EDCA), is a simple, rule-based strategy that retains most of the attributes of traditional DCA that are appealing to most investors but yet adjusts to new information, which traditional DCA does not. Simulation results show that the EDCA strategy reliably outperforms the DCA strategy in terms of higher dollar-weighted returns about 90% of the time and nearly always delivers greater terminal wealth for reasonable values of the risk premium. EDCA is most effective when applied to high volatility assets, when cash flows are highly sensitive to past returns, and during secular bear markets. Historical back-testing on equity indexes and mutual funds indicates that investor dollar-weighted returns can be enhanced by between 30 and 70 basis points per year simply by switching from DCA to EDCA.

Measuring Investors' Historical Returns: Hindsight Bias in Dollar-Weighted Returns

A growing number of studies use dollar-weighted returns as evidence that consistently bad timing substantially reduces investor returns, and that consequently the equity risk premium must be considerably lower than previously thought. These studies measure the impact of bad timing as the difference between the geometric mean return (corresponding to a buy-and-hold strategy) and the dollar-weighted return. However, the present paper demonstrates that this differential combines two distinct effects: The correlation of investor cashflows with (i) future asset returns, and (ii) past asset returns. Both correlations tend to alter the dollar-weighted return, but only the first affects investors’ expected wealth. The second generates a hindsight bias. This paper also derives a method which separates these two effects. The results show that the great majority of the return differential for mainstream US equities has been due to hindsight bias, and very little due to bad investor timing. Dollar-weighted returns have been low because aggregate investment flows reflect past returns rather than future returns, and these low returns should not lead us to adopt correspondingly low estimates of the risk premium. The decomposition method which is derived here also has many applications in other fields where dollar-weighted returns are used, such as project finance and investment management.

Capacity and factor timing effects in active portfoliomanagement

Capacity constraints limit the profits of some investment strategies, while other strategies are more scalable. We develop a dollar-weighted return measure that parses the factor timing by investors and a strategy’s capacity constraints. We find that actively managed funds exhibit significant capacity and timing effects, while index funds display only timing effects. A portfolio’s liquidity, investment style, and distribution policy are important in explaining variation in capacity constraints. The analysis demonstrates that capacity and timing effects are important in analyzing portfolio manager skill and the cost of active investing.

Capacity and Factor Timing Effects in Active Portfolio Management

Capacity constraints limit the profits of some investment strategies, while other strategies are more scalable. We develop a dollar-weighted return measure that parses the factor timing by investors and a strategy’s capacity constraints. We find that actively managed funds exhibit significant capacity and timing effects, while index funds display only timing effects. A portfolio’s liquidity, investment style, and distribution policy are important in explaining variation in capacity constraints. The analysis demonstrates that capacity and timing effects are important in analyzing portfolio manager skill and the cost of active investing.

Dollar-Weighted Returns to Stock Investors: A New Look at the Evidence

Dollar-Weighted Returns to Stock Investors: A New Look at the Evidence

Higher Risk, Lower Returns: What Hedge Fund Investors Really Earn

The returns of hedge fund investors depend not only on the returns of the funds they hold but also on the timing and magnitude of their capital flows in and out of these funds. We use dollar-weighted returns (a form of IRR) to assess the properties of actual investor returns on hedge funds and compare them to buy-and-hold fund returns. Our main finding is that annualized dollar-weighted returns are on the magnitude of 3 to 7 percent lower than corresponding buy-and-hold fund returns. Using factor models of risk and the estimated dollar-weighted performance gap, we find that the real alpha of hedge fund investors is close to zero. In absolute terms, dollar-weighted returns are reliably lower than the return on the S&P 500 index, and are only marginally higher than the risk-free rate as of the end of 2008. The combined impression from these results is that the return experience of hedge fund investors is much worse than previously thought.

Dollar-Weighted Returns to Stock Investors: A New Look at the Evidence

Dichev (2007, American Economic Review), in an influential paper, examines the gap between the performance of major stock markets and the dollar-weighted performance of investors in these markets. He finds a significant gap of 1.3 percent per year for NYSE/AMEX and 1.5 percent internationally. We question these results. The NYSE/AMEX performance gap is actually negative in the last two thirds of Dichev's 1926-2002 period, while his international results are influenced by a dramatic increase in Datastream's coverage. When, instead of Datastream, we use a comprehensive share price database, the U.K. performance gap changes from 1.1 to -1.3 percent. In short, Dichev's findings are not robust.