New regulations have come to Canada, which will require more clarity and disclosure of investor fees and performance. Before I dive into understanding how your performance is calculated, we need to understand why this conversation has come about. So let me me give a quick outline on Client Relationship Model 2 (CRM2) and why the regulators have introduced it. CRM2 is a new set of requirements the Canadian Securities Administrators have implemented to ensure investors receive proper information about their costs and performance reporting. Before CRM2 performance wasn’t reported with the client in mind and fees were not disclosed to clients, directly affecting the clients’ performance and client having no idea if fees even existed. So all in all CRM2 is a very good thing. Regulators are trying to make it much more transparent and accurate for clients and it also levels the playing field for everyone, as some have always disclosed their fees. My guess is that you will see a lot of investors questioning their advisors on the value of their service once they can see the true costs of the advice they are getting. But that’s for another blog, on to rates of returns!
In the past it has been standard for Canadian investment firms to report rates returns as ‘time-weighted’. With the introduction of the CRM2, firms are now required to report their returns as ‘money-weighted’. As an investor, do you really care about all this mumbo jumbo? You likely just want to know how much money your advisor is making you. Turns out rates of returns aren’t always as straightforward as they appear.
TIME-WEIGHTED RETURNS VS. MONEY-RATED RETURNS
The timing of cash flows such as contributions, transfers or withdrawals can affect your portfolio’s return. While the time-weighted method of calculating returns will exclude the effect of these cash flows, the money-weighted method will include them. If there are no cash flows both methods should report the same return.
Up until the beginning of 2017 majority investor returns were calculated using the time-weighted method. The reason this was a problem was because in most accounts, people are contributing or withdrawing on a regular basis. For the return calculation to not account for this can leave investors with a skewed return number that doesn’t actually reflect their advisor’s performance. So rightfully, the regulators realized that this was not a good way to report returns for clients. The time-weighted method is better suited for reporting returns on market indices or mutual funds as they won’t have the same cash flow issues that an investors accounts will have.
In contrast to the time-weighted method, the money-weighted method accounts for the impact of contributions, withdrawals or transfers and weights their impact on the portfolio proportionally. This calculation is much more suitable for assessing an investor’s personal performance relative to their financial plans and projections allowing them to get a full understanding of their returns and better understand what they need to do to achieve their goals.
For more information on time and money-weighted returns and their effects on a portfolio check out the table below.