Jim, an investment manager with Smith, Kleen & Associates, is in the process of determining the annualized return for a client portfolio. Jim uses a specific three- step process to determine this annualized return, which is detailed as follows:
Step 1:
Jim prices the portfolio immediately prior to any significant addition or withdrawal of funds. The portfolio is broken into specific subperiods based on the dates of cash inflows and outflows. The product of the subperiods is 10 years.
Step 2:
Jim calculates the holding period return of the portfolio for each subperiod.
Step 3:
Jim calculates the geometric mean of the annual returns. This calculation is used as the annual portfolio return measure.
Which of the following best describes the final calculation produced by Jim?
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A. B. C. D. E. F.B
The process illustrated in this example is the calculation of the time-weighted rate of return. This method of calculating portfolio returns is superior in many respects to the dollar-weighted rate of return, which is also known as the IRR. The reason for this relative superiority is the fact that the time-weighted rate of return is not sensitive to portfolio additions or withdrawals. So said, the time-weighted rate of return is more popular in the field of investment management.
While "annualized holding period return" is a tempting choice, it does not represent the best possible answer. "Geometrical rate of return" could refer to several return measures, but not the time-weighted rate of return.