At first glance, the task of measuring investment returns of corporate cash portfolios seems relatively straightforward, since they most typically invest only in “plain vanilla” securities and have limited numbers of transactions. Treasury practitioners, however, often tell a different tale of performance measurement. One frequent complaint involves apples-to-oranges performance comparisons between money managers. Another involves the difficulty of estimating coupon yields. And still others complain about the lack of appropriate benchmarks for buy-and-hold portfolios.
This state of confusion often derives from the fact that there are both apples and oranges in the investment performance world, otherwise known as market value returns and book value returns. While investors often have some understanding of the former since it is the way most stock and bond portfolios are measured, the concept of returns based on adjusted book value is typically known only in such limited circles as money market fund managers, government investment pool investors, and insurance companies. Until one understands the different concepts and their proper applications, meaningful interpretation of performance records can be difficult. This paper attempts to help investors gain a glimpse into the complex world of performance measurement with a brief overview of the two types of return methodologies and their applications to cash portfolios.
Market Value Returns (MVR)
MVR are sometimes called total returns as they measure returns from both the income and principal components of a security. They are also frequently referred to as “marked-to-market” returns as they are computed with the value of investments using prevailing market prices.
For a single reporting period, the basic MVR calculation formula is: “(End Market Value + Income Earned) / Beginning Market Value.” The “modified Dietz” method assigns a time weighting factor to intra-period transactions and removes “noise” created by noninvestment activities. Using a compounded return formula, monthly returns are chain-linked to arrive at quarterly and annual returns.
The CFA Institute establishes and interprets the Global Investment Performance Standards (GIPS). GIPS are standards specifically designed to provide a standardized way investment advisors report composite returns which will allow a perspective investor to make an apples-to-apples MVR performance comparison.
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