Working in the retirement fund industry, it is often surprising how little Trustees or Management Committees understand about investment returns.

The industry standard is for asset managers to use time-weighted returns when publishing factsheets. But, what does this mean? Simply put, time-weighted returns measure the return or rate of growth of an investment over a specific time period. Time-weighted returns do not consider the impact of the timing of cash flows (whether these are contributions or withdrawals) on investment returns i.e. they simply detail the increase or decrease in the price of a security. The rationale is that asset managers cannot control cash flows – when and how much you add or withdraw – and therefore by eliminating these distorting effects, this is the best measure to use when evaluating or assessing the performance of an asset manager / portfolio manager.

In addition, returns for periods are often annualised to show the geometric average return earned each year over the specified time period.

What does this mean? Let’s look at the following simple example in Table 1:

Assume you are 35 years old and have saved an amount of R500,000 in your retirement fund and you leave these savings in a preservation fund for another 20 years. Using fictitious returns, the value of your savings could increase or decrease as follows:

Returns – Reality vs. Reality Table

What is your time-weighted return at age 55 (20 years later) in the above example? This is simply your growth on the initial R500,000. i.e.:

Returns – Reality vs. Reality Graphic

Now let’s annualise this return over 20 years, i.e. find a single consistent rate of return which would lead to the same outcome. This is shown in the grey columns in Table 2 below:

Returns – Reality vs. Reality table 2

The above example illustrates that an annualized return of 4.76% per year would result in the same end value.. Simplistically put, the annualised return gives you the ‘average’ return of all the highs and lows.

What is interesting to note when evaluating the returns in Table 1 is that there are periods with negative return while in Table 2 the annualised return is consistently positive. Even though the final outcome is exactly the same, the Value of Savings A and Savings B can vary substantially at different ages or points in time. The above begins to illustrate why members of retirement funds are often sceptical about the ‘reported’ performance of investment portfolios as their time invested is often not the same as the reported annualised period.

The way in which returns are calculated and reported is not the only reason why members’ experience may be different to ‘reported’ returns. Consider the following simple example:

Let member A and member B both have R1,000 invested in their pension fund on 1 January and the fund returns 10% in January.  Therefore, at the end of January both members will have R1,100.

Returns – Reality vs. Reality table 3

On 1 February, member A makes a lump sum contribution of R100,000 and member B makes no contribution.  Assume that the fund returns 5% in February.

Returns – Reality vs. Reality Table 4

Calculating member A and member B’s return can be done as follows:

Returns – Reality vs. Reality table 7

Member A and B had the same fund returns for each month (10% in Jan and 5% in Feb), but their actual returns are different!

You will see that member A has an individual return quite close to the return of the fund in February.  This is because the member had much more money invested in February than January, so the return is weighted towards February. This is referred to as the money weighted return.

As stated earlier, time-weighted returns, which the industry uses as a standard does not consider the impact of cash flows (contributions or withdrawals) for individual members and concomitantly, this is the reason why a member’s actual returns may be different to the reported returns.

One must take cognisance of the fact that the returns are not reported incorrectly but rather the lack of education and understanding must be addressed through effective knowledge transfer.

For more information please contact Jonathan Lau on +27 11 305 1949 or