I'm in Toronto for a couple days teaching a performance class for a client. And, as often happens, a thought occurred that seemed interesting.Peter Dietz introduced the "original Dietz formula" in 1966, which treats cash flows as occurring mid-period; this was adjusted several years later to day-weight the flows (what has become known as the "Modified Dietz Formula"). Why didn't he introduce this earlier?
Also, in 1968 the Bank Administration Institute pointed out that the Exact Method (where we revalue portfolios whenever flows occur) is the best approach to time-weighting. And so why didn't they encourage firms to use it sooner?
In both cases the answer is the same: technology. In 1966 and 1968 we didn't have personal computers, spreadsheets, or even calculators. No doubt many folks calculated returns by hand (math by hand? perish the thought!). To do a mid-point method is pretty simple by hand but to add day-weighting could complicate the process quite a bit.
And to use the Exact method would have required access to daily prices: in the mid '60s? Right! Forget about it!
Makes sense, yes?
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What do you need inorder to have a more precise return: 1) calculation method, 2) underline data, or 3) none of the above.
ReplyDeleteThe answer: 3) none of the above. There is no such thing as precise or correct return method. The return number is a normalized value. With different calculation methods, the result would be different.
Concerning underline data, the custodian and internal accounting is constantly changing. Thus, the portfolio values will be change from retroactive and repostment activities.
Yes, when the accounting data changes, the market value changes as well. Which will you see more changes to: the market value or return number?
Why bother to search and find accuracy and/or precision when all you need to know is your market value. The market value is your true wealth.